Kennametal - 10-Q quarterly report FY

 

(Exact name of registrant as specified in its charter)

World Headquarters
1600 Technology Way
P.O. Box 231
Latrobe, Pennsylvania 15650-0231
(Address of principal executive offices)

Website: www.kennametal.com

Registrant’s telephone number, including area code: (724) 539-5000

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 and regional economic conditions; risks associated with the availability and costs of raw materials; energy costs; commodity prices; risks associated with integrating and divesting businesses and achieving the expected savings and synergies; competition; demands on management resources; risks associated with international markets such as currency exchange rates and social and political environments; future terrorist attacks; labor relations; 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.

The accompanying notes are an integral part of these condensed consolidated financial statements.

The accompanying notes are an integral part of these condensed consolidated financial statements.

The accompanying notes are an integral part of these condensed consolidated financial statements.

EXECUTIVE SUMMARY

Sales for the quarter ended December 31, 2005 were $585.3 million, an increase of $29.1 million or 5.2 percent from $556.2 million in the prior year quarter. Sales for the six months ended December 31, 2005 were $1,154.5 million, an increase of $66.8 million or 6.1 percent from $1,087.7 million in the prior year. Gross profit for the quarter ended December 31, 2005 increased $18.3 million, or 10.1 percent, from $181.4 million in the prior year quarter to $199.7 million. Gross profit for the six months ended December 31, 2005 increased $44.8 million, or 12.6 percent, from $354.8 million in the prior year to $399.6 million. Net income for the quarter ended December 31, 2005 was $31.1 million, or $0.79 per diluted share, compared to $28.2 million, or $0.74 per diluted share last year. Net income for the six months ended December 31, 2005 was $59.2 million, or $1.52 per diluted share, compared to $50.9 million, or $1.35 per diluted share last year. Earnings benefited from continued volume growth, the net effects of acquisitions and divestiture and product price increases. These benefits were partially offset by significantly increased raw material costs, increased employment costs, a higher effective tax rate and unfavorable foreign currency effects.

Foreign currency exchange rate fluctuations reduced earnings per diluted share by $0.05 for the three months ended December 31, 2005 as compared to the prior year quarter. The impact of foreign currency exchange rate fluctuations on earnings for the six months ended December 31, 2005 was not material as compared to the prior year period. Foreign currency exchange rate fluctuations have materially impacted earnings in the past and may impact future earnings in the short-term and long-term.

Sales for the quarter ended December 31, 2005 were $585.3 million, an increase of $29.1 million, or 5.2 percent, from $556.2 million in the prior year quarter. The increase in sales is primarily attributed to 8.0 percent organic growth partially offset by unfavorable foreign currency effects of 1.0 percent and the net effects of acquisitions and divestiture. The increase in organic sales is primarily attributed to product price increases implemented to offset raw material cost increases.

Sales for the six months ended December 31, 2005 were $1,154.5 million, an increase of $66.8 million, or 6.1 percent, from $1,087.7 million in the prior year. The increase in sales is primarily attributed to product price increases and market penetration in North America and Asia partially offset by the net effects of acquisitions and divestiture.

Gross profit for the quarter ended December 31, 2005 increased $18.3 million, or 10.1 percent, to $199.7 million from $181.4 million a year ago. The increase in gross profit is primarily due to product price increases and the net effects of acquisitions and divestiture. Such benefits were partially offset by significantly higher raw material costs and reduced capacity utilization as a result of inventory quantity reductions made during the current year quarter. We believe our raw material costs, particularly tungsten, have recently stabilized and are expected to remain stable throughout the remainder of 2006.

Gross profit margin for the quarter ended December 31, 2005 increased from 32.6 percent last year to 34.1 percent in the current quarter. The gross profit margin benefited from product price increases and the net effects of acquisitions and divestiture. Such benefits were partially offset by significantly higher raw material costs.

Gross profit for the six months ended December 31, 2005 increased $44.8 million, or 12.6 percent, to $399.6 million from $354.8 million a year ago. The increase in gross profit is primarily due to product price increases, increased sales volume and the net effects of acquisitions and divestiture. Such benefits were partially offset by significantly higher raw material costs.

