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) (Zip Code)

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 þ   NO o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer þ    Accelerated filer o   Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES o   NO þ

Indicate the number of shares outstanding of each of the issuer’s classes of capital stock, as of the latest practicable date:

This Form 10-Q contains “forward-looking” statements within the meaning of Section 21E of the Securities Exchange Act of 1934. Forward-looking statements are statements that do not relate strictly to historical or current facts. You can identify 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. These statements are likely to relate to, among other things, our strategy, goals, plans and projections regarding our financial position, results of operations, market position, and product development, all of which are based on current expectations that involve inherent risks and uncertainties, including factors that could delay, divert or change any of them in the next several years. It is not possible to predict or identify all factors; however, they may include the following: global and regional economic conditions; risks associated with the availability and costs of the raw materials we use to manufacture our products; our ability to protect our intellectual property in foreign jurisdictions; risks associated with our foreign operations and international markets, such as currency exchange rates, different regulatory environments, trade barriers, exchange controls, and social and political instability; energy costs; commodity prices; risks associated with integrating recent acquisitions, as well as any future acquisitions, and achieving the expected savings and synergies; risks relating to our recent business divestitures; competition; demands on management resources; future terrorist attacks or acts of war; 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 provide additional information about many of the specific risks we face in the “Risk Factors” Section of our Annual Report on Form 10-K, and in this Form 10-Q, as applicable. 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.

5. DIVESTITURES

13. COMPREHENSIVE INCOME

     Comprehensive income is as follows:

14. GOODWILL AND OTHER INTANGIBLE ASSETS

     The carrying amount of goodwill attributable to each segment is as follows:

During the six months ended December 31, 2006, we completed two business acquisitions in our AMSG segment for a combined purchase price of $76.7 million (2007 Business Acquisitions), which generated goodwill of $30.6 million based on our preliminary purchase price allocations.

The components of our other intangible assets and their useful lives are as follows:

As a result of the 2007 Business Acquisitions, we recorded $30.4 million of identifiable intangible assets based on our preliminary purchase price allocations as follows: contract-based of $0.6 million, technology-based and other of $5.8 million, customer-related of $22.1 million and trademarks of $1.9 million.

15. SEGMENT DATA

We currently operate two reportable operating segments consisting of MSSG and AMSG, and Corporate. During 2006, we divested our J&L segment. We do not allocate corporate costs, performance-based bonuses, domestic pension expense, interest expense, other expense, income taxes, stock-based compensation expense or minority interest to the operating segment results presented below.

Our external sales, intersegment sales and operating income by segment are as follows:

16. SHARE REPURCHASE PROGRAM

On October 24, 2006, the Board of Directors authorized a share repurchase program for up to 3.3 million shares of our outstanding capital stock. The purchases would be made from time to time, on the open market or in private transactions, with consideration given to the market price of the stock, the nature of other investment opportunities, cash flows from operating activities and general economic conditions.

17. AUTHORIZED SHARES OF CAPITAL STOCK

At the Annual Meeting of Shareowners on October 24, 2006, our shareowners voted to increase the authorized shares of capital stock from 70,000,000 shares to 120,000,000 shares. Shares of capital stock may be used for general purposes, including stock splits and stock dividends, acquisitions, possible financing activities and other employee, executive and director benefit plans. We have no present plans, arrangements, commitments or understanding with respect to the issuance of these additional shares of capital stock.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

SALES

Sales for the three months ended December 31, 2006 were $569.3 million, an increase of $6.8 million, or 1.2 percent, from $562.5 million in the prior year quarter. The change in sales is primarily attributed to 6.0 percent organic growth and a 2.0 percent favorable foreign currency impact offset by the net impact of acquisitions and divestitures. The organic increase in sales for the quarter is primarily attributed to favorable market conditions, particularly in the energy and mining markets, growth in the distribution and general engineering markets, growth in Europe and market penetration in developing economies.

