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KMT > SEC Filings for KMT > Form 10-K on 13-Aug-2014All Recent SEC Filings

Show all filings for KENNAMETAL INC

Form 10-K for KENNAMETAL INC


13-Aug-2014

Annual Report


ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in connection with the consolidated financial statements of Kennametal Inc. and the related financial statement notes. Unless otherwise specified, any reference to a "year" is to a fiscal year ended June 30. Additionally, when used in this annual report on Form 10-K, unless the context requires otherwise, the terms "we," "our" and "us" refer to Kennametal Inc. and its subsidiaries.
OVERVIEW As a global industrial leader, Kennametal Inc. delivers productivity solutions to customers seeking peak performance in demanding environments. We provide innovative wear-resistant products, application engineering and services backed by advanced material science serving customers across diverse sectors of industrial production, transportation, earthworks, energy, infrastructure and aerospace. Our solutions are built around industry-essential technology platforms, including precision-engineered metalworking tools and components, surface technologies and earth cutting tools that are mission-critical to customer operations battling extreme conditions associated with wear fatigue, corrosion and high temperatures. The Company's reputation for material and industrial technology excellence, as well as expertise and innovation in development of custom solutions and services, contributes to our leading position in our primary industrial and infrastructure markets. End users of our products include manufacturers, metalworking suppliers, machinery operators and processors engaged in a diverse array of industries, including the manufacture of transportation vehicles and systems; machine tool, light machinery and heavy machinery industries; airframe and aerospace components and systems, defense; as well as producers and suppliers in equipment-intensive operations such as coal mining, road construction, quarrying, oil and gas exploration, refining, production and supply. We believe we are one of the largest global providers of consumable metal cutting tools and tooling supplies.
For 2014, sales were $2,837.2 million, an increase of 9.6 percent compared to prior year sales of $2,589.4 million, driven by the TMB acquisition as well as 2 percent organic growth. Operating income was $263.4 million, a decrease of $33.0 million compared to operating income of $296.4 million in 2013. The decrease in operating income was driven by higher employment costs, restructuring and related charges, acquisition-related charges, as well as unfavorable currency exchange rates. The decrease was partially offset by organic sales growth. Raw material costs stabilized in the current year and had a favorable impact on profitability of the business. The Company reported earnings per diluted share of $1.99 in 2014.
On November 4, 2013, the Company completed its transaction to acquire TMB from ATI which included all of the assets of TDY Industries, LLC, a wholly owned subsidiary of ATI, used or held for use by TDY in connection with the business and all of the shares of TDY Limited and ATI Holdings SAS, both wholly-owned subsidiaries of ATI, for a purchase price of $607.0 million, net of cash acquired. We funded the acquisition primarily through a combination of cash from operations and borrowings from our existing credit facility.
TMB, with approximately $340 million in annual sales in calendar 2012, is a leading producer of tungsten metallurgical powders, as well as tooling technologies and components. The business had approximately 1,175 employees in 12 locations primarily in the U.S., and 6 other countries. The acquisition aligns with the Company's long-term growth strategies, expands presence in aerospace and energy end markets, further augments the Company's tooling portfolio and accelerates our metallurgical strategy including planned tungsten carbide recycling and production.
In August 2013, we acquired the operating assets of Emura, based in La Paz, Bolivia, and secured related material sourcing agreements for a purchase price of $40.1 million. Emura's operations are engaged in collection, testing, processing and exporting tungsten ore material, and is a long-standing supplier to Kennametal. The acquisition furthers the Company's efforts to diversify and balance our tungsten sourcing capabilities.
We generated cash flow from operating activities of $271.9 million in the current year. We have actively managed our business portfolio by returning over $70.6 million to Shareowners through share repurchases and dividends. In addition, we made capital expenditures of $117.4 million during the year. 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 $44.0 million for 2014. In addition, we generated approximately 47 percent of our sales from new products in fiscal year 2014.

