<PAGE> 1
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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 1999
Commission file number 1-5318
KENNAMETAL INC.
(Exact name of registrant as specified in its charter)
PENNSYLVANIA 25-0900168
(State or other jurisdiction (I.R.S. Employer
of incorporation) Identification No.)
WORLD HEADQUARTERS
1600 TECHNOLOGY WAY
P.O. BOX 231
LATROBE, PENNSYLVANIA 15650-0231
(Address of registrant's principal executive offices)
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 [X] NO [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
Title Of Each Class Outstanding at February 1, 2000
- ---------------------------------------- -------------------------------
Capital Stock, par value $1.25 per share 30,293,917
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KENNAMETAL INC.
FORM 10-Q
FOR QUARTER ENDED DECEMBER 31, 1999
TABLE OF CONTENTS
Item No. Page
- -------- ----
PART I. FINANCIAL INFORMATION
1. Financial Statements:
Condensed Consolidated Statements of Income (Unaudited)
Three and six months ended December 31, 1999 and 1998................. 1
Condensed Consolidated Balance Sheets (Unaudited)
December 31, 1999 and June 30, 1999................................... 2
Condensed Consolidated Statements of Cash Flows (Unaudited)
Six months ended December 31, 1999 and 1998........................... 3
Notes to Condensed Consolidated Financial Statements
(Unaudited) ......................................................... 4
2. Management's Discussion and Analysis of Financial Condition
and Results of Operations............................................. 11
3. Quantitative and Qualitative Disclosures about Market Risk............ 21
PART II. OTHER INFORMATION
4. Submission of Matters to a Vote of Security Holders................... 22
6. Exhibits and Reports on Form 8-K...................................... 22
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
KENNAMETAL INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
- --------------------------------------------------------------------------------
(in thousands, except per share data)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
December 31, December 31,
--------------------- ---------------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
OPERATIONS
Net sales $453,928 $484,318 $896,871 $965,240
Cost of goods sold 285,061 303,256 564,675 605,162
-------- -------- -------- --------
Gross profit 168,867 181,062 332,196 360,078
Operating expenses 126,702 130,540 249,189 269,459
Restructuring and asset impairment charges 3,981 -- 3,981 --
Amortization of intangibles 6,597 6,261 13,600 12,666
-------- -------- -------- --------
Operating income 31,587 44,261 65,426 77,953
Interest expense 13,753 17,635 28,280 35,256
Other expense (income), net 510 (223) 252 193
-------- -------- -------- --------
Income before provision for income taxes and
minority interest 17,324 26,849 36,894 42,504
Provision for income taxes 7,709 11,400 16,418 18,100
Minority interest 1,104 1,413 2,052 2,974
-------- -------- -------- --------
Income before extraordinary item 8,511 14,036 18,424 21,430
Extraordinary loss on early extinguishment
of debt, net of tax of $178 (267) -- (267) --
-------- -------- -------- --------
Net income $ 8,244 $ 14,036 $ 18,157 $ 21,430
======== ======== ======== ========
PER SHARE DATA
Basic earnings per share before
extraordinary item $ 0.28 $ 0.47 $ 0.61 $ 0.72
Extraordinary item (0.01) -- (0.01) --
-------- -------- -------- --------
Basic earnings per share $ 0.27 $ 0.47 $ 0.60 $ 0.72
======== ======== ======== ========
Diluted earnings per share before
extraordinary item $ 0.28 $ 0.47 $ 0.61 $ 0.72
Extraordinary item (0.01) -- (0.01) --
-------- -------- -------- --------
Diluted earnings per share $ 0.27 $ 0.47 $ 0.60 $ 0.72
======== ======== ======== ========
Dividends per share $ 0.17 $ 0.17 $ 0.34 $ 0.34
======== ======== ======== ========
Basic weighted average shares outstanding 30,184 29,878 30,146 29,868
======== ======== ======== ========
Diluted weighted average shares outstanding 30,330 29,889 30,255 29,915
======== ======== ======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
1
<PAGE> 4
KENNAMETAL INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
- --------------------------------------------------------------------------------
(in thousands)
<TABLE>
<CAPTION>
December 31, June 30,
1999 1999
---- ----
<S> <C> <C>
ASSETS
Current assets:
Cash and equivalents $ 17,258 $ 17,408
Marketable equity securities available-for-sale 10,113 13,436
Accounts receivable, less allowance for
doubtful accounts of $14,626 and $15,269 224,022 231,287
Inventories 417,473 434,462
Deferred income taxes 43,657 44,182
Other current assets 16,717 9,673
---------- ----------
Total current assets 729,240 750,448
---------- ----------
Property, plant and equipment:
Land and buildings 231,937 235,375
Machinery and equipment 736,886 756,917
Less accumulated depreciation (450,085) (452,492)
---------- ----------
Net property, plant and equipment 518,738 539,800
---------- ----------
Other assets:
Investments in affiliated companies 916 844
Intangible assets, less accumulated amortization
of $75,709 and $64,096 671,678 685,695
Deferred income taxes 33,742 33,996
Other 32,707 32,865
---------- ----------
Total other assets 739,043 753,400
---------- ----------
Total assets $1,987,021 $2,043,648
========== ==========
LIABILITIES
Current liabilities:
Current maturities of long-term debt and capital leases $ 4,672 $ 117,217
Notes payable to banks 16,423 26,222
Accounts payable 111,056 89,339
Accrued vacation pay 27,305 27,323
Accrued payroll 19,006 19,730
Other current liabilities 102,719 97,035
---------- ----------
Total current liabilities 281,181 376,866
---------- ----------
Long-term debt and capital leases, less current maturities 750,322 717,852
Deferred income taxes 53,834 53,108
Other liabilities 95,271 97,186
---------- ----------
Total liabilities 1,180,608 1,245,012
---------- ----------
Minority interest in consolidated subsidiaries 54,245 53,505
---------- ----------
SHAREOWNERS' EQUITY
Preferred stock, no par value; 5,000 shares authorized; none issued -- --
Capital stock, $1.25 par value; 70,000 shares authorized;
32,994 and 32,903 shares issued 41,242 41,128
Additional paid-in capital 328,956 325,382
Retained earnings 485,502 477,593
Treasury shares, at cost; 2,746 and 2,836 shares held (56,068) (57,199)
Unearned compensation (2,836) (3,330)
Accumulated other comprehensive loss (44,628) (38,443)
---------- ----------
Total shareowners' equity 752,168 745,131
---------- ----------
Total liabilities and shareowners' equity $1,987,021 $2,043,648
========== ==========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
2
<PAGE> 5
KENNAMETAL INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
- --------------------------------------------------------------------------------
(in thousands)
<TABLE>
<CAPTION>
Six Months Ended
December 31,
-------------------------------
1999 1998
---- ----
<S> <C> <C>
OPERATING ACTIVITIES
Net income $ 18,157 $ 21,430
Adjustments for noncash items:
Depreciation 37,685 34,749
Amortization 13,600 12,666
Restructuring and asset impairment charges 2,673 --
Loss on early extinguishment of debt, net of tax 267 --
Other 3,541 9,327
Changes in certain assets and liabilities, net of effects of acquisitions
and divestiture:
Accounts receivable 3,586 17,396
Inventories 13,894 (22,677)
Accounts payable and accrued liabilities 20,335 (27,507)
Other (288) (11,268)
--------- ---------
Net cash flow from operating activities 113,450 34,116
--------- ---------
INVESTING ACTIVITIES
Purchases of property, plant and equipment (21,676) (61,681)
Disposals of property, plant and equipment 5,964 2,515
Other 405 (2,384)
--------- ---------
Net cash flow used for investing activities (15,307) (61,550)
--------- ---------
FINANCING ACTIVITIES
Increase (decrease) in short-term debt (9,965) 5,441
Increase in long-term debt 104,586 88,609
Decrease in long-term debt (186,779) (47,109)
Dividend reinvestment and employee stock plans 4,549 1,745
Cash dividends paid to shareowners (10,248) (10,155)
Other (409) (298)
--------- ---------
Net cash flow from (used for) financing activities (98,266) 38,233
--------- ---------
Effect of exchange rate changes on cash (27) 146
--------- ---------
CASH AND EQUIVALENTS
Net increase (decrease) in cash and equivalents (150) 10,945
Cash and equivalents, beginning 17,408 18,366
--------- ---------
Cash and equivalents, ending $ 17,258 $ 29,311
========= =========
SUPPLEMENTAL DISCLOSURES
Interest paid $ 31,092 $ 37,234
Income taxes paid 7,128 14,779
</TABLE>
See accompanying notes to condensed consolidated financial statements.
