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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, 1998
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, 1999
- ---------------------------------------- -------------------------------
Capital Stock, par value $1.25 per share 29,892,541
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KENNAMETAL INC.
FORM 10-Q
FOR QUARTER ENDED DECEMBER 31, 1998
TABLE OF CONTENTS
Item No. Page
- -------- ----
PART I. FINANCIAL INFORMATION
1. Financial Statements:
Condensed Consolidated Balance Sheets (Unaudited)
December 31, 1998 and June 30, 1998................................... 1
Condensed Consolidated Statements of Income (Unaudited)
Three and six months ended December 31, 1998 and 1997................. 2
Condensed Consolidated Statements of Cash Flows (Unaudited)
Six months ended December 31, 1998 and 1997........................... 3
Notes to Condensed Consolidated Financial Statements
(Unaudited) ........................................................ 4
2. Management's Discussion and Analysis of Financial Condition
and Results of Operations............................................ 8
PART II. OTHER INFORMATION
4. Submission of Matters to a Vote of Security Holders.................. 14
6. Exhibits and Reports on Form 8-K..................................... 14
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
KENNAMETAL INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
- ------------------------------------------------------------------------------------------------------------------
(in thousands)
December 31, June 30,
1998 1998
------------ --------
ASSETS
Current assets:
Cash and equivalents $ 29,311 $ 18,366
Accounts receivable, less allowance for
doubtful accounts of $13,935 and $11,974 333,235 332,677
Inventories 465,154 436,472
Deferred income taxes 32,104 31,316
----------- -----------
Total current assets 859,804 818,831
----------- -----------
Property, plant and equipment:
Land and buildings 238,653 222,426
Machinery and equipment 755,313 690,143
Less accumulated depreciation (436,293) (386,642)
----------- -----------
Net property, plant and equipment 557,673 525,927
----------- -----------
Other assets:
Investments in affiliated companies 3,652 13,740
Intangible assets, less accumulated
amortization of $51,209 and $39,408 692,836 706,619
Deferred income taxes 33,219 39,426
Other 39,652 34,450
----------- -----------
Total other assets 769,359 794,235
----------- -----------
Total assets $ 2,186,836 $ 2,138,993
=========== ===========
LIABILITIES
Current liabilities:
Current maturities of long-term debt and capital leases $ 115,224 $ 78,632
Notes payable to banks 55,571 48,103
Accounts payable 96,678 115,373
Accrued payroll 18,660 30,600
Accrued vacation pay 27,197 21,523
Other current liabilities 89,165 82,838
----------- -----------
Total current liabilities 402,495 377,069
----------- -----------
Long-term debt and capital leases, less current maturities 846,459 840,932
Deferred income taxes 45,280 45,253
Other liabilities 90,890 98,073
----------- -----------
Total liabilities 1,385,124 1,361,327
----------- -----------
Minority interest in consolidated subsidiaries 52,833 42,206
----------- -----------
SHAREHOLDERS' EQUITY
Preferred stock, 5,000 shares authorized; none issued -- --
Capital stock, $1.25 par value; 70,000 shares authorized;
32,820 shares issued 41,025 41,025
Additional paid-in capital 321,612 320,645
Retained earnings 470,080 458,805
Treasury shares, at cost; 2,929 and 2,991 shares held (58,353) (59,131)
Accumulated other comprehensive income (25,485) (25,884)
----------- -----------
Total shareholders' equity 748,879 735,460
----------- -----------
Total liabilities and shareholders' equity $ 2,186,836 $ 2,138,993
=========== ===========
See accompanying notes to condensed consolidated financial statements.
