KENNAMETAL INC. The following discussion should be read in connection with the consolidated financial statements ofKennametal Inc. and the related financial statement notes included in Item 8 of this Annual Report. Unless otherwise specified, any reference to a "year" is to our fiscal year endedJune 30 . Additionally, when used in this Annual Report, unless the context requires otherwise, the terms "we," "our" and "us" refer toKennametal Inc. and its subsidiaries. OVERVIEWKennametal 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 metal cutting and wear applications including turning, milling, hole making, tooling systems and services, as well as specialized wear components and metallurgical powders. End users of the Company's metal cutting 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. The Company's wear and metallurgical powders are used by producers and suppliers in equipment-intensive operations such as road construction, mining, quarrying, and oil and gas exploration, refining, production and supply. Throughout Management's Discussion and Analysis of Financial Condition and Results of Operations (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 growth (decline), constant currency regional sales growth (decline) and constant currency end market sales growth (decline). The explanation at the end of the MD&A provides the definition of these non-GAAP financial measures as well as details on their use and a reconciliation to the most directly comparable GAAP financial measures. Our sales of$1,841.4 million for the year endedJune 30, 2021 decreased 2 percent year-over-year, reflecting 4 percent organic sales decline and a 2 percent favorable currency exchange effect. Despite the challenging macro-economic environment due to the COVID-19 pandemic, the Company continued to have success with sequential sales improvement each quarter throughout the year. Operating income was$102.2 million in 2021 compared to$22.3 million in the prior year. The increase in operating income was primarily due to incremental simplification/modernization benefits of$85.0 million , lower raw material costs and$40.4 million of pre-tax restructuring and related charges compared to$83.3 million in the prior year, partially offset by increased variable compensation expense, organic sales decline and associated volume-related manufacturing inefficiencies and unfavorable geographical and product mix. Operating margin in 2021 was 5.5 percent compared to 1.2 percent in the prior year. In 2021, the Metal Cutting and Infrastructure segments had operating margins of 4.0 percent and 8.6 percent, respectively. OnMarch 11, 2020 , theWorld Health Organization declared the Coronavirus Disease 2019 (COVID-19) a pandemic bringing significant uncertainty in our end markets and operations. Since then, national, regional and local governments have taken steps at various times since the pandemic began to limit the spread of the virus through stay-at-home, social distancing, and various other orders and guidelines. Although some jurisdictions have relaxed these measures, others have not or have reinstated them as COVID-19 cases surge and variants emerge. The imposition of these measures has created significant operating constraints on our business. Throughout the pandemic, based on the guidance provided by theU.S. Centers for Disease Control and other relevant authorities, we have deployed safety protocols and processes to keep our employees safe while continuing to serve our customers. To date, we have not experienced a material disruption in our supply chain. The extent to which the COVID-19 pandemic may continue to affect our business, operating results or financial condition in the future will depend on future developments, including the duration of the outbreak, the emergence of more contagious or virulent strains of the virus, travel restrictions, business and workforce disruptions, the availability, update and efficacy of vaccines and the effectiveness of other actions taken to contain and treat the disease. The Company's cost structure benefited from our simplification/modernization initiative including the FY21 Restructuring Actions which have resulted in annualized savings of$68.0 million and pre-tax charges of$82.2 million inception to date. We recorded$40.4 million of pre-tax restructuring and related charges in 2021. Total benefits from our simplification/modernization efforts, including restructuring initiatives, were approximately$85.0 million in 2021, and we achieved total savings from simplification/modernization of approximately$186.0 million since inception. At the end of fiscal 2021 we consider the capital investment and restructuring from simplification/modernization to be substantially complete. 18
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We reported earnings per diluted share (EPS) of$0.65 for fiscal 2021. EPS for the year was unfavorably affected by restructuring and related charges of$0.40 per share, effects from the early extinguishment of debt of$0.08 per share and partial annuitization of the Canadian pension plans of$0.02 per share, partially offset by a discrete tax benefit of$0.11 per share. Loss per diluted share in the prior year of$0.07 was unfavorably affected by restructuring and related charges of$0.88 per share, goodwill and other intangible asset impairment charges of$0.33 per share and loss on divestiture of$0.06 per share, partially offset by discrete benefits from Swiss tax reform of$0.17 per share, the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) of$0.08 per share and other tax matters of$0.01 per share. We generated cash flow from operating activities of$235.7 million in 2021 compared to$223.7 million during the prior year. Capital expenditures were$127.3 million and$244.2 million during 2021 and 2020, respectively, primarily related to our simplification/modernization initiatives. The Company returned$66.7 million and$66.3 million to shareholders through dividends during 2021 and 2020, respectively. In connection with of the Company's focus on organizational efficiency, commercial excellence and growing its metal cutting businesses, effectiveJuly 1, 2020 ,Kennametal combined its former Industrial and Widia business segments to form one Metal Cutting business segment. The Infrastructure segment remains unchanged. Segment results have been retrospectively restated to reflect the change in reportable segments. For a discussion related to the results of operations, changes in financial condition and liquidity and capital resources for fiscal 2020 compared to fiscal 2019 refer to Part II, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations in our fiscal 2020 Form 10-K, which was filed with theUnited States Securities and Exchange Commission onAugust 20, 2020 . RESULTS OF CONTINUING OPERATIONS SALES Sales in 2021 were$1,841.4 million , a 2 percent decrease from$1,885.3 million in 2020. The decrease was primarily due to organic sales decline of 4 percent and a 2 percent favorable currency exchange effect. 2021 As (in percentages) Reported Constant
Currency
End market sales (decline) growth:
Energy (10)% (11)%
Transportation 7 4
General engineering 1 (1)
Aerospace (33) (34)
Earthworks (1) (3)
Regional sales (decline) growth:
Americas (9)% (9)%
Europe, the Middle East and Africa (EMEA) 2 (3)
Asia Pacific 10 6
GROSS PROFIT Gross profit increased $23.0 million to $552.5 million in 2021 from
$529.5 million in 2020. This increase was primarily due to incremental
simplification/modernization benefits, partially offset by an organic sales
decline and unfavorable labor and fixed cost absorption due to lower volumes.
