KMT 12.31.2014 10Q
Table of Contents


 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 2014
Commission file number 1-5318
KENNAMETAL INC.
(Exact name of registrant as specified in its charter)
 
       Pennsylvania
  
25-0900168
(State or other jurisdiction of incorporation or organization)
  
(I.R.S. Employer Identification No.)
 
 
 
                                     World Headquarters
                                     1600 Technology Way
                                     P.O. Box 231
                                     Latrobe, Pennsylvania
  
15650-0231
(Address of principal executive offices)
  
(Zip Code)                    
Website: www.kennametal.com
Registrant’s telephone number, including area code: (724) 539-5000
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
YES [X] NO [  ]
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES [X] NO [  ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer [X]
  
Accelerated filer [  ]
Non-accelerated filer [  ] (Do not check if a smaller reporting company)
  
Smaller reporting company [  ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES [  ] NO [X]
Indicate the number of shares outstanding of each of the issuer’s classes of capital stock, as of the latest practicable date.
 
Title of Each Class
 
Outstanding at January 30, 2015
Capital Stock, par value $1.25 per share        
 
79,162,006
 


Table of Contents


KENNAMETAL INC.
FORM 10-Q
FOR THE THREE AND SIX MONTHS ENDED DECEMBER 31, 2014
TABLE OF CONTENTS
 
Item No.
Page No.
 
 
 
 
 
 
1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2.
 
 
 
3.
 
 
 
4.
 
 
 
 
 
 
2.
 
 
 
6.
 
 

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FORWARD-LOOKING INFORMATION
This Quarterly Report on Form 10-Q contains “forward-looking” statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements are statements that do not relate strictly to historical or current facts. You can identify forward-looking statements by the fact they use words such as “should,” “anticipate,” “estimate,” “approximate,” “expect,” “may,” “will,” “project,” “intend,” “plan,” “believe” and other words of similar meaning and expression in connection with any discussion of future operating or financial performance or events. We have also included forward looking statements in this Quarterly Report on Form 10-Q concerning, among other things, our strategy, goals, plans and projections regarding our financial position, liquidity and capital resources, results of operations, market position and product development. These statements are based on current estimates that involve inherent risks and uncertainties. Should one or more of these risks or uncertainties materialize, or should the assumptions underlying the forward-looking statements prove incorrect, our actual results could vary materially from our current expectations. There are a number of factors that could cause our actual results to differ from those indicated in the forward-looking statements. They include: economic recession; availability and cost of the raw materials we use to manufacture our products; our foreign operations and international markets, such as currency exchange rates, different regulatory environments, trade barriers, exchange controls and social and political instability; changes in the regulatory environment in which we operate, including environmental, health and safety regulations; our ability to protect and defend our intellectual property; competition; our ability to retain our management and employees; demands on management resources; potential claims relating to our products; integrating acquisitions and achieving the expected savings and synergies; business divestitures; global or regional catastrophic events; energy costs; commodity prices; labor relations; demand for and market acceptance of new and existing products; and implementation of environmental remediation matters. We provide additional information about many of the specific risks we face in the “Risk Factors” Section of our Annual Report on Form 10-K. We can give no assurance that any goal or plan set forth in forward-looking statements can be achieved and readers are cautioned not to place undue reliance on such statements, which speak only as of the date made. We undertake no obligation to release publicly any revisions to forward-looking statements as a result of future events or developments.



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PART I – FINANCIAL INFORMATION

ITEM 1.    FINANCIAL STATEMENTS

KENNAMETAL INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
 
 
 
 
 
 
Three Months Ended December 31,
 
Six Months Ended December 31,
(in thousands, except per share amounts)
2014

 
2013

 
2014

 
2013

Sales
$
675,631

 
$
689,936

 
$
1,370,572

 
$
1,309,743

Cost of goods sold
476,173

 
482,965

 
953,015

 
904,536

Gross profit
199,458

 
206,971

 
417,557

 
405,207

Operating expense
137,459

 
148,421

 
285,947

 
282,685

Restructuring and asset impairment charges (Notes 8 and 18)
388,839

 
2,310

 
390,402

 
2,310

Amortization of intangibles
6,931

 
6,524

 
13,959

 
11,667

Operating (loss) income
(333,771
)
 
49,716

 
(272,751
)
 
108,545

Interest expense
7,960

 
8,037

 
16,170

 
15,118

Other expense, net
2,223

 
856

 
409

 
1,466

(Loss) income before income taxes
(343,954
)
 
40,823

 
(289,330
)
 
91,961

Provision for income taxes
43,751

 
16,656

 
58,248

 
29,236

Net (loss) income
(387,705
)
 
24,167

 
(347,578
)
 
62,725

Less: Net income (loss) attributable to noncontrolling interests
597

 
(42
)
 
1,236

 
679

Net (loss) income attributable to Kennametal
$
(388,302
)
 
