KENNAMETAL INC. OVERVIEW
Kennametal Inc. was founded based on a tungsten carbide technology breakthrough in 1938. The Company was incorporated inPennsylvania in 1943 as a manufacturer of tungsten carbide metal cutting tooling and was listed on theNew York Stock Exchange (NYSE) in 1967. With more than 80 years of materials expertise, the Company is a global industrial technology leader, helping customers across the aerospace, earthworks, energy, general engineering and transportation industries manufacture with precision and efficiency. This expertise includes the development and application of tungsten carbides, ceramics, super-hard materials and solutions used in metal cutting and extreme wear applications to keep customers up and running longer against conditions such as corrosion and high temperatures. Our standard and custom product offering spans metalworking and wear applications including turning, milling, hole making, tooling systems and services, as well as specialized wear components and metallurgical powders. End users of our 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. Our wear and metallurgical powders are used by producers and suppliers in equipment-intensive operations such as road construction, mining, 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 inthe United States of America (U.S. GAAP), including organic sales decline, constant currency regional sales (decline) growth and constant currency end market sales 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$483.1 million for the quarter endedMarch 31, 2020 decreased 19 percent year-over-year, reflecting 17 percent organic sales decline, a 1 percent unfavorable currency exchange effect and a 1 percent decline from divestiture. The decline reflects a global manufacturing slow down and deteriorating end markets. Operating income decreased$44.0 million from$81.9 million in the prior year quarter to$37.9 million in the current quarter. The decrease in operating income was primarily due to organic sales decline, unfavorable labor and fixed cost absorption due to lower volumes and simplification/modernization efforts in progress,$15.6 million of goodwill and other intangible asset impairment charges and higher restructuring and related charges of$2.6 million , partially offset by incremental simplification/modernization benefits and lower variable compensation expense. Operating margin was 7.8 percent compared to 13.7 percent in the prior year quarter. The Industrial and Infrastructure segments had operating margins of 11.6 percent and 12.2 percent, respectively, while the Widia segment had operating loss margin of 31.7 percent. The Coronavirus Disease 2019 (COVID-19) emerged inChina at the end of calendar year 2019 bringing significant uncertainty in our end markets and operations. National, regional and local governments have taken steps to limit the spread of the virus through stay-at-home, social distancing, and various other orders and guidelines. The imposition of these measures has created potentially significant operating constraints on our business. Recognizing the potential for COVID-19 to significantly disrupt operations, we began to deploy safety protocols and processes globally during the third quarter of fiscal 2020 to keep our employees safe while continuing to serve our customers. We have been deemed an essential business and continue to operate globally, apart fromKennametal India Ltd. and our Bolivian operations which were closed during the latter part of the third quarter of fiscal 2020 due to government mandates. We have not experienced a material disruption in our supply chain to date as a result of these facility closures or elsewhere in our supply chain. We expect COVID-19 will more materially negatively affect customer demand in the fourth quarter of fiscal 2020 as a result of the disruption and uncertainty it is causing most acutely in the energy, aerospace and transportation end markets. The extent to which the COVID-19 pandemic may impact our business, operating results, financial condition, or liquidity in the future will depend on future developments, including the duration of the outbreak, travel restrictions, business and workforce disruptions, and the effectiveness of actions taken to contain and treat the disease. The Company's strong liquidity position has allowed us to continue our simplification/modernization initiatives and the FY20 and FY21 Restructuring Actions are expected to deliver annualized savings of$30 million to$35 million and$25 million to$30 million , respectively. We recorded$5.8 million of pre-tax restructuring and related charges in the quarter, and incremental pre-tax benefits our from simplification/modernization restructuring initiatives were approximately$5 million in the quarter. Total benefits from our simplification/modernization efforts, including restructuring initiatives, were approximately$15 million in the quarter, and we achieved annualized run-rate savings from simplification/modernization of approximately$87 million since inception. 26
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We recorded non-cash pre-tax Widia goodwill and other intangible asset impairment charges of$15.6 million in the current quarter as a result of further deteriorating market conditions caused by the COVID-19 global pandemic. We reported current quarter earnings per diluted share (EPS) of$0.03 . EPS for the current quarter was unfavorably affected by restructuring and related charges and goodwill and other intangible asset impairment charges. The earnings per diluted share of$0.82 in the prior year quarter included a discrete benefit fromU.S. tax reform of$0.08 and restructuring and related charges of$0.03 per share. We generated net cash flows from operating activities of$146.1 million during the nine months endedMarch 31, 2020 compared to$157.5 million during the prior year quarter. Capital expenditures were$206.1 million and$145.9 million during the nine months endedMarch 31, 2020 and 2019, respectively, with the increase primarily due to higher spending associated with our simplification/modernization initiatives.
