FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2004
Commission file number 1-5318
KENNAMETAL INC.
World Headquarters1600 Technology WayP.O. Box 231Latrobe, Pennsylvania 15650-0231(Address of registrant’s principal executive offices)
Website: www.kennametal.com
Registrant’s telephone number, including area code: (724) 539-5000
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ]
Indicate by check mark whether the registrant is an accelerated filer (as defined by Rule 12b-2 of the Exchange Act). YES [X] NO [ ]
Indicate the number of shares outstanding of each of the issuer’s classes of capital stock, as of the latest practicable date:
KENNAMETAL INC.FORM 10-QFOR THE QUARTER ENDED MARCH 31, 2004
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
The accompanying notes are an integral part of these condensed consolidated financial statements.
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KENNAMETAL INC.NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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RESULTS OF OPERATIONS
This Form 10-Q contains “forward-looking” statements within the meaning of Section 21E of the Securities Exchange Act of 1934. You can identify these forward-looking statements by the fact they use words such as “should,” “anticipate,” “estimate,” “approximate,” “expect,” “may,” “will,” “project,” “intend,” “plan,” “believe” and other words of similar meaning and expression in connection with any discussion of future operating or financial performance. One can also identify forward-looking statements by the fact that they do not relate strictly to historical or current facts. These statements are likely to relate to, among other things, our goals, plans and projections regarding our financial position, results of operations, cash flows, market position and product development, which are based on current expectations that involve inherent risks and uncertainities, including factors that could delay, divert or change any of them in the next several years. Although it is not possible to predict or identify all factors, they may include the following: global economic conditions; future terrorist attacks; epidemics; risks associated with integrating and divesting businesses and achieving the expected savings and synergies; demands on management resources; risks associated with international markets such as currency exchange rates, and social and political environments; competition; labor relations; commodity prices; demand for and market acceptance of new and existing products, and risks associated with the implementation of restructuring plans and environmental remediation matters. We can give no assurance that any goal or plan set forth in forward-looking statements can be achieved and readers are cautioned not to place undue reliance on such statements, which speak only as of the date made. We undertake no obligation to release publicly any revisions to forward-looking statements as a result of future events or developments.
SALES
Sales for the quarter ended March 31, 2004 were $524.2 million, an increase of $65.0 million or 14.2 percent from $459.2 million in the prior year. The increase in sales is primarily attributed to 6.4 percent in organic growth, principally in North America and developing markets, and favorable foreign currency effects of 5.9 percent.
Sales for the nine months ended March 31, 2004 were $1,429.6 million, an increase of $134.4 million or 10.4 percent from $1,295.2 million in the prior year. The increase in sales is primarily attributed to a 5.2 percent favorable foreign currency effect and 2.6 percent improvement from the Widia acquisition, as well as 1.9 percent improvement in organic sales growth, principally in North America, offset in part by persistent weakness in our European markets.
GROSS PROFIT
Gross profit for the quarter increased $24.2 million, or 16.0 percent compared to the prior year. The increase in gross profit is primarily attributed to favorable foreign currency effects of $13.2 million, coupled with $12.2 million from improved sales volumes and $4.5 million from improved production efficiencies during the current quarter. In addition, gross margins in the current quarter improved by $4.2 million as a result of a previously announced change in the estimated useful lives of existing Kennametal machinery and equipment, partially reduced by increased depreciation related to Widia fixed assets. These benefits were partially offset by $5.3 million in price pressures and unfavorable product mix shifts, coupled with $3.9 million in higher raw material costs incurred in the current quarter. We believe these costs will remain at higher levels through at least the end of the current fiscal year.
Gross profit margin for the quarter ended March 31, 2004 increased from 33.0 percent last year to 33.5 percent in the current quarter. The gross profit margin benefited 0.7 percent from favorable foreign currency effects, 0.8 percent from the depreciation policy change and 0.9 percent from improved production efficiencies. Such benefits were partially offset by pricing pressures and unfavorable product mix shifts, coupled with higher raw material costs, which negatively impacted gross margins by 1.0 percent and 0.7 percent, respectively, in the current quarter.