Sales for the six months ended December 31, 2006 were $1,112.1 million, an increase of $3.8 million, or 0.3 percent, from $1,108.3 million in the same period a year ago. The change in sales is primarily attributed to 6.0 percent organic growth and a 2.0 percent favorable foreign currency impact offset by the net impact of acquisitions and divestitures. The organic increase in sales for the period is primarily attributed to the above-mentioned factors for the quarter.

GROSS PROFIT

Gross profit for the three months ended December 31, 2006 increased $1.5 million to $198.2 million from $196.7 million in the prior year quarter. This change is primarily due to the favorable impacts of organic sales growth, cost containment and foreign currency effects, mostly offset by a reduction from the net impact of acquisitions and divestiture amounting to $15.9 million, higher raw material costs and costs related to a plant closure of $2.6 million.

Gross profit margin for the three months ended December 31, 2006 was 34.8 percent; a decrease of 20 basis points from 35.0 percent for the prior year quarter. This decrease is primarily attributed to an unfavorable 50 basis point impact due to the above-mentioned plant closure costs and higher raw material costs partially offset by the net impact of acquisitions and divestitures, which favorably impacted the margin by 80 basis points.

Gross profit for the six months ended December 31, 2006 decreased $8.9 million, or 2.3 percent, to $385.2 million from $394.1 million in the prior year period. This decrease is primarily due to the unfavorable impact of acquisitions and divestitures amounting to $33.2 million, higher raw material costs and costs related to a plant closure of $2.6 million, partially offset by the favorable impact of organic sales growth and favorable foreign currency effects.

Gross profit margin for the six months ended December 31, 2006 decreased 100 basis points to 34.6 percent from 35.6 percent in the prior year period. The decrease is primarily attributed to higher raw material costs and an unfavorable 30 basis point impact due to the above-mentioned plant closure costs partially offset by the net impact of acquisitions and divestitures, which favorably impacted the margin by 70 basis points.

OPERATING EXPENSE

Operating expense for the three months ended December 31, 2006 was $140.3 million, a decrease of $2.4 million, or 1.6 percent, compared to $142.7 million in the prior year quarter. The decrease in operating expense is primarily attributed to the net impact of acquisitions and divestitures of $11.2 million partially offset by a $4.6 million increase in employment costs and foreign currency exchange rate fluctuations of $3.3 million.

Operating expense for the six months ended December 31, 2006 was $275.4 million, a decrease of $12.2 million, or 4.2 percent, compared to $287.6 million in the prior year period. The decrease in operating expense is primarily attributed to the net impact of acquisitions and divestitures of $21.8 million and a $3.3 million reduction in professional fee expense, driven by a reduction in fees related to compliance with Section 404 of the Sarbanes-Oxley Act of 2002, partially offset by foreign currency exchange rate fluctuations of $5.5 million and a $4.8 million increase in employment costs.

AMORTIZATION EXPENSE

Amortization expense was $2.0 million for the three months ended December 31, 2006, an increase of $0.6 million from $1.4 million in the prior year quarter. Amortization expense was $3.9 million for the six months ended December 31, 2006, an increase of $1.1 million from $2.8 million in the prior year period. These increases are due to the impact of acquisitions.

INTEREST EXPENSE

Interest expense for the three months ended December 31, 2006 decreased to $7.3 million from $8.0 million in the prior year quarter. This decrease is due primarily to a $174.3 million decrease in average daily domestic borrowings partially offset by the impact of higher average borrowing rates. The weighted average domestic borrowing rate increased from 5.2 percent in the prior year quarter to 7.0 percent in the current quarter.

Interest expense for the six months ended December 31, 2006 decreased to $14.7 million from $15.8 million in the prior year period. This decrease is due primarily to a $182.8 million decrease in average daily domestic borrowings partially offset by the impact of higher average borrowing rates. The weighted average domestic borrowing rate increased from 5.5 percent in the prior year period to 7.0 percent in the current period.

OTHER INCOME, NET

Other income for the three months ended December 31, 2006 was $0.6 million compared to $1.2 million in the prior year quarter. This decrease is primarily due to unfavorable foreign currency effects of $1.7 million partially offset by a reduction in accounts receivable securitization fees of $1.2 million.

