Kennametal Inc 10-Q for FY2020 Q3
Kennametal Inc (KMT)
10-Q
2020-05-05
For: 2020-03-31
View Original
Added on
April 07, 2026
About this 10-Q
Kennametal Inc filed this 10-Q on May 5, 2020, covering the quarter ended March 31, 2020 (FY2020 Q3).
Headline figures
Quarter ended March 31, 2020, as reported in this filing, compared with the same period a year earlier where the filing states it.
- Revenue
- $483.08M
- down 19.1% from $597.2M a year earlier
- Net income
- $2.92M
- down 95.7% from net income of $68.55M a year earlier
- Diluted EPS
- $0.03
- down 96.3% from $0.82 a year earlier
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the quarterly period ended: March 31, 2020
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the transition period from _______ to _______
Commission file number 1-5318
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | ||
(Address of principal executive offices) | (Zip Code) | ||
Registrant’s telephone number, including area code: (412 ) 248-8000
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
☒ | Accelerated filer | ☐ | |
Non-accelerated filer | ☐ | Smaller reporting company | |
Emerging growth company | |||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Trading Symbol | Name of each exchange on which registered |
As of April 30, 2020, 82,913,959 shares of the Registrant’s Capital Stock, par value $1.25 per share, were outstanding.
KENNAMETAL INC.
FORM 10-Q
FOR THE THREE AND NINE MONTHS ENDED MARCH 31, 2020
TABLE OF CONTENTS
Item No. | Page No. | |
1. | ||
Three and nine months ended March 31, 2020 and 2019 | ||
Three and nine months ended March 31, 2020 and 2019 | ||
March 31, 2020 and June 30, 2019 | ||
Nine months ended March 31, 2020 and 2019 | ||
2. | ||
3. | ||
4. | ||
1. | ||
2. | ||
6. | ||
2
FORWARD-LOOKING INFORMATION
This Quarterly Report on Form 10-Q contains “forward-looking” statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements are statements that do not relate strictly to historical or current facts. You can identify forward-looking statements by words such as “should,” “anticipate,” “estimate,” “approximate,” “expect,” “may,” “will,” “project,” “intend,” “plan,” “believe” and other words of similar meaning and expression in connection with any discussion of future operating or financial performance or events. We have also included forward-looking statements in this Quarterly Report on Form 10-Q concerning, among other things, our strategy, goals, plans and projections regarding our financial position, liquidity and capital resources, results of operations, market position and product development. These statements are based on current estimates that involve inherent risks and uncertainties. Should one or more of these risks or uncertainties materialize, or should the assumptions underlying the forward-looking statements prove incorrect, our actual results could vary materially from our current expectations. There are a number of factors that could cause our actual results to differ from those indicated in the forward-looking statements. They include: the duration of the COVID-19 pandemic and its impact on our business operations, financial results and financial position and on the industries in which we operate and the global economy generally; other downturns in the business cycle or the economy; our ability to achieve anticipated benefits from our restructuring, simplification and modernization initiatives; risks related to our foreign operations and international markets, such as fluctuations in currency exchange rates, different regulatory environments, trade barriers, exchange controls, and social and political instability; changes in the regulatory environment in which we operate, including environmental, health and safety regulations; potential for future goodwill and other intangible asset impairment charges; our ability to protect and defend our intellectual property; continuity and security of information technology infrastructure; competition; our ability to retain our management and employees; demands on management resources; availability and cost of the raw materials we use to manufacture our products; product liability claims; integrating acquisitions and achieving the expected savings and synergies; global or regional catastrophic events; demand for and market acceptance of our products; business divestitures; labor relations; and implementation of environmental remediation matters. We provide additional information about many of the specific risks we face in the “Risk Factors” section of our Annual Report on Form 10-K, as updated in Part II, Item 1A of this Form 10-Q, and in other periodic reports we file from time to time with the Securities and Exchange Commission. We can give no assurance that any goal or plan set forth in our forward-looking statements will be achieved and readers are cautioned not to place undue reliance on such statements, which speak only as of the date made. Except as required by law, we do not intend to release publicly any revisions to forward-looking statements as a result of future events or developments.
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PART I – FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
-KENNAMETAL INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
Three Months Ended March 31, | Nine Months Ended March 31, | ||||||||||||||
(in thousands, except per share amounts) | 2020 | 2019 | 2020 | 2019 | |||||||||||
Sales | $ | $ | $ | $ | |||||||||||
Cost of goods sold | |||||||||||||||
Gross profit | |||||||||||||||
Operating expense | |||||||||||||||
Restructuring and asset impairment charges (Notes 7 and 18) | |||||||||||||||
Loss on divestiture (Note 4) | |||||||||||||||
Amortization of intangibles | |||||||||||||||
Operating income | |||||||||||||||
Interest expense | |||||||||||||||
Other income, net | ( | ) | ( | ) | ( | ) | ( | ) | |||||||
Income (loss) before income taxes | ( | ) | |||||||||||||
Provision (benefit) for income taxes | ( | ) | |||||||||||||
Net income | |||||||||||||||
Less: Net (loss) income attributable to noncontrolling interests | ( | ) | ( | ) | |||||||||||
Net income attributable to Kennametal | $ | $ | $ | $ | |||||||||||
PER SHARE DATA ATTRIBUTABLE TO KENNAMETAL SHAREHOLDERS | |||||||||||||||
Basic earnings per share | $ | $ | $ | $ | |||||||||||
Diluted earnings per share | $ | $ | $ | $ | |||||||||||
Dividends per share | $ | $ | $ | $ | |||||||||||
Basic weighted average shares outstanding | |||||||||||||||
Diluted weighted average shares outstanding | |||||||||||||||
KENNAMETAL INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
Three Months Ended March 31, | Nine Months Ended March 31, | ||||||||||||
(in thousands) | 2020 | 2019 | 2020 | 2019 | |||||||||
Net income | $ | $ | $ | ||||||||||
Other comprehensive (loss) income, net of tax | |||||||||||||
Unrealized (loss) gain on derivatives designated and qualified as cash flow hedges | ( | ) | ( | ) | |||||||||
Reclassification of unrealized loss on derivatives designated and qualified as cash flow hedges | |||||||||||||
Unrecognized net pension and other postretirement benefit gain | |||||||||||||
Reclassification of net pension and other postretirement benefit loss | |||||||||||||
Foreign currency translation adjustments | ( | ) | ( | ) | ( | ) | ( | ) | |||||
Total other comprehensive (loss) income, net of tax | ( | ) | ( | ) | ( | ) | |||||||
Total comprehensive (loss) income | ( | ) | ( | ) | |||||||||
Less: comprehensive (loss) income attributable to noncontrolling interests | ( | ) | ( | ) | |||||||||
Comprehensive (loss) income attributable to Kennametal Shareholders | $ | ( | ) | $ | ( | ) | $ | ||||||
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KENNAMETAL INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(in thousands, except per share data) | March 31, 2020 | June 30, 2019 | |||||
ASSETS | |||||||
Current assets: | |||||||
Cash and cash equivalents | $ | $ | |||||
Accounts receivable, less allowance for doubtful accounts of $10,090 and $10,083, respectively | |||||||
Inventories (Note 10) | |||||||
Other current assets | |||||||
Total current assets | |||||||
Property, plant and equipment: | |||||||
Land and buildings | |||||||
Machinery and equipment | |||||||
Less accumulated depreciation | ( | ) | ( | ) | |||
Property, plant and equipment, net | |||||||
Other assets: | |||||||
Goodwill (Note 18) | |||||||
Other intangible assets, less accumulated amortization of $133,306 and $158,507, respectively (Note 18) | |||||||
Operating lease right-of-use assets (Note 11) | |||||||
Deferred income taxes | |||||||
Other | |||||||
Total other assets | |||||||
Total assets | $ | $ | |||||
LIABILITIES | |||||||
Current liabilities: | |||||||
Current maturities of long-term debt (Note 12) | $ | $ | |||||
Notes payable to banks | |||||||
Current operating lease liabilities (Note 11) | |||||||
Accounts payable | |||||||
Accrued income taxes | |||||||
Accrued expenses | |||||||
Other current liabilities | |||||||
Total current liabilities | |||||||
Long-term debt, less current maturities (Note 12) | |||||||
Operating lease liabilities (Note 11) | |||||||
Deferred income taxes | |||||||
Accrued pension and postretirement benefits | |||||||
Accrued income taxes | |||||||
Other liabilities | |||||||
Total liabilities | |||||||
Commitments and contingencies | |||||||
EQUITY (Note 16) | |||||||
Kennametal Shareholders’ Equity: | |||||||
Preferred stock, no par value; 5,000 shares authorized; none issued | |||||||
Capital stock, $1.25 par value; 120,000 shares authorized; 82,914 and 82,421 shares issued, respectively | |||||||
Additional paid-in capital | |||||||
Retained earnings | |||||||
Accumulated other comprehensive loss | ( | ) | ( | ) | |||
Total Kennametal Shareholders’ Equity | |||||||
Noncontrolling interests | |||||||
Total equity | |||||||
Total liabilities and equity | $ | $ | |||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
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KENNAMETAL INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW (UNAUDITED)
Nine Months Ended March 31, | |||||||
(in thousands) | 2020 | 2019 | |||||
OPERATING ACTIVITIES | |||||||
Net income | $ | $ | |||||
Adjustments for non-cash items: | |||||||
Depreciation | |||||||
Amortization | |||||||
Stock-based compensation expense | |||||||
Restructuring and asset impairment charges (Notes 7 and 18) | |||||||
Deferred income tax provision (benefit) | ( | ) | |||||
Loss on divestiture (Note 4) | |||||||
Other | |||||||
Changes in certain assets and liabilities: | |||||||
Accounts receivable | ( | ) | |||||
Inventories | ( | ) | |||||
Accounts payable and accrued liabilities | ( | ) | ( | ) | |||
Accrued income taxes | ( | ) | |||||
Accrued pension and postretirement benefits | ( | ) | ( | ) | |||
Other | |||||||
Net cash flow provided by operating activities | |||||||
INVESTING ACTIVITIES | |||||||
Purchases of property, plant and equipment | ( | ) | ( | ) | |||
Disposals of property, plant and equipment | |||||||
Proceeds from divestiture (Note 4) | |||||||
Other | ( | ) | ( | ) | |||
Net cash flow used for investing activities | ( | ) | ( | ) | |||
FINANCING ACTIVITIES | |||||||
Net decrease in notes payable | ( | ) | ( | ) | |||
Net increase (decrease) in short-term revolving and other lines of credit | ( | ) | |||||
Term debt repayments | ( | ) | |||||
Purchase of capital stock | ( | ) | ( | ) | |||
The effect of employee benefit and stock plans and dividend reinvestment | ( | ) | ( | ) | |||
Cash dividends paid to Shareholders | ( | ) | ( | ) | |||
Other | ( | ) | ( | ) | |||
Net cash flow used for financing activities | ( | ) | ( | ) | |||
Effect of exchange rate changes on cash and cash equivalents | ( | ) | ( | ) | |||
CASH AND CASH EQUIVALENTS | |||||||
Net decrease in cash and cash equivalents | ( | ) | ( | ) | |||
Cash and cash equivalents, beginning of period | |||||||
Cash and cash equivalents, end of period | $ | $ | |||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
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1. | BASIS OF PRESENTATION |
The condensed consolidated financial statements and accompanying notes included in this Quarterly Report on Form 10-Q, which include our accounts and those of our majority-owned subsidiaries, should be read in conjunction with the consolidated financial statements and accompanying notes included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2019 (the “2019 Annual Report”). The condensed consolidated balance sheet as of June 30, 2019 was derived from the audited balance sheet included in our 2019 Annual Report. The interim statements are unaudited; however, we believe that all adjustments necessary for a fair statement of the results of the interim periods were made and all adjustments are normal recurring adjustments. The results for the nine months ended March 31, 2020 and 2019 are not necessarily indicative of the results to be expected for a full fiscal year. Unless otherwise specified, any reference to a “year” is to a fiscal year ended June 30. For example, a reference to 2020 is to the fiscal year ending June 30, 2020. When used in this Quarterly Report on Form 10-Q, unless the context requires otherwise, the terms “the Company,” “we,” “our” and “us” refer to Kennametal Inc. and its subsidiaries.
2. | NEW ACCOUNTING STANDARDS |
Adopted
In February 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-02, "Leases: Topic 842," which replaces the existing guidance in ASC 840, Leases. The standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for substantially all leases. We adopted this ASU on July 1, 2019 using the modified retrospective transition approach with the optional transition relief that allows for a cumulative-effect adjustment in the period of adoption and without a restatement of prior periods. Therefore, prior period amounts were not adjusted and will continue to be reported under the accounting standards in effect for those periods. We determined that there was no cumulative-effect adjustment to beginning retained earnings on the condensed consolidated balance sheet. In addition, the Company elected the package of practical expedients permitted under the transition guidance within the new standard, which among other things, allowed us to carry forward historical lease classification. Adoption of this ASU resulted in the recording of lease liabilities of approximately $49 million with the offset to lease ROU assets of $49 million as of July 1, 2019. The standard did not materially impact our condensed consolidated statement of income and our condensed consolidated statement of cash flows. Refer to Note 11 for additional disclosure regarding the adoption of this new standard.
In August 2017, the FASB issued ASU No. 2017-12, "Targeted Improvements to Accounting for Hedging Activities," which seeks to improve financial reporting and obtain closer alignment with risk management activities, in addition to simplifying the application of hedge accounting guidance and additional disclosures. We adopted this ASU on July 1, 2019. Adoption of this guidance did not have a material effect on our condensed consolidated financial statements.