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KENNAMETAL INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
- ---------------------------------------------------------------------------------------------------------------------------
(in thousands, except per share data)
Three Months Ended Six Months Ended
December 31, December 31,
------------------ ----------------
1998 1997 1998 1997
---- ---- ---- ----
OPERATIONS
Net sales $ 484,318 $ 370,048 $ 965,240 $ 680,840
Cost of goods sold 303,256 219,546 605,162 398,115
--------- --------- --------- ---------
Gross profit 181,062 150,502 360,078 282,725
Research and development expenses 5,239 4,956 10,810 10,183
Selling, marketing and distribution expenses 97,812 79,056 200,296 147,627
General and administrative expenses 27,489 23,816 58,353 48,536
Amortization of intangibles 6,261 2,713 12,666 3,765
--------- --------- --------- ---------
Operating income 44,261 39,961 77,953 72,614
Interest expense 17,635 18,693 35,256 19,873
Other (income) expense (223) 221 193 661
--------- --------- --------- ---------
Income before income taxes and minority interest 26,849 21,047 42,504 52,080
Provision for income taxes 11,400 10,000 18,100 22,100
Minority interest 1,413 1,473 2,974 2,858
--------- --------- --------- ---------
Net income $ 14,036 $ 9,574 $ 21,430 $ 27,122
========= ========= ========= =========
PER SHARE DATA
Basic earnings per share $ 0.47 $ 0.36 $ 0.72 $ 1.03
========= ========= ========= =========
Diluted earnings per share $ 0.47 $ 0.36 $ 0.72 $ 1.02
========= ========= ========= =========
Dividends per share $ 0.17 $ 0.17 $ 0.34 $ 0.34
========= ========= ========= =========
Weighted average shares outstanding 29,878 26,273 29,868 26,223
========= ========= ========= =========
Diluted weighted average shares outstanding 29,889 26,669 29,915 26,565
========= ========= ========= =========
See accompanying notes to condensed consolidated financial statements.
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KENNAMETAL INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
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(in thousands)
Six Months Ended
December 31,
-------------------
1998 1997
---- ----
OPERATING ACTIVITIES
Net income $ 21,430 $ 27,122
Adjustments for noncash items:
Depreciation and amortization 47,415 25,060
Other 9,327 3,775
Changes in certain assets and liabilities, net of effects of acquisitions:
Accounts receivable 17,396 218
Inventories (22,677) (8,796)
Accounts payable and accrued liabilities (27,507) 17,501
Other (11,268) (25,497)
--------- ---------
Net cash flow from operating activities 34,116 39,383
--------- ---------
INVESTING ACTIVITIES
Purchases of property, plant and equipment (61,681) (29,307)
Disposals of property, plant and equipment 2,515 1,226
Acquisitions, net of cash -- (711,609)
Other (2,384) (7,609)
--------- ---------
Net cash used for investing activities (61,550) (747,299)
--------- ---------
FINANCING ACTIVITIES
Change in short-term debt 5,441 (92,750)
Increase in long-term debt 88,609 758,238
Reduction in long-term debt (47,109) (31,458)
Net proceeds from issuance and sale of subsidiary stock -- 90,430
Dividend reinvestment and employee stock plans 1,745 8,606
Cash dividends paid to shareholders (10,155) (8,923)
Other (298) (7,369)
--------- ---------
Net cash flow from financing activities 38,233 716,774
--------- ---------
Effect of exchange rate changes on cash 146 (1,462)
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CASH AND EQUIVALENTS
Net increase in cash and equivalents 10,945 7,396
Cash and equivalents, beginning 18,366 21,869
--------- ---------
Cash and equivalents, ending $ 29,311 $ 29,265
========= =========
SUPPLEMENTAL DISCLOSURES
Interest paid $ 37,234 $ 16,030
Income taxes paid 14,779 22,708
See accompanying notes to condensed consolidated financial statements.
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KENNAMETAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
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1. The condensed consolidated financial statements should be read in
conjunction with the Notes to Consolidated Financial Statements included in
the company's 1998 Annual Report. The condensed consolidated balance sheet
as of June 30, 1998 has been derived from the audited balance sheet
included in the company's 1998 Annual Report. These 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 months and six months
ended December 31, 1998 are not necessarily indicative of the results to be
expected for the full fiscal year. Certain amounts in the prior years'
condensed 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 50 percent of total inventories at December
31, 1998. 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):
December 31, June 30,
1998 1998
------------ --------
Finished goods $ 336,604 $ 302,374
Work in process and powder blends 110,880 117,428
Raw materials and supplies 55,341 53,449
-------- ---------
Inventory at current cost 502,825 473,251
Less LIFO valuation (37,671) (36,779)
--------- ---------
Total inventories $ 465,154 $ 436,472
========= =========
4. The company has been involved in various environmental cleanup and
remediation activities at several of its manufacturing facilities. In
addition, the company has been named as a potentially responsible party at
five Superfund sites in the United States. However, it is management's
opinion, based on its evaluations and discussions with outside counsel and
independent consultants, that the ultimate resolution of these
environmental matters will not have a material adverse effect on the
results of operations, financial position or cash flows of the company.
