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$505.1 million for the quarter endedDecember 31, 2019 decreased 14 percent year-over-year, reflecting 12 percent organic sales decline from deteriorating end markets, a 1 percent unfavorable currency exchange effect and a 1 percent decline from divestiture. The decline reflects weakening end-market conditions, particularly from greater than expected deceleration in theU.S. ,Germany andIndia , combined with headwinds developing in the 737 MAX supply chain. Operating loss was$47.6 million , compared to operating income of$78.9 million in the prior year quarter. The year-over-year change in operating income was primarily due to higher restructuring and related charges of$48.9 million , organic sales decline, unfavorable labor and fixed cost absorption in certain facilities due to lower volumes and simplification/modernization efforts in progress,$14.6 million of goodwill and other intangible asset impairment charges, higher raw material costs, and a loss on divestiture of$6.5 million , partially offset by incremental simplification/modernization benefits. Operating loss margin was 9.4 percent, compared to operating income margin of 13.4 percent in the prior year quarter. Higher raw material costs, which we expect to abate in the second half of fiscal 2020, had a detrimental effect on year-over-year operating margin of approximately 130 basis points. Segment operating loss margins were 6.9 percent, 35.9 percent and 6.4 percent for the Industrial, Widia and Infrastructure segments, respectively. FY20 and FY21 Restructuring Actions are on-track to deliver the projected savings, and we expect profitability in the second half of the fiscal year to reflect increasing benefits from these programs in addition to lower raw material costs. We recorded$51.3 million of pre-tax restructuring and related charges in the quarter, and incremental pre-tax benefits from simplification/modernization restructuring were approximately$3 million in the quarter. Total benefits from simplification/modernization, including restructuring initiatives, were approximately$11 million in the quarter. We achieved annualized run-rate savings from simplification/modernization of approximately$69 million since inception. As part of the FY20 Restructuring Actions, we completed the full closures of the Lichtenau,Germany andIrwin, Pennsylvania manufacturing facilities. Additionally, distribution activities at the Neunkirchen,Germany distribution center have been transitioned to third-party logistics providers. As previously announced, we also expect to deliver the FY21 Restructuring Actions with the original estimated annualized savings of$25 to$30 million , but with lower estimated pre-tax charges of approximately$55 to$65 million , down from$60 to$75 million . Following negotiations with local employee representatives, we agreed to downsize theEssen, Germany operations rather than proceed with the previously proposed closure. Since the inception of simplification/modernization, we have taken steps to permanently reduce our cost structure, decreasing footprint by five facilities. We also completed the divestiture of the non-core specialty alloys business in the Infrastructure segment as part of our ongoing simplification/modernization initiatives. Cash proceeds from the sale were$24 million , and the pre-tax loss on the sale was$7 million , or$0.03 per share. Transaction proceeds were primarily used for capital expenditures related to our simplification/modernization initiatives. The divestiture is expected to be accretive to margins. 25
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Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
We recognized a discrete tax benefit of$14.5 million in the quarter due to transition benefits associated with legislation that was effectively enacted during the three months endedDecember 31, 2019 when theCanton of Schaffhausen approved the Federal Act on Tax Reform and AHV Financing onOctober 8, 2019 (Swiss tax reform). We recorded non-cash pre-tax Widia goodwill and intangible asset impairment charges of$14.6 million as a result of deteriorating market conditions, primarily in general engineering and transportation applications inIndia andChina , in addition to overall global weakness in the manufacturing sector. We reported current quarter loss per diluted share (LPS) of$0.07 . LPS for the current quarter includes restructuring and related charges of$0.39 per share, loss on divestiture of$0.03 and discrete benefits from foreign tax reforms of$0.18 . The earnings per diluted share of$0.66 in the prior year quarter included net discrete tax charges of$0.03 and restructuring and related charges of$0.02 per share. We generated net cash flows from operating activities of$87.1 million during the six months