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 MARCH 31, 2019
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.) | |
600 Grant Street Suite 5100 Pittsburgh, Pennsylvania | 15219-2706 | |
(Address of principal executive offices) | (Zip Code) | |
Registrant’s telephone number, including area code: (412) 248-8000
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 every Interactive Data File required to be submitted 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 such files). YES [X] NO [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer [X] | Accelerated filer [ ] | |
Non-accelerated filer [ ] | Smaller reporting company [ ] | |
Emerging growth company [ ] | ||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES [ ] NO [X]
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Trading Symbol | Name of each exchange on which registered |
Capital Stock, par value $1.25 per share | KMT | New York Stock Exchange |
Preferred Stock Purchase Rights | New York Stock Exchange | |
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 April 30, 2019 | |
Capital Stock, par value $1.25 per share | 82,390,406 | |
KENNAMETAL INC.
FORM 10-Q
FOR THE THREE AND NINE MONTHS ENDED MARCH 31, 2019
TABLE OF CONTENTS
Item No. | Page No. | |
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3. | ||
4. | ||
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6. | ||
2
FORWARD-LOOKING INFORMATION
This Quarterly Report on 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. We have also included forward-looking statements in this Quarterly Report on Form 10-Q concerning, among other things, our strategy, goals, plans and projections regarding our financial position, liquidity and capital resources, results of operations, market position and product development. These statements are based on current estimates that involve inherent risks and uncertainties. Should one or more of these risks or uncertainties materialize, or should the assumptions underlying the forward-looking statements prove incorrect, our actual results could vary materially from our current expectations. There are a number of factors that could cause our actual results to differ from those indicated in the forward-looking statements. They include: downturns in the business cycle or the economy; our ability to achieve anticipated benefits from our restructuring, simplification and modernization initiatives; risks related to our foreign operations and international markets, such as fluctuations in 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; potential for future goodwill and other intangible asset impairment charges; our ability to protect and defend our intellectual property; continuity and security of information technology infrastructure; competition; our ability to retain our management and employees; demands on management resources; availability and cost of the raw materials we use to manufacture our products; product liability claims; integrating acquisitions and achieving the expected savings and synergies; global or regional catastrophic events; demand for and market acceptance of our products; business divestitures; labor relations; and implementation of environmental remediation matters. We provide additional information about many of the specific risks we face in the “Risk Factors” section of our Annual Report on Form 10-K. We can give no assurance that any goal or plan set forth in our forward-looking statements will be achieved and readers are cautioned not to place undue reliance on such statements, which speak only as of the date made. Except as required by law, we do not intend to release publicly any revisions to forward-looking statements as a result of future events or developments.
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PART I – FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
KENNAMETAL INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
Three Months Ended March 31, | Nine Months Ended March 31, | ||||||||||||||
(in thousands, except per share amounts) | 2019 | 2018 | 2019 | 2018 | |||||||||||
Sales (Note 3) | $ | 597,204 | $ | 607,936 | $ | 1,771,285 | $ | 1,721,734 | |||||||
Cost of goods sold | 389,118 | 391,519 | 1,153,509 | 1,133,866 | |||||||||||
Gross profit | 208,086 | 216,417 | 617,776 | 587,868 | |||||||||||
Operating expense | 120,135 | 130,630 | 358,054 | 373,361 | |||||||||||
Restructuring and asset impairment charges (Note 7) | 2,440 | 1,264 | 5,061 | 6,834 | |||||||||||
Amortization of intangibles | 3,640 | 3,690 | 10,780 | 11,028 | |||||||||||
Operating income | 81,871 | 80,833 | 243,881 | 196,645 | |||||||||||
Interest expense | 8,104 | 7,468 | 24,305 | 21,848 | |||||||||||
Other income, net | (4,993 | ) | (3,876 | ) | (11,775 | ) | (11,314 | ) | |||||||
Income before income taxes | 78,760 | 77,241 | 231,351 | 186,111 | |||||||||||
Provision for income taxes | 8,632 | 24,130 | 46,553 | 51,204 | |||||||||||
Net income | 70,128 | 53,111 | 184,798 | 134,907 | |||||||||||
Less: Net income attributable to noncontrolling interests | 1,578 | 2,245 | 4,852 | 3,256 | |||||||||||
Net income attributable to Kennametal | $ | 68,550 | $ | 50,866 | $ | 179,946 | $ | 131,651 | |||||||
PER SHARE DATA ATTRIBUTABLE TO KENNAMETAL SHAREHOLDERS | |||||||||||||||
Basic earnings per share | $ | 0.83 | $ | 0.62 | $ | 2.19 | $ | 1.62 | |||||||
Diluted earnings per share | $ | 0.82 | $ | 0.61 | $ | 2.16 | $ | 1.59 | |||||||
Dividends per share | $ | 0.20 | $ | 0.20 | $ | 0.60 | $ | 0.60 | |||||||
Basic weighted average shares outstanding | 82,479 | 81,793 | 82,305 | 81,445 | |||||||||||
Diluted weighted average shares outstanding | 83,339 | 83,109 | 83,266 | 82,670 | |||||||||||
KENNAMETAL INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
Three Months Ended March 31, | Nine Months Ended March 31, | |||||||||||||
(in thousands) | 2019 | 2018 | 2019 | 2018 | ||||||||||
Net income | $ | 70,128 | $ | 53,111 | $ | 184,798 | $ | 134,907 | ||||||
Other comprehensive income (loss), net of tax | ||||||||||||||
Unrealized gain (loss) on derivatives designated and qualified as cash flow hedges | 232 | (783 | ) | 141 | (1,688 | ) | ||||||||
Reclassification of unrealized loss on derivatives designated and qualified as cash flow hedges | 695 | 898 | 1,552 | 2,301 | ||||||||||
Unrecognized net pension and other postretirement benefit gain (loss) | 51 | (1,749 | ) | 1,246 | (4,339 | ) | ||||||||
Reclassification of net pension and other postretirement benefit loss | 1,287 | 1,344 | 3,893 | 4,692 | ||||||||||
Foreign currency translation adjustments | (1,239 | ) | 20,282 | (20,845 | ) | 54,075 | ||||||||
Total other comprehensive income (loss), net of tax | 1,026 | 19,992 | (14,013 | ) | 55,041 | |||||||||
Total comprehensive income | 71,154 | 73,103 | 170,785 | 189,948 | ||||||||||
Less: comprehensive income attributable to noncontrolling interests | 1,612 | 2,515 | 4,154 | 4,699 | ||||||||||
Comprehensive income attributable to Kennametal Shareholders | $ | 69,542 | $ | 70,588 | $ | 166,631 | $ | 185,249 | ||||||
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KENNAMETAL INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(in thousands, except per share data) | March 31, 2019 | June 30, 2018 | |||||
ASSETS | |||||||
Current assets: | |||||||
Cash and cash equivalents | $ | 112,597 | $ | 556,153 | |||
Accounts receivable, less allowance for doubtful accounts of $10,750 and $11,807, respectively | 403,411 | 401,290 | |||||
Inventories (Note 10) | 588,613 | 525,466 | |||||
Other current assets | 58,221 | 63,257 | |||||
Total current assets | 1,162,842 | 1,546,166 | |||||
Property, plant and equipment: | |||||||
Land and buildings | 347,814 | 351,953 | |||||
Machinery and equipment | 1,772,074 | 1,702,243 | |||||
Less accumulated depreciation | (1,234,052 | ) | (1,229,983 | ) | |||
Property, plant and equipment, net | 885,836 | 824,213 | |||||
Other assets: | |||||||
Goodwill (Note 17) | 298,279 | 301,802 | |||||
Other intangible assets, less accumulated amortization of $155,115 and $145,334, respectively (Note 17) | 165,147 | 176,468 | |||||
Deferred income taxes | 16,183 | 17,015 | |||||
Other | 79,396 | 60,073 | |||||
Total other assets | 559,005 | 555,358 | |||||
Total assets | $ | 2,607,683 | $ | 2,925,737 | |||
LIABILITIES | |||||||
Current liabilities: | |||||||
Current maturities of long-term debt (Note 11) | $ | — | $ | 399,266 | |||
Notes payable to banks | — | 934 | |||||
Accounts payable | 205,069 | 221,903 | |||||
Accrued income taxes | 22,936 | 18,603 | |||||
Accrued expenses | 74,531 | 95,239 | |||||
Other current liabilities | 127,482 | 150,586 | |||||
Total current liabilities | 430,018 | 886,531 | |||||
Long-term debt, less current maturities (Note 11) | 592,070 | 591,505 | |||||
Deferred income taxes | 30,274 | 26,991 | |||||
Accrued pension and postretirement benefits | 156,537 | 159,522 | |||||
Accrued income taxes | 9,166 | 6,249 | |||||
Other liabilities | 24,213 | 24,612 | |||||
Total liabilities | 1,242,278 | 1,695,410 | |||||
Commitments and contingencies | |||||||
EQUITY (Note 15) | |||||||
Kennametal Shareholders’ Equity: | |||||||
Preferred stock, no par value; 5,000 shares authorized; none issued | — | — | |||||
Capital stock, $1.25 par value; 120,000 shares authorized; 82,367 and 81,646 shares issued, respectively | 102,958 | 102,058 | |||||
Additional paid-in capital | 524,442 | 511,909 | |||||
Retained earnings | 1,031,361 | 900,683 | |||||
Accumulated other comprehensive loss | (333,640 | ) | (320,325 | ) | |||
Total Kennametal Shareholders’ Equity | 1,325,121 | 1,194,325 | |||||
Noncontrolling interests | 40,284 | 36,002 | |||||
Total equity | 1,365,405 | 1,230,327 | |||||
Total liabilities and equity | $ | 2,607,683 | $ | 2,925,737 | |||
The accompanying notes are an integral part of these condensed consolidated financial statements.
5
KENNAMETAL INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW (UNAUDITED)
Nine Months Ended March 31, | |||||||
(in thousands) | 2019 | 2018 | |||||
OPERATING ACTIVITIES | |||||||
Net income | $ | 184,798 | $ | 134,907 | |||
Adjustments for non-cash items: | |||||||
Depreciation | 72,087 | 69,994 | |||||
Amortization | 10,780 | 11,028 | |||||
Stock-based compensation expense | 18,844 | 16,225 | |||||
Restructuring and asset impairment charges (Note 7) | 1,905 | 4,267 | |||||
Deferred income tax provision | 2,409 | 6,911 | |||||
Other | 2,567 | 3,384 | |||||
Changes in certain assets and liabilities: | |||||||
Accounts receivable | (7,595 | ) | (14,761 | ) | |||
Inventories | (71,814 | ) | (32,861 | ) | |||
Accounts payable and accrued liabilities (Note 4) | (57,165 | ) | (38,403 | ) | |||
Accrued income taxes | 5,936 | 20,206 | |||||
Accrued pension and postretirement benefits | (13,862 | ) | (19,973 | ) | |||
Other | 8,575 | (3,038 | ) | ||||
Net cash flow provided by operating activities | 157,465 | 157,886 | |||||
INVESTING ACTIVITIES | |||||||
Purchases of property, plant and equipment (Note 4) | (145,942 | ) | (105,610 | ) | |||
Disposals of property, plant and equipment | 3,575 | 2,196 | |||||
Other | (371 | ) | 321 | ||||
Net cash flow used for investing activities | (142,738 | ) | (103,093 | ) | |||
FINANCING ACTIVITIES | |||||||
Net (decrease) increase in notes payable | (871 | ) | 791 | ||||
Net decrease in short-term revolving and other lines of credit | (174 | ) | — | ||||
Term debt repayments | (400,000 | ) | (190 | ) | |||
Purchase of capital stock | (161 | ) | (163 | ) | |||
The effect of employee benefit and stock plans and dividend reinvestment | (5,249 | ) | 17,493 | ||||
Cash dividends paid to Shareholders | (49,268 | ) | (48,773 | ) | |||
Other | (687 | ) | (415 | ) | |||
Net cash flow used for financing activities | (456,410 | ) | (31,257 | ) | |||
Effect of exchange rate changes on cash and cash equivalents | (1,873 | ) | 7,741 | ||||
CASH AND CASH EQUIVALENTS | |||||||
Net (decrease) increase in cash and cash equivalents | (443,556 | ) | 31,277 | ||||
Cash and cash equivalents, beginning of period | 556,153 | 190,629 | |||||
Cash and cash equivalents, end of period | $ | 112,597 | $ | 221,906 | |||
The accompanying notes are an integral part of these condensed consolidated financial statements.
6
1.BASIS OF PRESENTATION
The condensed consolidated financial statements and accompanying notes included in this Quarterly Report on Form 10-Q, which include our accounts and those of our majority-owned subsidiaries, should be read in conjunction with the consolidated financial statements and accompanying notes included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2018 (the "2018 Annual Report"). The condensed consolidated balance sheet as of June 30, 2018 was derived from the audited balance sheet included in our 2018 Annual Report. The 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 nine months ended March 31, 2019 and 2018 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 2019 is to the fiscal year ending June 30, 2019. When used in this Quarterly Report on Form 10-Q, unless the context requires otherwise, the terms "the Company," “we,” “our” and “us” refer to Kennametal Inc. and its subsidiaries.
2.NEW ACCOUNTING STANDARDS
Adopted
In May 2014, the Financial Accounting Standards Board (FASB) issued ASU No. 2014-09, "Revenue from Contracts with Customers (Topic 606)," which requires an entity to recognize revenue in a manner that depicts the transfer of promised goods to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange. The standard also expands the disclosure requirements around contracts with customers. We adopted Topic 606 on July 1, 2018 using the modified retrospective transition method applied to those contracts that were not completed as of that date. The adoption did not have a material impact on the condensed consolidated financial statements beyond the additional disclosure requirements. Refer to Notes 3 and 18 to the condensed consolidated financial statements for further details.