In February 2018, the FASB issued ASU No. 2018-02, “Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income,” which includes amendments allowing the reclassification of the income tax effects of the Tax Cuts and Jobs Act of 2017 (TCJA) to improve the usefulness of information reported to financial statement users. The amendments in this update also require certain disclosures about stranded tax effects. Certain guidance is optional and was effective for Kennametal on July 1, 2019. We elected not to reclassify the stranded tax effects as permissible under this standard. Adoption of this guidance did not have a material effect on our condensed consolidated financial statements.
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3. | SUPPLEMENTAL CASH FLOW DISCLOSURES |
Nine Months Ended March 31, | |||||||
(in thousands) | 2020 | 2019 | |||||
Cash paid during the period for: | |||||||
Income taxes | $ | $ | |||||
Interest | |||||||
Supplemental disclosure of non-cash information: | |||||||
Changes in accounts payable related to purchases of property, plant and equipment | ( | ) | |||||
4. | DIVESTITURE |
During the nine months ended March 31, 2020, we completed the sale of certain assets of the non-core specialty alloys and metals business within the Infrastructure segment located in New 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 ended December 31, 2019 was $6.5 million. Transaction proceeds were primarily used for capital expenditures related to our simplification/modernization efforts.
5. | FAIR VALUE MEASUREMENTS |
Fair value is defined as the price that would be received on the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair value hierarchy consists of three levels to prioritize the inputs used in valuations, as defined below:
Level 1: Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.
Level 2: Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly, including quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; inputs other than quoted prices that are observable for the asset or liability (e.g., interest rates); and inputs that are derived principally from or corroborated by observable market data by correlation or other means.
Level 3: Inputs that are unobservable.
As of March 31, 2020, the fair values of our financial assets and financial liabilities are categorized as follows:
(in thousands) | Level 1 | Level 2 | Level 3 | Total | |||||||||||
Assets: | |||||||||||||||
Derivatives (1) | $ | — | $ | $ | — | $ | |||||||||
Total assets at fair value | $ | — | $ | $ | — | $ | |||||||||
Liabilities: | |||||||||||||||
Derivatives (1) | $ | — | $ | $ | — | $ | |||||||||
Total liabilities at fair value | $ | — | $ | $ | — | $ | |||||||||
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As of June 30, 2019, the fair values of our financial assets and financial liabilities are categorized as follows:
(in thousands) | Level 1 | Level 2 | Level 3 | Total | |||||||||||
Assets: | |||||||||||||||
Derivatives (1) | $ | — | $ | $ | — | $ | |||||||||
Total assets at fair value | $ | — | $ | $ | — | $ | |||||||||
Liabilities: | |||||||||||||||
Derivatives (1) | $ | — | $ | $ | — | $ | |||||||||
Total liabilities at fair value | $ | — | $ | $ | — | $ | |||||||||
(1) Currency and interest rate derivatives are valued based on observable market spot and forward rates and are classified within Level 2 of the fair value hierarchy.
6. | DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES |
As part of our financial risk management program, we use certain derivative financial instruments. We do not enter into derivative transactions for speculative purposes and, therefore, hold no derivative instruments for trading purposes. We account for derivative instruments as a hedge of the related asset, liability, firm commitment or anticipated transaction, when the derivative is specifically designated and qualifies as a hedge of such items. Our objective in managing foreign exchange exposures with derivative instruments is to reduce volatility in cash flow. We measure hedge effectiveness by assessing the changes in the fair value or expected future cash flows of the hedged item.
The fair value of derivatives designated and not designated as hedging instruments in the condensed consolidated balance sheet are as follows:
(in thousands) | June 30, 2019 | ||||||
Derivatives designated as hedging instruments | |||||||
Other current assets - range forward contracts | $ | $ | |||||
Other assets - forward starting interest rate swap contracts | |||||||
Other liabilities - forward starting interest rate swap contracts | ( | ) | |||||
Total derivatives designated as hedging instruments | ( | ) | |||||
Derivatives not designated as hedging instruments | |||||||
Other current assets - currency forward contracts | |||||||
Other current liabilities - currency forward contracts | ( | ) | ( | ) | |||
Total derivatives not designated as hedging instruments | ( | ) | ( | ) | |||
Total derivatives | $ | ( | ) | $ | |||
Certain currency forward contracts that hedge significant cross-border intercompany loans are considered as other derivatives and therefore do not qualify for hedge accounting. These contracts are recorded at fair value in the condensed consolidated balance sheet, with the offset to other income, net. Losses (gains) related to derivatives not designated as hedging instruments have been recognized as follows:
Three Months Ended March 31, | Nine Months Ended March 31, | ||||||||||||||
(in thousands) | 2020 | 2019 | 2020 | 2019 | |||||||||||
Other income, net - currency forward contracts | $ | $ | ( | ) | $ | $ | |||||||||
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CASH FLOW HEDGES
Range forward contracts (a transaction where both a put option is purchased and a call option is sold) are designated as cash flow hedges and hedge anticipated cash flows from cross-border intercompany sales of products and services. Gains and losses realized on these contracts are recorded in accumulated other comprehensive loss and are recognized as a component of cost of goods sold and other income, net when the underlying sale of products or services is recognized into earnings. The notional amount of the contracts translated into U.S. dollars at March 31, 2020 and June 30, 2019 was $12.1 million and $61.5 million, respectively. The time value component of the fair value of range forward contracts is excluded from the assessment of hedge effectiveness. Assuming the market rates remain constant with the rates at March 31, 2020 , we expect to recognize into earnings $0.1 million of income on outstanding derivatives in the next 12 months.
During the third quarter of fiscal 2020, we entered into forward starting interest rate swap contracts to hedge a portion of the interest rate risk related to our anticipated refinancing of the Senior Unsecured Notes due fiscal 2022. We recorded the fair value of these contracts as an asset or a liability, as applicable, in the balance sheet, with the offset to accumulated other comprehensive income, net of tax. The notional amount of the contracts at March 31, 2020 was $200.0 million. As of March 31, 2020, we recorded an asset of $0.1 million and a liability of $1.6 million on these contracts, the net effect of which was recorded as a decrease to other comprehensive income, net of tax.
The following represents gains and losses related to cash flow hedges:
Three Months Ended March 31, | Nine Months Ended March 31, | ||||||||||||||
(in thousands) | 2020 | 2019 | 2020 | 2019 | |||||||||||
(Losses) gains recognized in other comprehensive (loss) income, net | $ | ( | ) | $ | $ | ( | ) | $ | |||||||
Losses reclassified from accumulated other comprehensive loss into cost of goods sold and other income, net | $ | $ | $ | $ | |||||||||||
NET INVESTMENT HEDGES
As of March 31, 2020 , we had certain foreign currency-denominated intercompany loans payable with total aggregate principal amounts of €42.5 million as net investment hedges to hedge the foreign exchange exposure of our net investment in our Euro-based subsidiaries. We recorded gains of $1.1 million and $2.3 million as a component of foreign currency translation adjustments in other comprehensive (loss) income for the three months ended March 31, 2020 and 2019, respectively. We recorded gains of $1.0 million and $2.8 million as a component of foreign currency translation adjustments in other comprehensive loss for the nine months ended March 31, 2020 and 2019, respectively.
As of March 31, 2020 , the foreign currency-denominated intercompany loans payable designated as net investment hedges consisted of:
Instrument | Notional (EUR in thousands)(2) | Notional (USD in thousands)(2) | Maturity | ||||
Foreign currency-denominated intercompany loan payable | € | $ | June 26, 2022 | ||||
Foreign currency-denominated intercompany loan payable | November 22, 2021 | ||||||
7. | RESTRUCTURING AND RELATED 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. These actions are expected to be completed in fiscal 2020 and are expected to be primarily cash expenditures.
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The pre-tax charges for these programs are expected to be in the range of $55 million to $60 million, which are expected to be 80 percent Industrial, 15 percent Infrastructure and 5 percent Widia. Total restructuring and related charges since inception of $50.0 million were recorded for this program through March 31, 2020, consisting of: $40.6 million in Industrial; $7.2 million in Infrastructure; and $2.2 million in Widia.
FY21 Restructuring Actions
On July 11, 2019, we announced the initiation of restructuring actions in Germany associated with our simplification/modernization initiative, which are expected to reduce structural costs. We have agreed with local employee representatives to downsize our Essen, 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 be completed by the end of fiscal 2021 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 is expected to be primarily in the Industrial segment. Total restructuring and related charges since inception of $28.8 million were recorded for this program through March 31, 2020, all of which were recorded in the Industrial segment.
Restructuring and Related Charges Recorded
We recorded restructuring and related charges of $5.8 million and $3.7 million for the three months ended March 31, 2020 and 2019, respectively. Of these amounts, restructuring charges totaled $1.8 million and $2.6 million for the three months ended March 31, 2020 and 2019, respectively, of which $0.2 million were related to inventory and were recorded in cost of goods sold for the three months ended March 31, 2020 and 2019. Restructuring-related charges of $4.0 million and $0.9 million were recorded in cost of goods sold for the three months ended March 31, 2020 and 2019, respectively. Restructuring-related charges of $0.1 million were recorded in operating expense for the three months ended March 31, 2019.
We recorded restructuring and related charges of $65.1 million and $6.8 million for the nine months ended March 31, 2020 and 2019, respectively. Of these amounts, restructuring charges totaled $54.5 million and $5.3 million for the nine months ended March 31, 2020 and 2019, respectively, of which $0.6 million and $0.2 million were related to inventory and were recorded in cost of goods sold for the nine months ended March 31, 2020 and 2019, respectively. Restructuring-related charges of $10.6 million and $1.4 million were recorded in cost of goods sold for the nine months ended March 31, 2020 and 2019, respectively. Restructuring-related charges of $0.1 million were recorded in operating expense for the nine months ended March 31, 2019.
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As of March 31, 2020, $24.7 million and $16.2 million of the restructuring accrual is recorded in other current liabilities and other liabilities, respectively, in our condensed consolidated balance sheet. The restructuring accrual of $19.2 million as of June 30, 2019 is recorded in other current liabilities. The amount attributable to each segment is as follows:
(in thousands) | June 30, 2019 | Expense | Asset Write-Down | Translation | Cash Expenditures | March 31, 2020 | |||||||||||||||||
Industrial | |||||||||||||||||||||||
Severance | $ | $ | $ | $ | ( | ) | $ | ( | ) | $ | |||||||||||||
Facilities | ( | ) | |||||||||||||||||||||
Other | ( | ) | ( | ) | |||||||||||||||||||
Total Industrial | $ | $ | $ | ( | ) | $ | ( | ) | $ | ( | ) | $ | |||||||||||
Widia | |||||||||||||||||||||||
Severance | $ | $ | $ | $ | ( | ) | $ | ( | ) | $ | |||||||||||||
Facilities | ( | ) | |||||||||||||||||||||
Other | |||||||||||||||||||||||
Total Widia | $ | $ | $ | ( | ) | $ | ( | ) | $ | ( | ) | $ | |||||||||||
Infrastructure | |||||||||||||||||||||||
Severance | $ | $ | $ | $ | ( | ) | $ | ( | ) | $ | |||||||||||||
Facilities | ( | ) | |||||||||||||||||||||
Other | ( | ) | ( | ) | |||||||||||||||||||
Total Infrastructure | $ | $ | $ | ( | ) | $ | ( | ) | $ | ( | ) | $ | |||||||||||
Total | $ | $ | $ | ( | ) | $ | ( | ) | $ | ( | ) | $ | |||||||||||
8. | STOCK-BASED COMPENSATION |
Stock Options
Changes in our stock options for the nine months ended March 31, 2020 were as follows:
Options | Weighted Average Exercise Price | Weighted Average Remaining Life (years) | Aggregate Intrinsic value (in thousands) | |||||||||
Options outstanding, June 30, 2019 | $ | |||||||||||
Exercised | ( | ) | ||||||||||
Lapsed or forfeited | ( | ) | ||||||||||
Options outstanding, March 31, 2020 | $ | $ | ||||||||||
Options vested, March 31, 2020 | $ | $ | ||||||||||
Options exercisable, March 31, 2020 | $ | $ | ||||||||||
As of March 31, 2020, there was no unrecognized compensation cost related to options outstanding.
All options were fully vested as of March 31, 2020. Fair value of options vested during the nine months ended March 31, 2019 was $1.2 million.
Tax benefits relating to excess stock-based compensation deductions are presented in the operating activities section of the condensed consolidated statements of cash flow for the nine months ended March 31, 2020 and 2019. Tax benefits resulting from stock-based compensation deductions were greater than the amounts reported for financial reporting purposes by $0.2 million and $1.3 million for the nine months ended March 31, 2020 and 2019, respectively.
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The amount of cash received from the exercise of options during the nine months ended March 31, 2020 and 2019 was $0.7 million and $4.2 million, respectively. The total intrinsic value of options exercised during the nine months ended March 31, 2020 and 2019 was $0.3 million and $1.9 million, respectively.
Restricted Stock Units – Performance Vesting and Time Vesting
Changes in our performance vesting and time vesting restricted stock units for the nine months ended March 31, 2020 were as follows:
Performance Vesting Stock Units | Performance Vesting Weighted Average Fair Value | Time Vesting Stock Units | Time Vesting Weighted Average Fair Value | ||||||||||
Unvested, June 30, 2019 | $ | $ | |||||||||||
Granted | |||||||||||||
Vested | ( | ) | ( | ) | |||||||||
Performance metric adjustments, net | |||||||||||||
Forfeited | ( | ) | ( | ) | |||||||||
Unvested, March 31, 2020 | $ | $ | |||||||||||
9. | PENSION AND OTHER POSTRETIREMENT BENEFITS |
The table below summarizes the components of net periodic pension income:
Three Months Ended March 31, | Nine Months Ended March 31, | ||||||||||||||
(in thousands) | 2020 | 2019 | 2020 | 2019 | |||||||||||
Service cost | $ | $ | $ | $ | |||||||||||
Interest cost | |||||||||||||||
Expected return on plan assets | ( | ) | ( | ) | ( | ) | ( | ) | |||||||
Amortization of transition obligation | |||||||||||||||
Amortization of prior service cost (credit) | ( | ) | ( | ) | |||||||||||
Recognition of actuarial losses | |||||||||||||||
Settlement gain | ( | ) | |||||||||||||
Net periodic pension income | $ | ( | ) | $ | ( | ) | $ | ( | ) | $ | ( | ) | |||
The table below summarizes the components of net periodic other postretirement benefit cost:
Three Months Ended March 31, | Nine Months Ended March 31, | ||||||||||||||
(in thousands) | 2020 | 2019 | 2020 | 2019 | |||||||||||
Interest cost | $ | $ | $ | $ | |||||||||||
Amortization of prior service credit | ( | ) | ( | ) | ( | ) | ( | ) | |||||||
Recognition of actuarial loss | |||||||||||||||
Net periodic other postretirement benefit cost | $ | $ | $ | $ | |||||||||||
The service cost component of net periodic pension income is reported as a component of cost of goods sold and operating expense. All other components of net periodic pension income and net periodic other postretirement benefit cost are reported as a component of other income, net.