RESULTS OF CONTINUING OPERATIONS
SALES
Sales for the three months endedMarch 31, 2020 were$483.1 million , a decrease of$114.1 million , or 19 percent, from$597.2 million in the prior year quarter. The decrease in sales was driven by 17 percent organic sales decline, a 1 percent unfavorable currency exchange impact and a 1 percent decline from divestiture. Sales for the nine months endedMarch 31, 2020 were$1,506.3 million , a decrease of$265.0 million , or 15 percent, from$1,771.3 million in the prior year period. The decrease in sales was driven by 13 percent organic sales decline, a 1 percent unfavorable currency exchange impact and a 1 percent decline from divestiture. Three Months Ended Nine Months Ended March 31, 2020 March 31, 2020 Constant Constant (in percentages) As Reported Currency As Reported Currency End market sales decline: Energy (25)% (23)% (24)% (23)% General engineering (20) (17) (14) (12) Transportation (19) (17) (17) (16) Aerospace (17) (16) (9) (8) Earthworks (8) (6) (5) (3) Regional sales decline: Americas (20)% (18)% (16)% (14)% Europe, the Middle East and Africa (EMEA) (19) (16) (15) (11) Asia Pacific (17) (15) (13) (12) GROSS PROFIT Gross profit for the three months endedMarch 31, 2020 was$157.0 million , a decrease of$51.1 million from$208.1 million in the prior year quarter. The decrease was primarily due to organic sales decline, unfavorable labor and fixed cost absorption due to lower volumes and simplification/modernization efforts in progress and greater restructuring and related charges of$3 million , partially offset by lower raw material costs of approximately$17 million and incremental simplification/modernization benefits. Gross profit margin for the three months endedMarch 31, 2020 was 32.5 percent, as compared to 34.8 percent in the prior year quarter. Gross profit for the nine months endedMarch 31, 2020 was$428.0 million , a decrease of$189.8 million from$617.8 million in the prior year period. The decrease was primarily due to organic sales decline, unfavorable labor and fixed cost absorption due to lower volumes and simplification/modernization efforts in progress, greater restructuring and related charges of$9 million and higher effective raw material costs, partially offset by incremental simplification/modernization benefits. Gross profit margin for the nine months endedMarch 31, 2020 was 28.4 percent, as compared to 34.9 percent in the prior year period. 27
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OPERATING EXPENSE Operating expense for the three months endedMarch 31, 2020 was$98.5 million compared to$120.1 million for the three months endedMarch 31, 2019 . The decrease was primarily due to lower incentive compensation expense, incremental restructuring simplification benefits and favorable currency exchange impact of approximately$1 million . Operating expense for the nine months endedMarch 31, 2020 was$320.3 million compared to$358.1 million for the nine months endedMarch 31, 2019 . The decrease was primarily due to incremental restructuring simplification benefits, lower incentive compensation expense and favorable currency exchange impact of approximately$4 million . We invested further in technology and innovation during the current quarter to continue delivering high quality products to our customers. Research and development expenses included in operating expense totaled$9.8 million and$10.5 million for the three months endedMarch 31, 2020 and 2019, respectively, and$30.3 million and$29.1 million for the nine months endedMarch 31, 2020 and 2019, respectively. RESTRUCTURING AND RELATED CHARGES AND ASSET IMPAIRMENT CHARGES FY20 Restructuring Actions In the June quarter of fiscal 2019, we began implementing the current phase of restructuring associated with our simplification/modernization initiative. These actions are expected to reduce structural costs, improve operational efficiency and position us for long-term profitable growth and are currently estimated to achieve$30 million to$35 million of annualized savings by the end of fiscal 2020. These actions are expected to be completed in fiscal 2020 and are expected to be primarily cash expenditures. The pre-tax charges for these programs are expected to be in the range of$55 million to$60 million , which are expected to be 80 percent Industrial, 15 percent Infrastructure and 5 percent Widia. Restructuring and related charges since inception of$50.0 million were recorded for this program throughMarch 31, 2020 , consisting of:$40.6 million in Industrial;$7.2 million in Infrastructure; and$2.2 million in Widia. Inception to date, we have achieved annualized savings of approximately$32 million . FY21 Restructuring Actions OnJuly 11, 2019 , we announced the initiation of restructuring actions inGermany associated with our simplification/modernization initiative, which are expected to reduce structural costs. We have agreed with local employee representatives to downsize ourEssen, Germany operations instead of the previously proposed closure. We are also evaluating the acceleration of other facility closures as part of these restructuring activities. These actions are expected to deliver estimated annualized savings of$25 million to$30 million , be completed by the end of fiscal 2021 and be primarily cash expenditures. The pre-tax charges for these programs are expected to be in the range of$55 million to$65 million , which is expected to be primarily in the Industrial segment. Total restructuring and related charges since inception of$28.8 million were recorded for this program throughMarch 31, 2020 in the Industrial segment. Inception to date, we have achieved annualized savings of approximately$4 million . Restructuring and Related Charges Recorded We recorded restructuring and related charges of$5.8 million and$3.7 million for the three months endedMarch 31, 2020 and 2019, respectively. Of these amounts, restructuring charges totaled$1.8 million and$2.6 million for the three months endedMarch 31, 2020 and 2019, respectively, of which$0.2 million were related