In August 2016, the FASB issued ASU No. 2016-15, "Classification of Certain Cash Receipts and Cash Payments (a consensus of the Emerging Issues Task Force)," which addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice with respect to how these are classified in the statement of cash flows. We adopted this ASU on July 1, 2018. Adoption of this guidance did not have a material effect on our condensed consolidated financial statements.
In October 2016, the FASB issued ASU No. 2016-16, "Intra-Entity Transfers of Assets Other Than Inventory," which clarifies that an entity should recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. We adopted this on ASU July 1, 2018. Adoption of this guidance did not have a material effect on our condensed consolidated financial statements.
In March 2017, the FASB issued ASU No. 2017-07, "Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost," which requires that an employer report the service cost component in the same line item or items as other compensation costs arising from services rendered by the pertinent employees during the period. The other components of net benefit cost are required to be presented in the income statement separately from the service cost component and outside a subtotal of income from operations. We adopted this ASU on July 1, 2018, with the amendments applied on a retrospective basis. Refer to Note 9 to the condensed consolidated financial statements for further details.
In May 2017, the FASB issued ASU No. 2017-09, "Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting," which clarifies when to account for a change to the terms or conditions of a share-based payment award as a modification. Under the new guidance, modification accounting is required only if the fair value, the vesting conditions, or the classification of the award (as equity or liability) changes as a result of the change in terms or conditions. We adopted this ASU on July 1, 2018. Adoption of this guidance did not have a material effect on our condensed consolidated financial statements.
7
Issued
In February 2016, the FASB issued ASU No. 2016-02, "Leases: Topic 842," which replaces the existing guidance in ASC 840, Leases. The standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for substantially all leases. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. This standard is effective for Kennametal beginning July 1, 2019. We expect to adopt this standard using a modified retrospective transition approach without an adjustment to comparative periods. Currently, we are inventorying our leasing arrangements and gathering lease data in order to determine the impact this ASU will have on our consolidated financial statements. While we have not yet completed the evaluation of the effects of adopting this standard, ROU assets and lease liabilities are expected to be recorded in the condensed consolidated balance sheets as of the effective date and thereafter.
3. | REVENUE RECOGNITION |
Revenue Accounting Description and Policy
The Company's contracts with customers are comprised of purchase orders, and for larger customers, may also include long-term agreements. We account for a contract when it has approval and commitment from both parties, the rights of the parties and payment terms are identified, the contract has commercial substance and collectability of consideration is probable. These contracts with customers typically relate to the manufacturing of products, which represent single performance obligations that are satisfied when control of the product passes to the customer. The Company considers the timing of right to payment, transfer of risk and rewards, transfer of title, transfer of physical possession and customer acceptance when determining when control transfers to the customer. As a result, revenue is generally recognized at a point in time - either upon shipment or delivery - based on the specific shipping terms in the contract. The shipping terms vary across all businesses and depend on the product, customary local commercial terms and the type of transportation. Shipping and handling activities are accounted for as activities to fulfill a promise to transfer a product to a customer and as such, costs incurred are recorded when the related revenue is recognized. Payment for products is due within a limited time period after shipment or delivery, typically within 30 to 90 calendar days of the respective invoice dates. The Company does not generally offer extended payment terms.
Revenue is measured as the amount of consideration we expect to receive in exchange for transferring goods. Amounts billed and due from our customers are classified as accounts receivable, less allowance for doubtful accounts on the condensed consolidated balance sheet. Certain contracts with customers, primarily distributor customers, have an element of variable consideration that is estimated when revenue is recognized under the contract. Variable consideration primarily includes volume incentive rebates, which are based on achieving a certain level of purchases and other performance criteria as established by our distributor programs. These rebates are estimated based on projected sales to the customer and accrued as a reduction of net sales as they are earned. The majority of our products are consumed by our customers or end users in the manufacture of their products. Historically, we have experienced very low levels of returned products and do not consider the effect of returned products to be material.
See "Note 18. Segment Data" for disaggregation of revenue by geography and end market.
Contract Balances
The Company records a contract asset when it has a right to payment from a customer that is conditioned on events that have occurred other than the passage of time. The Company also records a contract liability when customers prepay but the Company has not yet satisfied its performance obligation. The Company did not have any material remaining performance obligations, contract assets or liabilities as of March 31, 2019 and June 30, 2018.
Practical Expedient
The Company pays sales commissions related to certain contracts, which qualify as incremental costs of obtaining a contract. However, the Company applies the practical expedient that allows an entity to recognize incremental costs of obtaining a contract as an expense when incurred if the amortization period of the asset that would have been recognized is one year or less. These costs are recorded within operating expense in our condensed consolidated statement of income.
8
4. | SUPPLEMENTAL CASH FLOW DISCLOSURES |
Nine Months Ended March 31, | |||||||
(in thousands) | 2019 | 2018 | |||||
Cash paid during the period for: | |||||||
Income taxes | $ | 38,208 | $ | 24,087 | |||
Interest | 23,175 | 21,091 | |||||
Supplemental disclosure of non-cash information: | |||||||
Changes in accounts payable related to purchases of property, plant and equipment | 2,400 | 11,200 | |||||
During the current quarter, the Company revised its condensed consolidated statement of cash flow for the nine months ended March 31, 2018 to correct the changes in accounts payable and accrued liabilities and in purchases of property, plant and equipment previously reported, resulting in a decrease of $22.7 million to previously reported net cash flow provided by operating activities and a corresponding decrease to previously reported net cash flow used for investing activities. The supplemental disclosure of non-cash information for changes in accounts payable related to purchases of property, plant and equipment for the nine months ended March 31, 2018 was also revised accordingly, at an increase of $11.2 million. The Company has evaluated these corrections and determined they were not material to the previously issued interim financial statements. The corrections had no effect on the previously issued annual consolidated financial statements.
5.FAIR VALUE MEASUREMENTS
Fair value is defined as the price that would be received on the sale of 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 March 31, 2019, the fair values of the Company’s financial assets and financial liabilities are categorized as follows:
(in thousands) | Level 1 | Level 2 | Level 3 | Total | |||||||||||
Assets: | |||||||||||||||
Derivatives (1) | $ | — | $ | 862 | $ | — | $ | 862 | |||||||
Total assets at fair value | $ | — | $ | 862 | $ | — | $ | 862 | |||||||
Liabilities: | |||||||||||||||
Derivatives (1) | $ | — | $ | 184 | $ | — | $ | 184 | |||||||
Total liabilities at fair value | $ | — | $ | 184 | $ | — | $ | 184 | |||||||
9
As of June 30, 2018, the fair values of the Company’s financial assets and financial liabilities are categorized as follows:
(in thousands) | Level 1 | Level 2 | Level 3 | Total | |||||||||||
Assets: | |||||||||||||||
Derivatives (1) | $ | — | $ | 1,665 | $ | — | $ | 1,665 | |||||||
Total assets at fair value | $ | — | $ | 1,665 | $ | — | $ | 1,665 | |||||||
Liabilities: | |||||||||||||||
Derivatives (1) | $ | — | $ | 207 | $ | — | $ | 207 | |||||||
Total liabilities at fair value | $ | — | $ | 207 | $ | — | $ | 207 | |||||||
(1) Currency derivatives are valued based on observable market spot and forward rates and are classified within Level 2 of the fair value hierarchy.
There have been no changes in classification and transfers between levels in the fair value hierarchy in the current period.
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 account for derivative instruments as a hedge of the related asset, liability, firm commitment or anticipated transaction, when the derivative is specifically designated and qualifies as a hedge of such items. Our objective in managing foreign exchange exposures with derivative instruments is to reduce volatility in cash flow. 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 and not designated as hedging instruments in the condensed consolidated balance sheet are as follows:
(in thousands) | March 31, 2019 | June 30, 2018 | |||||
Derivatives designated as hedging instruments | |||||||
Other current assets - range forward contracts | $ | 862 | $ | 799 | |||
Other current liabilities - range forward contracts | — | (5 | ) | ||||
Other assets - range forward contracts | — | 27 | |||||
Total derivatives designated as hedging instruments | 862 | 821 | |||||
Derivatives not designated as hedging instruments | |||||||
Other current assets - currency forward contracts | — | 839 | |||||
Other current liabilities - currency forward contracts | (184 | ) | (202 | ) | |||
Total derivatives not designated as hedging instruments | (184 | ) | 637 | ||||
Total derivatives | $ | 678 | $ | 1,458 | |||
Certain currency forward contracts that hedge 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 condensed consolidated balance sheet, with the offset to other income, net. (Gains) losses related to derivatives not designated as hedging instruments have been recognized as follows:
Three Months Ended March 31, | Nine Months Ended March 31, | ||||||||||||||
(in thousands) | 2019 | 2018 | 2019 | 2018 | |||||||||||
Other income, net - currency forward contracts | $ | (11 | ) | $ | 182 | $ | 65 | $ | (26 | ) | |||||
10
CASH FLOW HEDGES
Range forward contracts (a transaction where both a put option is purchased and a call option is sold) are designated as cash flow hedges and hedge anticipated cash flows from cross-border intercompany sales of products and services. Gains and losses realized on these contracts are recorded in accumulated other comprehensive loss and are recognized as a component of other income, net when the underlying sale of products or services is recognized into earnings. The notional amount of the contracts translated into U.S. dollars at March 31, 2019 and June 30, 2018, was $46.1 million and $62.9 million, respectively. The time value component of the fair value of range forward contracts is excluded from the assessment of hedge effectiveness. Assuming the market rates remain constant with the rates at March 31, 2019, we expect to recognize into earnings $0.6 million of income on outstanding derivatives in the next 12 months.
The following represents gains and losses related to cash flow hedges:
Three Months Ended March 31, | Nine Months Ended March 31, | ||||||||||||||
(in thousands) | 2019 | 2018 | 2019 | 2018 | |||||||||||
Gains (losses) recognized in other comprehensive income (loss), net | $ | 695 | $ | (782 | ) | $ | 603 | $ | (1,688 | ) | |||||
Losses reclassified from accumulated other comprehensive loss into other income, net | $ | 403 | $ | 761 | $ | 1,500 | $ | 2,024 | |||||||
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 nine months ended March 31, 2019 and 2018.
NET INVESTMENT HEDGES
As of March 31, 2019, we had certain foreign currency-denominated intercompany loans payable with total aggregate principal amounts of €101.0 million as net investment hedges to hedge the foreign exchange exposure of our net investment in Euro-based subsidiaries. We recorded a gain of $2.3 million and a loss of $1.1 million as a component of foreign currency translation adjustments in other comprehensive income (loss) for the three months ended March 31, 2019 and 2018, respectively. We recorded a gain of $2.8 million and a loss of $2.9 million as a component of foreign currency translation adjustments in other comprehensive income (loss) for the nine months ended March 31, 2019 and 2018, respectively.
As of March 31, 2019, the foreign currency-denominated intercompany loans payable designated as net investment hedges consisted of:
Instrument | Notional (EUR in thousands)(2) | Notional (USD in thousands)(2) | Maturity | ||||
Foreign currency-denominated intercompany loan payable | € | 40,287 | $ | 45,250 | June 27, 2019 | ||
Foreign currency-denominated intercompany loan payable | 30,074 | 33,780 | June 27, 2019 | ||||
Foreign currency-denominated intercompany loan payable | 27,925 | 31,366 | June 26, 2022 | ||||
Foreign currency-denominated intercompany loan payable | 6,527 | 7,332 | November 20, 2021 | ||||
Foreign currency-denominated intercompany loan payable | 2,028 | 2,278 | October 11, 2019 | ||||
7. | RESTRUCTURING AND RELATED CHARGES |
2018/2019 Phase of Restructuring Associated with Simplification/Modernization
In the June quarter of fiscal 2018, we implemented and substantially completed restructuring actions to simplify the Industrial segment's cost structure by directing resources to more profitable business and increasing sales force productivity. We supplemented this with the rationalization of small manufacturing facilities in the Infrastructure and Industrial segments, which we expect to complete in fiscal 2019. Total restructuring and related charges since inception of $17.4 million have been recorded for this program through March 31, 2019.
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We recorded restructuring and related charges of $3.7 million and $1.7 million for the three months ended March 31, 2019 and 2018, respectively. Of these amounts, restructuring charges totaled $2.6 million and $1.1 million for the three months ended March 31, 2019 and 2018, respectively, of which expense of $0.2 million and benefit of $0.2 million was related to inventory and was recorded in cost of goods sold for the three months ended March 31, 2019 and 2018, respectively. Restructuring-related charges of $0.9 million were recorded in cost of goods sold and $0.1 million of expense and $0.3 million of benefit were recorded in operating expense for the three months ended March 31, 2019 and 2018, respectively.
We recorded restructuring and related charges of $6.8 million and $10.0 million for the nine months ended March 31, 2019 and 2018, respectively. Of these amounts, restructuring charges totaled $5.3 million and $6.7 million, respectively, of which expense of $0.2 million and benefit of $0.2 million was related to inventory and were recorded in cost of goods sold for the nine months ended March 31, 2019 and 2018, respectively. Restructuring-related charges of $1.4 million and $3.3 million were recorded in cost of goods sold and $0.1 million were recorded in operating expense for the nine months ended March 31, 2019 and 2018, respectively.