$
24,209

 
$
(348,814
)
 
$
62,046

PER SHARE DATA ATTRIBUTABLE TO KENNAMETAL SHAREHOLDERS
 
 
 
 
Basic (loss) earnings per share
$
(4.89
)
 
$
0.31

 
$
(4.40
)
 
$
0.79

Diluted (loss) earnings per share
$
(4.89
)
 
$
0.30

 
$
(4.40
)
 
$
0.78

Dividends per share
$
0.18

 
$
0.18

 
$
0.36

 
$
0.36

Basic weighted average shares outstanding
79,343

 
78,729

 
79,229

 
78,587

Diluted weighted average shares outstanding
79,343

 
79,776

 
79,229

 
79,597

The accompanying notes are an integral part of these condensed consolidated financial statements.


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KENNAMETAL INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
 
 
 
 
 
 
Three Months Ended December 31,
 
Six Months Ended December 31,
(in thousands)
2014

 
2013

 
2014

 
2013

Net (loss) income
$
(387,705
)
 
$
24,167

 
$
(347,578
)
 
$
62,725

Unrealized gain (loss) on derivatives designated and qualified as cash flow hedges, net of income tax expense (benefit) of $0.8 million, ($0.2) million, $1.7 million and ($0.5) million, respectively
1,206

 
(273
)
 
2,713

 
(843
)
Reclassification of unrealized (gain) loss on expired derivatives designated and qualified as cash flow hedges, net of income tax (expense) benefit of ($0.0) million, $0.3 million, $0.2 million and $0.5 million, respectively
(35
)
 
440

 
329

 
849

Unrecognized net pension and other postretirement benefit gain (loss), net of income tax expense (benefit) of $0.7 million, ($0.3) million, $2.0 million and ($1.0) million, respectively
1,924

 
(810
)
 
5,565

 
(2,776
)
Reclassification of net pension and other postretirement benefit loss, net of income tax benefit of $0.3 million, $0.2 million, $0.7 million and $0.4 million, respectively
735

 
498

 
1,489

 
982

Foreign currency translation adjustments, net of income tax (benefit) expense of ($1.5) million, $0.7 million, ($4.8) million and $2.1 million, respectively
(30,209
)
 
11,675

 
(81,722
)
 
39,586

Total comprehensive (loss) income
(414,084
)
 
35,697

 
(419,204
)
 
100,523

Comprehensive (loss) income attributable to noncontrolling interests
(184
)
 
371

 
(1,037
)
 
906

Comprehensive (loss) income attributable to Kennametal Shareholders
$
(413,900
)
 
$
35,326

 
$
(418,167
)
 
$
99,617

The accompanying notes are an integral part of these condensed consolidated financial statements.



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KENNAMETAL INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
 
 
 
 
 
(in thousands, except per share data)
December 31,
2014
 
June 30,
2014
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
146,267

 
$
177,929

Accounts receivable, less allowance for doubtful accounts of $13,616 and $14,027, respectively
449,166

 
531,515

Inventories (Note 11)
662,883

 
703,766

Deferred income taxes
45,644

 
47,897

Other current assets
70,027

 
64,089

Total current assets
1,373,987

 
1,525,196

Property, plant and equipment:
 
 
 
Land and buildings
422,301

 
437,783

Machinery and equipment
1,596,571

 
1,638,215

Less accumulated depreciation
(1,175,771
)
 
(1,191,540
)
Property, plant and equipment, net
843,101

 
884,458

Other assets:
 
 
 
Investments in affiliated companies
408

 
495

Goodwill (Note 18)
579,567

 
975,576

Other intangible assets, less accumulated amortization of $143,355 and $139,245, respectively (Note 18)
310,251

 
343,176

Deferred income taxes
36,260

 
41,006

Other
108,869

 
98,179

Total other assets
1,035,355

 
1,458,432

Total assets
$
3,252,443

 
$
3,868,086

LIABILITIES
 
 
 
Current liabilities:
 
 
 
Current maturities of long-term debt and capital leases (Note 12)
$
8,629

 
$
7,662

Notes payable to banks
86,884

 
72,455

Accounts payable
159,464

 
206,891

Accrued income taxes
66,223

 
16,953

Accrued expenses
63,182

 
99,892

Other current liabilities
144,322

 
158,903

Total current liabilities
528,704

 
562,756

Long-term debt and capital leases, less current maturities (Note 12)
867,103

 
981,666

Deferred income taxes
105,382

 
118,092

Accrued pension and postretirement benefits
167,284

 
180,784

Accrued income taxes
19,653

 
21,384

Other liabilities
33,730

 
41,796

Total liabilities
1,721,856

 
1,906,478

Commitments and contingencies

 

EQUITY (Note 16)
 
 
 
Kennametal Shareholders’ Equity:
 
 
 
Preferred stock, no par value; 5,000 shares authorized; none issued

 

Capital stock, $1.25 par value; 120,000 shares authorized; 79,147 and 78,672 shares issued, respectively
98,932

 
98,340

Additional paid-in capital
411,979

 
395,890

Retained earnings
1,123,892

 
1,501,157

Accumulated other comprehensive loss
(135,483
)
 
(66,131
)
Total Kennametal Shareholders’ Equity
1,499,320

 
1,929,256

Noncontrolling interests
31,267

 
32,352

Total equity
1,530,587

 
1,961,608

Total liabilities and equity
$
3,252,443

 
$
3,868,086

The accompanying notes are an integral part of these condensed consolidated financial statements.