to inventory and were recorded in cost of goods sold for the three months endedMarch 31, 2020 and 2019. Restructuring-related charges of$4.0 million and$0.9 million were recorded in cost of goods sold for the three months endedMarch 31, 2020 and 2019, respectively. Restructuring-related charges of$0.1 million were recorded in operating expense for the three months endedMarch 31, 2019 . We recorded restructuring and related charges of$65.1 million and$6.8 million for the nine months endedMarch 31, 2020 and 2019, respectively. Of these amounts, restructuring charges totaled$54.5 million and$5.3 million for the nine months endedMarch 31, 2020 and 2019, respectively, of which$0.6 million and$0.2 million were related to inventory and were recorded in cost of goods sold for the nine months endedMarch 31, 2020 and 2019, respectively. Restructuring-related charges of$10.6 million and$1.4 million were recorded in cost of goods sold for the nine months endedMarch 31, 2020 and 2019, respectively. Restructuring-related charges of$0.1 million were recorded in operating expense for the nine months endedMarch 31, 2019 . 28
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Intangible Asset Impairment Charges
We recorded non-cash pre-tax goodwill and other intangible asset impairment
charges of
LOSS ON DIVESTITURE During the nine months endedMarch 31, 2020 , we completed the sale of certain assets of the non-core specialty alloys and metals business within the Infrastructure segment located inNew Castle, Pennsylvania to Advanced Metallurgical Group N.V. for an aggregate price of$24.0 million . The net book value of these assets at closing was$29.5 million , and the pre-tax loss on divestiture recognized during the three months endedDecember 31, 2019 was$6.5 million . Transaction proceeds were primarily used for capital expenditures related to our simplification/modernization efforts. INTEREST EXPENSE Interest expense for the three months endedMarch 31, 2020 and 2019 was$7.9 million and$8.1 million , respectively. Interest expense for the nine months endedMarch 31, 2020 decreased to$23.8 million compared to$24.3 million for the nine months endedMarch 31, 2019 . OTHER INCOME, NET Other income for the three months endedMarch 31, 2020 decreased to$2.4 million from$5.0 million during the three months endedMarch 31, 2019 . Other income for the nine months endedMarch 31, 2020 decreased to$9.3 million from$11.8 million during the nine months endedMarch 31, 2019 . The decreases in both periods were primarily driven by higher foreign currency transaction losses and less interest income, partially offset by higher pension income. PROVISION FOR INCOME TAXES Effective tax rates The effective income tax rates for the three months endedMarch 31, 2020 and 2019 were 93.1 percent and 11.0 percent, respectively. The year-over-year change is primarily due to the effects of current year restructuring and the Widia goodwill and other intangible asset impairment charges. The prior year rate included a$6.8 million discrete benefit to adjust the Toll Tax charge based on regulations issued during the March quarter of fiscal 2019. The effective income tax rates for the nine months endedMarch 31, 2020 and 2019 were 143.5 percent (benefit on a loss) and 20.1 percent (provision on income), respectively. The year-over-year change is primarily due to the change in the jurisdictional mix caused by expected restructuring and related charges, the Widia goodwill and other intangible asset impairment charges, a discrete$14.5 million benefit for the one-time effect of Swiss tax reform and the increase in global intangible low-taxed income (GILTI) and base erosion anti-abuse tax (BEAT). The prior year rate included a$9.7 million discrete benefit associated with tax reform and a$6.1 million charge related to changes in the indefinite reinvestment assertion on certain foreign subsidiaries' undistributed earnings. Coronavirus Aid, Relief, and Economic Security Act (CARES Act) OnMarch 27, 2020 , the CARES Act was enacted in response to the COVID-19 pandemic. The CARES Act, among other things, allows net operating losses arising in taxable years beginning afterDecember 31, 2017 and beforeJanuary 1, 2021 to be carried back to each of the 5 preceding taxable years to generate a refund of previously paid income taxes; permits net operating loss carryovers and carrybacks to offset 100 percent of taxable income for taxable years beginning beforeJanuary 1, 2021 ; and modifies the limitation on business interest by increasing the allowable business interest deduction from 30 percent of adjusted taxable income to 50 percent of adjusted taxable income for taxable years beginning in 2019 or 2020. We are currently in the process of evaluating the potential impact these provisions may have on the Company. Swiss tax reform Legislation was effectively enacted during the nine months endedMarch 31, 2020 when theCanton of Schaffhausen approved the Federal Act on Tax Reform and AHV Financing onOctober 8, 2019 (Swiss tax reform). Significant changes from Swiss tax reform include the abolishment of certain favorable tax regimes and the creation of a ten-year transitional period at both the federal and cantonal levels. 29