The gross profit margin for 2021 was 30.0 percent compared to 28.1 percent in
2020.
OPERATING EXPENSE Operating expense in 2021 was $407.2 million , an increase of
$18.8 million , or 4.8 percent, from $388.4 million in 2020. The increase was
primarily due to higher incentive compensation expense and unfavorable currency
exchange effect of approximately $8.5 million , partially offset by incremental
restructuring simplification benefits.
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 $39.5 million and $38.7 million for 2021 and 2020,
respectively.
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RESTRUCTURING AND RELATED CHARGES AND ASSET IMPAIRMENT CHARGES FY20 Restructuring Actions In the June quarter of fiscal 2019, we implemented, and in fiscal 2020 substantially completed, the FY20 Restructuring Actions associated with our simplification/modernization initiative to reduce structural costs, improve operational efficiency and position us for long-term profitable growth. Total restructuring and related charges since inception of$54.8 million were recorded for this program throughJune 30, 2021 , consisting of:$46.6 million in Metal Cutting and$8.3 million in Infrastructure. FY21 Restructuring Actions In the September quarter of fiscal 2020, we announced the initiation of restructuring actions inGermany associated with our simplification/modernization initiative to reduce structural costs. Subsequently, we agreed with local employee representatives to downsize ourEssen, Germany operations instead of the previously proposed closure. During the fourth quarter of fiscal 2020, we also announced the acceleration of our other structural cost reduction plans. The estimated annualized savings of the FY21 Restructuring Actions are$75 million and the expected pre-tax charges are approximately$90 million . The majority of the remaining charges related to the FY21 Restructuring Actions are expected to be in the Metal Cutting segment. Total restructuring and related charges since inception of$82.2 million were recorded for this program throughJune 30, 2021 , consisting of:$74.5 million in Metal Cutting and$7.7 million in Infrastructure. Inception to date, we have achieved annualized savings of approximately$68.0 million . Annual Restructuring Charges During 2021, we recorded restructuring and related charges of$40.4 million , which consisted of$35.6 million in Metal Cutting and$4.8 million in Infrastructure. Of this amount, restructuring charges totaled$29.6 million , of which$0.5 million was related to inventory and was recorded in cost of goods sold. Restructuring-related charges of$10.8 million were recorded in cost of goods sold. During 2020, we recorded restructuring and related charges of$83.3 million . Of this amount, restructuring charges totaled$69.2 million , of which$0.9 million was related to inventory and was recorded in cost of goods sold. Restructuring-related charges of$14.1 million were recorded in cost of goods sold. LOSS ON DIVESTITURE During the year endedJune 30, 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 year endedJune 30, 2020 was$6.5 million . Transaction proceeds were primarily used for capital expenditures related to our simplification/modernization efforts. AMORTIZATION OF INTANGIBLES Amortization expense was$14.0 million and$13.8 million in 2021 and 2020, respectively. INTEREST EXPENSE Interest expense in 2021 was$46.4 million , an increase of$11.2 million , compared to$35.2 million in 2020. The increase was primarily due to the early extinguishment of the$300.0 million of 3.875 percent Senior Unsecured Notes due 2022 (the 2022 Senior Notes). See Note 11 "Long-Term Debt" in the consolidated financial statements for further details. The portion of our debt subject to variable rates of interest was less than 1 percent atJune 30, 2021 and 45.7 percent atJune 30, 2020 due to$500.0 million of borrowings outstanding under the Credit Agreement in the prior year. There were no borrowings outstanding under the Credit Agreement as ofJune 30, 2021 . OTHER INCOME, NET In 2021, other income, net was$8.9 million , a decrease of$6.0 million from$14.9 million in 2020. The decrease was primarily due to lower net periodic pension income in fiscal 2021, including the partial annuitization of our Canadian defined benefit pension plans and lower interest income. INCOME TAXES The effective tax rate for 2021 was 9.7 percent compared to 357.5 percent for 2020. Current year items driving the year-over-year change in the tax rate include (i) tax benefits from a provision to return adjustment related to our fiscal 2020 U.S. income tax return that included an election pursuant to Global Intangible Low-Taxed Income (GILTI) tax regulations issued during the current year, and (ii) the recognition of a stranded deferred tax balance in accumulated other comprehensive loss associated with the forward starting interest rate swaps that were terminated during fiscal 2021 when the 2022 Senior Notes were extinguished. Prior year items driving the year-over-year change include: (i) the effects of higher restructuring and related charges compared to the current year, (ii) goodwill and other intangible asset impairment charges, (iii) a$14.5 million benefit for the one-time effect of Swiss tax reform and (iv) a$6.9 million tax benefit associated with the CARES Act. See Note 13 of our consolidated financial statements set forth in Item 8 of this Annual Report for a more comprehensive discussion about Swiss tax reform and the CARES Act. 20
