UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2010

Commission file number 1-5318

KENNAMETAL INC.

(Exact name of registrant as specified in its charter)

		Pennsylvania		25-0900168
(State or other jurisdiction of incorporation or organization)				(I.R.S. Employer Identification No.)
		World Headquarters
		1600 Technology Way
		P.O. Box 231
		Latrobe, Pennsylvania		15650-0231
(Address of principal executive offices)				(Zip Code)

Website: www.kennametal.com

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 by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES [ ] NO [ ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (check one):

Large accelerated filer [X]		Accelerated filer [ ]
Non-accelerated filer [ ] (Do not check if a smaller reporting company)		Smaller reporting company [ ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES [ ] NO [X]

Indicate the number of shares outstanding of each of the issuer’s classes of capital stock, as of the latest practicable date.

Title of Each Class				Outstanding at October 31, 2010
Capital Stock, par value $1.25 per share				82,093,973

 

 

KENNAMETAL INC.
FORM 10-Q
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2010

TABLE OF CONTENTS

Item No.				Page No.
		PART I - FINANCIAL INFORMATION
1.		Financial Statements.
		Condensed Consolidated Statements of Income (Unaudited) Three months ended September 30, 2010 and 2009			4
		Condensed Consolidated Balance Sheets (Unaudited) September 30, 2010 and June 30, 2010			5
		Condensed Consolidated Statements of Cash Flow (Unaudited) Three months ended September 30, 2010 and 2009			6
		Notes to Condensed Consolidated Financial Statements (Unaudited)			7
2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			20
3.		Quantitative and Qualitative Disclosures About Market Risk			25
4.		Controls and Procedures			25
		PART II - OTHER INFORMATION
2.		Unregistered Sales of Equity Securities and Use of Proceeds			26
6.		Exhibits			27
Signatures					28
EX-10.1
EX-31.1
EX-31.2
EX-32.1
EX-101 INSTANCE DOCUMENT
EX-101 SCHEMA DOCUMENT
EX-101 CALCULATION LINKBASE DOCUMENT
EX-101 LABELS LINKBASE DOCUMENT
EX-101 PRESENTATION LINKBASE DOCUMENT

FORWARD-LOOKING INFORMATION

This Form 10-Q contains “forward-looking” statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements are statements that do not relate strictly to historical or current facts. You can identify forward-looking statements by the fact they use words such as “should,” “anticipate,” “estimate,” “approximate,” “expect,” “may,” “will,” “project,” “intend,” “plan,” “believe” and other words of similar meaning and expression in connection with any discussion of future operating or financial performance or events. Forward-looking statements in this Form 10-Q may concern, among other things, Kennametal’s expectations regarding our strategy, goals, plans and projections regarding our financial position, liquidity and capital resources, results of operations, market position, and product development, all of which are based on current estimates that involve inherent risks and uncertainties. Among the factors that could cause the actual results to differ materially from those indicated in the forward-looking statements are risks and uncertainties related to: prolonged economic recession; restructuring and related actions (including associated costs and anticipated benefits); availability and cost of the raw materials we use to manufacture our products; our foreign operations and international markets, such as currency exchange rates, different regulatory environments, trade barriers, exchange controls, and social and political instability; changes in the regulatory environment in which we operate, including environmental, health and safety regulations; our ability to protect and defend our intellectual property; competition; our ability to retain our management and employees; demands on management resources; successful completion of information systems upgrades, including our enterprise system software; potential claims relating to our products; integrating acquisitions and achieving the expected savings and synergies; business divestitures; global or regional catastrophic events; energy costs; commodity prices; labor relations; demand for and market acceptance of new and existing products; implementation of environmental remediation matters; and implementation of a new segment structure. Should one or more of these risks or uncertainties materialize, or should the assumptions underlying the forward-looking statements prove incorrect, actual outcomes could vary materially from those indicated. These and other risks are more fully described in the “Risk Factors” Section of our Annual Report on Form 10-K and in our other periodic filings with the Securities and Exchange Commission. We undertake no obligation to release publicly any revisions to forward-looking statements as a result of future events or developments.

PART I – FINANCIAL INFORMATION

ITEM 1.   FINANCIAL STATEMENTS

KENNAMETAL INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

			Three Months Ended
			September 30,
	(in thousands, except per share amounts)		2010				2009
	Sales		$	529,158			$	409,395
	Cost of goods sold			340,418				291,594
	Gross profit			188,740				117,801
	Operating expense			125,020				116,162
	Restructuring charges (Note 7)			3,260				7,830
	Amortization of intangibles			2,948				3,340
	Operating income (loss)			57,512				(9,531	)
	Interest expense			5,963				6,371
	Other expense (income), net			1,911				(2,952	)
	Income (loss) from continuing operations before income taxes			49,638				(12,950	)
	Provision (benefit) for income taxes			13,682				(5,129	)
	Income (loss) from continuing operations			35,956				(7,821	)
	Loss from discontinued operations (Note 8)			-				(1,367	)
	Net income (loss)			35,956				(9,188	)
	Less: Net income attributable to noncontrolling interests			1,035				629
	Net income (loss) attributable to Kennametal		$	34,921			$	(9,817	)
	Amounts Attributable to Kennametal Shareowners:
	Income (loss) from continuing operations		$	34,921			$	(8,450	)
	Loss from discontinued operations			-				(1,367	)
	Net income (loss) attributable to Kennametal		$	34,921			$	(9,817	)
	PER SHARE DATA ATTRIBUTABLE TO KENNAMETAL
	Basic earnings (loss) per share:
	Continuing operations		$	0.43			$	(0.10	)
	Discontinued operations			-				(0.02	)
			$	0.43			$	(0.12	)
	Diluted earnings (loss) per share:
	Continuing operations		$	0.42			$	(0.10	)
	Discontinued operations			-				(0.02	)
			$	0.42			$	(0.12	)
	Dividends per share		$	0.12			$	0.12
	Basic weighted average shares outstanding			82,105				79,772
	Diluted weighted average shares outstanding			82,689				79,772

The accompanying notes are an integral part of these condensed consolidated financial statements.

