Summary of KENNAMETAL INC - Yahoo! Finance

ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
The following discussion should be read in connection with the consolidated financial statements of Kennametal Inc. and the related footnotes. Unless otherwise specified, any reference to a "year" is to a fiscal year ended June 30. Additionally, when used in this annual report on Form 10-K, unless the context requires otherwise, the terms "we," "our" and "us" refer to Kennametal Inc. and its subsidiaries.
OVERVIEW Kennametal Inc. is a leading global supplier of tooling, engineered components and advanced materials consumed in production processes. We believe that our reputation for manufacturing excellence as well as our technological expertise and innovation in our principal products has enabled us to achieve a leading market presence in our primary markets. We believe that we are one of the largest global providers of consumable metalcutting tools and tooling supplies.
We entered fiscal year 2009 after delivering record sales in our fiscal year ended June 30, 2008. Our sales continued to grow during the first months of our fiscal year 2009 and we reported record September quarter sales for the three months ended September 30, 2008. Following that, global economic conditions and industrial activity deteriorated substantially with a further downward acceleration in the March 2009 quarter. This resulted in significantly lower industrial production and much lower demand for our products in all major geographic regions, as well as most industry and market sectors. This had a corresponding effect on our sales levels, operating performance and financial results.
For the full fiscal year 2009, our sales were $2.0 billion, a decrease of 23 percent from the record $2.6 billion achieved in the prior fiscal year. For 2009, we recorded a net loss of $119.7 million, or $1.64 per diluted share. Included in our 2009 results were pre-tax restructuring and asset impairment charges of $173.7 million. Also included in our 2009 results was a loss on discontinued operations of $17.3 million, including a loss on divestiture. These items, along with other charges related to our restructuring programs, as well as the impact of the severe global economic downturn, were the primary drivers for the net loss that we recorded for 2009. Benefits realized from our restructuring actions and other cost reduction actions, as well as higher price realization, helped to mitigate these items.
Despite recording a net loss for the year, we generated cash flow from operating activities of $192.3 million during 2009. Also helping our cash flow, we reduced our capital expenditures by $58.6 million from the prior year. We also took other steps to improve our financial position and enhance our liquidity, including two significant actions taken in July 2009 which involved the amendment of our revolving credit facility and the issuance of 8.1 million shares of our capital stock.
While undertaking our many actions to reduce costs and optimize cash flow during the challenging economic environment in 2009, we took additional steps to further enhance our products and capabilities and preserve our competitive strengths. As a result of all of our actions, we believe that we are well positioned and better prepared to perform well in an eventual economic upturn. In response to the impact of the rapid and steep decline in global demand, we implemented and will continue to drive restructuring programs and other measures to reduce our manufacturing costs and operating expenses. In April 2008, we announced restructuring actions to rationalize certain manufacturing and service facilities, as well as other employment and cost reduction programs. In January 2009, we announced a global salaried workforce reduction. In April 2009, we announced further restructuring actions which involve additional employment and other cost reduction programs. For our restructuring program in total, we realized approximately $50 million in pre-tax benefits from restructuring actions in 2009 and expect to realize approximately $75 million of additional pre-tax benefits from these actions in 2010. This would bring the total annual ongoing pre-tax benefits from restructuring to approximately $125 million. In addition to our restructuring programs, we have taken and will continue to take other actions to adjust our costs and level of operations to the extent necessary and appropriate. These other actions included employee furloughs from March 2009 through June 2009 and the suspension of matching contributions to certain employee benefit plans effective March 2009. We also implemented salary reductions effective July 2009 which will remain in effect until business conditions improve to a level that will permit partial or full restoration of the previous employee compensation levels.
As a result of the impact of the severe downturn in the global economy, we recorded a non-cash pre-tax impairment charge related to two businesses within our AMSG segment during 2009. This charge amounted to $111.0 million, of which $100.2 million was for goodwill and $10.8 million was for an indefinite-lived trademark.