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As ofJune 30, 2021 , we have$26.3 million ofU.S. net deferred tax assets. Within this amount is$57.0 million related to net operating loss, tax credit, and other carryforwards that can be used to offset futureU.S. taxable income. Certain of these carryforwards will expire if they are not used within a specified timeframe. At this time, we consider it more likely than not that we will have sufficientU.S. taxable income in the future that will allow us to realize these net deferred tax assets. However, it is possible that some or all of these tax attributes could ultimately expire unused, especially if our end markets do not continue to recover from the COVID-19 global pandemic. Therefore, if we are unable to generate sufficientU.S. taxable income from our operations, a valuation allowance to reduce theU.S. net deferred tax assets may be required, which would materially increase income tax expense in the period in which the valuation allowance is recorded. 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 tax authority served notice in the September quarter of fiscal 2020 requiring payment in the amount of €36.0 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 €36.0 million, or$43.0 million , of which penalties and interest is €21.0 million, or$25.0 million . NET INCOME (LOSS) ATTRIBUTABLE TO KENNAMETAL Net income attributable toKennametal was$54.4 million , or$0.65 earnings per diluted share (EPS) in 2021, compared to net loss attributable toKennametal of$5.7 million , or$0.07 loss per share in 2020. The increase is a result of the factors previously discussed. BUSINESS SEGMENT REVIEW We operate in two reportable operating segments consisting of Metal Cutting and Infrastructure. Corporate expenses that are not allocated are reported in Corporate. Segment determination is based upon internal organizational structure, the manner in which we organize segments for making operating decisions and assessing performance and the availability of separate financial results. See Note 21 of our consolidated financial statements set forth in Item 8 of this Annual Report. Our sales and operating income by segment are as follows: (in thousands) 2021 2020 Sales: Metal Cutting$ 1,150,746 $ 1,178,053 Infrastructure 690,695 707,252 Total sales$ 1,841,441 $ 1,885,305 Operating income: Metal Cutting$ 45,855 $ 985 Infrastructure 59,461 23,113 Corporate (3,148) (1,846) Total operating income 102,168 22,252 Interest expense 46,375 35,154 Other income, net (8,867) (14,862) Income before income taxes$ 64,660 $ 1,960 METAL CUTTING (in thousands) 2021 2020 Sales$ 1,150,746 $ 1,178,053 Operating income 45,855 985 Operating margin 4.0 % 0.1 % 21
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(in percentages) 2021
Organic sales decline (4)%
Foreign currency exchange effect 2
Sales decline (2)%
2021
(in percentages) As Reported ConstantCurrency
End market sales growth (decline):
Transportation 7% 4%
General engineering 1 (1)
Aerospace (33) (34)
Energy (10) (12)
Regional sales growth (decline):
EMEA 2% (3)%
Americas (11) (10)
Asia Pacific 6 3
In 2021, Metal Cutting sales of $1,150.7 million decreased by $27.3 million , or
2 percent, from 2020. Aerospace end market sales declined in all regions due to
a significant reduction in airplane manufacturing. Energy sales decreased
primarily due to a decline in oil and gas drilling in the Americas , partially
offset by strength in wind power generation in China . Sales in our general
engineering end market declined in all regions except for Asia Pacific . The
general engineering end market was impacted by lower manufacturing activity
related to the COVID-19 pandemic. Transportation end market sales increased in
the Americas and EMEA due to improving automotive manufacturing levels. On a
regional basis, the sales increase in Asia Pacific was driven by the general
engineering and energy end markets, partially offset by a decline in the
aerospace end market. The sales decline in EMEA was primarily due to the
aerospace end market, partially offset by an increase in the transportation end
market. The sales decrease in the Americas was driven by declines in the
aerospace, energy, and general engineering end markets, partially offset by an
increase in sales in the transportation end market.
In 2021, Metal Cutting operating income was $45.9 million , a $44.9 million
increase from 2020. The increase was primarily driven by incremental
simplification/modernization benefits, no goodwill and other intangible asset
impairment charges in the current year, lower restructuring and related charges
of $38.1 million and lower raw material costs, partially offset by organic sales
decline, unfavorable labor and fixed cost absorption due to lower volumes, an
increase in variable compensation and unfavorable product mix.