KENNAMETAL INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)

			September 30,				June 30,
	(in thousands, except per share data)		2010				2010
	ASSETS
	Current assets:
	Cash and cash equivalents		$	124,249			$	118,129
	Accounts receivable, less allowance for doubtful accounts of $26,625 and $24,789			342,830				326,699
	Inventories (Note 11)			418,048				364,268
	Deferred income taxes			64,392				62,083
	Other current assets			48,827				44,752
	Total current assets			998,346				915,931
	Property, plant and equipment:
	Land and buildings			357,875				341,748
	Machinery and equipment			1,337,381				1,281,872
	Less accumulated depreciation			(1,017,876	)			(959,085	)
	Property, plant and equipment, net			677,380				664,535
	Other assets:
	Investments in affiliated companies			1,823				2,251
	Goodwill (Note 18)			502,744				489,443
	Other Intangible assets, less accumulated amortization of $68,612 and $63,343 (Note 18)			157,531				155,306
	Deferred income taxes			12,459				11,827
	Other			30,448				28,530
	Total other assets			705,005				687,357
	Total assets		$	2,380,731			$	2,267,823
	LIABILITIES
	Current liabilities:
	Current maturities of long-term debt and capital leases (Note 12)		$	1,305			$	3,539
	Notes payable to banks			3,759				19,454
	Accounts payable			129,865				125,360
	Accrued income taxes			25,990				17,857
	Accrued expenses			81,336				73,989
	Other current liabilities (Note 7)			147,143				152,806
	Total current liabilities			389,398				393,005
	Long-term debt and capital leases, less current maturities (Note 12)			313,755				314,675
	Deferred income taxes			59,846				63,266
	Accrued pension and postretirement benefits			140,831				129,701
	Accrued income taxes			5,648				5,193
	Other liabilities			33,637				28,540
	Total liabilities			943,115				934,380
	Commitments and contingencies
	EQUITY (Note 16)
	Kennametal shareowners’ equity:
	Preferred stock, no par value; 5,000 shares authorized; none issued			-				-
	Capital stock, $1.25 par value; 120,000 shares authorized; 81,981 and 81,903 shares issued			102,476				102,379
	Additional paid-in capital			500,159				492,454
	Retained earnings			818,405				793,448
	Accumulated other comprehensive loss			(3,911	)			(72,781	)
	Total Kennametal shareowners’ equity			1,417,129				1,315,500
	Noncontrolling interests			20,487				17,943
	Total equity			1,437,616				1,333,443
	Total liabilities and equity		$	2,380,731			$	2,267,823

The accompanying notes are an integral part of these condensed consolidated financial statements.

KENNAMETAL INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW (UNAUDITED)

	Three months ended September 30 (in thousands)		2010				2009(1)
	OPERATING ACTIVITIES
	Net income (loss)		$	35,956			$	(9,188	)
	Adjustments for non-cash items:
	Depreciation			19,825				20,150
	Amortization			2,948				3,340
	Stock-based compensation expense			7,305				5,392
	Restructuring charges			-				49
	Deferred income tax provision			(10	)			(1,410	)
	Other			2,694				1,295
	Changes in certain assets and liabilities, excluding effects of acquisitions and divestitures:
	Accounts receivable			787				2,228
	Inventories			(34,045	)			16,817
	Accounts payable and accrued liabilities			(9,579	)			(6,772	)
	Accrued income taxes			6,318				(5,281	)
	Other			(5,771	)			(9,330	)
	Net cash flow provided by operating activities			26,428				17,290
	INVESTING ACTIVITIES
	Purchases of property, plant and equipment			(10,062	)			(8,915	)
	Disposals of property, plant and equipment			90				987
	Proceeds from divestitures (Note 8)			-				27,000
	Other			1,251				386
	Net cash flow (used for) provided by investing activities			(8,721	)			19,458
	FINANCING ACTIVITIES
	Net decrease in notes payable			(15,729	)			(11,490	)
	Net increase in short-term revolving and other lines of credit			-				4,500
	Term debt borrowings			155,028				85,101
	Term debt repayments			(156,475	)			(195,319	)
	Purchase of capital stock			(73	)			(72	)
	Net proceeds from equity offering			-				120,696
	Dividend reinvestment and the effect of employee benefit and stock plans			1,574				1,694
	Cash dividends paid to shareowners			(9,964	)			(9,781	)
	Other			(669	)			(1,874	)
	Net cash flow used for financing activities			(26,308	)			(6,545	)
	Effect of exchange rate changes on cash and cash equivalents			14,721				5,073
	CASH AND CASH EQUIVALENTS
	Net increase in cash and cash equivalents			6,120				35,276
	Cash and cash equivalents, beginning of period			118,129				69,823
	Cash and cash equivalents, end of period		$	124,249			$	105,099

The accompanying notes are an integral part of these condensed consolidated financial statements.

KENNAMETAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1.

ORGANIZATION

Kennametal Inc. was incorporated in Pennsylvania in 1943. Kennametal Inc. and its subsidiaries (collectively, Kennametal or the Company) are a leading global manufacturer and supplier of tooling, engineered components and advanced materials consumed in production processes. We believe that our reputation for manufacturing excellence, as well as our technological expertise and innovation in our principle products, has helped us to achieve a leading market presence in our primary markets. End users of our products include metalworking manufacturers and suppliers across a diverse array of industries including the aerospace, defense, transportation, machine tool, light machinery and heavy machinery industries, as well as manufacturers, producers and suppliers in a number of other industries including coal mining, highway construction, quarrying and oil and gas exploration and production industries. Our end users’ products include items ranging from airframes to coal, engines to oil wells and turbochargers to construction. We operate two global business units consisting of Industrial and Infrastructure.

2.

BASIS OF PRESENTATION

The condensed consolidated financial statements, which include our accounts and those of our majority-owned subsidiaries, should be read in conjunction with our 2010 Annual Report on Form 10-K. The condensed consolidated balance sheet as of June 30, 2010 was derived from the audited balance sheet included in our 2010 Annual Report on Form 10-K. These interim statements are unaudited; however, we believe that all adjustments necessary for a fair statement of the results of the interim periods were made and all adjustments are normal, recurring adjustments. The results for the three months ended September 30, 2010 and 2009 are not necessarily indicative of the results to be expected for a full fiscal year. Unless otherwise specified, any reference to a “year” is to a fiscal year ended June 30. For example, a reference to 2011 is to the fiscal year ending June 30, 2011. When used in this Form 10-Q, unless the context requires otherwise, the terms “we,” “our” and “us” refer to Kennametal Inc. and its consolidated subsidiaries.

3.		NEW ACCOUNTING STANDARDS
		Adopted
		As of July 1, 2010, Kennametal adopted new guidance on consolidations for enterprises involved with variable interest entities. The guidance modifies how a company determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar) rights should be consolidated and clarifies that the determination of whether a company is required to consolidate a variable interest entity is based on, among other things, an entity’s purpose and design and a company’s ability to direct the activities of the entity that most significantly impact the entity’s economic performance. This guidance requires an ongoing reassessment of whether a company is the primary beneficiary of a variable interest entity and also requires additional disclosures about a company’s involvement in variable interest entities and any significant changes in risk exposure due to that involvement. The adoption of this guidance did not have a material impact on our condensed consolidated financial statements.
		As of July 1, 2010, Kennametal adopted new guidance on accounting for transfers of financial assets. This guidance requires additional disclosure regarding transfers of financial assets, including securitization transactions, and where companies have continuing exposure to the risks related to transferred financial assets. The adoption of this guidance did not have a material impact on our condensed consolidated financial statements.
		As of July 1, 2010, Kennametal adopted new guidance on revenue recognition for multiple-deliverable revenue arrangements. The guidance allows companies to allocate arrangement consideration in multiple deliverable arrangements in a manner that better reflects the transaction’s economics and may result in earlier revenue recognition. In addition, the residual method of allocating arrangement consideration is no longer permitted. The adoption of this guidance did not have a material impact on our condensed consolidated financial statements.

KENNAMETAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

4.

SUPPLEMENTAL CASH FLOW DISCLOSURES

	Three months ended September 30 (in thousands)		2010				2009
	Cash paid during the period for:
	Interest		$	1,293			$	2,018
	Income taxes			7,432				3,423
	Supplemental disclosure of non-cash information:
	Contribution of stock to employees’ defined contribution benefit plans			948				1,482

5.		FAIR VALUE MEASUREMENTS
		Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair value hierarchy consists of three levels to prioritize the inputs used in valuations, as defined below:
		Level 1: Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.
		Level 2: Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly, including quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; inputs other than quoted prices that are observable for the asset or liability (e.g., interest rates); and inputs that are derived principally from or corroborated by observable market data by correlation or other means.
		Level 3: Inputs that are unobservable.
		As of September 30, 2010, the fair values of the Company’s financial assets and financial liabilities measured at fair value on a recurring basis are categorized as follows:

	(in thousands)		Level 1				Level 2				Level 3				Total
	Assets:
	Derivatives (1)			-				1,677				-				1,677
	Total assets at fair value		$	-			$	1,677			$	-			$	1,677
	Liabilities:
	Derivatives (1)			-				8,107				-				8,107
	Total liabilities at fair value		$	-			$	8,107			$	-			$	8,107

As of June 30, 2010, the fair value of the Company’s financial assets and financial liabilities measured at fair value on a recurring basis are categorized as follows:

	(in thousands)		Level 1				Level 2				Level 3				Total
	Assets:
	Derivatives (1)			-				43				-				43
	Total assets at fair value		$	-			$	43			$	-			$	43
	Liabilities:
	Derivatives (1)			-				3,453				-				3,453
	Total liabilities at fair value		$	-			$	3,453			$	-			$	3,453

(1)

Foreign currency derivative and interest rate swap contracts are valued based on observable market spot and forward rates and are classified within Level 2 of the fair value hierarchy.

KENNAMETAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

6.		DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
		As part of our financial risk management program, we use certain derivative financial instruments. We do not enter into derivative transactions for speculative purposes and therefore hold no derivative instruments for trading purposes. We use derivative financial instruments to provide predictability to the effects of changes in foreign exchange rates on our consolidated results and to achieve our targeted mix of fixed and floating interest rates on outstanding debt. We account for derivative instruments as a hedge of the related asset, liability, firm commitment or anticipated transaction when the derivative is specifically designated as a hedge of such items. Our objective in managing foreign exchange exposures with derivative instruments is to reduce volatility in cash flow, allowing us to focus more of our attention on business operations. With respect to interest rate management, these derivative instruments allow us to achieve our targeted fixed-to-floating interest rate mix as a separate decision from funding arrangements in the bank and public debt markets. We measure hedge effectiveness by assessing the changes in the fair value or expected future cash flows of the hedged item. The ineffective portions are recorded in other income, net.
		The fair value of derivatives designated in the condensed consolidated balance sheet are as follows:

			September 30,				June 30,
	(in thousands)		2010				2010
	Derivatives designated as hedging instruments
	Other current assets - range forward contracts		$	9			$	34
	Other current liabilities - range forward contracts			(642	)			(2	)
	Other liabilities - forward starting interest rate swap contracts			(7,332	)			(2,348	)
	Total derivatives designated as hedging instruments			(7,965	)			(2,316	)
	Derivatives not designated as hedging instruments
	Other current assets - currency forward contracts			1,668				9
	Other current liabilities - currency forward contracts			(133	)			(1,103	)
	Total derivatives not designated as hedging instruments			1,535				(1,094	)
	Total derivatives		$	(6,430	)		$	(3,410	)

Certain currency forward contracts hedging significant cross-border intercompany loans are considered as other derivatives and therefore do not qualify for hedge accounting. These contracts are recorded at fair value in the balance sheet, with the offset to other income, net. Losses (gains) related to derivatives not designated as hedging instruments have been recognized as follows:

	Three months ended September 30 (in thousands)		2010				2009
	Other expense (income), net - currency forward contracts		$	(2,647	)		$	(2,745	)

		FAIR VALUE HEDGES
		Fixed-to-floating interest rate swap contracts, designated as fair value hedges, are entered into from time to time to hedge our exposure to fair value fluctuations on a portion of our fixed rate debt. These interest rate swap contracts convert a portion of our fixed rate debt to floating rate debt. These contracts require periodic settlement and the difference between amounts to be received and paid under the interest rate swap contracts is recognized in interest expense. We had no such contracts outstanding at September 30, 2010 and June 30, 2010, respectively.
		In February 2009, we terminated interest rate swap contracts to convert $200.0 million of our fixed rate debt to floating rate debt. These contracts were originally set to mature in June 2012. Upon termination, we received a cash payment of $13.2 million. This gain is being amortized as a component of interest expense over the remaining term of the related debt using the effective interest rate method. During the three months ended September 30, 2010 and 2009, $1.5 million and $1.4 million, respectively, were recognized as reductions in interest expense.

KENNAMETAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

		CASH FLOW HEDGES
		Currency forward contracts and range forward contracts (a transaction where both a put option is purchased and a call option is sold), designated as cash flow hedges, hedge anticipated cash flows from cross-border intercompany sales of products and services. Gains and losses realized on these contracts at maturity are recorded in accumulated other comprehensive loss, net of tax, and are recognized as a component of other expense (income), net when the underlying sale of products or services are recognized into earnings. The notional amount of the contracts translated into U.S. dollars at September 30, 2010 and 2009, was $48.5 million and $14.0 million, respectively. The time value component of the fair value of range forwards is excluded from the assessment of hedge effectiveness. Assuming the market rates remain constant with the rates at September 30, 2010, we expect to recognize a loss of $0.5 million in the next 12 months on outstanding derivatives.
		We enter into floating-to-fixed interest rate swap contracts, designated as cash flow hedges, from time to time to hedge our exposure to interest rate changes on a portion of our floating rate debt. These interest rate swap contracts convert a portion of our floating rate debt to fixed rate debt. We record the fair value of these contracts as an asset or a liability, as applicable, in the balance sheet, with the offset to accumulated other comprehensive loss, net of tax. At September 30, 2010 we had forward starting interest rate swap contracts outstanding for forecasted transactions that effectively converted a cumulative notional amount of $125 million from floating to fixed interest rates. As of September 30, 2010 we recorded a liability of $7.3 million on these contracts which was recorded as an offset in other comprehensive loss, net of tax. Over the next 12 months assuming the market rates remain constant with the rates at September 30, 2010, we do not expect to recognize into earnings any significant gains or losses on outstanding derivatives. We had no such contracts outstanding at September 30, 2009.
		Gains (losses) related to cash flow hedges have been recognized as follows:

	Three months ended September 30 (in thousands)		2010				2009
	Losses recognized in other comprehensive loss - range forward contracts		$	(494	)		$	(37	)
	Gains (losses) reclassified from accumulated other comprehensive loss into other (income) expense, net - range forward contracts		$	(25	)		$	1,408

No portion of the gains or losses recognized in earnings was due to ineffectiveness and no amounts were excluded from our effectiveness testing for the three months ended September 30, 2010 and 2009, respectively.