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Gross profit for the nine months ended March 31, 2004 was $467.6 million, an increase of $47.5 million over the same period a year ago. Owning Widia for two additional months in the current period accounted for $9.9 million of the increase. A favorable foreign currency effect of $33.3 million, coupled with the improvements in sales and production volumes in the current period totaling $13.7 million and the $11.0 million favorable impact of the fixed asset depreciation policy change also contributed to the increase. These benefits were partially offset by $10.3 million of pricing pressures and unfavorable product mix shifts, $6.4 million in higher raw material prices and increased pension costs of $4.3 million in the current period.
Gross profit margin for the nine months ended March 31, 2004 increased slightly from 32.4 percent to 32.7 percent. The gross profit margin benefited 0.7 percent from favorable foreign currency effects and 0.8 percent from the depreciation policy change. Such benefits were partially offset by pricing pressures and unfavorable product mix shifts of 0.7 percent, higher raw material costs of 0.4 percent and increased pension costs of 0.3 percent in the current period.
BENEFIT AMENDMENTS
As discussed in the notes to condensed consolidated financial statements (Note 7) we have amended certain employee benefits effective January 1, 2004. The curtailment of the RIP Plan resulted in a pre-tax charge in the fiscal 2004 second quarter of $1.3 million. As a result of this amendment, total pension costs for fiscal 2004 (excluding the effects of the curtailment) are expected to be $9.3 million versus $13.3 million originally expected for fiscal 2004. Contributions to the Thrift Plus Plan are expected to total $1.8 million for fiscal 2004, with such contributions beginning on January 1, 2004. Additionally, as a result of the amendment to the Company’s OPEB plan, total OPEB expense for fiscal 2004 is expected to be $1.2 million versus $4.4 million originally expected for fiscal 2004.
OPERATING EXPENSE
Operating expenses for the quarter ended March 31, 2004 were $132.2 million, an increase of $9.6 million, or 7.8 percent, compared to $122.6 million of a year ago. The increase in operating expense is attributed to unfavorable foreign currency effects of $7.2 million and $2.6 million related to increased employee benefit costs.
Operating expenses for the nine months ended March 31, 2004 were $378.2 million, an increase of $35.1 million, or 10.2 percent, compared to $343.1 million in the prior year. The increase in operating expense is attributed to $19.4 million of unfavorable foreign currency effects, $8.4 million related to two additional months ownership of Widia, $7.3 million related to increased employee benefit costs and a charge of $1.8 million related to a note receivable from a previous divestiture of a business.
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RESTRUCTURING AND ASSET IMPAIRMENT CHARGE
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INTEREST EXPENSE
Interest expense for the quarter ended March 31, 2004 declined 29.5 percent to $6.3 million from $9.0 million a year ago. The decrease in interest expense is due to total debt, including capital leases and notes payable, declining from $580.1 million at March 31, 2003 to $494.3 million at March 31, 2004. Additionally, the average borrowing rate for the quarter decreased from 5.2 percent in 2003 to 4.4 percent in 2004. The decrease in the average borrowing rate is due to the decline in market interest rates and an increase in the percentage of our debt subject to floating rates of interest.
For the nine months ended March 31, 2004, interest expense decreased $7.6 million, or 28.0 percent from $27.1 million to $19.5 million. The decrease is attributed to the factors listed above. As of March 31, 2003, 63.6 percent of our debt was subject to variable rates of interest compared to 65.3 percent of our debt at March 31, 2004.
OTHER EXPENSE (INCOME), NET
Other expense for the quarter ended March 31, 2004 decreased $0.2 million from $0.7 million in 2003 to $0.5 million in 2004. No material items were noted.
For the nine months ended March 31, 2004, other income increased $1.6 million from $0.4 million in 2003 to $2.0 million in 2004. The increase is a result of a $4.4 million pre-tax gain related to the sale of our investment in Toshiba Tungaloy. The other significant component is the increase in foreign exchange losses of $3.4 million versus last year. Other expenses for the nine months ended March 31, 2004 and 2003 included fees of $1.2 million and $1.5 million, respectively, related to the accounts receivable securitization program.
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INCOME TAXES
The effective tax rate for both the quarter and nine months ended March 31, 2004 was 32 percent versus 30 percent for the comparable periods a year ago. Our effective tax rate differs from the statutory rate primarily due to international tax planning initiatives. During the quarter ended March 31, 2004, we substantially completed certain reviews being conducted by various tax authorities, the net effect of which was not material to our financial statements.