endedDecember 31, 2019 compared to$61.5 million during the prior year quarter. Capital expenditures were$147.5 million and$88.1 million during the six months endedDecember 31, 2019 and 2018, 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 endedDecember 31, 2019 were$505.1 million , a decrease of$82.3 million , or 14 percent, from$587.4 million in the prior year quarter. The decrease in sales was driven by 12 percent organic sales decline, a 1 percent unfavorable currency exchange impact and a 1 percent decline from divestiture. Sales for the six months endedDecember 31, 2019 were$1,023.2 million , a decrease of$150.9 million , or 13 percent, from$1,174.1 million in the prior year period. The decrease in sales was driven by 11 percent organic sales decline and 2 percent unfavorable currency exchange impact. Three Months Ended December Six Months Ended 31, 2019 December 31, 2019 As Constant As Constant (in percentages) Reported Currency Reported Currency End market sales decline: Energy (28)% (27)% (24)% (23)% Transportation (14) (13) (17) (15) General engineering (12) (9) (11) (8) Aerospace (7) (6) (5) (3) Earthworks (4) (3) (4) (2) Regional sales decline: Americas (17)% (15)% (14)% (13)% Europe, the Middle East and Africa (EMEA) (14) (11) (12) (9) Asia Pacific (7) (6) (12) (11) GROSS PROFIT Gross profit for the three months endedDecember 31, 2019 was$132.0 million , a decrease of$66.6 million from$198.6 million in the prior year quarter. The decrease was primarily due to organic sales decline, unfavorable labor and fixed cost absorption in certain facilities due to lower volumes and simplification/modernization efforts in progress and higher raw material costs, partially offset by incremental simplification/modernization benefits. Gross profit margin for the three months endedDecember 31, 2019 was 26.1 percent, as compared to 33.8 percent in the prior year quarter. Higher raw material costs, which we expect to abate in the second half of fiscal 2020, had a detrimental effect on year-over-year gross profit margin of approximately 130 basis points. 26
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Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Gross profit for the six months endedDecember 31, 2019 was$271.0 million , a decrease of$138.7 million from$409.7 million in the prior year period. The decrease was primarily due to organic sales decline, unfavorable labor and fixed cost absorption in certain facilities due to lower volumes and simplification/modernization efforts in progress and higher raw material costs, partially offset by incremental simplification/modernization benefits. Gross profit margin for the six months endedDecember 31, 2019 was 26.5 percent, as compared to 34.9 percent in the prior year period. Higher raw material costs, which are expected to abate in the second half of fiscal 2020, had a detrimental effect on year-over-year gross profit margin of approximately 240 basis points. OPERATING EXPENSE Operating expense for the three months endedDecember 31, 2019 was$107.5 million compared to$114.6 million for the three months endedDecember 31, 2018 . The decrease was primarily due to incremental restructuring simplification benefits and favorable currency exchange impact of approximately$1 million , partially offset by higher compensation expense. Operating expense for the six months endedDecember 31, 2019 was$221.7 million compared to$237.9 million for the six months endedDecember 31, 2018 . The decrease was primarily due to incremental restructuring simplification benefits, favorable currency exchange impact of approximately$3 million and lower incentive compensation expense. 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$10.1 million and$8.9 million for the three months endedDecember 31, 2019 and 2018, respectively, and$20.5 million and$18.6 million for the six months endedDecember 31, 2019 and 2018, 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$35 million to$40 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$65 million , which are expected to be 80 percent Industrial, 15 percent Infrastructure and 5 percent Widia. Restructuring and related charges since inception of$44.5 million were recorded for this program throughDecember 31, 2019 , consisting of:$36.6 million in Industrial,$5.8 million in Infrastructure and$2.2 million in Widia. Inception to date, we have achieved annualized savings of approximately$16 million . FY21 Restructuring Actions OnJuly 11, 2019 , we announced the initiation of restructuring actions inGermany associated with simplification/modernization, which are expected to reduce structural costs. We have agreed with local employee representatives to downsize theEssen, 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. Restructuring and related charges since inception of$28.7 