The company maintains a Corporate Environmental, Health and Safety (EH&S)
Department to facilitate compliance with environmental regulations and to
monitor and oversee remediation activities. In addition, the company has
established an EH&S administrator at each of 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 average 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 10,783 and 395,907 for the three months ended December 31,
1998 and 1997, respectively, and 46,956 and 342,389 for the six months
ended December 31, 1998 and 1997, respectively.
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KENNAMETAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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6. In June 1997, the Financial Accounting Standards Board issued SFAS No. 130,
"Reporting Comprehensive Income," which requires the presentation of
comprehensive income in a company's financial statement disclosures.
Comprehensive income represents all changes in the equity of a company
during the reporting period, including net income, as well as charges and
credits directly to retained earnings which are excluded from net income.
The company's components of comprehensive income consist of the following
(in thousands):
Three Months Ended Six Months Ended
December 31, December 31,
-------------------- --------------------
1998 1997 1998 1997
---- ---- ---- ----
Net income $ 14,036 $ 9,574 $ 21,430 $ 27,122
Foreign currency translation adjustments 2,925 (3,924) 399 (5,242)
-------- -------- -------- --------
Comprehensive income $ 16,961 $ 5,650 $ 21,829 $ 21,880
======== ======== ======== ========
Accumulated other comprehensive income consists solely of cumulative
foreign currency translation adjustments.
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 year 2000. SFAS No. 133
establishes accounting and reporting standards requiring all derivative
instruments (including certain derivative instruments imbedded in other
contracts) are to 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 criteria are met. Accounting for qualifying
hedges allow 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. On July 2, 1997, an initial public offering (IPO) of approximately 4.9
million shares of common stock of JLK Direct Distribution Inc. (JLK), a
subsidiary of the company, was consummated at a price of $20.00 per share.
JLK's operations consist of the company's wholly owned subsidiary J&L
Industrial Supply (J&L) and its Full Service Supply programs. The net
proceeds from the offering were approximately $90.4 million and represented
approximately 20 percent of JLK's common stock. The transaction has been
accounted for as a capital transaction in the consolidated financial
statements. The net proceeds were used by JLK to repay $20.0 million of
indebtedness related to a dividend to the company and $20.0 million related
to intercompany obligations to the company incurred in 1997. The company
used these proceeds to repay short-term debt. Pending other uses, the
remaining net proceeds were loaned to the company, under an intercompany
debt/investment and cash management agreement at a fluctuating rate of
interest equal to the company's short-term borrowing costs. The remaining
net proceeds of $50.4 million were used to make acquisitions in 1998.
9. On November 17, 1997, the company completed the acquisition of Greenfield
Industries, Inc. (Greenfield) for approximately $1.0 billion, including
$324.4 million in assumed Greenfield debt and convertible redeemable
preferred securities and transaction costs.
The Greenfield acquisition was recorded using the purchase method of
accounting and, accordingly, the results of operations of Greenfield have
been included in the company's results from the date of acquisition. The
purchase price was allocated to assets acquired and liabilities assumed
based on their estimated fair values at the date of acquisition. The excess
of purchase price over the fair value of the net assets acquired has been
recorded as goodwill and is being amortized over forty years.
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KENNAMETAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
- -------------------------------------------------------------------------------
Additionally, the company made several other acquisitions in 1998 to expand
its product offering and distribution channels. These acquisitions were
accounted for using the purchase method of accounting and their results
have been included in the company's results from the respective dates of
acquisition. Except for Greenfield, the pro forma effects, individually and
collectively, of the acquisitions in the company's consolidated financial
statements would not have a material impact on the reported results.
The allocation of the purchase price to assets acquired and liabilities
assumed of Greenfield is as follows (in thousands):
Working capital, other than cash $ 171,710
Property, plant and equipment 167,798
Other assets 9,246
Other liabilities (28,510)
Long-term debt (318,146)
Goodwill 654,117
----------
Net purchase price $ 656,215
==========
Pro forma results of operations for the acquisition of Greenfield, but
excluding the effects of all other acquisitions, are based on the
historical financial statements of the company and Greenfield adjusted to
give effect to the acquisition of Greenfield. The pro forma results of
operations assume that the acquisition of Greenfield occurred as of the
first day of the company's 1998 fiscal year (July 1, 1997).