INFRASTRUCTURE
(in thousands) 2021 2020
Sales $ 690,695 $ 707,252
Operating income 59,461 23,113
Operating margin 8.6 % 3.3 %
(in percentages) 2021
Organic sales decline (3)%
Foreign currency exchange effect 2
Divestiture effect (1)
Sales decline (2)%
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2021
(in percentages) As Reported Constant CurrencyEnd market sales (decline) growth:
Energy (10)% (11)%
General engineering 2 -
Earthworks (1) (3)Regional sales (decline) growth:
Americas (8)% (8)%
Asia Pacific 15 11
EMEA 3 (2)
In 2021, Infrastructure sales of $690.7 million decreased by $16.6 million , or 2
percent, from 2020. The reduction in U.S. oil and gas drilling activity drove
year-over-year decline in the energy market. Earthworks end market sales were
down year-over-year due to softness in the Americas underground mining and
construction, partially offset by EMEA construction. In general engineering the
increase in sales was driven by Asia Pacific and the Americas . On a regional
basis, the sales decrease in the Americas was driven by declines in the energy
and earthworks end markets, partially offset by an increase in the general
engineering end market. The sales decrease in EMEA was primarily driven by a
decline in general engineering, partly offset by an increase in the earthworks
end market. The increase in sales in Asia Pacific was primarily driven by growth
in the general engineering end market.
In 2021, Infrastructure operating income was $59.5 million , a $36.3 million
increase from 2020. The primary drivers for the increase were incremental
simplification/modernization benefits and lower material costs. These benefits
were partially offset by increased variable compensation, an organic sales
decline and unfavorable geographical and product mix.
CORPORATE
(in thousands) 2021 2020
Corporate expense $ (3,148) $ (1,846) In 2021, Corporate expense increased
LIQUIDITY AND CAPITAL RESOURCES Cash flow from operations is the primary source of funding for our capital expenditures. During the year endedJune 30, 2021 , cash flow provided by operating activities was$235.7 million . During fiscal 2021, we entered into the First Amendment (the Amendment) to the Fifth Amended and Restated Credit Agreement dated as ofJune 21, 2018 , (as amended by the Amendment, the Credit Agreement). The Credit Agreement is a five-year, multi-currency, revolving credit facility and we use it to augment cash from operations and as 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: (1) a maximum leverage ratio where debt, net of domestic cash in excess of$25 million and sixty percent of the unrestricted cash held outside ofthe United States , must be less than or equal to 3.5 times trailing twelve months EBITDA (temporarily increased by the Amendment to 4.25 times trailing twelve months EBITDA during the period fromSeptember 30, 2020 through and includingDecember 31, 2021 ), adjusted for certain non-cash expenses and which may be further adjusted, at our discretion, to include up to$120 million of cash restructuring charges throughDecember 31, 2021 ; and (2) a minimum consolidated interest coverage ratio of EBITDA to interest of 3.5 times (as such terms are defined in the Credit Agreement). Borrowings under the Credit Agreement are guaranteed by our significant domestic subsidiaries. As ofJune 30, 2021 , we were in compliance with all covenants of the Credit Agreement and we had no borrowings outstanding and$700.0 million of availability. There were$500.0 million borrowings outstanding as ofJune 30, 2020 . 23
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Other lines of credit and notes payable were$8.4 million and$0.4 million atJune 30, 2021 and 2020, respectively. The lines of credit represented short-term borrowings under credit lines with commercial banks in the various countries in which we operate. These credit lines, translated intoU.S. dollars atJune 30, 2021 exchange rates, totaled$65.0 million . For the year endedJune 30, 2021 , average daily borrowings outstanding under the Credit Agreement were approximately$128.2 million . The weighted average interest rate on borrowings under the Credit Agreement was 3.1 percent for the year endedJune 30, 2021 . Based upon our debt structure atJune 30, 2021 , less than 1 percent of our debt was exposed to variable rates of interest. AtJune 30, 2020 , 45.7 percent of our debt was exposed to variable rates of interest due to the$500.0 million of borrowings outstanding under the Credit Agreement in the prior year. We consider the majority of the$1.5 billion 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. Determination of the amount of unrecognized deferred tax liability related to indefinitely reinvested earnings is not practicable due to our legal entity structure and the complexity ofU.S. and local tax laws. 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. The deferred tax liability associated with unremitted earnings of our non-U.S. subsidiaries not permanently reinvested is$6.4 million as ofJune 30, 2021 . AtJune 30, 2021 , we had cash and cash equivalents of$154.0 million . Total Kennametal Shareholders' equity was$1,329.6 million and total debt was$600.5 million . Our current senior credit ratings are considered investment grade. We believe that our current financial position, liquidity and credit ratings provide us access to the capital markets. We continue to closely monitor our liquidity position and the condition of the capital markets, as well as the counterparty risk of our credit providers. The following is a summary of our contractual obligations and other commercial commitments as ofJune 30, 2021 : Contractual Obligations (in thousands) Total 2022 2023-2024 2025-2026 Thereafter Long-term debt, including current maturities (1)$ 777,262
Other lines of credit and notes payable 8,418 8,418 - - - Pension benefit payments (2) 53,088 108,023 110,841 (2) Postretirement benefit payments (2) 1,268 2,257 1,906 (2) Operating leases 58,690 15,062 19,459 8,329 15,840 Purchase obligations (3) 184,500 84,105 100,395 - - Unrecognized tax benefits (4) 10,082 5,836 2,716 - 1,530 Total$ 190,052 $ 277,400 $ 165,626 (1)Long-term debt includes interest obligations of$177.8 million and excludes debt issuance costs of$6.2 million . (2)Annual payments are expected to continue into the foreseeable future at the amounts noted in the table. (3)Purchase obligations consist of purchase commitments for materials, supplies and machinery and equipment as part of the ordinary conduct of business. Purchase obligations with variable price provisions were determined assuming market prices as ofJune 30, 2021 remain constant. (4)Unrecognized tax benefits are positions taken or expected to be taken on an income tax return that may result in additional payments to tax authorities. These amounts include interest of$1.4 million accrued related to such positions as ofJune 30, 2021 . Positions for which we are not able to reasonably estimate the timing of potential future payments are included in the 'Thereafter' column. If a tax authority agrees with the tax position taken or expected to be taken or the applicable statute of limitations expires, then additional payments will not be necessary. Other Commercial Commitments (in thousands) Total 2022 2023-2024 2025-2026 Thereafter Standby letters of credit$ 5,462 $ 2,752 $ 2,710 $ - $ - Guarantees 20,992 10,428 675 - 9,889 Total$ 26,454 $ 13,180 $ 3,385 $ -$ 9,889
The standby letters of credit relate to insurance and other activities. The guarantees are non-debt guarantees with financial institutions, which are required primarily for security deposits, product performance guarantees and advances.
