Kennametal - 10-Q quarterly report FY

 

(Exact name of registrant as specified in its charter)

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, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

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 27A of the Securities Act of 1933 and 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 or events. Forward-looking statements in this Form 10-Q may concern, among other things, Kennametal’s expectations regarding our strategy, goals, plans and projections regarding our financial position, liquidity and capital resources, results of operations, market position, and product development, all of which are based on current expectations that involve inherent risks and uncertainties. Among the factors that could cause the actual results to differ materially from those indicated in the forward-looking statements are risks and uncertainties related to: global and regional economic conditions; availability and cost of the raw materials we use to manufacture our products; our ability to protect our intellectual property in foreign jurisdictions; 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; competition; integrating recent acquisitions, as well as any future acquisitions, and achieving the expected savings and synergies; business divestitures; demands on management resources; future terrorist attacks or acts of war; labor relations; demand for and market acceptance of new and existing products; and implementation of restructuring plans and environmental remediation matters. Should one or more of these risks or uncertainties materialize, or should the assumptions underlying the forward-looking statements prove incorrect, actual outcomes could vary materially from those indicated. These and other risks are more fully described in the “Risk Factors” Section of our Annual Report on Form 10-K, in this Form 10-Q if applicable and in our other periodic filings with the Securities and Exchange Commission. 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.

SALES

Sales for the three months ended September 30, 2008 were $669.3 million, an increase of $54.2 million, or 8.8 percent, from $615.1 million in the prior year quarter. The increase in sales was primarily attributed to 3 percent organic growth, 5 percent from foreign currency effects and 2 percent from more workdays partially offset by the impact of divestitures of 1 percent. The organic increase in sales for the quarter was primarily driven by growth in European, Asia Pacific, Indian and Latin American markets. North American sales were essentially flat. We achieved sales gains in all major metalworking markets outside of North America as well as sales growth in our advanced materials businesses which more than offset the impact of weaker market conditions in the North American metalworking market.

Gross profit for the three months ended September 30, 2008 increased $6.7 million, or 3.2 percent, to $218.8 million from $212.1 million in the prior year quarter. This increase was primarily due to higher organic sales volume, the effect of price increases and the favorable impact of foreign currency effects of $11.3 million partially offset by higher raw material costs and temporary disruption costs related to our restructuring actions.

Gross profit margin for the three months ended September 30, 2008 was 32.7 percent, down 180 basis points from 34.5 percent in the prior year quarter. The change from the prior year quarter was primarily due to higher raw material costs as well as temporary disruption costs partially offset by the impact of price increases.

Operating expense for the three months ended September 30, 2008 was $153.7 million, an increase of $8.7 million, or 6.0 percent, compared to $145.0 million in the prior year quarter. The increase in operating expense was primarily attributed to foreign currency effects of $7.6 million.

During the fourth fiscal quarter of 2008, we announced our intent to implement a program of restructuring actions to further our ability to achieve our long-term goals for margin expansion and earnings growth as well as reduce costs and improve efficiency in our operations. Consistent with this announcement, we continued actions in 2009 related to facility rationalizations and employment reductions. For the three months ended September 30, 2008, we recorded restructuring charges of $8.4 million. MSSG, AMSG and Corporate charges were $6.7 million, $1.2 million and $0.5 million, respectively. See Note 5 to our condensed consolidated financial statements set forth in Part 1 Item 1 of this Form 10-Q.

The restructuring actions under this program are expected to be completed over the next six to twelve months. The related charges recorded through September 30, 2008 were $17.4 million. Including these charges, the Company expects to recognize total program-related charges in the range of $40 million to $50 million of which approximately 90 percent are expected to be cash expenditures. Annual ongoing benefits from these actions, once fully implemented, are expected to be in the range of $20 million to $25 million.

Amortization expense was $3.4 million for the three months ended September 30, 2008, an increase of $0.5 million from $2.9 million in the prior year quarter. The year-over-year increase was due to the impact of acquisitions.

