RESULTS OF CONTINUING OPERATIONS
SALES
Sales of
$2,367.9 million
in
2018
increased
15 percent
from
$2,058.4 million
in
2017
reflecting a
12 percent
increase from organic sales growth and favorable currency exchange impact of
4 percent
, partially offset by
1 percent
decrease due to fewer business days. Sales increased by
16 percent
in the Infrastructure segment,
15 percent
in the Industrial segment and
12 percent
in the Widia segment.
Sales of
$2,058.4 million
in
2017
decreased
2 percent
from
$2,098.4 million
in
2016
reflecting a 4 percent divestiture impact and a 2 percent unfavorable currency exchange impact, partially offset by 4 percent organic sales growth. Sales increased by
4 percent
in the Widia segment and
3 percent
in the Industrial segment, while sales decreased by
9 percent
in the Infrastructure segment.
|
|
|
|
|
|
|
|
|
|
|
|
|
End Market Sales Growth (Decline):
|
As Reported
|
|
Constant Currency
|
|
Year Ended June 30, 2018
|
|
Year Ended June 30, 2017
|
|
Year Ended June 30, 2018
|
|
Year Ended June 30, 2017
|
Energy
|
19
|
%
|
|
2
|
%
|
|
17
|
%
|
|
9
|
%
|
General engineering
|
15
|
|
|
2
|
|
|
11
|
|
|
6
|
|
Aerospace and defense
|
15
|
|
|
2
|
|
|
11
|
|
|
4
|
|
Transportation
|
13
|
|
|
(1
|
)
|
|
8
|
|
|
2
|
|
Earthworks
|
10
|
|
|
(10
|
)
|
|
7
|
|
|
(4
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Regional Sales Growth (Decline):
|
As Reported
|
|
Constant Currency
|
|
Year Ended June 30, 2018
|
|
Year Ended June 30, 2017
|
|
Year Ended June 30, 2018
|
|
Year Ended June 30, 2017
|
Asia Pacific
|
19
|
%
|
|
4
|
%
|
|
15
|
%
|
|
8
|
%
|
Europe, the Middle East and Africa (EMEA)
|
16
|
|
|
(9
|
)
|
|
7
|
|
|
—
|
|
Americas
|
13
|
|
|
—
|
|
|
13
|
|
|
4
|
|
GROSS PROFIT
Gross profit increased
$174.6 million
to
$832.3 million
in
2018
from
$657.7 million
in
2017
. This increase was primarily due to organic sales growth, incremental restructuring benefits of approximately $42 million, favorable currency exchange impact of $29.6 million, favorable mix, modernization benefits of approximately $9 million and $4.3 million less restructuring-related charges, partially offset by higher raw material and overtime costs and salary inflation. The gross profit margin for
2018
was
35.1
percent compared to
32.0
percent in
2017
.
Gross profit increased
$41.6 million
to
$657.7 million
in
2017
from
$616.1 million
in
2016
. This increase was primarily due to incremental restructuring benefits of approximately $36 million, better absorption and productivity, organic sales growth and lower raw material costs, partially offset by an unfavorable currency exchange impact of $12.6 million, unfavorable business mix and divestiture impact of $11.4 million. The gross profit margin for
2017
was
32.0
percent compared to
29.4
percent in
2016
.
OPERATING EXPENSE
Operating expense in
2018
was
$498.2 million
, an increase of
$35.0 million
, or
7.6 percent
, compared to
$463.2 million
in
2017
. The increase was primarily due to higher variable compensation expense of $14 million due to higher than expected operating results, an unfavorable currency exchange impact of $14.5 million and salary inflation, partially offset by incremental restructuring benefits of approximately $13 million and $2.5 million less in restructuring-related charges.
Operating expense in
2017
was
$463.2 million
, a decrease of
$31.8 million
, or
6.4 percent
, compared to
$495.0 million
in
2016
. The decrease was primarily due to incremental restructuring benefits of approximately $36 million, divestiture impact of $10.5 million, $12.7 million less in restructuring-related charges and a favorable foreign currency exchange impact of $5.1 million, offset partially by higher performance-based compensation.
RESTRUCTURING AND RELATED CHARGES AND ASSET IMPAIRMENT CHARGES
Restructuring and Related Charges
Legacy Restructuring
In prior years, we implemented certain actions to streamline the Company's cost structure. The purpose of this restructuring initiative was to improve the alignment of our cost structure with the operating environment through employee reductions and to consolidate certain manufacturing facilities. These restructuring actions were substantially completed in the September quarter of 2018, were mostly cash expenditures and achieved annual run rate ongoing pre-tax savings of approximately $165 million.
Total restructuring and related charges since inception of
$152.7 million
have been recorded for these programs through
June 30, 2018
:
$85.6 million
in Industrial,
$13.9 million
in Widia,
$45.9 million
in Infrastructure and
$7.3 million
in Corporate.
Industrial Simplification
In the June quarter of 2018, we implemented and substantially completed restructuring actions to streamline the Industrial segment's cost structure by directing resources to more profitable business and increasing sales force productivity. These actions are currently anticipated to deliver annual ongoing pre-tax savings of approximately $10 million in the first half of fiscal 2019 and are anticipated to be mostly cash expenditures. Total restructuring and related charges since inception of $8.2 million have been recorded for this program in the Industrial segment through
June 30, 2018
.
Combined Restructuring
During
2018
, we recorded restructuring and related charges of
$15.9 million
, net of a
$4.7 million
gain on sale of the previously closed Houston manufacturing location that was part of our legacy restructuring programs. Of this amount, restructuring charges totaled
$16.4 million
, of which benefit of
$0.2 million
was related to inventory and were recorded in cost of goods sold. Restructuring-related charges of
$3.7 million
were recorded in cost of goods sold and
$0.5 million
were recorded in operating expense during
2018
.
During
2017
, we recorded restructuring and related charges of
$76.2 million
. Of this amount, restructuring charges totaled
$65.6 million
, of which $0.6 million were charges related to inventory and were recorded in cost of goods sold. Restructuring-related charges of
$7.1 million
were recorded in cost of goods sold and
$3.5 million
were recorded in operating expense during
2017
.
During
2016
, we recorded restructuring and related charges of
$53.5 million
. Of this amount, restructuring charges totaled
$30.0 million
. Restructuring-related charges of
$7.3 million
were recorded in cost of goods sold and
$16.2 million
in operating expense during
2016
.
Asset Impairment Charges
During
2016
, we recorded non-cash pre-tax goodwill and other intangible asset impairment charges of $108.5 million. See Note 2 of our consolidated financial statements set forth in Item 8 of this Annual Report (Note 2).
During
2016
, we identified specific machinery and equipment that was no longer being utilized in the manufacturing organization, which we disposed of by abandonment. As a result of this review, we recorded property, plant, and equipment impairment charges of $5.4 million during 2016, which has been presented as restructuring and asset impairment charges in our consolidated statement of income.
LOSS ON DIVESTITURE
We recognized a pre-tax loss on the sale of non-core businesses of $131.5 million in 2016, which includes the impact of estimated working capital adjustments, deal costs and transaction costs. Of this amount,
$127.9 million
and
$3.6 million
were recorded in the Infrastructure and Industrial segments, respectively. See Note 4 of our consolidated financial statements set forth in Item 8 of this Annual Report.
AMORTIZATION OF INTANGIBLES
Amortization expense was
$14.7 million
,
$16.6 million
and
$20.8 million
in
2018
,
2017
and
2016
, respectively. The decrease of
$1.9 million
from 2017 to 2018 was driven primarily by certain finite-lived intangible assets being fully amortized in 2018, and the decrease of
$4.2 million
from 2016 to 2017 was driven primarily by the impact of divestiture.
INTEREST EXPENSE
Interest expense increased
$1.2 million
to
$30.1 million
in
2018
, compared with
$28.8 million
in
2017
primarily due to the incremental interest expense on the New Notes, partially offset by lower average borrowings in 2018. Interest expense increased
$1.1 million
to
$28.8 million
in
2017
, compared with
$27.8 million
in
2016
due to higher average borrowings and a higher credit facility fee. The portion of our debt subject to variable rates of interest was less than 1 percent at June 30, 2018, 2017 and 2016.
