KMT

Business Context and Reporting Period

Kennametal Inc. is a global manufacturer of tooling, engineered components, and advanced materials serving industries such as aerospace, automotive, mining, and oil and gas. The company operates through two segments: Metalworking Solutions & Services Group (MSSG) and Advanced Materials Solutions Group (AMSG). This Form 10-Q covers the quarterly period ended March 31, 2010, and the nine-month period ended on the same date.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Sales for the quarter increased 16% year-over-year (YoY) to $493.2 million, driven by an 11% organic increase and 5% favorable foreign currency effects. This marks the third consecutive quarter of sequential sales growth. However, for the nine-month period, sales declined 17% YoY due to a 20% organic decline.
• Profitability Turnaround: The company returned to profitability with $9.7 million in net income for the quarter, compared to a net loss of $137.9 million in the prior year quarter. Operating income improved from a loss of $150.1 million to a profit of $26.3 million.
• Restructuring Impact: Restructuring and asset impairment charges were significantly lower in the current period ($20.7 million for the quarter) compared to the prior year ($142.8 million). The prior year included a $111.0 million non-cash impairment charge related to the AMSG segment.
• Debt Reduction: Total debt decreased by $149.8 million since June 30, 2009, largely due to the use of $120.7 million in net proceeds from a July 2009 equity offering to pay down revolving credit facility borrowings.

Outlook, Risks, and Management Commentary

• Restructuring Progress: Management expects restructuring programs to deliver annual ongoing pre-tax permanent savings of $155 million to $160 million. Total pre-tax charges are now expected to be $160 million to $165 million, slightly higher than previously announced due to legislative changes extending COBRA benefits.
• Liquidity: The company maintains investment-grade credit ratings. Cash and cash equivalents increased to $110.9 million. The revolving credit facility expires in March 2011, and discussions for renewal are ongoing.
• Segment Performance:
  • MSSG: Reported operating income of $31.0 million for the quarter, driven by higher sales volumes and cost savings.
  • AMSG: Reported operating income of $24.8 million, a significant improvement from the prior year loss, primarily due to the absence of the prior year's $111 million impairment charge.
• Risks: Key risks include the potential for a deepening economic recession, currency exchange rate fluctuations, raw material costs, and the ability to integrate acquisitions and achieve restructuring synergies.

Investor Verification Checklist

• Restructuring Savings: Verify the realization of the projected $155-$160 million in annual pre-tax permanent savings.
• Debt Covenant Compliance: Monitor compliance with the amended 2006 Credit Agreement, specifically the leverage and interest coverage ratios, given the recent amendment terms.
• Organic Sales Trends: Assess whether the 11% organic sales growth in the quarter is sustainable across all geographies, noting the 20% organic decline over the nine-month period.
• Environmental Liabilities: Review the adequacy of the $5.3 million total accrual for environmental remediation (Superfund and other issues) against potential future costs.
• Equity Offering Impact: Confirm the long-term capital structure benefits of the July 2009 equity issuance versus the dilution effects on earnings per share.