In December 2003, the German Parliament adopted a substantial part of the government’s 2004 tax package. The major provisions of this tax law change are effective for Kennametal’s fiscal 2005. The law changes are not expected to have a material impact on the Company’s global effective tax rate for fiscal 2004. These changes, without any action by the Company, would have a material impact on the Company’s global effective tax rate beginning in fiscal 2005.
The Company continues to review our international tax planning initiatives in an effort to optimize its overall global effective tax rate.
NET INCOME
Net income for the quarter ended March 31, 2004 was $24.1 million, or $0.66 per diluted share, compared to $9.7 million, or $0.27 per diluted share, in the same quarter last year. The increase in earnings is primarily attributable to organic sales growth, cost containment, a decrease in restructuring cost, favorable foreign currency translation effects and the Widia acquisition, which included efficiencies derived from the integration with Kennametal operations. These improvements were offset, in part, by increased pricing pressure and unfavorable product mix shifts, higher raw material costs and increased employee benefit costs in the current quarter.
Net income for the nine months ended March 31, 2004, increased $20.7 million, or 90.0 percent, from $23.0 million, or $0.65 per diluted share, in 2003 to $43.7 million, or $1.20 per diluted share, in 2004. The increase is primarily attributed to the factors listed above.
METALWORKING SOLUTIONS & SERVICES GROUP
MSSG sales increased 10.8 percent or $30.9 million compared to the March 2003 quarter. The increase in sales is attributed primarily to $22.6 million of favorable foreign currency effects and $8.3 million in organic sales growth. In Metalworking North America, sales were up 8.8 percent compared to the prior year due to organic sales growth and favorable foreign currency effects. Metalworking Europe sales increased 11.2 percent, due to favorable foreign currency effects, partially offset by overall weakness in Europe. Asia Pacific and India increased sales by 29.4 percent and 33.2 percent, respectively, attributed to strength in the automotive sector and favorable foreign currency effects. South America also delivered sales growth of 26.9 percent, due to favorable economic conditions, market share growth and foreign currency effects.
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Operating income of $36.8 million was up $13.2 million compared to $23.6 million last year. Operating income benefited from organic sales growth, coupled with a reduction in restructuring and integration costs of $3.0 million, reduced depreciation expense resulting from the extension of useful lives, integration benefits and favorable foreign currency effects, offset by an increase in raw material costs, pricing pressure and unfavorable product mix shifts and higher benefit costs.
For the nine months ended March 31, 2004, MSSG sales increased $75.3 million or 9.4 percent compared to the same period last year. Most of this increase was associated with the Widia acquisition, which contributed a year-over-year increase of $26.0 million in net sales during the nine month period and favorable foreign currency effects of $54.7 million. The prior year includes seven months of Widia sales, whereas the current year includes nine months of sales.
Operating income was $82.9 million, an increase of $18.3 million compared to $64.6 million last year. The increase in operating income is due to the factors mentioned above.
ADVANCED MATERIALS SOLUTIONS GROUP
AMSG sales increased 24.1 percent or $21.6 million from the quarter ended March 31, 2003. The increase in sales is attributed to overall growth in the Mining and Construction and Energy divisions, as well as favorable foreign currency effects in the current quarter of $4.6 million and the addition of Conforma Clad. Mining and Construction had a 29.9 percent increase in revenue due to a continued recovery in mining, market penetration in construction and favorable foreign currency effects. The Energy Products Group experienced strong growth of 25.9 percent year-over-year due to increased activity in oil and gas exploration. Electronics sales were up 14.7 percent, while Engineered Products sales were up 9.5 percent.
Operating income was $15.1 million, an increase of $5.8 million, over the prior year. The increase is attributed to sales growth, including the addition of Conforma Clad, reduced depreciation expense due to the change in estimated lives, favorable foreign currency effects, a reduction in restructuring costs and cost reduction programs.
For the nine months ended March 31, 2004, AMSG sales increased $43.3 million or 16.9 percent compared to the same period last year. The increase in sales is attributed to strong growth in the Energy Products and Mining and Construction divisions, the positive benefits of $5.5 million from the Widia acquisition and $14.3 million of favorable foreign currency effects.
Operating income increased $9.3 million to $36.4 million due primarily to the factors mentioned above.
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J&L INDUSTRIAL SUPPLY
J&L sales increased $8.3 million or 16.1 percent compared to the quarter ended March 31, 2003. The increase in sales is primarily attributable to volume growth of $7.5 million and favorable foreign exchange currency effects of $0.8 million. Operating income was $6.4 million compared to $1.3 million in the prior year. The increase in operating income is a result of the improvement in sales growth, coupled with cost containment, benefits from prior restructuring programs and favorable currency effects.