Other income for the six months ended December 31, 2006 was $3.6 million compared to $2.1 million in the prior year period. This increase is primarily due to a reduction in accounts receivable securitization fees of $2.2 million and an increase in interest income of $1.9 million partially offset by unfavorable foreign currency effects of $3.1 million.

INCOME TAXES

The effective income tax rate for the three months ended December 31, 2006 and 2005 was 30.5 percent and 31.4 percent, respectively. The reduction from prior year is primarily the result of the extension of the research, development and experimental tax credit that was enacted during the quarter, partially offset by non-tax benefited plant-closing costs. Both periods reflect benefits of our pan-European business model strategy.

The effective income tax rate for the six months ended December 31, 2006 and 2005 was 31.1 percent and 33.0 percent, respectively. The reduction from prior year is primarily the result of benefits of our pan-European business model strategy, as well as the extension of the research, development and experimental tax credit, partially offset by the net effects of non-tax benefited plant closing costs recorded in the current period and a favorable valuation allowance adjustment recorded in the prior period related to a change in judgment about the realizability of certain deferred tax assets in Europe.

INCOME FROM CONTINUING OPERATIONS

Income from continuing operations for the three months ended December 31, 2006 was $33.6 million, or $0.86 per diluted share, compared to $30.9 million, or $0.79 per diluted share, in the same quarter last year. Income from continuing operations for the six months ended December 31, 2006 was $63.0 million, or $1.61 per diluted share, compared to $59.0 million, or $1.51 per diluted share, in the prior year period. The increase in income from continuing operations is a result of the factors set forth above.

During 2006, our Board of Directors and management approved plans to divest our Kemmer Praezision Electronics business (Electronics) and our consumer retail product line, including industrial saw blades (CPG) as part of our strategy to exit non-core businesses. These divestitures are accounted for as discontinued operations. As a result, prior years’ financial results have been restated to reflect the activity from these operations as discontinued operations.

Electronics The divestiture of Electronics, which was part of the AMSG segment, was completed in two separate transactions. The first transaction closed during 2006. The second transaction closed on December 31, 2006. During the three and six months ended December 31, 2006, we recognized a pre-tax gain on divestiture of $0.1 million to adjust the related net assets to fair value, which has been presented in discontinued operations.

During the three months ended December 31, 2006, management completed its assessment of the future use of a building owned and previously used by Electronics, but not divested. We concluded that we have no future economic use for this facility. As a result, we wrote the building down to fair value and have recognized a pre-tax impairment charge of $3.0 million, which has been presented in discontinued operations.

CPG The divestiture of CPG, which was part of the MSSG segment, closed August 31, 2006 for net consideration of $31.2 million. We have received $21.2 million in net proceeds related to the sale of this business of which $1.5 million and $19.7 million were received during 2006 and the six months ended December 31, 2006, respectively. We expect to receive the remaining $10.0 million prior to February 28, 2007. During the three and six months ended December 31, 2006, we recognized additional pre-tax losses on divestiture of $0.7 million and $1.0 million, respectively, related to post-closing adjustments which have been recorded in discontinued operations.

The following represents the results of discontinued operations:

In 2006, we divested our J&L segment for net consideration of $359.2 million. During the first quarter of 2007, we recognized a pre-tax loss of $1.7 million related to a post-closing adjustment. Certain claims raised by the purchaser related to the post-closing adjustment were submitted to binding arbitration for resolution in accordance with the terms of the sale agreement. These claims were resolved during the current quarter. We have received $359.2 million in net proceeds related to the sale of this business of which $9.7 million was received during the six months ended December 31, 2006.

Our operations were previously organized into three reportable operating segments consisting of Metalworking Solutions & Services Group (MSSG), Advanced Materials Solutions Group (AMSG) and J&L Industrial Supply (J&L), and Corporate. We divested J&L in 2006. For the three and six months ended December 31, 2005, J&L outside sales, intersegment sales and operating income were $65.3 million and $130.3 million, $0.2 million and $0.4 million, and $6.3 million and $13.2 million, respectively. The presentation of segment information reflects the manner in which we organize segments for making operating decisions and assessing performance.