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Cash Flow Provided by Operating Activities During 2021, cash flow provided by operating activities was$235.7 million , compared to$223.7 million in 2020. During 2021, cash flow provided by operating activities consisted of net income and non-cash items amounting to$210.0 million and changes in certain assets and liabilities netting to an inflow of$25.7 million . Contributing to the changes in certain assets and liabilities were an increase in accounts payable and accrued liabilities of$46.8 million and a decrease in inventories of$61.3 million , partially offset by an increase in accounts receivable of$53.3 million , a decrease in accrued pension and postretirement benefits of$31.6 million and a decrease in accrued income taxes of$18.3 million . During 2020, cash flow provided by operating activities was$223.7 million . Cash flow provided by operating activities consisted of net loss and non-cash items amounting to$150.3 million and changes in certain assets and liabilities netting to an inflow of$73.5 million . Contributing to the changes in certain assets and liabilities were a decrease in accounts receivable of$128.7 million and a decrease in inventories of$28.2 million , partially offset by a decrease in accounts payable and accrued liabilities of$46.3 million , a decrease in accrued pension and postretirement benefits of$20.0 million and a decrease in accrued income taxes of$8.6 million . The decreases in inventories and accounts receivable were primarily due to the decrease in demand in the March and June quarters of fiscal 2020. Cash Flow Used for Investing Activities Cash flow used for investing activities was$123.0 million for 2021, a decrease of$95.4 million , compared to$218.3 million in 2020. During 2021, cash flow used for investing activities included capital expenditures, net of$122.9 million , which consisted primarily of expenditures related to our simplification/modernization initiatives. Cash flow used for investing activities was$218.3 million for 2020. During 2020, cash flow used for investing activities included capital expenditures, net of$241.5 million , which consisted primarily of expenditures 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 . Cash Flow (Used for) Provided by Financing Activities Cash flow used for financing activities was$574.2 million for 2021, compared to cash flow provided by financing activities of$425.5 million in 2020. During the current year period, cash flow used for financing activities included$500.0 million of a net decrease in the revolving and other lines of credit, the debt refinancing (see Note 11. "Long-Term Debt" to our consolidated financial statements set forth in Part II, Item 8 of this Annual Report on Form 10-K for further discussion) and$66.7 million of cash dividends paid to Shareholders. Cash flow provided by financing activities was$425.5 million for 2020. During 2020, cash flow provided by financing activities included an inflow of$500.4 million primarily due to borrowings outstanding under the Credit Agreement, partially offset by$66.3 million of cash dividends paid to Shareholders and$5.5 million of the effect of employee benefit and stock plans and dividend reinvestment. FINANCIAL CONDITION AtJune 30, 2021 , total assets were$2,665.8 million , a decrease of$371.8 million from$3,037.6 million atJune 30, 2020 . Total liabilities decreased$471.2 million from$1,768.8 million atJune 30, 2020 to$1,297.6 million atJune 30, 2021 . Working capital was$567.4 million atJune 30, 2021 , an increase of$24.7 million from$542.7 million atJune 30, 2020 . The increase in working capital was primarily driven by a decrease in revolving and other lines of credit and notes payable of$492.0 million due primarily to repayments on our Credit Agreement and an increase in accounts receivable of$65.0 million . Partially offsetting these items were a decrease in cash and cash equivalents of$452.6 million primarily due to the$500.0 million repayment under the Credit Agreement, a decrease in inventory of$46.1 million , an increase in accounts payable of$13.0 million and an increase in accrued payroll of$13.0 million . Currency exchange rate effects increased working capital by a total of approximately$26 million , the effects of which are included in the aforementioned changes. Property, plant and equipment, net increased$16.9 million from$1,038.3 million atJune 30, 2020 to$1,055.1 million atJune 30, 2021 , primarily due to capital additions of$127.3 million , partially offset by depreciation expense of$112.5 million , and a positive currency exchange effect of approximately$24 million . AtJune 30, 2021 , other assets were$605.8 million , an increase of$47.3 million from$558.5 million atJune 30, 2020 . The primary drivers for the increase were the increase in long-term prepaid pension benefit of$46.1 million as well as an increase in deferred income taxes by$12.0 million . These were partially offset by amortization expense of$14.0 million . 25
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Kennametal Shareholders' equity was$1,329.6 million atJune 30, 2021 , an increase of$99.7 million from$1,229.9 million in the prior year. The increase was primarily due to net income during the year of$54.4 million , capital stock issued under employee benefit and stock plans of$24.6 million and other comprehensive income. These increases were partially offset by cash dividends to Shareholders of$66.7 million . EFFECTS OF INFLATION Despite modest inflation in recent years, rising costs, including the cost of certain raw materials, continue to affect our operations throughout the world. We strive to minimize the effects of inflation through cost containment, productivity improvements and price increases. DISCUSSION OF CRITICAL ACCOUNTING POLICIES In preparing our consolidated financial statements in conformity with accounting principles generally accepted in theU.S. , we make judgments and estimates about the amounts reflected in our consolidated financial statements. As part of our financial reporting process, our management collaborates to determine the necessary information on which to base our judgments and develops estimates used to prepare the consolidated financial statements. We use historical experience and available information to make these judgments and estimates. However, different amounts could be reported using different assumptions and in light of different facts and circumstances. Therefore, actual amounts could differ from