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The transitional provisions of Swiss tax reform allow companies to utilize a combination of lower tax rates and tax basis adjustments to fair value, which are used for tax depreciation and amortization purposes resulting in deductions over the transitional period. To reflect the federal and cantonal transitional provisions, as they apply to us, we recorded a deferred tax asset of$14.5 million during the three months endedDecember 31, 2019 . We consider the deferred tax asset from Swiss tax reform to be an estimate based on our current interpretation of the legislation, which is subject to change based on further legislative guidance, review with the Swiss federal and cantonal authorities and modifications to the underlying valuation. We currently expect a modestly unfavorable effect on our Swiss tax expense during the ten-year transitional period. BUSINESS SEGMENT REVIEW We operate three reportable segments consisting of Industrial, Widia and Infrastructure. Our reportable operating segments have been determined in accordance with our internal management structure, which is organized based on operating activities, the manner in which we organize segments for allocating resources, making operating decisions and assessing performance and the availability of separate financial results. We do not allocate certain corporate expenses related to executive retirement plans, our Board of Directors, strategic initiatives, and certain other costs and report them in Corporate. Our sales and operating (loss) income by segment are as follows: Three Months Ended March 31, Nine Months Ended March 31, (in thousands) 2020 2019 2020 2019 Sales: Industrial$ 260,738 $ 318,636 $ 820,008 $ 956,515 Widia 42,721 50,966 131,115 148,592 Infrastructure 179,625 227,602 555,129 666,178 Total sales$ 483,084 $ 597,204 $ 1,506,252 $ 1,771,285 Operating income (loss): Industrial$ 30,147 $ 57,218 $ 32,159 $ 173,279 Widia (13,528 ) (4 ) (31,410 ) 3,817 Infrastructure 21,941 24,934 7,679 69,407 Corporate (667 ) (277 ) (1,797 ) (2,622 ) Total operating income 37,893 81,871 6,631 243,881 Interest expense 7,897 8,104 23,834 24,305 Other income, net (2,438 ) (4,993 ) (9,330 ) (11,775 ) Income (loss) from continuing operations before income taxes$ 32,434 $ 78,760 $ (7,873 ) $ 231,351 30
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Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
INDUSTRIAL
Three Months Ended March 31, Nine Months Ended March 31,
(in thousands, except operating
margin) 2020 2019 2020 2019
Sales $ 260,738 $ 318,636 $ 820,008 $ 956,515
Operating income 30,147 57,218 32,159 173,279
Operating margin 11.6 % 18.0 % 3.9 % 18.1 %
Three
Months Nine Months
Ended March Ended March
(in percentages) 31, 2020 31, 2020
Organic sales decline (17)% (13)%
Foreign currency exchange impact(1) (2) (1)
Business days impact(2) 1 -
Sales decline (18)% (14)%
Three Months Ended March Nine Months Ended March
31, 2020 31, 2020
Constant Constant
(in percentages) As Reported Currency As Reported Currency
End market sales decline:
General engineering (20)% (18)% (15)% (13)%
Transportation (19) (17) (17) (16)
Aerospace (17) (16) (9) (8)
Energy (7) (6) (9) (7)
Regional sales decline:
EMEA (22)% (19)% (18)% (15)%
Americas (16) (16) (11) (11)
Asia Pacific (14) (12) (12) (11)
For the three months ended March 31, 2020 , Industrial sales decreased 18 percent
from the prior year quarter due to the global manufacturing slowdown and
deteriorating conditions across all end markets and regions. Transportation
sales declined in all regions due to continued weakness in auto build rates
caused by a slowdown in auto sales. Sales in our general engineering end market
declined in all regions as a result of continued declines in manufacturing
activity and, in Asia Pacific , partially related to the COVID-19 pandemic.
Energy sales decreased primarily due to a decline in oil and gas drilling in the
Americas , partially offset by continued strength in power generation in China.
Aerospace sales declined in the Americas and EMEA, primarily driven by lower OEM
production rates on certain platforms. In Asia , aerospace sales increased
slightly due to inventory stocking orders from customers amid supply chain
concerns. On a regional basis, the sales decrease in EMEA was primarily driven
by declines in the general engineering and transportation end markets, in
addition to declines in the aerospace end market, while the sales decrease in
the Americas was driven by declines in all four end markets. The sales decrease
in Asia Pacific was primarily driven by declines in the general engineering and
transportation end markets, partially offset by increases in the energy and
aerospace end markets.
For the three months ended March 31, 2020 , Industrial operating income decreased
by $27.1 million , driven primarily by organic sales decline and unfavorable
labor and fixed cost absorption due to lower volumes and
simplification/modernization efforts in progress, partially offset by
incremental simplification/modernization benefits, lower raw material costs and
lower variable compensation expense.
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For the nine months endedMarch 31, 2020 , Industrial sales decreased 14 percent from the prior year period. Transportation sales declined in all regions due to continued weakness in auto build rates, while sales in our general engineering end market declined in all regions driven by overall continued decline in global manufacturing activity. Energy sales decreased primarily due to a decline in oil and gas drilling in theAmericas , partially offset by continued strength in renewable energy in China. Aerospace sales declined in all regions driven primarily by lower OEM production rates on certain platforms and timing of large projects in the first quarter of the prior year that did not repeat. On a regional basis, the sales decrease in EMEA was primarily due to declines in the transportation and general engineering end markets, and to a lesser extent, declines in the energy and aerospace end markets, while the sales decrease in theAmericas was primarily driven by declines in all four end markets. The sales decrease inAsia Pacific was primarily driven by declines in the general engineering and transportation end markets and, to a lesser extent, a decline in the aerospace end market, partially offset by an increase in sales in the energy end market. For the nine months endedMarch 31, 2020 , Industrial operating income decreased by$141.1 million , driven primarily by greater restructuring and related charges of$56.6 million , organic sales decline and unfavorable labor and fixed cost absorption due to lower volumes and simplification/modernization efforts in progress, partially offset by incremental simplification/modernization benefits and lower variable compensation expense.