For the nine months ended March 31, 2004, J&L sales increased 7.1 percent compared to last year. The increase in sales is attributed to volume growth of $9.1 million and favorable foreign exchange currency effects of $1.5 million. Operating income was $13.4 million, compared to $5.2 million in the prior year. The increase in operating income is a result of the improvement in sales growth, coupled with cost containment, benefits from prior restructuring programs and favorable currency effects.
FULL SERVICE SUPPLY
FSS sales increased $4.1 million compared to the prior year quarter. The increase in sales is primarily associated with volume growth. The volume growth is attributed to new contracts obtained during the current year. Operating income improved to $0.4 million in the current quarter on the improved sales volume.
Compared to the same period last year, FSS sales increased $5.3 million or 5.6 percent for the nine months ended March 31, 2004, largely on the strength of improved sales in the current quarter. For the nine month period, the operating loss improved slightly to $0.1 million from $0.3 million last year, with improvement due primarily to the stronger sales performance in the current quarter.
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CORPORATE AND ELIMINATIONS
Corporate and eliminations represents corporate shared service costs, certain employee benefit costs and eliminations of operating results between segments. For the three months ended March 31, 2004, the operating expense increased $6.0 million or 62.2 percent. The increase is attributed to an increase in employee benefit expenses.
For the nine months ended March 31, 2004, the operating expense has increased $14.0 million or 40.6 percent. The increase is attributed to the same factors listed above, couple with a $1.8 million charge recorded in our fiscal second quarter related to a note receivable from the divestiture of a company previously owned by Kennametal.
LIQUIDITY AND CAPITAL RESOURCES
Our cash flow from operations is the primary source of financing for capital expenditures and internal growth. During the nine months ended March 31, 2004, we generated $109.5 million in cash flow from operations, a decrease of $4.7 million, or 4.1 percent compared to a year-ago. Net income plus non-cash items improved $15.0 million to $107.9 million versus $92.9 million in last year’s comparable period. This improvement was completely offset by a $19.8 million net cash outflow from changes in operating working capital items. A $25.6 million net increase in income tax payments was partially offset by a $4.6 million net reduction in interest payments. Income tax and interest payments during nine months ended March 31, 2004 totaled $26.4 million and $14.4 million, respectively.
As previously discussed, we have incurred all costs associated with our restructuring and integration programs. The remaining cash payments of $15.4 million are primarily expected to be paid by June 30, 2004, except certain lease and severance costs which will extend into fiscal 2005.
Net cash used for investing activities was $71.9 million, a decrease of $133.6 million compared to $205.4 million in the year-ago period. The change is due primarily to a $100.9 million reduction in spending on acquisitions. Last year’s total includes $165.5 million related to the Widia acquisition, while this year’s total includes $64.6 million related to the Conforma Clad acquisition. The remaining change is due primarily to receiving $17.4 million in proceeds from the sale of our investment in Toshiba Tungaloy and $12.3 million from the sale of our Mining and Construction business in India, both of which occurred in the current year-to-date period. Capital expenditures remained flat at approximately $36.1 million. We have projected our capital expenditures for 2004 to be $50 to $55 million and will be primarily used to support new strategic initiatives, new products and to upgrade machinery and equipment. We believe this level of capital spending is sufficient to maintain competitiveness and improve productivity.
Net cash used for financing activities was $29.0 million, compared to a cash inflow of $95.0 million in the same period last year. This decrease is due to the absence of incremental borrowings required to finance the Widia acquisition of $185.3 million, partially offset by decreases in repayments on our line of credit and notes. As of March 31, 2004, we were in compliance with all debt covenants.
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On July 3, 2003, the Company entered into a new three-year securitization program (“2003 Securitization Program”) which permitted us to securitize up to $100.0 million of accounts receivable. The 2003 Securitization Program was amended on September 19, 2003, permitting the Company to securitize up to $125 million of accounts receivable. The 2003 Securitization Program provides for a co-purchase arrangement with Falcon Asset Securitization Corporation and Victory Receivables Corporation, whereby the two financial institutions participate in the purchase of the Company’s accounts receivable. As of March 31, 2004, the Company had securitized $108.9 million in accounts receivable.