the estimates reflected in our consolidated financial statements. Our significant accounting policies are described in Note 2 of our consolidated financial statements, which are included in Item 8 of this Annual Report. We believe that the following discussion addresses our critical accounting policies. Revenue RecognitionThe Company's contracts with customers are comprised of purchase orders, and for larger customers, may also include long-term agreements. We account for a contract when it has approval and commitment from both parties, the rights of the parties and payment terms are identified, the contract has commercial substance and collectability of consideration is probable. These contracts with customers typically relate to the manufacturing of products, which represent single performance obligations that are satisfied when control of the product passes to the customer. The Company considers the timing of right to payment, transfer of risk and rewards, transfer of title, transfer of physical possession and customer acceptance when determining when control transfers to the customer. As a result, revenue is generally recognized at a point in time - either upon shipment or delivery - based on the specific shipping terms in the contract. The shipping terms vary across all businesses and depend on the product, customary local commercial terms and the type of transportation. Shipping and handling activities are accounted for as activities to fulfill a promise to transfer a product to a customer and as such, costs incurred are recorded when the related revenue is recognized. Payment for products is due within a limited time period after shipment or delivery, typically within 30 to 90 calendar days of the respective invoice dates. The Company does not generally offer extended payment terms. Revenue is measured as the amount of consideration we expect to receive in exchange for transferring goods. Amounts billed and due from our customers are classified as accounts receivable, less allowance for doubtful accounts on the consolidated balance sheets. Certain contracts with customers, primarily distributor customers, have an element of variable consideration that is estimated when revenue is recognized under the contract. Variable consideration primarily includes volume incentive rebates, which are based on achieving a certain level of purchases and other performance criteria as established by our distributor programs. These rebates are estimated based on projected sales to the customer and accrued as a reduction of net sales as they are earned. The majority of our products are consumed by our customers or end users in the manufacture of their products. Historically, we have experienced very low levels of returned products and do not consider the effect of returned products to be material. We have recorded an estimated returned goods allowance to provide for any potential returns. We warrant that products sold are free from defects in material and workmanship under normal use and service when correctly installed, used and maintained. This warranty terminates 30 days after delivery of the product to the customer and does not apply to products that have been subjected to misuse, abuse, neglect or improper storage, handling or maintenance. Products may be returned toKennametal only after inspection and approval byKennametal and upon receipt by the customer of shipping instructions fromKennametal . We have included an estimated allowance for warranty returns in our returned goods allowance discussed above. The Company records a contract asset when it has a right to payment from a customer that is conditioned on events that have occurred other than the passage of time. The Company also records a contract liability when customers prepay but the Company has not yet satisfied its performance obligation. The Company did not have any material remaining performance obligations, contract assets or liabilities as ofJune 30, 2021 and 2020. The Company pays sales commissions related to certain contracts, which qualify as incremental costs of obtaining a contract. However, the Company applies the practical expedient that allows an entity to recognize incremental costs of obtaining a contract as an expense when incurred if the amortization period of the asset that would have been recognized is one year or less. These costs are recorded within operating expense in our consolidated statements of income. 26
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Stock-Based Compensation We recognize stock-based compensation expense for all stock options, restricted stock awards and restricted stock units over the period from the date of grant to the date when the award is no longer contingent on the employee providing additional service (substantive vesting period), net of expected forfeitures. We utilize the Black-Scholes valuation method to establish the fair value of all stock option awards. Time vesting stock units are valued at the market value of the stock on the grant date. Performance vesting stock units with a market condition are valued using aMonte Carlo model. Accounting for Contingencies We accrue for contingencies when it is probable that a liability or loss has been incurred and the amount can be reasonably estimated. Contingencies by their nature relate to uncertainties that require the exercise of judgment in both assessing whether or not a liability or loss has been incurred and estimating the amount of probable loss. The significant contingencies affecting our consolidated financial statements include environmental, health and safety matters and litigation. Long-Lived Assets We evaluate the recoverability of property, plant and equipment, operating lease right-of-use (ROU) assets and intangible assets that are amortized whenever events or changes in circumstances indicate the carrying amount of such assets may not be fully recoverable. Changes in circumstances include technological advances, changes in our business model, capital structure, economic conditions or operating performance. Our evaluation is performed at the asset group level, based upon, among other things, our assumptions about the estimated future undiscounted cash flows these assets are expected to generate. When the sum of the undiscounted cash flows is less than the carrying value, we will recognize an impairment loss to the extent that carrying value exceeds fair value. We apply our best judgment when performing these evaluations to determine if a triggering event has occurred, the undiscounted cash flows used to assess recoverability and the fair value of the asset group.Goodwill and Indefinite-Lived Intangible Assets We evaluate the recoverability of goodwill of each of our reporting units by comparing the fair value of each reporting unit with its carrying value. 