As of March 31, 2019, the total restructuring accrual is recorded in other current liabilities in our condensed consolidated balance sheet. As of June 30, 2018, $17.5 million and $0.1 million of the restructuring accrual is recorded in other current liabilities and other liabilities, respectively. The amount attributable to each segment is as follows:
(in thousands) | June 30, 2018 | Expense | Asset Write-Down | Translation | Cash Expenditures | March 31, 2019 | |||||||||||||||||
Industrial | |||||||||||||||||||||||
Severance | $ | 7,967 | $ | 1,204 | $ | — | $ | (145 | ) | $ | (3,630 | ) | $ | 5,396 | |||||||||
Facilities | — | 1,057 | (1,057 | ) | — | — | — | ||||||||||||||||
Other | — | 22 | — | — | 1 | 23 | |||||||||||||||||
Total Industrial | $ | 7,967 | $ | 2,283 | $ | (1,057 | ) | $ | (145 | ) | $ | (3,629 | ) | $ | 5,419 | ||||||||
Widia | |||||||||||||||||||||||
Severance | $ | 2,087 | $ | 363 | $ | — | $ | (44 | ) | $ | (1,094 | ) | $ | 1,312 | |||||||||
Facilities | — | 401 | (401 | ) | — | — | — | ||||||||||||||||
Other | 15 | 7 | — | — | — | 22 | |||||||||||||||||
Total Widia | $ | 2,102 | $ | 771 | $ | (401 | ) | $ | (44 | ) | $ | (1,094 | ) | $ | 1,334 | ||||||||
Infrastructure | |||||||||||||||||||||||
Severance | $ | 7,558 | $ | 1,754 | $ | — | $ | (211 | ) | $ | (5,291 | ) | $ | 3,810 | |||||||||
Facilities | — | 447 | (447 | ) | — | — | — | ||||||||||||||||
Other | 12 | 32 | — | — | 2 | 46 | |||||||||||||||||
Total Infrastructure | $ | 7,570 | $ | 2,233 | $ | (447 | ) | $ | (211 | ) | $ | (5,289 | ) | $ | 3,856 | ||||||||
Total | $ | 17,639 | $ | 5,287 | $ | (1,905 | ) | $ | (400 | ) | $ | (10,012 | ) | $ | 10,609 | ||||||||
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8. | STOCK-BASED COMPENSATION |
Stock Options
Changes in our stock options for the nine months ended March 31, 2019 were as follows:
Options | Weighted Average Exercise Price | Weighted Average Remaining Life (years) | Aggregate Intrinsic value (in thousands) | |||||||||
Options outstanding, June 30, 2018 | 989,992 | $ | 33.08 | |||||||||
Exercised | (145,568 | ) | 29.18 | |||||||||
Lapsed or forfeited | (7,000 | ) | 45.24 | |||||||||
Options outstanding, March 31, 2019 | 837,424 | $ | 33.66 | 3.6 | $ | 4,508 | ||||||
Options vested and expected to vest, March 31, 2019 | 837,424 | $ | 33.66 | 3.6 | $ | 4,508 | ||||||
Options exercisable, March 31, 2019 | 837,424 | $ | 33.66 | 3.6 | $ | 4,508 | ||||||
Fair value of options vested during the nine months ended March 31, 2019 and 2018 was $1.2 million and $1.9 million, respectively.
Tax benefits relating to excess stock-based compensation deductions are presented in the operating activities section of the condensed consolidated statements of cash flow for the nine months ended March 31, 2019 and 2018. Tax benefits resulting from stock-based compensation deductions were greater than the amounts reported for financial reporting purposes by $1.3 million and $0.1 million for the nine months ended March 31, 2019 and 2018, respectively.
The amount of cash received from the exercise of capital stock options during the nine months ended March 31, 2019 and 2018 was $4.2 million and $21.7 million, respectively. The related tax benefit was $0.4 million and $1.4 million for the nine months ended March 31, 2019 and 2018, respectively. The total intrinsic value of options exercised during the nine months ended March 31, 2019 and 2018 was $1.9 million and $6.4 million, respectively.
Restricted Stock Units – Performance Vesting and Time Vesting
Changes in our performance vesting and time vesting restricted stock units for the nine months ended March 31, 2019 were as follows:
Performance Vesting Stock Units | Performance Vesting Weighted Average Fair Value | Time Vesting Stock Units | Time Vesting Weighted Average Fair Value | ||||||||||
Unvested, June 30, 2018 | 409,297 | $ | 31.22 | 1,083,675 | $ | 30.47 | |||||||
Granted | 161,066 | 40.10 | 542,444 | 38.91 | |||||||||
Vested | (141,394 | ) | 27.77 | (635,556 | ) | 28.67 | |||||||
Performance metric adjustments, net | 41,196 | 29.69 | — | — | |||||||||
Forfeited | (59,329 | ) | 32.58 | (41,653 | ) | 34.12 | |||||||
Unvested, March 31, 2019 | 410,836 | $ | 35.54 | 948,910 | $ | 36.38 | |||||||
During the nine months ended March 31, 2019 and 2018, compensation expense related to time vesting and performance vesting restricted stock units was $18.0 million and $15.0 million, respectively. As of March 31, 2019, the total unrecognized compensation cost related to unvested time vesting and performance vesting restricted stock units was $22.6 million and is expected to be recognized over a weighted average period of 2.1 years.
9. | PENSION AND OTHER POSTRETIREMENT BENEFITS |
We sponsor several defined benefit pension plans. Additionally, we provide varying levels of postretirement health care and life insurance benefits to certain U.S. participants.
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The table below summarizes the components of net periodic pension income:
Three Months Ended March 31, | Nine Months Ended March 31, | ||||||||||||||
(in thousands) | 2019 | 2018 | 2019 | 2018 | |||||||||||
Service cost | $ | 406 | $ | 414 | $ | 1,224 | $ | 1,224 | |||||||
Interest cost | 7,979 | 7,716 | 23,939 | 23,051 | |||||||||||
Expected return on plan assets | (13,456 | ) | (14,188 | ) | (40,352 | ) | (42,410 | ) | |||||||
Amortization of transition obligation | 23 | 24 | 68 | 70 | |||||||||||
Amortization of prior service (credit) cost | (5 | ) | (42 | ) | (15 | ) | 90 | ||||||||
Recognition of actuarial losses | 1,682 | 1,746 | 5,056 | 5,174 | |||||||||||
Net periodic pension income | $ | (3,371 | ) | $ | (4,330 | ) | $ | (10,080 | ) | $ | (12,801 | ) | |||
The table below summarizes the components of net periodic other postretirement benefit cost:
Three Months Ended March 31, | Nine Months Ended March 31, | ||||||||||||||
(in thousands) | 2019 | 2018 | 2019 | 2018 | |||||||||||
Interest cost | $ | 153 | $ | 157 | $ | 460 | $ | 471 | |||||||
Amortization of prior service credit | (22 | ) | (6 | ) | (68 | ) | (16 | ) | |||||||
Recognition of actuarial loss | 62 | 70 | 186 | 210 | |||||||||||
Net periodic other postretirement benefit cost | $ | 193 | $ | 221 | $ | 578 | $ | 665 | |||||||
In accordance with ASU 2017-07, as described in Note 2, the service cost of $0.4 million and $1.2 million for the three and nine months ended March 31, 2019 and 2018 was reported as a component of cost of goods sold and operating expense. The other components of net periodic pension income and net periodic other postretirement benefit cost totaling a net benefit of $3.6 million and $10.7 million for the three and nine months ended March 31, 2019, respectively, were presented as a component of other income, net. For the three and nine months ended March 31, 2018, we reclassified a net benefit of $3.0 million and $9.1 million, respectively, from cost of goods sold to other income, net and a net benefit of $1.5 million and $4.2 million, respectively, from operating expense to other income, net.
10. | INVENTORIES |
We used the last-in, first-out (LIFO) method of valuing inventories for 41 percent and 40 percent of total inventories at March 31, 2019 and June 30, 2018, respectively. Since 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.
Inventories consisted of the following:
(in thousands) | March 31, 2019 | June 30, 2018 | |||||
Finished goods | $ | 309,182 | $ | 279,240 | |||
Work in process and powder blends | 261,074 | 232,973 | |||||
Raw materials | 101,887 | 96,859 | |||||
Inventories at current cost | 672,143 | 609,072 | |||||
Less: LIFO valuation | (83,530 | ) | (83,606 | ) | |||
Total inventories | $ | 588,613 | $ | 525,466 | |||
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11. | LONG-TERM DEBT |
Our five-year, multi-currency, revolving credit facility, as amended and restated in June 2018 (Credit Agreement), provides for revolving credit loans of up to $700 million for working capital, capital expenditures and general corporate purposes. The 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 Credit Agreement). We were in compliance with all such covenants as of March 31, 2019. We had no borrowings outstanding under the Credit Agreement as of March 31, 2019 and June 30, 2018. Borrowings under the Credit Agreement are guaranteed by our significant domestic subsidiaries. The Credit Agreement matures in June 2023.
Fixed rate debt had a fair market value of $606.8 million and $996.4 million at March 31, 2019 and June 30, 2018, respectively. The Level 2 fair value is determined based on the quoted market prices for similar debt instruments as of March 31, 2019 and June 30, 2018, respectively.
On July 9, 2018, the Company completed the early redemption of its previously outstanding $400.0 million of 2.650 percent Senior Unsecured Notes due 2019.
12. | 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.
We establish and maintain reserves for certain potential environmental issues. At March 31, 2019 and June 30, 2018, the balances of these reserves were $12.4 million and $12.6 million, respectively. These reserves represent anticipated costs associated with the remediation of these issues and are generally not discounted.
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 United States Environmental Protection Agency (USEPA), other governmental agencies and by the Potentially Responsible Party (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.
Superfund Sites Among other environmental laws, we are subject to the Comprehensive Environmental Response Compensation and Liability Act of 1980 (CERCLA), under which we have been designated by the USEPA as a PRP with respect to environmental remedial costs at certain Superfund sites. We have evaluated our claims and liabilities associated with these Superfund sites based upon best currently available information. We believe our environmental accruals are adequate to cover our portion of the environmental remedial costs at the Superfund sites where we have been designated a PRP, to the extent these expenses are probable and reasonably estimable.
13. | INCOME TAXES |
Tax Cuts and Jobs Act of 2017 (TCJA)
The three primary items from TCJA that effect the Company for fiscal 2019 are the reduction in the statutory tax rate, the one-time tax that is imposed on our unremitted foreign earnings (Toll Tax) and the tax on global intangible low-taxed income (GILTI) which we elected to record as a period cost.
The U.S. federal tax rate reduction was effective as of January 1, 2018. As a June 30 fiscal year-end taxpayer, our fiscal 2018 U.S. federal statutory tax rate was a blended rate of 28.1 percent. Our U.S. federal statutory tax rate is 21.0 percent in fiscal 2019.
The finalized estimate of the total Toll Tax charge is $71.2 million as of March 31, 2019. Based on regulations issued by the U.S. Department of the Treasury and the Internal Revenue Service and other relevant guidance issued through March 31, 2019, we recorded net benefits of $6.8 million and $9.7 million during the three and nine months ended March 31, 2019, respectively, to adjust the finalized estimate of the Toll Tax charge. We do not expect to make a cash payment associated with the Toll Tax.
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In addition to the direct effects of TCJA, the provisions of TCJA caused the Company to re-evaluate its permanent reinvestment assertion in all jurisdictions, concluding that a portion of the unremitted earnings and profits of certain non-U.S. subsidiaries and affiliates will no longer be permanently reinvested. These changes in assertion required the recognition of a tax charge of $6.1 million recorded in the December quarter of fiscal 2019 primarily for foreign withholding and U.S. state income taxes. The remaining amount of unremitted earnings of non-U.S. subsidiaries continue to be indefinitely reinvested. With regard to the unremitted earnings which remain indefinitely reinvested, we have not, nor do we anticipate the need to, repatriate funds to the U.S. to satisfy domestic liquidity needs arising in the ordinary course of business, including liquidity needs associated with our domestic debt service requirements.
At this time, the Company does not anticipate a material impact to the fiscal 2019 condensed consolidated financial statements from the base erosion anti-abuse tax or a deduction for foreign-derived intangible income.
In accordance with the SEC Staff Accounting Bulletin 118, in the December quarter of fiscal 2019 we finalized our accounting for the impacts of the TCJA provisions enacted in fiscal 2018, including the remeasurement of deferred tax assets and liabilities at the reduced U.S. federal rate of 21.0 percent.
Effective Tax Rates
The effective income tax rates for the three months ended March 31, 2019 and 2018 were 11.0 percent and 31.2 percent, respectively. The current quarter rate reflects the lower U.S. federal statutory tax rate and a $6.8 million discrete benefit to adjust the Toll Tax charge based on regulations issued during the March quarter of fiscal 2019. The prior year rate includes a discrete Toll Tax charge of $6.4 million.
The effective income tax rates for the nine months ended March 31, 2019 and 2018 were 20.1 percent and 27.5 percent, respectively. The current year rate reflects the lower U.S. federal statutory tax rate and the $9.7 million discrete benefit associated with tax reform. It also includes the $6.1 million charge related to changes in the indefinite reinvestment assertion on certain foreign subsidiaries' undistributed earnings, which are no longer considered permanently reinvested, and GILTI. The prior year rate includes charges related to tax reform and to an out of period adjustment.
14. | 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 would occur related to the issuance of capital stock under stock option grants, performance awards and restricted stock units. The difference between basic and diluted earnings per share relates solely to the effect of capital stock options, performance awards and restricted stock units.