Three Months Ended Six Months Ended
(in thousands, except per share data) December 31, 1997 December 31, 1997
------------------ -----------------
Net sales $ 464,972 $ 915,600
Net income 5,754 19,500
Basic earnings per share 0.22 0.75
Diluted earnings per share 0.22 0.74
The pro forma financial information does not purport to present what the
company's results of operations would actually have been if the acquisition
of Greenfield had occurred on the assumed date, as specified above, or to
project the company's financial condition or results of operations for any
future period.
On June 26, 1998, the company sold the Marine Products division of
Greenfield which operated as Rule Industries, Inc. (Rule). The company
acquired Rule as part of its acquisition of Greenfield and, for strategic
reasons, chose to divest itself of this part of the business. Annual sales
of the Marine Products division were approximately $25.0 million. Cash
proceeds of $62.1 million were used to reduce a portion of the company's
long-term debt incurred in connection with the acquisition of Greenfield
(see Note 10).
10. In connection with the acquisition of Greenfield, the company entered into
a $1.4 billion Bank Credit Agreement (Agreement). Subject to certain
conditions, the Agreement permits term loans of up to $500.0 million and
revolving credit loans of up to $900.0 million for working capital, capital
expenditures and general corporate purposes. Interest payable under the
term loan and revolving credit loans are currently based on LIBOR plus
1.125%. The Agreement also includes a commitment fee on the revolving
credit loans of 0.25% of the unused balance.
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KENNAMETAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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The Agreement also contains various restrictive and affirmative covenants
requiring the maintenance of certain financial ratios. The term loan is
subject to mandatory amortization which commenced on November 30, 1998 and
matures on August 31, 2002. The revolving credit loan also matures on
August 31, 2002. During fiscal 1998, the term loan was permanently reduced
with the net proceeds received in connection with the issuance of company
stock and from the sale of certain assets (see Notes 9 and 11).
11. On March 20, 1998, the company sold 3.45 million shares of common stock
resulting in net proceeds of $171.4 million. The proceeds were used to
reduce a portion of the company's long-term debt incurred in connection
with the acquisition of Greenfield (see Note 10).
12. On January 18, 1999, the company entered into a business cooperation
agreement with Toshiba Tungaloy Co., Ltd. (TT) to enhance the global
business prospects for metalcutting tools of both companies. The agreement
includes various joint activities in areas such as product development,
research and development, private labeling, cross-licensing, and sales and
marketing. As part of the agreement, the company purchased approximately
4.9% of the outstanding shares of TT in a private transaction from TT's
largest shareholder, Toshiba Corporation, for approximately $16.1 million,
including the costs of the transaction. In accordance with accounting
rules, the company will realize a loss of approximately $3.7 million in the
March 1999 quarter due to the difference between the cost and the fair
market value of the securities on the date the securities were purchased.
The investment will be accounted for as an available-for-sale security
under SFAS No. 115, "Accounting for Certain Investments in Debt and Equity
Securities."
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
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RESULTS OF OPERATIONS
SALES AND EARNINGS
During the quarter ended December 31, 1998, consolidated sales were $484.3
million, up 31 percent from $370.0 million in the same quarter last year. The
increase in sales was primarily attributable to the acquisition of Greenfield
and other companies, which accounted for $134.4 million of sales in the quarter
ended December 31, 1998. Excluding acquisitions, sales were 4 percent lower due
to reduced industrial demand of the company's metalworking products in North
America. This was partially offset by stronger demand in the European
metalworking market.
Net income for the quarter ended December 31, 1998, was $14.0 million, or $0.47
per share, as compared with net income of $9.6 million, or $0.36 per share in
the same quarter last year. The results for the quarter ended December 31, 1997
were reduced by approximately $10.6 million or $0.40 per share related to the
net effects of the Greenfield acquisition, including one-time costs of $4.6
million or $0.18 per share. Excluding the one-time costs for the December 1997
quarter, net income was negatively affected by lower sales in traditional
Kennametal markets, lower earnings at JLK and higher interest and amortization
expense related to acquisitions. This was partially offset by cost-reduction
actions implemented in November 1998.