7.		RESTRUCTURING CHARGES
		We continued to implement restructuring plans to reduce costs and improve operating efficiencies. These actions taken in the September quarter related primarily to the rationalization of certain manufacturing facilities. Restructuring and related charges recorded in the three months ended September 30, 2010 amounted to $4.3 million, including $3.3 million of restructuring charges. Restructuring-related charges of $1.0 million were recorded in cost of goods sold during the three months ended September 30, 2010.
		Restructuring and related charges recorded in the three months ended September 30, 2009 amounted to $8.5 million, including $7.8 million of restructuring charges. Restructuring-related charges of $0.5 million and $0.3 million were recorded in cost of goods sold and operating expense, respectively, during the three months ended September 30, 2009.
		The combined total pre-tax charges are expected to be approximately $160 million to $165 million, which is expected to be approximately 70% Industrial and 30% Infrastructure. We expect the majority of these pre-tax charges to be severance charges. Total restructuring and related charges since inception of $133 million have been recorded through September 30, 2010: $94 million in Industrial and $39 million in Infrastructure. The remaining restructuring charges are expected to be completed within the next 6 to 9 months and are anticipated to be mostly cash expenditures.

KENNAMETAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

The restructuring accrual is recorded in other current liabilities in our condensed consolidated balance sheet and the amount attributable to each segment is as follows:

											Asset				Cash
	(in thousands)		June 30, 2010				Expense				Write-down				Expenditures				Translation				September 30, 2010
	Industrial
	Severance		$	18,327			$	1,734			$	-			$	(4,544	)		$	1,483			$	17,000
	Facilities			508				-				-				(390	)			-				118
	Other			403				568				-				(541	)			50				480
	Total Industrial			19,238				2,302				-				(5,475	)			1,533				17,598
	Infrastructure
	Severance			7,637				722				-				(1,893	)			618				7,084
	Facilities			211				-				-				(162	)			-				49
	Other			168				236				-				(225	)			21				200
	Total Infrastructure			8,016				958				-				(2,280	)			639				7,333
	Total		$	27,254			$	3,260			$	-			$	(7,755	)		$	2,172			$	24,931

											Asset				Cash
	(in thousands)		June 30, 2009				Expense				Write-down				Expenditures				Translation				June 30, 2010
	Industrial
	Severance		$	18,378			$	29,082			$	-			$	(28,086	)		$	(1,047	)		$	18,327
	Facilities			477				790				(604	)			(142	)			(13	)			508
	Other			176				1,393				-				(1,241	)			75				403
	Total Industrial			19,031				31,265				(604	)			(29,469	)			(985	)			19,238
	Infrastructure
	Severance			7,659				12,119				-				(11,704	)			(437	)			7,637
	Facilities			199				329				(251	)			(59	)			(7	)			211
	Other			73				580				-				(517	)			32				168
	Total Infrastructure			7,931				13,028				(251	)			(12,280	)			(412	)			8,016
	Total		$	26,962			$	44,293			$	(855	)		$	(41,749	)		$	(1,397	)		$	27,254

See Note 19 for further discussion regarding the Company’s new segments.

8.		DISCONTINUED OPERATIONS
		On June 30, 2009, we completed the sale of our high speed steel drills and related product lines as we continued to focus on shaping our business portfolio and rationalizing our manufacturing footprint. This divestiture was accounted for as discontinued operations. Cash proceeds received from this divestiture amounted to $28.5 million. We did not incur any pre-tax charges related to this divestiture during the three months ended September 30, 2010. We incurred pre-tax charges related to the divestiture of $2.2 million during the three months ended September 30, 2009. These pre-tax charges as well as the related tax effects were recorded in discontinued operations. We do not expect to incur any additional pre-tax charges related to this divestiture.
		The following represents the results of discontinued operations:

	Three months ended September 30 (in thousands)		2009
	Sales		$	-
	Loss from discontinued operations before income taxes		$	(2,210	)
	Income tax benefit			(843	)
	Loss from discontinued operations		$	(1,367	)

9.		STOCK BASED COMPENSATION
		On October 26, 2010, the Company’s shareholders approved the Kennametal Inc., Stock and Incentive Plan of 2010 (the “2010 Plan”). The 2010 Plan authorizes the issuance of up to 3,500,000 shares of the Company’s common stock plus the remaining shares from the 2002 Plan. Shares can be issued in the form of incentive stock options, non-statutory stock options, stock appreciation rights, performance share awards, performance unit awards, restricted stock awards, restricted unit awards and share awards.

KENNAMETAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

		Options
		The assumptions used in our Black-Scholes valuation related to grants made during the three months ended September 30, 2010 and 2009 were as follows:

			2010				2009
	Risk-free interest rate			1.4	%			2.3	%
	Expected life (years) (1)			4.5				4.5
	Expected volatility (2)			47.0	%			43.9	%
	Expected dividend yield			2.0	%			1.8	%

	(1)		Expected life is derived from historical experience.
	(2)		Expected volatility is based on the historical volatility of our stock.

Changes in our stock options for the three months ended September 30, 2010 were as follows:

											Weighted
							Weighted				Average				Aggregate
							Average				Remaining				Intrinsic value
			Options				Exercise Price				Life (years)				(in thousands)
	Options outstanding, June 30, 2010			3,582,075			$	25.59
	Granted			529,012				26.89
	Exercised			(28,726	)			18.29
	Lapsed and forfeited			(24,187	)			28.49
	Options outstanding, September 30, 2010			4,058,174			$	25.80				6.5			$	24,022
	Options vested and expected to vest,
	September 30, 2010			3,949,209			$	25.81				6.4			$	23,392
	Options exercisable, September 30, 2010			2,529,708			$	25.75				5.1			$	15,636

		During the three months ended September 30, 2010 and 2009, compensation expense related to stock options was $2.0 million and $2.1 million, respectively. As of September 30, 2010, the total unrecognized compensation cost related to options outstanding was $7.9 million and is expected to be recognized over a weighted average period of 2.7 years.
		Weighted average fair value of options granted during the three months ended September 30, 2010 and 2009 was $9.18 and $7.26, respectively. Fair value of options vested during the three months ended September 30, 2010 and 2009 was $4.1 million and $3.8 million, respectively.
		Tax benefits, relating to excess stock-based compensation deductions, are presented in the statement of cash flow as financing cash inflows. Tax benefits resulting from stock-based compensation deductions in excess of amounts reported for financial reporting purposes were immaterial for the three months ended September 30, 2010. Amounts reported for financial reporting purposes exceeded the tax benefit by $0.3 million for the three months ended September 30, 2009.
		The amount of cash received from the exercise of capital stock options during the three months ended September 30, 2010 and 2009 was $0.5 million and $1.0 million, respectively. The related tax benefit was $0.1million for each of the three months ended September 30, 2010 and 2009. The total intrinsic value of options exercised during each of the three months ended September 30, 2010 and 2009 was $0.3 million.

KENNAMETAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

		Restricted Stock Awards
		Changes in our restricted stock awards for the three months ended September 30, 2010 were as follows:

							Weighted
							Average Fair
			Shares				Value
	Unvested restricted stock awards, June 30, 2010			198,701			$	32.71
	Vested			(77,552	)			31.89
	Forfeited			(753	)			31.26
	Unvested restricted stock awards, September 30, 2010			120,396			$	33.21

		During the three months ended September 30, 2010 and 2009, compensation expense related to restricted stock awards was $0.6 million and $0.8 million, respectively. As of September 30, 2010, the total unrecognized compensation cost related to unvested restricted stock awards was $2.3 million and is expected to be recognized over a weighted average period of 1.5 years.
		Restricted Stock Units – Time Vesting and Performance Vesting
		Performance vesting restricted stock units (performance units) were granted to certain individuals. These performance units are earned pro rata each year if certain performance goals are met over a 3-year period, and are also subject to a service condition that requires the individual to be employed by the Company at the payment date after the 3-year performance period.
		Changes in our time vesting and performance vesting restricted stock units for the three months ended September 30, 2010 were as follows:

							Performance
			Performance				Vesting								Time Vesting
			Vesting				Weighted				Time Vesting				Weighted
			Stock				Average Fair				Stock				Average Fair
			Units				Value				Units				Value
	Unvested performance vesting and time vesting restricted stock units, June 30, 2010			-			$	-				546,713			$	24.29
	Granted			134,807				26.89				518,879				26.66
	Vested			-				-				(43,076	)			21.49
	Forfeited			-				-				(4,508	)			26.06
	Unvested performance vesting and time vesting restricted stock units, September 30, 2010			134,807			$	26.89				1,018,008			$	25.61

		During the three months ended September 30, 2010 and 2009, compensation expense related to time vesting and performance vesting restricted stock units was $3.6 million and $0.9 million, respectively. As of September 30, 2010, the total unrecognized compensation cost related to unvested time vesting and performance vesting restricted stock units was $19.6 million and is expected to be recognized over a weighted average period of 3.0 years.
		Restricted Stock Units – STEP
		As of September 30, 2010, participating executives had been granted awards under the Kennametal Inc. 2008 Strategic Transformational Equity Program, under the 2002 Plan (STEP), equal to that number of restricted stock units having a value of $30.3 million. A further amount of $7.0 million remains available under the STEP for additional awards that could be made to other executives; however, the Company has decided that it will not make any further awards under the STEP. No new grants under the STEP were made in the three months ended September 30, 2010. There are no voting rights or dividends associated with restricted stock units under the STEP.

KENNAMETAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

		Under the STEP, there are two interim measurement dates, September 30, 2009 and 2010, and a final measurement date, September 30, 2011, at which performance is assessed. Participants may earn up to a cumulative 35 percent of the maximum restricted stock units awarded if certain threshold levels of performance are achieved through the two interim measurement dates. The threshold level of performance for September 30, 2010 and 2009 were not achieved and no restricted stock units were earned under the STEP. Generally, the payment of any restricted stock units under the STEP is also conditioned upon the participants being employed by the Company on the date of distribution and the satisfaction of all other provisions of the STEP. As of September 30, 2010, no restricted stock units have been earned or paid under the STEP.
		The unvested EPS performance-based STEP restricted stock units as of September 30, 2010 were 502,371 and the weighted average fair value was $35.54.
		As of September 30, 2010, we assumed that none of the EPS performance-based restricted stock units will vest.
		There were no new TSR performance-based restricted stock units granted under the STEP during the three months ended September 30, 2010 and 2009, respectively. The unvested TSR performance-based STEP restricted stock units as of September 30, 2010 were 270,501 and the weighted average fair value was $8.35.
		During the three months ended September 30, 2010 and 2009, compensation expense related to STEP restricted stock units was $0.2 million in both years. As of September 30, 2010, the total unrecognized compensation cost related to unvested STEP restricted stock units was $0.5 million and is expected to be recognized over a weighted average period of 1.0 years.

10.

BENEFIT PLANS

		We sponsor several defined benefit pension plans. Additionally, we provide varying levels of postretirement health care and life insurance benefits to most U.S. employees.
		The table below summarizes the components of net periodic pension cost:

	Three months ended September 30 (in thousands)		2010				2009
	Service cost		$	1,912			$	1,997
	Interest cost			10,250				10,675
	Expected return on plan assets			(12,046	)			(11,573	)
	Amortization of transition obligation			13				14
	Amortization of prior service credit			(70	)			(70	)
	Special termination benefits			-				1,460
	Settlement loss			263				-
	Recognition of actuarial losses			3,069				1,123
	Net periodic pension cost		$	3,391			$	3,626

The table below summarizes the components of the net periodic other postretirement cost:

	Three months ended September 30 (in thousands)		2010				2009
	Service cost		$	19			$	25
	Interest cost			259				316
	Amortization of prior service cost			-				2
	Recognition of actuarial gains			(47	)			(92	)
	Net periodic other postretirement benefit cost		$	231			$	251

11.		INVENTORIES
		We used the last-in, first-out (LIFO) method of valuing inventories for approximately 48 percent and 51 percent of total inventories at September 30, 2010 and June 30, 2010, respectively. 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 our projections of expected year-end inventory levels and costs. Therefore, the interim financial results are subject to any final year-end LIFO inventory adjustments.

KENNAMETAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Inventories consisted of the following:

			September 30,				June 30,
	(in thousands)		2010				2010
	Finished goods		$	270,427			$	227,096
	Work in process and powder blends			136,492				134,732
	Raw materials and supplies			80,567				62,673
	Inventories at current cost			487,486				424,501
	Less: LIFO valuation			(69,438	)			(60,233	)
	Total inventories		$	418,048			$	364,268

12.

LONG-TERM DEBT AND CAPITAL LEASES

		Debt and capital lease obligations consist primarily of Senior Unsecured Notes issued in June 2002 having an aggregate face amount of $300.0 million as well as borrowings under a five-year, multi-currency, revolving credit facility (2010 Credit Agreement) which permits revolving credit loans of up to $500.0 million for working capital, capital expenditures and general corporate purposes. The 2010 Credit Agreement allows for borrowings in U.S. dollars, euro, Canadian dollars, pound sterling and Japanese yen. Interest payable under the 2010 Credit Agreement is based upon the type of borrowing under the facility and may be (1) LIBOR plus an applicable margin, (2) the greater of the prime rate or the Federal Funds effective rate plus an applicable margin, or (3) fixed as negotiated by us.
		The 2010 Credit Agreement requires us to comply with various restrictive and affirmative covenants, including two financial covenants: a maximum leverage ratio and a minimum consolidated interest coverage ratio (as those terms are defined in the agreement). We were in compliance with these financial covenants as of September 30, 2010. We had no borrowings outstanding under the 2010 Credit Agreement as of September 30, 2010 and June 30, 2010.
		Borrowings under the 2010 Credit Agreement are guaranteed by our significant domestic subsidiaries.
		Fixed rate debt had a fair market value of $323.6 million and $325.5 million at September 30, 2010 and June 30, 2010, respectively. The fair value is determined based on the quoted market price of this debt as of September 30, 2010 and June 30, 2010, respectively.