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10. | INVENTORIES |
We used the last-in, first-out (LIFO) method of valuing inventories for 43 percent and 41 percent of total inventories at March 31, 2020 and June 30, 2019, respectively. Inventory valuations under the LIFO method are based on an annual determination of quantities and costs as of June 30 of each year; therefore, the interim LIFO valuations are based on our projections of expected year-end inventory levels and costs and are subject to any final year-end LIFO inventory adjustments.
Inventories consisted of the following:
(in thousands) | March 31, 2020 | June 30, 2019 | |||||
Finished goods | $ | $ | |||||
Work in process and powder blends | |||||||
Raw materials | |||||||
Inventories at current cost | |||||||
Less: LIFO valuation | ( | ) | ( | ) | |||
Total inventories | $ | $ | |||||
11. | LEASES |
At the inception of our contracts we determine if the contract is or contains a lease. A contract is or contains a lease if it conveys the right to control the use of an identified asset for a period of time in exchange for consideration. ROU assets and operating lease liabilities are recognized based on the present value of lease payments over the lease term at commencement. For leases that do not have a readily determinable implicit rate, we use a discount rate based on our incremental borrowing rate, which is determined considering factors such as the lease term, our credit rating and the economic environment of the location of the lease as of the commencement date.
We account for non-lease components separately from lease components. These costs often relate to the payments for a proportionate share of real estate taxes, insurance, common area maintenance and other operating costs in addition to base rent. We also do not recognize ROU assets and liabilities for leases with an initial term of 12 months or less. Lease costs associated with leases of less than 12 months were $1.6 million and $5.8 million for the three and nine months ended March 31, 2020, respectively.
As a lessee, we have various operating lease agreements primarily related to real estate, vehicles and office and plant equipment. Our real estate leases, which are comprised primarily of manufacturing, warehousing, office and administration facilities, represent a majority of our lease liability. Our lease payments are largely fixed. Any variable lease payments, including utilities, common area maintenance and repairs and maintenance, are expensed during the period incurred. Variable lease costs were immaterial for the three and nine months ended March 31, 2020. A majority of our real estate leases include options to extend the lease and options to early terminate the lease. Leases with an early termination option generally involve a termination payment. We review all options to extend, terminate, or purchase the ROU assets at the inception of the lease and account for these options when they are reasonably certain of being exercised. Our lease agreements generally do not contain any material residual value guarantees or materially restrictive covenants. We do not have any material leases that have been signed but not commenced, and we did not have any lease transactions with related parties.
The weighted average remaining lease term and discount rate for our operating leases were approximately 8.7 years and 3.3 percent, respectively, at March 31, 2020.
Operating lease expense is recognized on a straight-line basis over the lease term and is included in operating expense on our consolidated statement of income. Operating lease cost was $4.2 million and $12.3 million for the three and nine months ended March 31, 2020, respectively.
The following table sets forth supplemental cash flow information related to our operating leases:
(in thousands) | Nine Months Ended March 31, 2020 | |||
Operating cash flows from operating leases | $ | |||
ROU assets obtained in exchange for new operating lease liabilities | $ | |||
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The following table sets forth the maturities of our operating lease liabilities and reconciles the respective undiscounted payments to the operating lease liabilities in the condensed consolidated balance sheet as of March 31, 2020:
Year Ended June 30, (in thousands) | March 31, 2020 | |||
Remaining three months of 2020 | $ | |||
2021 | ||||
2022 | ||||
2023 | ||||
2024 | ||||
Thereafter | ||||
Total undiscounted operating lease payments | $ | |||
Less: discount to net present value | ||||
Total operating lease liabilities | $ | |||
The following table sets forth the future minimum lease payments for non-cancelable operating leases as of the year ended June 30, 2019:
Year Ended June 30, (in thousands) | June 30, 2019 | |||
2020 | $ | |||
2021 | ||||
2022 | ||||
2023 | ||||
2024 | ||||
Thereafter | ||||
Total future minimum lease payments | $ | |||
12. | LONG-TERM DEBT |
Our five-year, multi-currency, revolving credit facility, as amended and restated in June 2018 (Credit Agreement), provides for revolving credit loans of up to $700 million for working capital, capital expenditures and general corporate purposes. The Credit Agreement requires us to comply with various restrictive and affirmative covenants, including two financial covenants: a maximum leverage ratio where debt, net of domestic cash in excess of $25 million, must be less than or equal to 3.5 times trailing twelve months EBITDA, adjusted for certain non-cash expenses and which may be further adjusted, at our discretion, to include up to $80 million of cash restructuring charges through December 31, 2021; and a minimum consolidated interest coverage ratio of EBITDA to interest of 3.5 times (as the aforementioned terms are defined in the Credit Agreement). We were in compliance with all such covenants as of March 31, 2020 and we expect to maintain compliance over the next 12 months. The Company reached this conclusion after considering the information currently available to us, including the anticipated effect of the Coronavirus 2019 (COVID-19) pandemic on the macroeconomic environment. Because the extent and duration of COVID-19 is unknown, its effect on the Company’s business, financial condition, operating results and cash flows is uncertain, and therefore it could adversely affect availability under the Credit Agreement.
We had $4.5 million of borrowings outstanding under the Credit Agreement as of March 31, 2020 , and we had no borrowings outstanding as of June 30, 2019. Borrowings under the Credit Agreement are guaranteed by our significant domestic subsidiaries. The Credit Agreement matures in June 2023.
Subsequent to March 31, 2020, we drew $500.0 million under the Credit Agreement. We decided to draw this $500.0 million as a measure to ensure access to future liquidity in light of the global financial market uncertainty resulting from the COVID-19 pandemic.
15
Fixed rate debt had a fair market value of $623.1 million and $622.0 million at March 31, 2020 and June 30, 2019, respectively. The Level 2 fair value is determined based on the quoted market prices for similar debt instruments as of March 31, 2020 and June 30, 2019, respectively.
13. | ENVIRONMENTAL MATTERS |
The operation of our business has exposed us to certain liabilities and compliance costs related to environmental matters. We are involved in various environmental cleanup and remediation activities at certain of our locations.
We establish and maintain reserves for certain potential environmental liabilities. At March 31, 2020 and June 30, 2019, the balances of these reserves were $11.8 million and $12.4 million, respectively. These reserves represent anticipated costs associated with potential remedial requirements and are generally not discounted.
The reserves we have established for potential environmental liabilities represent our best current estimate of the costs of addressing all identified environmental situations, based on our review of currently available evidence, and taking into consideration our prior experience in remediation and that of other companies, as well as public information released by the United States Environmental Protection Agency (USEPA), other governmental agencies and by the Potentially Responsible Party (PRP) groups in which we are participating. Although our reserves currently appear to be sufficient to cover these potential environmental liabilities, there are uncertainties associated with environmental liabilities, and we can give no assurance that our estimate of any environmental liability will not increase or decrease in the future. The reserved and unreserved liabilities for all environmental concerns could change substantially due to factors such as the nature and extent of contamination, changes in remedial requirements, technological changes, discovery of new information, the financial strength of other PRPs, the identification of new PRPs and the involvement of and direction taken by the government on these matters.
Superfund Sites Among other environmental laws, we are subject to the Comprehensive Environmental Response Compensation and Liability Act of 1980 (CERCLA), under which we have been designated by the USEPA as a PRP with respect to environmental remedial costs at certain Superfund sites. We have evaluated our claims and liabilities associated with these Superfund sites based upon best currently available information. We believe our environmental accruals are adequate to cover our portion of the environmental remedial costs at the Superfund sites where we have been designated a PRP, to the extent these expenses are probable and reasonably estimable.
14. | INCOME TAXES |
Effective tax rates
The effective income tax rates for the three months ended March 31, 2020 and 2019 were 93.1 percent and 11.0 percent, respectively. The year-over-year change is primarily due to the effects of current year restructuring and the Widia goodwill and other intangible asset impairment charges. The prior year rate included a $6.8 million discrete benefit to adjust the Toll Tax charge based on regulations issued during the March quarter of fiscal 2019.
The effective income tax rates for the nine months ended March 31, 2020 and 2019 were 143.5 percent (benefit on a loss) and 20.1 percent (provision on income), respectively. The year-over-year change is primarily due to the change in the jurisdictional mix caused by expected restructuring and related charges, the Widia goodwill and other intangible asset impairment charges, a discrete $14.5 million benefit for the one-time effect of Swiss tax reform and the increase in global intangible low-taxed income (GILTI) and base erosion anti-abuse tax (BEAT). The prior year rate included a $9.7 million discrete benefit associated with tax reform and a $6.1 million charge related to changes in the indefinite reinvestment assertion on certain foreign subsidiaries' undistributed earnings.
Coronavirus Aid, Relief, and Economic Security Act (CARES Act)
On March 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 after December 31, 2017 and before January 1, 2021 to be carried back to each of the 5 preceding taxable years to generate a refund of previously paid income taxes; permits net operating loss carryovers and carrybacks to offset 100 percent of taxable income for taxable years beginning before January 1, 2021; and modifies the limitation on business interest by increasing the allowable business interest deduction from 30 percent of adjusted taxable income to 50 percent of adjusted taxable income for taxable years beginning in 2019 or 2020. We are currently in the process of evaluating the potential impact these provisions may have on the Company.
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Swiss tax reform
Legislation was effectively enacted during the nine months ended March 31, 2020 when the Canton of Schaffhausen approved the Federal Act on Tax Reform and AHV Financing on October 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.
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 ended December 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.
15. | EARNINGS PER SHARE |
Basic earnings per share is computed using the weighted average number of shares outstanding during the period, while diluted earnings per share is calculated to reflect the potential dilution that would occur related to the issuance of capital stock under stock option grants, performance awards and restricted stock units. The difference between basic and diluted earnings per share relates solely to the effect of capital stock options, performance awards and restricted stock units.
The following tables provide the computation of diluted shares outstanding for the three and nine months ended March 31, 2020 and 2019:
Three Months Ended March 31, | Nine Months Ended March 31, | |||||||||||
(in thousands) | 2020 | 2019 | 2020 | 2019 | ||||||||
Weighted-average shares outstanding during period | ||||||||||||
Add: Unexercised stock options and unvested restricted stock units | ||||||||||||
Number of shares on which diluted earnings per share is calculated | ||||||||||||
Unexercised stock options with an exercise price greater than the average market price and restricted stock units not included in the computation because they were anti-dilutive | ||||||||||||
16. | EQUITY |
A summary of the changes in the carrying amounts of total equity, Kennametal Shareholders’ equity and equity attributable to noncontrolling interests for the three months ending March 31, 2020 and 2019 is as follows:
Kennametal Shareholders’ Equity | |||||||||||||||||||||||
(in thousands) | Capital stock | Additional paid-in capital | Retained earnings | Accumulated other comprehensive loss | Non- controlling interests | Total equity | |||||||||||||||||
Balance as of December 31, 2019 | $ | $ | $ | $ | ( | ) | $ | $ | |||||||||||||||
Net income (loss) | — | — | — | ( | ) | ||||||||||||||||||
Other comprehensive loss | — | — | — | ( | ) | ( | ) | ( | ) | ||||||||||||||
Dividend reinvestment | — | — | — | ||||||||||||||||||||
Capital stock issued under employee benefit and stock plans(3) | — | — | — | ||||||||||||||||||||
Purchase of capital stock | ( | ) | ( | ) | — | — | — | ( | ) | ||||||||||||||
Cash dividends | — | — | ( | ) | ( | ) | |||||||||||||||||
Total equity, March 31, 2020 | $ | $ | $ | $ | ( | ) | $ | $ | |||||||||||||||
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Kennametal Shareholders’ Equity | |||||||||||||||||||||||
(in thousands) | Capital stock | Additional paid-in capital | Retained earnings | Accumulated other comprehensive loss | Non- controlling interests | Total equity | |||||||||||||||||
Balance as of December 31, 2018 | $ | $ | $ | $ | ( | ) | $ | $ | |||||||||||||||
Net income | — | — | — | ||||||||||||||||||||
Other comprehensive income | — | — | — | ||||||||||||||||||||
Dividend reinvestment | — | — | — | ||||||||||||||||||||
Capital stock issued under employee benefit and stock plans(3) | — | — | — | ||||||||||||||||||||
Purchase of capital stock | ( | ) | ( | ) | — | — | — | ( | ) | ||||||||||||||
Additions to noncontrolling interest | — | — | — | — | |||||||||||||||||||
Cash dividends | — | — | ( | ) | — | ( | ) | ( | ) | ||||||||||||||
Total equity, March 31, 2019 | $ | $ | $ | $ | ( | ) | $ | $ | |||||||||||||||
A summary of the changes in the carrying amounts of total equity, Kennametal Shareholders’ equity and equity attributable to noncontrolling interests for the nine months ending March 31, 2020 and 2019 is as follows:
Kennametal Shareholders’ Equity | |||||||||||||||||||||||
(in thousands) | Capital stock | Additional paid-in capital | Retained earnings | Accumulated other comprehensive loss | Non- controlling interests | Total equity | |||||||||||||||||
Balance as of June 30, 2019 | $ | $ | $ | $ | ( | ) | $ | $ | |||||||||||||||
Net income (loss) | — | — | — | ( | ) | ||||||||||||||||||
Other comprehensive loss | — | — | — | ( | ) | ( | ) | ( | ) | ||||||||||||||
Dividend reinvestment | — | — | — | ||||||||||||||||||||
Capital stock issued under employee benefit and stock plans(3) | — | — | — | ||||||||||||||||||||
Purchase of capital stock | ( | ) | ( | ) | — | — | — | ( | ) | ||||||||||||||
Additions to noncontrolling interest | — | — | — | — | |||||||||||||||||||
Cash dividends | — | — | ( | ) | — | ( | ) | ||||||||||||||||
Total equity, March 31, 2020 | $ | $ | $ | $ | ( | ) | $ | $ | |||||||||||||||
18
Kennametal Shareholders’ Equity | |||||||||||||||||||||||
(in thousands) | Capital stock | Additional paid-in capital | Retained earnings | Accumulated other comprehensive loss | Non- controlling interests | Total equity | |||||||||||||||||
Balance as of June 30, 2018 | $ | $ | $ | $ | ( | ) | $ | $ | |||||||||||||||
Net income | — | — | — | ||||||||||||||||||||
Other comprehensive loss | — | — | — | ( | ) | ( | ) | ( | ) | ||||||||||||||
Dividend reinvestment | — | — | — | ||||||||||||||||||||
Capital stock issued under employee benefit and stock plans(3) | — | — | — | ||||||||||||||||||||
Purchase of capital stock | ( | ) | ( | ) | — | — | — | ( | ) | ||||||||||||||
Additions to noncontrolling interest | — | — | — | — | |||||||||||||||||||
Cash dividends | — | — | ( | ) | — | ( | ) | ( | ) | ||||||||||||||
Total equity, March 31, 2019 | $ | $ | $ | $ | ( | ) | $ | $ | |||||||||||||||
(3) Net of restricted stock units delivered upon vesting to satisfy tax withholding requirements.