During the six-month period ended December 31, 1998, consolidated sales were
$965.2 million, up 42 percent from $680.8 million last year. Net income was
$21.4 million, or $0.72 per share, compared to $27.1 million, or $1.02 per share
last year.
The following table presents the Company's sales by geographic area (in
thousands):
Three Months Ended Six Months Ended
December 31, December 31,
------------------------------- -------------------------------
1998 1997 % Change 1998 1997 % Change
---- ---- -------- ---- ---- --------
Sales(1):
Metalworking:
North America $ 93,383 $101,565 (8)% $184,901 $200,656 (8)%
Europe 75,423 65,166 16 145,463 120,821 20
Asia Pacific 9,568 11,771 (19) 18,877 23,524 (20)
Industrial Products 88,172 32,961 168 176,917 32,961 437
Engineered Products & Other 45,459 27,406 66 90,337 36,721 146
JLK/Industrial Supply 130,291 91,132 43 259,282 183,917 41
Mining and Construction 42,022 40,047 5 89,463 82,240 9
-------- -------- --- -------- -------- ---
Net sales $484,318 $370,048 31% $965,240 $680,840 42%
======== ======== === ======== ======== ===
By Geographic Area:
Within the United States $319,313 $239,214 33% $652,201 $449,177 45%
International 165,005 130,834 26 313,039 231,663 35
-------- -------- --- -------- -------- ---
Net sales $484,318 $370,048 31% $965,240 $680,840 42%
======== ======== === ======== ======== ===
(1) Certain amounts in prior period sales have been reclassified to conform to the current year presentation.
METALWORKING
During the December 1998 quarter, sales in the North America Metalworking market
decreased 8 percent from the previous year due to reduced demand by customers in
the aerospace, agriculture equipment, light engineering, oil field services and
other markets. Sales of Kennametal traditional metalcutting products sold
through all sales channels in North America, including sales through the JLK
market, decreased 4 percent during the quarter.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
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Sales in the Europe Metalworking market grew 16 percent over the same quarter of
a year ago due to stronger demand, acquisitions and favorable foreign currency
translation effects. Demand for metalworking products continued to show gains in
the automotive and truck industries, though these gains were less robust than in
the previous quarter. Acquisition-related sales accounted for $7.2 million,
while favorable foreign currency translation effects were 4 percent during the
quarter. The acquisition-related sales were a result of the company's July 1,
1998 purchase of an increased ownership of affiliated companies in Italy.
In the Asia Pacific Metalworking market, sales declined 10 percent on a local
currency basis during the quarter. Sales continued to be affected by weak
economic conditions across most Asia Pacific countries. Including unfavorable
foreign currency translation effects, sales in the Asia Pacific Metalworking
market decreased 19 percent.
Sales in the Industrial Products market increased due to the inclusion of two
additional months of sales related to the acquisition of Greenfield which
occurred on November 17, 1997. On a comparable basis, demand for Greenfield
Industrial Products rose 1 percent during the quarter due to increased demand of
industrial products sold in consumer markets as a result of new sales programs.
Sales in the Greenfield Engineered Products and Other market increased due to
the inclusion of two additional months of sales related to the acquisition of
Greenfield which occurred on November 17, 1997, partially offset by the
divestiture of the Marine Products division in June 1998. On a comparable basis,
demand for Greenfield Engineered Products and Other declined 15 percent during
the quarter due to continued weak market conditions in the oil field services
industry and in electronic circuit board manufacturing.
For the six-month period ended December 31, 1998, sales in the North America
Metalworking market decreased 8 percent, sales in the Europe Metalworking market
increased 20 percent and sales in the Asia Pacific Metalworking market decreased
20 percent.
JLK/INDUSTRIAL SUPPLY
Sales at JLK rose 43 percent primarily because of acquisitions, which accounted
for approximately $39.2 million of the sales gain. Excluding the effects of
acquisitions and the General Electric (GE) Contract disengagement, sales at JLK
increased 4 percent primarily due to higher sales to Full Service Supply
customers. The December 1997 quarter was the last quarter significantly affected
by the GE Contract disengagement. Sales to GE in the December 1997 quarter
amounted to $3.8 million. Overall, sales were affected by reduced industrial
demand across North America and weakness in the oil field services industry.