METALWORKING SOLUTIONS & SERVICES GROUP

For the three months ended December 31, 2006, MSSG external sales increased $37.8 million, or 11.2 percent, from the prior year quarter. This increase was driven primarily by growth in European sales of 16.7 percent and growth in North American sales of 7.7 percent. MSSG experienced growth in the distribution, aerospace and general engineering markets. Favorable foreign currency effects were $11.4 million for the quarter.

For the three months ended December 31, 2006, operating income increased $2.6 million, or 6.2 percent, from the prior year quarter. Operating margin on total sales of 11.1 percent for the three months ended December 31, 2006 decreased 20 basis points compared to 11.3 percent in the prior year quarter. The decrease in operating margin is primarily due to $2.6 million of plant closure costs and higher raw material costs realized in the current quarter, partially offset by the impacts of continued cost containment.

For the six months ended December 31, 2006, MSSG external sales increased $63.3 million, or 9.5 percent, from the prior year period. This increase was driven primarily by growth in European sales of 11.3 percent, North American sales of 8.2 percent and Asia Pacific sales of 12.2 percent. MSSG experienced growth in the distribution, aerospace and general engineering markets. Favorable foreign currency effects were $18.8 million for the period.

For the six months ended December 31, 2006, operating income increased $2.3 million, or 2.7 percent, from the prior year period. Operating margin on total sales of 11.4 percent for the six months ended December 31, 2006 decreased 30 basis points compared to 11.7 percent in the prior year period. The decrease in operating margin is primarily due to the factors discussed above.

ADVANCED MATERIALS SOLUTIONS GROUP

For the three months ended December 31, 2006, AMSG external sales increased $34.3 million, or 21.3 percent, from the prior year quarter. The increase in sales is primarily attributed to the impact of favorable market conditions and the effects of acquisitions. The increase in sales was achieved primarily in energy, engineered and mining and construction products, which were up 32.4 percent, 18.2 percent and 8.5 percent, respectively.

For the three months ended December 31, 2006, operating income increased $4.4 million, or 14.9 percent, over the prior year quarter. The increase is primarily attributed to the factors discussed above and the effects of acquisitions and new product introductions partially offset by higher raw material costs.

For the six months ended December 31, 2006, AMSG external sales increased $70.9 million, or 22.9 percent, from the prior year period. The increase in sales is primarily attributed to the impact of favorable market conditions and the effects of acquisitions. The increase in sales was achieved primarily in energy, engineered and mining and construction products, which were up 33.9 percent, 17.6 percent and 8.6 percent, respectively.

For the six months ended December 31, 2006, operating income increased $7.9 million, or 14.9 percent, over the prior year period. The increase is primarily attributed to the factors discussed above and the effects of acquisitions partially offset by higher raw material costs.

CORPORATE

Corporate represents corporate shared service costs, certain employee benefit costs, stock-based compensation expense and eliminations of operating results between segments.

For the three months ended December 31, 2006, operating loss decreased $2.5 million, or 9.8 percent, compared to the prior year quarter. The decrease is primarily attributed to reductions in employment costs of $1.2 million and a decrease in information technology costs of $0.9 million.

For the six months ended December 31, 2006, operating loss decreased $3.4 million, or 6.6 percent, compared to the prior year period. The decrease is primarily attributed to reductions in employment costs of $3.7 million.

Cash flows from discontinued operations are not deemed material and have been combined with cash flows from continuing operations within each cash flow statement category. The absence of cash flows from discontinued operations is not expected to have a material impact on our future liquidity and capital resources.

Our cash flow from operations is our primary source of financing for capital expenditures and internal growth. During the six months ended December 31, 2006, cash flow provided by operating activities was $35.8 million, compared to $75.6 million for the prior year period. Cash flow provided by operating activities for the period ended December 31, 2006 consists of net income and non-cash items totaling $115.0 million offset by changes in certain assets and liabilities netting to $79.2 million. Contributing to this change was a decrease in accrued income taxes of $78.7 million primarily due to tax payments related to the gain on divestiture of J&L and cash repatriated during 2006 under the American Jobs Creation Act (AJCA). During the six months ended December 31, 2006, cash paid for income taxes totaled $104.9 million.