Interest expense for the three months ended September 30, 2008 decreased $0.7 million, or 8.8 percent, to $7.1 million from $7.8 million in the prior year quarter. The impact of an increase in average domestic borrowings of $111.0 million was more than offset by lower average interest rates on domestic borrowings. The increase in average domestic borrowings was driven by the repurchase of 4 million of the Company’s shares during the three months ended September 30, 2008 at a total cost of $127.3 million.

Other expense, net for the three months ended September 30, 2008 was $1.4 million compared to other income, net of $1.1 million in the prior year quarter. This change was driven by unfavorable foreign currency transaction results of $2.5 million and lower other income of $1.1 million, partially offset by higher interest income of $1.1 million.

The effective income tax rate for the three months ended September 30, 2008 and 2007 was 19.0 percent and 37.7 percent, respectively. The prior year’s rate was unfavorably impacted by a $6.6 million non-cash income tax charge related to a German tax law change which impacted the rate by 11.4 percent. The current year rate reflects a benefit from the release of a valuation allowance in Europe that was driven by further expansion of our Pan-European business strategy.

On October 3, 2008, the Emergency Economic Stabilization Act of 2008 was enacted, which extended the Research Credit for Increasing Research Activities in the United States of America. Our subsequent filings will reflect the impact of this legislation, which will have a slightly favorable impact on our effective tax rate.

Our operations are organized into two reportable operating segments consisting of Metalworking Solutions & Services Group (MSSG) and Advanced Materials Solutions Group (AMSG), and Corporate. The presentation of segment information reflects the manner in which we organize segments for making operating decisions and assessing performance. Corporate represents certain corporate shared service costs, employee benefit costs, employment costs, such as performance-based bonuses and stock-based compensation expense, and eliminations of operating results between segments.

For the three months ended September 30, 2008, MSSG external sales increased $23.6 million, or 5.8 percent, from the prior year quarter. This increase was the result of 6 percent from favorable foreign currency effects, 2 percent from more workdays, less 2 percent from divestitures. On a global basis, industrial activity was mixed. Activity in certain industry and market sectors, such as aerospace, defense and energy, remained positive while others, such as automotive and other durable goods, were somewhat weaker. MSSG achieved organic sales growth of 22 percent in Asia Pacific, 7 percent in Latin America, 6 percent in India and 2 percent in Europe. This growth offset a reduction in North American organic sales of 8 percent primarily attributed to a decline in distribution sales that resulted from our distributors’ increased reliance on our higher fill rates as well as the overall economic environment.

For the three months ended September 30, 2008, MSSG operating income decreased $12.0 million, or 21.8 percent, from the prior year quarter. Operating margin on total sales of 9.0 percent for the current quarter decreased 330 basis points compared to 12.3 percent in the prior year quarter. The primary drivers of the decline in operating margin were restructuring and related charges of $7.2 million, temporary disruption effects related to restructuring initiatives and higher raw material costs offset somewhat by benefits from price increases and favorable foreign currency effects.

For the three months ended September 30, 2008, AMSG external sales increased $30.6 million, or 14.8 percent, from the prior year quarter. This was the result of 10 percent organic growth, 3 percent from favorable foreign currency effects and 2 percent from more workdays. Organic sales increased on stronger mining and construction sales and higher energy-related sales, offset somewhat by lower sales of engineered products and surface finishing machines and services.

For the three months ended September 30, 2008, AMSG operating income was flat compared to the prior year quarter. Operating margin on total sales of 12.2 percent for the current quarter decreased 150 basis points compared to 13.7 percent in the prior year quarter. This decline is primarily due to restructuring and related charges of $1.4 million, unfavorable business mix and lower performance related to the engineered products and surface finishing machines and services businesses. Improved price realization more than offset the impact of higher raw material costs for the current quarter.