ENHANCED OPERATING STRUCTURE IMPLEMENTED AS OF JULY 1, 2013 At the start of fiscal 2014, the Company enhanced its organizational structure to align a broader base management team with customer-facing products and technology platforms, as well as to further increase cross-selling opportunities. This operating structure supports the Company's stated growth objectives across diverse market sectors, preserves the focus on customers and increases product innovation.
The Company will continue to report results in each of the Industrial and Infrastructure segments, as well as by served end markets, while also providing expanded disclosures discussing technology-based sales for each segment. Consistent with previous allocation methodologies, corporate expenses related to each segment will be classified accordingly.
Previously disclosed Industrial and Infrastructure segment results will be restated for certain sales reclassifications based on products and technologies and disclosed in future filings as appropriate.

RESTRUCTURING ACTIONS In December 2013, 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 related to employment reduction and consolidating operations and recognized restructuring and related charges of $19.1 million during the year ended June 30, 2014. This included $17.8 million of restructuring charges of which $0.2 million were related to inventory disposals and recorded in cost of goods sold. Restructuring-related charges of $1.2 million were recorded in cost of goods sold and a $0.1 million in operating expense during 2014. See Note 14 in our consolidated financial statements set forth in Item 8.

These and other restructuring actions are expected to be completed over the next two years. Total restructuring costs are expected to be in the range of $40 million to $50 million, most of which are expected to be cash expenditures. 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. We realized pre-tax benefits from these restructuring programs of approximately $3 million during fiscal 2014.

RESULTS OF CONTINUING OPERATIONS
SALES Sales of $2,837.2 million in 2014 increased 9.6 percent from $2,589.4 million in 2013 reflecting an 8 percent increase from the TMB acquisition and a 2 percent organic increase. Sales increased by 4 percent in the Industrial segment and decreased by 1 percent in the Infrastructure segment. Drivers of the sales increase, excluding TMB, were general engineering of 7 percent, transportation of 5 percent, energy markets of 4 percent, partially offset by sales declines in earthworks of 5 percent and aerospace and defense of 4 percent.
Sales of $2,589.2 million in 2013 decreased 5.4 percent from $2,736.2 million in 2012 as a result of an organic decline of 8 percent, 2 percent unfavorable effect from currency exchange and 1 percent fewer business days in 2013, partially offset by a 6 percent increase from Stellite. Sales decreased in both segments and across most regions. Drivers of the sales decline were general engineering of 12 percent, energy markets of 11 percent, earthworks of 6 percent and transportation of 5 percent, offset by an organic sales increase in aerospace and defense of 6 percent.
GROSS PROFIT Gross profit increased $52.0 million to $897.0 million in 2014 from $845.0 million in 2013. This increase was primarily due to owning TMB for eight months, organic sales growth of $44.6 million and favorable raw material pricing, partially offset by higher employment costs and a nonrecurring inventory charge of $6.4 million. The gross profit margin for 2014 was 31.6 percent compared to 32.6 percent in 2013.
Gross profit decreased $149.3 million to $845.0 million in 2013 from $994.3 million in 2012. This decrease was primarily due to an organic sales decline of $217.5 million and lower related absorption of manufacturing costs from both lower sales as well as the impact of our inventory reduction efforts, partially offset by the gross profit benefit of owning Stellite for a full year and cost containment efforts. The gross profit margin for 2013 was 32.6 percent compared to 36.3 percent in 2012
OPERATING EXPENSE Operating expense in 2014 was $589.8 million, an increase of $61.9 million, or 11.7 percent, compared to $527.9 million in 2013. The increase is primarily due to operating expense of $28.8 million related to eight months of owning TMB, $22.2 million increase in employment costs, mostly related to annual merit increase and sales compensation, acquisition-related charges of $7.5 million and unfavorable currency exchange rates of $2.0 million. Operating expense in 2013 was $527.9 million, a decrease of $33.6 million, or 6.0 percent, compared to $561.5 million in 2012. The decrease is primarily due to a $19.8 million decrease in employment costs, which was driven by performance-based compensation, $11.9 million impact of favorable currency exchange rates, a decrease in Deloro Stellite Holdings 1 Limited (Stellite) acquisition-related costs of $8.9 million and containment of discretionary spending, partially offset by additional operating expenditures of $21.1 million related to a full year of Stellite in our operations.