The following tables provide the computation of diluted shares outstanding for the three and nine months ended March 31, 2019 and 2018:
Three Months Ended March 31, | Nine Months Ended March 31, | |||||||||||
(in thousands) | 2019 | 2018 | 2019 | 2018 | ||||||||
Weighted-average shares outstanding during period | 82,479 | 81,793 | 82,305 | 81,445 | ||||||||
Add: Unexercised capital stock options, unvested performance awards and unvested restricted stock units | 860 | 1,316 | 961 | 1,225 | ||||||||
Number of shares on which diluted earnings per share is calculated | 83,339 | 83,109 | 83,266 | 82,670 | ||||||||
Unexercised capital stock options, performance awards and restricted stock units not included in the computation because the option exercise price was greater than the average market price | 515 | 5 | 423 | 416 | ||||||||
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15. | EQUITY |
A summary of the changes in the carrying amounts of total equity, Kennametal Shareholders’ equity and equity attributable to noncontrolling interests for the three months ending March 31, 2019 and 2018 is as follows:
Kennametal Shareholders’ Equity | |||||||||||||||||||||||
(in thousands) | Capital stock | Additional paid-in capital | Retained earnings | Accumulated other comprehensive loss | Non- controlling interests | Total equity | |||||||||||||||||
Balance as of December 31, 2018 | $ | 102,700 | $ | 522,413 | $ | 979,259 | $ | (334,632 | ) | $ | 38,544 | $ | 1,308,284 | ||||||||||
Net income | — | — | 68,550 | — | 1,578 | 70,128 | |||||||||||||||||
Other comprehensive income | — | — | — | 992 | 34 | 1,026 | |||||||||||||||||
Dividend reinvestment | 2 | 52 | — | — | — | 54 | |||||||||||||||||
Capital stock issued under employee benefit and stock plans(3) | 258 | 2,029 | — | — | — | 2,287 | |||||||||||||||||
Purchase of capital stock | (2 | ) | (52 | ) | — | — | — | (54 | ) | ||||||||||||||
Additions to noncontrolling interest | — | — | — | — | 443 | 443 | |||||||||||||||||
Cash dividends | — | — | (16,448 | ) | — | (315 | ) | (16,763 | ) | ||||||||||||||
Total equity, March 31, 2019 | $ | 102,958 | $ | 524,442 | $ | 1,031,361 | $ | (333,640 | ) | $ | 40,284 | $ | 1,365,405 | ||||||||||
Kennametal Shareholders’ Equity | |||||||||||||||||||||||
(in thousands) | Capital stock | Additional paid-in capital | Retained earnings | Accumulated other comprehensive loss | Non- controlling interests | Total equity | |||||||||||||||||
Balance as of December 31, 2017 | $ | 101,897 | $ | 500,388 | $ | 813,936 | $ | (289,816 | ) | $ | 37,543 | $ | 1,163,948 | ||||||||||
Net income | — | — | 50,866 | — | 2,245 | 53,111 | |||||||||||||||||
Other comprehensive income | — | — | — | 19,722 | 270 | 19,992 | |||||||||||||||||
Dividend reinvestment | 2 | 52 | — | — | — | 54 | |||||||||||||||||
Capital stock issued under employee benefit and stock plans(3) | 135 | 6,514 | — | — | — | 6,649 | |||||||||||||||||
Purchase of capital stock | (2 | ) | (52 | ) | — | — | — | (54 | ) | ||||||||||||||
Cash dividends | — | — | (16,317 | ) | — | (1,229 | ) | (17,546 | ) | ||||||||||||||
Total equity, March 31, 2018 | $ | 102,032 | $ | 506,902 | $ | 848,485 | $ | (270,094 | ) | $ | 38,829 | $ | 1,226,154 | ||||||||||
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A summary of the changes in the carrying amounts of total equity, Kennametal Shareholders’ equity and equity attributable to noncontrolling interests for the nine months ending March 31, 2019 and 2018 is as follows:
Kennametal Shareholders’ Equity | |||||||||||||||||||||||
(in thousands) | Capital stock | Additional paid-in capital | Retained earnings | Accumulated other comprehensive loss | Non- controlling interests | Total equity | |||||||||||||||||
Balance as of June 30, 2018 | $ | 102,058 | $ | 511,909 | $ | 900,683 | $ | (320,325 | ) | $ | 36,002 | $ | 1,230,327 | ||||||||||
Net income | — | — | 179,946 | — | 4,852 | 184,798 | |||||||||||||||||
Other comprehensive loss | — | — | — | (13,315 | ) | (698 | ) | (14,013 | ) | ||||||||||||||
Dividend reinvestment | 5 | 156 | — | — | — | 161 | |||||||||||||||||
Capital stock issued under employee benefit and stock plans(3) | 900 | 12,533 | — | — | — | 13,433 | |||||||||||||||||
Purchase of capital stock | (5 | ) | (156 | ) | — | — | — | (161 | ) | ||||||||||||||
Additions to noncontrolling interest | — | — | — | — | 443 | 443 | |||||||||||||||||
Cash dividends | — | — | (49,268 | ) | — | (315 | ) | (49,583 | ) | ||||||||||||||
Total equity, March 31, 2019 | $ | 102,958 | $ | 524,442 | $ | 1,031,361 | $ | (333,640 | ) | $ | 40,284 | $ | 1,365,405 | ||||||||||
Kennametal Shareholders’ Equity | |||||||||||||||||||||||
(in thousands) | Capital stock | Additional paid-in capital | Retained earnings | Accumulated other comprehensive loss | Non- controlling interests | Total equity | |||||||||||||||||
Balance as of June 30, 2017 | $ | 100,832 | $ | 474,547 | $ | 765,607 | $ | (323,692 | ) | $ | 35,359 | $ | 1,052,653 | ||||||||||
Net income | — | — | 131,651 | — | 3,256 | 134,907 | |||||||||||||||||
Other comprehensive income | — | — | — | 53,598 | 1,443 | 55,041 | |||||||||||||||||
Dividend reinvestment | 5 | 158 | — | — | — | 163 | |||||||||||||||||
Capital stock issued under employee benefit and stock plans(3) | 1,200 | 32,355 | — | — | — | 33,555 | |||||||||||||||||
Purchase of capital stock | (5 | ) | (158 | ) | — | — | — | (163 | ) | ||||||||||||||
Cash dividends | — | — | (48,773 | ) | — | (1,229 | ) | (50,002 | ) | ||||||||||||||
Total equity, March 31, 2018 | $ | 102,032 | $ | 506,902 | $ | 848,485 | $ | (270,094 | ) | $ | 38,829 | $ | 1,226,154 | ||||||||||
(3) Net of restricted stock units delivered upon vesting to satisfy tax withholding requirements.
The amounts of comprehensive income attributable to Kennametal Shareholders and noncontrolling interests are disclosed in the condensed consolidated statements of comprehensive income.
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16. | ACCUMULATED OTHER COMPREHENSIVE LOSS |
The components of, and changes in, accumulated other comprehensive loss (AOCL) were as follows, net of tax, for the nine months ended March 31, 2019:
(in thousands) | Postretirement benefit plans | Currency translation adjustment | Derivatives | Total | ||||||||
Attributable to Kennametal: | ||||||||||||
Balance, June 30, 2018 | $ | (187,755 | ) | $ | (127,347 | ) | $ | (5,223 | ) | $ | (320,325 | ) |
Other comprehensive income (loss) before reclassifications | 1,246 | (20,147 | ) | 141 | (18,760 | ) | ||||||
Amounts reclassified from AOCL | 3,893 | — | 1,552 | 5,445 | ||||||||
Net current period other comprehensive income (loss) | 5,139 | (20,147 | ) | 1,693 | (13,315 | ) | ||||||
AOCL, March 30, 2019 | $ | (182,616 | ) | $ | (147,494 | ) | $ | (3,530 | ) | $ | (333,640 | ) |
Attributable to noncontrolling interests: | ||||||||||||
Balance, June 30, 2018 | $ | — | $ | (2,913 | ) | $ | — | $ | (2,913 | ) | ||
Other comprehensive loss before reclassifications | — | (698 | ) | — | (698 | ) | ||||||
Net current period other comprehensive loss | — | (698 | ) | — | (698 | ) | ||||||
AOCL, March 31, 2019 | $ | — | $ | (3,611 | ) | $ | — | $ | (3,611 | ) | ||
The components of, and changes in, AOCL were as follows, net of tax, for the nine months ended March 31, 2018:
(in thousands) | Postretirement benefit plans | Currency translation adjustment | Derivatives | Total | ||||||||
Attributable to Kennametal: | ||||||||||||
Balance, June 30, 2017 | $ | (189,038 | ) | $ | (126,606 | ) | $ | (8,048 | ) | $ | (323,692 | ) |
Other comprehensive (loss) income before reclassifications | (4,339 | ) | 52,632 | (1,688 | ) | 46,605 | ||||||
Amounts reclassified from AOCL | 4,692 | — | 2,301 | 6,993 | ||||||||
Net current period other comprehensive income | 353 | 52,632 | 613 | 53,598 | ||||||||
AOCL, March 31, 2018 | $ | (188,685 | ) | $ | (73,974 | ) | $ | (7,435 | ) | $ | (270,094 | ) |
Attributable to noncontrolling interests: | ||||||||||||
Balance, June 30, 2017 | $ | — | $ | (2,164 | ) | $ | — | $ | (2,164 | ) | ||
Other comprehensive income before reclassifications | — | 1,443 | — | 1,443 | ||||||||
Net current period other comprehensive income | — | 1,443 | — | 1,443 | ||||||||
AOCL, March 31, 2018 | $ | — | $ | (721 | ) | $ | — | $ | (721 | ) | ||
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Reclassifications out of AOCL for the three and nine months ended March 31, 2019 and 2018 consisted of the following:
Three Months Ended March 31, | Nine Months Ended March 31, | |||||||||||||||
(in thousands) | 2019 | 2018 | 2019 | 2018 | Affected line item in the Income Statement | |||||||||||
Losses on cash flow hedges: | ||||||||||||||||
Forward starting interest rate swaps | $ | 588 | $ | 566 | $ | 1,764 | $ | 1,698 | Interest expense | |||||||
Currency exchange contracts | 333 | 623 | 292 | 1,350 | Other income, net | |||||||||||
Total before tax | 921 | 1,189 | 2,056 | 3,048 | ||||||||||||
Tax impact | (226 | ) | (291 | ) | (504 | ) | (747 | ) | Provision for income taxes | |||||||
Net of tax | $ | 695 | $ | 898 | $ | 1,552 | $ | 2,301 | ||||||||
Postretirement benefit plans: | ||||||||||||||||
Amortization of transition obligations | $ | 23 | $ | 24 | $ | 68 | $ | 70 | Other income, net | |||||||
Amortization of prior service (credit) cost | (27 | ) | (48 | ) | (83 | ) | 74 | Other income, net | ||||||||
Recognition of actuarial losses | 1,744 | 1,816 | 5,242 | 5,384 | Other income, net | |||||||||||
Total before tax | 1,740 | 1,792 | 5,227 | 5,528 | ||||||||||||
Tax impact | (453 | ) | (448 | ) | (1,334 | ) | (836 | ) | Provision for income taxes | |||||||
Net of tax | $ | 1,287 | $ | 1,344 | $ | 3,893 | $ | 4,692 | ||||||||
The amount of income tax allocated to each component of other comprehensive income for the three months ended March 31, 2019 and 2018 were as follows:
2019 | 2018 | |||||||||||||||||||
(in thousands) | Pre-tax | Tax impact | Net of tax | Pre-tax | Tax impact | Net of tax | ||||||||||||||
Unrealized gain (loss) on derivatives designated and qualified as cash flow hedges | $ | 307 | $ | (75 | ) | $ | 232 | $ | (1,037 | ) | $ | 254 | $ | (783 | ) | |||||
Reclassification of unrealized loss on derivatives designated and qualified as cash flow hedges | 921 | (226 | ) | 695 | 1,189 | (291 | ) | 898 | ||||||||||||
Unrecognized net pension and other postretirement benefit gain (loss) | 172 | (121 | ) | 51 | (2,271 | ) | 522 | (1,749 | ) | |||||||||||
Reclassification of net pension and other postretirement benefit loss | 1,740 | (453 | ) | 1,287 | 1,792 | (448 | ) | 1,344 | ||||||||||||
Foreign currency translation adjustments | (1,327 | ) | 88 | (1,239 | ) | 20,437 | (155 | ) | 20,282 | |||||||||||
Other comprehensive (loss) income | $ | 1,813 | $ | (787 | ) | $ | 1,026 | $ | 20,110 | $ | (118 | ) | $ | 19,992 | ||||||
20
The amount of income tax allocated to each component of other comprehensive (loss) income for the nine months ended March 31, 2019 and 2018 were as follows:
2019 | 2018 | |||||||||||||||||||
(in thousands) | Pre-tax | Tax impact | Net of tax | Pre-tax | Tax impact | Net of tax | ||||||||||||||
Unrealized loss on derivatives designated and qualified as cash flow hedges | $ | 187 | $ | (46 | ) | $ | 141 | $ | (2,236 | ) | $ | 548 | $ | (1,688 | ) | |||||
Reclassification of unrealized loss on derivatives designated and qualified as cash flow hedges | 2,056 | (504 | ) | 1,552 | 3,048 | (747 | ) | 2,301 | ||||||||||||
Unrecognized net pension and other postretirement benefit gain (loss) | 1,723 | (477 | ) | 1,246 | (5,705 | ) | 1,366 | (4,339 | ) | |||||||||||
Reclassification of net pension and other postretirement benefit loss | 5,227 | (1,334 | ) | 3,893 | 5,528 | (836 | ) | 4,692 | ||||||||||||
Foreign currency translation adjustments | (21,007 | ) | 162 | (20,845 | ) | 54,495 | (420 | ) | 54,075 | |||||||||||
Other comprehensive (loss) income | $ | (11,814 | ) | $ | (2,199 | ) | $ | (14,013 | ) | $ | 55,130 | $ | (89 | ) | $ | 55,041 | ||||
17. | GOODWILL AND OTHER INTANGIBLE ASSETS |
A summary of the carrying amount of goodwill attributable to each segment, as well as the changes in such carrying amounts, is as follows:
(in thousands) | Industrial | Widia | Infrastructure | Total | |||||||||||
Gross goodwill | $ | 411,458 | $ | 41,186 | $ | 633,211 | $ | 1,085,855 | |||||||
Accumulated impairment losses | (137,204 | ) | (13,638 | ) | (633,211 | ) | (784,053 | ) | |||||||
Balance as of June 30, 2018 | $ | 274,254 | $ | 27,548 | $ | — | $ | 301,802 | |||||||
Activity for the nine months ended March 31, 2019: | |||||||||||||||
Change in gross goodwill due to translation | (3,409 | ) | (114 | ) | — | (3,523 | ) | ||||||||
Gross goodwill | 408,049 | 41,072 | 633,211 | 1,082,332 | |||||||||||
Accumulated impairment losses | (137,204 | ) | (13,638 | ) | (633,211 | ) | (784,053 | ) | |||||||
Balance as of March 31, 2019 | $ | 270,845 | $ | 27,434 | $ | — | $ | 298,279 | |||||||
The components of our other intangible assets were as follows:
Estimated Useful Life (in years) | March 31, 2019 | June 30, 2018 | ||||||||||||||||
(in thousands) | Gross Carrying Amount | Accumulated Amortization | Gross Carrying Amount | Accumulated Amortization | ||||||||||||||
Contract-based | 3 to 15 | $ | 7,060 | $ | (7,055 | ) | $ | 7,061 | $ | (7,036 | ) | |||||||
Technology-based and other | 4 to 20 | 46,446 | (31,732 | ) | 46,666 | (30,923 | ) | |||||||||||
Customer-related | 10 to 21 | 205,338 | (92,188 | ) | 206,162 | (85,301 | ) | |||||||||||
Unpatented technology | 10 to 30 | 31,796 | (14,921 | ) | 31,854 | (13,096 | ) | |||||||||||
Trademarks | 5 to 20 | 12,384 | (9,219 | ) | 12,450 | (8,978 | ) | |||||||||||
Trademarks | Indefinite | 17,238 | — | 17,609 | — | |||||||||||||
Total | $ | 320,262 | $ | (155,115 | ) | $ | 321,802 | $ | (145,334 | ) | ||||||||
21
18. | SEGMENT DATA |
Our reportable operating segments have been determined in accordance with our internal management structure, which is organized based on operating activities, the manner in which we organize segments for making operating decisions and assessing performance and the availability of separate financial results. We do not allocate certain corporate expenses related to, among other things, executive retirement plans, our Board of Directors and strategic initiatives to our reportable operating segments. These costs are instead reported in Corporate. None of our three reportable operating segments represent the aggregation of two or more operating segments.