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KENNAMETAL INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW (UNAUDITED)
 
 
 
 
 
 
Six Months Ended December 31,
(in thousands)
2014

 
2013

OPERATING ACTIVITIES
 
 
 
Net (loss) income
$
(347,578
)
 
$
62,725

Adjustments for non-cash items:
 
 
 
Depreciation
53,341

 
48,267

Amortization
13,959

 
11,667

Stock-based compensation expense
13,475

 
12,108

Restructuring and asset impairment charges (Notes 8 and 18)
383,489

 

Deferred income tax provision
(13,824
)
 
13,116

Other
8,938

 
1,587

Changes in certain assets and liabilities:
 
 
 
Accounts receivable
54,928

 
26,942

Inventories
4,727

 
(27,044
)
Accounts payable and accrued liabilities
(74,969
)
 
(34,322
)
Accrued income taxes
45,596

 
(13,997
)
Other
(6,760
)
 
(16,432
)
Net cash flow provided by operating activities
135,322

 
84,617

INVESTING ACTIVITIES
 
 
 
Purchases of property, plant and equipment
(54,672
)
 
(48,804
)
Disposals of property, plant and equipment
978

 
444

Business acquisitions, net of cash acquired

 
(634,615
)
Other
(126
)
 
(60
)
Net cash flow used for investing activities
(53,820
)
 
(683,035
)
FINANCING ACTIVITIES
 
 
 
Net increase in notes payable
15,241

 
40,910

Net increase in short-term revolving and other lines of credit
8,500

 
14,900

Term debt borrowings
50,727

 
345,485

Term debt repayments
(154,547
)
 
(5,000
)
Purchase of capital stock
(168
)
 
(4,400
)
Dividend reinvestment and the effect of employee benefit and stock plans
7,891

 
18,072

Cash dividends paid to Shareholders
(28,451
)
 
(28,180
)
Other
(4,786
)
 
250

Net cash flow (used for) provided by financing activities
(105,593
)
 
382,037

Effect of exchange rate changes on cash and cash equivalents
(7,571
)
 
2,354

CASH AND CASH EQUIVALENTS
 
 
 
Net decrease in cash and cash equivalents
(31,662
)
 
(214,027
)
Cash and cash equivalents, beginning of period
177,929

 
377,316

Cash and cash equivalents, end of period
$
146,267

 
$
163,289

The accompanying notes are an integral part of these condensed consolidated financial statements.


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KENNAMETAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
 
 



1.ORGANIZATION
From its founding in 1938, the McKenna family incorporated Kennametal Inc. in Pennsylvania in 1943. Kennametal Inc. and its subsidiaries (collectively, Kennametal or the Company) are a leading global manufacturer and supplier of tooling, engineered components and advanced materials consumed in production processes. We believe that our reputation for manufacturing excellence, as well as our technological expertise and innovation we deliver in our products and services, helps us to achieve a leading position in our primary markets. 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 operate two global business segments consisting of Industrial and Infrastructure.
 
2.BASIS OF PRESENTATION

The condensed consolidated financial statements, which include our accounts and those of our majority-owned subsidiaries, should be read in conjunction with our 2014 Annual Report on Form 10-K. The condensed consolidated balance sheet as of June 30, 2014 was derived from the audited balance sheet included in our 2014 Annual Report on Form 10-K. These interim statements are unaudited; however, we believe that all adjustments necessary for a fair statement of the results of the interim periods were made and all adjustments are normal adjustments. The results for the six months ended December 31, 2014 and 2013 are not necessarily indicative of the results to be expected for a full fiscal year. Unless otherwise specified, any reference to a “year” is to a fiscal year ended June 30. For example, a reference to 2015 is to the fiscal year ending June 30, 2015. When used in this Form 10-Q, unless the context requires otherwise, the terms “we,” “our” and “us” refer to Kennametal Inc. and its subsidiaries.

During the current quarter, the Company revised its condensed consolidated statement of cash flow for the three months ended September 30, 2014 to correctly present the net cash flow provided by operating activities and effect of exchange rate changes on cash and cash equivalents, resulting in an increase of $8.4 million to operating cash flows and a corresponding decrease in effect of exchange rate changes on cash and cash equivalents. The Company has evaluated this error and determined that the impact of the error was not material to the previously issued interim and annual financial statements.