3
<PAGE> 6
KENNAMETAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
- --------------------------------------------------------------------------------
1. The condensed consolidated financial statements should be read in
conjunction with the Notes to the Consolidated Financial Statements
included in the company's 1999 Annual Report. The condensed
consolidated balance sheet as of June 30, 1999 has been derived from
the audited balance sheet included in the company's 1999 Annual Report.
These accompanying interim statements are unaudited; however,
management believes that all adjustments necessary for a fair
presentation have been made and all adjustments are normal, recurring
adjustments. The results for the three and six months ended December
31, 1999 are not necessarily indicative of the results to be expected
for the full fiscal year. Certain amounts in the prior years'
consolidated financial statements have been reclassified to conform
with the current year presentation.
2. Inventories are stated at lower of cost or market. Cost is determined
using the last-in, first-out (LIFO) method for a significant portion of
domestic inventories and the first-in, first-out (FIFO) method or
average cost for other inventories. The company used the LIFO method of
valuing its inventories for approximately 45 percent of total
inventories at December 31, 1999. Because inventory valuations under
the LIFO method are based on an annual determination of quantities and
costs as of June 30 of each year, the interim LIFO valuations are based
on management's projections of expected year-end inventory levels and
costs. Therefore, the interim financial results are subject to any
final year-end LIFO inventory adjustments.
3. The major classes of inventory as of the balance sheet dates were as
follows (in thousands):
<TABLE>
<CAPTION>
December 31, June 30,
1999 1999
---- ----
<S> <C> <C>
Finished goods $316,304 $318,736
Work in process and powder blends 100,442 117,987
Raw materials and supplies 33,222 32,619
-------- --------
Inventory at current cost 449,968 469,342
Less LIFO valuation (32,495) (34,880)
-------- --------
Total inventories $417,473 $434,462
======== ========
</TABLE>
4. The company has been involved in various environmental cleanup and
remediation activities at several of its manufacturing facilities. In
addition, the company is currently named as a potentially responsible
party (PRP) at several Superfund sites in the United States. In the
December 1999 quarter, the company recorded a remediation reserve of
$3.0 million with respect to its involvement in these matters, which is
recorded as a component of operating expenses. This represents
management's best estimate of its future obligation based on its
evaluations and discussions with outside counsel and independent
consultants, and the current facts and circumstances related to these
matters. The company has recorded this liability in the December
quarter because certain events occurred, including sufficient progress
made by the government and the PRPs in the identification of other PRPs
and review of potential remediation solutions, that clarified the level
of involvement in these matters by the company and its relationship to
other PRPs. This led the company to conclude that it was probable that
a liability had been incurred.
In addition to the amount currently reserved, the company may be
subject to loss contingencies related to these matters estimated to be
up to an additional $3.3 million. The company believes that such
unreserved losses are reasonably possible but are not currently
considered to be probable of occurrence. The reserved and unreserved
liabilities may change substantially in the near term due to
4
<PAGE> 7
KENNAMETAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
- --------------------------------------------------------------------------------
factors such as the nature and extent of contamination, changes in
remedial requirements, technological changes, discovery of new
information, the financial strength of other PRPs and the
identification of new PRPs.
The company maintains a Corporate Environmental, Health and Safety
(EH&S) Department, as well as an EH&S Policy Committee, to ensure
compliance with environmental regulations and to monitor and oversee
remediation activities. In addition, the company has established an
EH&S administrator at its domestic manufacturing facilities. The
company's financial management team periodically meets with members of
the Corporate EH&S Department and the Corporate Legal Department to
review and evaluate the status of environmental projects and
contingencies. On a quarterly and annual basis, management establishes
or adjusts financial provisions and reserves for environmental
contingencies in accordance with Statement of Financial Accounting
Standards (SFAS) No. 5, "Accounting for Contingencies."
5. For purposes of determining the number of dilutive shares outstanding,
weighted average shares outstanding for basic earnings per share
calculations were increased due to the dilutive effect of unexercised
stock options by 145,834 and 10,783 for the three months ended December
31, 1999 and 1998, respectively, and 108,417 and 46,956 for the six
months ended December 31, 1999 and 1998, respectively.