Additionally, a new showroom was opened in Buffalo, New York and 14 new Full
Service Supply contracts were added during this quarter.
For the six-month period ended December 31, 1998, sales in the Industrial Supply
market increased 41 percent.
MINING AND CONSTRUCTION
During the December 1998 quarter, sales in the Mining and Construction market
increased 5 percent from a year ago and benefited from the Greenfield
acquisition. Excluding Greenfield, sales declined 5 percent as a result of lower
sales of metallurgical powders used in the oil field services industry.
For the six-month period ended December 31, 1998, sales in the Mining and
Construction market increased 9 percent.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
- -------------------------------------------------------------------------------
GROSS PROFIT MARGIN
As a percentage of sales, the gross profit margin for the December 1998 quarter
was 37.4 percent as compared with 40.7 percent in the prior year. Excluding the
effects of Greenfield, the gross margin would have been 40.5 percent. The gross
profit margin was affected by costs associated with plant consolidations and
rearrangements, lower-margin sales from acquired companies and an unfavorable
sales mix, partially offset by favorable foreign currency translation effects.
For the six-month period ended December 31, 1998, the gross profit margin was
37.3 percent, compared with 41.5 percent last year.
OPERATING EXPENSES
For the December 1998 quarter, operating expenses as a percentage of sales were
27.0 percent compared to 29.1 percent last year. Excluding the effects of
Greenfield, the operating expense ratio would have been 30.3 percent. Operating
expenses were affected by acquisitions, cost-reduction actions implemented in
November 1998 and other programs. These cost-reduction actions involved salaried
work force reductions, salary reductions, rationalization of several JLK
acquired locations and other measures.
The increase in the level of operating expenses is attributed to the inclusion
of operating expenses of acquired companies, the JLK expansion program, and
other programs. Additionally, amortization of intangibles increased
approximately $3.5 million related to the acquisition of Greenfield and other
companies.
For the six-month period ended December 31, 1998, the operating expenses as a
percentage of sales were 27.9 percent, compared with 30.3 percent last year. The
prior-year results include additional expenses of $5.5 million for the
completion of the company's world headquarters project. On an absolute dollar
basis, the increase in operating expenses is attributable to the acquisitions,
the JLK expansion program, including costs to relocate JLK's office and
warehouse in the United Kingdom, facility rationalizations and other programs.
These increases were partially offset by cost-reduction actions implemented in
November 1998. Additionally, amortization of intangibles increased approximately
$8.9 million related primarily to the acquisition of Greenfield and other
companies.
INTEREST EXPENSE
Interest expense in the December 1997 quarter included one-time costs of $8.0
million for the amortization of deferred bank financing fees related to the
acquisition of Greenfield. Excluding this one-time cost, interest expense
increased $6.9 million, due to higher average borrowings during the quarter.
For the six-month period ended December 31, 1998, interest expense was $35.3
million, compared with $19.9 million last year.
INCOME TAXES
The effective tax rate for the December 1998 quarter was 42.5 percent compared
to an effective tax rate of 47.5 percent in the second quarter of a year ago.
The effective tax rate in the prior year increased significantly due to the
alignment of the annual effective tax rate as a result of higher, nondeductible
goodwill related to the Greenfield acquisition.
For the six-month period ended December 31, 1998, the effective tax rate was
42.6 percent, compared with 42.4 percent last year.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
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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, 1998, the Company generated $34.1 million in cash from operations. The
decrease in cash provided by operations compared to the same period a year ago
resulted primarily from lower net income and increased working capital
requirements, offset in part by higher noncash items.
Net cash used for investing activities was $61.6 million. Compared to the prior
year, the decrease in net cash used for investing activities was due to a
reduction in the level of acquisition activity in the first six-months of fiscal
1999. Cash used for investing activities during this same period consisted of
higher capital expenditures to upgrade machinery and equipment and to acquire
additional client-server information systems.
Net cash from financing activities was $38.2 million. The decrease in net cash
from financing activities compared to the same period a year ago was a result of
increased borrowings in fiscal 1998 under the company's bank credit agreement to
finance the acquisition of Greenfield including the assumption of Greenfield's
debt, as well as the net proceeds from the issuance and sale of common stock of
the company's JLK subsidiary.