The amounts of comprehensive income attributable to Kennametal Shareholders and noncontrolling interests are disclosed in the condensed consolidated statements of comprehensive income.
17. |
The components of, and changes in, accumulated other comprehensive loss (AOCL) were as follows, net of tax, for the nine months ended March 31, 2020:
(in thousands) | Pension and other postretirement benefits | Currency translation adjustment | Derivatives | Total | ||||||||
Attributable to Kennametal: | ||||||||||||
Balance, June 30, 2019 | $ | ( | ) | $ | ( | ) | $ | ( | ) | $ | ( | ) |
Other comprehensive income (loss) before reclassifications | ( | ) | ( | ) | ( | ) | ||||||
Amounts reclassified from AOCL | ||||||||||||
Net current period other comprehensive income (loss) | ( | ) | ( | ) | ||||||||
AOCL, March 31, 2020 | $ | ( | ) | $ | ( | ) | $ | ( | ) | $ | ( | ) |
Attributable to noncontrolling interests: | ||||||||||||
Balance, June 30, 2019 | $ | — | $ | ( | ) | $ | — | $ | ( | ) | ||
Other comprehensive loss before reclassifications | — | ( | ) | — | ( | ) | ||||||
Net current period other comprehensive loss | — | ( | ) | — | ( | ) | ||||||
AOCL, March 31, 2020 | $ | — | $ | ( | ) | $ | — | $ | ( | ) | ||
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The components of, and changes in, AOCL were as follows, net of tax, for the nine months ended March 31, 2019:
(in thousands) | Pension and other postretirement benefits | Currency translation adjustment | Derivatives | Total | ||||||||
Attributable to Kennametal: | ||||||||||||
Balance, June 30, 2018 | $ | ( | ) | $ | ( | ) | $ | ( | ) | $ | ( | ) |
Other comprehensive income (loss) before reclassifications | ( | ) | ( | ) | ||||||||
Amounts reclassified from AOCL | ||||||||||||
Net current period other comprehensive income (loss) | ( | ) | ( | ) | ||||||||
AOCL, March 31, 2019 | $ | ( | ) | $ | ( | ) | $ | ( | ) | $ | ( | ) |
Attributable to noncontrolling interests: | ||||||||||||
Balance, June 30, 2018 | $ | — | $ | ( | ) | $ | — | $ | ( | ) | ||
Other comprehensive loss before reclassifications | — | ( | ) | — | ( | ) | ||||||
Net current period other comprehensive loss | — | ( | ) | — | ( | ) | ||||||
AOCL, March 31, 2019 | $ | — | $ | ( | ) | $ | — | $ | ( | ) | ||
Reclassifications out of AOCL for the three and nine months ended March 31, 2020 and 2019 consisted of the following:
Three Months Ended March 31, | Nine Months Ended March 31, | |||||||||||||||
(in thousands) | 2020 | 2019 | 2020 | 2019 | Affected line item in the Income Statement | |||||||||||
Gains and losses on cash flow hedges: | ||||||||||||||||
Forward starting interest rate swaps | $ | $ | $ | $ | Interest expense | |||||||||||
Currency exchange contracts | ( | ) | Cost of goods sold and other income, net | |||||||||||||
Total before tax | ||||||||||||||||
Tax impact | ( | ) | ( | ) | ( | ) | ( | ) | Provision (benefit) for income taxes | |||||||
Net of tax | $ | $ | $ | $ | ||||||||||||
Pension and other postretirement benefits: | ||||||||||||||||
Amortization of transition obligations | $ | $ | $ | $ | Other income, net | |||||||||||
Amortization of prior service credit | ( | ) | ( | ) | ( | ) | ( | ) | Other income, net | |||||||
Recognition of actuarial losses | Other income, net | |||||||||||||||
Total before tax | ||||||||||||||||
Tax impact | ( | ) | ( | ) | ( | ) | ( | ) | Provision (benefit) for income taxes | |||||||
Net of tax | $ | $ | $ | $ | ||||||||||||
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The amount of income tax allocated to each component of other comprehensive (loss) income for the three months ended March 31, 2020 and 2019 were as follows:
2020 | 2019 | |||||||||||||||||||
(in thousands) | Pre-tax | Tax impact | Net of tax | Pre-tax | Tax impact | Net of tax | ||||||||||||||
Unrealized (loss) gain on derivatives designated and qualified as cash flow hedges | $ | ( | ) | $ | $ | ( | ) | $ | $ | ( | ) | $ | ||||||||
Reclassification of unrealized loss on derivatives designated and qualified as cash flow hedges | ( | ) | ( | ) | ||||||||||||||||
Unrecognized net pension and other postretirement benefit gain | ( | ) | ( | ) | ||||||||||||||||
Reclassification of net pension and other postretirement benefit loss | ( | ) | ( | ) | ||||||||||||||||
Foreign currency translation adjustments | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||||||
Other comprehensive (loss) income | $ | ( | ) | $ | ( | ) | $ | ( | ) | $ | $ | ( | ) | $ | ||||||
The amount of income tax allocated to each component of other comprehensive loss for the nine months ended March 31, 2020 and 2019 were as follows:
2020 | 2019 | |||||||||||||||||||
(in thousands) | Pre-tax | Tax impact | Net of tax | Pre-tax | Tax impact | Net of tax | ||||||||||||||
Unrealized (loss) gain on derivatives designated and qualified as cash flow hedges | $ | ( | ) | $ | $ | ( | ) | $ | $ | ( | ) | $ | ||||||||
Reclassification of unrealized loss on derivatives designated and qualified as cash flow hedges | ( | ) | ( | ) | ||||||||||||||||
Unrecognized net pension and other postretirement benefit gain | ( | ) | ( | ) | ||||||||||||||||
Reclassification of net pension and other postretirement benefit loss | ( | ) | ( | ) | ||||||||||||||||
Foreign currency translation adjustments | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||||||
Other comprehensive loss | $ | ( | ) | $ | ( | ) | $ | ( | ) | $ | ( | ) | $ | ( | ) | $ | ( | ) | ||
18. | GOODWILL AND OTHER INTANGIBLE ASSETS |
2020 December Quarter Widia Impairment Charges
In the December quarter of fiscal 2020, the Company experienced deteriorating market conditions, primarily in general engineering and transportation applications in India and China, 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, indefinite-lived trademark intangible asset and other long-lived assets of our Widia reporting unit. We evaluated the recoverability of goodwill for the reporting unit by comparing the fair value with its carrying value, with the fair values determined using a combination of a discounted cash flow analysis and market multiples based upon historical and projected financial information. As a result of this test, we recorded a non-cash pre-tax impairment charge during the three months ended December 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. These impairment charges are recorded in restructuring and asset impairment charges in our condensed consolidated statements of income. No impairment was recorded for the other Widia long-lived assets.
21
2020 March Quarter Widia Impairment Charges
We performed an interim quantitative impairment test of goodwill and the indefinite-lived trademark intangible asset for the Widia reporting unit during the March quarter of fiscal 2020. The decline in actual and projected financial results for the Widia reporting unit, primarily as a result of the COVID-19 pandemic, represented an interim impairment triggering event because there was essentially zero cushion between the reporting unit's carrying value and fair value as of March 31 2020. This is because the Widia reporting unit was recorded at fair value as of the last impairment date of December 31, 2019. We evaluated the recoverability of goodwill for the reporting unit by comparing the fair value with its carrying value, with the fair values determined using a combination of a discounted cash flow analysis and market multiples based upon historical and projected financial information. As a result of this interim test, we recorded a non-cash pre-tax impairment charge during the three months ended March 31, 2020 of $15.6 million in the Widia segment, of which $13.7 million was for goodwill and $1.9 million was for an indefinite-lived trademark intangible asset. These impairment charges are recorded in restructuring and asset impairment charges in our condensed consolidated statements of income. No impairment was recorded for the other Widia long-lived assets. Subsequent to the impairment charges recorded in the March quarter of fiscal 2020, there is no remaining goodwill for the Widia reporting unit and the carrying value of the indefinite-lived trademark is $10.9 million, which approximates fair value. Additionally, due to the significant cushion that existed between the fair value and the carrying value of the Industrial reporting unit, as measured on the last annual testing date, we determined that there was not an interim triggering event for this reporting unit during the third quarter of fiscal 2020. Certain events or circumstances that could reasonably be expected to negatively affect the underlying key assumptions and ultimately impact the estimated fair values of our reporting units and of the indefinite-lived trademark may include such items as: (i) a decrease in expected future cash flows, specifically, a further decrease in sales volume driven by a prolonged weakness in customer demand or other pressures, including those related to the COVID-19 pandemic, adversely affecting our long-term sales trends; (ii) inability to achieve the anticipated benefits from simplification/modernization and other cost reduction programs and (iii) inability to achieve the sales from our strategic growth initiatives.
Divestiture Impact on Other Intangible Assets
During the three months ended December 31, 2019, we completed the sale of certain assets of the non-core specialty alloys and metals business within the Infrastructure segment. See Note 4. As a result of this transaction, other intangibles decreased by $12.5 million in our Infrastructure segment. This decrease was recorded in the loss on divestiture account in our condensed consolidated statements of income.
A summary of the carrying amount of goodwill attributable to each segment, as well as the changes in such carrying amounts, is as follows:
(in thousands) | Industrial | Widia | Infrastructure | Total | |||||||||||
Gross goodwill | $ | $ | $ | $ | |||||||||||
Accumulated impairment losses | ( | ) | ( | ) | ( | ) | ( | ) | |||||||
Balance as of June 30, 2019 | $ | $ | $ | $ | |||||||||||
Activity for the nine months ended March 31, 2020: | |||||||||||||||
Change in gross goodwill due to translation | ( | ) | ( | ) | ( | ) | |||||||||
Impairment charges | ( | ) | ( | ) | |||||||||||
Gross goodwill | |||||||||||||||
Accumulated impairment losses | ( | ) | ( | ) | ( | ) | ( | ) | |||||||
Balance as of March 31, 2020 | $ | $ | $ | $ | |||||||||||
22
The components of our other intangible assets were as follows:
Estimated Useful Life (in years) | March 31, 2020 | June 30, 2019 | ||||||||||||||||
(in thousands) | Gross Carrying Amount | Accumulated Amortization | Gross Carrying Amount | Accumulated Amortization | ||||||||||||||
Contract-based | 3 to 15 | ( | ) | |||||||||||||||
Technology-based and other | 4 to 20 | ( | ) | ( | ) | |||||||||||||
Customer-related | 10 to 21 | ( | ) | ( | ) | |||||||||||||
Unpatented technology | 10 to 30 | ( | ) | ( | ) | |||||||||||||
Trademarks | 5 to 20 | ( | ) | ( | ) | |||||||||||||
Trademarks | Indefinite | — | — | |||||||||||||||
Total | $ | $ | ( | ) | $ | $ | ( | ) | ||||||||||
19. | SEGMENT DATA |
Our reportable operating segments have been determined in accordance with the our internal management structure, which is organized based on operating activities, the manner in which we organize segments for allocating resources, making operating decisions and assessing performance and the availability of separate financial results. We do not allocate certain corporate expenses related to executive retirement plans, our Board of Directors, strategic initiatives, and certain other costs and report them in Corporate. None of our reportable operating segments represent the aggregation of two or more operating segments.