million were recorded for this program throughDecember 31, 2019 in the Industrial segment. Restructuring and Related Charges Recorded We recorded restructuring and related charges of$51.3 million and$2.1 million for the three months endedDecember 31, 2019 and 2018, respectively. Of these amounts, restructuring charges for the three months endedDecember 31, 2019 totaled$48.0 million , of which$0.3 million were related to inventory and were recorded in cost of goods sold, and restructuring charges for the three months endedDecember 31, 2018 totaled$1.5 million . Restructuring-related charges of$3.3 million and$0.6 million were recorded in cost of goods sold for the three months endedDecember 31, 2019 and 2018, respectively. 27
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Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
We recorded restructuring and related charges of$59.3 million and$3.1 million for the six months endedDecember 31, 2019 and 2018, respectively. Of these amounts, restructuring charges for the six months endedDecember 31, 2019 totaled$52.7 million , of which$0.3 million were related to inventory and were recorded in cost of goods sold, and restructuring charges for the six months endedDecember 31, 2018 totaled$2.6 million . Restructuring-related charges of$6.6 million and$0.5 million were recorded in cost of goods sold for the six months endedDecember 31, 2019 and 2018, respectively. Intangible Asset Impairment Charges We recorded non-cash pre-tax intangible asset impairment charges of$14.6 million during the three months endedDecember 31, 2019 . See Note 18 to our condensed consolidated financial statements set forth in Part I, Item 1 of this Quarterly Report on Form 10-Q. LOSS ON DIVESTITURE During the three months endedDecember 31, 2019 , 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 endedDecember 31, 2019 and 2018 was$8.1 million . Interest expense for the six months endedDecember 31, 2019 decreased to$15.9 million compared to$16.2 million for the six months endedDecember 31, 2018 . OTHER INCOME, NET Other income for the three months endedDecember 31, 2019 increased slightly to$4.2 million from$4.0 million during the three months endedDecember 31, 2018 . Other income for the six months endedDecember 31, 2019 increased slightly to$6.9 million from$6.8 million during the six months endedDecember 31, 2018 . PROVISION FOR INCOME TAXES Effective tax rates The effective income tax rates for the three months endedDecember 31, 2019 and 2018 were 87.9 percent (benefit on a loss) and 24.8 percent (provision on income), respectively. The year-over-year change is primarily due to a discrete$14.5 million benefit for the one-time effect of Swiss tax reform, the impairment of Widia goodwill, the change in the jurisdictional mix caused by expected restructuring and related charges and the increase in tax on global intangible low-taxed income (GILTI) and the base erosion anti-abuse tax (BEAT), which are both components of theU.S. Tax Cuts and Jobs Act of 2017. The prior year rate included a$6.1 million charge related to changes in the indefinite reinvestment assertion on certain foreign subsidiaries' undistributed earnings and a$3.9 million benefit recorded to reflect the finalization of the amount of the one-time tax imposed on our unremitted foreign earnings. The effective income tax rates for the six months endedDecember 31, 2019 and 2018 were 102.9 percent (benefit on a loss) and 24.9 percent (provision on income), respectively. The year-over-year change is primarily due to a discrete$14.5 million benefit for the one-time effect of Swiss tax reform, the impairment of Widia goodwill, the change in the jurisdictional mix caused by expected restructuring and related charges, the increase in GILTI and BEAT. Swiss tax reform Legislation was effectively enacted during the three months endedDecember 31, 2019 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. 28
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Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
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$14.5 million during the three months endedDecember 31, 2019 . We consider the deferred tax asset from Swiss tax reform to be an estimate based on our current interpretation of the legislation, which is subject to change based on further legislative guidance, review with the Swiss federal and cantonal authorities and modifications to the underlying valuation. We currently expect a modestly unfavorable effect on our Swiss tax expense during the ten-year transitional period. BUSINESS SEGMENT REVIEW We operate three reportable segments consisting of Industrial, Widia and Infrastructure. Expenses that are not allocated are reported in Corporate. Segment determination is based upon the manner in which we organize segments