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KMT > SEC Filings for KMT > Form 10-Q on 6-Feb-2014All Recent SEC Filings

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Form 10-Q for KENNAMETAL INC


6-Feb-2014

Quarterly Report


Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

OVERVIEW

Kennametal Inc. is a leading global manufacturer and supplier of tooling, engineered components and advanced materials consumed in production processes. We deliver productivity to customers seeking peak performance in demanding environments by providing innovative custom and standard wear-resistant solutions. To provide these solutions, we harness our knowledge of advanced materials and application development with a commitment to environmental sustainability. Our solutions are built around industry-essential technology platforms. These include metalworking tools, engineered components, surface technologies and earth cutting tools that are mission-critical to the performance of our customers battling extreme conditions such as fatigue wear, corrosion and high temperatures. We believe that our reputation for manufacturing excellence, as well as our technological expertise and innovation we deliver in our products and services, help us to achieve a leading position in our primary markets: general engineering, transportation, aerospace, defense, energy and earthworks. End users of our products include metalworking and machinery manufacturers and suppliers across a diverse array of industries, including the aerospace, defense, transportation, machine tool, light machinery and heavy machinery, as well as producers and suppliers in a number of equipment-intensive industries such as coal mining, road construction and quarrying, as well as oil and gas exploration, refining, production and supply. Our end users' applications range from airframes to mining operations, engines to oil wells and turbochargers to processing. We believe we are one of the largest global providers of consumable metalcutting tools and tooling supplies.

On November 4, 2013, we acquired Allegheny Technologies Incorporated's (ATI) Tungsten Materials Business (TMB) for approximately $607 million. TMB, with approximately $340.0 million in annual sales, is a leading producer of tungsten metallurgical powders, as well as tooling technologies and components. The business has approximately 1,175 employees in 12 locations across seven countries. The acquired business brings industry-leading tungsten carbide production wear products and recycling capabilities, as well as a tooling and product portfolio with a strong position in the aerospace, energy and process industries. The acquisition is aligned with the our metallurgical growth strategy and positions us to further diversify our portfolio.

Our sales of $689.9 million for the quarter ended December 31, 2013 increased 9 percent compared to sales for the December quarter one year ago. Operating income was $49.7 million, a decrease of $16.8 million as compared to $66.5 million in the prior year quarter. TMB had an operating loss of $7.9 million in the current quarter, including the impacts of purchase accounting. Operating income declined due to higher employment costs related to the annual employee merit increase and increased commissions on higher sales, two months operating loss of TMB of $7.9 million, restructuring charges of $2.3 million and acquisition-related charges of $1.7 million. This decrease was partially offset by the favorable impact of organic growth and lower raw material costs. Organic sales growth includes both volume and price.

During the quarter, we announced that we intend to undertake restructuring actions and expect to incur pre-tax charges of approximately $40 million to $50 million over the next three years. We recorded pre-tax restructuring charges of $2.3 million during the three months ended December 31, 2013. We expected to generate annual savings of approximately $35 million to $45 million once these initiatives are fully implemented.

We reported current quarter earnings per diluted share of $0.30, which included TMB operating loss of $0.09, tax repatriation expense of $0.09, acquisition-related charges of $0.02 and restructuring and related charges of $0.02.

Raw material prices were relatively stable in the market during the quarter.

We generated cash flow from operating activities of $84.6 million during the six months ended December 31, 2013. Capital expenditures were $48.8 million during the quarter.

We invested further in technology and innovation to continue delivering a high level of new products to our customers. Research and development expenses included in operating expense totaled $10.8 million for the three months ended December 31, 2013.

The following narrative provides further discussion and analysis of our results of operations, liquidity and capital resources, as well as other pertinent matters.