Cash flow provided by operating activities for the six months ended December 31, 2005 consisted 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 an increase in inventory of $22.2 million resulting from higher raw material costs and the increase in production to meet sales demand, offset by a net decrease in accounts receivable of $12.5 million due to focused collection efforts.

Net cash flow used for investing activities was $91.5 million for the six months ended December 31, 2006, an increase of $33.0 million, compared to $58.5 million in the prior year period. During the six months ended December 31, 2006, cash used for investing activities includes $44.9 million used for purchases of property, plant and equipment, which consisted primarily of equipment upgrades, and $76.7 million used for the acquisition of business assets, partially offset by proceeds from divestitures of $29.4 million. During the prior year period, cash used for investing activities included $31.3 million of purchases of property, plant and equipment, which consisted primarily of equipment upgrades, and $30.0 million used for the acquisition of business assets.

During the six months ended December 31, 2006 net cash flow used for financing activities was $65.6 million, an increase of $47.2 million, compared to $18.4 million in the prior year period. During the current year period, cash used for financing activities includes a $46.4 million net decrease in borrowings, $24.6 million for the repurchase of capital stock and $15.5 million of cash dividends paid to shareowners offset by $21.3 million of dividend reinvestment and the effects of employee benefit and stock plans. The reduction in borrowings, repurchase of capital stock and increase in cash dividends paid of $0.8 million reflect the Company’s priority uses of cash as a result of the J&L divestiture in 2006. During the prior year period, cash used for financing activities included a $16.2 million net decrease in borrowings, $4.6 million for the repurchase of capital stock, $14.7 million of cash dividends paid to shareowners offset by $23.5 million of dividend reinvestment and the effects of employee benefit and stock plans.

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, 2006.

The Company is party to a three-year securitization program, which permits us to securitize up to $10.0 million of accounts receivable. As of December 31, 2006, the Company had no securitized accounts receivable.

Total assets were $2,396.9 million at December 31, 2006, compared to $2,435.3 million at June 30, 2006. Working capital decreased $33.5 million to $591.2 million at December 31, 2006 from $624.7 million at June 30, 2006. The decrease in working capital is primarily driven by cash used for acquisitions of $76.7 million, partially offset by proceeds from divestitures of $29.4 million. Net property, plant and equipment increased $26.9 million to $557.3 million at December 31, 2006 from $530.4 million at June 30, 2006 due to acquisitions of business assets and machinery and equipment upgrades partially offset by depreciation expense.

Total liabilities decreased $114.0 million to $1,011.3 million at December 31, 2006 from $1,125.3 million at June 30, 2006, primarily due to decreases in accrued income taxes of $79.8 million and a net reduction in long-term debt, notes payable and capital leases of $35.3 million.

Shareowners’ equity increased $74.3 million to $1,369.7 million as of December 31, 2006 from $1,295.4 million as of June 30, 2006. The increase is primarily a result of net income of $60.4 million, foreign currency translation adjustments of $24.6 million and the effect of employee benefit and stock plans of $24.7 million, partially offset by repurchases of capital stock of $24.6 million and cash dividends paid to shareowners of $15.5 million.

The operation of our business has exposed us to certain liabilities and compliance costs related to environmental matters. We are involved in various environmental cleanup and remediation activities at certain of our locations.

Superfund Sites We are involved as a potentially responsible party (PRP) at various sites designated by the United States Environmental Protection Agency (USEPA) as Superfund sites, including the Li Tungsten Superfund site in Glen Cove, New York. With respect to the Li Tungsten site, we recorded an environmental reserve following the identification of other PRPs, an assessment of potential remediation solutions and an entry of a unilateral order by the USEPA directing certain remedial action. In May 2006, we reached an agreement in principle with the U.S. Department of Justice (DOJ) with respect to this site; the DOJ informed us that it would accept a payment of $0.9 million in full settlement for its claim against us for costs related to the Li Tungsten site. To date, the draft Consent Order and Agreement for settlement of our Li Tungsten liability has not been finalized, but we expect that the final settlement will proceed according to the terms outlined in the agreement in principle. At December 31, 2006 we had an accrual of $1.0 million recorded relative to this environmental issue.