3.NEW ACCOUNTING STANDARDS
Adopted
In July 2013, the Financial Accounting Standards Board (FASB) issued new guidance on the presentation in the financial statements of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. The guidance takes into account these losses and carryforwards as well as the intended or likelihood of use of the unrecognized tax benefit in determining the balance sheet classification as an asset or liability. This guidance was effective for Kennametal beginning July 1, 2014 and did not have a material impact.

4.
SUPPLEMENTAL CASH FLOW DISCLOSURES
 
Six Months Ended December 31,
(in thousands)
2014

 
2013

Cash paid during the period for:
 
 
 
Interest
$
16,334

 
$
14,231

Income taxes
24,894

 
24,868

Supplemental disclosure of non-cash information:
 
 
 
Changes in accounts payable related to purchases of property, plant and equipment
6,470

 
8,600



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KENNAMETAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
 
 


5.
ACQUISITION

On November 4, 2013, the Company completed its transaction to acquire the Tungsten Materials Business (TMB) from Allegheny Technologies Incorporated (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 available borrowings under our existing credit facility.

The accompanying condensed consolidated balance sheet as of December 31, 2014 reflects the final allocation of the purchase price. No material adjustments have been made to the allocation in conjunction with finalization.

The accompanying condensed consolidated statement of income for the six months ended December 31, 2014, includes net sales of $123.3 million and net income of $6.1 million related to TMB.
Unaudited Pro Forma Financial Information
The following unaudited pro forma summary of operating results presents the consolidated results of operations as if the TMB acquisition had occurred on July 1, 2012. These amounts were calculated after applying our accounting policies and adjusting TMB’s results to reflect increased depreciation and amortization expense resulting from recording fixed assets and intangible assets at fair value, as well as increased cost of sales resulting from recording inventory at fair value. The pro forma results have been presented for comparative purposes only, include no expected sales or cost synergies and are not indicative of future results of operations or what would have occurred had the acquisition been made on July 1, 2012.

Unaudited pro forma summary of operating results of Kennametal, assuming the acquisition had occurred as of July 1, 2012, are as follows:
Six months ended December 31 (in thousands, except per share data)
2013

Pro forma (unaudited):
 
Net Sales
$
1,451,678

Net income attributable to Kennametal
$
83,387

Per share data attributable to Kennametal:
 
Basic earnings per share
$
1.06

Diluted earnings per share
$
1.05


6.FAIR VALUE MEASUREMENTS
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair value hierarchy consists of three levels to prioritize the inputs used in valuations, as defined below:
Level 1: Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.
Level 2: Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly, including quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; inputs other than quoted prices that are observable for the asset or liability (e.g., interest rates); and inputs that are derived principally from or corroborated by observable market data by correlation or other means.
Level 3: Inputs that are unobservable.

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KENNAMETAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
 
 


As of December 31, 2014, the fair values of the Company’s financial assets and financial liabilities measured at fair value on a recurring basis are categorized as follows: 
(in thousands)
Level 1

 
Level 2

 
Level 3

 
Total

Assets:
 
 
 
 
 
 
 
Derivatives (1)
$

 
$
9,762

 
$

 
$
9,762

Total assets at fair value
$

 
$
9,762

 
$

 
$
9,762

 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
Derivatives (1)
$

 
$
120

 
$

 
$
120

   Contingent consideration

 

 
10,000

 
10,000

Total liabilities at fair value
$

 
$
120

 
$
10,000

 
$
10,120

 
As of June 30, 2014, the fair value of the Company’s financial assets and financial liabilities measured at fair value on a recurring basis are categorized as follows:
(in thousands)
Level 1

 
Level 2

 
Level 3

 
Total

Assets:
 
 
 
 
 
 
 
Derivatives (1)
$

 
$
253

 
$

 
$
253

Total assets at fair value
$

 
$
253

 
$

 
$
253

 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
Derivatives (1)
$

 
$
1,053

 
$

 
$
1,053

   Contingent consideration

 

 
14,000

 
14,000

Total liabilities at fair value
$

 
$
1,053

 
$
14,000

 
$
15,053

 (1) Currency derivatives are valued based on observable market spot and forward rates and are classified within Level 2 of the fair value hierarchy.

The fair value of contingent consideration payable that was classified as Level 3 relates to our probability assessments of expected future milestone targets, primarily associated with product delivery, related to the Emura acquisition. The contingent consideration is to be paid over the next 2 years. During the three months ended December 31, 2014, the Company paid $4.0 million in conjunction with achieved milestone targets. The Company reassessed this contingent consideration and determined that no adjustment to the fair value of the remaining contingent consideration was necessary and that no changes in the expected outcome have occurred during the quarter ended December 31, 2014.
 