WIDIA
Three Months Ended March 31, Nine Months Ended March 31,
(in thousands) 2020 2019 2020 2019
Sales $ 42,721 $ 50,966 $ 131,115 $ 148,592
Operating (loss) income (13,528 ) (4 ) (31,410 ) 3,817
Operating margin (31.7 )% - % (24.0 )% 2.6 %
Three
Months Nine Months
Ended March Ended March
(in percentages) 31, 2020 31, 2020
Organic sales decline (16)% (11)%
Foreign currency exchange impact(1) (1) (1)
Business days impact(2) 1 -
Sales decline (16)% (12)%
Three Months Ended March Nine Months Ended March
31, 2020 31, 2020
Constant Constant
(in percentages) As Reported Currency As Reported Currency
Regional sales decline:
Asia Pacific (26)% (25)% (23)% (22)%
EMEA (16) (14) (9) (7)
Americas (10) (10) (6) (6)
For the three months ended March 31, 2020 , Widia sales decreased 16 percent from
the prior year quarter. The sales decrease in Asia Pacific was driven primarily
by the overall weak market conditions, most notably in China and India , which
were significantly impacted by the COVID-19 pandemic. Sales in EMEA decreased
primarily due to the increasingly difficult market environment, while the
decrease in the Americas was primarily due to a slower U.S. manufacturing
environment.
For the three months ended March 31, 2020 , Widia operating loss was $13.5
million compared to break-even operating income in the prior year quarter. The
change was driven primarily by organic sales decline and $15.6 million of
goodwill and other intangible asset impairment charges, partially offset by
incremental simplification/modernization benefits, lower raw material costs and
lower variable compensation expense.
For the nine months ended March 31, 2020 , Widia sales decreased 12 percent from
the prior year period. The sales decrease in Asia Pacific for both periods was
driven primarily by the overall weak market conditions, most notably in India
and China .
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Sales in EMEA decreased primarily due to the increasingly difficult market environment, partially offset by growth in products focused on aerospace applications, while the decrease in theAmericas was primarily due to a slowerU.S. manufacturing environment, partially offset by strength inLatin America . For the nine months endedMarch 31, 2020 , Widia operating loss was$31.4 million compared to operating income of$3.8 million in the prior year period. The change was driven primarily by$30.2 million of goodwill and other intangible asset impairment charges, organic sales decline, and higher manufacturing costs, partially offset by incremental simplification/modernization benefits and lower variable compensation expense. INFRASTRUCTURE Three Months Ended March 31, Nine Months Ended March 31, (in thousands) 2020 2019 2020 2019 Sales$ 179,625 $ 227,602 $ 555,129 $ 666,178 Operating income 21,941 24,934 7,679 69,407 Operating margin 12.2 % 11.0 % 1.4 % 10.4 % Three Months Nine Months Ended March Ended March (in percentages) 31, 2020 31, 2020 Organic sales decline (17)%
(14)%
Foreign currency exchange impact(1) (1) (1)
Divestiture impact(3) (3) (2)
Sales decline (21)% (17)%
Three Months Ended March Nine Months Ended March
31, 2020 31, 2020
Constant Constant
(in percentages) As Reported Currency As Reported Currency
End market sales decline:
Energy (31)% (29)% (30)% (29)%
General engineering (23) (17) (14) (9)
Earthworks (8) (6) (5) (3)
Regional sales (decline) growth:
Americas (24)% (21)% (21)% (19)%
Asia Pacific (18) (16) (12) (10)
EMEA (10) (6) (3) 2
For the three months ended March 31, 2020 , Infrastructure sales decreased by 21
percent from the prior year quarter primarily as a result of lower activity in
the oil and gas portion of the energy end market in the U.S. In the general
engineering end market, the lower level of manufacturing activity drove the
decline in the Americas and Asia Pacific , offset by increased defense-related
activity in EMEA. Earthworks end market sales were down year-over-year due to
softness in mining in the Americas and Asia Pacific . On a regional basis, the
sales decrease in the Americas was primarily driven by a decline in the energy
end market, and to a lesser extent, declines in both the general engineering and
earthworks end markets. The sales decrease in Asia Pacific was primarily due to
the negative impacts of COVID-19 on the general engineering and earthworks end
markets. In EMEA, the sales decrease was driven primarily by declines in both
the energy and earthworks end markets, partially offset by growth in the general
engineering end market.
For the three months ended March 31, 2020 , Infrastructure operating income
decreased by $3.0 million , driven primarily by organic sales decline and
unfavorable labor and fixed cost absorption due to lower volumes and
simplification/modernization efforts in progress, partially offset by
incremental simplification/modernization benefits, lower raw material costs and
lower variable compensation expense.