for making operating decisions and assessing performance and the availability of separate financial results. Our sales and operating (loss) income by segment are as follows: Three Months Ended December 31, Six Months Ended December 31, (in thousands) 2019 2018 2019 2018 Sales: Industrial$ 279,242 $ 317,320 $ 559,270 $ 637,878 Widia 44,337 48,954 88,394 97,626 Infrastructure 181,501 221,120 375,504 438,576 Total sales$ 505,080 $ 587,394 $ 1,023,168 $ 1,174,080 Operating (loss) income: Industrial$ (19,259 ) $ 57,519 $ 2,012$ 116,061 Widia (15,918 ) 1,728 (17,882 ) 3,822 Infrastructure (11,570 ) 20,614 (14,260 ) 44,474 Corporate (891 ) (1,003 ) (1,131 ) (2,347 ) Total operating (loss) income (47,638 ) 78,858 (31,261 ) 162,010 Interest expense 8,055 8,104 15,936 16,201 Other income, net (4,211 ) (4,022 ) (6,891 ) (6,782 ) (Loss) income from continuing operations before income taxes$ (51,482 ) $ 74,776 $ (40,306 ) $ 152,591 INDUSTRIAL Three Months Ended December 31, Six Months Ended December 31, (in thousands, except operating margin) 2019 2018 2019 2018 Sales$ 279,242 $ 317,320 $ 559,270 $ 637,878 Operating (loss) income (19,259 ) 57,519 2,012 116,061 Operating margin (6.9 )% 18.1 % 0.4 % 18.2 % Three Months Six Months Ended Ended December December (in percentages) 31, 2019 31, 2019 Organic sales decline (11)% (11)% Foreign currency exchange impact(1) (1) (1) Sales decline (12)% (12)% 29
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Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Three Months Ended Six Months Ended December
December 31, 2019 31, 2019
As Constant Constant
(in percentages) Reported Currency As Reported Currency
End market sales decline:
Transportation (14)% (13)% (17)% (15)%
General engineering (12) (10) (12) (10)
Energy (10) (9) (9) (8)
Aerospace (7) (6) (5) (3)
Regional sales decline:
EMEA (17)% (14)% (16)% (13)%
Americas (10) (10) (9) (8)
Asia Pacific (5) (4) (11) (10)
For the three months ended December 31, 2019 , Industrial sales decreased 12
percent from the prior year quarter due to slower conditions across all end
markets and regions. Transportation sales declined in the Americas and EMEA due
to continued weakness in auto build rates, while transportation in Asia
stabilized with slight growth in the quarter. Sales in our general engineering
end market declined in all regions as a result of continued declines in
manufacturing activity. Energy sales decreased primarily due to a decline in oil
and gas drilling in the Americas , partially offset by continued strength in
renewable energy in China. Aerospace sales declined in all regions primarily
driven by lower OEM production rates on certain platforms. The sales decreases
in the Americas and in EMEA were primarily driven by declines in the
transportation and general engineering end markets, in addition to declines in
the energy and Americas aerospace end markets. The sales decrease in Asia
Pacific was primarily driven by declines in the general engineering end market,
partially offset by increases in the transportation and energy end markets.
For the three months ended December 31, 2019 , Industrial operating loss was
$19.3 million compared to operating income of $57.5 million in the prior year
quarter. The change was driven primarily by greater restructuring and related
charges of $47.5 million , organic sales decline, unfavorable labor and fixed
cost absorption in certain facilities due to lower volumes and
simplification/modernization efforts in progress and higher compensation
expense, partially offset by incremental simplification/modernization benefits.
For the six months ended December 31, 2019 , Industrial sales decreased 12
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
declined in global manufacturing activity. Energy sales decreased primarily due
to a decline in oil and gas drilling in the Americas , 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. The sales decrease in EMEA was primarily due to a decline in the
transportation and general engineering end markets but was also due to a decline
in the energy end market. The sales decrease in the Americas was driven
primarily by declines in the general engineering and transportation end markets,
in addition to declines in the energy and aerospace end markets. The sales
decrease in Asia 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 the energy end
market.
For the six months ended December 31, 2019 , Industrial operating income
decreased by $114.0 million , driven primarily by greater restructuring and
related charges of $53.5 million , organic sales decline and unfavorable labor
and fixed cost absorption in certain facilities due to lower volumes and
simplification/modernization efforts in progress and higher compensation
expense, partially offset by incremental simplification/modernization benefits.