In the Industrial segment, we focus on customers in the transportation, general engineering, aerospace and defense market sectors, delivering high performance metalworking tools for specified purposes. Our customers in these end markets use our products and services in the manufacture of engines, airframes, automobiles, trucks, ships and various other types of industrial equipment. The technology and customization services we provide vary by customer, application and industry. Industrial goes to market under the Kennametal® brand through its direct sales force, a network of independent and national chain distributors, integrated supplier channels and via the Internet. Application engineers and technicians are critical to the sales process and directly assist our customers with specified product design, selection, application and support.
The Widia segment offers a focused assortment of standard custom metal cutting solutions to general engineering, aerospace, energy and transportation customers. We serve our customers primarily through a network of value added resellers, integrated supplier channels and via the Internet. Widia markets its products under the WIDIA®, WIDIA Hanita® and WIDIA GTD® brands.
The Infrastructure segment generally serves customers that operate in the energy and earthworks market sectors that support primary industries such as oil and gas, power generation and chemicals; underground, surface and hard-rock mining; highway construction and road maintenance; and process industries such as food and feed. Our success is determined by our ability to gain an in-depth understanding of our customers’ engineering and development needs, to provide complete system solutions and high-performance capabilities to optimize and add value to their operations. Infrastructure markets its products primarily under the Kennametal® brand and sells through a direct sales force as well as distributors.
Our sales and operating income by segment are as follows:
Three Months Ended March 31, | Nine Months Ended March 31, | ||||||||||||||
(in thousands) | 2019 | 2018 | 2019 | 2018 | |||||||||||
Sales: | |||||||||||||||
Industrial | $ | 318,636 | $ | 333,012 | $ | 956,515 | $ | 942,922 | |||||||
Widia | 50,966 | 52,217 | 148,592 | 145,204 | |||||||||||
Infrastructure | 227,602 | 222,707 | 666,178 | 633,608 | |||||||||||
Total sales | $ | 597,204 | $ | 607,936 | $ | 1,771,285 | $ | 1,721,734 | |||||||
Operating income (loss): | |||||||||||||||
Industrial | $ | 57,218 | $ | 50,239 | $ | 173,279 | $ | 122,782 | |||||||
Widia | (4 | ) | 1,260 | 3,817 | 1,414 | ||||||||||
Infrastructure | 24,934 | 30,097 | 69,407 | 74,320 | |||||||||||
Corporate | (277 | ) | (763 | ) | (2,622 | ) | (1,871 | ) | |||||||
Total operating income | 81,871 | 80,833 | 243,881 | 196,645 | |||||||||||
Interest expense | 8,104 | 7,468 | 24,305 | 21,848 | |||||||||||
Other income, net | (4,993 | ) | (3,876 | ) | (11,775 | ) | (11,314 | ) | |||||||
Income from continuing operations before income taxes | $ | 78,760 | $ | 77,241 | $ | 231,351 | $ | 186,111 | |||||||
22
The following table presents Kennametal's revenue disaggregated by geography:
Three Months Ended | |||||||||||||||
March 31, 2019 | March 31, 2018 | ||||||||||||||
(in thousands) | Industrial | Widia | Infrastructure | Total Kennametal | Industrial | Widia | Infrastructure | Total Kennametal | |||||||
Americas | 40% | 46% | 67% | 51% | 38% | 46% | 65% | 48% | |||||||
EMEA | 41 | 26 | 16 | 30 | 43 | 26 | 16 | 32 | |||||||
Asia Pacific | 19 | 28 | 17 | 19 | 19 | 28 | 19 | 20 | |||||||
Nine Months Ended | |||||||||||||||
March 31, 2019 | March 31, 2018 | ||||||||||||||
(in thousands) | Industrial | Widia | Infrastructure | Total Kennametal | Industrial | Widia | Infrastructure | Total Kennametal | |||||||
Americas | 40% | 46% | 66% | 50% | 38% | 46% | 65% | 48% | |||||||
EMEA | 40 | 25 | 15 | 30 | 42 | 26 | 16 | 31 | |||||||
Asia Pacific | 20 | 29 | 19 | 20 | 20 | 28 | 19 | 21 | |||||||
The following tables presents Kennametal's revenue disaggregated by end market:
Three Months Ended March 31, 2019 | |||||||
(in thousands) | Industrial | Widia | Infrastructure | Total Kennametal | |||
General engineering | 45% | 100% | 36% | 46% | |||
Transportation | 33 | — | — | 18 | |||
Aerospace and defense | 13 | — | — | 7 | |||
Energy | 9 | — | 33 | 17 | |||
Earthworks | — | — | 31 | 12 | |||
Three Months Ended March 31, 2018 | |||||||
(in thousands) | Industrial | Widia | Infrastructure | Total Kennametal | |||
General engineering | 43% | 100% | 32% | 44% | |||
Transportation | 36 | — | — | 20 | |||
Aerospace and defense | 12 | — | — | 6 | |||
Energy | 9 | — | 34 | 17 | |||
Earthworks | — | — | 34 | 13 | |||
Nine Months Ended March 31, 2019 | |||||||
(in thousands) | Industrial | Widia | Infrastructure | Total Kennametal | |||
General engineering | 44% | 100% | 34% | 45% | |||
Transportation | 34 | — | — | 18 | |||
Aerospace and defense | 13 | — | — | 7 | |||
Energy | 9 | — | 34 | 18 | |||
Earthworks | — | — | 32 | 12 | |||
23
Nine Months Ended March 31, 2018 | |||||||
(in thousands) | Industrial | Widia | Infrastructure | Total Kennametal | |||
General engineering | 43% | 100% | 32% | 44% | |||
Transportation | 37 | — | — | 20 | |||
Aerospace and defense | 11 | — | — | 6 | |||
Energy | 9 | — | 32 | 17 | |||
Earthworks | — | — | 36 | 13 | |||
24
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (MD&A)
OVERVIEW
Kennametal Inc. was incorporated in Pennsylvania in 1943 as a manufacturer of tungsten carbide metal cutting tooling. From this beginning, the Company has grown into a global leader in the development and application of tungsten carbides, ceramics, super-hard materials and solutions used in metal cutting and mission-critical wear applications to combat extreme conditions associated with wear fatigue, corrosion and high temperatures. The Company's reputation for material technology, metal cutting application knowledge, as well as expertise and innovation in the development of custom solutions and services, contributes to its leading position in its primary markets.
Our product offering includes a wide selection of standard and customized technologies for metalworking applications, such as turning, milling, hole making, tooling systems and services. End users of the Company's metalworking products include manufacturers engaged in a diverse array of industries including: the manufacturers of transportation vehicles and components, machine tools and light and heavy machinery; airframe and aerospace components; and energy-related components for the oil and gas industry, as well as power generation.
In addition, we produce specialized wear components and metallurgical powders that are used for custom-engineered and challenging applications. End users of these products include producers and suppliers in equipment-intensive operations such as coal mining, road construction, quarrying, oil and gas exploration, refining, production and supply.
Throughout the MD&A, we refer to measures used by management to evaluate performance. We also refer to a number of financial measures that are not defined under accounting principles generally accepted in the United States of America (U.S. GAAP), including organic sales growth, constant currency regional sales growth (decline) and constant currency end market sales growth (decline). We provide the definitions of these non-GAAP financial measures at the end of the MD&A section as well as details on the use and derivation of these financial measures.
Our sales of $597.2 million for the quarter ended March 31, 2019 decreased 2 percent year-over-year, reflecting 4 percent unfavorable currency exchange effect and a 1 percent unfavorable business day effect, partially offset by 3 percent organic sales growth. The Company delivered organic sales growth in every business segment on tough comparables, and end markets remained generally positive except for transportation.
Operating income was $81.9 million, compared to $80.8 million in the prior year quarter. The increase in operating income reflects organic sales growth, incremental simplification/modernization benefits and lower compensation expense, partially offset by unfavorable volume-related labor and fixed cost absorption in certain facilities in part due to simplification/modernization efforts in progress, higher raw material costs and unfavorable currency exchange. Price realization exceeded raw material cost inflation, and operating margin improved to 13.7 percent from 13.3 percent in the prior year quarter. The Industrial and Infrastructure segments had operating margins of 18.0 percent and 11.0 percent, respectively, while Widia operating income was break-even.
We announced details of the next phase of restructuring associated with simplification/modernization. These actions are expected to reduce structural costs and are currently estimated to achieve $35-$40 million of annualized savings by the end of fiscal 2020. The Company is expected to incur pre-tax charges of $55-$65 million through fiscal 2019 and 2020 for these restructuring activities.
In connection with our previous phase of our substantially completed simplification/modernization initiative, we recorded $3 million of pre-tax restructuring and related charges in the current quarter and incremental pre-tax benefits from simplification/modernization restructuring were approximately $3 million in the quarter. Annualized run-rate pre-tax benefits of approximately $12 million have been achieved in connection with these substantially completed simplification/modernization initiatives.
We reported current quarter earnings per diluted share (EPS) of $0.82, which is our tenth consecutive quarter of year-over-year EPS growth. EPS for the current quarter includes a discrete benefit from U.S. tax reform of $0.08 and restructuring and related charges of $0.03 per share. The earnings per diluted share of $0.61 in the prior year quarter included a discrete charge related to U.S. tax reform of $0.08 per share and restructuring and related charges of $0.01 per share.
We had a net cash inflow from operating activities of $157.5 million during the nine months ended March 31, 2019 compared to $157.9 million during the prior year quarter. Capital expenditures were $145.9 million and $105.6 million during the nine months ended March 31, 2019 and 2018, respectively, with the increase due in part to higher spending for modernization.
25
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
RESULTS OF CONTINUING OPERATIONS
SALES
Sales for the three months ended March 31, 2019 were $597.2 million, a decrease of $10.7 million or 2 percent, from $607.9 million in the prior year quarter. The decrease in sales was driven by a 4 percent unfavorable currency exchange impact and a 1 percent decrease due to less business days, partially offset by 3 percent organic sales growth.
Sales for the nine months ended March 31, 2019 were $1,771.3 million, an increase of $49.6 million or 3 percent, from $1,721.7 million in the prior year period. The increase in sales was driven by 5 percent organic sales growth and a 1 percent increase due to more business days, partially offset by a 3 percent unfavorable currency exchange impact.