On January 18, 1999, the company entered into a business cooperation agreement
with Toshiba Tungaloy Co., Ltd. (TT) to enhance the global business prospects
for metalcutting tools of both companies. The agreement includes various joint
activities in areas such as product development, research and development,
private labeling, cross-licensing, and sales and marketing. As part of the
agreement and as is customary in Japan as a sign of good faith, the company
purchased approximately 4.9% of the outstanding shares of TT in a private
transaction from TT's largest shareholder, Toshiba Corporation, for
approximately $16.1 million, including the costs of the transaction. In
accordance with accounting rules, the company will realize a loss of
approximately $3.7 million in the March 1999 quarter due to the difference
between the cost and the fair market value of the securities on the date the
securities were purchased. This transaction was financed through the borrowing
of Japanese yen under a new revolving credit agreement.
The intentions of the companies are to make the business cooperation agreement
successful and to develop a strong working relationship that will benefit both
companies in the future. The company will periodically evaluate the progress
made under this agreement and its current ownership position in TT to ensure
both are aligned with the company's operational and financial goals.
FINANCIAL CONDITION
Total assets were $2.2 billion at December 31, 1998, up 2.2 percent from $2.1
billion at June 30, 1998. Net working capital was $457.3 million an increase of
3.5 percent from $441.8 million at June 30, 1998. The ratio of current assets to
current liabilities was 2.1 as of December 31, 1998 and 2.2 as of June 30, 1998.
The total debt-to-total-capital ratio was 55.9 percent as of December 31, 1998
and 55.4 percent as of June 30, 1998.
YEAR 2000
Management believes that the company has substantially mitigated its exposure
relative to year 2000 issues for both information and non-information technology
systems. 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 monitors the status of the readiness program of each of the company's
business units. The company has currently completed more than 80 percent of the
tasks identified to remediate the year 2000 exposure, with the majority of the
remaining tasks targeted for June 1999 completion. The information systems being
utilized by the company that were not year 2000 compliant were either replaced
with a compliant system, or are in the process of being modified to become
compliant.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
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Year 2000 exposure related to information systems has been substantially
mitigated throughout key metalworking and mining and construction operations
through the implementation of SAP R3 for most business processes. In efforts to
manage other business processes on year 2000 compliant information systems, the
company is implementing Manugistics to manage inventory and replenishment and
the Human Resources module of SAP. These systems are to be implemented by June
30, 1999.
The company is in the process of modifying existing non-compliant business
systems in the industrial product and engineered product operations to ensure
these operations are supported by a year 2000 compliant information system.
These modifications are expected to be completed and tested by April 1999.
Management intends to implement SAP R3 in these operations in the future.
At JLK, HK Systems' Enterprise Information System currently is being
implemented in two phases and will address the year 2000 issue. The initial
phase of this implementation is expected to be tested and completed by June
1999. The second phase is expected to be implemented in late 1999 and completed
thereafter. Due to the timing of the completion of the second phase, the company
currently is modifying the existing non-compliant systems to ensure the
remainder of these operations are supported by a year 2000 compliant information
system. These modifications are expected to be completed by August 1999.
Management has determined that sufficient internal resources are available and
adequate time exists to implement these procedures.
The company also has substantially 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 tooling, and other non-information technology items, and has
determined that the majority of these systems are year 2000 compliant. The
company has identified a few non-information systems, critical to the
manufacturing operations, as non-year 2000 compliant and is currently replacing
these systems with year 2000 compliant systems. Other systems that have been
identified as not year 2000 compliant are not considered "mission critical"
systems to the overall manufacturing operations. The company is currently taking
action to remedy these other non-compliant systems through replacement of or
modification to the existing systems. Such remedies will be tested for year 2000
compliance prior to September 30, 1999. Contingency plans include shifting
production processes to year 2000 compliant manufacturing operations. The
company does not anticipate employing this contingency plan.
The company estimates the total year 2000 expenditures to be approximately $45.0
to $50.0 million, half of which are 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.
Expenditures to rectify non-compliant personal computers and various
non-information technology items are estimated to be an additional $5.0 million.
These costs include both internal and external personnel costs related to the
assessment and remediation processes, as well as the cost of purchasing certain
hardware and software. There can be no guarantee that these estimates will be
achieved and actual results could differ from those planned.