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Our sharp focus on cash flow generation and liquidity during 2009 included persistent diligence with receivable collection, close management of production and inventory levels and tight control over capital expenditures. We reduced inventory in each of the final three quarters of 2009 despite the rapid and steep drop-off in sales volumes. This included a $60 million inventory reduction in the second half of the fiscal year. At the same time, we maintained high off-the-shelf inventory availability. Capital expenditures were reduced to $12 million in the June 2009 quarter which is the lowest quarterly capital spending level since the December 2003 quarter.
Also providing us with additional cash as well as taking another positive step in shaping our business portfolio was the completion of the divestiture of our high speed steel drills business, including related product lines and assets (HSS) on June 30, 2009. The cash proceeds from this deal are $29 million. We received $2 million of these cash proceeds prior to closing and another $24 million in July 2009. We expect to receive the remaining balance in the December 2009 quarter. For 2009, this divested business generated sales of $81 million and essentially breakeven results.
Earlier in the fiscal year, we enhanced our business portfolio within the AMSG segment with the acquisition of Tricon, a leading supplier of custom wear solutions in the surface and underground mining markets.
In addition, we invested further in technology and innovation to continue delivering a high level of new products to our customers. Research and development expenses totaled $27.6 million for 2009. In 2009, we generated over 40 percent of our sales from new products.
Our financial position and liquidity were further bolstered by the amendment to our credit facility and the common stock issuance that we undertook in July 2009.
RESTRUCTURING ACTIONS During 2009, we continued to implement restructuring plans to reduce costs and improve operating efficiencies. These actions relate to the rationalization of certain manufacturing and service facilities as well as other employment and cost reduction programs. Restructuring and related charges recorded in 2009 amounted to $73.3 million. This included $64.7 million of restructuring charges of which $2.1 million were related to inventory disposals and recorded as cost of goods sold. Restructuring related charges of $8.8 million were recorded in cost of goods sold and a net restructuring benefit of $0.2 million was recorded in operating expense. See Note 16 in our consolidated financial statements set forth in Item 8.
Total restructuring and related charges since the inception of our restructuring plans through June 30, 2009 were $81.5 million. Including these charges, we expect to recognize approximately $115 million of pre-tax charges related to our restructuring plans. The majority of the remaining charges are expected to be incurred by December 31, 2009, most of which are expected to be cash expenditures. We realized pre-tax benefits of approximately $50 million from these actions in fiscal 2009 and expect to realize approximately $75 million of additional pre-tax benefits in fiscal 2010. This would bring the annual ongoing pre-tax benefits from these actions to approximately $125 million.
ACQUISITIONS AND DIVESTITURES On October 1, 2008, we acquired Tricon Metals and Services Inc. (Tricon) in our AMSG segment for a net purchase price of $64.1 million. Tricon is a leading supplier of custom wear solutions specializing in consumable proprietary steels for the surface and underground mining markets, including hard rock and coal. During 2009, we also made a small acquisition within our MSSG segment.
During 2008, we did not complete any material acquisitions or divestitures. However, we made two small acquisitions in Europe, both within our MSSG segment. Also during 2008, we divested two small, non-core businesses from our MSSG segment, one in the U.S. and one in Europe. Combined cash proceeds received were $20.2 million and we recognized a combined loss on divestitures of $0.6 million. During 2007, we completed five acquisitions. Three of these acquisitions were in our AMSG segment and two were within our MSSG segment.

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DISCONTINUED OPERATIONS On June 30, 2009, we divested HSS from our MSSG segment as part of our continuing focus to shape our business portfolio and rationalize our manufacturing footprint. This divestiture was accounted for as discontinued operations. Cash proceeds from this divestiture were $29 million, of which $2 million was received prior to closing and $24 million was received in July 2009. We expect to receive the remaining $3 million in proceeds in the December 2009 quarter. For 2009, this divested business generated sales of $81 million and essentially breakeven results. The pre-tax loss on the sale and related pre-tax charges of $25.5 million, as well as the related tax effects, were recorded in discontinued operations. We expect to incur additional pre-tax charges related to this divestiture of $4.0 million to $7.0 million during the six months ending December 2009.
During 2007, we completed two other divestitures which were accounted for as discontinued operations. See Note 5 in our consolidated financial statements set forth in Item 8.
The following represents the results of discontinued operations for the years ended June 30:

(in thousands)                                               2009             2008             2007

Sales                                                   $  80,630        $ 115,343        $ 135,191

(Loss) income from discontinued operations before
income taxes                                            $ (25,923 )      $   5,412        $   1,879
Income tax (benefit) expense                               (8,583 )          1,303            2,353

(Loss) income from discontinued operations              $ (17,340 )      $   4,109        $    (474 )