7.
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
As part of our financial risk management program, we use certain derivative financial instruments. We do not enter into derivative transactions for speculative purposes and, therefore, hold no derivative instruments for trading purposes. We account for derivative instruments as a hedge of the related asset, liability, firm commitment or anticipated transaction, when the derivative is specifically designated and qualifies as a hedge of such items. Our objective in managing foreign exchange exposures with derivative instruments is to reduce volatility in cash flow. We measure hedge effectiveness by assessing the changes in the fair value or expected future cash flows of the hedged item. The ineffective portions are recorded in other expense, net.

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KENNAMETAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
 
 


The fair value of derivatives designated and not designated as hedging instruments in the condensed consolidated balance sheet are as follows:
(in thousands)
December 31,
2014
 
June 30,
2014
Derivatives designated as hedging instruments
 
 
 
Other current assets - range forward contracts
$
3,668

 
$
184

Other current liabilities - range forward contracts

 
(6
)
Other assets - range forward contracts

 
42

Total derivatives designated as hedging instruments
3,668

 
220

Derivatives not designated as hedging instruments
 
 
 
Other current assets - currency forward contracts
6,094

 
27

Other current liabilities - currency forward contracts
(120
)
 
(1,047
)
Total derivatives not designated as hedging instruments
5,974

 
(1,020
)
Total derivatives
$
9,642

 
$
(800
)

Certain currency forward contracts that hedge significant cross-border intercompany loans are considered as other derivatives and therefore do not qualify for hedge accounting. These contracts are recorded at fair value in the condensed consolidated balance sheet, with the offset to other expense, net. (Gains) losses related to derivatives not designated as hedging instruments have been recognized as follows:
 
Three Months Ended December 31,
 
Six Months Ended December 31,
(in thousands)
2014

 
2013

 
2014

 
2013

Other (income) expense, net - currency forward contracts
$
(2,273
)
 
$
72

 
$
(7,169
)
 
$
114

 
CASH FLOW HEDGES
Range forward contracts (a transaction where both a put option is purchased and a call option is sold) are designated as cash flow hedges and hedge anticipated cash flows from cross-border intercompany sales of products and services. Gains and losses realized on these contracts at maturity are recorded in accumulated other comprehensive loss and are recognized as a component of other expense (income), net when the underlying sale of products or services is recognized into earnings. The notional amount of the contracts translated into U.S. dollars at December 31, 2014 and June 30, 2014, was $57.0 million and $91.1 million, respectively. The time value component of the fair value of range forward contracts is excluded from the assessment of hedge effectiveness. Assuming the market rates remain constant with the rates at December 31, 2014, we expect to recognize into earnings in the next 12 months $2.3 million of income on outstanding derivatives.
In February 2012, we settled forward starting interest rate swap contracts to convert $150.0 million of our floating rate debt to fixed rate debt. Upon settlement, we made a cash payment of $22.4 million. The loss is being amortized as a component of interest expense over the term of the related debt using the effective interest rate method. During the three months ended December 31, 2014 and 2013, $0.5 million and $0.5 million was recognized as interest expense, respectively. During the six months ended December 31, 2014 and 2013, $1.0 million and $1.0 million was recognized as interest expense, respectively.
The following represents gains and losses related to cash flow hedges:
 
Three Months Ended December 31,
 
Six Months Ended December 31,
(in thousands)
2014

 
2013

 
2014

 
2013

Gains (losses) recognized in other comprehensive income, net
$
1,205

 
$
(273
)
 
$
2,712

 
$
(843
)
Losses reclassified from accumulated other comprehensive loss into other expense (income), net
$
152

 
$
324

 
$
502

 
$
714

No portion of the gains or losses recognized in earnings was due to ineffectiveness and no amounts were excluded from our effectiveness testing for the six months ended December 31, 2014 and 2013.
8.
RESTRUCTURING AND RELATED CHARGES AND ASSET IMPAIRMENT CHARGES

11

Table of Contents

KENNAMETAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
 
 


Restructuring and Related
As previously set forth in the 2014 Annual Report on Form 10-K, we are implementing restructuring actions in conjunction with our Phase 1 restructuring program to achieve synergies across Kennametal as a result of the TMB acquisition by consolidating operations among both organizations, reducing administrative overhead and leveraging the supply chain. These restructuring actions are expected to be completed by the end of fiscal 2016 and are anticipated to be mostly cash expenditures.
During the six months ended December 31, 2014, we recognized restructuring and related charges of $20.4 million, of this amount, restructuring charges totaled $8.6 million, of which $0.2 million were charges related to inventory disposals and were recorded in cost of goods sold. Restructuring-related charges of $6.3 million were recorded in cost of goods sold and $5.5 million in operating expense for the six months ended December 31, 2014.
During the six months ended December 31, 2013, we recorded restructuring charges of $2.3 million.
The total pre-tax charges for Phase 1 programs are expected to be in the range of $55 million to $60 million, which is expected to be approximately 50 percent Industrial and 50 percent Infrastructure. Total restructuring and related charges since inception of $39.5 million have been recorded for these programs through December 31, 2014: $24.5 million in Industrial, $13.1 million in Infrastructure, and $1.8 million in Corporate.
The restructuring accrual is recorded in other current liabilities in our condensed consolidated balance sheet and the amount attributable to each segment is as follows:
(in thousands)
June 30, 2014
 