Three Months Ended March 31, 2019 | Nine Months Ended March 31, 2019 | |||
(in percentages) | As Reported | Constant Currency | As Reported | Constant Currency |
End market sales growth (decline): | ||||
Aerospace and defense | 9% | 13% | 14% | 17% |
General engineering | 3 | 7 | 6 | 9 |
Energy | (1) | 1 | 8 | 10 |
Earthworks | (7) | (3) | (6) | (3) |
Transportation | (13) | (8) | (6) | (2) |
Regional sales growth (decline): | ||||
Americas | 3% | 4% | 7% | 8% |
Europe, the Middle East and Africa (EMEA) | (6) | 2 | (1) | 4 |
Asia Pacific | (7) | (1) | — | 5 |
GROSS PROFIT
Gross profit for the three months ended March 31, 2019 was $208.1 million, a decrease of $8.3 million from $216.4 million in the prior year quarter. The decrease was primarily due to unfavorable volume-related labor and fixed cost absorption in certain facilities in part due to simplification/modernization efforts in progress, higher raw material costs and unfavorable foreign currency exchange impact of approximately $9 million, partially offset by organic sales growth and incremental simplification/modernization benefits. The gross profit margin for the three months ended March 31, 2019 was 34.8 percent, as compared to 35.6 percent in the prior year quarter.
Gross profit for the nine months ended March 31, 2019 was $617.8 million, an increase of $29.9 million from $587.9 million in the prior year period. The increase was primarily due to organic sales growth, incremental simplification/modernization benefits and favorable mix, partially offset by higher raw material costs, unfavorable volume-related labor and fixed cost absorption in certain facilities in part due to simplification/modernization efforts in progress and unfavorable foreign currency exchange impact of approximately $20 million. The gross profit margin for the nine months ended March 31, 2019 was 34.9 percent, as compared to 34.1 percent in the prior year period.
OPERATING EXPENSE
Operating expense for the three months ended March 31, 2019 was $120.1 million compared to $130.6 million for the three months ended March 31, 2018. The decrease was primarily due to lower compensation expense, favorable currency exchange impact of approximately $5 million, and incremental restructuring simplification benefits.
Operating expense for the nine months ended March 31, 2019 was $358.1 million compared to $373.4 million for the nine months ended March 31, 2018. The decrease was primarily due to favorable currency exchange impact of approximately $9 million, lower compensation expense and incremental restructuring simplification benefits.
26
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
We invested further in technology and innovation to continue delivering high quality products to our customers. Research and development expenses included in operating expense totaled $10.5 million and $10.0 million for the three months ended March 31, 2019 and 2018, respectively, and $29.1 million for the nine months ended March 31, 2019 and 2018.
RESTRUCTURING AND RELATED CHARGES AND ASSET IMPAIRMENT CHARGES
2019/2020 Phase of Restructuring Associated with Simplification/Modernization
Beginning in the June quarter of fiscal 2019, we are implementing the next phase of restructuring associated with simplification/modernization. These actions are expected to reduce structural costs and are currently estimated to achieve $35-$40 million of annualized savings by the end of fiscal 2020. This project is a subset of the expected simplification/modernization benefits in fiscal 2020. The Company is expected to incur pre-tax charges of $55-$65 million through fiscal 2019 and 2020 for these restructuring activities, which are anticipated to be primarily cash expenditures.
2018/2019 Phase of Restructuring Associated with Simplification/Modernization
In the June quarter of fiscal 2018, we implemented and substantially completed restructuring actions to simplify the Industrial segment's cost structure by directing resources to more profitable business and increasing sales force productivity. We supplemented this with the rationalization of small manufacturing facilities in the Infrastructure and Industrial segments, which we expect to complete in fiscal 2019. Total restructuring and related charges since inception of $17.4 million have been recorded for this program through March 31, 2019.
We recorded restructuring and related charges of $3.7 million and $1.7 million for the three months ended March 31, 2019 and 2018, respectively. Of these amounts, restructuring charges totaled $2.6 million and $1.1 million for the three months ended March 31, 2019 and 2018, respectively, of which expense of $0.2 million and benefit of $0.2 million was related to inventory and was recorded in cost of goods sold for the three months ended March 31, 2019 and 2018, respectively. Restructuring-related charges of $0.9 million were recorded in cost of goods sold and $0.1 million of expense and $0.3 million of benefit were recorded in operating expense for the three months ended March 31, 2019 and 2018, respectively.
We recorded restructuring and related charges of $6.8 million and $10.0 million for the nine months ended March 31, 2019 and 2018, respectively. Of these amounts, restructuring charges totaled $5.3 million and $6.7 million, respectively, of which expense of $0.2 million and benefit of $0.2 million was related to inventory and were recorded in cost of goods sold for the nine months ended March 31, 2019 and 2018, respectively. Restructuring-related charges of $1.4 million and $3.3 million were recorded in cost of goods sold and $0.1 million were recorded in operating expense for the nine months ended March 31, 2019 and 2018, respectively.
INTEREST EXPENSE
Interest expense for the three months ended March 31, 2019 increased to $8.1 million compared to $7.5 million for the three months ended March 31, 2018. Interest expense for the nine months ended March 31, 2019 increased to $24.3 million compared to $21.8 million for the nine months ended March 31, 2018. Both increases were primarily due to the incremental interest expense associated with the $300.0 million of 4.625 percent Senior Unsecured Notes due 2028 issued in June 2018. On July 9, 2018, the Company completed the early redemption of its previously outstanding $400.0 million of 2.650 percent Senior Unsecured Notes due 2019.
OTHER INCOME, NET
Other income for the three months ended March 31, 2019 increased to $5.0 million compared to $3.9 million for the three months ended March 31, 2018. Other income for the nine months ended March 31, 2019 increased to $11.8 million compared to $11.3 million for the nine months ended March 31, 2018. Both increases were primarily due to lower foreign currency transaction losses, partially offset by lower pension income in the current period.
PROVISION FOR INCOME TAXES
The effective income tax rates for the three months ended March 31, 2019 and 2018 were 11.0 percent and 31.2 percent, respectively. The current quarter rate reflects the lower U.S. federal statutory tax rate and a $6.8 million discrete benefit to adjust the Toll Tax charge based on regulations issued during the March quarter of fiscal 2019. The prior year rate includes a discrete Toll Tax charge of $6.4 million.
27
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
The effective income tax rates for the nine months ended March 31, 2019 and 2018 were 20.1 percent and 27.5 percent, respectively. The current year rate reflects the lower U.S. federal statutory tax rate and the $9.7 million discrete benefit associated with tax reform. It also includes the $6.1 million charge related to changes in the indefinite reinvestment assertion on certain foreign subsidiaries' undistributed earnings, which are no longer considered permanently reinvested, and GILTI. The prior year rate includes charges related to tax reform and to an out of period adjustment.
See Note 13 in our condensed consolidated financial statements set forth in Part I, Item 1 of this Quarterly Report on Form 10-Q.
BUSINESS SEGMENT REVIEW
We operate three reportable segments consisting of Industrial, Widia and Infrastructure. Expenses that are not allocated are reported in Corporate. Segment determination is based upon the manner in which we organize segments for making operating decisions and assessing performance and the availability of separate financial results.
Our sales and operating income by segment are as follows:
Three Months Ended March 31, | Nine Months Ended March 31, | ||||||||||||||
(in thousands) | 2019 | 2018 | 2019 | 2018 | |||||||||||
Sales: | |||||||||||||||
Industrial | $ | 318,636 | $ | 333,012 | $ | 956,515 | $ | 942,922 | |||||||
Widia | 50,966 | 52,217 | 148,592 | 145,204 | |||||||||||
Infrastructure | 227,602 | 222,707 | 666,178 | 633,608 | |||||||||||
Total sales | $ | 597,204 | $ | 607,936 | $ | 1,771,285 | $ | 1,721,734 | |||||||
Operating (loss) income: | |||||||||||||||
Industrial | $ | 57,218 | $ | 50,239 | $ | 173,279 | $ | 122,782 | |||||||
Widia | (4 | ) | 1,260 | 3,817 | 1,414 | ||||||||||
Infrastructure | 24,934 | 30,097 | 69,407 | 74,320 | |||||||||||
Corporate | (277 | ) | (763 | ) | (2,622 | ) | (1,871 | ) | |||||||
Total operating income | 81,871 | 80,833 | 243,881 | 196,645 | |||||||||||
Interest expense | 8,104 | 7,468 | 24,305 | 21,848 | |||||||||||
Other income, net | (4,993 | ) | (3,876 | ) | (11,775 | ) | (11,314 | ) | |||||||
Income from continuing operations before income taxes | $ | 78,760 | $ | 77,241 | $ | 231,351 | $ | 186,111 | |||||||
INDUSTRIAL
Three Months Ended March 31, | Nine Months Ended March 31, | ||||||||||||||
(in thousands, except operating margin) | 2019 | 2018 | 2019 | 2018 | |||||||||||
Sales | $ | 318,636 | $ | 333,012 | $ | 956,515 | $ | 942,922 | |||||||
Operating income | 57,218 | 50,239 | 173,279 | 122,782 | |||||||||||
Operating margin | 18.0 | % | 15.1 | % | 18.1 | % | 13.0 | % | |||||||
Three Months Ended March 31, 2019 | Nine Months Ended March 31, 2019 | |||
(in percentages) | ||||
Organic sales growth | 1% | 5% | ||
Foreign currency exchange impact(1) | (5) | (4) | ||
Business days impact(2) | — | — | ||
Sales (decline) growth | (4)% | 1% | ||
28
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Three Months Ended March 31, 2019 | Nine Months Ended March 31, 2019 | ||||||
(in percentages) | As Reported | Constant Currency | As Reported | Constant Currency | |||
End market sales growth (decline): | |||||||
Aerospace and defense | 9% | 13% | 14% | 17% | |||
General engineering | — | 5 | 5 | 8 | |||
Energy | (5) | (2) | — | 3 | |||
Transportation | (13) | (8) | (6) | (3) | |||
Regional sales growth (decline): | |||||||
Americas | 2% | 4% | 7% | 9% | |||
Asia Pacific | (7) | (2) | (2) | 2 | |||
EMEA | (8) | (1) | (2) | 3 | |||
For the three months ended March 31, 2019, Industrial sales decreased 4 percent from the prior year quarter, but grew 1 percent excluding the impact from foreign currency exchange. Sales in aerospace benefited from higher demand for engines and frames globally as well as strength in accessory sales in the Americas. General engineering sales experienced growth in all three regions from strength in the indirect channel. Energy sales declined in the current quarter due to a deceleration in activity in the Americas and EMEA, partially offset by strength in Asia. Transportation sales were down in all three regions primarily due to lower production levels in China, Germany and India. The sales increase in the Americas was driven primarily by increases in the aerospace and general engineering end markets, partially offset by a decrease in transportation. The slight decline in EMEA, excluding the unfavorable impact of currency exchange, was mostly due to a decrease in transportation, partially offset by increases in the general engineering and aerospace end markets. The sales decrease in Asia Pacific was primarily driven by a decline in the transportation end market, partially offset by an increase in the general engineering end market.
For the three months ended March 31, 2019, Industrial operating income increased by $7.0 million, driven primarily by organic sales growth and incremental simplification/modernization benefits, partially offset by unfavorable volume-related labor and fixed cost absorption in certain facilities in part due to simplification/modernization efforts in progress and unfavorable currency exchange impact of approximately $4 million.
For the nine months ended March 31, 2019, Industrial sales increased 1 percent from the prior year period. Sales in aerospace were higher in all three regions driven by higher demand for engines and frames globally. General engineering sales were also higher in all three regions driven by strength in the indirect channel particularly in the Americas and a more robust light and general engineering sector in EMEA. Energy growth was driven primarily by oil and gas drilling in the Americas. Transportation sales declined in all three regions due to weaker market conditions, specifically in Asia and EMEA. The sales increase in the Americas was primarily driven by the performance in the aerospace and general engineering end markets, partially offset by a decline in transportation. The sales increases in both EMEA and Asia Pacific, excluding the unfavorable impact of currency exchange, were primarily driven by growth in the general engineering and aerospace end markets, partially offset by a decline in transportation.
For the nine months ended March 31, 2019, Industrial operating income increased by $50.5 million, driven primarily by organic sales growth, incremental simplification/modernization benefits and favorable mix, partially offset by unfavorable volume-related labor and fixed cost absorption in certain facilities in part due to simplification/modernization efforts in progress, unfavorable currency exchange impact of approximately $8 million and higher raw material costs.
WIDIA
Three Months Ended March 31, | Nine Months Ended March 31, | ||||||||||||||
(in thousands) | 2019 | 2018 | 2019 | 2018 | |||||||||||
Sales | $ | 50,966 | $ | 52,217 | $ | 148,592 | $ | 145,204 | |||||||
Operating (loss) income | (4 | ) | 1,260 | 3,817 | 1,414 | ||||||||||
Operating margin | — | % | 2.4 | % | 2.6 | % | 1.0 | % | |||||||
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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Three Months Ended March 31, 2019 | Nine Months Ended March 31, 2019 | |||
(in percentages) | ||||
Organic sales growth | 3% | 6% | ||
Foreign currency exchange impact(1) | (4) | (4) | ||
Business days impact(2) | (1) | — | ||
Sales (decline) growth | (2)% | 2% | ||
Three Months Ended March 31, 2019 | Nine Months Ended March 31, 2019 | ||||||
(in percentages) | As Reported | Constant Currency | As Reported | Constant Currency | |||
Regional sales (decline) growth: | |||||||
EMEA | (2)% | 6% | 2% | 8% | |||
Americas | (2) | (1) | — | 1 | |||
Asia Pacific | (3) | 3 | 6 | 13 | |||
For the three months ended March 31, 2019, Widia sales decreased 2 percent from the prior year quarter, but grew 3 percent excluding the impact from foreign currency exchange and business days. Growth in EMEA, excluding the unfavorable impact of currency exchange, reflects continuing progress with aerospace growth initiatives, followed by sales growth in Asia Pacific, excluding the unfavorable impact of currency exchange, which reflects some short-term market softness in India. In the Americas, we continued to make steady progress in establishing an effective distribution network in order to improve profitability.