OTHER EXPENSE (INCOME), NET
In
2018
, other expense, net was
$2.4 million
compared to
$2.2 million
in
2017
. Prior year income from transition services provided related to a prior divestiture that did not repeat and a gain on sale of an investment that did not repeat were partially offset by higher interest income and foreign currency transaction gains.
In
2017
, other expense, net was
$2.2 million
compared to other income, net of $4.1 million in 2016. The year-over-year change was due primarily to foreign currency transaction losses and the prior year reduction of a contingent liability associated with a past acquisition that did not repeat in the current year, partially offset by a prior year loss on sale of assets and income from transition services provided to the acquirer of our non-core businesses.
INCOME TAXES
The effective tax rate for
2018
was
25.4 percent
compared to
36.5 percent
for
2017
. The change was primarily driven by the prior year U.S. loss, which was mostly attributable to restructuring and related charges, not being tax-effected and current year U.S. income being subject to tax as a result of the aforementioned release of the U.S. valuation allowance, in addition to the net discrete tax charges recorded in
2018
associated with TCJA.
The effective tax rate for
2017
was
36.5
percent (provision on income) compared to
12.7
percent (provision on a loss) for
2016
. The change was primarily driven by the 2016 discrete tax charge for a valuation allowance recorded against our net deferred tax assets in the U.S., primarily related to asset impairment charges and the 2016 loss on divestiture.
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. The outcome of the litigation is still pending; however, we continue to believe that the assessment is baseless, and do not anticipate making a payment in connection with this assessment. 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 at its face value would result in an approximate €22 million, or $25 million, increase to income tax expense.
NET INCOME (LOSS) ATTRIBUTABLE TO KENNAMETAL
Net income attributable to Kennametal was
$200.2 million
, or
$2.42
EPS, in
2018
, compared to
$49.1 million
, or
$0.61
EPS, in
2017
. The increase is a result of the factors previously discussed.
Net income attributable to Kennametal was
$49.1 million
, or
$0.61
EPS, in
2017
, compared to a loss of
$226.0 million
, or
$2.83
loss per diluted share, in
2016
. The year-over-year change is a result of the factors previously discussed.
BUSINESS SEGMENT REVIEW
We operate in three reportable operating segments consisting of Industrial, Widia and Infrastructure. Corporate expenses that are not allocated are reported in Corporate. Segment determination is based upon internal organizational structure, the manner in which we organize segments for making operating decisions and assessing performance and the availability of separate financial results. See Note 20 of our consolidated financial statements set forth in Item 8 of this Annual Report.
Our sales and operating income (loss) by segment are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
2018
|
|
2017
|
|
2016
|
Sales:
|
|
|
|
|
|
Industrial
|
$
|
1,292,098
|
|
|
$
|
1,126,309
|
|
|
$
|
1,098,439
|
|
Widia
|
198,568
|
|
|
177,662
|
|
|
170,723
|
|
Infrastructure
|
877,187
|
|
|
754,397
|
|
|
829,274
|
|
Total sales
|
$
|
2,367,853
|
|
|
$
|
2,058,368
|
|
|
$
|
2,098,436
|
|
|
|
|
|
|
|
Operating income (loss):
|
|
|
|
|
|
Industrial
|
$
|
187,495
|
|
|
$
|
82,842
|
|
|
$
|
90,324
|
|
Widia
|
4,441
|
|
|
(9,606
|
)
|
|
(9,081
|
)
|
Infrastructure
|
119,701
|
|
|
40,011
|
|
|
(246,306
|
)
|
Corporate
|
(4,072
|
)
|
|
(303
|
)
|
|
(9,880
|
)
|
Total operating income (loss)
|
$
|
307,565
|
|
|
$
|
112,944
|
|
|
$
|
(174,943
|
)
|
|
|
|
|
|
|
Interest expense
|
$
|
30,081
|
|
|
$
|
28,842
|
|
|
$
|
27,752
|
|
Other expense (income), net
|
2,443
|
|
|
2,227
|
|
|
(4,124
|
)
|
Income (loss) before income taxes
|
$
|
275,041
|
|
|
$
|
81,875
|
|
|
$
|
(198,571
|
)
|
INDUSTRIAL
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
2018
|
|
2017
|
|
2016
|
Sales
|
|
$
|
1,292,098
|
|
|
$
|
1,126,309
|
|
|
$
|
1,098,439
|
|
Operating income
|
|
187,495
|
|
|
82,842
|
|
|
90,324
|
|
Operating margin
|
|
14.5
|
%
|
|
7.4
|
%
|
|
8.2
|
%
|
|
|
|
|
|
|
|
|
(in percentages)
|
|
2018
|
|
2017
|
Organic sales growth
|
|
11
|
%
|
|
5
|
%
|
Foreign currency exchange impact
|
|
5
|
|
|
(2
|
)
|
Business days impact
|
|
(1
|
)
|
|
—
|
|
Sales growth
|
|
15
|
%
|
|
3
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Regional sales growth (decline):
|
|
As Reported
|
|
Constant Currency
|
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
EMEA
|
|
17
|
%
|
|
(1
|
)%
|
|
8
|
%
|
|
2
|
%
|
Asia Pacific
|
|
16
|
|
|
9
|
|
|
12
|
|
|
11
|
|
Americas
|
|
12
|
|
|
3
|
|
|
12
|
|
|
5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
End market sales growth (decline):
|
|
As Reported
|
|
Constant Currency
|
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Energy
|
|
15
|
%
|
|
2
|
%
|
|
11
|
%
|
|
5
|
%
|
General engineering
|
|
15
|
|
|
5
|
|
|
10
|
|
|
7
|
|
Aerospace and defense
|
|
14
|
|
|
4
|
|
|
11
|
|
|
6
|
|
Transportation
|
|
13
|
|
|
(1
|
)
|
|
8
|
|
|
2
|
|
In
2018
, Industrial sales of
$1,292.1 million
increased by
$165.8 million
, or
15 percent
, from
2017
. General engineering sales experienced growth from the indirect channel across all regions, a more robust light and general engineering sector in EMEA and the Americas as well as growth in sales to tooling manufacturers in EMEA. Transportation sales to tier suppliers globally increased in the period, as well as to OEMs in EMEA and Asia Pacific. These increases were partially offset by lower sales to OEMs in the Americas. Conditions continue to be favorable in the aerospace sector due to growth in engine sales in the Americas and Asia Pacific supplemented by increasing demand related to frames in the Americas. Oil and gas sales in the Americas continue to provide overall growth in energy in addition to increases in renewable power generation sales in the Americas and EMEA. The sales increases in Asia Pacific and EMEA were primarily driven by the performance in the transportation and general engineering end markets. The sales increase in the Americas was primarily driven by the performance in the general engineering, aerospace and defense and energy end markets.
In
2018
, Industrial operating income was
$187.5 million
, a
$104.7 million
increase from
2017
. The primary drivers for the increase were organic sales growth, incremental restructuring and modernization benefits of approximately $34 million, $31.5 million less restructuring and related charges and favorable currency exchange impact of $10.7 million, partially offset by decreased manufacturing efficiency in part due to modernization efforts in progress, higher variable compensation expense due to higher than expected operating results and salary inflation.
In
2017
, Industrial sales of
$1,126.3 million
increased by
$27.9 million
, or
3 percent
, from
2016
. General engineering sales benefited globally from growth in the indirect channel, supported by increasing demand in the U.S. energy markets and China transportation markets, and to a lesser extent the addition of new distributors. Sales to airplane engine manufacturers globally was the primary driver of the sales growth in aerospace. In addition, we experienced growth in frame-related sales in EMEA and Asia Pacific that were offset by declines in the Americas. Oil and gas drilling and power generation in the Americas contributed to the growth in energy sales while energy-related sales were down in EMEA and Asia Pacific. Transportation performance was mixed for the fiscal year with overall growth coming from Asia Pacific. Sales to tier suppliers were up, as strong Asia Pacific growth was offset by declines in EMEA and the Americas. Similarly, growth in sales to OEMs in Asia Pacific was offset by declines in the other regions. In addition, railroad-related sales declined primarily in the Americas. The sales increase in Asia Pacific was driven by transportation, general engineering and aerospace and defense. The sales increase in the Americas was driven by general engineering and energy and to a lesser extent aerospace and defense, offset partially by decreases in transportation. The sales increase in EMEA was driven by general engineering and aerospace and defense, offset partially by decreases in transportation and energy.