Table of Contents

Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)


RESULTS OF CONTINUING OPERATIONS

SALES

Sales for the three months ended December 31, 2013 were $689.9 million, an increase of $56.8 million or 9 percent, from $633.1 million in the prior year quarter. The increase in sales was driven by the impact of acquisition of TMB of 7 percent and organic growth of 2 percent. The increase in sales was primarily due to improved demand from customers in our Industrial end markets and distribution sales for the quarter reflecting double-digit growth from prior year, partially offset by continuing weakness in the mining sector. Excluding TMB, sales increased by approximately 6 percent in general engineering, 4 percent in transportation and 2 percent in the energy markets, while aerospace and defense decreased by 6 percent and earthworks market decreased by 5 percent, respectively.

Sales for the six months ended December 31, 2013 were $1,309.7 million, an increase of $47.1 million or 4 percent, from $1,262.6 million in the prior year period. The increase in sales was driven by the impacts of acquisition of 4 percent and organic growth of 1 percent, partially offset by the unfavorable impact from fewer business days of 1 percent. The increase in sales was primarily due to improved demand from customers in our industrial end markets and distribution sales, partially offset by weakness in the mining sector and demand softness in the energy market. Excluding TMB, sales increased by approximately 4 percent in general engineering and 2 percent in transportation, while earthworks decreased by 8 percent, aerospace and defense decreased by 7 percent and energy markets decreased by 1 percent, respectively.

GROSS PROFIT

Gross profit for the three months ended December 31, 2013 was $207.0 million, an increase of $7.6 million from $199.4 million in the prior year quarter. The increase was primarily due to lower raw material costs and higher organic sales, partially offset by higher manufacturing spend. The gross profit margin for the three months ended December 31, 2013 was 30.0 percent, as compared to 31.5 percent generated in the prior year quarter.

Gross profit for the six months ended December 31, 2013 was $405.2 million, a decrease of $2.6 million from $407.8 million in the prior year period. The decrease was primarily due to non-recurring physical inventory adjustment of $5.7 million related to our mining business and higher manufacturing spend, partially offset by lower raw material costs. The gross profit margin for the six months ended December 31, 2013 was 30.9 percent, as compared to 32.3 percent generated in the prior year quarter.

OPERATING EXPENSE

Operating expense for the three months ended December 31, 2013 increased $20.6 million or 16.2 percent to $148.4 million as compared to $127.8 million in the prior year quarter. The increase was primarily due to higher employment costs of $7.6 million driven mainly by our annual employee merit increase and an increase in commissions due to higher sales, additional operating expenditures related to TMB of $7.3 million and TMB acquisition-related costs of $1.7 million.

Operating expense for the six months ended December 31, 2013 increased $16.1 million or 6.0 percent to $282.7 million as compared to $266.6 million in the prior year period. The increase was primarily due to higher employment costs of $7.6 million driven by our annual employee merit increase and an increase in commissions due to higher sales, additional operating expenditures related to TMB of $7.3 million, TMB acquisition-related costs of $2.8 million and unfavorable foreign currency impact of $0.7 million, partially offset by favorable impact of cost containment measures.

RESTRUCTURING CHARGES
During the quarter, we announced our intent to implement restructuring actions to achieve synergies across Kennametal and TMB by consolidating operations among both organizations, reducing administrative overhead and leveraging the supply chain. Consistent with this announcement, we initiated actions during the current quarter related to employment reductions and recorded restructuring charges of $2.3 million during the six months ended December 31, 2013. Industrial and Infrastructure charges were $1.1 million and $1.2 million, respectively. See Note 8 in our condensed consolidated financial statements set forth in Part I Item 1 of this Quarterly Report on Form 10-Q.


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Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)


Total restructuring costs are expected to be in the range of $40 million to $50 million and are expected to be completed over the next three years. Annual ongoing benefits from these actions are expected to be in the range of $35 million to $45 million, once these initiatives are fully implemented.

INTEREST EXPENSE

Interest expense for the three months ended December 31, 2013 increased $1.0 million to $8.0 million as compared to
$7.0 million in the prior year quarter. For the six months ended December 31, 2013 interest expense increased $2.2 million to $15.1 million as compared to $12.9 million in the prior year period. The increase in both periods was primarily due to higher year-over-year borrowings due to acquisitions and the higher borrowing rate for our $400 million 2.65 percent Senior Unsecured Notes issued in November 2012.