RESULTS OF CONTINUING OPERATIONS
SALES Sales of $1,999.9 million in 2009 decreased 22.8 percent versus $2,590.0 million in 2008. The decrease in sales was primarily due to organic sales decline of $549.7 million and unfavorable foreign currency effects of $62.7 million, partially offset by the net favorable impact of acquisitions and divestitures of $22.3 million. As a result of the severe downturn in the global economy, organic sales declined in all major metalworking markets. Organic sales declined in our advanced materials business primarily due to lower sales in the surface finishing machines and services business, as well as the engineered products business.
Sales of $2,590.0 million in 2008 increased 14.3 percent versus $2,265.3 million in 2007. The increase in sales was primarily attributed to organic sales growth of $97.9 million, the impact of acquisitions of $86.8 million and favorable foreign currency effects of $140.0 million. Regionally, organic sales growth was mostly driven by growth in European and Asia Pacific markets offset somewhat by weakness in the North American market. Organic sales growth by sector was led by year-over-year expansion in the aerospace, machine tools, general engineering, mining and highway construction markets.
GROSS PROFIT Gross profit decreased $330.6 million to $576.5 million in 2009 from $907.1 million in 2008. The decrease was primarily due to lower organic sales volume, reduced absorption of manufacturing costs due to lower production levels, less favorable business unit mix, temporary disruption effects from restructuring programs, unfavorable foreign currency effects of $12.9 million, an increase in restructuring and related charges of $9.5 million. Improved price realization more than offset the impact of higher raw material costs. In addition, the benefits of restructuring and other cost reduction actions, lower provisions for incentive compensation programs as well as the net favorable impact of acquisitions and divestitures helped to mitigate the impact of lower sales and production volumes. The gross profit margin for 2009 decreased to 28.8 percent from 35.0 percent in 2008.
Gross profit increased $79.9 million to $907.1 million in 2008 from $827.2 million in 2007. The 9.7 percent increase was primarily due to organic sales growth, the effect of acquisitions, the effects of price increases and the impact of favorable foreign currency effects of $53.9 million. These benefits were partially offset by higher raw material costs, particularly products containing steel and cobalt, as well as a less favorable sales mix primarily due to a lower proportion of sales of energy-related products and lower performance in our surface finishing machines and services business. Gross profit for 2008 included restructuring charges of $1.2 million related to inventory write-offs and $0.2 million of other restructuring-related charges. The gross profit margin for 2008 decreased to 35.0 percent from 36.5 percent in 2007.
OPERATING EXPENSE Operating expense in 2009 was $489.6 million, a decrease of $104.6 million, or 17.6 percent, compared to $594.2 million in 2008. The decrease is attributable to an $80.0 million decrease in employment expenses driven by restructuring and cost management activities as well as lower provisions for incentive compensation programs of $24.3 million, favorable foreign currency effects of $15.0 million, a decrease in restructuring and related charges of $2.1 million, and the impact of other cost reductions of $16.6 million, offset somewhat by the net unfavorable impact of acquisitions and divestitures of $9.1 million.