In
2017
, Industrial operating income was
$82.8 million
, a
$7.5 million
decrease from
2016
. The primary drivers of the decrease in operating income were $20.6 million more in restructuring charges, unfavorable currency exchange, unfavorable business mix, higher performance-based compensation and higher raw material costs, partially offset by $40 million incremental restructuring benefits, organic sales growth and prior period loss on divestiture and fixed asset disposal charges of $3.6 million and $2.6 million, respectively.
WIDIA
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
2018
|
|
2017
|
|
2016
|
Sales
|
|
$
|
198,568
|
|
|
$
|
177,662
|
|
|
$
|
170,723
|
|
Operating income (loss)
|
|
4,441
|
|
|
(9,606
|
)
|
|
(9,081
|
)
|
Operating margin
|
|
2.2
|
%
|
|
(5.4
|
)%
|
|
(5.3
|
)%
|
|
|
|
|
|
|
|
|
(in percentages)
|
|
2018
|
|
2017
|
Organic sales growth
|
|
9
|
%
|
|
6
|
%
|
Foreign currency exchange impact
|
|
3
|
|
|
—
|
|
Business days impact
|
|
—
|
|
|
(2
|
)
|
Sales growth
|
|
12
|
%
|
|
4
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Regional sales growth (decline):
|
|
As Reported
|
|
Constant Currency
|
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
EMEA
|
|
20
|
%
|
|
(3
|
)%
|
|
14
|
%
|
|
(2
|
)%
|
Asia Pacific
|
|
18
|
|
|
11
|
|
|
15
|
|
|
12
|
|
Americas
|
|
4
|
|
|
4
|
|
|
4
|
|
|
4
|
|
In
2018
, Widia sales of
$198.6 million
increased by
$20.9 million
, or
12 percent
, from
2017
. Sales in EMEA have benefited from the reestablishment of the national and local distribution network in Central Europe. Sales growth was broadly strong across Asia Pacific, due in part to tapping into new demand streams and benefits from establishing the brand channel strategy globally. In the Americas, we continue to make steady progress in establishing an effective distribution network. We have selectively exited portions of our portfolio to improve profitability.
In
2018
, Widia operating income was
$4.4 million
compared to an operating loss of
$9.6 million
in
2017
. The year-over-year change of
$14.0 million
was driven primarily by organic sales growth, $6.0 million less restructuring and related charges and incremental restructuring benefits of approximately $1 million, partially offset by higher variable compensation expense due to higher than expected operating results and unfavorable mix.
In
2017
, Widia sales of
$177.7 million
increased by
$6.9 million
, or
4 percent
, from
2016
. Sales benefited globally from growth in the indirect channel, supported by increasing demand in the U.S. energy markets and China transportation markets, and to a lesser extent the addition of new distributors. Unlike the prior year, for those indirect lines where we have visibility, we believe that we did not experience destocking in the indirect channel, as sales were generally consistent with end-user purchases.
In
2017
, Widia operating loss was
$9.6 million
and increased by
$0.5 million
from
2016
. The primary drivers of the increase in operating loss were $3.6 million higher restructuring and related charges, unfavorable mix and unfavorable currency exchange, partially offset by incremental restructuring benefits of approximately $6 million, organic sales growth, a prior period other intangible asset impairment charge of $2.3 million, lower raw material costs, higher absorption and productivity and prior period fixed asset disposal charges of $0.7 million.
INFRASTRUCTURE
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
2018
|
|
2017
|
|
2016
|
Sales
|
|
$
|
877,187
|
|
|
$
|
754,397
|
|
|
$
|
829,274
|
|
Operating income (loss)
|
|
119,701
|
|
|
40,011
|
|
|
(246,306
|
)
|
Operating margin
|
|
13.6
|
%
|
|
5.3
|
%
|
|
(29.7
|
)%
|
|
|
|
|
|
|
|
|
(in percentages)
|
|
2018
|
|
2017
|
Organic sales growth
|
|
15
|
%
|
|
1
|
%
|
Foreign currency exchange impact
|
|
2
|
|
|
(1
|
)
|
Business days impact
|
|
(1
|
)
|
|
—
|
|
Divestiture impact
|
|
—
|
|
|
(9
|
)
|
Sales growth
|
|
16
|
%
|
|
(9
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Regional sales growth (decline):
|
|
As Reported
|
|
Constant Currency
|
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Asia Pacific
|
|
24
|
%
|
|
(5
|
)%
|
|
20
|
%
|
|
2
|
%
|
Americas
|
|
16
|
|
|
(3
|
)
|
|
16
|
|
|
3
|
|
EMEA
|
|
10
|
|
|
(30
|
)
|
|
1
|
|
|
(6
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
End market sales growth (decline):
|
|
As Reported
|
|
Constant Currency
|
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Energy
|
|
20
|
%
|
|
2
|
%
|
|
19
|
%
|
|
11
|
%
|
General Engineering
|
|
19
|
|
|
(7
|
)
|
|
16
|
|
|
6
|
|
Earthworks
|
|
10
|
|
|
(12
|
)
|
|
7
|
|
|
(6
|
)
|
In
2018
, Infrastructure sales of
$877.2 million
increased by
$122.8 million
, or
16 percent
, from
2017
. Infrastructure saw improvements in all end markets, including underground mining and construction. Year-over-year growth in energy was strong with an increase in rig count activity and increased power generation activity. Strong growth in general engineering is driven primarily by overall more robust activity in the general economy, particularly in the Americas. The sales increase in Asia Pacific was driven primarily by the performance in the earthworks and general engineering end markets. Growth in the Americas was driven by the performance in all three end markets: energy, general engineering and earthworks. The slight increase in sales in EMEA was driven primarily by the performance in the general engineering end market, partially offset by a decrease in earthworks.
In
2018
, Infrastructure operating income was
$119.7 million
, a
79.7 million
increase from
2017
. The primary drivers for the increase were organic sales growth, $22.9 million less restructuring and related charges, incremental restructuring and modernization benefits of approximately $21 million, favorable currency exchange impact and favorable mix, partially offset by higher raw material costs, higher variable compensation expense due to higher than expected operating results and higher overtime costs.
In
2017
, Infrastructure sales of
$754.4 million
decreased by
$74.9 million
, or
9 percent
, from
2016
. Beginning in 2017, the segment reported year-over-year quarterly sales declines. However, during the year, sales improved sequentially and the year ended with two consecutive quarters of organic sales growth after two and a half years of organic sales declines. For the year, sales were positively impacted by the energy markets which continued to strengthen during 2017. Challenging conditions in underground mining continued to drive sales declines, particularly in North America and Asia, and construction sales primarily in EMEA. The sales increase in the Americas was driven by oil and gas and general engineering, partially offset by a decrease in earthworks. The sales increase in Asia Pacific was driven by general engineering and to a lesser extent energy, partially offset by a decrease in earthworks. The sales decrease in EMEA was driven primarily by a decrease in construction, offset partially by an increase in mining.
In
2017
, Infrastructure operating income was
$40.0 million
, compared to operating loss of
$246.3 million
in 2016. The year-over-year change in operating results was due primarily to a prior period $127.9 million loss on divestiture and prior period goodwill and other intangible asset impairment charges of $106.1 million. Additionally, comparative operating results were impacted by incremental restructuring benefits of approximately $26 million, lower raw material costs, higher absorption and productivity and prior year divestiture impact of $1.9 million, offset partially by $4.2 million increase in restructuring and related charges and the negative impacts of unfavorable price and mix.
CORPORATE
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
2018
|
|
2017
|
|
2016
|
Corporate expense
|
|
$
|
(4,072
|
)
|
|
$
|
(303
|
)
|
|
$
|
(9,880
|
)
|
In
2018
, Corporate expense increased
$3.8 million
from
2017
, primarily due to higher professional fees. In
2017
, Corporate expense decreased
$9.6 million
from
2016
, primarily due to $5.7 million lower restructuring-related charges and lower professional fees.
LIQUIDITY AND CAPITAL RESOURCES
Cash flow from operations is the primary source of funding for our capital expenditures. During the year ended
June 30, 2018
, cash flow provided by operating activities was
$277.3 million
.
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 as an additional source of funds. The Credit Agreement provides for revolving credit loans of up to
$700.0 million
for working capital, capital expenditures and general corporate purposes. The Credit Agreement allows for borrowings 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. We had
no
outstanding borrowings on our Credit Agreement as of
June 30, 2018
.