For the three months ended September 30, 2008, operating loss decreased $1.2 million, or 5.6 percent, compared to the prior year quarter, primarily due to the impact of cost containment efforts.

Despite the recent unprecedented turmoil in the global financial markets, we continue to believe that cash flow from operations and the availability under our credit lines will be sufficient to meet our cash requirements for the foreseeable future. At September 30, 2008, we had cash and cash equivalents of $68.9 million. Also at September 30, 2008, we had additional borrowing capacity of $346.3 million available under our multi-currency, revolving credit line which extends to March 2011. Our current credit ratings are at solid investment grade levels. We believe that our current financial position, liquidity and credit ratings provide access to the capital markets. We continue to closely monitor our liquidity position and the condition of the capital markets as well as the counterparty risk of our credit providers.

There have been no material changes in our contractual obligations and commitments since June 30, 2008.

Cash flow from operations is our primary source of financing for capital expenditures and internal growth. During the three months ended September 30, 2008, cash flow provided by operating activities was $38.0 million, compared to $56.9 million for the prior year period. Cash flow provided by operating activities for the current year quarter consisted of net income and non-cash items totaling $62.5 million offset somewhat by changes in certain assets and liabilities netting to $24.5 million. Contributing to these changes were a decrease in accounts payable and accrued liabilities of $24.1 million, due in part to a $14.3 million payment of 2008 performance-based bonuses, and an increase in inventories of $26.9 million due to higher raw material costs, partially offset by a decrease in accounts receivable of $27.9 million.

Cash flow provided by operating activities for the three months ended September 30, 2007 consisted of net income and non-cash items totaling $68.7 million offset somewhat by changes in certain assets and liabilities netting to $11.8 million. Contributing to these changes were a decrease in accounts receivable of $30.7 million, an increase in inventories of $29.4 million due to higher sales volume, initiatives to increase service levels and increased raw material inventory and a decrease in accounts payable and accrued liabilities of $18.9 million driven by a $15.1 million payment of 2007 performance-based bonuses.

Cash flow used for investing activities was $43.6 million for the three months ended September 30, 2008, an increase of $12.2 million, compared to $31.4 million in the prior year quarter. During the three months ended September 30, 2008, cash used for investing activities included $44.6 million used for purchases of property, plant and equipment, which consisted primarily of equipment upgrades.

During the three months ended September 30, 2007, cash used for investing activities included $42.7 million used for purchases of property, plant and equipment, which consisted primarily of equipment upgrades, partially offset by proceeds from the sale of an equity investment of $5.4 million, proceeds from divestitures of $3.0 million and $1.6 million of post-closing purchase price adjustments related to the acquisition of business assets.

During the three months ended September 30, 2008, cash flow provided by financing activities was $4.1 million and included a $134.3 million net increase in borrowings and $3.4 million of dividend reinvestment and the effect of employee benefit and stock plans mostly offset by $127.3 million used for the repurchase of capital stock and $9.2 million of cash dividends paid to shareowners.

During the three months ended September 30, 2007, cash flow used for financing activities was $12.0 million and included $15.9 million for the repurchase of capital stock and $8.2 million of cash dividends paid to shareowners, partially offset by $7.1 million of dividend reinvestment and the effect of employee benefit and stock plans.

At September 30, 2008, total assets were $2,678.2 million having decreased $106.1 million from $2,784.3 million at June 30, 2008. Total liabilities increased $77.1 million from $1,114.9 million at June 30, 2008 to $1,192.0 million at September 30, 2008.

Working capital was $626.9 million at September 30, 2008, a decrease of $3.8 million or 0.6 percent from $630.7 million at June 30, 2008. The decrease in working capital included a decrease in accounts receivable of $55.6 million, a decrease in accounts payable of $32.0 million and a decrease in accrued expenses of $22.5 driven by the payment of fiscal 2008 performance-based bonuses of $14.3 million. Foreign currency effects accounted for $26.9 million and $15.5 million of the decreases in accounts receivable and accrued liabilities, respectively.