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Operating expense in 2008 was $594.2 million, an increase of $50.2 million, or 9.2 percent, compared to $544.0 million in 2007. The increase in operating expense was primarily due to unfavorable foreign currency effects of $32.0 million, the impact of acquisitions of $16.5 million, a $5.9 million increase in employment costs and a $5.7 million increase in professional fees, partially offset by a $9.9 million decrease in other expenses. Operating expense for 2008 included restructuring-related charges of $1.9 million. RESTRUCTURING AND ASSET IMPAIRMENT CHARGES During 2009, we initiated certain restructuring actions and recognized $64.7 million of restructuring charges of which $62.6 million were recorded as restructuring charges and $2.1 million were related to inventory disposals and recorded in cost of goods sold. See the discussion under the heading "Restructuring Actions" within this MD&A for additional information.
In the process of preparing our interim financial statements for the March 2009 quarter, we determined that the magnitude and duration of the economic downturn, as well as other factors, served as a triggering event for an impairment test of our surface finishing machines and services business as well as our engineered products business. These businesses are both part of our AMSG segment. As a result of our test, we recorded a goodwill impairment charge of $100.2 million. Of this amount, $37.3 million related to our surface finishing machines and services business and $62.9 million related to our engineered products business. No goodwill remains on the books for our surface finishing machines and services business. In addition, as a result of our impairment test, we recorded a $10.8 million impairment charge for the indefinite-lived trademark for our surface finishing machines and services business in 2009.
We also recorded a goodwill impairment charge of $35.0 million during 2008 for our surface finishing machines and services business. The change was recorded as a result of a revised earnings forecast for the business due to a decline in operating performance and market weakness.
During 2007, we completed our strategic analysis and plan for our Widia brand. As a key element of our channel and brand strategy, we decided to leverage the strength of this brand to accelerate growth in the distribution market. Since demand in the distribution market is mostly for standard products and to further our relationship with our Widia distributors, we furthermore decided to migrate direct sales of Widia custom solutions products to the Kennametal brand. As a result, we recorded a pre-tax impairment charge of $6.0 million related to our MSSG Widia trademark during 2007.
LOSS ON DIVESTITURES During 2008, we completed the divestitures of two non-core MSSG businesses for proceeds of $20.2 million and recognized a net loss on divestitures of $0.6 million. The results of operations for these businesses were not material and have not been presented as discontinued operations. During 2007, we recorded a loss on divestiture of $1.6 million as a result of a post-closing adjustment related to our divestiture of J&L Industrial Supply. AMORTIZATION OF INTANGIBLES Amortization expense was $13.1 million in 2009, a decrease of $0.8 million from $13.9 million in 2008. The decrease was due to some intangibles becoming fully amortized in 2009.
Amortization expense was $13.9 million in 2008, an increase of $4.0 million from $9.9 million in 2007. The increase was due to the impact of acquisitions. INTEREST EXPENSE Interest expense decreased $4.4 million to $27.2 million in 2009, compared with $31.6 million in 2008. This decrease was due to lower average interest rates on domestic borrowings of 3.9 percent, compared to 6.2 percent in 2008. The portion of our debt subject to variable rates of interest was approximately 34 percent and 68 percent at June 30, 2009 and 2008, respectively. The decrease in the portion of our debt subject to variable rates was due to the termination in February 2009 of interest rate swap agreements to convert $200 million of our fixed rate debt to floating rate debt.
Interest expense increased $2.6 million to $31.6 million in 2008, compared with $29.0 million in 2007. This increase was primarily due to an increase in average domestic borrowings of $110.2 million, offset in part by the effect of lower average interest rates on domestic borrowings of 6.2 percent, compared to 7.0 percent in 2007. The portion of our debt subject to variable rates of interest was approximately 68 percent and 53 percent at June 30, 2008 and 2007, respectively.
OTHER INCOME, NET In 2009, other income, net increased by $12.2 million to $14.6 million compared to $2.4 million in 2008. The increase was primarily due to a favorable change in foreign currency transaction results of $13.1 million. In 2008, other income, net decreased by $6.0 million to $2.4 million compared to $8.4 million in 2007. The decrease was due to unfavorable foreign currency transaction results of $4.4 million, lower other income of $1.6 million and lower interest income of $0.6 million.
INCOME TAXES The effective tax rate from continuing operations for 2009 was 10.0 percent (benefit on a loss) compared to 27.4 percent (provision on income) for 2008. The change in the effective rate from 2008 to 2009 was primarily driven by asset impairment charges in

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both periods. In addition, the 2009 effective rate benefited from a valuation allowance adjustment in Europe as well as the settlement of a routine audit examination in the U.S. The 2008 effective rate was unfavorably impacted by a non-cash income tax charge related to a German tax reform bill that was enacted in the first quarter of 2008, but benefited from our dividend reinvestment plan in China.
The effective tax rate from continuing operations for 2008 was 27.4 percent compared to 27.8 percent for 2007. The decrease in the effective rate from 2007 to 2008 was primarily driven by a further increase in earnings under our pan-European business strategy, the combined effects of other international operations, and a tax benefit associated with a dividend reinvestment plan in China. The effects of these items were partially offset by the effect of the goodwill impairment charge related to our surface finishing machines and services businesses for which there was no tax benefit, and a non-cash income tax charge related to a German tax reform bill that was enacted in the first quarter of 2008.
During 2008, we made a change in our determination with respect to cumulative undistributed earnings of international subsidiaries and affiliates whereby we now consider unremitted previously taxed income of our international subsidiaries to not be permanently reinvested. As a result of this change, we accrued an income tax liability of $3.0 million. Of this amount, $2.1 million decreased accumulated other comprehensive income and $0.9 million increased tax expense.
(LOSS) INCOME FROM CONTINUING OPERATIONS Loss from continuing operations was ($102.4) million, or ($1.40) per diluted share, in 2009 compared to income of $163.7 million, or $2.10 per diluted share, in 2008. The decrease in income from continuing operations was a result of the factors previously discussed. Income from continuing operations was $163.7 million, or $2.10 per diluted share, in 2008 compared to $174.7 million, or $2.22 per diluted share, in 2007. The decrease in income from continuing operations was a result of the factors previously discussed.
BUSINESS SEGMENT REVIEW 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.

