KMT

Kennametal Inc. 10-Q Summary: Quarter Ended September 30, 2009

Business Context and Reporting Period

This Form 10-Q covers the three-month period ended September 30, 2009. 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 primary segments: Metalworking Solutions & Services Group (MSSG) and Advanced Materials Solutions Group (AMSG). The reporting period reflects the ongoing impact of the global economic recession, characterized by reduced industrial production and demand.

Key Financial Metrics

Note: Total debt decreased by $118.6 million during the quarter compared to June 30, 2009.

Material Changes vs. Prior Period

• Revenue Decline: Sales decreased 36% year-over-year, driven by a 36% organic decline due to the global recession. Foreign currency effects were unfavorable by 3%.
• Profitability: The company reported a net loss of $9.8 million compared to a net income of $35.5 million in the prior year. This shift was driven by lower sales volumes, reduced manufacturing cost absorption, and restructuring charges of $7.8 million.
• Segment Performance:
  • MSSG: External sales dropped 43% to $231.0 million, resulting in an operating loss of $12.8 million (vs. $42.4 million income in 2008).
  • AMSG: External sales dropped 25% to $178.4 million, with operating income declining to $23.1 million (vs. $30.0 million in 2008).
• Discontinued Operations: The company recorded a net loss of $1.4 million from discontinued operations related to the divestiture of its high-speed steel drills business.

Guidance, Outlook, and Management Commentary

• Restructuring Progress: Management realized $30 million in pre-tax benefits from restructuring programs in the quarter, nearing the target of $125 million in annual pre-tax benefits. Total expected pre-tax charges for the restructuring plan are approximately $115 million, with the majority of remaining charges expected over the next six to nine months.
• Liquidity Actions: In July 2009, the company issued 8.1 million shares of capital stock, generating net proceeds of $120.7 million, which were used to pay down debt. Additionally, the revolving credit facility was amended to exclude certain restructuring charges from leverage calculations, though interest rates on borrowings increased by approximately 200 basis points.
• Outlook: Management expressed confidence in navigating challenging economic conditions, citing improved sequential sales performance (up 6% from Q2 2009) and strong working capital management. They anticipate expanding sales and profitability as the global economy improves.
• Risks: Key risks include the depth and duration of the economic recession, foreign currency fluctuations, commodity prices, and the ability to achieve expected savings from restructuring and acquisitions.

Investor Verification Checklist

• Debt Covenants: Verify compliance with the amended credit agreement covenants, specifically the leverage and interest coverage ratios, given the recent amendment and increased interest rates.
• Restructuring Execution: Monitor the timing and cash impact of the remaining $25 million in expected restructuring charges over the next 6-9 months.
• Inventory Levels: Confirm the sustainability of the $16.8 million inventory reduction achieved in the quarter and its impact on future cost of goods sold.
• Discontinued Operations: Track the finalization of the high-speed steel divestiture and any additional charges expected ($2.0-$3.0 million) over the next three to six months.
• Foreign Currency Impact: Assess the sensitivity of future earnings to foreign exchange rates, which negatively impacted sales and gross profit in the current quarter.