Expense
 
Asset Write-Down
 
Other (2)
 
Translation
 
Cash Expenditures
 
December 31, 2014
Industrial
 
 
 
 
 
 
 
 
 
 
 
 
 
Severance
$
5,815

 
$
3,361

 
$

 
$

 
$
(282
)
 
$
(4,291
)
 
$
4,603

Facilities
444

 
489

 
(489
)
 

 
(22
)
 
(389
)
 
33

Other
67

 
21

 

 

 
(2
)
 
(86
)
 

Total Industrial
$
6,326

 
$
3,871

 
$
(489
)
 
$

 
$
(306
)
 
$
(4,766
)
 
$
4,636

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Infrastructure
 
 
 
 
 
 
 
 
 
 
 
 
 
Severance
$
2,458

 
$
4,177

 
$

 
$
(459
)
 
$
(312
)
 
$
(4,747
)
 
$
1,117

Facilities
190

 
542

 
(541
)
 

 
(25
)
 
(166
)
 

Other
28

 
23

 

 

 
(3
)
 
(48
)
 

Total Infrastructure
$
2,676

 
$
4,742

 
$
(541
)
 
$
(459
)
 
$
(340
)
 
$
(4,961
)
 
$
1,117

Total
$
9,002

 
$
8,613

 
$
(1,030
)
 
$
(459
)
 
$
(646
)
 
$
(9,727
)
 
$
5,753

(2) Special termination benefit charge for one of our U.S.-based benefit pension plans resulting from a plant closure - see Note 10.

Asset impairment

See discussion on Infrastructure segment goodwill and other intangible asset impairment charges in Note 18.


12

Table of Contents

KENNAMETAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
 
 


9.
STOCK-BASED COMPENSATION
Stock Options
The assumptions used in our Black-Scholes valuation related to grants made during the six months ended December 31, 2014 and 2013 were as follows:
 
2014

 
2013

Risk-free interest rate
1.5
%
 
1.3
%
Expected life (years) (3)
4.5

 
4.5

Expected volatility (4)
32.5
%
 
40.4
%
Expected dividend yield
1.6
%
 
1.5
%
(3) Expected life is derived from historical experience.
(4) Expected volatility is based on the implied historical volatility of our stock.
 
Changes in our stock options for the six months ended December 31, 2014 were as follows:
 
Options

 
Weighted
Average
Exercise Price

 
Weighted Average Remaining Life (years)
 
Aggregate
Intrinsic value
(in thousands)

Options outstanding, June 30, 2014
2,264,824

 
$
33.95

 
 
 
 
Granted
436,541

 
40.81

 
 
 
 
Exercised
(222,206
)
 
27.54

 
 
 
 
Lapsed and forfeited
(11,905
)
 
41.10

 
 
 
 
Options outstanding, December 31, 2014
2,467,254

 
$
35.71

 
5.3
 
$
7,580

Options vested and expected to vest,
  December 31, 2014
2,206,567

 
$
35.02

 
5.4
 
$
7,578

Options exercisable, December 31, 2014
1,600,847

 
$
32.76

 
4.1
 
$
7,562

During the six months ended December 31, 2014 and 2013, compensation expense related to stock options was $2.8 million and $3.5 million, respectively. As of December 31, 2014, the total unrecognized compensation cost related to options outstanding was $3.7 million and is expected to be recognized over a weighted average period of 2.8 years.
Weighted average fair value of options granted during the six months ended December 31, 2014 and 2013 was $10.16 and $13.79, respectively. Fair value of options vested during the six months ended December 31, 2014 and 2013 was $6.9 million and $5.0 million, respectively.
Tax benefits relating to excess stock-based compensation deductions are presented in the condensed consolidated statements of cash flow as financing cash inflows. Tax benefits resulting from stock-based compensation deductions exceeded amounts reported for financial reporting purposes by $1.3 million and $4.5 million for the six months ended December 31, 2014 and 2013, respectively.
The amount of cash received from the exercise of capital stock options during the six months ended December 31, 2014 and 2013 was $6.1 million and $12.7 million, respectively. The related tax benefit for the six months ended December 31, 2014 and 2013 was $1.3 million and $2.7 million, respectively. The total intrinsic value of options exercised during the six months ended December 31, 2014 and 2013 was $3.4 million and $9.2 million, respectively.
Under the provisions of the Kennametal Inc. Stock and Incentive Plan of 2010 as amended and restated on October 22, 2013, plan participants may deliver stock, owned by the holder for at least six months, in payment of the option price and receive credit for the fair market value of the shares on the date of delivery. The fair market value of shares delivered during the six months ended December 31, 2014 was immaterial. The fair market value of shares delivered during the six months ended December 31, 2013 was $0.2 million.