6. Comprehensive income for the three and six months ended December 31,
1999 and 1998 is as follows (in thousands):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
December 31, December 31,
---------------------- --------------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net income $ 8,244 $14,036 $18,157 $21,430
Unrealized loss on marketable equity securities
available-for-sale, net of tax (1,328) -- (3,326) --
Minimum pension liability adjustment 73 -- 47 --
Foreign currency translation adjustments (6,968) 2,925 (2,906) 399
------- ------- ------- -------
Comprehensive income $ 21 $16,961 $11,972 $21,829
======= ======= ======= =======
</TABLE>
The components of accumulated other comprehensive loss consist of the
following (in thousands):
<TABLE>
<CAPTION>
December 31, June 30,
1999 1999
---- ----
<S> <C> <C>
Unrealized gain (loss) on marketable equity securities
available-for-sale, net of tax $ (2,166) $ 1,160
Minimum pension liability adjustment (1,218) (1,265)
Foreign currency translation adjustments (41,244) (38,338)
-------- --------
Total accumulated other comprehensive loss $(44,628) $(38,443)
======== ========
</TABLE>
7. In June 1998, SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities," was issued. The company must adopt the standard by
the beginning of the first quarter of fiscal 2001. SFAS No. 133
establishes accounting and reporting standards requiring all derivative
instruments (including certain derivative instruments imbedded in other
contracts) be recorded in the balance sheet as either an asset or
liability measured at their fair value. SFAS No. 133 requires that
changes in the derivative's fair value be recognized currently in
earnings unless specific hedge accounting
5
<PAGE> 8
KENNAMETAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
- --------------------------------------------------------------------------------
criteria are met. Accounting for qualifying hedges allows a
derivative's gains and losses to offset related results on the hedged
item in the income statement, and requires that a company must formally
document, designate and assess the effectiveness of transactions that
receive hedge accounting. The company is currently evaluating the
effects of SFAS No. 133 and does not believe that the adoption will
have a material effect on the financial statements or results of
operations of the company.
8. In March 1999, the company's management began to implement
restructuring plans, including several programs to reduce costs,
improve operations and enhance customer satisfaction. The costs accrued
for these plans were based on management estimates using the latest
information available at the time that the accrual was established. The
costs charged against the accrual as of December 31, 1999 were as
follows (in thousands):
<TABLE>
<CAPTION>
June 30, Cash December 31,
1999 Expenditures Adjustments 1999
------ ------------ ----------- ------
<S> <C> <C> <C> <C>
Plant closure $2,200 $(1,581) $ -- $ 619
Voluntary early retirement program 1,367 (412) -- 955
------ ------- ---- ------
Total $3,567 $(1,993) $ -- $1,574
====== ======= ==== ======
</TABLE>
Additional period costs of $0.6 million and $2.0 million resulting from
the relocation of employees, hiring and training new employees and
other costs associated with the temporary duplication of certain
operations and other inefficiencies related to the Solon, Ohio plant
closure were included in cost of goods sold during the three and
six-month periods ended December 31, 1999, respectively. The remaining
period costs related to these items are estimated to be $0.5 million
and will be incurred through the remainder of fiscal 2000.
9. During the September 1999 quarter, the company entered into two
interest rate swap agreements that effectively convert a notional
amount of $50.0 million from floating to fixed interest rates. This
increases the total notional amount of floating-to-fixed interest rate
swaps to $100.0 million. These new agreements mature in July 2002.
At December 31, 1999, the company would have received $2.2 million to
settle all interest rate swap agreements, representing the excess of
fair value over the carrying cost of these agreements. The effect of
all interest rate swaps on the company's composite interest rate on
long-term debt was not material at December 31, 1999.
At December 31, 1999, the company had a notional amount of $21.4
million of outstanding foreign exchange forward contracts to sell
foreign currency. These contracts mature before March 31, 2000. The net
unrealized loss on foreign currency contracts was $1.1 million at
December 31, 1999.
10. In November 1999, the company announced plans to close, consolidate or
downsize several plants, warehouses and offices, and associated
workforce reductions as part of its overall plan to increase asset
utilization and financial performance, and to reposition the company to
become the premier tooling solutions supplier. The company expects to
record total charges of $25 to $30 million related to these programs by
its fiscal 2000 year-end.
6
<PAGE> 9
KENNAMETAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
- --------------------------------------------------------------------------------
Management implemented several of these programs in the December 1999
quarter. The costs accrued for the implemented programs were based upon
management estimates using the latest information available at the time
that the accrual was established. The components of the charges are as
follows (in thousands):
<TABLE>
<CAPTION>
Initial
Total Asset Restructuring
Charge Write-Downs Liability
------ -------------- -------------
<S> <C> <C> <C>
Asset impairment charges $2,544 $(2,544) $ --
Employee severance 1,368 -- 1,368
Product rationalization 100 (100) --
Facility rationalizations 69 (29) 40
------ ------- ------
Total $4,081 $(2,673) $1,408
====== ======= ======
</TABLE>
In conjunction with the company's ongoing review of underperforming
businesses, certain assets are reviewed for impairment pursuant to the
provisions of SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." An
asset impairment charge of $1.6 million was recorded in the December
1999 quarter, related to a metalworking manufacturing operation in
Shanghai, China as it was determined to be impaired.
This operation became fully operational in fiscal 1998 and to date, has
not generated the performance that was expected at the time the company
entered into this market. Management performed an in-depth review of
the operations, capacity utilization and the local management team, and
engaged a consultant to perform an independent review of the same.
These reviews enabled management to determine that the market served by
this operation had eroded compared to the original expectations, that
the operations were in good working order and utilized modern
technology, and that the management team in place was competent.
Management also determined that this facility had excess capacity given
the level of market demand.
Accordingly, management updated its operating forecast to reflect the
current market demand. In comparing the projected cash flows of the
updated forecast to the net book value of the assets of this operation,
management determined that the full value of these assets would not be
recoverable. Accordingly, a charge was recorded to adjust the carrying
value of the long-lived assets of this operation to fair value. The
estimated fair value of these assets was based on various
methodologies, including a discounted value of estimated future cash
flows.
The product rationalization charge of $0.1 million represents the
write-down of certain discontinued product lines manufactured in these
operations. The company manufactured these products specifically for
the market served by these operations and management has determined
that these products are no longer salable. This charge has been
recorded as a component of cost of goods sold.
The company recorded an asset impairment charge of $0.7 million related
to the write-down of equipment in its North American metalworking
operations. Management completed an assessment of the assets currently
being used in these operations and determined that these assets were
not going to be further utilized in conducting these operations. This
amount represents the write-down of the book value of the assets, net
of salvage value.
7
<PAGE> 10
KENNAMETAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
- --------------------------------------------------------------------------------
The company also recorded an asset impairment charge of $0.2 million
related to a mining and construction manufacturing operation in China,
as certain assets of this operation were not considered recoverable.
The company accrued $1.4 million related to severance packages provided
to 77 hourly and salaried employees terminated in connection with a
global workforce reduction. The charge for facility rationalization
relates to employee severance for 13 employees and other exit costs
associated with the closure or downsizing of several offices in the
Asia Pacific region and in South America.
The costs related to the asset impairment charges, employee severance
and facility rationalizations of $4.0 million have been recorded as a
component of restructuring and asset impairment charges. The costs
charged against the restructuring cost accrual as of December 31, 1999
were as follows (in thousands):
<TABLE>
<CAPTION>
Initial Cash December 31,
Liability Expenditures Adjustments 1999
--------- ------------ ----------- ------------
<S> <C> <C> <C> <C>
Employee severance $1,368 $(577) $ -- $791
Facility rationalizations 40 -- -- 40
------ ----- ---- ----
Total $1,408 $(577) $ -- $831
====== ===== ==== ====
</TABLE>
The company continues to review its business strategies and pursue
other cost-reduction activities, some of which could result in future
charges.