Gross profit margin for the six months ended December 31, 2005 increased from 32.6 percent last year to 34.6 percent. The gross profit margin benefited from product price increases and the net effects of acquisitions and divestiture. Such benefits were partially offset by significantly higher raw material costs.

Operating expense for the quarter ended December 2005 was $145.3 million, an increase of $5.8 million, or 4.1 percent, compared to $139.5 million a year ago. The increase in operating expense is primarily attributed to $1.5 million related to stock option expense resulting from the adoption of SFAS 123(R), $1.4 million related to increased defined benefit pension expense and other employment costs increases of $5.9 million partially offset by favorable foreign currency effects of $2.1 million.

Operating expense for the six months ended December 2005 was $292.9 million, an increase of $22.4 million, or 8.3 percent, compared to $270.5 million a year ago. The increase in operating expense is primarily attributed to $4.6 million related to stock option expense resulting from the adoption of SFAS 123(R), increased defined benefit pension expense of $2.9 million, increased performance-based bonus provision of $2.5 million, other employment costs increases of $10.4 million and a $3.4 million increase in professional fees driven by the timing of services performed related to compliance with Section 404 of the Sarbanes-Oxley Act of 2002.

Interest expense for the quarter ended December 31, 2005 increased to $8.0 million from $6.1 million a year ago. This increase is due primarily to an increase in the average domestic borrowing rate to 5.2 percent in 2005 from 4.7 percent in 2004 and a $44.7 million increase in average domestic borrowings due primarily to acquisition activity.

Interest expense for the six months ended December 31, 2005 increased to $15.8 million from $12.6 million a year ago. This increase is due primarily to an increase in the average domestic borrowing rate for the period to 5.2 percent in 2005 from 4.6 percent in 2004 and a $43.9 million increase in average domestic borrowings due primarily to acquisition activity.

Other income decreased $0.1 million for the quarter ended December 31, 2005 to $1.1 million. The decrease is primarily due to unfavorable foreign currency effects of $1.4 million and increased accounts receivable securitization fees of $0.4 million offset by a gain on the sale of a non-core product line of $1.1 million and increased interest income of $0.5 million. Annual sales of the divested product line are immaterial to our consolidated results.

Other income for the six months ended December 31, 2005 was $2.0 million compared to $2.8 million in the prior year. The decrease is primarily due to unfavorable foreign currency effects of $1.7 million and increased accounts receivable securitization fees of $0.9 million offset by a gain on the sale of a non-core product line of $1.1 million and increased interest income of $0.8 million.

The effective tax rate for the quarter ended December 31, 2005 was 31.5% versus 20.0% for the comparable period a year ago. In the current year quarter, we recorded a valuation allowance adjustment of $1.9 million, which reduced income tax expense. This valuation allowance adjustment reflects a change in circumstances that caused a change in judgment about the realizability of certain deferred tax assets in Europe. In the prior year quarter, we recorded valuation allowance adjustments of $6.6 million related to certain net operating losses in Europe that reduced income tax expense.

On October 22, 2004, the American Jobs Creation Act of 2004 (the Act) was enacted. The Company is currently evaluating its options for repatriation and the corresponding tax impact under this legislation with regards to the effect of a provision within the Act that provides for a special one-time tax deduction of 85.0 percent of foreign earnings that are repatriated to the United States, as defined by the Act. The Company expects to complete this evaluation during the second half of the fiscal year. The Company is considering repatriating, under the Act, an amount between $0.0 and $200.0 million, which would result in an estimated tax cost between $0.0 and $19.0 million. Until its evaluation is completed, the unremitted earnings of the Company’s foreign investments continue to be considered permanently reinvested, and accordingly, no deferred tax liability has been established.

Net income for the quarter ended December 31, 2005 was $31.1 million, or $0.79 per diluted share, compared to $28.2 million, or $0.74 per diluted share, in the same quarter last year. The increase in net income is a result of the factors previously discussed.

Net income for the six months ended December 31, 2005 was $59.2 million, or $1.52 per diluted share, compared to $50.9 million, or $1.35 per diluted share, in the same period last year. The increase in net income is a result of the factors previously discussed.