OTHER EXPENSE (INCOME), NET

Other expense, net for the three months ended December 31, 2013 was $0.9 million compared to $0.7 million for the prior year quarter. The increase was primarily due to unfavorable currency exchange rate losses of $0.4 million, partially offset by higher interest income.

Other expense, net for the six months ended December 31, 2013 was $1.5 million compared to other income, net of $0.2 million for the prior year quarter. The decrease was primarily due to unfavorable currency exchange rate losses of $1.8 million.

INCOME TAXES
The effective income tax rate for the three months ended December 31, 2013 and 2012 was 40.8 percent and 26.4 percent, respectively. The effective income tax rate for the six months ended December 31, 2013 and 2012 was 31.8 percent and 23.5 percent, respectively. The increase for both the three and six month periods was primarily driven by a $7.2 million tax charge incurred in the quarter related to a change in assertion of a foreign subsidiary's certain undistributed earnings, which are no longer considered permanently reinvested. This change in assertion during the current quarter is related to the repatriation of $57.0 million. All earnings of other non U.S. subsidiaries are indefinitely reinvested and no deferred taxes have been provided on those earnings. This tax charge was partially offset by a lower relative U.S. current year earnings contribution.

BUSINESS SEGMENT REVIEW

We operate two reportable segments consisting of Industrial 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, the availability of separate financial results and materiality considerations.

Amounts for the three and six months ended December 31, 2012 have been restated to reflect the enhanced operating structure as of July 1, 2013.

INDUSTRIAL
                                                                   Six Months Ended
                       Three Months Ended December 31,                December 31,
(in thousands)               2013                       2012         2013         2012
Sales            $        370,647                  $ 336,007    $ 708,876    $ 671,201
Operating income           33,218                     40,677       73,038       80,004


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Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)


For the three months ended December 31, 2013, Industrial sales increased by 10 percent due to 6 percent organic growth and 5 percent growth related to the acquisition of TMB, partially offset by a 1 percent decline due to fewer business days. Excluding TMB, sales increased by 8 percent in transportation, 7 percent in general engineering, 5 percent in energy and 2 percent in aerospace and defense. The transportation market benefited from increased demand in the light vehicle markets in Europe, U.S. and China and general engineering increased due to improvements in demand from distribution channels. Energy sales reflected increased activity in industrial applications. Sales increased in all geographies. On a regional basis, excluding TMB, sales increased by approximately12 percent in Asia, 7 percent in Europe and 2 percent in the Americas. The sales increase in Asia was driven by the growth in all of the end markets. The sales increase in Europe was primarily driven by the performance in the transportation, general engineering and energy end markets. The sales increase in the Americas was primarily driven by the performance in the transportation and general engineering end markets, partially offset by the decline in the energy end market.

For the three months ended December 31, 2013, Industrial operating income decreased by $7.5 million. Industrial operating income was reduced by the effects of TMB operations of $6.1 million, restructuring and related charges of $1.1 million and TMB acquisition-related charges of $0.6 million, partially offset by organic sales growth. Industrial operating margin was 9.0 percent compared with 12.1 percent in the prior year.

For the six months ended December 31, 2013, Industrial sales increased by 6 percent due to 3 percent organic growth, 2 percent growth related to acquisitions and 1 percent due to more business days. Excluding TMB, sales increased by 4 percent in transportation, 4 percent in general engineering, 2 percent in energy and remained relatively flat in aerospace and defense. The transportation market benefited from increased demand in the light vehicle market in Europe, U.S. and China and general engineering increased due to improvements in production and overall demand for machinery and demand from distribution channels. Energy sales reflected increased activity in industrial applications. On a regional basis, excluding TMB, sales increased by approximately 6 percent in Asia, 5 percent in Europe and 1 percent in the Americas. Asia experienced growth in all end markets except transportation. The sales increase in Europe was 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 transportation and general engineering end markets, partially offset by a decline in the energy end market.