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RESTRUCTURING CHARGES During 2014, we initiated certain restructuring actions and recognized $17.8 million of restructuring charges of which $0.2 million were related to inventory disposals and recorded in cost of goods sold. See the discussion under the heading "Restructuring Actions" within this MD&A for additional information.
During 2013 and 2012, there were no restructuring charges.
AMORTIZATION OF INTANGIBLES Amortization expense was $26.2 million, $20.8 million and $16.4 million in 2014, 2013 and 2012, respectively. The increase of amortization expense in 2014 of $5.4 million or 26.2 percent was due to eight months of amortization of intangibles related to the TMB acquisition. The increase of amortization expense in 2013 of $4.4 million or 27.0 percent was due to a full year of amortization of intangibles related to the Stellite acquisition.
INTEREST EXPENSE Interest expense increased $5.0 million to $32.5 million in 2014, compared with $27.5 million in 2013 due to increased borrowings to fund the TMB acquisition. The portion of our debt subject to variable rates of interest was approximately 34 percent and 6 percent at June 30, 2014 and 2013, respectively. The increase in the portion of our debt subject to variable rates was due to the increase in the balance outstanding on our revolving credit facility.
Interest expense increased $0.3 million to $27.5 million in 2013, compared with $27.2 million in 2012 due to increased borrowings to fund the Stellite acquisition, and the issuance of $400 million of 2.65 percent Senior Unsecured Notes due in 2019, partially offset by lower interest rates on our borrowings resulting from the favorable effect of refinancing our 7.2 percent Senior Unsecured Notes that matured in June 2012 with lower interest 3.875% ten year Senior Unsecured Notes maturing in 2022.
OTHER EXPENSE (INCOME), NET In 2014, other expense, net was $2.2 million compared to other expense, net of $2.3 million in 2013.
In 2013, other expense, net was $2.3 million compared to other income, net of $0.8 million in 2012. The change was primarily due to unfavorable currency exchange rate losses of $1.8 million and lower interest income of $0.8 million. INCOME TAXES The effective tax rate for 2014 was 29.1 percent compared to 22.4 percent for 2013. The change in the effective rate from 2013 to 2014 was primarily driven by a $7.2 million tax charge 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 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. In addition to this tax charge, the 2014 rate increased due to non-deductible restructuring and divestiture costs, and expiration of the credit for increasing research activities.
The effective tax rate for 2013 was 22.4 percent compared to 20.3 percent for 2012. The change in the effective rate from 2012 to 2013 was primarily driven by a prior year valuation allowance release and higher relative earnings in the U.S. where the tax rates are higher than the rest of the world.
INCOME ATTRIBUTABLE TO KENNAMETAL SHAREOWNERS Income attributable to Kennametal Shareowners was $158.4 million, or $1.99 per diluted share, in 2014, compared to $203.3 million, or $2.52 per diluted share, in 2013. The decrease in income from continuing operations was a result of the factors previously discussed. Income from continuing operations attributable to Kennametal Shareowners was $203.3 million or $2.52 per diluted share in 2013, compared to $307.2 million, or $3.77 per diluted share, in 2012. The decrease in income from continuing operations was a result of the factors previously discussed.

BUSINESS SEGMENT REVIEW We operate two reportable operating 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 years ended June 30, 2013 and 2012, respectively, have been restated to reflect the enhanced operating structure as of July 1, 2013.

INDUSTRIAL

(in thousands)            2014           2013           2012
External sales     $ 1,524,075    $ 1,386,690    $ 1,560,157
Operating income       177,040        192,828        278,105