INDUSTRIAL The Industrial segment develops and manufactures high performance tooling and metalworking products and services for diverse end markets, including aerospace and defense, general engineering, energy and transportation. These products include milling, hole making, turning, threading and toolmaking systems used in the manufacture of airframes, aero engines, trucks and automobiles, ships and various types of industrial equipment. We leverage advanced manufacturing capabilities in combination with varying levels of customization to solve our customers’ toughest challenges and deliver improved productivity for a wide range of applications. Industrial goes to market under the Kennametal® brand through its direct sales force, a network of independent and national distributors, integrated supplier channels and via the Internet. Application engineers and technicians are critical to the sales process and directly assist our customers with specified product design, selection, application and support.
WIDIA Widia offers an assortment of standard and custom metal cutting solutions to general engineering, aerospace, energy and transportation customers. We serve our customers primarily through a network of value-added resellers, integrated supplier channels and via the internet. Widia markets its products under the WIDIA®, WIDIA Hanita® and WIDIA GTD® brands.
INFRASTRUCTURE Our Infrastructure segment produces engineered tungsten carbide and ceramic components, earth-cutting tools, and advanced metallurgical powders, primarily for the energy, earthworks and general engineering end markets. These wear-resistant products include compacts, nozzles, frac seats and custom components used in oil and gas and petrochemical industries; rod blanks and abrasive water jet nozzles for general industries; earth cutting tools and systems used in underground mining, trenching and foundation drilling and road milling; tungsten carbide powders for the oil and gas, aerospace and process industries; and ceramics used by the packaging industry for metallization of films and papers. We combine deep metallurgical and engineering expertise with advanced manufacturing capabilities to deliver solutions that drive improved productivity for our customers. Infrastructure markets its products primarily under the Kennametal® brand and sells through a direct sales force as well as through distributors.
23
Our sales and operating income (loss) by segment are as follows:
Three Months Ended March 31, | Nine Months Ended March 31, | ||||||||||||||
(in thousands) | 2020 | 2019 | 2020 | 2019 | |||||||||||
Sales: | |||||||||||||||
Industrial | $ | $ | $ | $ | |||||||||||
Widia | |||||||||||||||
Infrastructure | |||||||||||||||
Total sales | $ | $ | $ | $ | |||||||||||
Operating income (loss): | |||||||||||||||
Industrial | $ | $ | $ | $ | |||||||||||
Widia | ( | ) | ( | ) | ( | ) | |||||||||
Infrastructure | |||||||||||||||
Corporate | ( | ) | ( | ) | ( | ) | ( | ) | |||||||
Total operating income | |||||||||||||||
Interest expense | |||||||||||||||
Other income, net | ( | ) | ( | ) | ( | ) | ( | ) | |||||||
Income (loss) from continuing operations before income taxes | $ | $ | $ | ( | ) | $ | |||||||||
The following table presents Kennametal's revenue disaggregated by geography:
Three Months Ended | |||||||||||||||
March 31, 2020 | March 31, 2019 | ||||||||||||||
(in thousands) | Industrial | Widia | Infrastructure | Total Kennametal | Industrial | Widia | Infrastructure | Total Kennametal | |||||||
Americas | |||||||||||||||
EMEA | |||||||||||||||
Asia Pacific | |||||||||||||||
Nine Months Ended | |||||||||||||||
March 31, 2020 | March 31, 2019 | ||||||||||||||
(in thousands) | Industrial | Widia | Infrastructure | Total Kennametal | Industrial | Widia | Infrastructure | Total Kennametal | |||||||
Americas | |||||||||||||||
EMEA | |||||||||||||||
Asia Pacific | |||||||||||||||
The following tables presents Kennametal's revenue disaggregated by end market:
Three Months Ended March 31, 2020 | |||||||
(in thousands) | Industrial | Widia | Infrastructure | Total Kennametal | |||
General engineering | |||||||
Transportation | — | — | |||||
Aerospace | — | — | |||||
Energy | — | ||||||
Earthworks | — | — | |||||
24
Three Months Ended March 31, 2019 | |||||||
(in thousands) | Industrial | Widia | Infrastructure | Total Kennametal | |||
General engineering | |||||||
Transportation | — | — | |||||
Aerospace | — | — | |||||
Energy | — | ||||||
Earthworks | — | — | |||||
Nine Months Ended March 31, 2020 | |||||||
(in thousands) | Industrial | Widia | Infrastructure | Total Kennametal | |||
General engineering | |||||||
Transportation | — | — | |||||
Aerospace | — | — | |||||
Energy | — | ||||||
Earthworks | — | — | |||||
Nine Months Ended March 31, 2019 | |||||||
(in thousands) | Industrial | Widia | Infrastructure | Total Kennametal | |||
General engineering | |||||||
Transportation | — | — | |||||
Aerospace | — | — | |||||
Energy | — | ||||||
Earthworks | — | — | |||||
25
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (MD&A)
OVERVIEW
Kennametal Inc. was founded based on a tungsten carbide technology breakthrough in 1938. The Company was incorporated in Pennsylvania in 1943 as a manufacturer of tungsten carbide metal cutting tooling and was listed on the New 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 in the United States of America (U.S. GAAP), including organic sales decline, constant currency regional sales (decline) growth and constant currency end market sales decline. We provide the definitions of these non-GAAP financial measures at the end of the MD&A section as well as details on the use and derivation of these financial measures.
Our sales of $483.1 million for the quarter ended March 31, 2020 decreased 19 percent year-over-year, reflecting 17 percent organic sales decline, a 1 percent unfavorable currency exchange effect and a 1 percent decline from divestiture. The decline reflects a global manufacturing slow down and deteriorating end markets.
Operating income decreased $44.0 million from $81.9 million in the prior year quarter to $37.9 million in the current quarter. The decrease in operating income was primarily due to organic sales decline, unfavorable labor and fixed cost absorption due to lower volumes and simplification/modernization efforts in progress, $15.6 million of goodwill and other intangible asset impairment charges and higher restructuring and related charges of $2.6 million, partially offset by incremental simplification/modernization benefits and lower variable compensation expense. Operating margin was 7.8 percent compared to 13.7 percent in the prior year quarter. The Industrial and Infrastructure segments had operating margins of 11.6 percent and 12.2 percent, respectively, while the Widia segment had operating loss margin of 31.7 percent.
The Coronavirus Disease 2019 (COVID-19) emerged in China at the end of calendar year 2019 bringing significant uncertainty in our end markets and operations. National, regional and local governments have taken steps to limit the spread of the virus through stay-at-home, social distancing, and various other orders and guidelines. The imposition of these measures has created potentially significant operating constraints on our business. Recognizing the potential for COVID-19 to significantly disrupt operations, we began to deploy safety protocols and processes globally during the third quarter of fiscal 2020 to keep our employees safe while continuing to serve our customers. We have been deemed an essential business and continue to operate globally, apart from Kennametal India Ltd. and our Bolivian operations which were closed during the latter part of the third quarter of fiscal 2020 due to government mandates. We have not experienced a material disruption in our supply chain to date as a result of these facility closures or elsewhere in our supply chain. We expect COVID-19 will more materially negatively affect customer demand in the fourth quarter of fiscal 2020 as a result of the disruption and uncertainty it is causing most acutely in the energy, aerospace and transportation end markets. The extent to which the COVID-19 pandemic may impact our business, operating results, financial condition, or liquidity in the future will depend on future developments, including the duration of the outbreak, travel restrictions, business and workforce disruptions, and the effectiveness of actions taken to contain and treat the disease.
The Company's strong liquidity position has allowed us to continue our simplification/modernization initiatives and the FY20 and FY21 Restructuring Actions are expected to deliver annualized savings of $30 million to $35 million and $25 million to $30 million, respectively. We recorded $5.8 million of pre-tax restructuring and related charges in the quarter, and incremental pre-tax benefits our from simplification/modernization restructuring initiatives were approximately $5 million in the quarter. Total benefits from our simplification/modernization efforts, including restructuring initiatives, were approximately $15 million in the quarter, and we achieved annualized run-rate savings from simplification/modernization of approximately $87 million since inception.
26
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
We recorded non-cash pre-tax Widia goodwill and other intangible asset impairment charges of $15.6 million in the current quarter as a result of further deteriorating market conditions caused by the COVID-19 global pandemic.
We reported current quarter earnings per diluted share (EPS) of $0.03. EPS for the current quarter was unfavorably affected by restructuring and related charges and goodwill and other intangible asset impairment charges. The earnings per diluted share of $0.82 in the prior year quarter included a discrete benefit from U.S. tax reform of $0.08 and restructuring and related charges of $0.03 per share.
We generated net cash flows from operating activities of $146.1 million during the nine months ended March 31, 2020 compared to $157.5 million during the prior year quarter. Capital expenditures were $206.1 million and $145.9 million during the nine months ended March 31, 2020 and 2019, respectively, with the increase primarily due to higher spending associated with our simplification/modernization initiatives.
RESULTS OF CONTINUING OPERATIONS
SALES
Sales for the three months ended March 31, 2020 were $483.1 million, a decrease of $114.1 million, or 19 percent, from $597.2 million in the prior year quarter. The decrease in sales was driven by 17 percent organic sales decline, a 1 percent unfavorable currency exchange impact and a 1 percent decline from divestiture.
Sales for the nine months ended March 31, 2020 were $1,506.3 million, a decrease of $265.0 million, or 15 percent, from $1,771.3 million in the prior year period. The decrease in sales was driven by 13 percent organic sales decline, a 1 percent unfavorable currency exchange impact and a 1 percent decline from divestiture.
Three Months Ended March 31, 2020 | Nine Months Ended March 31, 2020 | |||
(in percentages) | As Reported | Constant Currency | As Reported | Constant Currency |
End market sales decline: | ||||
Energy | (25)% | (23)% | (24)% | (23)% |
General engineering | (20) | (17) | (14) | (12) |
Transportation | (19) | (17) | (17) | (16) |
Aerospace | (17) | (16) | (9) | (8) |
Earthworks | (8) | (6) | (5) | (3) |
Regional sales decline: | ||||
Americas | (20)% | (18)% | (16)% | (14)% |
Europe, the Middle East and Africa (EMEA) | (19) | (16) | (15) | (11) |
Asia Pacific | (17) | (15) | (13) | (12) |
GROSS PROFIT
Gross profit for the three months ended March 31, 2020 was $157.0 million, a decrease of $51.1 million from $208.1 million in the prior year quarter. The decrease was primarily due to organic sales decline, unfavorable labor and fixed cost absorption due to lower volumes and simplification/modernization efforts in progress and greater restructuring and related charges of $3 million, partially offset by lower raw material costs of approximately $17 million and incremental simplification/modernization benefits. Gross profit margin for the three months ended March 31, 2020 was 32.5 percent, as compared to 34.8 percent in the prior year quarter.
Gross profit for the nine months ended March 31, 2020 was $428.0 million, a decrease of $189.8 million from $617.8 million in the prior year period. The decrease was primarily due to organic sales decline, unfavorable labor and fixed cost absorption due to lower volumes and simplification/modernization efforts in progress, greater restructuring and related charges of $9 million and higher effective raw material costs, partially offset by incremental simplification/modernization benefits. Gross profit margin for the nine months ended March 31, 2020 was 28.4 percent, as compared to 34.9 percent in the prior year period.
27
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
OPERATING EXPENSE
Operating expense for the three months ended March 31, 2020 was $98.5 million compared to $120.1 million for the three months ended March 31, 2019. The decrease was primarily due to lower incentive compensation expense, incremental restructuring simplification benefits and favorable currency exchange impact of approximately $1 million.
Operating expense for the nine months ended March 31, 2020 was $320.3 million compared to $358.1 million for the nine months ended March 31, 2019. The decrease was primarily due to incremental restructuring simplification benefits, lower incentive compensation expense and favorable currency exchange impact of approximately $4 million.
We invested further in technology and innovation during the current quarter to continue delivering high quality products to our customers. Research and development expenses included in operating expense totaled $9.8 million and $10.5 million for the three months ended March 31, 2020 and 2019, respectively, and $30.3 million and $29.1 million for the nine months ended March 31, 2020 and 2019, respectively.
RESTRUCTURING AND RELATED CHARGES AND ASSET IMPAIRMENT CHARGES
FY20 Restructuring Actions
In the June quarter of fiscal 2019, we began implementing the current phase of restructuring associated with our simplification/modernization initiative. These actions are expected to reduce structural costs, improve operational efficiency and position us for long-term profitable growth and are currently estimated to achieve $30 million to $35 million of annualized savings by the end of fiscal 2020. These actions are expected to be completed in fiscal 2020 and are expected to be primarily cash expenditures.
The pre-tax charges for these programs are expected to be in the range of $55 million to $60 million, which are expected to be 80 percent Industrial, 15 percent Infrastructure and 5 percent Widia. Restructuring and related charges since inception of $50.0 million were recorded for this program through March 31, 2020, consisting of: $40.6 million in Industrial; $7.2 million in Infrastructure; and $2.2 million in Widia. Inception to date, we have achieved annualized savings of approximately $32 million.
FY21 Restructuring Actions
On July 11, 2019, we announced the initiation of restructuring actions in Germany associated with our simplification/modernization initiative, which are expected to reduce structural costs. We have agreed with local employee representatives to downsize our Essen, Germany operations instead of the previously proposed closure. We are also evaluating the acceleration of other facility closures as part of these restructuring activities. These actions are expected to deliver estimated annualized savings of $25 million to $30 million, be completed by the end of fiscal 2021 and be primarily cash expenditures.
The pre-tax charges for these programs are expected to be in the range of $55 million to $65 million, which is expected to be primarily in the Industrial segment. Total restructuring and related charges since inception of $28.8 million were recorded for this program through March 31, 2020 in the Industrial segment. Inception to date, we have achieved annualized savings of approximately $4 million.
Restructuring and Related Charges Recorded
We recorded restructuring and related charges of $5.8 million and $3.7 million for the three months ended March 31, 2020 and 2019, respectively. Of these amounts, restructuring charges totaled $1.8 million and $2.6 million for the three months ended March 31, 2020 and 2019, respectively, of which $0.2 million were related to inventory and were recorded in cost of goods sold for the three months ended March 31, 2020 and 2019. Restructuring-related charges of $4.0 million and $0.9 million were recorded in cost of goods sold for the three months ended March 31, 2020 and 2019, respectively. Restructuring-related charges of $0.1 million were recorded in operating expense for the three months ended March 31, 2019.