11. In November 1999, the company repaid its term loan under the Bank
Credit Agreement. This resulted in an acceleration of the write-off of
deferred financing fees of $0.4 million, which was recorded as an
extraordinary item of $0.3 million, net of tax.
12. In the December 1999 quarter, the company engaged an investment bank to
explore strategic alternatives regarding its 83 percent owned
subsidiary, JLK Direct Distribution Inc. (JLK), including a possible
divestiture. Management believes a divestiture may enhance growth
prospects for both the company and JLK by allowing each company to
focus on its core competencies. Management intends to conclude the
evaluation of its alternatives by June 30, 2000. The company is
currently not a party to any written or oral agreement regarding the
divestiture of this business.
13. On December 16, 1999, the company determined that certain performance
measurements in the accounts receivable securitization program
agreement were not met due to an increase in the aging of the accounts
receivable of one of the participating subsidiaries as a result of a
system implementation at that subsidiary. The program sponsor waived
this condition and the agreement was amended to temporarily revise the
performance measurements until May 2000, at which time these
performance measurements revert to the original terms of the agreement.
8
<PAGE> 11
KENNAMETAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
- --------------------------------------------------------------------------------
14. In November 1999, management reorganized the financial reporting of its
operations to focus on global business units consisting of
Metalworking, Engineered Products, Mining & Construction and
JLK/Industrial Supply, and corporate functional shared services. The
results for all periods presented have been restated to conform to the
new reporting structure. The company's external sales, intersegment
sales and operating income by business unit for the three and six
months ended December 31, 1999 and 1998 are as follows (in thousands):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
December 31, December 31,
------------------------ -------------------------
External sales: 1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Metalworking $253,450 $267,890 $495,614 $ 528,727
Engineered Products 43,926 45,459 83,109 90,337
Mining & Construction 39,010 40,678 84,627 86,894
JLK/Industrial Supply 117,542 130,291 233,521 259,282
-------- -------- -------- ----------
Total external sales $453,928 $484,318 $896,871 $ 965,240
======== ======== ======== ==========
Intersegment sales:
Metalworking $ 28,567 $ 28,357 $ 70,470 $ 50,950
Engineered Products 4,988 4,930 9,763 10,947
Mining & Construction 1,122 1,290 3,735 2,470
JLK/Industrial Supply 2,187 3,444 4,523 6,215
-------- -------- -------- ----------
Total intersegment sales $ 36,864 $ 38,021 $ 88,491 $ 70,582
======== ======== ======== ==========
Total sales:
Metalworking $282,017 $296,247 $566,084 $ 579,677
Engineered Products 48,914 50,389 92,872 101,284
Mining & Construction 40,132 41,968 88,362 89,364
JLK/Industrial Supply 119,729 133,735 238,044 265,497
-------- -------- -------- ----------
Total sales $490,792 $522,339 $985,362 $1,035,822
======== ======== ======== ==========
Operating income:
Metalworking $ 26,049 $ 35,575 $ 55,306 $ 64,308
Engineered Products 5,462 6,724 9,258 11,895
Mining & Construction 2,479 3,153 9,306 9,222
JLK/Industrial Supply 7,089 8,937 14,068 15,351
Corporate & Eliminations (9,492) (10,128) (22,512) (22,823)
-------- -------- -------- ----------
Total operating income $ 31,587 $ 44,261 $ 65,426 $ 77,953
======== ======== ======== ==========
</TABLE>
Metalworking operating income for the three and six months ended
December 31, 1999 was reduced by $3.5 million related to asset
impairment charges, and costs associated with employee severance and
product and facility rationalizations. Mining & Construction operating
income for the three and six months ended December 31, 1999 was reduced
by $0.4 million related to asset impairment charges and costs
associated with employee severance. Corporate operating income for the
three and six months ended December 31, 1999 was reduced by $3.0
million and $0.2 million related to environmental remediation costs and
costs associated with employee severance, respectively.
9
<PAGE> 12
KENNAMETAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
- --------------------------------------------------------------------------------
The company's assets by business area at December 31, 1999 and June 30,
1999 are as follows (in thousands):
<TABLE>
<CAPTION>
December 31, 1999 June 30, 1999
----------------- -------------
<S> <C> <C>
Assets:
Metalworking $1,006,458 $1,039,854
Engineered Products 326,026 363,739
Mining & Construction 134,106 146,295
JLK/Industrial Supply 291,293 274,989
Corporate 229,138 218,771
---------- ----------
Total assets $1,987,021 $2,043,648
========== ==========
</TABLE>
10
<PAGE> 13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
- --------------------------------------------------------------------------------
RESULTS OF OPERATIONS
OVERVIEW
Sales for the December 1999 quarter were $453.9 million, a decrease of six
percent from $484.3 million in the year-ago quarter. Sales were down three
percent from the same quarter a year ago excluding the one percent impact of the
divestiture of the Strong Tool Company steel mill supply business and
unfavorable foreign currency translation effects of two percent. The remainder
of the decline was due to weak demand in the company's end markets.
Net income for the quarter ended December 31, 1999 was $8.2 million, or $0.27
per share, compared to net income of $14.0 million, or $0.47 per share, in the
same quarter last year. The results for the quarter ended December 31, 1999 were
reduced by approximately $7.5 million, or $0.14 per share, including $4.1
million, or $0.07 per share, related to restructuring and asset impairment
charges, $3.0 million, or $0.06 per share, related to environmental remediation,
and $0.4 million, or $0.01 per share, related to an extraordinary loss related
to the early extinguishment of debt. The performance for the quarter was in line
with management's expectations and reflects the company's growing success in
implementing operational improvement programs and strong cost controls.
Sales for the six months ended December 31, 1999 were $896.9 million compared to
$965.2 million in the same period a year ago, a decline of seven percent.
Unfavorable foreign currency effects and the divestiture of the Strong Tool
Company steel mill supply business accounted for two and one percent,
respectively, of the sales decline from last year. Net income for the six months
ended December 31, 1999 was $18.2 million, or $0.60 per share, compared to $21.4
million, or $0.72 per share, in the same period last year. Sales and earnings
were affected by the factors mentioned above.
BUSINESS SEGMENT REVIEW
In November 1999, management reorganized the financial reporting of its
operations to focus on global business units consisting of Metalworking,
Engineered Products, Mining & Construction and JLK/Industrial Supply, and
corporate functional shared services. The results for all periods presented have
been restated to conform to the new reporting structure.