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For the nine months endedMarch 31, 2020 , Infrastructure sales decreased by 17 percent from the prior year period. TheU.S. oil and gas market drove year-over-year decline in the energy market, while the decline in general engineering was driven by general economic decline in theAmericas andAsia Pacific , offset by increased defense activity in EMEA. Earthworks end market sales declined year-over-year due to softness in mining in theAmericas and softness in mining and construction inAsia Pacific , partially offset by growth in construction in theAmericas . The sales decrease in theAmericas was primarily driven by a decline in the energy end market, but also due to decline in the general engineering end market. The decrease inAsia Pacific was driven by lower levels of manufacturing activity and the negative impacts of COVID-19 in the general engineering end market. The sales increase in EMEA, excluding the unfavorable impact of currency exchange, was driven primarily by growth in the general engineering end market, partially offset by declines in both the energy and earthworks end markets. For the nine months endedMarch 31, 2020 , Infrastructure operating income decreased by$61.7 million , driven primarily by organic sales decline, unfavorable labor and fixed cost absorption due to lower volumes and simplification/modernization efforts in progress, unfavorable mix and a loss on divestiture of$6.5 million , partially offset by incremental simplification/modernization benefits and lower variable compensation expense. CORPORATE Three Months Ended March 31, Nine Months Ended March 31, (in thousands) 2020 2019 2020 2019 Corporate expense$ (667 ) $ (277 ) $ (1,797 ) $ (2,622 ) For the three months endedMarch 31, 2020 , Corporate expense increased by$0.4 million from the prior year quarter. For the nine months endedMarch 31, 2020 , Corporate expense decreased by$0.8 million from the prior year period. LIQUIDITY AND CAPITAL RESOURCES Cash flow from operations is the primary source of funding for our capital expenditures. For the nine months endedMarch 31, 2020 , cash flow provided by operating activities was$146.1 million , primarily due to the net inflow from net income with adjustments for non-cash items. Our five-year, multi-currency, revolving credit facility, as amended and restated inJune 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 inU.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 inJune 2023 . The Credit Agreement requires us to comply with various restrictive and affirmative covenants, including two financial covenants: a maximum leverage ratio where debt, net of domestic cash in excess of$25 million , must be less than or equal to 3.5 times trailing twelve months EBITDA, adjusted for certain non-cash expenses and which may be further adjusted, at our discretion, to include up to$80 million of cash restructuring charges throughDecember 31, 2021 ; and a minimum consolidated interest coverage ratio of EBITDA/Interest of 3.5x (as the aforementioned terms are defined in the Credit Agreement). We were in compliance with all such covenants as ofMarch 31, 2020 and we expect to maintain compliance over the next 12 months. As a result of COVID-19, certain events or circumstances that could reasonably be expected to negatively affect our availability under the Credit Agreement may include such items as: (i) a decrease in expected profitability, specifically, a further decrease in sales volume driven by a prolonged weakness in customer demand or other pressures, including those related to the COVID-19 pandemic, adversely affecting our sales trends; and (ii) inability to achieve the anticipated benefits from simplification/modernization and other cost reduction programs. For the nine months endedMarch 31, 2020 , average daily borrowings outstanding under the Credit Agreement were approximately$10.5 million . We had$4.5 million of borrowings outstanding under the Credit Agreement as ofMarch 31, 2020 , and we had no borrowings outstanding as ofJune 30, 2019 . Borrowings under the Credit Agreement are guaranteed by our significant domestic subsidiaries. 34
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Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
We consider the majority of the unremitted earnings of our non-U.S. subsidiaries to be permanently reinvested. With regard to these unremitted earnings, we have not, nor do we anticipate the need to, repatriate funds to theU.S. to satisfy domestic liquidity needs arising in the ordinary course of business, including liquidity needs associated with our domestic debt service requirements. With regard to the small portion of unremitted earnings that are not indefinitely reinvested, we maintain a deferred tax liability for foreign withholding andU.S. state income taxes. In 2012, we received an assessment from the Italian tax authority that denied certain tax deductions primarily related to our 2008 tax return. Attempts at negotiating a reasonable settlement with the tax authority were unsuccessful; and as a result, we decided to litigate the matter. While the outcome of the litigation is still pending, the authority has served notice requiring payment in the amount of €36 million. Accordingly, we requested and were granted a stay and are not currently required to make a payment in connection with this assessment. We continue to believe that the assessment is baseless and accordingly, no income tax liability has been recorded in connection with this assessment in any period. However, if the Italian tax authority were to be successful in litigation, settlement of the amount alleged by the Italian tax authority would result in an increase to income tax expense for as much as €36 million, or$40 million , of which penalties and interest is €20 million, or$23 million . AtMarch 31, 2020 , cash and cash equivalents were$85.2 million , Total Kennametal Shareholders' equity was$1,260.6 million and total debt was$598.1 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. There have been no material changes in our contractual obligations and commitments sinceJune 30, 2019 . We are also closely monitoring the rapidly evolving effects of the COVID-19 pandemic on our business operations, financial results and financial position and on the industries in which we operate. Subsequent toMarch 31, 2020 , we drew$500.0 million under the Credit Agreement. We decided to draw this$500.0 million as a measure to ensure access to future liquidity in light of the global financial market uncertainty resulting from the COVID-19 pandemic. Cash Flow Provided by Operating Activities During the nine months endedMarch 31, 2020 , cash flow provided by operating activities was$146.1 million , compared to$157.5 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$126.7 million and changes in certain assets and liabilities netting to an inflow of$19.4 million . Contributing to the changes in certain assets and liabilities were a decrease in accounts receivable of$60.6 million and a decrease in inventories of$29.9 million . Partially offsetting these cash inflows were a decrease in accounts payable and accrued liabilities of$34.4 million , a decrease in accrued income taxes of$22.0 million and a decrease in accrued pension and postretirement benefits of$18.2 million . During the nine months endedMarch 31, 2019 , cash flow provided by operating activities 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 . Cash Flow Used for Investing Activities Cash flow used for investing activities