The Credit Agreement requires us to comply with various restrictive and affirmative covenants, including two financial covenants: a maximum leverage ratio and a minimum consolidated interest coverage ratio (as those terms are defined in the Credit agreement). We were in compliance with all covenants as of
June 30, 2018
. For the year ended
June 30, 2018
, average daily borrowings outstanding under the Credit Agreement were approximately $1.0 million. We had
no
borrowings outstanding under the Credit Agreement as of
June 30, 2018
and
2017
. Borrowings under the Credit Agreement are guaranteed by our significant domestic subsidiaries.
Additionally, we obtain local financing through credit lines with commercial banks in the various countries in which we operate. At
June 30, 2018
, these borrowings amounted to
$0.9 million
of notes payable. We believe that cash flow from operations and the availability under our credit lines will be sufficient to meet our cash requirements over the next 12 months.
Based upon our debt structure at
June 30, 2018
and
2017
, less than 1 percent of our debt was exposed to variable rates of interest.
We consider substantially all of the unremitted earnings of our non-U.S. subsidiaries to be permanently reinvested. As a result of TCJA, which among other provisions allows for a 100 percent dividends received deduction from controlled foreign subsidiaries, we are in the process of re-evaluating our assertion with respect to permanent reinvestment. As part of this evaluation, we are considering our global working capital and capital investment requirements, among other considerations, including the potential tax liabilities that would be incurred if the non-U.S. subsidiaries distribute cash to the U.S. parent. If we determine that an entity should no longer remain subject to the permanent reinvestment assertion, we will accrue additional tax charges, including but not limited to state income taxes, withholding taxes, U.S. tax on foreign currency gains and losses and other relevant foreign taxes in the period the conclusion is determined. As of June 30, 2018, the unremitted earnings and profits of our non-U.S. subsidiaries and affiliates is approximately $1.3 billion. This amount has been subject to U.S. federal income tax, but may remain subject to state and foreign taxes if repatriated. In accordance with SAB 118, we expect to complete our evaluation by December 22, 2018.
During 2018, we estimated the toll tax charge to be $80.9 million after available foreign tax credits. The toll tax charge consumed our entire U.S. federal net operating loss carryforward and other credit carryforwards, which represent a significant portion of our previously available deferred tax assets, and was offset by the release of the valuation allowance associated with these assets. We estimate a cash payment of $3.5 million associated with the toll charge which will be paid over eight years, of which $3.2 million is classified as long-term accrued income taxes in our consolidated balance sheet as of June 30, 2018. The toll tax charge is preliminary, and subject to finalization of the 2018 U.S. federal income tax return and applying any additional regulatory guidance issued after June 30, 2018.
At
June 30, 2018
, we had cash and cash equivalents of
$556.2 million
. Total Kennametal Shareholders’ equity was
$1,194.3 million
and total debt was
$991.7 million
. Our current senior credit ratings are considered investment grade. We believe that our current financial position, liquidity and credit ratings provide us access to the capital markets. We continue to closely monitor our liquidity position and the condition of the capital markets, as well as the counterparty risk of our credit providers.
The following is a summary of our contractual obligations and other commercial commitments as of
June 30, 2018
(in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contractual Obligations
|
|
|
|
Total
|
|
2019
|
|
2020-2021
|
|
2022-2023
|
|
Thereafter
|
Long-term debt, including current maturities
|
|
(1
|
)
|
|
$
|
1,124,781
|
|
|
$
|
425,500
|
|
|
$
|
51,000
|
|
|
$
|
335,500
|
|
|
$
|
312,781
|
|
Notes payable
|
|
(2
|
)
|
|
1,063
|
|
|
1,063
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Pension benefit payments
|
|
|
|
(3)
|
|
49,273
|
|
|
101,971
|
|
|
106,352
|
|
|
(3)
|
Postretirement benefit payments
|
|
|
|
(3)
|
|
1,631
|
|
|
2,984
|
|
|
2,676
|
|
|
(3)
|
Operating leases
|
|
|
|
65,285
|
|
|
17,606
|
|
|
22,985
|
|
|
9,466
|
|
|
15,228
|
|
Purchase obligations
|
|
(4
|
)
|
|
343,076
|
|
|
170,497
|
|
|
143,464
|
|
|
29,115
|
|
|
—
|
|
Unrecognized tax benefits
|
|
(5
|
)
|
|
7,032
|
|
|
3,890
|
|
|
1,034
|
|
|
—
|
|
|
2,108
|
|
Total
|
|
|
|
|
|
$
|
669,460
|
|
|
$
|
323,438
|
|
|
$
|
483,109
|
|
|
|
|
|
|
(1)
|
Long-term debt includes interest obligations of $125.9 million and excludes debt issuance costs of
$6.8 million
. Interest obligations were determined assuming interest rates as of
June 30, 2018
remain constant.
|
|
|
(2)
|
Notes payable includes interest obligations of $0.1 million. Interest obligations were determined assuming interest rates as of
June 30, 2018
remain constant.
|
|
|
(3)
|
Annual payments are expected to continue into the foreseeable future at the amounts noted in the table.
|
|
|
(4)
|
Purchase obligations consist of purchase commitments for materials, supplies and machinery and equipment as part of the ordinary conduct of business. Purchase obligations with variable price provisions were determined assuming market prices as of
June 30, 2018
remain constant.
|
|
|
(5)
|
Unrecognized tax benefits are positions taken or expected to be taken on an income tax return that may result in additional payments to tax authorities. These amounts include interest of $1.1 million and penalty of $0.1 million accrued related to such positions as of
June 30, 2018
. Positions for which we are not able to reasonably estimate the timing of potential future payments are included in the ‘Thereafter’ column. If a tax authority agrees with the tax position taken or expected to be taken or the applicable statute of limitations expires, then additional payments will not be necessary.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other Commercial Commitments
|
|
Total
|
|
2019
|
|
2020-2021
|
|
2022-2023
|
|
Thereafter
|
Standby letters of credit
|
|
$
|
4,190
|
|
|
$
|
2,608
|
|
|
$
|
1,582
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Guarantees
|
|
10,844
|
|
|
5,262
|
|
|
1,473
|
|
|
—
|
|
|
4,109
|
|
Total
|
|
$
|
15,034
|
|
|
$
|
7,870
|
|
|
$
|
3,055
|
|
|
$
|
—
|
|
|
$
|
4,109
|
|
The standby letters of credit relate to insurance and other activities. The guarantees are non-debt guarantees with financial institutions, which are required primarily for security deposits, product performance guarantees and advances.
Cash Flow Provided by Operating Activities
During
2018
, cash flow provided by operating activities was
$277.3 million
, compared to
$195.3 million
in
2017
. During
2018
, cash flow provided by operating activities consisted of net income and non-cash items amounting to
$361.9 million
and changes in certain assets and liabilities netting to an outflow of
$84.6 million
. Contributing to the changes in certain assets and liabilities were an increase inventories of
$37.2 million
, a decrease in accrued pension and postretirement benefits of
$26.8 million
, an increase in accounts receivable of
$22.2 million
and a decrease in accounts payable and accrued liabilities of
$5.0 million
, partially offset by an increase in accrued income taxes of
$11.1 million
. The increases in inventories and accounts receivable are due in part to higher demand in our end markets, in addition to the effects of raw material cost inflation on inventories.
During
2017
, cash flow provided by operating activities was
$195.3 million
, compared to
$222.5 million
in
2016
. Cash flow provided by operating activities consisted of net income and non-cash items amounting to
$188.9 million
and changes in certain assets and liabilities netting to an inflow of
$6.5 million
. Contributing to the changes in certain assets and liabilities were an increase in accounts payable and accrued liabilities of
$54.6 million
and an increase in accrued income taxes of
$6.9 million
. Partially offsetting these inflows were a decrease in accrued pension and postretirement benefits of
$27.8 million
, an increase in inventories of
$24.3 million
and an increase in accounts receivable of
$7.6 million
. The increases in inventories, accounts payable and accounts receivable are due in part to higher demand in most of our end markets.