Our operations are organized into three global business units consisting of Metalworking Solutions & Services Group (MSSG), Advanced Materials Solutions Group (AMSG) and J&L Industrial Supply (J&L), and Corporate. The presentation of segment information reflects the manner in which we organize segments for making operating decisions and assessing performance.

For the quarter ended December 31, 2005, MSSG external sales increased 4.2 percent, or $14.2 million, from the prior year quarter. This increase was driven primarily by growth in North America, Asia Pacific and India, which were up 10.7 percent, 13.9 percent and 29.1 percent, respectively. Sales in Europe decreased 5.1 percent for the quarter compared to prior year due to unfavorable foreign currency effects. MSSG experienced growth across several sectors such as distribution, energy and automotive. Unfavorable foreign currency effects were $4.9 million for the quarter.

For the quarter ended December 31, 2005, operating income increased 1.8 percent, or $0.8 million, from the prior year quarter. Operating income was leveraged as a result of sales growth and a continued focus on cost containment. These benefits were partially offset by higher raw material and employment costs.

For the six months ended December 31, 2005, MSSG external sales increased 6.9 percent, or $44.9 million, from the prior year period. This increase was driven primarily by growth in North America, Asia Pacific and India, which were up 12.0 percent, 16.3 percent and 28.8 percent, respectively. MSSG experienced growth across several sectors such as distribution, energy, light engineering and automotive.

Operating income increased 10.0 percent, or $8.1 million, from last year. Operating income was leveraged as a result of sales growth and a continued focus on cost containment. These benefits were partially offset by higher raw material and employment costs.

For the quarter ended December 31, 2005, AMSG external sales increased 38.6 percent, or $47.2 million, from the prior year quarter. The increase in sales is attributed to favorable market conditions, product price increases and the effects of acquisitions. The increase in sales was achieved primarily in energy products, engineered products and mining and construction products, which were up 43.1 percent, 28.9 percent and 14.8 percent, respectively.

For the quarter ended December 31, 2005, operating income increased $15.2 million, or 109.8 percent, over the prior year quarter. The increase is attributed to sales growth and the effects of acquisitions. These benefits were partially offset by a significant increase in raw material costs.

For the six months ended December 31, 2005, AMSG external sales increased 36.2 percent, or $87.0 million, from the prior year. The increase in sales is attributed to favorable market conditions, product price increases and the effects of acquisitions. The increase in sales was achieved primarily in mining and construction products, engineered products and energy products, which were up 16.3 percent, 26.6 percent and 36.0 percent, respectively.

Operating income for the six months ended December 31, 2005 increased $24.0 million, or 84.6 percent, over the prior year period. The increase is attributed to sales growth and the effects of acquisitions. These benefits were partially offset by a significant increase in raw material costs.

J&L external sales increased $4.0 million, or 6.5 percent, from the prior year quarter. The increase in sales is attributable to new customer growth and increased e-commerce. J&L also experienced growth in the energy and automotive markets. Operating income increased $0.4 million, or 7.6 percent, compared to the prior year quarter. The increase in operating income is the result of sales growth.

For the six months ended December 31, 2005, J&L external sales increased $7.6 million, or 6.2 percent, from the prior year period. The increase in sales is attributable to new customer growth and increased e-commerce. Operating income increased $1.6 million, or 13.5 percent, compared to the prior year. The increase in operating income is a result of the improvement in sales growth.

Corporate represents corporate shared service costs, certain employee benefit costs, stock-based compensation expense and eliminations of operating results between segments. For the quarter ended December 31, 2005, operating loss increased $4.1 million, or 19.0 percent, compared to the prior year. The increase is primarily attributed to an increase in defined benefit pension expense of $3.3 million and stock option expense of $1.5 million resulting from the adoption of SFAS 123(R).

For the six months ended December 31, 2005, operating loss increased $12.4 million, or 31.6 percent, compared to the prior year period. The increase is primarily attributed to an increase in defined benefit pension expense of $4.2 million, stock option expense of $4.6 million resulting from the adoption of SFAS 123(R) and increased performance-based bonus provision of $2.5 million.

We adopted SFAS 123(R) effective July 1, 2005. See Note 3 to the condensed consolidated financial statements for a discussion on the effects of adoption and the valuation method and assumptions applied to current period stock option grants.

There have been no other material changes to our critical accounting policies since June 30, 2005.