During 2006, the USEPA notified us that we have been named as a PRP at the Alternate Energy Resources Inc. site located in Augusta, Georgia. The proceedings in this matter have not yet progressed to a stage where it is possible to estimate the ultimate cost of remediation, the timing and extent of remedial action that may be required by governmental authorities, or the amount of our liability, if any, alone or in relation to that of any other PRPs.

Other Environmental Issues Additionally, we also maintain reserves for other potential environmental issues. At December 31, 2006 the total of these accruals was $5.5 million, and represents anticipated costs associated with the remediation of these issues. We recorded unfavorable foreign currency translation adjustments of $0.2 million during the three months ended December 31, 2006 related to these reserves.

There have been no material changes to our critical accounting policies since June 30, 2006.

In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans—an amendment of FASB Statements No. 87, 88, 106, and 132(R)” (SFAS 158). SFAS 158 requires an employer to recognize the overfunded or underfunded status of a defined benefit postretirement plan as an asset or liability in its statement of financial position and to recognize changes in that funded status through comprehensive income of a business entity in the year in which the changes occur. SFAS 158 is effective for Kennametal June 30, 2007. The provisions of SFAS 158 are to be applied on a prospective basis; therefore, prior periods presented will not be restated. Based on the funded status of our pension and other postretirement benefit plans as of June 30, 2006, the adoption of SFAS 158 would have resulted in the following estimated impacts: a $0.8 million reduction of intangible assets, recognition of a $0.5 million deferred tax asset, a $78.5 million reduction of prepaid pension assets, a $20.8 million reduction in deferred tax liabilities, a $6.2 million reduction in accrued postretirement benefits, recognition of a $4.9 million pension liability and recognition of a $56.7 million other comprehensive loss. The ultimate impact is contingent on plan asset returns and the assumptions that will be used to measure the funded status of each of our pension and other postretirement benefit plans as of June 30, 2007.

SFAS 158 also requires an employer to measure the funded status of a plan as of the date of its year-end statement of financial position. The funded status of each of our pension and other postretirement benefit plans is currently measured as of June 30.

In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108, (SAB 108), which expresses the staff’s views regarding the process of quantifying financial statement misstatements. The guidance in SAB 108 must be applied in our 2007 annual financial statements. We are in the process of evaluating the guidance in SAB 108 to determine the impact, if any, on our results of operations or financial condition.

In September 2006, the FASB issued SFAS 157, “Fair Value Measurements” (SFAS 157). SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. The provisions of this standard apply to other accounting pronouncements that require or permit fair value measurements. SFAS 157 is effective for Kennametal July 1, 2008. Upon adoption, the provisions of SFAS 157 are to be applied prospectively with limited exceptions. We are in the process of evaluating the impact of the provisions of SFAS 157 on our consolidated financial statements.

In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — an Interpretation of FASB Statement No. 109” (FIN 48). FIN 48 prescribes a method of recognition, measurement, presentation and disclosure within the financial statements for uncertain tax positions that a company has taken or expects to take in a tax return. FIN 48 is effective for Kennametal July 1, 2007. We are in the process of evaluating the provisions of FIN 48 to determine the impact of adoption on our results of operations or financial condition.

We have experienced certain changes in our exposure to market risk from June 30, 2006. The fair value of our interest rate swap agreements was a liability of $8.2 million as of December 31, 2006 compared to a liability of $14.2 million as of June 30, 2006. The offset to this liability is a corresponding increase to long-term debt, as the instruments are accounted for as a fair value hedge of our long-term debt. The $6.0 million change in the recorded value of these agreements was non-cash and was the result of marking these instruments to market.

There have been no other material changes to our market risk exposure since June 30, 2006.

ITEM 4. CONTROLS AND PROCEDURES

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 to provide reasonable assurance at December 31, 2006 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.

ITEM 6. EXHIBITS

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.