During
2016
, cash flow provided by operating activities was
$222.5 million
. Cash flow provided by operating activities consisted of net income and non-cash items amounting to
$163.8 million
and changes in certain assets and liabilities netting to
$58.7 million
. These changes were primarily driven by a decrease in inventory of $69.6 million due to our continued focus on working capital management and a decrease in accounts receivable of $32.7 million due to lower sales volume. Partially offsetting these inflows were a decrease in accrued income taxes of $25.2 million driven by payment of a capital gains tax related to a prior period tax reorganization.
Cash Flow Used for Investing Activities
Cash flow used for investing activities was
$156.9 million
for
2018
, an increase of
$44.1 million
, compared to
$112.7 million
in
2017
. During
2018
, cash flow used for investing activities included capital expenditures, net of
$156.6 million
, which consisted primarily of machinery and equipment upgrades and additions related to our modernization initiatives and capacity additions.
Cash flow used for investing activities was
$112.7 million
for
2017
, an increase of
$64.8 million
, compared to
$47.9 million
in
2016
. During
2017
, cash flow used for investing activities included capital expenditures, net of
$113.0 million
, which consisted primarily of equipment purchases.
Cash flow used for investing activities was
$47.9 million
for
2016
. During
2016
, cash flow used for investing activities included capital expenditures, net of
$104.7 million
, which consisted primarily of equipment purchases. Partially offsetting this outflow was an inflow of $56.1 million of proceeds from the divestiture of non-core businesses.
Cash Flow Provided by (Used for) Financing Activities
Cash flow provided by financing activities was
$247.2 million
for
2018
, compared to cash flow used for financing activities of
$53.3 million
in
2017
. During
2018
, cash flow provided by financing activities included a
$296.2 million
net increase in borrowings due primarily to the issuance of the New Notes and
$18.0 million
of the effect of employee benefit and stock plans and dividend reinvestment, partially offset by
$65.1 million
of cash dividends paid to Shareholders.
Cash flow used for financing activities was
$53.3 million
for
2017
, compared to
$113.6 million
in
2016
. During
2017
, cash flow used for financing activities included
$64.1 million
of cash dividends paid to Shareholders, a $6.6 million payment on the remaining contingent consideration related to a prior acquisition and
$0.9 million
net decrease in borrowings, partially offset by
$18.3 million
of the effect of employee benefit and stock plans and dividend reinvestment.
Cash flow used for financing activities was
$113.6 million
in
2016
. During
2016
, cash flow used for financing activities included
$63.7 million
of cash dividends paid to Shareholders and
$50.8 million
net decrease in borrowings, partially offset by
$1.3 million
of dividend reinvestment and the effect of employee benefit and stock plans.
FINANCIAL CONDITION
At
June 30, 2018
, total assets were
$2,925.7 million
, an increase of
$510.2 million
from
$2,415.5 million
at
June 30, 2017
. Total liabilities increased
$332.6 million
from
$1,362.8 million
at
June 30, 2017
to
$1,695.4 million
at
June 30, 2018
.
Working capital was
$659.6 million
at
June 30, 2018
, an increase of
$7.2 million
from
$652.4 million
at
June 30, 2017
. The increase in working capital was primarily driven by an increase in cash and cash equivalents of
$365.5 million
, an increase in inventory of
$37.8 million
due primarily to increasing demand and cost inflation and an increase in accounts receivable of
$20.9 million
due in part to increasing volumes. Partially offsetting these items were an increase in current maturities of long-term debt and capital leases of
$399.1 million
due to the reclassification of our
$400.0 million
Notes to current maturities due to our notification of early redemption to bondholders creating an irrevocable commitment to redeem the debt, an increase in accrued income taxes of
$12.4 million
due primarily to increased taxable income in taxpaying jurisdictions and an increase in accrued payroll of
$9.6 million
. The currency exchange rate impact to working capital, which is included in the aforementioned changes, lowered working capital by $4.8 million compared to the prior year.
Property, plant and equipment, net increased
$79.8 million
from
$744.4 million
at
June 30, 2017
to
$824.2 million
at
June 30, 2018
, primarily due to
capital additions
of $180.5 million and favorable currency exchange impacts of $1.5 million. This increase was partially offset by depreciation expense of
$94.0 million
and disposals of
$14.4 million
.
At
June 30, 2018
, other assets were
$555.4 million
, a decrease of
$1.8 million
from
$557.2 million
at
June 30, 2017
. Pension plan assets increased
$25.3 million
. Offsetting this increase was a decrease in other intangible assets of
$14.1 million
which was primarily due to amortization expense of
$14.7 million
, a decrease in deferred income taxes of
$11.3 million
due in part to an out of period adjustment related to tax assets recorded on intra-entity inventory transfers, partially offset by release of the valuation allowance on U.S. deferred tax assets, and a decrease in assets held for sale of
$7.0 million
primarily due to the sale of the Houston closed manufacturing location that was part of our legacy restructuring program.
Long-term debt and capital leases decreased
$103.5 million
to
$591.5 million
at
June 30, 2018
from
$695.0 million
at
June 30, 2017
primarily due to the aforementioned reclassification of the
$400.0 million
Notes to current maturities as of
June 30, 2018
. The redemption of the $400.0 million Notes was completed on July 9, 2018. This decrease was partially offset by the June 2018 issuance of
$300.0 million
of
4.625 percent
Senior Unsecured Notes.
Kennametal Shareholders’ equity was
$1,194.3 million
at
June 30, 2018
, an increase of
$177.0 million
from
$1,017.3 million
in the prior year. The increase was primarily due to net income attributable to Kennametal of
$200.2 million
, capital stock issued under employee benefit and stock plans of
$38.6 million
, the reclassification of net pension and other postretirement benefit loss of
$7.3 million
and the reclassification of unrealized loss on expired derivatives designated and qualified as cash flow hedges of
$3.7 million
, partially offset by cash dividends paid to Shareholders of
$65.1 million
.
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 locations in the countries in which we operate.
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 United States Environmental Protection Agency (USEPA) as a Potentially Responsible Party (PRP) with respect to environmental remedial costs at certain Superfund sites. We have evaluated our claims and potential liability associated with these Superfund sites based upon the best information currently available to us. We believe our environmental accruals will be adequate to cover our portion of the environmental remedial costs at those Superfund sites where we have been designated a PRP, to the extent these expenses are probable and reasonably estimable.
Other Environmental Issues
We establish and maintain reserves for other potential environmental issues. At
June 30, 2018
and
2017
, the balance of these reserves was
$12.5 million
and
$12.4 million
, respectively. These reserves represent anticipated costs associated with the remediation of these environmental issues and are generally not discounted.
The reserves we have established for our 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, taking into consideration our prior experience in environmental remediation and the experiences of other companies, as well as public information released by the USEPA, other governmental agencies, and by the PRP groups in which we are participating. Although our reserves currently appear to be sufficient to cover our potential environmental liabilities, there are uncertainties associated with environmental remediation matters, and we can give no assurance that our estimate of any environmental liability will not increase or decrease in the future. Our reserved and unreserved liabilities for environmental matters 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.
We maintain a Corporate EHS Department to monitor our compliance with environmental regulations and to oversee our remediation activities. In addition, we have designated EHS analysts who are responsible for each of our global manufacturing facilities. Our financial management team periodically meets with members of the Corporate EHS Department and the Corporate Legal Department to review and evaluate the status of environmental projects and contingencies. On a quarterly basis, we review financial provisions and reserves for environmental contingencies and adjust these reserves when appropriate.
EFFECTS OF INFLATION
Despite modest inflation in recent years, rising costs, including the cost of certain raw materials, continue to affect our operations throughout the world. We strive to minimize the effects of inflation through cost containment, productivity improvements and price increases.
DISCUSSION OF CRITICAL ACCOUNTING POLICIES
In preparing our financial statements in conformity with accounting principles generally accepted in the U.S., we make judgments and estimates about the amounts reflected in our financial statements. As part of our financial reporting process, our management collaborates to determine the necessary information on which to base our judgments and develops estimates used to prepare the financial statements. We use historical experience and available information to make these judgments and estimates. However, different amounts could be reported using different assumptions and in light of different facts and circumstances. Therefore, actual amounts could differ from the estimates reflected in our financial statements. Our significant accounting policies are described in Note 2 of our financial statements, which are included in Item 8 of this Annual Report. We believe that the following discussion addresses our critical accounting policies.