Property, plant and equipment, net decreased $20.7 million from $749.8 million at June 30, 2008 to $729.1 million at September 30, 2008, primarily due to a reduction from foreign currency effects of $29.2 million and depreciation expense of $21.3 million partially offset by capital additions of $31.8 million related to machinery and equipment upgrades and geographic expansion.

At September 30, 2008, other assets were $857.1 million, a decrease of $25.5 million from $882.6 million at June 30, 2008. The decrease in other assets was primarily attributed to a decrease in goodwill and intangible assets of $26.6 million caused mostly by unfavorable foreign currency effects of $23.6 million.

Long-term debt and capital leases increased $135.1 million from $313.1 million at June 30, 2008 to $448.2 million at September 30, 2008 primarily due to borrowings for the repurchase of capital stock during the current quarter of $127.3 million.

Shareowners’ equity was $1,465.8 million at September 30, 2008, a decrease of $182.1 million from $1,647.9 million at June 30, 2008. The decrease was primarily attributed to the purchase of capital stock of $127.3 million and a reduction from foreign currency translation adjustments of $92.7 million partially offset by net income of $35.5 million.

We are subject to various U.S. Federal, state and international environmental laws and regulatory requirements and are involved from time to time in investigations or proceedings of various potential environmental issues concerning activities at our facilities or former facilities or remediation efforts as a result of past activities (including past activities of companies we have acquired). From time to time, we receive notices from the U.S. Environmental Protection Agency or equivalent state or international environmental agencies that we are a potentially responsible party (PRP) under the Comprehensive Environmental Response, Compensation and Liability Act (commonly known as the “Superfund Act”) and/or equivalent laws. These notices assert potential liability for cleanup costs at various sites, which include sites owned by us, sites we previously owned and treatment or disposal sites not owned by us.

Superfund Sites We are involved as a PRP at several Superfund sites, and have responded to notices for other Superfund sites as to which our records disclose no involvement or for which predecessors of certain of our acquired companies have acknowledged responsibility. We have established reserves that we believe to be adequate to cover our share of the potential costs of remediation at certain of the Superfund sites; at September 30, 2008 the total of these accruals was $0.2 million. For the remaining Superfund sites, proceedings in those matters 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 alone or in relation to that of any other PRPs. Although the outcome of the pending Superfund claims cannot be predicted with certainty, management does not believe that the resolution of these claims will have a material adverse effect on our financial condition, results of operations or cash flows.

Other Environmental Issues We also maintain reserves for other potential environmental issues. At September 30, 2008, the total of these accruals was $5.4 million, and represents anticipated costs associated with the remediation of these issues. We recorded favorable foreign currency translation adjustments of $0.6 million during the three months ended September 30, 2008 related to these reserves.

There have been no material changes to our critical accounting policies since June 30, 2008.

See Note 3 to our condensed consolidated financial statements set forth in Part 1 Item 1 of this Form 10-Q for a description of new accounting standards.

We have experienced certain changes in our exposure to market risk from June 30, 2008. The fair value of our interest rate swap agreements was an asset of $2.4 million as of September 30, 2008 and an asset of $0.7 million as of June 30, 2008. We recorded the change in fair value of these agreements as a gain in other comprehensive income and a corresponding decrease to long-term debt, as these instruments are accounted for as a fair value hedge of our long-term debt. The $1.7 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, 2008.

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 were effective.

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.

At the Annual Meeting of Shareowners on October 21, 2008, our shareowners voted on the election of three directors, the ratification of the selection of PricewaterhouseCoopers LLP as our independent registered public accounting firm for 2009 and the approval of the Amended and Restated Kennametal Inc. Stock and Incentive Plan of 2002. Of the 68,953,616 shares present in person or by proxy, the following is the number of shares voted in favor of, abstained or voted against each matter and the number of shares having authority to vote on each matter but withheld.

 

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.