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External sales of $1,524.1 million in 2014 increased by $137.4 million, or 10 percent, from 2013. The increase in sales was attributed to acquisition growth of 5 percent, organic sales increase of 4 percent and the impact of more business days of 1 percent. Sales increased in all served market sectors and geographies. Excluding TMB, sales increased in both general engineering and transportation by 7 percent while the aerospace and defense served markets increased only slightly. General engineering increased due to improvements in production and overall demand for machinery and demand in distribution channels. The transportation market benefited from increased demand in the light vehicle markets world-wide. On a regional basis, excluding TMB, sales increased by approximately 9 percent in Asia, 6 percent in Europe and 2 percent in the Americas. The Americas sales were dampened by the weather impacts in North America. The sales increase in Asia was driven by general engineering followed by transportation and to a lesser extent aerospace and defense. The sales increase in Europe was driven by both transportation and general engineering and the Americas was driven by general engineering and to a lesser extent transportation.
In 2014, Industrial operating income was $177.0 million and decreased by $15.8 million from 2013. The primary drivers of the decrease in operating income were restructuring and related charges of $13.2 million; the dilutive effects of eight months of TMB base operations of $9.8 million, which included purchase accounting impacts of $13.4 million; higher employment costs and acquisition-related charges of $2.9 million, partially offset by the margin impact of higher organic sales. Industrial operating margin was 11.6 percent compared with 13.9 percent in the prior year.
External sales of $1,386.7 million in 2013 decreased by $173.5 million, or 11 percent, from 2012. The decrease in sales was attributed to an organic sales decrease of 8 percent, the impact of fewer business days of 2 percent and unfavorable currency exchange rate effects of 1 percent. On an organic basis, sales decreased in all served market sectors except aerospace and defense where we had organic growth of 6 percent. Organic sales declined in general engineering by 12 percent and transportation by 5 percent. The aerospace and defense end markets' sales growth is due to a significant increase in commercial aircraft production. General engineering was unfavorably impacted by lower sales to the indirect channels due to further inventory destocking earlier in the year and overall lower customer inventory levels throughout the year. Transportation experienced lower vehicle production rates in most geographic regions and extended plant shut-downs, particularly in Europe and Asia. On a regional basis, sales decreased by approximately 11 percent in the Americas, 8 percent in Europe and 8 percent in Asia due to strong comparisons to the prior year. The sales decrease in the Americas and Asia was driven by general engineering, while Europe was driven by both the general engineering and transportation end markets.
In 2013, Industrial operating income was $192.8 million and decreased by $85.3 million from 2012. The primary drivers of the decrease in operating income were lower organic sales and lower related absorption of manufacturing costs from both lower sales as well as the impact of our inventory reduction efforts, partially offset by operating expense discipline. Industrial operating margin was 13.9 percent compared with 17.8 percent in the prior year.

INFRASTRUCTURE

(in thousands)            2014           2013           2012
External sales     $ 1,313,115    $ 1,202,683    $ 1,176,089
Operating income        94,940        111,453        146,768

External sales of $1,313.1 million in 2014 increased by $110.4 million, or 9 percent, from 2013. The increase in sales was attributed to acquisition growth of 10 percent, partially offset by an organic sales decrease of 1 percent. Excluding TMB, the energy market had sales growth of 4 percent, which was offset by the decrease of 6 percent in the earthworks markets. Energy sales improved year over year reflecting improved demand in oil and gas drilling activity, coupled with continued gains in the production, completion and process applications. Earthworks sales declined from persistently weak underground coal and surface mining markets globally, as well as weaker road construction activity. On a regional basis, excluding TMB, sales grew 2 percent in Europe, offset by decreased sales of approximately 5 percent in Asia and 3 percent in the Americas. The sales increase in Europe was driven by the energy markets and a slightly favorable earthworks market. The sales decrease in Asia was driven by the earthworks market, which overshadowed the positive growth in the energy markets, while the Americas sales decline was due to the earthworks market and to a slightly lesser extent the energy markets.