METALWORKING
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
December 31, December 31,
------------------------ ------------------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
External sales $253,450 $267,890 $495,614 $528,727
Intersegment sales 28,567 28,357 70,470 50,950
Operating income 26,049 35,575 55,306 64,308
</TABLE>
Sales in the Metalworking segment declined five percent during the December 1999
quarter, compared to the same quarter a year ago. Unfavorable foreign currency
effects accounted for three percent of this decline. Sales in North America were
down two percent compared to last year due to continued weak demand in the
aerospace and agriculture markets, partially offset by strong sales in the
automotive and truck markets.
Sales in the European Metalworking market decreased 16 percent over the same
quarter last year. Unfavorable foreign currency translation effects accounted
for nine percent of this decline. The decline
11
<PAGE> 14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
- --------------------------------------------------------------------------------
in sales was due to weaker customer demand in the German automotive and light
engineering markets, as well as internal plant consolidations and a weak market
in the United Kingdom. Sales in Asia continued to grow and were up 21 percent,
in local currency, compared to the prior year.
Operating income declined to $26.0 million and was affected by lower sales
levels, restructuring and asset impairment charges of $3.5 million, an
unfavorable sales mix and lower production levels. This was partially offset by
continued strong cost controls, improved manufacturing variances, and a
reduction in operating expenses due to the cost improvement program the company
initiated in November 1998. Period costs associated with the Solon, Ohio plant
closure were $0.6 million for the quarter ended December 31, 1999.
For the six months ended December 31, 1999, sales declined six percent compared
to last year due to the same factors mentioned above. Unfavorable foreign
currency effects accounted for two percent of the decline. Operating income
declined to $55.3 million and was affected by the same factors mentioned above.
Period costs associated with the Solon, Ohio plant closure were $2.0 million for
the six months ended December 31, 1999.
ENGINEERED PRODUCTS
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
December 31, December 31,
----------------------- -----------------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
External sales $43,926 $45,459 $83,109 $90,337
Intersegment sales 4,988 4,930 9,763 10,947
Operating income 5,462 6,724 9,258 11,895
</TABLE>
Sales in the Engineered Products market declined three percent compared to last
year due to unfavorable foreign exchange effects. Sales were affected by
increased demand for electronic circuit board drills, offset by year-over-year
weakness in the oil industry. Sales to the energy sector improved sequentially
during the December 31, 1999 quarter. Operating income for the December 31, 1999
quarter declined to $5.5 million due to an unfavorable sales mix and reduced
sales levels, partially offset by improved manufacturing variances.
Compared to a year ago, sales for the six months ended December 31, 1999
declined eight percent, including unfavorable foreign exchange effects of two
percent, due to the factors mentioned above. Operating income declined to $9.3
million also due to the factors mentioned above.
MINING & CONSTRUCTION
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
December 31, December 31,
----------------------- -----------------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
External sales $39,010 $40,678 $84,627 $86,894
Intersegment sales 1,122 1,290 3,735 2,470
Operating income 2,479 3,153 9,306 9,222
</TABLE>
Sales in this segment declined four percent from the December 1998 quarter.
Strong construction tool sales in North America were offset by continued
weakness in the underground coal, energy and in the European construction
markets. Included in the sales decline are unfavorable foreign currency
translation effects of two percent. Operating income decreased to $2.5 million
in the December 31, 1999 quarter due to higher manufacturing variances resulting
from lower sales and production levels, and
12
<PAGE> 15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
- --------------------------------------------------------------------------------
restructuring and asset impairment charges of $0.4 million. This was partially
offset by a favorable sales mix and continued cost control.
Sales for the six months ended December 31, 1999 declined three percent,
including one percent unfavorable foreign exchange effects, compared to the
year-ago period due to the factors mentioned above. Operating income increased
to $9.3 million due to a favorable sales mix and continued cost controls,
partially offset by higher manufacturing variances, restructuring and asset
impairment charges and lower sales volumes.
JLK/INDUSTRIAL SUPPLY
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
December 31, December 31,
------------------------ ------------------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
External sales $117,542 $130,291 $233,521 $259,282
Intersegment sales 2,187 3,444 4,523 6,215
Operating income 7,089 8,937 14,068 15,351
</TABLE>
In this segment, sales declined ten percent from the same quarter a year ago due
to reduced demand in North America and the divestiture of the Strong Tool
Company steel mill business unit. Excluding the divestiture, sales declined
seven percent. In North America, the J&L catalog business continues to be
affected by weak market conditions and from a competitive price environment.
Full Service Supply sales increased two percent compared to the December 1998
quarter, however FSS growth continued to be curtailed by the implementation of
its new business system and from weakness in some accounts. Management has
delayed the implementation of new programs in order to focus attention on
keeping existing customers serviced. The company provided FSS programs to 154
customers covering 247 different facilities at December 31, 1999, compared to
135 customers covering 210 different facilities at December 31, 1998.
Operating income declined to $7.1 million due to lower sales and an unfavorable
sales mix, partially offset by continued operating cost controls. The gross
margin was 31.8 percent compared to 32.2 percent due to a decline in the
higher-margin J&L catalog sales. Operating expenses declined $3.1 million due
primarily to the implementation of several cost reduction initiatives since
December 1998.
For the six months ended December 31, 1999, sales declined ten percent compared
to a year ago. Excluding the divestiture, sales declined seven percent due to
the factors mentioned above. Operating income declined to $14.1 million due to
the factors mentioned above.
GROSS PROFIT MARGIN
The consolidated gross profit margin for the December 1999 quarter was 37.2
percent, compared to 37.4 percent in same quarter in the prior year. Gross
profit margin was essentially unchanged despite an unfavorable sales mix and
lower production levels. Lean manufacturing techniques allowed the company to
improve manufacturing variances despite lower production levels. The December
1999 quarter gross profit margin was negatively affected by $0.6 million of
Solon, Ohio plant closure period costs and $0.1 million for the write-down of
discontinued product lines.
13
<PAGE> 16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
- --------------------------------------------------------------------------------
Consolidated gross profit margin was 37.0 percent for the six months ended
December 31, 1999, compared with 37.3 percent in same period a year ago. Period
costs incurred in fiscal 2000 of $2.0 million related to the Solon, Ohio plant
closure account for the majority of the decline. Excluding these costs, gross
profit margin was affected by the factors mentioned above.
OPERATING EXPENSES
Operating expenses for the December 1999 quarter were $126.7 million, a
reduction of three percent from $130.5 million in the same quarter last year.
Operating expenses for 1999 include a $3.0 million charge for environmental
remediation costs. Excluding this charge, operating expenses for the current
quarter were five percent below the prior year quarter and reflects management's
resolve to control costs. The improvement is due to ongoing cost and
productivity improvement programs.
For the six months ended December 31, 1999, operating expenses of $249.2 million
were eight percent below 1998 levels despite the $3.0 million charge for
environmental remediation costs. Operating expenses improved due to the factors
mentioned above.