13.

ENVIRONMENTAL MATTERS

		The operation of our business has exposed us to certain liabilities and compliance costs related to environmental matters. We are involved in various environmental cleanup and remediation activities at certain of our locations.
		Superfund Sites We are involved as a Potentially Responsible Party (PRP) at various sites designated by the U.S. Environmental Protection Agency (USEPA) as Superfund sites. For certain of these sites, we have evaluated the claims and potential liabilities and have determined that neither are material, individually or in the aggregate. For certain other sites, proceedings are in the very early stages and have not yet progressed to a point where it is possible to estimate the ultimate cost of remediation, the timing and extent of remedial action that may be required by governmental authorities or the amount of our liability alone or in relation to that of any other PRPs.
		Other Environmental Issues We establish and maintain reserves for other potential environmental issues. At September 30, 2010, the total accrual for these reserves was $5.8 million. This total represents anticipated costs associated with the remediation of these issues. We recorded favorable foreign currency translation adjustments of $0.6 million for the three months ended September 30, 2010.
		The reserves we have established for environmental liabilities represent our best current estimate of the costs of addressing all identified environmental situations, based on our review of currently available evidence, and taking into consideration our prior experience in remediation and that of other companies, as well as public information released by the USEPA, other governmental agencies, and by the PRP groups in which we are participating. Although the reserves currently appear to be sufficient to cover these environmental liabilities, there are uncertainties associated with environmental liabilities, and we can give no assurance that our estimate of any environmental liability will not increase or decrease in the future. The reserved and unreserved liabilities for all environmental concerns could change substantially 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, the identification of new PRPs and the involvement of and direction taken by the government on these matters.

KENNAMETAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

We maintain a Corporate Environmental, Health and Safety (EHS) Department, as well as an EHS Steering Committee, to monitor compliance with environmental regulations and to oversee remediation activities. In addition, we have designated EHS coordinators who are responsible for each of our global manufacturing facilities. Our financial management team periodically meets with members of the Corporate EHS Department and the Corporate Legal Department to review and evaluate the status of environmental projects and contingencies. On a quarterly basis, we review financial provisions and reserves for environmental contingencies and adjust these reserves when appropriate.

14.

INCOME TAXES

The effective income tax rate for the three months ended September 30, 2010 and 2009 was 27.6 percent (provision on income) compared to 39.6 percent (benefit on a loss), respectively. The prior year rate reflects a benefit from certain favorable tax settlements in the United States and Europe.

15.

EARNINGS PER SHARE

Basic earnings per share is computed using the weighted average number of shares outstanding during the period, while diluted earnings per share is calculated to reflect the potential dilution that occurs related to the issuance of capital stock through grants of capital stock options, restricted stock awards and restricted stock units. The difference between basic and diluted earnings per share relates solely to the effect of capital stock options, restricted stock awards and restricted stock units.

For purposes of determining the number of diluted shares outstanding at September 30, 2010, weighted average shares outstanding for basic earnings per share calculations were increased due solely to the dilutive effect of unexercised capital stock options, unvested restricted stock awards and unvested restricted stock units by 0.6 million shares. For the three months ended September 30, 2009, the effect of these items was anti-dilutive and therefore has been excluded from diluted shares outstanding as well as from the diluted earnings per share calculation. Unexercised capital stock options, restricted stock units and restricted stock awards of 1.5 million and 3.1 million shares at September 30, 2010 and 2009, respectively, were not included in the computation of diluted earnings per share because the inclusion would have been anti-dilutive.

16.

EQUITY

A summary of the changes in the carrying amounts of total equity, Kennametal shareowners’ equity and equity attributable to noncontrolling interests as of September 30, 2010 is as follows:

			Kennametal Shareowners’ Equity
															Accumulated
							Additional								other				Non-
			Capital				paid-in				Retained				comprehensive				controlling
	(in thousands)		stock				capital				earnings				(loss) income				interests				Total Equity
	Balance as of June 30, 2010		$	102,379			$	492,454			$	793,448			$	(72,781	)		$	17,943			$	1,333,443
	Net income attributable to Kennametal			-				-				34,921				-				1,035				35,956
	Other comprehensive income			-				-				-				68,870				1,509				70,379
	Dividend reinvestment			4				69				-				-				-				73
	Capital stock issued under employee benefit and stock plans			97				7,705				-				-				-				7,802
	Purchase of capital stock			(4	)			(69	)			-				-				-				(73	)
	Cash dividend paid to shareowners			-				-				(9,964	)			-				-				(9,964	)
	Total equity, September 30, 2010		$	102,476			$	500,159			$	818,405			$	(3,911	)		$	20,487			$	1,437,616

KENNAMETAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

A summary of the changes in the carrying amounts of total equity, Kennametal shareowners’ equity and equity attributable to noncontrolling interests as of September 30, 2009 is as follows:

			Kennametal Shareowners’ Equity
															Accumulated
							Additional								other				Non-
			Capital				paid-in				Retained				comprehensive				controlling
	(in thousands)		stock				capital				earnings				income				interests				Total Equity
	Balance as of June 30, 2009		$	91,540			$	357,839			$	786,345			$	11,719			$	20,012			$	1,267,455
	Net (loss) income attributable to Kennametal			-				-				(9,817	)			-				629				(9,188	)
	Other comprehensive income			-				-				-				25,280				416				25,696
	Dividend reinvestment			4				68				-				-				-				72
	Capital stock issued under employee benefit and stock plans			98				5,783				-				-				-				5,881
	Purchase of capital stock			(4	)			(68	)			-				-				-				(72	)
	Equity offering			10,063				110,633																120,696
	Cash dividend paid to shareowners			-				-				(9,781	)			-				-				(9,781	)
	Total equity, September 30, 2009		$	101,701			$	474,255			$	766,747			$	36,999			$	21,057			$	1,400,759

During July 2009, we completed the issuance of 8,050,000 shares of our capital stock generating gross proceeds of $126.8 million and net proceeds, after deduction of fees, of $120.7 million. The net proceeds were used to pay down outstanding indebtedness under our revolving credit facility.

The amounts of comprehensive income attributable to Kennametal shareowners’ and noncontrolling interests are disclosed in Note 17.

17.