was$180.2 million for the nine months endedMarch 31, 2020 , compared to$142.7 million for the prior year period. During the current year period, cash flow used for investing activities included capital expenditures, net of$203.3 million , which consisted primarily of expenses related to our simplification/modernization initiatives and equipment upgrades, partially offset by proceeds from divestiture of$24.0 million from the sale of certain assets of the non-core specialty alloys and metals business located inNew Castle, Pennsylvania . For the nine months endedMarch 31, 2019 , cash flow used for investing activities included capital expenditures, net of$142.4 million , which consisted primarily of equipment upgrades and expenses related to our simplification/modernization initiatives. Cash Flow Used for Financing Activities Cash flow used for financing activities was$54.0 million for the nine months endedMarch 31, 2020 compared to$456.4 million in the prior year period. During the current year period, cash flow used for financing activities included$49.7 million of cash dividends paid to Kennametal Shareholders and$5.7 million of the effect of employee benefit and stock plans and dividend reinvestment, partially offset by$4.5 million of borrowings outstanding under the Credit Agreement. 35
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Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
For the nine months endedMarch 31, 2019 , 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 Kennametal 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 . FINANCIAL CONDITION Working capital was$583.6 million atMarch 31, 2020 , a decrease of$145.5 million from$729.1 million atJune 30, 2019 . The decrease in working capital was primarily driven by a decrease in cash and cash equivalents of$96.8 million ; a decrease in accounts receivable of$75.7 million due primarily to a decline in sales, a decrease in inventories of$54.8 million and the addition of current operating lease liabilities of$12.9 million due to the adoption of the new lease accounting standard without a restatement of prior periods. Partially offsetting these items were a decrease in accounts payable of$47.8 million , a decrease in accrued expenses of$25.2 million primarily due to payroll timing and lower accrued vacation pay and a decrease in accrued income taxes of$18.8 million . Currency exchange rate effects decreased working capital by a total of approximately$22 million , the impact of which is included in the aforementioned changes. Property, plant and equipment, net increased$80.5 million from$934.9 million atJune 30, 2019 to$1,015.4 million atMarch 31, 2020 , primarily due to capital additions of approximately$190.7 million , partially offset by depreciation expense of$79.1 million , a negative currency exchange impact of approximately$17 million , disposals of$7.8 million and divestiture effect of$6.7 million . AtMarch 31, 2020 , other assets were$556.0 million , an increase of$25.5 million from$530.5 million atJune 30, 2019 . The primary driver for the increase was the addition of operating lease ROU assets of$46.7 million in the quarter due to the adoption of the new lease accounting standard without a restatement of prior periods, an increase in other assets of$23.7 million primarily due to an increase in pension plan assets and an increase in deferred income taxes of$11.7 million , partially offset by a decrease in goodwill of$31.4 million primarily due to goodwill impairment charges recorded in the Widia segment of$26.8 million and unfavorable currency exchange effects of approximately$4 million , and a decrease in other intangible assets of$25.3 million , primarily due to divestiture effect of$12.5 million , amortization expense of$10.4 million and impairment charges recorded in the Widia segment of$3.4 million . Kennametal Shareholders' equity was$1,260.6 million atMarch 31, 2020 , a decrease of$74.5 million from$1,335.2 million atJune 30, 2019 . The decrease was primarily due to cash dividends paid to Kennametal Shareholders of$49.7 million and unfavorable currency exchange effects of$44.9 million , partially offset by capital stock issued under employee benefit and stock plans of$8.4 million , pension and other postretirement benefit effects in other comprehensive loss of$8.0 million and net income attributable toKennametal of$3.4 million . DISCUSSION OF CRITICAL ACCOUNTING POLICIES There have been no changes to our critical accounting policies sinceJune 30, 2019 .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 goodwill and other indefinite-lived intangible asset using a discounted cash flow analysis based on projected financial information. We perform our annual impairment tests for the June quarter in connection with our annual planning process unless there are impairment indicators based on the results of an ongoing cumulative qualitative assessment that warrants a test prior to that quarter. 36
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Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
We performed an interim quantitative impairment test of goodwill and the indefinite-lived trademark intangible asset for the Widia reporting unit during the March quarter of fiscal 2020. The decline in actual and projected financial results for the Widia reporting unit, primarily as a result of the COVID-19 pandemic, represented an interim impairment triggering event because there was essentially zero cushion between the reporting unit's carrying value and fair value as ofMarch 31 2020 . This is because the Widia reporting unit was recorded at fair value as of the last impairment date ofDecember 31, 2019 . As a result of the March quarter fiscal 2020 interim test, we recorded a non-cash pre-tax impairment charge during the three months endedMarch 31, 2020 of$15.6 million in the Widia segment, of which$13.7 million was for goodwill and$1.9 million was for an indefinite-lived trademark intangible asset. Subsequent to the third quarter impairment charge, there is no remaining goodwill for the Widia reporting unit and the carrying value of the indefinite-lived trademark is$10.9 million , which approximates fair value. Additionally, due to the significant cushion that existed between the fair value and the carrying value of the Industrial reporting unit, as measured on the last annual testing date, we determined that there was not an interim triggering event for this reporting unit during the third quarter of fiscal 2020. Fair value determinations require considerable judgment and are sensitive to changes in underlying assumptions and factors. As a result, there can be no assurance that the estimates and assumptions made for purposes of the interim and annual goodwill and indefinite-lived intangible impairment test will prove to be an accurate prediction of the future. Certain events or circumstances that could reasonably be expected to negatively affect the underlying key assumptions and ultimately impact the estimated fair values of our reporting units and of the indefinite-lived trademark may include such items as: (i) a decrease in expected future cash flows, specifically, a further decrease in sales volume driven by a prolonged weakness in customer demand or other pressures, including those related to the COVID-19 pandemic, adversely affecting our long-term sales trends; (ii) inability to achieve the anticipated benefits from simplification/modernization and other cost reduction programs and (iii) inability to achieve the sales from our strategic growth initiatives.