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Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
WIDIA
Three Months Ended December 31, Six Months Ended December 31,
(in thousands) 2019 2018 2019 2018
Sales $ 44,337 $ 48,954 $ 88,394 $ 97,626
Operating (loss) income (15,918 ) 1,728 (17,882 ) 3,822
Operating margin (35.9 )% 3.5 % (20.2 )% 3.9 %
Three
Months Six Months
Ended Ended
December December
(in percentages) 31, 2019 31, 2019
Organic sales decline (8)% (9)%
Business days impact(2) (1) -
Sales decline (9)% (9)%
Three Months Ended Six Months Ended December
December 31, 2019 31, 2019
As Constant Constant
(in percentages) Reported Currency As Reported Currency
Regional sales decline:
Asia Pacific (17)% (17)% (21)% (20)%
EMEA (8) (6) (5) (3)
Americas (6) (6) (4) (4)
For the three and six months ended December 31, 2019 , Widia sales decreased 9
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 , which accelerated in the second quarter of fiscal 2020, and in China .
Sales in EMEA decreased in both periods primarily due to the increasingly
difficult market environment, partially offset by growth in products focused on
aerospace applications, while the decreases in the Americas was primarily due to
a slower U.S. manufacturing environment, partially offset by strength in Mexico .
For the three months ended December 31, 2019 , Widia operating loss was $15.9
million compared to operating income of $1.7 million in the prior year quarter.
The change was driven primarily by $14.6 million of goodwill and other
intangible asset impairment charges, organic sales decline and higher raw
material costs, partially offset by incremental simplification/modernization
benefits. Higher raw material costs, which are expected to abate in the second
half of fiscal 2020, had a detrimental effect on year-over-year operating margin
of approximately 230 basis points for the three months ended December 31, 2019 .
For the six months ended December 31, 2019 , Widia operating loss was $17.9
million compared to operating income of $3.8 million in the prior year period.
The change was driven primarily by $14.6 million of goodwill and other
intangible asset impairment charges, organic sales decline, higher raw material
costs and higher manufacturing costs, partially offset by incremental
simplification/modernization benefits. Higher raw material costs, which are
expected to abate in the second half of fiscal 2020, had a detrimental effect on
year-over-year operating margin of approximately 330 basis points for the six
months ended December 31, 2019 .
INFRASTRUCTURE
Three Months Ended December 31, Six Months Ended December 31,
(in thousands) 2019 2018 2019 2018
Sales $ 181,501 $ 221,120 $ 375,504 $ 438,576
Operating (loss) income (11,570 ) 20,614 (14,260 ) 44,474
Operating margin (6.4 )% 9.3 % (3.8 )% 10.1 %
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Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Three
Months Six Months
Ended Ended
December December
(in percentages) 31, 2019 31, 2019
Organic sales decline (14)% (12)%
Foreign currency exchange impact(1) (1) (1)
Business days impact(2) (1) -
Divestiture impact(3) (2) (1)
Sales decline (18)% (14)%
Three Months Ended Six Months Ended December
December 31, 2019 31, 2019
As Constant Constant
(in percentages) Reported Currency As Reported Currency
End market sales decline:
Energy (35)% (33)% (30)% (29)%
General engineering (12) (6) (9) (5)
Earthworks (4) (3) (4) (2)
Regional sales (decline) growth:
Americas (25)% (22)% (19)% (18)%
Asia Pacific (6) (5) (10) (8)
EMEA (2) 2 1 5
For the three months ended December 31, 2019 , Infrastructure sales decreased by
18 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 general
engineering, 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 EMEA, partially offset by growth in Asia Pacific mining. 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 a decline in the general engineering end market,
partially offset by increases in the earthworks and energy end markets. In EMEA,
the sales increase, 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 three months ended December 31, 2019 , Infrastructure operating loss was
$11.6 million compared to operating income of $20.6 million in the prior year
quarter. The change was driven primarily by organic sales decline, higher
manufacturing costs, a loss on divestiture of $6.5 million , unfavorable mix and
higher raw material costs, partially offset by incremental
simplification/modernization benefits. Higher raw material costs, which are
expected to abate in the second half of fiscal 2020, had a detrimental effect on
year-over-year operating margin of approximately 180 basis points for the three
months ended December 31, 2019 .