Revenue Recognition
We recognize revenue for our products and assembled machines when title and all risks of loss and damages pass to the buyer. Our general conditions of sale explicitly state that the delivery of our products and assembled machines is freight on board shipping point and that title and all risks of loss and damages pass to the buyer upon delivery of the sold products or assembled machines to the common carrier.
We recognize revenue related to the sale of specialized assembled machines upon customer acceptance and installation, as installation is deemed essential to the functionality of a specialized assembled machine. Sales of specialized assembled machines were immaterial for
2018
,
2017
and
2016
.
Our general conditions of sale explicitly state that acceptance of the conditions of shipment is considered to have occurred unless written notice of objection is received by Kennametal within 10 calendar days of the date specified on the invoice. We do not ship products or assembled machines unless we have documentation authorizing shipment to our customers. The majority of our products are consumed by our customers in the manufacture of their products. Historically, we have experienced very low levels of returned products and assembled machines and do not consider the effect of returned products and assembled machines to be material. We have recorded an estimated returned goods allowance to provide for any potential returns.
We warrant that products and services sold are free from defects in material and workmanship under normal use and service when correctly installed, used and maintained. This warranty terminates 30 days after delivery of the product to the customer and does not apply to products that have been subjected to misuse, abuse, neglect or improper storage, handling or maintenance. Products may be returned to Kennametal only after inspection and approval by Kennametal and upon receipt by the customer of shipping instructions from Kennametal. We have included an estimated allowance for warranty returns in our returned goods allowance discussed above.
Stock-Based Compensation
We recognize stock-based compensation expense for all stock options, restricted stock awards and restricted stock units over the period from the date of grant to the date when the award is no longer contingent on the employee providing additional service (substantive vesting period), net of expected forfeitures. We utilize the Black-Scholes valuation method to establish the fair value of all stock option awards. Time vesting stock units are valued at the market value of the stock on the grant date. Performance vesting stock units with a market condition are valued using a Monte Carlo model.
Accounting for Contingencies
We accrue for contingencies when it is probable that a liability or loss has been incurred and the amount can be reasonably estimated. Contingencies by their nature relate to uncertainties that require the exercise of judgment in both assessing whether or not a liability or loss has been incurred and estimating the amount of probable loss. The significant contingencies affecting our financial statements include environmental, health and safety matters and litigation.
Long-Lived Assets
We evaluate the recoverability of property, plant and equipment and intangible assets that are amortized whenever events or changes in circumstances indicate the carrying amount of such assets may not be fully recoverable. Changes in circumstances include technological advances, changes in our business model, capital structure, economic conditions or operating performance. Our evaluation is based upon, among other things, our assumptions about the estimated future undiscounted cash flows these assets are expected to generate. When the sum of the undiscounted cash flows is less than the carrying value, we will recognize an impairment loss to the extent that carrying value exceeds fair value. We apply our best judgment when performing these evaluations to determine if a triggering event has occurred, the undiscounted cash flows used to assess recoverability and the fair value of the asset.
Goodwill and Indefinite-Lived Intangible Assets
We evaluate the recoverability of goodwill of each of our reporting units by comparing the fair value of each reporting unit with its carrying value. The fair values of our reporting units are determined using a combination of a discounted cash flow analysis and market multiples based upon historical and projected financial information. We apply our best judgment when assessing the reasonableness of the financial projections used to determine the fair value of each reporting unit. We evaluate the recoverability of indefinite-lived intangible assets using a discounted cash flow analysis based on projected financial information. We perform our annual impairment tests during the June quarter in connection with our annual planning process unless there are impairment indicators based on the results of an ongoing cumulative qualitative assessment that warrant a test prior to that quarter.
The
$274.3 million
of goodwill allocated to the Industrial reporting unit and the
$27.5 million
of goodwill allocated to the Widia reporting unit are not at risk of failing Step 1 of the impairment test since fair value substantially exceeded the carrying value as of the date of the last impairment test. Certain factors could negatively affect the estimated fair value, of the Widia reporting unit in particular, including items such as: (i) a decrease in expected future cash flows, specifically, a decrease in sales volume driven by a prolonged weakness in consumer demand or other competitive pressures adversely affecting our long-term volume trends and an inability to successfully achieve our cost savings targets; and (ii) inability to achieve all of the anticipated benefits from simplification and modernization actions assumed. There is
no
goodwill allocated to the Infrastructure reporting unit. Further, an indefinite-lived trademark intangible asset of $15.0 million in the Widia reporting unit had a fair value that approximated its carrying value as of the date of the last impairment test. The estimated fair value of this asset could be negatively affected by a decrease in expected future cash flows, specifically, a decrease in sales volume driven by a prolonged weakness in consumer demand or other competitive pressures adversely affecting our long-term volume trends.
Pension and Other Postretirement Benefits
We sponsor pension and other postretirement benefit plans for certain employees and retirees. Accounting for the cost of these plans requires the estimation of the cost of the benefits to be provided well into the future and attributing that cost over either the expected work life of employees or over average life of participants participating in these plans, depending on plan status and on participant population. This estimation requires our judgment about the discount rate used to determine these obligations, expected return on plan assets, rate of future compensation increases, rate of future health care costs, withdrawal and mortality rates and participant retirement age. Differences between our estimates and actual results may significantly affect the cost of our obligations under these plans.
In the valuation of our pension and other postretirement benefit liabilities, management utilizes various assumptions. Our discount rates are derived by identifying a theoretical settlement portfolio of high quality corporate bonds sufficient to provide for a plan’s projected benefit payments. This rate can fluctuate based on changes in the corporate bond yields. At
June 30, 2018
, a hypothetical 25 basis point increase in our discount rates would increase our pre-tax income by approximately $0.1 million, and a hypothetical 25 basis point decrease in our discount rates would decrease our pre-tax income by approximately $0.1 million.
The long-term rate of return on plan assets is estimated based on an evaluation of historical returns for each asset category held by the plans, coupled with the current and short-term mix of the investment portfolio. The historical returns are adjusted for expected future market and economic changes. This return will fluctuate based on actual market returns and other economic factors.
The rate of future health care cost increases is based on historical claims and enrollment information projected over the next fiscal year and adjusted for administrative charges. This rate is expected to decrease until 2027. At
June 30, 2018
, a hypothetical 1 percent increase or decrease in our health care cost trend rates would be immaterial to our pre-tax income.
Future compensation rates, withdrawal rates and participant retirement age are determined based on historical information. These assumptions are not expected to significantly change. Mortality rates are determined based on a review of published mortality tables.
We expect to contribute approximately
$8.1 million
and
$1.6 million
to our pension and other postretirement benefit plans, respectively, in
2019
.
In 2016, substantially all plan participants of the U.S. Retirement Income Plan (RIP) became inactive. As a result, the average remaining life expectancy of the inactive participants was used to amortize the unrecognized net gain or loss instead of the average remaining service period of active plan participants in future periods.
Allowance for Doubtful Accounts
We record allowances for estimated losses resulting from the inability of our customers to make required payments. We assess the creditworthiness of our customers based on multiple sources of information and analyze additional factors such as our historical bad debt experience, industry and geographic concentrations of credit risk, current economic trends and changes in customer payment terms. This assessment requires significant judgment. If the financial condition of our customers was to deteriorate, additional allowances may be required, resulting in future operating losses that are not included in the allowance for doubtful accounts at
June 30, 2018
.
Inventories
We use the last-in, first-out method for determining the cost of a significant portion of our U.S. inventories, and they are stated at the lower of cost or market. The cost of the remainder of our inventories is measured using approximate costs determined on the first-in, first-out basis or using the average cost method, and are stated at the lower of cost or net realizable value. When market conditions indicate an excess of carrying costs over market value, a lower of cost or net realizable value provision or a lower of cost or market provision, as applicable, is recorded. Excess and obsolete inventory reserves are established based upon our evaluation of the quantity of inventory on hand relative to demand.
Income Taxes
Realization of our deferred tax assets is primarily dependent on future taxable income, the timing and amount of which are uncertain, in part, due to the expected profitability of certain foreign subsidiaries. A valuation allowance is recognized if it is “more likely than not” that some or all of a deferred tax asset will not be realized. As of
June 30, 2018
, the deferred tax assets net of valuation allowances relate primarily to net operating loss carryforwards, pension benefits, accrued employee benefits and inventory reserves. In the event that we were to determine that we would not be able to realize our deferred tax assets in the future, an increase in the valuation allowance would be required. In the event we were to determine that we are able to use our deferred tax assets for which a valuation allowance is recorded, a decrease in the valuation allowance would be required.