RESTRUCTURING AND ASSET IMPAIRMENT CHARGES
In November 1999, the company announced plans to close, consolidate or downsize
several plants, warehouses and offices, and associated workforce reductions as
part of its overall plan to increase asset utilization and financial
performance, and to reposition the company to become the premier tooling
solutions supplier. The company expects to record total one-time charges of $25
to $30 million related to these programs by its fiscal 2000 year-end. Additional
period costs are estimated to be $5 to $6 million and are expected to be
incurred through fiscal 2000 and 2001.
Management implemented several of these programs in the December 1999 quarter.
The costs accrued for the implemented programs were based upon management
estimates using the latest information available at the time that the accrual
was established. The components of the charges are as follows (in thousands):
<TABLE>
<CAPTION>
Initial
Total Asset Restructuring
Charge Write-Downs Liability
------ ----------- -------------
<S> <C> <C> <C>
Asset impairment charges $2,544 $(2,544) $ --
Employee severance 1,368 -- 1,368
Product rationalization 100 (100) --
Facility rationalizations 69 (29) 40
------ ------- ------
Total $4,081 $(2,673) $1,408
====== ======= ======
</TABLE>
In conjunction with the company's ongoing review of underperforming businesses,
certain assets are reviewed for impairment pursuant to the provisions of SFAS
No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of." An asset impairment charge of $1.6 million was
recorded in the December 1999 quarter, related to a metalworking manufacturing
operation in Shanghai, China as it was determined to be impaired.
This operation became fully operational in fiscal 1998 and to date, has not
generated the performance that was expected at the time the company entered into
this market. Management performed an in-depth review of the operations, capacity
utilization and the local management team, and engaged a consultant
14
<PAGE> 17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
- --------------------------------------------------------------------------------
to perform an independent review of the same. These reviews enabled management
to determine that the market served by this operation had eroded compared to the
original expectations, that the operations were in good working order and
utilized modern technology, and that the management team in place was competent.
Management also determined that this facility had excess capacity given the
level of market demand.
Accordingly, management updated its operating forecast to reflect the current
market demand. In comparing the projected cash flows of the updated forecast to
the net book value of the assets of this operation, management determined that
the full value of these assets would not be recoverable. Accordingly, a charge
was recorded to adjust the carrying value of the long-lived assets of this
operation to fair value. The estimated fair value of these assets was based on
various methodologies, including a discounted value of estimated future cash
flows.
The product rationalization charge of $0.1 million represents the write-down of
certain discontinued product lines manufactured in these operations. The company
manufactured these products specifically for the market served by these
operations and management has determined that these products are no longer
salable. This charge has been recorded as a component of cost of goods sold.
The company recorded an asset impairment charge of $0.7 million related to the
write-down of equipment in its North American metalworking operations.
Management completed an assessment of the assets currently being used in these
operations and determined that these assets were not going to be further
utilized in conducting these operations. This amount represents the write-down
of the book value of the assets, net of salvage value.
The company also recorded an asset impairment charge of $0.2 million related to
a mining and construction manufacturing operation in China, as certain assets of
this operation were not considered recoverable.
The company accrued $1.4 million related to severance packages provided to 77
hourly and salaried employees terminated in connection with a global workforce
reduction. The charge for facility rationalization relates to employee severance
for 13 employees and other exit costs associated with the closure or downsizing
of several offices in the Asia Pacific region and in South America.
The costs related to the asset impairment charges, employee severance and
facility rationalizations of $4.0 million have been recorded as a component of
restructuring and asset impairment charges. The costs charged against the
restructuring cost accrual as of December 31, 1999 were as follows (in
thousands):
<TABLE>
<CAPTION>
Initial Cash December 31,
Liability Expenditures Adjustments 1999
--------- ------------ ----------- ------------
<S> <C> <C> <C> <C>
Employee severance $1,368 $(577) $ -- $791
Facility rationalizations 40 -- -- 40
------ ----- ---- ----
Total $1,408 $(577) $ -- $831
====== ===== ==== ====
</TABLE>
The company continues to review its business strategies and pursue other
cost-reduction activities, some of which could result in future charges.
15
<PAGE> 18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
- --------------------------------------------------------------------------------
INTEREST EXPENSE
Interest expense for the December 1999 quarter declined to $13.8 million due to
reduced debt levels, partially offset by higher borrowing rates. Average U.S.
borrowing rates of 6.59 percent were 31 basis points higher compared to a year
ago due to the rising interest rate environment.
Interest expense for the six months ended December 31, 1999 declined to $28.3
million due to reduced debt levels. The average U.S. borrowing rate was flat for
both periods at 6.49 percent, which reflects the higher interest rate
environment in fiscal 2000, offset by improved pricing under the company's Bank
Credit Agreement.
OTHER EXPENSE (INCOME)
Other expense for the December 1999 quarter included fees of $1.3 million
incurred in connection with the accounts receivable securitization program
initiated in June 1999. This was partially offset by gains from the sale of
miscellaneous underutilized assets and dividend income.
For the six months ended December 31, 1999, other expense included fees of $2.5
million related to the accounts receivable securitization program. This was
partially offset by the factors mentioned above and a gain of $1.4 million from
asset sales.
INCOME TAXES
The effective tax rate for the December 1999 quarter was 44.5 percent compared
to 42.5 percent in the prior year. The increase in the effective tax rate is
attributable to the non-recurring utilization of tax benefits from costs to
repay senior debt in fiscal 1999. For the six months ended December 31, 1999,
the effective tax rate was 44.5 percent compared to 42.6 percent in the prior
year. The increase in the effective tax rate is attributable to the factor
mentioned above.
EXTRAORDINARY LOSS ON EARLY EXTINGUISHMENT OF DEBT
In November 1999, the company repaid its term loan under the Bank Credit
Agreement. This resulted in an acceleration of the write-off of deferred
financing fees of $0.4 million, which has been recorded as an extraordinary item
of $0.3 million, net of tax.
LIQUIDITY AND CAPITAL RESOURCES
The company's cash flow from operations is the primary source of financing for
capital expenditures and internal growth. During the six months ended December
31, 1999, the Company generated $113.5 million in cash flow from operations.
Compared to the prior year, cash flow increased significantly due to improved
working capital requirements and higher levels of non-cash items. This was
partially offset by lower net income. The working capital improvement reflects
management's initiatives to reduce working capital and generate strong cash
flow.
Net cash used for investing activities was $15.3 million for the six months
ended December 31, 1999. The decrease in net cash used for investing activities
was due to lower capital expenditures and
16
<PAGE> 19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
- --------------------------------------------------------------------------------
acquisition activity, coupled with increased proceeds from the sale of
underutilized assets. This reduction reflects management's enhanced capital
expenditure approval process and focus on monetizing underutilized assets.