Cash flows from operations have provided, and should continue to provide,
funding for these expenditures. The majority of these costs were incurred in
1997 and 1996. Total expenditures expected to be incurred in fiscal 1999 and
fiscal 2000 are estimated to be approximately $12.0 and $5.0 million,
respectively, related to the year 2000 issues. Expenditures incurred in fiscal
1999 to date approximate $9.1 million, over half of which relate to computer
hardware and software licenses.
Management believes the most significant impact of the year 2000 issue could be
an interrupted supply of goods and services from the company's vendors. The
company has an ongoing effort to gain assurances and certifications of
suppliers' readiness programs. To date, the results of this effort indicate that
the company's suppliers should be able to provide the company with sufficient
goods and services in the year 2000. To mitigate this risk, the company is
modestly increasing safety stock of critical materials and supplies. The company
will continue to expand its efforts to ensure that major third-party businesses
and public and private providers of infrastructure services, such as utilities,
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
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communications services and transportation, also will be prepared for the year
2000, and will address any failures on their part to become year 2000 compliant.
Contingency plans may include purchasing raw materials and supplies from
alternate certified vendors and a further increase of safety stock of critical
materials and supplies. The company does not anticipate employing this
contingency plan.
There can be no guarantee that the efforts of the company or of third parties,
whose systems the company relies upon, will completely mitigate a 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 all the year 2000 remediation activities discussed herein.
CONVERSION TO THE EURO CURRENCY
On January 1, 1999, certain members of the European Union established fixed
conversion rates between their existing currencies and the European Union's
common currency, the Euro. The company conducts business in member countries.
The transition period for the introduction of the Euro will be between January
1, 1999 and June 30, 2002. The company has been addressing the issues involved
with the introduction of the Euro. Where considered necessary, the company's
current business systems support this new currency, and therefore, the company
has the ability to perform transaction denominated in the Euro. Other than the
costs associated with the new systems as part of the year 2000 remediation,
there were no additional costs incurred by the company as a result of this
conversion.
Currently, the company has different price structures for goods being sold in
the member countries due to, among other things, historical differences in
volatility in the currencies of those individual countries. Price structure
harmonization has occurred over the past several years and is expected to
continue as these member countries become a unified common market. This
harmonization has not significantly affected the past financial results of the
company nor is it expected to have a significant impact in the future on the
company's financial results.
Further, the company's competitors will have to address the Euro conversion as
those companies currently have manufacturing facilities and distribution
networks in member countries. Management believes the conversion to the Euro
will not significantly impact any existing material contracts, nor should it
have any adverse tax or accounting consequences. Accordingly, conversion to the
Euro is not expected to have a material effect on the company's operations or
financial results.
OUTLOOK
In looking ahead to the remainder of the fiscal year, management expects to show
sequential improvement in sales over the first half of the year. The company's
results should continue to benefit from the cost-reduction actions implemented
in November 1998. On an ongoing basis, the company is evaluating consolidation
and other opportunities as a function of the ongoing operation of the business.
The cost of these opportunities and other initiatives could, in the future,
result in one-time charges to the income statement as these actions are
implemented. Management does not expect overall economic conditions to
strengthen in North America, but will remain focused on improving the operating
performance and balance sheet of the company.
This Form 10-Q contains "forward-looking statements" as defined by Section 21E
of the Securities Exchange Act of 1934. Actual results can differ materially
from those in the forward-looking statements to the extent that the economic
conditions in the United States, Europe and Asia Pacific, 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, change
from the company's expectations. The company undertakes no obligation to
publicly release any revisions to forward-looking statements to reflect events
or circumstances occurring after the date hereof.
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PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
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The information set forth in Part II, Item 4 of the company's September 30, 1998
Form 10-Q is incorporated by reference herein.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
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(a) Exhibits
(10) Material Contracts
10.1 Amendment to Credit Agreement with Mellon Bank, N.A.
and various creditors dated as of December 15, 1998. Filed
herewith.
(27) Financial Data Schedule for six months ended December 31,
1998, 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, 1998.
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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 10, 1999 By: /s/ FRANK P. SIMPKINS
--------------------------------
Frank P. Simpkins
Corporate Controller and
Chief Accounting Officer
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