13

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KENNAMETAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
 
 


Restricted Stock Units – Time Vesting and Performance Vesting
Performance vesting restricted stock units are earned pro rata each year if certain performance goals are met over a three-year period and are also subject to a service condition that requires the individual to be employed by the Company at the payment date after the three-year performance period, with the exception of retirement eligible grantees, who upon retirement are entitled to receive payment for any units that have been earned, including a prorated portion in the partially completed fiscal year in which the retirement occurs. 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.
Changes in our time vesting and performance vesting restricted stock units for the six months ended December 31, 2014 were as follows:
 
Performance Vesting Stock Units

 
Performance Vesting Weighted Average Fair Value

 
Time Vesting
Stock Units

 
Time Vesting Weighted Average Fair Value

Unvested performance vesting and time vesting restricted stock units, June 30, 2014
197,356

 
$
40.92

 
743,326

 
$
39.20

Granted
88,536

 
43.16

 
438,795

 
42.27

Vested
(28,022
)
 
38.95

 
(306,484
)
 
36.26

Performance metric not achieved
(65,373
)
 
43.16

 

 

Forfeited

 

 
(25,471
)
 
41.69

Unvested performance vesting and time vesting restricted stock units, December 31, 2014
192,497

 
$
42.98

 
850,166

 
$
41.78

During the six months ended December 31, 2014 and 2013, compensation expense related to time vesting and performance vesting restricted stock units was $10.6 million and $8.4 million, respectively. As of December 31, 2014, the total unrecognized compensation cost related to unvested time vesting and performance vesting restricted stock units was $21.3 million and is expected to be recognized over a weighted average period of 2.7 years.

10.
BENEFIT PLANS
We sponsor several defined benefit pension plans. Additionally, we provide varying levels of postretirement health care and life insurance benefits to some U.S. employees.
During the quarter we recognized a special termination benefit charge of $0.5 million and a curtailment loss of $0.4 million for one of our U.S.-based defined benefit pension plans resulting from a plant closure. The special termination benefit charge was recognized in restructuring expense.
The table below summarizes the components of net periodic pension income:
 
Three Months Ended December 31,
 
Six Months Ended December 31,
(in thousands)
2014

 
2013

 
2014

 
2013

Service cost
$
1,384

 
$
1,732

 
$
2,799

 
$
3,448

Interest cost
9,745

 
10,308

 
19,681

 
20,484

Expected return on plan assets
(14,900
)
 
(14,916
)
 
(29,947
)
 
(29,712
)
Amortization of transition obligation
19

 
20

 
40

 
38

Amortization of prior service credit
(71
)
 
(58
)
 
(141
)
 
(117
)
Recognition of actuarial losses
937

 
670

 
1,937

 
1,312

Curtailment loss
358

 

 
358

 

Special termination benefit charge
459

 

 
459

 

Net periodic pension income
$
(2,069
)
 
$
(2,244
)
 
$
(4,814
)
 
$
(4,547
)


14

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KENNAMETAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
 
 


The table below summarizes the components of the net periodic other postretirement benefit cost:
 
Three Months Ended December 31,
 
Six Months Ended December 31,
(in thousands)
2014

 
2013

 
2014

 
2013

Service cost
$
27

 
$
14

 
$
54

 
$
28

Interest cost
259

 
251

 
519

 
502

Amortization of prior service credit
(28
)
 
(28
)
 
(55
)
 
(56
)
Recognition of actuarial loss
207

 
79

 
414

 
158

Curtailment gain
(221
)
 

 
(221
)
 

Net periodic other postretirement benefit cost
$
244

 
$
316

 
$
711

 
$
632


The curtailment gain of $0.2 million was a result of the plant closure discussed above.

11.
INVENTORIES
We used the last-in, first-out (LIFO) method of valuing inventories for 47 percent and 43 percent of total inventories at December 31, 2014 and June 30, 2014, respectively. Since inventory valuations under the LIFO method are based on an annual determination of quantities and costs as of June 30 of each year, the interim LIFO valuations are based on our projections of expected year-end inventory levels and costs. Therefore, the interim financial results are subject to any final year-end LIFO inventory adjustments.
 