Net cash used for financing activities was $98.3 million for the six months
ended December 31, 1999. This compares to cash flow from financing activities of
$38.2 million in the prior year. The reduction in debt in the December 1999
quarter is attributable to the increase in operating cash flows, as well as the
company's focus on debt repayment.
Through the new management incentive program, management is reinforcing the
focus on cash flow and working capital improvement. Management believes free
operating cash flow (FOCF) is an appropriate measure of the company's cash flow.
The company generated FOCF of $51.5 million and $1.7 million for the quarters
ended December 31, 1999 and 1998, respectively. The company generated $102.0
million for the six months ended December 31, 1999, compared to a use of $25.9
million in the comparative period a year ago. The improvements in FOCF are due
to improved working capital and lower capital expenditures, partially offset by
lower levels of net income.
FOCF is defined as funds from operations minus capital expenditures, plus the
change in working capital (excluding changes in cash, marketable securities and
short-term debt). Funds from operations is defined as net income from continuing
operations plus depreciation, amortization, deferred income taxes and other non-
cash items. Cash flows from operating activities, as defined by generally
accepted accounting principles (GAAP), may be used as a measure of cash flow.
While FOCF is not a GAAP alternative measure of cash flow and may not be
comparable to other similarly titled measures of other companies, the company's
management believes FOCF is a meaningful measure of the company's cash flow.
On December 16, 1999, the company determined that certain performance
measurements in the accounts receivable securitization program agreement were
not met due to an increase in the aging of the accounts receivable of one of the
participating subsidiaries as a result of a system implementation at that
subsidiary. The program sponsor waived this condition and the agreement was
amended to temporarily revise the performance measurements until May 2000, at
which time these performance measurements revert to the original terms of the
agreement.
FINANCIAL CONDITION
Total assets were $2.0 billion at December 31, 1999, a three percent decline
from June 30, 1999. Net working capital was $448.1 million, up 20 percent from
$373.6 million at June 30, 1999. The ratio of current assets to current
liabilities at December 31, 1999 improved to 2.6 compared to 2.0 at June 30,
1999. The improvements in net working capital and the current ratio compared to
June 30, 1999 is due to the repayment of short-term debt. The total
debt-to-total-capital ratio declined to 48.9 percent as of December 31, 1999
from 51.9 percent as of June 30, 1999 due to the FOCF generated by the company
during the six months ended December 31, 1999.
One of the features of the new management incentive program is the focus on the
more efficient use of working capital to generate sales. Management believes the
ratio of primary working capital as a percentage of sales (PWC%) is appropriate
for measuring the company's efficiency in utilizing working capital to generate
sales. The company's PWC% at December 31, 1999 was 30.9 percent, compared to
34.9 percent at June 30, 1999 and 35.5 percent at December 31, 1998. The
improvement in PWC% is due to lower primary working capital, partially offset by
lower sales levels.
17
<PAGE> 20
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
- --------------------------------------------------------------------------------
Primary working capital (PWC) is defined as inventory plus accounts receivable,
less accounts payable. PWC% is calculated by averaging beginning of the year and
quarter-end balances for PWC, divided by annualized sales. Other asset turnover
ratios, as defined by GAAP, may be used to measure asset utilization efficiency.
While PWC% is not a GAAP alternative measure of asset utilization efficiency and
may not be comparable to other similarly titled measures of other companies, the
company's management believes PWC% is a meaningful measure of the company's
efficiency in utilizing working capital to generate sales.
STRATEGIC ALTERNATIVES
In the December 1999 quarter, the company engaged an investment bank to explore
strategic alternatives regarding its 83 percent owned subsidiary, JLK Direct
Distribution Inc. (JLK), including a possible divestiture. Management believes a
divestiture may enhance growth prospects for both the company and JLK by
allowing each company to focus on its core competencies. Management intends to
conclude the evaluation of its alternatives by June 30, 2000. The company is
currently not a party to any written or oral agreement regarding the divestiture
of this business.
ENVIRONMENTAL
The company has been involved in various environmental cleanup and remediation
activities at several of its manufacturing facilities. In addition, the company
is currently named as a potentially responsible party (PRP) at several Superfund
sites in the United States. In the December 1999 quarter, the company recorded a
remediation reserve of $3.0 million with respect to its involvement in these
matters, which is recorded as a component of operating expenses. This represents
management's best estimate of its future obligation based on its evaluations and
discussions with outside counsel and independent consultants, and the current
facts and circumstances related to these matters. The company has recorded this
liability in the December quarter because certain events occurred, including
sufficient progress made by the government and the PRPs in the identification of
other PRPs and review of potential remediation solutions, that clarified the
level of involvement in these matters by the company and its relationship to
other PRPs. This led the company to conclude that it was probable that a
liability had been incurred.
In addition to the amount currently reserved, the company may be subject to loss
contingencies related to these matters estimated to be up to an additional $3.3
million. The company believes that such unreserved losses are reasonably
possible but are not currently considered to be probable of occurrence. The
reserved and unreserved liabilities may change substantially in the near term
due to factors such as the nature and extent of contamination, changes in
remedial requirements, technological changes, discovery of new information, the
financial strength of other PRPs and the identification of new PRPs.
The company maintains a Corporate Environmental, Health and Safety (EH&S)
Department, as well as an EH&S Policy Committee, to ensure compliance with
environmental regulations and to monitor and oversee remediation activities. In
addition, the company has established an EH&S administrator at its domestic
manufacturing facilities. The company's financial management team periodically
meets with members of the Corporate EH&S Department and the Corporate Legal
Department to review and evaluate the status of environmental projects and
contingencies. On a quarterly and annual basis, management establishes or
adjusts financial provisions and reserves for environmental contingencies in
accordance with Statement of Financial Accounting Standards (SFAS) No. 5,
"Accounting for Contingencies."
18
<PAGE> 21
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
- --------------------------------------------------------------------------------
YEAR 2000
Management believes that the company substantially mitigated its exposure
relative to year 2000 issues for both information and non-information technology
systems. The transition into the year 2000 resulted in no significant impact to
the financial position or operations of the company.
The company initiated a program beginning in 1996 to assess the exposure to the
year 2000 issue, and to prepare its computer systems, computer applications and
other systems for the year 2000. A management committee actively monitored the
status of the readiness program of each of the company's business units. The
company completed the tasks identified to remediate its mission critical systems
and processes.
Year 2000 exposure related to information systems was mitigated throughout key
metalworking and mining and construction operations through the implementation
of SAP R3 for most business processes. The company completed the process of
modifying existing non-compliant business systems in its industrial product and
engineered product operations to ensure these operations are supported by a year
2000 compliant information system. These modifications were completed and tested
by September 1999.