METALWORKING SOLUTIONS & SERVICES GROUP

          (in thousands)                   2009            2008            2007

          External sales            $ 1,191,759     $ 1,674,516     $ 1,457,077
          Intersegment sales            139,509         174,004         135,502
          Operating (loss) income       (19,180 )       255,391         217,706

External sales of $1,191.8 million in 2009 decreased by $482.8 million, or 28.8 percent, from 2008. The decrease in sales was attributed to organic sales decline of 25 percent, unfavorable foreign currency effects of 3 percent and the effects of divestitures of 1 percent. On a global basis, industrial production declined sequentially and in comparison to the prior year. On a regional basis, Europe and North America reported organic sales declines of 27 percent and 26 percent, respectively. India, Asia Pacific and Latin America also experienced organic sales declines of 24 percent, 16 percent and 16 percent, respectively. Operating loss for 2009 was $19.2 million and reflects a decrease in operating performance of $274.6 million or 107.5 percent, from the operating income generated in 2008. The primary drivers of the decline in operating performance were reduced sales volumes and the related lower manufacturing cost absorption due to lower production levels, as well as higher restructuring and related charges. This was offset in part by restructuring benefits and other cost reduction actions, as well as higher price realization. MSSG operating (loss) income included restructuring and related charges of $52.9 million and $4.9 million in 2009 and 2008, respectively.
External sales of $1,674.5 million in 2008 increased by $217.4 million, or 14.9 percent, from 2007. The increase in sales was attributed to organic sales growth of 5 percent, favorable foreign currency effects of 7 percent and the effects of acquisitions of 3 percent. The organic sales growth was driven by increases in Europe of 8 percent, Asia Pacific of 15 percent, India of 8 percent and Latin America of 9 percent partially offset by an organic sales decline in North America of 3 percent. Industrial activity remained positive in most industry sectors on a global basis, most notably aerospace, machine tools and general engineering. Favorable foreign currency effects were $108.0 million for 2008.
Operating income for 2008 increased by $37.7 million, or 17.3 percent, from 2007. These results benefited from sales growth as discussed above, favorable foreign currency effects, continued cost containment and the impact of acquisitions. MSSG operating income included restructuring and related charges of $3.2 million and $1.7 million for 2008 and 2007, respectively.

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ADVANCED MATERIALS SOLUTIONS GROUP

             (in thousands)                 2009          2008          2007

             External sales            $ 808,100     $ 915,270     $ 808,259
             Intersegment sales           17,805        39,131        42,881
             Operating (loss) income     (39,539 )      83,925       131,323

External sales of $808.1 million in 2009 decreased by $107.2 million, or 11.7 percent, from 2008. The decrease in sales was attributed to organic sales decline of 15 percent, unfavorable foreign currency effects of 2 percent, partially offset by the positive effects of acquisitions of 5 percent. The decrease in organic sales was driven by lower sales in the engineered products business, as well as reduced demand for surface finishing machines and services and energy related products.
Operating loss for 2009 was $39.5 million and reflects a decrease of $123.5 million, or 147.1 percent, from the operating income generated in 2008. The decrease was driven by lower sales and production volumes, as well as higher impairment and restructuring and related charges. A considerable portion of these impacts were offset by a combination of restructuring benefits and other cost reductions, as well as higher price realization. For 2009, operating loss included $111.0 million of impairment charges and $18.3 million of restructuring and related charges, compared to $35.0 million of impairment charges and $3.0 million of restructuring charges in 2008.
External sales of $915.3 million in 2008 increased by $107.0 million, or 13.2 percent, from 2007. The increase in sales was attributed to organic sales growth of 4 percent and the effects of acquisitions of 5 percent and favorable foreign currency effects of 4 percent. The increase in organic sales was driven by stronger mining and construction product sales, which were up 10 percent, and energy and related product sales, which were up 3 percent. Engineered product sales were flat in 2008. Favorable foreign currency effects were $32.0 million for 2008.
Operating income for 2008 decreased $47.4 million, or 36.1 percent, from 2007. The decrease in operating income was driven by a $35.0 million goodwill . . .