For the six months ended December 31, 2013, Industrial operating income decreased by $7.0 million. Industrial operating income was negatively impacted by the effects of TMB operations of $6.1 million, restructuring and related charges of $1.1 million and TMB acquisition related charges of $0.6 million. Industrial operating margin was 10.3 percent compared with 11.9 percent in the prior year.

INFRASTRUCTURE
                                                                   Six Months Ended
                       Three Months Ended December 31,                December 31,
(in thousands)               2013                       2012         2013         2012
Sales            $        319,289                  $ 297,137    $ 600,867    $ 591,402
Operating income           18,604                     27,906       40,294       55,503

For the three months ended December 31, 2013, Infrastructure sales increased by 7 percent, driven by 10 percent growth related to the acquisition of TMB, partially offset by a 2 percent organic decline and 1 percent unfavorable impact from fewer business days. Excluding TMB, sales increased by 1 percent in energy and 1 percent in general engineering, offset by a 12 percent decrease in transportation and a 5 percent decrease in earthworks. Earthworks sales decreased due to persistently weak underground coal mining markets in China and the U.S., partially offset by continued strength globally in highway construction sales. Energy sales were slightly positive year over year reflecting some improvements in oil and gas drilling activity in the U.S., coupled with gains in production, completion and process applications. On a regional basis, excluding TMB, sales grew by 8 percent in Europe and declined by 7 percent in the Americas and 4 percent in Asia, respectively. The sales increase in Europe was driven primarily by the performance in the energy, earthworks and transportation end markets. The sales decrease in the Americas was driven primarily by a decline in energy, earthworks and transportation end markets. The sales decrease in Asia was driven primarily by the decline in the earthworks and transportation end markets, partially offset by an increase in the general engineering and energy end markets.


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Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)


For the three months ended December 31, 2013, Infrastructure operating income decreased by $9.3 million. Infrastructure operating income was negatively impacted by the effects of TMB operations of $1.7 million, restructuring and related charges of $1.2 million and TMB acquisition related charges of $1.1 million. Infrastructure operating margin was 5.8 percent compared with 9.4 percent in the prior year.

For the six months ended December 31, 2013, Infrastructure sales increased by 2 percent, driven by 5 percent growth related to acquisitions and 1 percent favorable impact from more business days, partially offset by a 4 percent organic decline. Excluding TMB, sales increased by 3 percent in general engineering, offset by a 8 percent decrease in earthworks, a 5 percent decrease in transportation and a 2 percent decrease in energy. General engineering reflects higher volumes from integrators and distributors. Earthworks sales decreased due to persistently weak underground coal mining markets in China and the U.S. Energy sales decreased due to lower drilling activity in oil and gas in the U.S., partially offset by gains in production and completion applications. On a regional basis, excluding TMB, sales grew 5 percent in Europe and declined by 7 percent in the Americas and 4 percent in Asia, respectively. The sales increase in Europe was driven primarily by the performance in the transportation, energy and general engineering end markets. The sales decrease in the Americas was driven primarily by the decline in the energy, earthworks and transportation end markets. The sales decrease in Asia was driven primarily by the decline in the earthworks and transportation end markets, partially offset by an increase in energy and general engineering end markets.

For the six months ended December 31, 2013, Infrastructure operating income decreased by $15.2 million. Infrastructure operating income was negatively impacted by a non recurring physical inventory adjustment of $5.7 million related to our mining business, effects of TMB operations of $1.7 million, restructuring and related charges of $1.2 million and the TMB acquisition related charges of $1.1 million. Infrastructure operating margin was 6.7 percent compared with 9.4 percent in the prior year.

CORPORATE

Six Months Ended
Three Months Ended December 31, December 31,
(in thousands) 2013 2012 2013 2012 Corporate unallocated expense $ (2,106 ) $ (2,114 ) $ (4,787 ) $ (4,657 )

For the three and six months ended December 31, 2013, Corporate unallocated expense remained relatively flat compared to prior year period.