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 perform our annual impairment tests during 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 warrant a test prior to that quarter. We apply our best judgment when assessing the reasonableness of the financial projections used to determine the fair value of each reporting unit. The discounted cash flow method was used to measure the fair value of our equity under the income approach. A terminal value utilizing a constant growth rate of cash flows was used to calculate a terminal value after the explicit projection period. The estimates and assumptions used in our calculations include revenue and gross margin growth rates, expected capital expenditures to determine projected cash flows, expected tax rates and an estimated discount rate to determine present value of expected cash flows. These estimates are based on historical experiences, our projections of future operating activity and our weighted average cost of capital (WACC). In order to determine the discount rate, the Company uses a market perspective WACC approach. The WACC is calculated incorporating weighted average returns on debt and equity from market participants. Therefore, changes in the market, which are beyond the control of the Company, may have an effect on future calculations of estimated fair value. As ofJune 30, 2021 , there is no goodwill allocated to the Infrastructure reporting unit. As ofJune 30, 2021 ,$277.6 million of goodwill was allocated to the Metal Cutting reporting unit. We completed an annual quantitative test of goodwill impairment and determined that the fair value of the reporting unit substantially exceeded the carrying value and, therefore, no impairment was recorded during fiscal 2021. Further, an indefinite-lived trademark intangible asset of$11.8 million in the Metal Cutting reporting unit had a fair value that approximated its carrying value as of the date of the annual impairment test and, therefore, no impairment was recorded during fiscal 2021. To determine fair value, we assumed revenue growth rates that take into effect the uncertainty related to COVID-19 in the near term, the eventual recovery of our end markets, and a residual period growth rate of 3 percent. We assumed a royalty rate of 1 percent, and the future period cash flows were discounted at 20 percent per annum. 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 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 affect the estimated fair values of the Metal Cutting reporting unit 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 and (ii) inability to achieve the sales from our strategic growth initiatives. 27
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Pension and Other Postretirement Benefits We sponsor pension and other postretirement benefit plans for certain employees and retirees. Accounting for the cost of these plans requires the estimation of the cost of the benefits to be provided well into the future and attributing that cost over either the expected work life of employees or over average life of participants participating in these plans, depending on plan status and on participant population. This estimation requires our judgment about the discount rate used to determine these obligations, expected return on plan assets, rate of future compensation increases, rate of future health care costs, withdrawal and mortality rates and participant retirement age. Differences between our estimates and actual results may significantly affect the cost of our obligations under these plans. In the valuation of our pension and other postretirement benefit liabilities, management utilizes various assumptions. Our discount rates are derived by identifying a theoretical settlement portfolio of high quality corporate bonds sufficient to provide for a plan's projected benefit payments. This rate can fluctuate based on changes in the corporate bond yields. AtJune 30, 2021 , a hypothetical 25 basis point increase or decrease in our discount rates would be immaterial to our pre-tax income. The long-term rate of return on plan assets is estimated based on an evaluation of historical returns for each asset category held by the plans, coupled with the current and short-term mix of the investment portfolio. The historical returns are adjusted for expected future market and economic changes. This return will fluctuate based on actual market returns and other economic factors. The rate of future health care cost increases is based on historical claims and enrollment information projected over the next fiscal year and adjusted for administrative charges. This rate is expected to decrease until 2027. AtJune 30, 2021 , a hypothetical 1 percent increase or decrease in our health care cost trend rates would be immaterial to our pre-tax income. Future compensation rates, withdrawal rates and participant retirement age are determined based on historical information. These assumptions are not expected to significantly change. Mortality rates are determined based on a review of published mortality tables. We expect to contribute approximately$8 million and$1 million to our pension and other postretirement benefit plans, respectively, in 2022. Expected pension contributions in 2022 are primarily for international plans. Allowance for Doubtful Accounts We record allowances for estimated losses resulting from the inability of our customers to make required payments. We assess the creditworthiness of our customers based on multiple sources of information and analyze additional factors such as our historical bad debt experience, industry concentrations of credit risk, current economic trends, changes in customer payment terms and forward-looking information. This assessment requires significant judgment. If the financial condition of our customers was to deteriorate, additional allowances may be required, resulting in future operating losses that are not included in the allowance for doubtful accounts atJune 30, 2021 . Inventories We use the last-in, first-out method for determining the cost of a significant portion of ourU.S. inventories, and they are stated at the lower of cost or market. The cost of the remainder of our