For the six months ended December 31, 2019 , Infrastructure sales decreased by 14
percent from the prior year period. The U.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 the Americas and Asia
Pacific , offset by increased activity in EMEA. Earthworks end market sales were
down year-over-year due to softness in mining in the Americas , partially offset
by growth in Americas construction and Asia Pacific mining. The sales decrease
in the Americas was primarily driven by a decline in the energy end market, but
also due to a decline in the general engineering end market. The decrease in
Asia Pacific was primarily due to a decline in the general engineering end
market, partially offset by growth in the energy end market. The sales increase
in EMEA was driven primarily by growth in the general engineering end market,
partially offset by declines in both the energy and earthworks end markets.
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For the six months endedDecember 31, 2019 , Infrastructure operating loss was$14.3 million compared to operating income of$44.5 million in the prior year period. The change was driven primarily by higher raw material costs, organic sales decline, higher manufacturing costs, unfavorable mix and a loss on divestiture of$6.5 million , partially offset by incremental simplification/modernization benefits. Higher raw material costs, which are expected to abate in the second half of fiscal 2020, had a detrimental effect on year-over-year operating margin of approximately 420 basis points for the six months endedDecember 31, 2019 .
CORPORATE
Three Months Ended December 31, Six Months Ended December 31,
(in thousands) 2019 2018 2019 2018
Corporate expense $ (891 ) $ (1,003 ) $ (1,131 ) $ (2,347 )
For the three months ended December 31, 2019 , Corporate expense decreased by
$0.1 million from the prior year quarter. For the six months ended December 31,
2019 , Corporate expense decreased by $1.2 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 six months ended December 31, 2019 , cash flow provided by
operating activities was $87.1 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 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 December 31, 2019 . For the six months ended December 31, 2019 , average
daily borrowings outstanding under the Credit Agreement were approximately $5.1
million . We had no borrowings outstanding under the Credit Agreement as of
December 31, 2019 and June 30, 2019 . Borrowings under the Credit Agreement are
guaranteed by our significant domestic subsidiaries.
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 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. With
regard to the small portion of unremitted earnings that are not indefinitely
reinvested, we maintain a deferred tax liability for foreign withholding and
U.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 .
At December 31, 2019 , cash and cash equivalents were $105.2 million , Total
Kennametal Shareholders' equity was $1,306.2 million and total debt was $595.3
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
since June 30, 2019 .
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Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Cash Flow Provided by Operating Activities During the six months endedDecember 31, 2019 , cash flow provided by operating activities was$87.1 million , compared to$61.5 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$86.8 million and changes in certain assets and liabilities netting to an inflow of$0.3 million . Contributing to the changes in certain assets and liabilities were a decrease in accounts receivable of$64.5 million and a decrease in inventories of$34.3 million . Partially offsetting these cash inflows were changes in accrued income taxes of$53.0 million , a decrease in accounts payable and accrued liabilities of$28.5 million and a decrease in accrued pension and postretirement benefits of$12.1 million . During the six months endedDecember 31, 2018 , cash flow provided by operating activities consisted of net income and non-cash items amounting to an inflow of$186.4 million and changes in certain assets and liabilities netting to an outflow of$124.9 million . Contributing to the changes in certain assets and liabilities were a decrease in accounts payable and accrued liabilities of$82.8 million and an increase in inventories of$59.2 million due in part to increasing demand and raw material price increases. Partially offsetting these cash outflows was a decrease in accounts receivable of$14.0 million . Cash Flow Used for Investing Activities Cash flow used for investing activities was$123.7 million for the six months endedDecember 31, 2019 , compared to$85.5 million for the prior year period. During the current year period, cash flow used for investing activities included capital expenditures, net of$146.7 million , which consisted primarily of 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 six months endedDecember 31, 2018 , cash flow used for investing activities included capital expenditures, net of$85.6 million , which consisted primarily of equipment upgrades and modernization