NEW ACCOUNTING STANDARDS
Adopted
In March 2016, the Financial Accounting Standards Board (FASB) issued ASU No. 2016-09, "Improvements to Employee Share-Based Payment Accounting," which is intended to simplify equity-based award accounting and presentation. The guidance impacts income tax accounting related to equity-based awards, the classification of awards as either equity or liabilities, and the classification on the statement of cash flows. We adopted this guidance July 1, 2017. The adoption of this guidance resulted in three changes: (1) the increase to deferred tax assets of $1.4 million related to cumulative excess tax benefits previously unrecognized was offset by a valuation allowance, due to the valuation allowance position of our U.S. entity at the time of adoption of this standard; (2) excess tax benefits, previously reported in the financing activities section of the consolidated statements of cash flow, is now reported in the operating activities section, adopted on a prospective basis; therefore, prior period statements of cash flow were not retrospectively adjusted for this provision; and (3) employee taxes paid when Kennametal withholds shares for tax withholding purposes, previously reported in the operating activities section of the consolidated statement of cash flows, are now reported in the financing activities section, adopted on a retrospective basis; therefore, prior period statements of cash flow were retrospectively adjusted for this provision. Cash flow provided by operating activities and cash flow used for financing activities increased by $3.1 million and $3.2 million in 2017 and 2016, respectively.
In July 2015, the FASB issued ASU No. 2015-11, "Simplifying the Measurement of Inventory," which requires that inventory other than LIFO be subsequently measured at the lower of cost and net realizable value, as opposed to the previous practice of lower of cost or market. Subsequent measurement is unchanged for inventory measured using LIFO. We adopted this guidance July 1, 2017. Adoption of this guidance did not have a material impact on our consolidated financial statements.
Issued
In June 2018, the FASB issued ASU No. 2018-07, “Improvements to Nonemployee Share-Based Payment Accounting" which expands the scope of accounting for stock-based compensation to nonemployees. This guidance is effective for Kennametal July 1, 2019. We are in the process of assessing the impact the adoption of this guidance may have on our 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 related to 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. This guidance is optional and is effective for Kennametal July 1, 2019, although early adoption is permitted. We are in the process of assessing the impact the adoption of this guidance may have on our consolidated financial statements and determining whether we will adopt this guidance.
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. This guidance is effective for Kennametal July 1, 2019. We are in the process of assessing the impact the adoption of this guidance may have on our consolidated financial statements.
In May 2017, the FASB issued ASU No. 2017-09, "Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting," which clarifies when to account for a change to the terms or conditions of a share-based payment award as a modification. Under the new guidance, modification accounting is required only if the fair value, the vesting conditions, or the classification of the award (as equity or liability) changes as a result of the change in terms or conditions. This guidance is effective for Kennametal beginning July 1, 2018. We do not expect the adoption of this guidance to have a material effect on our consolidated financial statements.
In March 2017, the FASB issued ASU No. 2017-07, "Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost," which requires that an employer report the service cost component in the same line item or items as other compensation costs arising from services rendered by the pertinent employees during the period. The other components of net benefit cost are required to be presented in the income statement separately from the service cost component and outside a subtotal of income from operations. This guidance is effective for Kennametal beginning July 1, 2018, with the amendments to be applied retrospectively. We expect to reclassify combined effects of pension income and postretirement benefit cost of approximately
$17 million
and
$18 million
out of operating income and into non-operating income for 2018 and 2017, respectively, when comparative financial information is presented going forward.
In October 2016, the FASB issued ASU No. 2016-16, "Intra-Entity Transfers of Assets Other Than Inventory," which clarifies that an entity should recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. This guidance is effective for Kennametal beginning July 1, 2018. We do not expect the adoption of this guidance to have a material effect on our consolidated financial statements.
In August 2016, the FASB issued ASU No. 2016-15, "Classification of Certain Cash Receipts and Cash Payments (a consensus of the Emerging Issues Task Force)," which addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice with respect to how these are classified in the statement of cash flows. This guidance is effective for Kennametal beginning July 1, 2018. We do not expect the adoption of this guidance to have a material effect on our consolidated financial statements.
In June 2016, the FASB issued ASU No. 2016-13, "Measurement of Credit Losses on Financial Instruments," which introduces an approach based on expected losses to estimate credit losses on certain types of financial instruments. Beyond other modifications in the update, the scope of this amendment includes valuation of trade receivables. This standard is effective for Kennametal beginning July 1, 2020. We are in the process of assessing the impact the adoption of this guidance will have on our consolidated financial statements.
In February 2016, the FASB issued ASU No. 2016-02, "Leases: Topic 842," which replaces the existing guidance in ASC 840, Leases. The standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. This standard is effective for Kennametal beginning July 1, 2019. We have a project team in place that will begin inventorying our leasing arrangements. We are in the process of assessing the impact the adoption of this guidance will have on our consolidated financial statements. As of
June 30, 2018
, our undiscounted future minimum payments outstanding for lease obligations were approximately
$65 million
.
In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers: Topic 606.” This ASU, along with subsequent complementary updates in ASU Nos. 2015-14, 2016-08, 2016-10 and 2016-12 among others, replaces nearly all existing U.S. GAAP guidance on revenue recognition. The standard prescribes a five-step model for recognizing revenue, the application of which will require significant judgment. It also requires additional disclosures. We adopted this standard on July 1, 2018 using the modified retrospective approach. We have a project team that has performed a detailed review of the terms and provisions in customer contracts, and concluded that the new standard will not affect the timing nor measurement of revenue for these contracts in comparison to the results of historical accounting policies and practices. We do not expect the adoption of this guidance to have a material effect on our consolidated financial statements other than additional disclosures.
RECONCILIATION OF FINANCIAL MEASURES NOT DEFINED BY U.S. GAAP
In accordance with the SEC's Regulation G, we are providing descriptions of the non-GAAP financial measures included in this Annual Report and reconciliations to the most closely related GAAP financial measures. We believe that these measures provide useful perspective on underlying business trends and results and a supplemental measure of year-over-year results. The non-GAAP financial measures described below are used by management in making operating decisions, allocating financial resources and for business strategy purposes and may, therefore, also be useful to investors as they are a view of our business results through the eyes of management. These non-GAAP financial measures are not intended to be considered by the user in place of the related GAAP financial measure, but rather as supplemental information to our business results. These non-GAAP financial measures may not be the same as similar measures used by other companies due to possible differences in method and in the items or events being adjusted.
Organic sales growth
Organic sales growth is a non-GAAP financial measure of sales growth (decline) (which is the most directly comparable GAAP measure) excluding the impacts of acquisitions, divestitures, business days and foreign currency exchange from year-over-year comparisons. We believe this measure provides investors with a supplemental understanding of underlying sales trends by providing sales growth on a consistent basis. We report organic sales growth at the consolidated and segment levels.
Constant currency end market sales growth (decline)
Constant currency end market sales growth (decline) is a non-GAAP financial measure of sales growth (decline) (which is the most directly comparable GAAP measure) by end market excluding the impacts of acquisitions, divestitures and foreign currency exchange from year-over-year comparisons. We note that, unlike organic sales growth, constant currency end market sales growth (decline) does not exclude the impact of business days. We believe this measure provides investors with a supplemental understanding of underlying end market trends by providing end market sales growth (decline) on a consistent basis. We report constant currency end market sales growth (decline) at the consolidated and segment levels. Widia sales are reported only in the general engineering end market. Therefore, we do not provide constant currency end market sales growth (decline) for the Widia segment and, thus, do not include a reconciliation for that metric.
Constant currency regional sales growth (decline)
Constant currency regional sales growth (decline) is a non-GAAP financial measure of sales growth (decline) (which is the most directly comparable GAAP measure) by region excluding the impacts of acquisitions, divestitures and foreign currency exchange from year-over-year comparisons. We note that, unlike organic sales growth, constant currency regional sales growth (decline) does not exclude the impact of business days. We believe this measure provides investors with a supplemental understanding of underlying regional trends by providing regional sales growth (decline) on a consistent basis. We report constant currency regional sales growth (decline) at the consolidated and segment levels.