Our cash flow from operations is our primary source of financing for capital expenditures and internal growth. During the six months ended December 31, 2005, we generated $75.6 million in cash flow from operations, a decrease of $7.8 million from $83.4 million for the prior year period. Cash flow provided by operations for the period ended December 31, 2005 consists of net income and non-cash items totaling $107.4 million offset by changes in certain assets and liabilities netting to $31.8 million. Contributing to this change was a decrease in accounts payable and accrued liabilities of $40.1 million and an increase in inventory of $22.2 million resulting from higher raw material costs. The net decrease in accounts receivable of $12.5 million was a result of focused collection efforts. Cash flow provided by operations for the six months ended December 31, 2004 consisted of net income and non-cash items totaling $86.7 million offset by changes in certain assets and liabilities netting to $3.3 million. The most significant components of this change were a decrease in accounts payable and accrued liabilities of $17.3 million and an increase in inventories of $12.7 million offset by a net decrease in accounts receivable of $15.0 million.

Net cash flow used for investing activities was $58.5 million for the six months ended December 31, 2005, an increase of $26.1 million, compared to $32.4 million in the prior year period. During the six months ended December 31, 2005, cash used for investing activities includes $31.3 million of purchases of property, plant and equipment, which consisted primarily of equipment upgrades, and $29.8 million for the acquisition of business assets. During the prior year period, cash used for investing activities included $35.8 million of purchases of property, plant and equipment. We have projected our capital expenditures for 2006 to be approximately $80.0 million and to 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.

During the six months ended December 31, 2005, net cash flow used for financing activities was $18.4 million compared to $53.1 million in the same period last year. During the current year period, cash used for financing activities includes a $16.2 million net decrease in borrowings, cash dividends paid to shareowners of $14.7 million and a $4.6 million purchase of treasury stock offset by $23.5 million of dividend reinvestment and the effects of employee benefit and stock plans. During the prior year period, cash used for financing activities included a $58.0 million net decrease in borrowings, cash dividends paid to shareowners of $12.6 million and $18.9 million of dividend reinvestment and the effects of employee benefit and stock plans. As of December 31, 2005, we were in compliance with all debt covenants.

We believe that cash flow from operations and the availability under our credit lines will be sufficient to meet our cash requirements over the next 12 months.

There have been no material changes in our contractual obligations and commitments since June 30, 2005.

The Company is party to a three-year securitization program, which permits us to securitize up to $125.0 million of accounts receivable. As of December 31, 2005, the Company had securitized $100.3 million in accounts receivable.

Total assets were $2,101.8 million at December 31, 2005, compared to $2,092.3 million at June 30, 2005. Working capital increased $76.1 million to $478.5 million at December 31, 2005 from $402.4 million at June 30, 2005. The increase in working capital is primarily driven by the net reduction of current maturities of long-term debt, capital leases and notes payable of $33.7 million, a decrease in accounts payable and accrued liabilities of $30.3 million and an increase in inventories of $24.2 million related to higher raw material costs, offset by a decrease in accounts receivable of $8.3 million. Total liabilities decreased $63.1 million from June 30, 2005 to $1,038.9 million, primarily due to decreases in accounts payable and accrued liabilities of $30.3 million and total debt, including notes payable, of $27.3 million. Shareowners’ equity increased $73.1 million to $1,046.0 million as of December 31, 2005 from $972.9 million as of June 30, 2005. The increase is primarily a result of net income of $59.2 million and the effect of employee benefit and stock plans of $36.6 million partially offset by cash dividends paid to shareowners of $14.7 million and $4.6 million for the purchase of treasury stock.

We have experienced certain changes in our exposure to market risk from June 30, 2005. The fair value of our interest rate swap agreements was a liability of $7.1 million as of December 31, 2005 compared to an asset of $0.2 million as of June 30, 2005. The offset to this liability is a corresponding decrease to long-term debt, as the instruments are accounted for as a fair value hedge of our long-term debt. The $7.3 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, as amended (Exchange Act), 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, have concluded that the Company’s disclosure controls and procedures are effective at December 31, 2005 to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act was (i) accumulated and communicated to management, including the Company’s Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure and (ii) recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission.

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.

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.