initiatives. Cash Flow Used for Financing Activities Cash flow used for financing activities was$38.7 million for the six months endedDecember 31, 2019 compared to$432.7 million in the prior year period. During the current year period, cash flow used for financing activities included$33.1 million of cash dividends paid to Kennametal Shareholders and$5.6 million of the effect of employee benefit and stock plans and dividend reinvestment. For the six months endedDecember 31, 2018 , 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,$32.8 million of cash dividends paid to Kennametal Shareholders and$2.2 million of the effect of employee benefit and stock plans and dividend reinvestment, partially offset by an inflow from a net increase in notes payable of$2.5 million . FINANCIAL CONDITION Working capital was$626.8 million atDecember 31, 2019 , a decrease of$102.3 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$76.8 million ; a decrease in accounts receivable of$69.5 million due primarily to a decline in sales, a decrease in inventories of$49.1 million , an increase in other current liabilities of$23.0 million primarily due to greater restructuring charges partially offset by bonus payments, and the addition of current operating lease liabilities of$14.0 million due to the adoption of the new lease accounting standard without a restatement of prior periods. Partially offsetting these items was a decrease in accounts payable of$39.7 million , a decrease in accrued expenses of$31.5 million primarily due to payroll timing and lower accrued vacation pay, an increase in other current assets of$40.4 million primarily due to an increase in prepaid taxes and a decrease in accrued income taxes of$20.4 million which is primarily due to timing of payments and losses in the year-to-date period. Currency exchange rate effects decreased working capital by a total of approximately$6 million , the impact of which is included in the aforementioned changes. Property, plant and equipment, net increased$73.7 million from$934.9 million atJune 30, 2019 to$1,008.6 million atDecember 31, 2019 , primarily due to capital additions of$147.5 million , partially offset by depreciation expense of$53.8 million , divestiture effect of$6.7 million , a negative currency exchange impact of approximately$5 million and disposals of$0.8 million . 34
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Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
AtDecember 31, 2019 , other assets were$578.5 million , an increase of$47.9 million from$530.5 million atJune 30, 2019 . The primary driver for the increase was the addition of operating lease ROU assets of$50.2 million in the quarter due to the adoption of the new lease accounting standard without a restatement of prior periods and an increase in other assets of$18.7 million primarily due to an increase in pension plan assets, partially offset by a decrease in other intangible assets of$19.6 million , which was primarily due to divestiture effect of$12.5 million , amortization expense of$7.0 million and an impairment charge recorded in the Widia segment of$1.5 million and a decrease in goodwill of$14.2 million primarily due to a goodwill impairment charge recorded in the Widia segment of$13.1 million and an unfavorable currency exchange effects of approximately$1 million . Kennametal Shareholders' equity was$1,306.2 million atDecember 31, 2019 , a decrease of$29.0 million from$1,335.2 million atJune 30, 2019 . The decrease was primarily due to cash dividends paid to Kennametal Shareholders of$33.1 million , unfavorable currency exchange effects of$8.8 million and net income attributable toKennametal of$0.5 million , partially offset by capital stock issued under employee benefit and stock plans of$8.3 million and pension and other postretirement benefit effects in other comprehensive loss of$3.5 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. In the December quarter of fiscal 2020, the Company experienced deteriorating market conditions, primarily in general engineering and transportation applications inIndia andChina , in addition to overall global weakness in the manufacturing sector. In view of these declining conditions and the significant detrimental effect on cash flows and actual and projected revenue and earnings compared with our most recent annual impairment test, we determined that an impairment triggering event had occurred and performed an interim quantitative impairment test of our goodwill and indefinite-lived trademark intangible asset of our Widia reporting unit. As a result of this interim test, we recorded a non-cash pre-tax impairment charge during the three months endedDecember 31, 2019 of$14.6 million in the Widia segment, of which$13.1 million was for goodwill and$1.5 million was for an indefinite-lived trademark intangible asset. The carrying values of the Widia reporting unit goodwill and indefinite-lived trademark of$14.0 million and$13.0 million , respectively, approximate fair values as of the interim test date. 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 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.