inventories is measured using approximate costs determined on the first-in, first-out basis or using the average cost method, and are stated at the lower of cost or net realizable value. When market conditions indicate an excess of carrying costs over market value, a lower of cost or net realizable value provision or a lower of cost or market provision, as applicable, is recorded. Once inventory is determined to be excess or obsolete, a new cost basis is established that is not subsequently written back up in future periods. Income Taxes Realization of our deferred tax assets is primarily dependent on future taxable income, the timing and amount of which are uncertain. A valuation allowance is recognized if it is "more likely than not" that some or all of a deferred tax asset will not be realized. As ofJune 30, 2021 , the deferred tax assets net of valuation allowances relate primarily to net operating loss and other carryforwards, pension benefits, accrued employee benefits and inventory. In the event that we were to determine that we would not be able to realize our deferred tax assets in the future, an increase in the valuation allowance would be required. In the event we were to determine that we are able to use our deferred tax assets for which a valuation allowance is recorded, a decrease in the valuation allowance would be required. 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 five 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 carried back our taxable loss in theU.S. for fiscal 2020 under the provisions of the CARES Act and recorded a benefit in our tax provision during fiscal 2020. 28
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Swiss tax reform Legislation was effectively enacted during the December quarter of fiscal 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 multi-year transitional period at both the federal and cantonal levels. 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 December quarter of fiscal 2020. 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 anticipate finalization of the deferred tax asset within the next twelve months. NEW ACCOUNTING STANDARDS See Note 2 to the consolidated financial statements for information regarding recently adopted accounting pronouncements. RECONCILIATION OF FINANCIAL MEASURES NOT DEFINED BYU.S. GAAP In accordance withSEC rules, we are providing descriptions of the non-GAAP financial measures included in this Annual Report and reconciliations to the most closely related GAAP financial measures. We believe that these measures provide useful perspective on underlying business trends and results and 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 and may, therefore, also be useful to investors as they are 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 effects of acquisitions, divestitures, business days and foreign currency exchange from year-over-year comparisons. We believe this measure provides investors with a supplemental understanding of underlying sales trends by providing sales growth on a consistent basis. We report organic sales 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 growth (decline) (which is the most directly comparable GAAP measure) by end market excluding the effects 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 effect of business days. We believe this measure provides investors with a supplemental understanding of underlying end market trends by providing end market sales decline on a consistent basis. We report constant currency end market sales growth (decline) at the consolidated and segment levels. 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 effects of acquisitions, divestitures and foreign currency exchange from year-over-year comparisons. We note that, unlike organic sales growth (decline), constant currency regional sales growth (decline) does not exclude the effect 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. 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: Year endedJune 30, 2021 Metal Cutting
Infrastructure Total
Organic sales decline (4)% (3)% (4)%
Foreign currency exchange effect(6) 2 2 2
Divestiture effect(7) - (1) -
Sales decline (2)% (2)% (2)%
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Reconciliations of constant currency end market sales growth (decline) to end market sales growth (decline), are as follows: Metal Cutting Year ended June 30, 2021 General engineering Transportation Aerospace Energy Constant currency end market sales (decline) growth (1)% 4% (34)% (12)% Foreign currency exchange effect(6) 2 3 1 2 End market sales growth (decline)(8) 1% 7% (33)% (10)% Infrastructure Year ended June 30, 2021 Energy Earthworks General engineering Constant currency end market sales decline (11)% (3)% -% Foreign currency exchange effect(6) 2 2 6 Divestiture effect(7) (1) - (4) End market sales (decline) growth(8) (10)% (1)% 2% Total Year ended June 30, 2021 General engineering Transportation Aerospace Energy Earthworks Constant currency end market sales (decline) growth (1)% 4% (34)% (11)% (3)% Foreign currency exchange effect(6) 3 3 1 1 2 Divestiture effect(7) (1) - - - - End market sales growth (decline)(8) 1% 7% (33)% (10)% (1)%
Reconciliations of constant currency regional sales growth (decline) to reported regional sales growth (decline), are as follows:
Year Ended
Americas EMEA Asia Pacific
Metal Cutting
Constant currency regional sales (decline) growth (10)% (3)% 3%
Foreign currency exchange effect(6) (1) 5 3
Regional sales (decline) growth(9) (11)% 2% 6%
Infrastructure
Constant currency regional sales (decline) growth (8)% (2)% 11% Foreign currency exchange effect(6) 2 5 4 Divestiture effect(7) (2) - - Regional sales (decline) growth(9) (8)% 3% 15%
Total
Constant currency regional sales (decline) growth (9)% (3)% 6% Foreign currency exchange effect(6) 1 5 4 Divestiture effect(7) (1) - - Regional sales (decline) growth(9) (9)% 2% 10% (6) Foreign currency exchange effect is calculated by dividing the difference between current period sales and current period sales at prior period foreign exchange rates by prior period sales. (7) Divestiture effect is calculated by dividing prior period sales attributable to divested businesses by prior period sales. (8) Aggregate sales for all end markets sum to the sales amount presented onKennametal's consolidated financial statements. (9) Aggregate sales for all regions sum to the sales amount presented onKennametal's consolidated financial statements. 30
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