For the three months ended March 31, 2019, Widia operating income was break-even compared with $1.3 million operating income in the prior year quarter. The change in operating income was driven primarily by lower margins from one-time costs associated with simplification efforts to streamline the product portfolio and $0.6 million higher restructuring and related charges in the current quarter, partially offset by organic sales growth.
For the nine months ended March 31, 2019, Widia sales increased 2 percent from the prior year period. We continued to see strong sales in Asia Pacific driven by general engineering and aerospace initiatives despite market softness in China and India, followed by sales growth in EMEA which also reflects successful aerospace growth initiatives. In the Americas we continued to make steady progress in establishing an effective distribution network and have exited portions of our portfolio in order to improve profitability.
For the nine months ended March 31, 2019, Widia operating income increased by $2.4 million primarily due to organic sales growth and $0.2 million less restructuring and related charges in the current period.
INFRASTRUCTURE
Three Months Ended March 31, | Nine Months Ended March 31, | ||||||||||||||
(in thousands) | 2019 | 2018 | 2019 | 2018 | |||||||||||
Sales | $ | 227,602 | $ | 222,707 | $ | 666,178 | $ | 633,608 | |||||||
Operating income | 24,934 | 30,097 | 69,407 | 74,320 | |||||||||||
Operating margin | 11.0 | % | 13.5 | % | 10.4 | % | 11.7 | % | |||||||
Three Months Ended March 31, 2019 | Nine Months Ended March 31, 2019 | |||
(in percentages) | ||||
Organic sales growth | 6% | 7% | ||
Foreign currency exchange impact(1) | (3) | (2) | ||
Business days impact(2) | (1) | — | ||
Sales growth | 2% | 5% | ||
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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Three Months Ended March 31, 2019 | Nine Months Ended March 31, 2019 | ||||||
(in percentages) | As Reported | Constant Currency | As Reported | Constant Currency | |||
End market sales growth (decline): | |||||||
General engineering | 13% | 16% | 10% | 13% | |||
Energy | 1 | 2 | 12 | 12 | |||
Earthworks | (7) | (3) | (6) | (3) | |||
Regional sales growth (decline): | |||||||
Americas | 5% | 5% | 7% | 8% | |||
EMEA | 2 | 11 | — | 5 | |||
Asia Pacific | (7) | (1) | 2 | 6 | |||
For the three months ended March 31, 2019, Infrastructure sales increased by 2 percent from the prior year quarter. The increase in sales in general engineering is driven primarily by more robust activity in the Americas and EMEA. The U.S. oil and gas market drove year-over-year growth in the energy market. Earthworks end market sales were down year-over-year due to softness in mining in the Americas, partially offset by growth in EMEA and Asia Pacific. The sales increase in EMEA was driven primarily by growth in the general engineering end market, while the increase in the Americas was driven by growth in the general engineering and energy end markets, partially offset by a decline in earthworks. The slight decline in Asia Pacific, excluding the unfavorable impact of currency exchange, was driven by a decline in the energy end market.
For the three months ended March 31, 2019, Infrastructure operating income decreased by $5.2 million driven primarily by higher raw material costs and manufacturing expenses, partially offset by organic sales growth and and incremental simplification/modernization benefits.
For the nine months ended March 31, 2019, Infrastructure sales increased by 5 percent from the prior year period. Strong growth in general engineering was driven primarily by more robust activity in the Americas and EMEA, while increases in process industries and the U.S. oil and gas market drove year-over-year growth in energy. Earthworks end market sales were down year-over-year due to softness in mining in the Americas, offset by growth in Asia Pacific. The sales increase in the Americas was driven primarily by growth in the general engineering and energy end markets, partially offset by a decrease in earthworks; while the sales increase in Asia Pacific was driven by growth in all three end markets: earthworks, general engineering, and energy. The sales increase in EMEA, excluding the unfavorable impact of currency exchange, was driven by the general engineering and energy end markets, partially offset by a decline in the earthworks end market.
For the nine months ended March 31, 2019, Infrastructure operating income decreased by $4.9 million driven primarily by higher raw material costs and manufacturing expenses and an unfavorable currency exchange impact of approximately $2 million, partially offset by organic sales growth, incremental simplification/modernization benefits, favorable mix and $1.2 million less restructuring and related charges in the current period.
CORPORATE
Three Months Ended March 31, | Nine Months Ended March 31, | ||||||||||||||
(in thousands) | 2019 | 2018 | 2019 | 2018 | |||||||||||
Corporate expense | $ | (277 | ) | $ | (763 | ) | $ | (2,622 | ) | $ | (1,871 | ) | |||
For the three and nine months ended March 31, 2019, Corporate expense decreased by $0.5 million from the prior year quarter, and increased by $0.8 million from the prior year period, respectively.
LIQUIDITY AND CAPITAL RESOURCES
Cash flow from operations is the primary source of funding for capital expenditures. For the nine months ended March 31, 2019, cash flow provided by operating activities was $157.5 million, primarily due to the net inflow from net income with adjustments for non-cash items, partially offset by a net outflow from changes in other assets and liabilities.
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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Our five-year, multi-currency, revolving credit facility, as amended and restated in June 2018 (Credit Agreement), is used to augment cash from operations and is an additional source of funds. The Credit Agreement provides for revolving credit loans of up to $700.0 million for working capital, capital expenditures and general corporate purposes. The Credit Agreement allows for borrowings in U.S. dollars, euros, Canadian dollars, pounds sterling and Japanese yen. Interest payable under the 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 Credit Agreement matures in June 2023.
The 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 Credit Agreement). We were in compliance with all such covenants as of March 31, 2019. For the nine months ended March 31, 2019, average daily borrowings outstanding under the Credit Agreement were approximately $16.1 million. We had no borrowings outstanding under the Credit Agreement as of March 31, 2019 and June 30, 2018. Borrowings under the Credit Agreement are guaranteed by our significant domestic subsidiaries.
The finalized estimate of the total Toll Tax charge is $71.2 million as of March 31, 2019. Based on regulations issued by the U.S. Department of the Treasury and the Internal Revenue Service and other relevant guidance issued through March 31, 2019, we recorded net benefits of $6.8 million and $9.7 million during the three and nine months ended March 31, 2019, respectively, to adjust the finalized estimate of the Toll Tax charge. We do not expect to make a cash payment associated with the Toll Tax.
In addition to the direct effects of TCJA, the provisions of TCJA caused the Company to re-evaluate its permanent reinvestment assertion in all jurisdictions, concluding that a portion of the unremitted earnings and profits of certain non-U.S. subsidiaries and affiliates will no longer be permanently reinvested. These changes in assertion required the recognition of a tax charge of $6.1 million recorded in the December quarter of fiscal 2019 primarily for foreign withholding and U.S. state income taxes. The remaining amount of unremitted earnings of non-U.S. subsidiaries continue to be indefinitely reinvested. With regard to the unremitted earnings which remain indefinitely reinvested, we have not, nor do we anticipate the need to, repatriate funds to the U.S. to satisfy domestic liquidity needs arising in the ordinary course of business, including liquidity needs associated with our domestic debt service requirements.
At March 31, 2019, cash and cash equivalents were $112.6 million, Total Kennametal Shareholders' equity was $1,325.1 million and total debt was $592.1 million. Our current senior credit ratings are at investment grade levels. We believe that our current financial position, liquidity and credit ratings provide us access to the capital markets. We believe that we have sufficient resources available to meet cash requirements for the next 12 months. We continue to closely monitor our liquidity position and the condition of the capital markets, as well as the counterparty risk of our credit providers.
Other than the completion of the early redemption of our previously outstanding $400.0 million of 2.650 percent Senior Unsecured Notes due 2019 on July 9, 2018, there have been no material changes in our contractual obligations and commitments since June 30, 2018.
Cash Flow Provided by Operating Activities
During the nine months ended March 31, 2019, cash flow provided by operating activities was $157.5 million, compared to $157.9 million for the prior year period. Cash flow provided by operating activities for the current year period consisted of net income and non-cash items amounting to an inflow of $293.4 million and changes in certain assets and liabilities netting to an outflow of $135.9 million. Contributing to the changes in certain assets and liabilities were an increase in inventories of $71.8 million, a decrease in accounts payable and accrued liabilities of $57.2 million and a decrease in accrued pension and postretirement benefits of $13.9 million. Partially offsetting these cash outflows was an increase in other of $8.6 million.
During the nine months ended March 31, 2018, cash flow used for operating activities consisted of net income and non-cash items amounting to an inflow of $246.7 million and changes in certain assets and liabilities netting to an outflow of $88.8 million. Contributing to the changes in certain assets and liabilities were a decrease in accounts payable and accrued liabilities of $38.4 million, an increase in inventories $32.9 million due in part to increasing volumes, a decrease in accrued pension and postretirement benefits of $20.0 million, and an increase in accounts receivable of $14.8 million due in part to increasing volumes. Partially offsetting these cash outflows was an increase in accrued income taxes of $20.2 million.
Cash Flow Used for Investing Activities
Cash flow used for investing activities was $142.7 million for the nine months ended March 31, 2019, compared to $103.1 million for the prior year period. During the current year period, cash flow used for investing activities included capital expenditures, net of $142.4 million, which consisted primarily of equipment upgrades and modernization initiatives.
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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
For the nine months ended March 31, 2018, cash flow used for investing activities included capital expenditures, net of $103.4 million, which consisted primarily of equipment upgrades and modernization initiatives.
Cash Flow Used for Financing Activities
Cash flow used for financing activities was $456.4 million for the nine months ended March 31, 2019 compared to $31.3 million in the prior year period. During the current year period, cash flow used for financing activities included outflows of $400.0 million of term debt repayments from the early extinguishment of our 2.650 percent Senior Unsecured Notes, $49.3 million of cash dividends paid to Shareholders and $5.2 million of the effect of employee benefit and stock plans and dividend reinvestment and an outflow from a net decrease in notes payable of $0.9 million.
For the nine months ended March 31, 2018, cash flow used for financing activities included $48.8 million of cash dividends paid to Shareholders, partially offset by $17.5 million of dividend reinvestment and the effect of employee benefit and stock plans.
FINANCIAL CONDITION
Working capital was $732.8 million at March 31, 2019, an increase of $73.2 million from $659.6 million at June 30, 2018. The increase in working capital was primarily driven by a decrease in current maturities of long-term debt of $399.3 million due to the early redemption of our $400 million of 2.650 percent Senior Unsecured Notes; an increase in inventories of $63.1 million due primarily to increased demand in the September and December quarters, increased strategic inventory on our high volume/high profitability products for improved customer service, raw material price increases, a temporary increase in inventory related to product moves between facilities as part of simplification/modernization and lower than anticipated sales in the March quarter; a decrease in other current liabilities of $23.1 million primarily due to bonus and restructuring payments; a decrease in accrued expenses of $20.7 million primarily due to payroll timing and a decrease in accounts payable of $16.8 million. Partially offsetting these items was a decrease in cash and cash equivalents of $443.6 million. Currency exchange rate effects decreased working capital by a total of approximately $12 million, the impact of which is included in the aforementioned changes.
Property, plant and equipment, net increased $61.6 million from $824.2 million at June 30, 2018 to $885.8 million at March 31, 2019, primarily due to capital additions of $145.9 million, partially offset by depreciation expense of $72.1 million, a negative currency exchange impact of approximately $8 million and disposals of $3.6 million.
At March 31, 2019, other assets were $559.0 million, an increase of $3.6 million from $555.4 million at June 30, 2018. The primary driver for the increase was an increase in other assets of $19.3 million primarily due to an increase in pension plan assets, partially offset by an $11.3 million decrease in other intangible assets, which was due to amortization expense of $10.8 million and unfavorable currency exchange effects of approximately $1 million, and a decrease in goodwill of $3.5 million primarily due to unfavorable currency exchange effects.
Kennametal Shareholders' equity was $1,325.1 million at March 31, 2019, an increase of $130.8 million from $1,194.3 million at June 30, 2018. The increase was primarily due to net income attributable to Kennametal of $179.9 million and capital stock issued under employee benefit and stock plans of $13.4 million, partially offset by cash dividends paid to Shareholders of $49.3 million and unfavorable currency exchange effects of $20.1 million.
DISCUSSION OF CRITICAL ACCOUNTING POLICIES
Revenue Recognition Effective July 1, 2018 with the adoption of Financial Accounting Standards Board (FASB) guidance on revenue from contracts with customers, our critical accounting policy for revenue recognition has been modified. See Note 3 to our condensed consolidated financial statements set forth in Part I, Item 1 of this Quarterly Report on Form 10-Q for a description of our revenue accounting policy.
There have been no other changes to our critical accounting policies since June 30, 2018.