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Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
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 growth (decline) Organic sales growth (decline) 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 decline on a consistent basis. Also, we report organic sales growth (decline) 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 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 (decline), 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 (decline) 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. Reconciliations of organic sales decline to sales decline are as follows: Three Months EndedDecember 31, 2019 Industrial Widia Infrastructure Total Organic sales decline (11)% (8)% (14)% (12)% Foreign currency exchange impact(1) (1) - (1) (1) Business days impact(2) - (1) (1) - Divestiture impact(3) - - (2) (1) Sales decline (12)% (9)% (18)% (14)%
Six Months Ended
(11)% (9)% (12)% (11)%
Foreign currency exchange impact(1) (1) - (1) (2)
Divestiture impact(3) - - (1) -
Sales decline (12)% (9)% (14)% (13)%
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Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Reconciliations of constant currency end market sales decline to end market sales decline(4) are as follows: Industrial
General
Three Months Ended December 31, 2019 engineering Transportation Aerospace Energy
Constant currency end market sales decline (10)% (13)% (6)% (9)%
Foreign currency exchange impact(1) (2) (1) (1) (1)
End market sales decline(4) (12)% (14)% (7)% (10)%
Infrastructure
Three Months Ended
(6)%
Foreign currency exchange impact(1) - (1) (1)
Divestiture impact(3) (2) - (5)
End market sales decline(4) (35)% (4)% (12)%
Total
Three Months Ended December 31, General
2019 engineering Transportation Aerospace Energy Earthworks
Constant currency end market sales
decline (9)% (13)% (6)% (27)% (3)%
Foreign currency exchange
impact(1) (2) (1) (1) - (1)
Divestiture impact(3) (1) - - (1) -
End market sales decline(4) (12)% (14)% (7)% (28)% (4)%
Industrial
General
Six Months Ended December 31, 2019 engineering Transportation Aerospace Energy
Constant currency end market sales decline (10)% (15)% (3)% (8)%
Foreign currency exchange impact(1) (2) (2) (2) (1)
End market sales decline(4) (12)% (17)% (5)% (9)%
Infrastructure
Six Months Ended
(5)%
Foreign currency exchange impact(1) - (2) (1)
Divestiture impact(3) (1) - (3)
End market sales decline(4) (30)% (4)% (9)%
Total
General
Six Months Ended December 31, 2019 engineering Transportation Aerospace Energy Earthworks
Constant currency end market sales
decline (8)% (15)% (3)% (23)% (2)%
Foreign currency exchange
impact(1) (2) (2) (2) - (2)
Divestiture impact(3) (1) - - (1) -
End market sales decline(4) (11)% (17)% (5)% (24)% (4)%
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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) growth(5), are as follows:
Three Months Ended
December 31, 2019 Six Months Ended
Americas EMEA Asia Pacific Americas EMEA Asia Pacific
Industrial
Constant currency regional sales
decline (10)% (14)% (4)% (8)% (13)% (10)%
Foreign currency exchange
impact(1) - (3) (1) (1) (3) (1)
Regional sales decline(5) (10)% (17)% (5)% (9)% (16)% (11)%
Widia
Constant currency regional sales decline (6)% (6)% (17)% (4)% (3)% (20)% Foreign currency exchange impact(1) - (2) - - (2) (1) Regional sales decline(5) (6)% (8)% (17)%
(4)% (5)% (21)%
Infrastructure
Constant currency regional sales (decline) growth (22)% 2% (5)% (18)% 5% (8)% Foreign currency exchange impact(1) - (4) (1) 1 (4) (2) Divestiture impact(3) (3) - - (2) - - Regional sales (decline) growth(5) (25)% (2)% (6)%
(19)% 1% (10)%
Total
Constant currency regional sales decline (15)% (11)% (6)% (13)% (9)% (11)% Foreign currency exchange impact(1) - (3) (1) - (3) (1) Divestiture impact(3) (2) - - (1) - - Regional sales decline(5) (17)% (14)% (7)%
(14)% (12)% (12)%
(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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