We recorded restructuring and related charges of $65.1 million and $6.8 million for the nine months ended March 31, 2020 and 2019, respectively. Of these amounts, restructuring charges totaled $54.5 million and $5.3 million for the nine months ended March 31, 2020 and 2019, respectively, of which $0.6 million and $0.2 million were related to inventory and were recorded in cost of goods sold for the nine months ended March 31, 2020 and 2019, respectively. Restructuring-related charges of $10.6 million and $1.4 million were recorded in cost of goods sold for the nine months ended March 31, 2020 and 2019, respectively. Restructuring-related charges of $0.1 million were recorded in operating expense for the nine months ended March 31, 2019.
28
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Intangible Asset Impairment Charges
We recorded non-cash pre-tax goodwill and other intangible asset impairment charges of $15.6 million and $30.2 million during the three and nine months ended March 31, 2020. 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 nine months ended March 31, 2020, we completed the sale of certain assets of the non-core specialty alloys and metals business within the Infrastructure segment located in New 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 ended December 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 ended March 31, 2020 and 2019 was $7.9 million and $8.1 million, respectively. Interest expense for the nine months ended March 31, 2020 decreased to $23.8 million compared to $24.3 million for the nine months ended March 31, 2019.
OTHER INCOME, NET
Other income for the three months ended March 31, 2020 decreased to $2.4 million from $5.0 million during the three months ended March 31, 2019. Other income for the nine months ended March 31, 2020 decreased to $9.3 million from $11.8 million during the nine months ended March 31, 2019. The decreases in both periods were primarily driven by higher foreign currency transaction losses and less interest income, partially offset by higher pension income.
PROVISION FOR INCOME TAXES
Effective tax rates
The effective income tax rates for the three months ended March 31, 2020 and 2019 were 93.1 percent and 11.0 percent, respectively. The year-over-year change is primarily due to the effects of current year restructuring and the Widia goodwill and other intangible asset impairment charges. The prior year rate included a $6.8 million discrete benefit to adjust the Toll Tax charge based on regulations issued during the March quarter of fiscal 2019.
The effective income tax rates for the nine months ended March 31, 2020 and 2019 were 143.5 percent (benefit on a loss) and 20.1 percent (provision on income), respectively. The year-over-year change is primarily due to the change in the jurisdictional mix caused by expected restructuring and related charges, the Widia goodwill and other intangible asset impairment charges, a discrete $14.5 million benefit for the one-time effect of Swiss tax reform and the increase in global intangible low-taxed income (GILTI) and base erosion anti-abuse tax (BEAT). The prior year rate included a $9.7 million discrete benefit associated with tax reform and a $6.1 million charge related to changes in the indefinite reinvestment assertion on certain foreign subsidiaries' undistributed earnings.
Coronavirus Aid, Relief, and Economic Security Act (CARES Act)
On March 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 after December 31, 2017 and before January 1, 2021 to be carried back to each of the 5 preceding taxable years to generate a refund of previously paid income taxes; permits net operating loss carryovers and carrybacks to offset 100 percent of taxable income for taxable years beginning before January 1, 2021; and modifies the limitation on business interest by increasing the allowable business interest deduction from 30 percent of adjusted taxable income to 50 percent of adjusted taxable income for taxable years beginning in 2019 or 2020. We are currently in the process of evaluating the potential impact these provisions may have on the Company.
Swiss tax reform
Legislation was effectively enacted during the nine months ended March 31, 2020 when the Canton of Schaffhausen approved the Federal Act on Tax Reform and AHV Financing on October 8, 2019 (Swiss tax reform). Significant changes from Swiss tax reform include the abolishment of certain favorable tax regimes and the creation of a ten-year transitional period at both the federal and cantonal levels.
29
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 ended December 31, 2019. We consider the deferred tax asset from Swiss tax reform to be an estimate based on our current interpretation of the legislation, which is subject to change based on further legislative guidance, review with the Swiss federal and cantonal authorities and modifications to the underlying valuation.
We currently expect a modestly unfavorable effect on our Swiss tax expense during the ten-year transitional period.
BUSINESS SEGMENT REVIEW
We operate three reportable segments consisting of Industrial, Widia and Infrastructure. Our reportable operating segments have been determined in accordance with our internal management structure, which is organized based on operating activities, the manner in which we organize segments for allocating resources, making operating decisions and assessing performance and the availability of separate financial results. We do not allocate certain corporate expenses related to executive retirement plans, our Board of Directors, strategic initiatives, and certain other costs and report them in Corporate.
Our sales and operating (loss) income by segment are as follows:
Three Months Ended March 31, | Nine Months Ended March 31, | ||||||||||||||
(in thousands) | 2020 | 2019 | 2020 | 2019 | |||||||||||
Sales: | |||||||||||||||
Industrial | $ | 260,738 | $ | 318,636 | $ | 820,008 | $ | 956,515 | |||||||
Widia | 42,721 | 50,966 | 131,115 | 148,592 | |||||||||||
Infrastructure | 179,625 | 227,602 | 555,129 | 666,178 | |||||||||||
Total sales | $ | 483,084 | $ | 597,204 | $ | 1,506,252 | $ | 1,771,285 | |||||||
Operating income (loss): | |||||||||||||||
Industrial | $ | 30,147 | $ | 57,218 | $ | 32,159 | $ | 173,279 | |||||||
Widia | (13,528 | ) | (4 | ) | (31,410 | ) | 3,817 | ||||||||
Infrastructure | 21,941 | 24,934 | 7,679 | 69,407 | |||||||||||
Corporate | (667 | ) | (277 | ) | (1,797 | ) | (2,622 | ) | |||||||
Total operating income | 37,893 | 81,871 | 6,631 | 243,881 | |||||||||||
Interest expense | 7,897 | 8,104 | 23,834 | 24,305 | |||||||||||
Other income, net | (2,438 | ) | (4,993 | ) | (9,330 | ) | (11,775 | ) | |||||||
Income (loss) from continuing operations before income taxes | $ | 32,434 | $ | 78,760 | $ | (7,873 | ) | $ | 231,351 | ||||||
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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
INDUSTRIAL
Three Months Ended March 31, | Nine Months Ended March 31, | ||||||||||||||
(in thousands, except operating margin) | 2020 | 2019 | 2020 | 2019 | |||||||||||
Sales | $ | 260,738 | $ | 318,636 | $ | 820,008 | $ | 956,515 | |||||||
Operating income | 30,147 | 57,218 | 32,159 | 173,279 | |||||||||||
Operating margin | 11.6 | % | 18.0 | % | 3.9 | % | 18.1 | % | |||||||
Three Months Ended March 31, 2020 | Nine Months Ended March 31, 2020 | ||
(in percentages) | |||
Organic sales decline | (17)% | (13)% | |
Foreign currency exchange impact(1) | (2) | (1) | |
Business days impact(2) | 1 | — | |
Sales decline | (18)% | (14)% | |
Three Months Ended March 31, 2020 | Nine Months Ended March 31, 2020 | ||||||
(in percentages) | As Reported | Constant Currency | As Reported | Constant Currency | |||
End market sales decline: | |||||||
General engineering | (20)% | (18)% | (15)% | (13)% | |||
Transportation | (19) | (17) | (17) | (16) | |||
Aerospace | (17) | (16) | (9) | (8) | |||
Energy | (7) | (6) | (9) | (7) | |||
Regional sales decline: | |||||||
EMEA | (22)% | (19)% | (18)% | (15)% | |||
Americas | (16) | (16) | (11) | (11) | |||
Asia Pacific | (14) | (12) | (12) | (11) | |||
For the three months ended March 31, 2020, Industrial sales decreased 18 percent from the prior year quarter due to the global manufacturing slowdown and deteriorating conditions across all end markets and regions. Transportation sales declined in all regions due to continued weakness in auto build rates caused by a slowdown in auto sales. Sales in our general engineering end market declined in all regions as a result of continued declines in manufacturing activity and, in Asia Pacific, partially related to the COVID-19 pandemic. Energy sales decreased primarily due to a decline in oil and gas drilling in the Americas, partially offset by continued strength in power generation in China. Aerospace sales declined in the Americas and EMEA, primarily driven by lower OEM production rates on certain platforms. In Asia, aerospace sales increased slightly due to inventory stocking orders from customers amid supply chain concerns. On a regional basis, the sales decrease in EMEA was primarily driven by declines in the general engineering and transportation end markets, in addition to declines in the aerospace end market, while the sales decrease in the Americas was driven by declines in all four end markets. The sales decrease in Asia Pacific was primarily driven by declines in the general engineering and transportation end markets, partially offset by increases in the energy and aerospace end markets.
For the three months ended March 31, 2020, Industrial operating income decreased by $27.1 million, driven primarily by organic sales decline and unfavorable labor and fixed cost absorption due to lower volumes and simplification/modernization efforts in progress, partially offset by incremental simplification/modernization benefits, lower raw material costs and lower variable compensation expense.
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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
For the nine months ended March 31, 2020, Industrial sales decreased 14 percent from the prior year period. Transportation sales declined in all regions due to continued weakness in auto build rates, while sales in our general engineering end market declined in all regions driven by overall continued decline in global manufacturing activity. Energy sales decreased primarily due to a decline in oil and gas drilling in 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. On a regional basis, the sales decrease in EMEA was primarily due to declines in the transportation and general engineering end markets, and to a lesser extent, declines in the energy and aerospace end markets, while the sales decrease in the Americas was primarily driven by declines in all four end markets. The sales decrease in Asia Pacific was primarily driven by declines in the general engineering and transportation end markets and, to a lesser extent, a decline in the aerospace end market, partially offset by an increase in sales in the energy end market.
For the nine months ended March 31, 2020, Industrial operating income decreased by $141.1 million, driven primarily by greater restructuring and related charges of $56.6 million, organic sales decline and unfavorable labor and fixed cost absorption due to lower volumes and simplification/modernization efforts in progress, partially offset by incremental simplification/modernization benefits and lower variable compensation expense.
WIDIA
Three Months Ended March 31, | Nine Months Ended March 31, | ||||||||||||||
(in thousands) | 2020 | 2019 | 2020 | 2019 | |||||||||||
Sales | $ | 42,721 | $ | 50,966 | $ | 131,115 | $ | 148,592 | |||||||
Operating (loss) income | (13,528 | ) | (4 | ) | (31,410 | ) | 3,817 | ||||||||
Operating margin | (31.7 | )% | — | % | (24.0 | )% | 2.6 | % | |||||||
Three Months Ended March 31, 2020 | Nine Months Ended March 31, 2020 | ||
(in percentages) | |||
Organic sales decline | (16)% | (11)% | |
Foreign currency exchange impact(1) | (1) | (1) | |
Business days impact(2) | 1 | — | |
Sales decline | (16)% | (12)% | |
Three Months Ended March 31, 2020 | Nine Months Ended March 31, 2020 | ||||||
(in percentages) | As Reported | Constant Currency | As Reported | Constant Currency | |||
Regional sales decline: | |||||||
Asia Pacific | (26)% | (25)% | (23)% | (22)% | |||
EMEA | (16) | (14) | (9) | (7) | |||
Americas | (10) | (10) | (6) | (6) | |||
For the three months ended March 31, 2020, Widia sales decreased 16 percent from the prior year quarter. The sales decrease in Asia Pacific was driven primarily by the overall weak market conditions, most notably in China and India, which were significantly impacted by the COVID-19 pandemic. Sales in EMEA decreased primarily due to the increasingly difficult market environment, while the decrease in the Americas was primarily due to a slower U.S. manufacturing environment.
For the three months ended March 31, 2020, Widia operating loss was $13.5 million compared to break-even operating income in the prior year quarter. The change was driven primarily by organic sales decline and $15.6 million of goodwill and other intangible asset impairment charges, partially offset by incremental simplification/modernization benefits, lower raw material costs and lower variable compensation expense.
For the nine months ended March 31, 2020, Widia sales decreased 12 percent from the prior year period. The sales decrease in Asia Pacific for both periods was driven primarily by the overall weak market conditions, most notably in India and China.
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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Sales in EMEA decreased primarily due to the increasingly difficult market environment, partially offset by growth in products focused on aerospace applications, while the decrease in the Americas was primarily due to a slower U.S. manufacturing environment, partially offset by strength in Latin America.
For the nine months ended March 31, 2020, Widia operating loss was $31.4 million compared to operating income of $3.8 million in the prior year period. The change was driven primarily by $30.2 million of goodwill and other intangible asset impairment charges, organic sales decline, and higher manufacturing costs, partially offset by incremental simplification/modernization benefits and lower variable compensation expense.