33
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Goodwill and Indefinite-Lived Intangible Assets The fair values of our reporting units are determined using a combination of a discounted cash flow analysis and market multiples based upon historical and projected financial information. We apply our best judgment when assessing the reasonableness of the financial projections used to determine the fair value of each reporting unit. We evaluate the recoverability of indefinite-lived intangible assets using a discounted cash flow analysis based on projected financial information. Certain factors could further negatively affect the estimated fair value, leading to a potential impairment in the future, including items such as: (i) a decrease in expected future cash flows, specifically, a decrease in sales volume driven by a weakness in consumer demand or other competitive pressures adversely affecting our long-term volume trends and an inability to successfully achieve our cost savings targets; and (ii) inability to achieve all of the anticipated benefits from simplification and modernization actions assumed. For the Widia reporting unit, recently certain factors have deteriorated, and as such we considered the potential for impairment. While our review did not indicate an impairment triggering event as of March 31, 2019, it did indicate a likely decrease in the excess of fair value over carrying value compared to our most recent impairment test during the June quarter of fiscal 2018. We expect to perform our annual impairment tests for fiscal 2019 during the June quarter in connection with our annual planning process.
NEW ACCOUNTING STANDARDS
See Note 2 to our condensed consolidated financial statements set forth in Part I, Item 1 of this Quarterly Report on Form 10-Q for a description of new accounting standards.
RECONCILIATION OF FINANCIAL MEASURES NOT DEFINED BY U.S. GAAP
In accordance with SEC rules, below are the definitions of the non-GAAP financial measures we use in this report and the reconciliation of these measures to the most closely related GAAP financial measure. We believe that these measures provide useful perspective on underlying business trends and results and provide a supplemental measure of year-over-year results. The non-GAAP financial measures described below are used by management in making operating decisions, allocating financial resources and for business strategy purposes. These measures may be useful to investors as they provide supplemental information about business performance and provide investors a view of our business results through the eyes of management. These non-GAAP financial measures are not intended to be considered by the user in place of the related GAAP financial measure, but rather as supplemental information to our business results. These non-GAAP financial measures may not be the same as similar measures used by other companies due to possible differences in method and in the items or events being adjusted.
Organic sales growth Organic sales growth is a non-GAAP financial measure of sales growth (decline) (which is the most directly comparable GAAP measure) excluding the impacts of acquisitions, divestitures, business days and foreign currency exchange from year-over-year comparisons. We believe this measure provides investors with a supplemental understanding of underlying sales trends by providing sales growth on a consistent basis. Also, we report organic sales growth at the consolidated and segment levels.
Constant currency end market sales growth (decline) Constant currency end market sales growth (decline) is a non-GAAP financial measure of sales growth (decline) (which is the most directly comparable GAAP measure) by end market excluding the impacts of acquisitions, divestitures and foreign currency exchange from year-over-year comparisons. We note that, unlike organic sales growth, constant currency end market sales growth (decline) does not exclude the impact of business days. We believe this measure provides investors with a supplemental understanding of underlying end market trends by providing end market sales growth (decline) on a consistent basis. Also, we report constant currency end market sales growth (decline) at the consolidated and segment levels. Widia sales are reported only in the general engineering end market. Therefore, we do not provide constant currency end market sales growth for the Widia segment and, thus, do not include a reconciliation for that metric.
Constant currency regional sales growth (decline) Constant currency regional sales growth (decline) is a non-GAAP financial measure of sales growth (decline) (which is the most directly comparable GAAP measure) by region excluding the impacts of acquisitions, divestitures and foreign currency exchange from year-over-year comparisons. We note that, unlike organic sales growth, constant currency regional sales growth (decline) does not exclude the impact of business days. We believe this measure provides investors with a supplemental understanding of underlying regional trends by providing regional sales growth (decline) on a consistent basis. Also, we report constant currency regional sales growth (decline) at the consolidated and segment levels.
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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Reconciliations of organic sales growth to sales growth are as follows:
Three Months Ended March 31, 2019 | Industrial | Widia | Infrastructure | Total |
Organic sales growth | 1% | 3% | 6% | 3% |
Foreign currency exchange impact(1) | (5) | (4) | (3) | (4) |
Business days impact(2) | — | (1) | (1) | (1) |
Sales (decline) growth | (4)% | (2)% | 2% | (2)% |
Nine Months Ended March 31, 2019 | Industrial | Widia | Infrastructure | Total |
Organic sales growth | 5% | 6% | 7% | 5% |
Foreign currency exchange impact(1) | (4) | (4) | (2) | (3) |
Business days impact(2) | — | — | — | 1 |
Sales growth | 1% | 2% | 5% | 3% |
Reconciliations of constant currency end market sales growth (decline) to end market sales growth (decline)(3), are as follows:
Industrial | ||||
Three Months Ended March 31, 2019 | General engineering | Transportation | Aerospace and defense | Energy |
Constant currency end market sales growth (decline) | 5% | (8)% | 13% | (2)% |
Foreign currency exchange impact(1) | (5) | (5) | (4) | (3) |
End market sales (decline) growth(3) | —% | (13)% | 9% | (5)% |
Infrastructure | |||
Three Months Ended March 31, 2019 | Energy | Earthworks | General engineering |
Constant currency end market sales growth (decline) | 2% | (3)% | 16% |
Foreign currency exchange impact(1) | (1) | (4) | (3) |
End market sales growth (decline)(3) | 1% | (7)% | 13% |
Total | |||||
Three Months Ended March 31, 2019 | General engineering | Transportation | Aerospace and defense | Energy | Earthworks |
Constant currency end market sales growth (decline) | 7% | (8)% | 13% | 1% | (3)% |
Foreign currency exchange impact(1) | (4) | (5) | (4) | (2) | (4) |
End market sales growth (decline)(3) | 3% | (13)% | 9% | (1)% | (7)% |
Industrial | ||||
Nine Months Ended March 31, 2019 | General engineering | Transportation | Aerospace and defense | Energy |
Constant currency end market sales growth (decline) | 8% | (3)% | 17% | 3% |
Foreign currency exchange impact(1) | (3) | (3) | (3) | (3) |
End market sales growth (decline)(3) | 5% | (6)% | 14% | —% |
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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Infrastructure | |||
Nine Months Ended March 31, 2019 | Energy | Earthworks | General engineering |
Constant currency end market sales growth (decline) | 12% | (3)% | 13% |
Foreign currency exchange impact(1) | — | (3) | (3) |
End market sales growth (decline)(3) | 12% | (6)% | 10% |
Total | |||||
Nine Months Ended March 31, 2019 | General engineering | Transportation | Aerospace and defense | Energy | Earthworks |
Constant currency end market sales growth (decline) | 9% | (2)% | 17% | 10% | (3)% |
Foreign currency exchange impact(1) | (3) | (4) | (3) | (2) | (3) |
End market sales growth (decline)(3) | 6% | (6)% | 14% | 8% | (6)% |
Reconciliations of constant currency regional sales growth (decline) to reported regional sales growth (decline)(4), are as follows:
Three Months Ended March 31, 2019 | Nine Months Ended March 31, 2019 | |||||||||||
Americas | EMEA | Asia Pacific | Americas | EMEA | Asia Pacific | |||||||
Industrial | ||||||||||||
Constant currency regional sales growth (decline) | 4% | (1)% | (2)% | 9% | 3% | 2% | ||||||
Foreign currency exchange impact(1) | (2) | (7) | (5) | (2) | (5) | (4) | ||||||
Regional sales growth (decline)(4) | 2% | (8)% | (7)% | 7% | (2)% | (2)% | ||||||
Widia | ||||||||||||
Constant currency regional sales (decline) growth | (1)% | 6% | 3% | 1% | 8% | 13% | ||||||
Foreign currency exchange impact(1) | (1) | (8) | (6) | (1) | (6) | (7) | ||||||
Regional sales (decline) growth(4) | (2)% | (2)% | (3)% | —% | 2% | 6% | ||||||
Infrastructure | ||||||||||||
Constant currency regional sales growth (decline) | 5% | 11% | (1)% | 8% | 5% | 6% | ||||||
Foreign currency exchange impact(1) | — | (9) | (6) | (1) | (5) | (4) | ||||||
Regional sales growth (decline)(4) | 5% | 2% | (7)% | 7% | —% | 2% | ||||||
Total | ||||||||||||
Constant currency regional sales growth (decline) | 4% | 2% | (1)% | 8% | 4% | 5% | ||||||
Foreign currency exchange impact(1) | (1) | (8) | (6) | (1) | (5) | (5) | ||||||
Regional sales growth (decline)(4) | 3% | (6)% | (7)% | 7% | (1)% | —% | ||||||
(1) Foreign currency exchange impact is calculated by dividing the difference between current period sales at prior period foreign exchange rates and prior period sales by prior period sales.
(2) Business days impact is calculated by dividing the year-over-year change in weighted average working days (based on mix of sales by country) by prior period weighted average working days.
(3) Aggregate sales for all end markets sum to the sales amount presented on Kennametal's financial statements.
(4) Aggregate sales for all regions sum to the sales amount presented on Kennametal's financial statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
There have been no material changes to our market risk exposures since June 30, 2018.
36
ITEM 4. CONTROLS AND PROCEDURES |
As of the end of the period covered by this Quarterly Report on Form 10-Q, the Company's management evaluated, with the participation of the Company's Chief Executive Officer and Chief Financial Officer, the effectiveness of the Company's disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)). The Company's disclosure controls were designed to provide a reasonable assurance that information required to be disclosed in reports that we file or submit under the Securities Exchange Act of 1934, as amended (Exchange Act), is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. It should be noted that the design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote. However, the controls have been designed to provide reasonable assurance of achieving the controls' stated goals. Based on that evaluation, the Company's Chief Executive Officer and Chief Financial Officer have concluded that the Company's disclosure controls and procedures are effective to provide reasonable assurance at March 31, 2019 to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is (i) accumulated and communicated to management, including the Company's Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure and (ii) recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission.
There were no changes in the Company's internal control over financial reporting that occurred during the Company's most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.
37
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS |
From time to time, we are party to legal claims and proceedings that arise in the ordinary course of business, which may relate to our operations or assets, including real, tangible or intellectual property. Although certain of these types of actions are currently pending, we do not believe that any individual proceeding is material or that our pending legal proceedings in the aggregate are material to Kennametal. See "Note 12. Environmental Matters" for a discussion of our exposure to certain environmental liabilities.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS |
ISSUER PURCHASES OF EQUITY SECURITIES
Period | Total Number of Shares Purchased (1) | Average Price Paid per Share | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs (2) | ||||||||
January 1 through January 31, 2019 | 41,696 | $ | 32.70 | — | 10,100,100 | |||||||
February 1 through February 28, 2019 | 3,127 | 38.57 | — | 10,100,100 | ||||||||
March 1 through March 31, 2019 | 43,198 | 37.69 | — | 10,100,100 | ||||||||
Total | 88,021 | $ | 35.36 | — | ||||||||
(1) | During the current period, 1,376 shares were purchased on the open market on behalf of Kennametal to fund the Company’s dividend reinvestment program. Also, during the current period employees delivered 86,645 shares of restricted stock to Kennametal, upon vesting, to satisfy tax withholding requirements. |
(2) | On July 25, 2013, the Company publicly announced an amended repurchase program for up to 17 million shares of its outstanding capital stock outside of the Company's dividend reinvestment program. |
UNREGISTERED SALES OF EQUITY SECURITIES
None.
ITEM 6. EXHIBITS |
(31) | Rule 13a-14(a)/15d-14(a) Certifications | |||
(31.1) | Filed herewith. | |||
(31.2) | Filed herewith. | |||
(32) | Section 1350 Certifications | |||
(32.1) | Filed herewith. | |||
(101) | XBRL | |||
(101.INS) | XBRL Instance Document | Filed herewith. | ||
(101.SCH) | XBRL Taxonomy Extension Schema Document | Filed herewith. | ||
(101.CAL) | XBRL Taxonomy Extension Calculation Linkbase Document | Filed herewith. | ||
(101.DEF) | XBRL Taxonomy Definition Linkbase | Filed herewith. | ||
(101.LAB) | XBRL Taxonomy Extension Label Linkbase Document | Filed herewith. | ||
(101.PRE) | XBRL Taxonomy Extension Presentation Linkbase Document | Filed herewith. | ||
38
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: | May 7, 2019 | By: | /s/ Patrick S. Watson | |
Patrick S. Watson Vice President Finance and Corporate Controller | ||||
39
Exhibit 31.1
I, Christopher Rossi, certify that:
1. | I have reviewed this quarterly report on Form 10-Q of Kennametal Inc.; |
2. | Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; |
3. | Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; |
4. | The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d -15(f)) for the registrant and have: |
a) | Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; |
b) | Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; |
c) | Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and |
d) | Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and |
5. | The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions) |
a) | All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and |
b) | Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. |
Date: | May 7, 2019 | /s/ Christopher Rossi | |
Christopher Rossi President and Chief Executive Officer | |||
Exhibit 31.2
I, Damon J. Audia, certify that:
1. | I have reviewed this quarterly report on Form 10-Q of Kennametal Inc.; |
2. | Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; |
3. | Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; |
4. | The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d -15(f)) for the registrant and have: |
a) | Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; |
b) | Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; |
c) | Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and |
d) | Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and |
5. | The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions) |
a) | All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and |
b) | Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. |
Date: | May 7, 2019 | /s/ Damon J. Audia | |
Damon J. Audia Vice President and Chief Financial Officer | |||
Exhibit 32.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Kennametal Inc. (the “Corporation”) on Form 10-Q for the period ended March 31, 2019, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), each of the undersigned officers of the Corporation certifies, pursuant to 18 U.S.C. § 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to his knowledge:
1) | The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and |
2) | The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Corporation. |
/s/ Christopher Rossi |
Christopher Rossi |
President and Chief Executive Officer |
May 7, 2019 |
/s/ Damon J. Audia |
Damon J. Audia |
Vice President and Chief Financial Officer |
May 7, 2019 |
*This certification is made solely for purposes of 18 U.S.C. Section 1350, subject to the knowledge standard contained therein, and not for any other purpose.