COMPREHENSIVE INCOME

Comprehensive income is as follows:

	Three months ended September 30 (in thousands)		2010				2009
	Net income (loss)		$	35,956			$	(9,188	)
	Unrealized gain (loss) on derivatives designated and qualified as cash flow hedges, net of income tax			46				(1,039	)
	Reclassification of unrealized gain on expired derivatives designated and qualified as cash flow hedges, net of income tax			(3,593	)			(37	)
	Unrecognized net pension and other postretirement benefit (losses) gains, net of income tax			(2,186	)			870
	Reclassification of net pension and other postretirement benefit losses, net of income tax			1,861				593
	Foreign currency translation adjustments, net of income tax			74,251				25,309
	Total comprehensive income			106,335				16,508
	Comprehensive income attributable to noncontrolling interests			2,544				1,045
	Comprehensive income attributable to Kennametal shareowners		$	103,791			$	15,463

18.

GOODWILL AND OTHER INTANGIBLE ASSETS

Goodwill represents the excess of cost over the fair value of the net assets of acquired companies. Goodwill and other intangible assets with indefinite lives are tested at least annually for impairment. We perform our annual impairment tests during the June quarter in connection with our annual planning process unless there are impairment indicators that warrant a test prior to that. We tested for impairment under the new segment structure and noted that there was no impairment as of September 30, 2010. See Note 19 for further discussion regarding the Company’s new segments.

KENNAMETAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

A summary of the carrying amount of goodwill attributable to each segment as well as the changes in such are as follows:

	(in thousands)		Industrial				Infrastructure				Total
	Goodwill		$	393,974			$	246,311			$	640,285
	Accumulated impairment losses			(150,842	)			-				(150,842	)
	Balance as of June 30, 2010		$	243,132			$	246,311			$	489,443
	Adjustments		$	65			$	-			$	65
	Translation			11,316				1,920				13,236
	Change in goodwill			11,381				1,920				13,301
	Goodwill			405,355				248,231				653,586
	Accumulated impairment losses			(150,842	)			-				(150,842	)
	Balance as of September 30, 2010		$	254,513			$	248,231			$	502,744

The components of our intangible assets were as follows:

			Estimated				September 30, 2010								June 30, 2010
			Useful Life				Gross Carrying				Accumulated				Gross Carrying				Accumulated
	(in thousands)		(in years)				Amount				Amortization				Amount				Amortization
	Contract-based			4 to 15			$	6,245			$	(5,170	)		$	6,357			$	(5,218	)
	Technology-based and other			4 to 15				38,834				(22,716	)			37,136				(20,422	)
	Customer-related			10 to 20				111,647				(32,051	)			108,470				(29,255	)
	Unpatented technology			30				19,423				(4,479	)			19,216				(4,572	)
	Trademarks			5 to 20				10,833				(4,196	)			10,647				(3,876	)
	Trademarks		Indefinite					39,161				-				36,823				-
	Total						$	226,143			$	(68,612	)		$	218,649			$	(63,343	)

During the three months ended September 30, 2010, we recorded amortization expense of $2.9 million related to our intangible assets and favorable foreign currency translation adjustments of $5.2 million.

19.

SEGMENT DATA

In order to take additional advantage of growth opportunities as well as to provide a better platform for continually improving the efficiency and effectiveness of operations, we implemented a new operating structure at the start of 2011.

The new structure provides for an enhanced market sector approach coupled with a more customer-centric focus for the sales organization and other key market-facing functions such as customer service, marketing, product management, engineering and product development. The new structure also involves the formation of a single, global integrated supply chain and logistics organization that unleashes additional opportunities to achieve higher customer satisfaction and realize lower costs to serve. Furthermore, the new structure provides for more uniform management of administrative functions on a global basis to further improve the consistency, effectiveness and efficiency of the services provided by these functions.

A key attribute of the new structure is the establishment of two new operating segments by market sector which replace the previous two operating segments that were based on a product focus. The two new reportable operating segments are named Industrial and Infrastructure. The Industrial business is focused on customers within the transportation, aerospace, defense and general engineering market sectors, as well as the machine tool industry. The Infrastructure business is focused on customers within the energy and earthworks industries. The formation of the two new reportable operating segments is consistent with the new management approach and internal financial reporting established under the new structure.

Under the new structure, more corporate expenses will be charged to the new segments than were charged to the previous segments. Corporate expenses related to executive retirement plans, the Company’s Board of Directors and strategic initiatives, as well as certain other costs determined to be non-chargeable, will continue to be reported as Corporate.

KENNAMETAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

		Kennametal delivers productivity to customers seeking peak performance in demanding environments by providing innovative custom and standard wear-resistant solutions, enabled through our advanced materials sciences, application knowledge and commitment to a sustainable environment. Our product offering includes a wide array of standard and custom solution products in metalworking, such as metal cutting tools and tooling systems, and advanced materials, such as cemented tungsten carbide products, to address customer demands. These products are offered through a variety of channels via an enterprise approach to customers in both of our operating segments.
		The Industrial segment serves customers that operate in industrial end markets such as aerospace, defense, transportation and general engineering. The customers in these end markets manufacture engines, airframes, automobiles, trucks, ships and various industrial goods. The technology needs and level of customization vary by customer and industry served. We deliver value to our Industrial segment customers through our application expertise and diverse product offering.
		The Infrastructure segment serves customers that operate in the earthworks and energy end markets. The customers support primary industries such as oil and gas, power generation, underground mining, surface and hard rock mining, highway construction and road maintenance. Generally, our Infrastructure segment customers are served through a customer intimacy model that allows us to offer full system solutions by gaining an in depth understanding of our customers engineering needs. Our product offering promotes value by bringing enhanced performance and productivity to our customers’ processes and systems.
		Our external sales and operating income (loss) by segment are as follows:

	Three months ended September 30 (in thousands)		2010				2009(1)
	External sales:
	Industrial		$	330,658			$	248,353
	Infrastructure			198,500				161,042
	Total external sales		$	529,158			$	409,395
	Operating income (loss):
	Industrial		$	36,108			$	(17,851	)
	Infrastructure			26,503				11,648
	Corporate			(5,099	)			(3,328	)
	Total operating income (loss)		$	57,512			$	(9,531	)
	Interest expense		$	5,963			$	6,371
	Other expense (income), net			1,911				(2,952	)
	Income (loss) from continuing operations before income taxes		$	49,638			$	(12,950	)

			September 30,				June 30,
	(in thousands)		2010				2010
	Total assets:
	Industrial		$	1,371,454			$	1,310,635
	Infrastructure			713,427				682,169
	Corporate			295,850				275,019
	Total assets		$	2,380,731			$	2,267,823

(1)

Amounts for the three months ended September 30, 2009 and for the period ended June 30, 2010 have been restated to reflect the change in reportable operating segments.

20.		SUBSEQUENT EVENTS
		On October 26, 2010, the Board of Directors authorized a repurchase program of up to 8 million shares of our outstanding common stock. The purchases would be made from time to time, on the open market or in private transactions, with consideration given to the market price of the stock, the nature of other investment opportunities, cash flows from operating activities and general economic conditions.