LIQUIDITY AND CAPITAL RESOURCES

Cash flow from operations and borrowings against our five-year, multi-currency, revolving credit facility (2011 Credit Agreement) are the primary sources of funding for capital expenditures and internal growth. Year to date December 31, 2013, cash flow provided by operating activities was $84.6 million, driven by our operating performance, and we had outstanding borrowings on our 2011 Credit Agreement of $360.7 million, primarily used to fund the acquisition of TMB.

The 2011 Credit Agreement is used to augment cash from operations and as an additional source of funds. The 2011 Credit Agreement permits revolving credit loans of up to $600.0 million for working capital, capital expenditures and general corporate purposes. The 2011 Credit Agreement allows for borrowings in U.S. dollars, euro, Canadian dollars, pound sterling and Japanese yen. Interest payable under the 2011 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 2011 Credit Agreement matures in April 2018.

The 2011 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 agreement). We were in compliance with all covenants as of December 31, 2013. For the six months ended December 31, 2013, average daily domestic borrowings outstanding under the 2011 Credit Agreement were approximately $112.4 million. Borrowings under the 2011 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)


Other than the repatriation of $57.0 million discussed in Note 14 set forth in Part I Item 1 of this Quarterly Report on Form 10-Q, we consider the unremitted earnings of our non-U.S. subsidiaries that have not previously been taxed in the U.S. to be permanently reinvested. As of December 31, 2013, cash and cash equivalents of $158.5 million and short-term intercompany advances made by our foreign subsidiaries to our U.S. parent of $21.8 million would not be available for use in the U.S. on a long term basis, without incurring U.S. federal and state income tax consequences. 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.

At December 31, 2013, cash and cash equivalents were $163.3 million, total debt was $1,145.7 million and total Kennametal Shareowners' equity was $1,872.0 million. Our current senior credit ratings are at investment grade levels. We believe that our current financial position, liquidity and credit ratings provide 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.

There have been no material changes in our contractual obligations and commitments since June 30, 2013.
Cash Flow Provided by Operating Activities During the six months ended December 31, 2013, cash flow provided by operating activities was $84.6 million, compared to $54.2 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 $149.5 million, partially offset by changes in certain assets and liabilities netting to an outflow of $64.9 million. Contributing to the changes in certain assets and liabilities were a decrease in accounts payable and accrued liabilities of $34.3 million primarily driven by timing of payroll payments and decrease in federal tax payments of $16.5 million, an increase in inventory of $27.0 million primarily driven by higher work in process and finished goods inventory, a decrease in other of $16.5 million and a decrease in accrued income taxes of $14.0 million. Offsetting these cash outflows were a decrease in accounts receivable of $26.9 million due to improved collections.

During the six months ended December 31, 2012, cash flow provided by operating activities consisted of net income and non-cash items amounting to an inflow of $164.1 million, partially offset by changes in certain assets and liabilities netting to an outflow of $109.9 million. Contributing to the changes in certain assets and liabilities was a decrease in accounts payable and accrued liabilities of $135.8 million primarily driven by lower accounts payable, lower accrued payroll and payment of $19.0 million of incentive compensation, an increase in inventory of $22.9 million primarily due to previously committed raw materials purchases, a decrease in accrued income taxes of $21.2 million and a decrease in other of $3.9 million, partially offset by a decrease in accounts receivable of $73.9 million due to lower sales volume. Cash Flow Used for Investing Activities
Cash flow used for investing activities was $683.0 million for the six months ended December 31, 2013, compared to
$33.8 million in the prior year period. During the current year period, cash flow used for investing activities included $634.6 million used for acquisitions, primarily TMB of $607.0 million and two other acquisitions in the Infrastructure segment. Capital expenditures, net were $48.4 million, which consisted primarily of equipment upgrades.

For the six months ended December 31, 2012, cash flow used for investing activities included capital expenditures, net of $33.7 million, which consisted primarily of equipment upgrades.
Cash Flow Provided by Financing Activities Cash flow provided by financing activities was $382.0 million for the six months ended December 31, 2013 compared to $73.0 million in the prior year period. . . .

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