INFRASTRUCTURE
Three Months Ended March 31, | Nine Months Ended March 31, | ||||||||||||||
(in thousands) | 2020 | 2019 | 2020 | 2019 | |||||||||||
Sales | $ | 179,625 | $ | 227,602 | $ | 555,129 | $ | 666,178 | |||||||
Operating income | 21,941 | 24,934 | 7,679 | 69,407 | |||||||||||
Operating margin | 12.2 | % | 11.0 | % | 1.4 | % | 10.4 | % | |||||||
Three Months Ended March 31, 2020 | Nine Months Ended March 31, 2020 | ||
(in percentages) | |||
Organic sales decline | (17)% | (14)% | |
Foreign currency exchange impact(1) | (1) | (1) | |
Divestiture impact(3) | (3) | (2) | |
Sales decline | (21)% | (17)% | |
Three Months Ended March 31, 2020 | Nine Months Ended March 31, 2020 | ||||||
(in percentages) | As Reported | Constant Currency | As Reported | Constant Currency | |||
End market sales decline: | |||||||
Energy | (31)% | (29)% | (30)% | (29)% | |||
General engineering | (23) | (17) | (14) | (9) | |||
Earthworks | (8) | (6) | (5) | (3) | |||
Regional sales (decline) growth: | |||||||
Americas | (24)% | (21)% | (21)% | (19)% | |||
Asia Pacific | (18) | (16) | (12) | (10) | |||
EMEA | (10) | (6) | (3) | 2 | |||
For the three months ended March 31, 2020, Infrastructure sales decreased by 21 percent from the prior year quarter primarily as a result of lower activity in the oil and gas portion of the energy end market in the U.S. In the general engineering end market, the lower level of manufacturing activity drove the decline in the Americas and Asia Pacific, offset by increased defense-related activity in EMEA. Earthworks end market sales were down year-over-year due to softness in mining in the Americas and Asia Pacific. On a regional basis, the sales decrease in the Americas was primarily driven by a decline in the energy end market, and to a lesser extent, declines in both the general engineering and earthworks end markets. The sales decrease in Asia Pacific was primarily due to the negative impacts of COVID-19 on the general engineering and earthworks end markets. In EMEA, the sales decrease was driven primarily by declines in both the energy and earthworks end markets, partially offset by growth in the general engineering end market.
For the three months ended March 31, 2020, Infrastructure operating income decreased by $3.0 million, driven primarily by organic sales decline and unfavorable labor and fixed cost absorption due to lower volumes and simplification/modernization efforts in progress, partially offset by incremental simplification/modernization benefits, lower raw material costs and lower variable compensation expense.
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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
For the nine months ended March 31, 2020, Infrastructure sales decreased by 17 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 defense activity in EMEA. Earthworks end market sales declined year-over-year due to softness in mining in the Americas and softness in mining and construction in Asia Pacific, partially offset by growth in construction in the Americas. The sales decrease in the Americas was primarily driven by a decline in the energy end market, but also due to decline in the general engineering end market. The decrease in Asia Pacific was driven by lower levels of manufacturing activity and the negative impacts of COVID-19 in the general engineering end market. The sales increase in EMEA, excluding the unfavorable impact of currency exchange, was driven primarily by growth in the general engineering end market, partially offset by declines in both the energy and earthworks end markets.
For the nine months ended March 31, 2020, Infrastructure operating income decreased by $61.7 million, driven primarily by organic sales decline, unfavorable labor and fixed cost absorption due to lower volumes and simplification/modernization efforts in progress, unfavorable mix and a loss on divestiture of $6.5 million, partially offset by incremental simplification/modernization benefits and lower variable compensation expense.
CORPORATE
Three Months Ended March 31, | Nine Months Ended March 31, | ||||||||||||||
(in thousands) | 2020 | 2019 | 2020 | 2019 | |||||||||||
Corporate expense | $ | (667 | ) | $ | (277 | ) | $ | (1,797 | ) | $ | (2,622 | ) | |||
For the three months ended March 31, 2020, Corporate expense increased by $0.4 million from the prior year quarter. For the nine months ended March 31, 2020, Corporate expense decreased by $0.8 million from the prior year period.
LIQUIDITY AND CAPITAL RESOURCES
Cash flow from operations is the primary source of funding for our capital expenditures. For the nine months ended March 31, 2020, cash flow provided by operating activities was $146.1 million, primarily due to the net inflow from net income with adjustments for non-cash items.
Our five-year, multi-currency, revolving credit facility, as amended and restated 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 where debt, net of domestic cash in excess of $25 million, must be less than or equal to 3.5 times trailing twelve months EBITDA, adjusted for certain non-cash expenses and which may be further adjusted, at our discretion, to include up to $80 million of cash restructuring charges through December 31, 2021; and a minimum consolidated interest coverage ratio of EBITDA/Interest of 3.5x (as the aforementioned terms are defined in the Credit Agreement). We were in compliance with all such covenants as of March 31, 2020 and we expect to maintain compliance over the next 12 months. As a result of COVID-19, certain events or circumstances that could reasonably be expected to negatively affect our availability under the Credit Agreement may include such items as: (i) a decrease in expected profitability, specifically, a further decrease in sales volume driven by a prolonged weakness in customer demand or other pressures, including those related to the COVID-19 pandemic, adversely affecting our sales trends; and (ii) inability to achieve the anticipated benefits from simplification/modernization and other cost reduction programs.
For the nine months ended March 31, 2020, average daily borrowings outstanding under the Credit Agreement were approximately $10.5 million. We had $4.5 million of borrowings outstanding under the Credit Agreement as of March 31, 2020, and we had no borrowings outstanding as of June 30, 2019. Borrowings under the Credit Agreement are guaranteed by our significant domestic subsidiaries.
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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
We consider the majority of the unremitted earnings of our non-U.S. subsidiaries to be permanently reinvested. With regard to these unremitted earnings, we have not, nor do we anticipate the need to, repatriate funds to 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 March 31, 2020, cash and cash equivalents were $85.2 million, Total Kennametal Shareholders' equity was $1,260.6 million and total debt was $598.1 million. Our current senior credit ratings are at investment grade levels. We believe that our current financial position, liquidity and credit ratings provide us access to the capital markets. We believe that we have sufficient resources available to meet cash requirements for the next 12 months. We continue to closely monitor our liquidity position and the condition of the capital markets, as well as the counterparty risk of our credit providers. There have been no material changes in our contractual obligations and commitments since June 30, 2019.
We are also closely monitoring the rapidly evolving effects of the COVID-19 pandemic on our business operations, financial results and financial position and on the industries in which we operate. Subsequent to March 31, 2020, we drew $500.0 million under the Credit Agreement. We decided to draw this $500.0 million as a measure to ensure access to future liquidity in light of the global financial market uncertainty resulting from the COVID-19 pandemic.
Cash Flow Provided by Operating Activities
During the nine months ended March 31, 2020, cash flow provided by operating activities was $146.1 million, compared to $157.5 million for the prior year period. Cash flow provided by operating activities for the current year period consisted of net income and non-cash items amounting to an inflow of $126.7 million and changes in certain assets and liabilities netting to an inflow of $19.4 million. Contributing to the changes in certain assets and liabilities were a decrease in accounts receivable of $60.6 million and a decrease in inventories of $29.9 million. Partially offsetting these cash inflows were a decrease in accounts payable and accrued liabilities of $34.4 million, a decrease in accrued income taxes of $22.0 million and a decrease in accrued pension and postretirement benefits of $18.2 million.
During the nine months ended March 31, 2019, cash flow provided by operating activities consisted of net income and non-cash items amounting to an inflow of $293.4 million and changes in certain assets and liabilities netting to an outflow of $135.9 million. Contributing to the changes in certain assets and liabilities were an increase in inventories of $71.8 million, a decrease in accounts payable and accrued liabilities of $57.2 million and a decrease in accrued pension and postretirement benefits of $13.9 million. Partially offsetting these cash outflows was an increase in other of $8.6 million.
Cash Flow Used for Investing Activities
Cash flow used for investing activities was $180.2 million for the nine months ended March 31, 2020, compared to $142.7 million for the prior year period. During the current year period, cash flow used for investing activities included capital expenditures, net of $203.3 million, which consisted primarily of expenses related to our simplification/modernization initiatives and equipment upgrades, partially offset by proceeds from divestiture of $24.0 million from the sale of certain assets of the non-core specialty alloys and metals business located in New Castle, Pennsylvania.
For the nine months ended March 31, 2019, cash flow used for investing activities included capital expenditures, net of $142.4 million, which consisted primarily of equipment upgrades and expenses related to our simplification/modernization initiatives.
Cash Flow Used for Financing Activities
Cash flow used for financing activities was $54.0 million for the nine months ended March 31, 2020 compared to $456.4 million in the prior year period. During the current year period, cash flow used for financing activities included $49.7 million of cash dividends paid to Kennametal Shareholders and $5.7 million of the effect of employee benefit and stock plans and dividend reinvestment, partially offset by $4.5 million of borrowings outstanding under the Credit Agreement.
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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
For the nine months ended March 31, 2019, cash flow used for financing activities included outflows of $400.0 million of term debt repayments from the early extinguishment of our 2.650 percent Senior Unsecured Notes, $49.3 million of cash dividends paid to Kennametal Shareholders and $5.2 million of the effect of employee benefit and stock plans and dividend reinvestment and an outflow from a net decrease in notes payable of $0.9 million.
FINANCIAL CONDITION
Working capital was $583.6 million at March 31, 2020, a decrease of $145.5 million from $729.1 million at June 30, 2019. The decrease in working capital was primarily driven by a decrease in cash and cash equivalents of $96.8 million; a decrease in accounts receivable of $75.7 million due primarily to a decline in sales, a decrease in inventories of $54.8 million and the addition of current operating lease liabilities of $12.9 million due to the adoption of the new lease accounting standard without a restatement of prior periods. Partially offsetting these items were a decrease in accounts payable of $47.8 million, a decrease in accrued expenses of $25.2 million primarily due to payroll timing and lower accrued vacation pay and a decrease in accrued income taxes of $18.8 million. Currency exchange rate effects decreased working capital by a total of approximately $22 million, the impact of which is included in the aforementioned changes.
Property, plant and equipment, net increased $80.5 million from $934.9 million at June 30, 2019 to $1,015.4 million at March 31, 2020, primarily due to capital additions of approximately $190.7 million, partially offset by depreciation expense of $79.1 million, a negative currency exchange impact of approximately $17 million, disposals of $7.8 million and divestiture effect of $6.7 million.
At March 31, 2020, other assets were $556.0 million, an increase of $25.5 million from $530.5 million at June 30, 2019. The primary driver for the increase was the addition of operating lease ROU assets of $46.7 million in the quarter due to the adoption of the new lease accounting standard without a restatement of prior periods, an increase in other assets of $23.7 million primarily due to an increase in pension plan assets and an increase in deferred income taxes of $11.7 million, partially offset by a decrease in goodwill of $31.4 million primarily due to goodwill impairment charges recorded in the Widia segment of $26.8 million and unfavorable currency exchange effects of approximately $4 million, and a decrease in other intangible assets of $25.3 million, primarily due to divestiture effect of $12.5 million, amortization expense of $10.4 million and impairment charges recorded in the Widia segment of $3.4 million.
Kennametal Shareholders' equity was $1,260.6 million at March 31, 2020, a decrease of $74.5 million from $1,335.2 million at June 30, 2019. The decrease was primarily due to cash dividends paid to Kennametal Shareholders of $49.7 million and unfavorable currency exchange effects of $44.9 million, partially offset by capital stock issued under employee benefit and stock plans of $8.4 million, pension and other postretirement benefit effects in other comprehensive loss of $8.0 million and net income attributable to Kennametal of $3.4 million.
DISCUSSION OF CRITICAL ACCOUNTING POLICIES
There have been no changes to our critical accounting policies since June 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.
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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
We performed an interim quantitative impairment test of goodwill and the indefinite-lived trademark intangible asset for the Widia reporting unit during the March quarter of fiscal 2020. The decline in actual and projected financial results for the Widia reporting unit, primarily as a result of the COVID-19 pandemic, represented an interim impairment triggering event because there was essentially zero cushion between the reporting unit's carrying value and fair value as of March 31 2020. This is because the Widia reporting unit was recorded at fair value as of the last impairment date of December 31, 2019. As a result of the March quarter fiscal 2020 interim test, we recorded a non-cash pre-tax impairment charge during the three months ended March 31, 2020 of $15.6 million in the Widia segment, of which $13.7 million was for goodwill and $1.9 million was for an indefinite-lived trademark intangible asset. Subsequent to the third quarter impairment charge, there is no remaining goodwill for the Widia reporting unit and the carrying value of the indefinite-lived trademark is $10.9 million, which approximates fair value. Additionally, due to the significant cushion that existed between the fair value and the carrying value of the Industrial reporting unit, as measured on the last annual testing date, we determined that there was not an interim triggering event for this reporting unit during the third quarter of fiscal 2020.
Fair value determinations require considerable judgment and are sensitive to changes in underlying assumptions and factors. As a result, there can be no assurance that the estimates and assumptions made for purposes of the interim and annual goodwill and indefinite-lived intangible impairment test will prove to be an accurate prediction of the future. Certain events or circumstances that could reasonably be expected to negatively affect the underlying key assumptions and ultimately impact the estimated fair values of our reporting units and of the indefinite-lived trademark may include such items as: (i) a decrease in expected future cash flows, specifically, a further decrease in sales volume driven by a prolonged weakness in customer demand or other pressures, including those related to the COVID-19 pandemic, adversely affecting our long-term sales trends; (ii) inability to achieve the anticipated benefits from simplification/modernization and other cost reduction programs and (iii) inability to achieve the sales from our strategic growth initiatives.
NEW ACCOUNTING STANDARDS
See Note 2 to our condensed consolidated financial statements set forth in Part I, Item 1 of this Quarterly Report on Form 10-Q for a description of new accounting standards.
RECONCILIATION OF FINANCIAL MEASURES NOT DEFINED BY U.S. GAAP
In accordance with SEC rules, below are the definitions of the non-GAAP financial measures we use in this report and the reconciliation of these measures to the most closely related GAAP financial measures. We believe that these measures provide useful perspective on underlying business trends and results and provide a supplemental measure of year-over-year results. The non-GAAP financial measures described below are used by management in making operating decisions, allocating financial resources and for business strategy purposes. We believe these measures may be useful to investors as they provide supplemental information about business performance and provide investors a view of our business results through the eyes of management. These non-GAAP financial measures are not intended to be considered by the user in place of the related GAAP financial measure, but rather as supplemental information to our business results. These non-GAAP financial measures may not be the same as similar measures used by other companies due to possible differences in method and in the items or events being adjusted.