ITEM 2.		MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

OVERVIEW

Kennametal Inc. is a leading global manufacturer and supplier of tooling, engineered components and advanced materials consumed in production processes. We believe that our reputation for manufacturing excellence, as well as our technological expertise and innovation in our principal products, has helped us to achieve a leading market presence in our primary markets. We believe we are one of the largest global providers of consumable metalcutting tools and tooling supplies. End users of our products include metalworking manufacturers and suppliers across a diverse array of industries including the aerospace, defense, transportation, machine tool, light machinery and heavy machinery industries, as well as manufacturers, producers and suppliers in a number of other industries including coal mining, highway construction, quarrying, and oil and gas exploration and production industries. Our end users’ products include items ranging from airframes to coal mining, engines to oil wells and turbochargers to construction.

We experienced growth for the September quarter across all major served end markets. Our sales for the quarter ended September 30, 2010 grew 29.3 percent compared to sales for the September quarter one year ago. Operating margin for the quarter increased by $67.0 million on sales that were $119.8 million higher, resulting in 56 percent year-over-year operating leverage. Our restructuring programs remain on track to deliver the anticipated annual ongoing pre-tax savings of $160 million to $165 million once all programs are fully implemented and we delivered $39 million of benefits in the quarter ended September 30, 2010.

For the quarter ended September 30, 2010, we recorded net income attributable to Kennametal of $34.9 million or $0.42 per diluted share compared to a loss attributable to Kennametal of $9.8 million or $0.12 loss per diluted share for the three months ended September 20, 2009. Higher sales volume, improved absorption of manufacturing costs due to higher production levels and mix, and incremental restructuring benefits of $9 million were the drivers for our improved performance. These benefits were partially offset by the restoration of temporary cost reductions, higher incentive compensation, and higher professional fees related to strategic projects. The prior year quarter also had a one-time benefit from certain labor negotiations in Europe.

We generated cash flow from operating activities of $26.4 million during the three months ended September 30, 2010, driven by our operating performance. Our days sales outstanding decreased by 12 days to 56 days at September 30, 2010 and inventory turns increased due to close management of production and inventory levels.

In addition, we invested further in technology and innovation to continue delivering a high level of new products to our customers. Research and development expenses totaled $17.4 million for the three months ended September 30, 2010. In the current quarter, we generated approximately 40 percent of our sales from new products.

NEW OPERATING STRUCTURE IMPLEMENTED AS OF JULY 1, 2010 In order to take additional advantage of growth opportunities as well as to provide a better platform for continually improving the efficiency and effectiveness of operations, we implemented a new operating structure at the start of 2011.

The new structure provides for an enhanced market sector approach coupled with a more customer-centric focus for the sales organization and other key market-facing functions such as customer service, marketing, product management, engineering and product development. The new structure also involves the formation of a single, global integrated supply chain and logistics organization that unleashes additional opportunities to achieve higher customer satisfaction and realize lower costs to serve. Furthermore, the new structure provides for more uniform management of administrative functions on a global basis to further improve the consistency, effectiveness and efficiency of the services provided by these functions.

A key attribute of the new structure is the establishment of two new operating segments by market sector which replace the previous two operating segments that were based on a product focus. The two new reportable operating segments are named Industrial and Infrastructure. The Industrial business is primarily focused on customers within the transportation, aerospace, defense, general engineering market sectors, as well as the machine tool industry. The Infrastructure business is primarily focused on customers within the energy and earthworks industries. The formation of the two new reportable operating segments is consistent with the new management approach and internal financial reporting established under the new structure.

Under the new structure, more corporate expenses will be charged to the new segments than were charged to the previous segments. Corporate expenses related to executive retirement plans, the Company’s Board of Directors and strategic initiatives, as well as certain other costs determined to be non-chargeable will continue to be reported as Corporate.

ITEM 2.		MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)

 

The following narrative provides further discussion and analysis of our results of operations, liquidity and capital resources as well as other pertinent matters.

RESULTS OF CONTINUING OPERATIONS

SALES

Sales for the three months ended September 30, 2010 were $529.2 million, an increase of $119.8 million, or 29.3 percent, from $409.4 million in the prior year quarter. Sales increased organically by 34 percent, partially offset by a 3 percent unfavorable impact from foreign currency effects and an unfavorable impact from fewer business days. The improvement in sales was driven by continued expansion in industrial activity in all of our major served end markets and all major geographies.

GROSS PROFIT

Gross profit for the three months ended September 30, 2010 was $188.7 million, an increase of $70.9 million from $117.8 million in the prior year quarter. This increase was due to higher organic sales volume, improved absorption of manufacturing costs due to higher production levels and favorable product mix, restructuring and other cost reduction benefits. The impact of these items was partially offset by higher raw material costs, unfavorable foreign currency effects of $6.1 million and the restoration of salaries and other employment costs that had been temporarily reduced. The prior year was also favorably impacted by one-time benefits from certain labor negotiations in Europe. The gross profit margin for the three months ended September 30, 2010 was 35.7 percent as compared to 28.8 percent generated in the prior year quarter.

OPERATING EXPENSE

Operating expense for the three months ended September 30, 2010 increased $8.8 million or 7.6 percent to $125.0 million compared to $116.2 million in the prior year quarter. The increase is primarily attributable to an increase in employment costs of $8.9 million due mostly to the restoration of salaries and other employment costs that had been temporarily reduced, and higher spending on professional fees of $1.9 million driven by the implementation of certain long-term strategic projects, partially offset by favorable foreign currency effects of $3.5 million.

RESTRUCTURING CHARGES

We continued to implement restructuring plans to reduce costs and improve operating efficiencies. The actions taken in the September quarter related primarily to rationalization of certain manufacturing facilities. Restructuring and related charges recorded in the three months ended September 30, 2010 amounted to $4.3 million, including $3.3 million of restructuring charges. Restructuring related charges of $1.0 million were recorded in cost of goods sold during the three months ended September 30, 2010. We realized pre-tax benefits from these restructuring programs of approximately $39 million for the three months ended September 30, 2010. See Note 7 of our condensed consolidated financial statements set forth in Part I Item 1 of this Form 10-Q.

The Company’s restructuring programs are on track to deliver the anticipated annual ongoing pre-tax savings of $160 million to $165 million once all programs are fully implemented. The combined total pre-tax charges are expected to be approximately $160 million to $165 million. Total restructuring and related charges recorded from inception to September 30, 2010 were $133 million. The remaining restructuring charges are expected to be completed within the next 6 to 9 months and are anticipated to be mostly cash expenditures.

INTEREST EXPENSE

Interest expense for the three months ended September 30, 2010 of $6.0 million decreased $0.4 million, or 6.3 percent, from $6.4 million in the prior year quarter.

OTHER EXPENSE (INCOME), NET

Other expense, net for the three months ended September 30, 2010 was $1.9 million, compared to other income, net of $3.0 million for the three months ended September 30, 2009. The decrease was primarily driven by unfavorable foreign currency transaction results of $3.6 million.

ITEM 2.		MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)