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 BYU.S. GAAP In accordance withSEC 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 measures. 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. We believe 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 decline Organic sales decline is a non-GAAP financial measure of sales 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 decline on a consistent basis. Also, we report organic sales decline at the consolidated and segment levels. Constant currency end market sales decline Constant currency end market sales decline is a non-GAAP financial measure of sales 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 decline, constant currency end market sales 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 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 decline for the Widia segment and, thus, do not include a reconciliation for that metric. 37
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Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
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. Reconciliations of organic sales decline to sales decline are as follows: Three Months Ended March 31, 2020 Industrial Widia Infrastructure Total Organic sales decline (17)% (16)% (17)% (17)% Foreign currency exchange impact(1) (2) (1) (1) (1) Business days impact(2) 1 1 - - Divestiture impact(3) - - (3) (1) Sales decline (18)% (16)% (21)% (19)%
Nine Months Ended
(13)% (11)% (14)% (13)%
Foreign currency exchange impact(1) (1) (1) (1) (1) Divestiture impact(3)
- - (2) (1)
Sales decline (14)% (12)% (17)% (15)%
Reconciliations of constant currency end market sales decline to end market sales decline(4) are as follows: Industrial
General
Three Months Ended March 31, 2020 engineering Transportation Aerospace Energy
Constant currency end market sales decline (18)% (17)% (16)% (6)%
Foreign currency exchange impact(1) (2) (2) (1) (1)
End market sales decline(4) (20)% (19)% (17)% (7)%
Infrastructure
Three Months Ended
(17)%
Foreign currency exchange impact(1) - (2) -
Divestiture impact(3) (2) - (6)
End market sales decline(4) (31)% (8)% (23)%
Total
General
Three Months Ended March 31, 2020 engineering Transportation Aerospace Energy Earthworks
Constant currency end market sales
decline (17)% (17)% (16)% (23)% (6)%
Foreign currency exchange
impact(1) (1) (2) (1) - (2)
Divestiture impact(3) (2) - - (2) -
End market sales decline(4) (20)% (19)% (17)% (25)% (8)%
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Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Industrial
General
Nine Months Ended March 31, 2020 engineering Transportation Aerospace Energy
Constant currency end market sales decline (13)% (16)% (8)% (7)%
Foreign currency exchange impact(1) (2) (1) (1) (2)
End market sales decline(4) (15)% (17)% (9)% (9)%
Infrastructure
Nine Months Ended March 31, 2020 Energy Earthworks General engineering
Constant currency end market sales decline (29)% (3)% (9)%
Foreign currency exchange impact(1) - (2) (1)
Divestiture impact(3) (1) - (4)
End market sales decline(4) (30)% (5)% (14)%
Total
General
Nine Months Ended March 31, 2020 engineering Transportation Aerospace Energy Earthworks
Constant currency end market sales
decline (12)% (16)% (8)% (23)% (3)%
Foreign currency exchange
impact(1) (1) (1) (1) - (2)
Divestiture impact(3) (1) - - (1) -
End market sales decline(4) (14)% (17)% (9)% (24)% (5)%
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Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Reconciliations of constant currency regional sales (decline) growth to reported regional sales decline(5) are as follows:
Three Months Ended
March 31, 2020 Nine Months Ended
Americas EMEA Asia Pacific Americas EMEA Asia Pacific
Industrial
Constant currency regional sales
decline (16)% (19)% (12)% (11)% (15)% (11)%
Foreign currency exchange
impact(1) - (3) (2) - (3) (1)
Regional sales decline(5) (16)% (22)% (14)% (11)% (18)% (12)%
Widia
Constant currency regional sales decline (10)% (14)% (25)% (6)% (7)% (22)% Foreign currency exchange impact(1) - (2) (1) - (2) (1) Regional sales decline(5) (10)% (16)% (26)%
(6)% (9)% (23)%
Infrastructure
Constant currency regional sales (decline) growth (21)% (6)% (16)% (19)% 2% (10)% Foreign currency exchange impact(1) 1 (3) (2) 1 (5) (2) Divestiture impact(3) (4) (1) - (3) - - Regional sales (decline) growth(5) (24)% (10)% (18)%
(21)% (3)% (12)%
Total
Constant currency regional sales decline (18)% (16)% (15)% (14)% (11)% (12)% Foreign currency exchange impact(1) - (3) (2) (1) (4) (1) Divestiture impact(3) (2) - - (1) - - Regional sales decline(5) (20)% (19)% (17)%
(16)% (15)% (13)%
(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) Divestiture impact is calculated by dividing prior period sales attributable to divested businesses by prior period sales. (4) Aggregate sales for all end markets sum to the sales amount presented onKennametal's financial statements. (5) Aggregate sales for all regions sum to the sales amount presented onKennametal's financial statements.
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