Organic sales decline Organic sales decline is a non-GAAP financial measure of sales decline (which is the most directly comparable GAAP measure) excluding the impacts of acquisitions, divestitures, business days and foreign currency exchange from year-over-year comparisons. We believe this measure provides investors with a supplemental understanding of underlying sales trends by providing sales growth decline on a consistent basis. Also, we report organic sales decline at the consolidated and segment levels.
Constant currency end market sales decline Constant currency end market sales decline is a non-GAAP financial measure of sales decline (which is the most directly comparable GAAP measure) by end market excluding the impacts of acquisitions, divestitures and foreign currency exchange from year-over-year comparisons. We note that, unlike organic sales decline, constant currency end market sales decline does not exclude the impact of business days. We believe this measure provides investors with a supplemental understanding of underlying end market trends by providing end market sales growth decline on a consistent basis. Also, we report constant currency end market sales decline at the consolidated and segment levels. Widia sales are reported only in the general engineering end market. Therefore, we do not provide constant currency end market sales decline for the Widia segment and, thus, do not include a reconciliation for that metric.
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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Constant currency regional sales growth (decline) Constant currency regional sales growth (decline) is a non-GAAP financial measure of sales growth (decline) (which is the most directly comparable GAAP measure) by region excluding the impacts of acquisitions, divestitures and foreign currency exchange from year-over-year comparisons. We note that, unlike organic sales growth, constant currency regional sales growth (decline) does not exclude the impact of business days. We believe this measure provides investors with a supplemental understanding of underlying regional trends by providing regional sales growth (decline) on a consistent basis. Also, we report constant currency regional sales growth (decline) at the consolidated and segment levels.
Reconciliations of organic sales decline to sales decline are as follows:
Three Months Ended March 31, 2020 | Industrial | Widia | Infrastructure | Total |
Organic sales decline | (17)% | (16)% | (17)% | (17)% |
Foreign currency exchange impact(1) | (2) | (1) | (1) | (1) |
Business days impact(2) | 1 | 1 | — | — |
Divestiture impact(3) | — | — | (3) | (1) |
Sales decline | (18)% | (16)% | (21)% | (19)% |
Nine Months Ended March 31, 2020 | Industrial | Widia | Infrastructure | Total |
Organic sales decline | (13)% | (11)% | (14)% | (13)% |
Foreign currency exchange impact(1) | (1) | (1) | (1) | (1) |
Divestiture impact(3) | — | — | (2) | (1) |
Sales decline | (14)% | (12)% | (17)% | (15)% |
Reconciliations of constant currency end market sales decline to end market sales decline(4) are as follows:
Industrial | ||||
Three Months Ended March 31, 2020 | General engineering | Transportation | Aerospace | Energy |
Constant currency end market sales decline | (18)% | (17)% | (16)% | (6)% |
Foreign currency exchange impact(1) | (2) | (2) | (1) | (1) |
End market sales decline(4) | (20)% | (19)% | (17)% | (7)% |
Infrastructure | |||
Three Months Ended March 31, 2020 | Energy | Earthworks | General engineering |
Constant currency end market sales decline | (29)% | (6)% | (17)% |
Foreign currency exchange impact(1) | — | (2) | — |
Divestiture impact(3) | (2) | — | (6) |
End market sales decline(4) | (31)% | (8)% | (23)% |
Total | |||||
Three Months Ended March 31, 2020 | General engineering | Transportation | Aerospace | Energy | Earthworks |
Constant currency end market sales decline | (17)% | (17)% | (16)% | (23)% | (6)% |
Foreign currency exchange impact(1) | (1) | (2) | (1) | — | (2) |
Divestiture impact(3) | (2) | — | — | (2) | — |
End market sales decline(4) | (20)% | (19)% | (17)% | (25)% | (8)% |
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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Industrial | ||||
Nine Months Ended March 31, 2020 | General engineering | Transportation | Aerospace | Energy |
Constant currency end market sales decline | (13)% | (16)% | (8)% | (7)% |
Foreign currency exchange impact(1) | (2) | (1) | (1) | (2) |
End market sales decline(4) | (15)% | (17)% | (9)% | (9)% |
Infrastructure | |||
Nine Months Ended March 31, 2020 | Energy | Earthworks | General engineering |
Constant currency end market sales decline | (29)% | (3)% | (9)% |
Foreign currency exchange impact(1) | — | (2) | (1) |
Divestiture impact(3) | (1) | — | (4) |
End market sales decline(4) | (30)% | (5)% | (14)% |
Total | |||||
Nine Months Ended March 31, 2020 | General engineering | Transportation | Aerospace | Energy | Earthworks |
Constant currency end market sales decline | (12)% | (16)% | (8)% | (23)% | (3)% |
Foreign currency exchange impact(1) | (1) | (1) | (1) | — | (2) |
Divestiture impact(3) | (1) | — | — | (1) | — |
End market sales decline(4) | (14)% | (17)% | (9)% | (24)% | (5)% |
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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Reconciliations of constant currency regional sales (decline) growth to reported regional sales decline(5) are as follows:
Three Months Ended March 31, 2020 | Nine Months Ended March 31, 2020 | |||||||||||
Americas | EMEA | Asia Pacific | Americas | EMEA | Asia Pacific | |||||||
Industrial | ||||||||||||
Constant currency regional sales decline | (16)% | (19)% | (12)% | (11)% | (15)% | (11)% | ||||||
Foreign currency exchange impact(1) | — | (3) | (2) | — | (3) | (1) | ||||||
Regional sales decline(5) | (16)% | (22)% | (14)% | (11)% | (18)% | (12)% | ||||||
Widia | ||||||||||||
Constant currency regional sales decline | (10)% | (14)% | (25)% | (6)% | (7)% | (22)% | ||||||
Foreign currency exchange impact(1) | — | (2) | (1) | — | (2) | (1) | ||||||
Regional sales decline(5) | (10)% | (16)% | (26)% | (6)% | (9)% | (23)% | ||||||
Infrastructure | ||||||||||||
Constant currency regional sales (decline) growth | (21)% | (6)% | (16)% | (19)% | 2% | (10)% | ||||||
Foreign currency exchange impact(1) | 1 | (3) | (2) | 1 | (5) | (2) | ||||||
Divestiture impact(3) | (4) | (1) | — | (3) | — | — | ||||||
Regional sales (decline) growth(5) | (24)% | (10)% | (18)% | (21)% | (3)% | (12)% | ||||||
Total | ||||||||||||
Constant currency regional sales decline | (18)% | (16)% | (15)% | (14)% | (11)% | (12)% | ||||||
Foreign currency exchange impact(1) | — | (3) | (2) | (1) | (4) | (1) | ||||||
Divestiture impact(3) | (2) | — | — | (1) | — | — | ||||||
Regional sales decline(5) | (20)% | (19)% | (17)% | (16)% | (15)% | (13)% | ||||||
(1) Foreign currency exchange impact is calculated by dividing the difference between current period sales at prior period foreign exchange rates and prior period sales by prior period sales.
(2) Business days impact is calculated by dividing the year-over-year change in weighted average working days (based on mix of sales by country) by prior period weighted average working days.
(3) Divestiture impact is calculated by dividing prior period sales attributable to divested businesses by prior period sales.
(4) Aggregate sales for all end markets sum to the sales amount presented on Kennametal's financial statements.
(5) Aggregate sales for all regions sum to the sales amount presented on Kennametal's financial statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
Except for the broad effects of COVID-19 as a result of its negative impact on the global economy and major financial markets, there have been no material changes to our market risk exposures since June 30, 2019.
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ITEM 4. CONTROLS AND PROCEDURES |
As of the end of the period covered by this Quarterly Report on Form 10-Q, the Company's management evaluated, with the participation of the Company's Chief Executive Officer and Chief Financial Officer, the effectiveness of the Company's disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)). The Company's disclosure controls were designed to provide a reasonable assurance that information required to be disclosed in reports that we file or submit under the Securities Exchange Act of 1934, as amended (Exchange Act), is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. It should be noted that the design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote. However, the controls have been designed to provide reasonable assurance of achieving the controls' stated goals. Based on that evaluation, the Company's Chief Executive Officer and Chief Financial Officer have concluded that the Company's disclosure controls and procedures are effective to provide reasonable assurance at March 31, 2020 to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is (i) accumulated and communicated to management, including the Company's Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure and (ii) recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission.
There were no changes in the Company's internal control over financial reporting that occurred during the Company's most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS |
From time to time, we are party to legal claims and proceedings that arise in the ordinary course of business, which may relate to our operations or assets, including real, tangible or intellectual property. Although certain of these types of actions are currently pending, we do not believe that any individual proceeding is material or that our pending legal proceedings in the aggregate are material to Kennametal. See "Note 13. Environmental Matters" for a discussion of our exposure to certain environmental liabilities.
Item 1A. Risk Factors
Except as set forth below, during the quarter ended March 31, 2020, there were no material changes to the Risk Factors disclosed in Item 1A - “Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended June 30, 2019.
Public health threats or outbreaks of communicable diseases could have a material adverse effect on our operations and financial results.
We may face risks related to public health threats or outbreaks of communicable diseases. A widespread healthcare crisis, such as an outbreak of a communicable disease could adversely affect the global economy and our business, our suppliers and our customers’ ability to conduct business for an indefinite period of time. For example, the ongoing global Coronavirus Disease 2019 (COVID-19) pandemic, has negatively impacted the global economy, disrupted financial markets and international trade, resulted in increased unemployment levels and significantly impacted global supply chains, all of which have and are expected to continue to negatively impact our end markets. In addition, Federal, state, and local governments have implemented various mitigation measures, including travel restrictions, border closings, restrictions on public gatherings, shelter-in-place restrictions and limitations on non-essential business. Although in many jurisdictions we are considered an essential business, some of these actions have adversely impacted the ability of our employees, contractors, suppliers, customers, and other business partners to conduct business activities, and could continue to do so for an indefinite period of time. This could have a material adverse effect on our results of operations, financial condition, and liquidity. In particular, the continued spread of COVID-19 and efforts to contain the virus could:
• | continue to affect customer demand across our end markets and geographical regions; |
• | affect our ability to conduct business in certain jurisdictions in which we operate where nationwide, regional or local lockdowns are currently implemented or may be implemented in the future; |
• | cause us to experience an increase in costs as a result of the emergency measures we have taken, delayed payments from customers and uncollectible accounts; |
• | cause delays and disruptions in our supply chain resulting in disruptions in the commencement dates of certain planned projects; |
• | affect the availability of qualified personnel; |
• | affect our ability to fund operations and maintain covenant compliance; |
• | affect our access to financial markets; |
• | negatively affect our ability to accurately forecast; and |
• | cause other unpredictable events. |
The situation surrounding COVID-19 remains fluid. The COVID-19 pandemic has negatively impacted our business operations, financial results and financial position and the industries in which we operate. The extent to which the COVID-19 pandemic may impact our business, operating results, financial condition, or liquidity in the future will depend on future developments, including the duration of the outbreak, travel restrictions, business and workforce disruptions, and the effectiveness of actions taken to contain and treat the disease.
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ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS |
ISSUER PURCHASES OF EQUITY SECURITIES
Period | Total Number of Shares Purchased (1) | Average Price Paid per Share | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs (2) | ||||||||
January 1 through January 31, 2020 | 5,863 | $ | 31.87 | — | 10,100,100 | |||||||
February 1 through February 29, 2020 | 3,071 | 28.97 | — | 10,100,100 | ||||||||
March 1 through March 31, 2020 | — | — | — | 10,100,100 | ||||||||
Total | 8,934 | $ | 30.87 | — | ||||||||
(1) | During the current period, 1,741 shares were purchased on the open market on behalf of Kennametal to fund the Company’s dividend reinvestment program. Also, during the current period employees delivered 7,193 shares of restricted stock to Kennametal, upon vesting, to satisfy tax withholding requirements. |
(2) | On July 25, 2013, the Company publicly announced an amended repurchase program for up to 17 million shares of its outstanding capital stock outside of the Company's dividend reinvestment program. |
UNREGISTERED SALES OF EQUITY SECURITIES
None.
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ITEM 6. EXHIBITS |
(31) | Rule 13a-14(a)/15d-14(a) Certifications | |||
(31.1) | Filed herewith. | |||
(31.2) | Filed herewith. | |||
(32) | Section 1350 Certifications | |||
(32.1) | Filed herewith. | |||
(101) | XBRL | |||
(101.INS) (3) | XBRL Instance Document | Filed herewith. | ||
(101.SCH) (4) | XBRL Taxonomy Extension Schema Document | Filed herewith. | ||
(101.CAL) (4) | XBRL Taxonomy Extension Calculation Linkbase Document | Filed herewith. | ||
(101.DEF) (4) | XBRL Taxonomy Definition Linkbase | Filed herewith. | ||
(101.LAB) (4) | XBRL Taxonomy Extension Label Linkbase Document | Filed herewith. | ||
(101.PRE) (4) | XBRL Taxonomy Extension Presentation Linkbase Document | Filed herewith. | ||
(3) | The instance document does not appear in the Interactive Data File because its XBRL (Extensible Business Reporting Language) tags are embedded within the Inline XBRL document. |
(4) | Attached as Exhibit 101 to this report are the following documents formatted in Inline XBRL: (i) the Condensed Consolidated Statement of Income for the three and nine months ended March 31, 2020 and 2019, (ii) the Condensed Consolidated Statement of Comprehensive Income for the three and nine months ended March 31, 2020 and 2019, (iii) the Condensed Consolidated Balance Sheet at March 31, 2020 and June 30, 2019, (iv) the Condensed Consolidated Statement of Cash Flows for the nine months ended March 31, 2020 and 2019 and (v) Notes to Condensed Consolidated Financial Statements for the three and nine ended March 31, 2020. |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
KENNAMETAL INC. | ||||
Date: | May 5, 2020 | By: | /s/ Patrick S. Watson | |
Patrick S. Watson Vice President Finance and Corporate Controller | ||||
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