Reconciliations of organic sales growth to sales growth are as follows:
|
|
|
|
|
|
|
|
|
|
Year ended June 30, 2018
|
|
Industrial
|
|
Widia
|
|
Infrastructure
|
|
Total
|
Organic sales growth
|
|
11%
|
|
9%
|
|
15%
|
|
12%
|
Foreign currency exchange impact
(6)
|
|
5
|
|
3
|
|
2
|
|
4
|
Business days impact
(7)
|
|
(1)
|
|
—
|
|
(1)
|
|
(1)
|
Sales growth
|
|
15%
|
|
12%
|
|
16%
|
|
15%
|
|
|
|
|
|
|
|
|
|
|
Year ended June 30, 2017
|
|
Industrial
|
|
Widia
|
|
Infrastructure
|
|
Total
|
Organic sales growth
|
|
5%
|
|
6%
|
|
1%
|
|
4%
|
Foreign currency exchange impact
(6)
|
|
(2)
|
|
—
|
|
(1)
|
|
(2)
|
Business days impact
(7)
|
|
—
|
|
(2)
|
|
—
|
|
—
|
Divestiture impact
(8)
|
|
—
|
|
—
|
|
(9)
|
|
(4)
|
Sales growth (decline)
|
|
3%
|
|
4%
|
|
(9)%
|
|
(2)%
|
Reconciliations of constant currency end market sales growth (decline) to end market sales growth (decline)
(9)
, are as follows:
|
|
|
|
|
|
|
|
|
|
Industrial
|
|
|
|
|
|
|
|
|
Year ended June 30, 2018
|
|
General engineering
|
|
Transportation
|
|
Aerospace and defense
|
|
Energy
|
Constant currency end market sales growth
|
|
10%
|
|
8%
|
|
11%
|
|
11%
|
Foreign currency exchange impact
(6)
|
|
5
|
|
5
|
|
3
|
|
4
|
End market sales growth
(9)
|
|
15%
|
|
13%
|
|
14%
|
|
15%
|
|
|
|
|
|
|
|
|
Infrastructure
|
|
|
|
|
|
|
Year ended June 30, 2018
|
|
Energy
|
|
Earthworks
|
|
General engineering
|
Constant currency end market sales growth
|
|
19%
|
|
7%
|
|
16%
|
Foreign currency exchange impact
(6)
|
|
1
|
|
3
|
|
3
|
End market sales growth
(9)
|
|
20%
|
|
10%
|
|
19%
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
Year ended June 30, 2018
|
|
General engineering
|
|
Transportation
|
|
Aerospace and defense
|
|
Energy
|
|
Earthworks
|
Constant currency end market sales growth
|
|
11%
|
|
8%
|
|
11%
|
|
17%
|
|
7%
|
Foreign currency exchange impact
(6)
|
|
4
|
|
5
|
|
4
|
|
2
|
|
3
|
End market sales growth
(9)
|
|
15%
|
|
13%
|
|
15%
|
|
19%
|
|
10%
|
|
|
|
|
|
|
|
|
|
|
Industrial
|
|
|
|
|
|
|
|
|
Year ended June 30, 2017
|
|
General engineering
|
|
Transportation
|
|
Aerospace and defense
|
|
Energy
|
Constant currency end market sales growth
|
|
7%
|
|
2%
|
|
6%
|
|
5%
|
Foreign currency exchange impact
(6)
|
|
(2)
|
|
(3)
|
|
(2)
|
|
(3)
|
End market sales growth (decline)
(9)
|
|
5%
|
|
(1)%
|
|
4%
|
|
2%
|
|
|
|
|
|
|
|
|
Infrastructure
|
|
|
|
|
|
|
Year ended June 30, 2017
|
|
Energy
|
|
Earthworks
|
|
General engineering
|
Constant currency end market sales growth (decline)
|
|
11%
|
|
(6)%
|
|
6%
|
Foreign currency exchange impact
(6)
|
|
(1)
|
|
—
|
|
(1)
|
Divestiture impact
(8)
|
|
(8)
|
|
(6)
|
|
(12)
|
End market sales growth (decline)
(9)
|
|
2%
|
|
(12)%
|
|
(7)%
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
Year ended June 30, 2017
|
|
General engineering
|
|
Transportation
|
|
Aerospace and defense
|
|
Energy
|
|
Earthworks
|
Constant currency end market sales growth (decline)
|
|
6%
|
|
2%
|
|
4%
|
|
9%
|
|
(4)%
|
Foreign currency exchange impact
(6)
|
|
(1)
|
|
(3)
|
|
(2)
|
|
(1)
|
|
—
|
Divestiture impact
(8)
|
|
(3)
|
|
—
|
|
—
|
|
(6)
|
|
(6)
|
End market sales growth (decline)
(9)
|
|
2%
|
|
(1)%
|
|
2%
|
|
2%
|
|
(10)%
|
Reconciliations of constant currency regional sales growth (decline) to reported regional sales growth (decline)
(10)
, are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Industrial
|
|
Year Ended June 30, 2018
|
|
Year Ended June 30, 2017
|
|
|
Americas
|
|
EMEA
|
|
Asia Pacific
|
|
Americas
|
|
EMEA
|
|
Asia Pacific
|
Constant currency regional sales
growth (decline)
|
|
12%
|
|
8%
|
|
12%
|
|
5%
|
|
2%
|
|
11%
|
Foreign currency exchange impact
(6)
|
|
—
|
|
9
|
|
4
|
|
(1)
|
|
(3)
|
|
(2)
|
Divestiture impact
(8)
|
|
—
|
|
—
|
|
—
|
|
(1)
|
|
—
|
|
—
|
Regional sales growth (decline)
(10)
|
|
12%
|
|
17%
|
|
16%
|
|
3%
|
|
(1)%
|
|
9%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Widia
|
|
Year Ended June 30, 2018
|
|
Year Ended June 30, 2017
|
|
|
Americas
|
|
EMEA
|
|
Asia Pacific
|
|
Americas
|
|
EMEA
|
|
Asia Pacific
|
Constant currency regional sales
growth (decline)
|
|
4%
|
|
14%
|
|
15%
|
|
4%
|
|
(2)%
|
|
12%
|
Foreign currency exchange impact
(6)
|
|
—
|
|
6
|
|
3
|
|
—
|
|
(1)
|
|
(1)
|
Regional sales growth (decline)
(10)
|
|
4%
|
|
20%
|
|
18%
|
|
4%
|
|
(3)%
|
|
11%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Infrastructure
|
|
Year Ended June 30, 2018
|
|
Year Ended June 30, 2017
|
|
|
Americas
|
|
EMEA
|
|
Asia Pacific
|
|
Americas
|
|
EMEA
|
|
Asia Pacific
|
Constant currency regional sales
growth (decline)
|
|
16%
|
|
1%
|
|
20%
|
|
3%
|
|
(6)%
|
|
2%
|
Foreign currency exchange impact
(6)
|
|
—
|
|
9
|
|
4
|
|
—
|
|
—
|
|
(4)
|
Divestiture impact
(8)
|
|
—
|
|
—
|
|
—
|
|
(6)
|
|
(24)
|
|
(3)
|
Regional sales growth (decline)
(10)
|
|
16%
|
|
10%
|
|
24%
|
|
(3)%
|
|
(30)%
|
|
(5)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
Year Ended June 30, 2018
|
|
Year Ended June 30, 2017
|
|
|
Americas
|
|
EMEA
|
|
Asia Pacific
|
|
Americas
|
|
EMEA
|
|
Asia Pacific
|
Constant currency regional sales
growth (decline)
|
|
13%
|
|
7%
|
|
15%
|
|
4%
|
|
—%
|
|
8%
|
Foreign currency exchange impact
(6)
|
|
—
|
|
9
|
|
4
|
|
—
|
|
(2)
|
|
(3)
|
Divestiture impact
(8)
|
|
—
|
|
—
|
|
—
|
|
(4)
|
|
(7)
|
|
(1)
|
Regional sales growth (decline)
(10)
|
|
13%
|
|
16%
|
|
19%
|
|
—%
|
|
(9)%
|
|
4%
|
(6)
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.
(7)
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.
(8)
Divestiture impact is calculated by dividing prior period sales attributable to divested businesses by prior period sales.
(9)
Aggregate sales for all end markets sum to the sales amount presented on Kennametal's financial statements.
(10)
Aggregate sales for all regions sum to the sales amount presented on Kennametal's financial statements.