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In 2014, Infrastructure operating income decreased $16.5 million from 2013. The primary drivers of the decrease in operating income were lower organic sales, a nonrecurring physical inventory adjustment of $6.4 million, lower absorption of fixed manufacturing costs, restructuring and related charges of $5.9 million, acquisition-related charges of $4.7 million and higher employment costs, partially offset by TMB's operating income contribution of $2.6 million and continued cost discipline. Infrastructure operating margin decreased to 7.2 percent from 9.3 percent in the prior year.
The Company is currently exploring strategic alternatives for a portion of its Infrastructure business, which has an estimated net book value of approximately $39 million as of June 30, 2014. As the strategic direction has not yet been determined, the Company cannot determine if an impairment loss is either probable or estimable.
External sales of $1,202.7 million in 2013 increased by $26.6 million, or 2 percent, from 2012. The increase in sales was attributed to acquisition growth of 15 percent, offset by an organic sales decrease of 10 percent, the impact of less business days of 1 percent and by unfavorable currency exchange rate effects of 2 percent. The organic decrease was driven by lower sales in the energy and earthworks markets of 11 percent and 6 percent, respectively. Energy sales decreased due to delayed orders and lower drilling activity in oil and gas, primarily in North America. Earthworks sales declined from persistently weak underground coal mining activity globally, as well as a delayed start to the North America road construction season due to the colder weather in the spring. On a regional basis, sales decreased by approximately 13 percent in the Americas, 5 percent in Europe and remained relatively flat in Asia due to strong comparisons to the prior year. The sales decrease in the Americas was driven by the energy markets and to a slightly lesser extent the earthworks markets, while the sales decrease in Europe was driven by the energy markets.
In 2013, Infrastructure operating income decreased $35.3 million from 2012. The primary drivers of the decrease in operating income were lower organic sales and lower related absorption of manufacturing costs from both lower sales as well as the impact of our inventory reduction efforts, partially offset by a decrease in Stellite acquisition-related costs of $8.9 million and containment of discretionary spending. Infrastructure operating margin decreased to 9.3 percent from 12.5 percent in the prior year.
CORPORATE

(in thousands) 2014 2013 2012 Corporate unallocated expense $ (8,548 ) $ (7,887 ) $ (8,464 )

In 2014, Corporate unallocated expense increased $0.6 million, or 8.4 percent from 2013. In 2013, Corporate unallocated expense decreased $0.6 million, or 6.8 percent from 2012.

LIQUIDITY AND CAPITAL RESOURCES Cash flow from operations and borrowings against our amended five-year, multi-currency, revolving credit facility (2011 Credit Agreement) are the primary sources of funding for capital expenditures and internal growth. During the year ended June 30, 2014, cash flow provided by operating activities was $271.9 million, driven by our operating performance. We had outstanding borrowings on our 2011 Credit Agreement of $287.1 million which were used primarily to fund the acquisition of TMB.
Our 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 June 30, 2014. For the year ended June 30, 2014, average daily borrowings outstanding under the 2011 Credit Agreement were approximately $248.7 million. Borrowings under the 2011 Credit Agreement are guaranteed by our significant domestic subsidiaries.


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Additionally, we obtain local financing through credit lines with commercial banks in the various countries in which we operate. At June 30, 2014, these borrowings amounted to $72.5 million of notes payable and $2.9 million of term debt, capital leases and other debt. 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, 2014 and 2013, approximately 34 percent and 6 percent of our debt, respectively, was exposed to variable rates of interest. The increase in the portion of our debt subject to variable rates was due to the increase in the balance outstanding on our 2011 Credit Agreement. 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 June 30, 2014, cash and cash equivalents of $126.2 million and short term intercompany advances made by our foreign subsidiaries to our U.S. parent of $22.1 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. These short term intercompany advances are in the form of intercompany loans made over each quarter end to repay borrowings under our revolving credit agreement and have a duration of not more than fourteen days. 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 June 30, 2014, we had cash and cash equivalents of $177.9 million. Total Kennametal Shareowners' equity was $1,929.3 million and total debt was $1,061.8 million. Our current senior credit ratings are at investment grade levels. We believe that our current financial position, liquidity and credit ratings provide us access to the capital markets. We 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, 2014 (in thousands):

Contractual
Obligations                                Total          2015      2016-2017      2018-2019       Thereafter
Long-term debt                (1 )   $ 1,126,572     $  33,048     $   50,839     $  326,445     $    716,240
Notes payable                 (2 )        73,509        73,509              -              -                -
Pension benefit
payments                                  (3)           48,958         99,271        107,754          (3)
Postretirement
benefit payments                          (3)            2,307          4,407          4,080          (3)
Capital leases                (4 )         3,127           247          2,682            198                -
Operating leases                          74,432        21,569         22,889          6,004           23,970
Purchase obligations          (5 )       927,759       365,993        497,812         34,077           29,877
Unrecognized tax
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