At JLK, HK Systems' Enterprise Information System was implemented and tested by
August 1999 in the FSS business to address the year 2000 issue. The company
modified the existing non-compliant systems in the catalog business to ensure
that J&L is supported by a year 2000 compliant information system. Testing of
these modifications was performed in September 1999.
The company also completed an assessment of the impact of this issue on its
non-information technology systems, including the company's personal computers,
embedded technology in manufacturing and processing equipment, and other
non-information technology items. All non-year 2000 compliant systems were
identified and remediated through replacement of or modification to the existing
systems. Such remedies were tested for year 2000 compliance in September 1999.
Contingency plans included shifting production processes to year 2000 compliant
manufacturing operations. The company was not required to employ this
contingency plan.
The company estimates the total year 2000 expenditures were approximately $53.0
million, approximately half of which were for computer hardware to replace
non-compliant computer systems and the other half to replace non-compliant
computer software, including software implementation and employee training.
These costs included both internal and external personnel costs related to the
assessment and remediation processes, as well as the cost of purchasing certain
hardware and software.
The majority of these costs were incurred in 1997 and 1996. Expenditures
incurred to date in fiscal 2000 approximate $3.5 million. The company does not
anticipate incurring additional expenditures related to year 2000 issues. Cash
flows from operations provided funding for these expenditures.
Management believed the most significant impact of the year 2000 issue would
have been an interrupted supply of goods and services from the company's
vendors. The company had an ongoing effort to gain assurances and certifications
of suppliers' readiness programs. To date, the company's suppliers continue to
provide the company with sufficient goods and services in the year 2000. There
were no failures by major third-party businesses and public and private
providers of infrastructure services, such as utilities, communications services
and transportation that affected the company during the transition to the year
2000. Contingency plans included purchasing raw materials and supplies from
alternate
19
<PAGE> 22
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
- --------------------------------------------------------------------------------
certified vendors and a further increase of safety stock of critical materials
and supplies. The company was not required to employ these contingency plans.
There can be no guarantee that the efforts of the company or of third parties,
whose systems the company relies upon, will completely mitigate any year 2000
problem that could have a material adverse affect on the company's operations or
financial results. While such problems could affect important operations of the
company and its subsidiaries, either directly or indirectly, in a significant
manner, the company cannot at present estimate either the likelihood or the
potential cost of such failures. However, the company will continue to
aggressively pursue remediation of any newly discovered year 2000 problem.
OUTLOOK
In looking to the third quarter of fiscal 2000, management expects Kennametal's
consolidated sales to increase by six to nine percent over the December 1999
quarter as sales in the second half of the fiscal year are typically higher than
in the first half. Demand in most end markets is expected to remain weak,
however, management sees continued strength in auto and improvement in energy.
Management will continue to focus on operational improvement programs and cost
discipline.
FORWARD-LOOKING STATEMENTS
This Form 10-Q contains "forward-looking statements" as defined by Section 21E
of the Securities Exchange Act of 1934. Actual results may differ materially
from those expressed or implied in the forward-looking statements. Factors that
could cause actual results to differ materially include, but are not limited to,
the extent that the economic conditions in the United States and Europe, and to
a lesser extent, Asia Pacific are not sustained, risks associated with
integrating businesses, demands on management resources, risks associated with
international markets such as currency exchange rates, competition,
risks associated with the implementation of restructuring actions and
environmental remediation, the effect of third party or company failures to
achieve timely remediation of year 2000 issues, and the effect of the conversion
to the Euro on the company's operations. The company undertakes no obligation to
publicly release any revisions to forward-looking statements to reflect events
or circumstances occurring after the date hereof.
20
<PAGE> 23
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- --------------------------------------------------------------------------------
During the September 1999 quarter, the company entered into two interest rate
swap agreements that effectively convert a notional amount of $50.0 million from
floating to fixed interest rates. This increases the total notional amount of
floating-to-fixed interest rate swaps to $100.0 million. These new agreements
mature in July 2002.
At December 31, 1999, the company would have received $2.2 million to settle all
interest rate swap agreements, representing the excess of fair value over the
carrying cost of these agreements. The effect of all interest rate swaps on the
company's composite interest rate on long-term debt was not material at December
31, 1999.
At December 31, 1999, the company had a notional amount of $21.4 million of
outstanding foreign exchange forward contracts to sell foreign currency. These
contracts mature before March 31, 1999. The net unrealized loss on foreign
currency contracts was $1.1 million at December 31, 1999. A hypothetical 10
percent change in the applicable December 31, 1999 quarter-end forward rates
would result in an increase or decrease in pretax income of approximately $2.2
million related to these positions.
There were no other material changes in the company's exposure to market risk
from June 30, 1999.
21
<PAGE> 24
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- --------------------------------------------------------------------------------
The information set forth in Part II, Item 4 of the company's September 30, 1999
Form 10-Q is incorporated by reference herein.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
- --------------------------------------------------------------------------------
(a) Exhibits
(10) Material Contracts
10.1 Kennametal Inc. Stock Option and Incentive
Plan of 1999 is incorporated herein by
reference to Exhibit A of the company's 1999
Proxy Statement.
(27) Financial Data Schedule for the six months ended
December 31, 1999, submitted to the Securities and
Exchange Commission in electronic format. Filed
herewith.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the quarter ended
December 31, 1999.
22
<PAGE> 25
SIGNATURES
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.
KENNAMETAL INC.
Date: February 11, 2000 By: /s/ FRANK P. SIMPKINS
------------------------
Frank P. Simpkins
Corporate Controller and
Chief Accounting Officer
23
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the December
31, 1999 Condensed Consolidated Financial Statements (unaudited) and is
qualified in its entirety by reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> JUN-30-2000
<PERIOD-START> JUL-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 17,258
<SECURITIES> 10,113
<RECEIVABLES> 238,648
<ALLOWANCES> 14,626
<INVENTORY> 417,473
<CURRENT-ASSETS> 729,240
<PP&E> 968,823
<DEPRECIATION> 450,085
<TOTAL-ASSETS> 1,987,021
<CURRENT-LIABILITIES> 281,181
<BONDS> 0
0
0
<COMMON> 41,242
<OTHER-SE> 710,926
<TOTAL-LIABILITY-AND-EQUITY> 1,987,021
<SALES> 896,871
<TOTAL-REVENUES> 896,871
<CGS> 564,675
<TOTAL-COSTS> 564,675
<OTHER-EXPENSES> 22,936
<LOSS-PROVISION> 1,543
<INTEREST-EXPENSE> 28,280
<INCOME-PRETAX> 36,894
<INCOME-TAX> 16,418
<INCOME-CONTINUING> 18,424
<DISCONTINUED> 0
<EXTRAORDINARY> 267
<CHANGES> 0
<NET-INCOME> 18,157
<EPS-BASIC> 0.60
<EPS-DILUTED> 0.60
</TABLE>