Total debt, including notes payable and capital leases, decreased from $525.7 million at June 30, 2003 to $494.3 million at March 31, 2004. The decrease in total debt is related to net operating cash flow after investing activities being utilized to reduce total debt.
FINANCIAL CONDITION
Total assets were $1,886.1 million at March 31, 2004, compared to $1,813.9 million at June 30, 2003. Working capital was $447.2 million, up slightly from $446.0 million at June 30, 2003. Total liabilities declined $13.8 million from June 30, 2003 to $1,059.6 million, primarily due to a reduction in long-term debt, partially offset by increased pension obligations. Stockholders’ equity increased $88.3 million to $809.9 million primarily as a result of net income of $43.7 million and a reduction in accumulated other comprehensive loss of $31.7 million.
There have been no material changes in our contractual obligations and commitments since June 30, 2003.
RECENTLY ISSUED ACCOUNTING STANDARDS
The Company adopted FASB Interpretation No. 46R (“FIN 46”), “Consolidation of Variable Interest Entities,” for the quarter ended March 31, 2004. FIN 46 clarifies the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” relating to consolidation of certain entities. First, FIN 46 requires identification of the Company’s participation in variable interests entities (“VIE”), which are defined as entities with a level of invested equity that is not sufficient to fund future activities to permit them to operate on a standalone basis, or whose equity holders lack certain characteristics of a controlling financial interest. Then, for entities identified as VIE, FIN 46 sets forth a model to evaluate potential consolidation based on an assessment of which party to the VIE, if any, bears a majority of the exposure to its expected losses, or stands to gain from a majority of its expected returns. FIN 46 also sets forth certain disclosures regarding interests in VIE that are deemed significant, even if consolidation is not required. The adoption of FIN 46 did not have any impact on the consolidated financial statements of the Company.
During the quarter ended March 31, 2004, the Company adopted SFAS No. 132 R (revised 2003), “Employers’ Disclosures about Pensions and Other Postretirement Benefits,” an amendment of FASB Statements No. 87, 88 and 106 and a revision of FASB Statement No. 132. This statement requires additional disclosure about the assets, obligations, cash flow and net periodic benefit cost of defined benefit pension plans and other post retirement benefit plans. Finally, this statement also requires interim disclosure of the net periodic benefit cost and actual or expected employer contributions. The Company provided the required interim disclosures in Note 7 to these condensed consolidated financial statements.
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In January 2004, the FASB issued Staff Position No. 106-1 “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (“FSP 106-1”).” This Act was signed into law by the President on December 8, 2003 and introduces a prescription drug benefit under Medicare Part D as well as a federal subsidy to sponsors of retiree health benefit plans that provide a benefit that is at least actuarially equivalent to Medicare Part D. FSP 106-1 permits employers to make a one-time election to defer accounting for any effects of this Act, due to pending specific authoritative guidance on the accounting for the federal subsidy. The guidance in FSP 106-1 is effective for interim or annual financial statements of fiscal years ending after December 7, 2003. The Company has elected to defer accounting for this Act until specific authoritative accounting guidance is issued. The net periodic post-retirement benefit cost and liability included in the financial statements does not reflect the effects of this Act.
There have been no material changes to our critical accounting policies since June 30, 2003.
We have experienced certain changes in our exposure to market risk from June 30, 2003.
As of June 30, 2003, we recorded an $8.4 million asset to recognize the fair value of our interest rate swap agreements. The offset to this asset was a corresponding increase to long-term debt, as the instruments are accounted for as a hedge of our long-term debt. As of March 31, 2004, the fair value of our interest rate swap agreements was a liability of $3.5 million, with the offsetting adjustment recorded as a reduction to long-term debt. The $11.9 million decrease in the recorded value of these agreements was non-cash and was the result of marking these instruments to market.
As of the end of the period covered by this quarterly report on Form 10-Q, the Company’s management evaluated, with the participation of the company’s Chief Executive Officer and Chief Financial Officer, the effectiveness of the company’s disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)). The Company’s disclosure controls were designed to provide a reasonable assurance that information required to be disclosed in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. It should be noted that the design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote. However, the controls have been designed to provide reasonable assurance of achieving the controls’ stated goals. Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective at the reasonable assurance level. There were no changes in the Company’s internal control over financial reporting that occurred during the Company’s most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
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PART II. OTHER INFORMATION
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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