Inventories consisted of the following: 
(in thousands)
December 31, 2014
 
June 30, 2014
Finished goods
$
362,979

 
$
371,599

Work in process and powder blends
286,841

 
308,129

Raw materials
110,756

 
126,004

Inventories at current cost
760,576

 
805,732

Less: LIFO valuation
(97,693
)
 
(101,966
)
Total inventories
$
662,883

 
$
703,766


12.
LONG-TERM DEBT
Our $600 million five-year, multi-currency, revolving credit facility (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, 2014. We had $174.1 million and $287.1 million of borrowings outstanding under the 2011 Credit Agreement as of December 31, 2014 and June 30, 2014, respectively. Borrowings under the 2011 Credit Agreement are guaranteed by our significant domestic subsidiaries. The 2011 Credit Agreement matures in April 2018.
Fixed rate debt had a fair market value of $703.3 million and $705.3 million at December 31, 2014 and June 30, 2014, respectively. The Level 2 fair value is determined based on the quoted market price of this debt as of December 31, 2014 and June 30, 2014, respectively.


15

Table of Contents

KENNAMETAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
 
 


13.
ENVIRONMENTAL MATTERS
The operation of our business has exposed us to certain liabilities and compliance costs related to environmental matters. We are involved in various environmental cleanup and remediation activities at certain of our locations.
Superfund Sites We are involved as a potentially responsible party (PRP) at various sites designated by the United States Environmental Protection Agency (USEPA) as Superfund sites. For certain of these sites, we have evaluated the claims and potential liabilities and have determined that neither are material, individually or in the aggregate. For certain other sites, proceedings are in the very early stages and have not yet progressed to a point where it is possible to estimate the ultimate cost of remediation, the timing and extent of remedial action that may be required by governmental authorities or the amount of our liability alone or in relation to that of any other PRP.
Other Environmental Matters We establish and maintain reserves for other potential environmental issues. At December 31, 2014 and June 30, 2014, the balances of these reserves were $12.6 million and $11.0 million. These reserves represent anticipated costs associated with the remediation of these issues.
The reserves we have established for environmental liabilities represent our best current estimate of the costs of addressing all identified environmental situations, based on our review of currently available evidence, and taking into consideration our prior experience in remediation and that of other companies, as well as public information released by the USEPA, other governmental agencies and by the PRP groups in which we are participating. Although the reserves currently appear to be sufficient to cover these environmental liabilities, there are uncertainties associated with environmental liabilities, and we can give no assurance that our estimate of any environmental liability will not increase or decrease in the future. The reserved and unreserved liabilities for all environmental concerns could change substantially due to factors such as the nature and extent of contamination, changes in remedial requirements, technological changes, discovery of new information, the financial strength of other PRPs, the identification of new PRPs and the involvement of and direction taken by the government on these matters.
We maintain a Corporate Environmental Health and Safety (EHS) Department to monitor compliance with environmental regulations and to oversee remediation activities. In addition, we have designated EHS coordinators 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.

14.
INCOME TAXES
The effective income tax rate for the three months ended December 31, 2014 and 2013 was negative 12.7 percent (provision on a loss) and 40.8 percent (provision on income), respectively. The effective income tax rate for six months ended December 31, 2014 and 2013 was negative 20.1 percent (provision on a loss) and 31.8 percent (provision on income), respectively. The change in both periods was primarily driven by the asset impairment charges recorded in the current quarter, most of which could not be tax effected, lower relative U.S. current year earnings compared with the rest of the world where the tax rates are generally lower, and favorable effects of the extension of the credit for increase in research activities contained in the Tax Increase Prevention Act of 2014 that was enacted during the current quarter. The prior year rate included a tax charge related to a change in assertion of a foreign subsidiary’s certain undistributed earnings, which were no longer considered permanently reinvested.


16

Table of Contents

KENNAMETAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
 
 


15.
EARNINGS PER SHARE
Basic earnings per share is computed using the weighted average number of shares outstanding during the period, while diluted earnings per share is calculated to reflect the potential dilution that occurs related to the issuance of capital stock under stock option grants and restricted stock units. The difference between basic and diluted earnings per share relates solely to the effect of capital stock options and restricted stock units.
For the three and six months ended December 31, 2014, the effect of unexercised capital stock options and unvested restricted stock units was anti-dilutive as a result of a net loss in the periods and therefore has been excluded from diluted shares outstanding as well as from the diluted earnings per share calculation. For purposes of determining the number of diluted shares outstanding for the three and six months ended December 31, 2013, weighted average shares outstanding for basic earnings per share calculations were increased due solely to the dilutive effect of unexercised capital stock options and unvested restricted stock units by $1.0 million and 1.0 million shares, respectively. Unexercised capital stock options and restricted stock units of 0.2 million shares and 0.3 million shares for the three and six months ended December 31, 2013, respectively, were not included in the computation of diluted earnings per share because the option exercise price was greater than the average market price, and therefore the inclusion would have been anti-dilutive.

16.
EQUITY
A summary of the changes in the carrying amounts of total equity, Kennametal Shareholders’ equity and equity attributable to noncontrolling interests as of December 31, 2014 and 2013 is as follows:
 
Kennametal Shareholders’ Equity
 
 
 
 
(in thousands)
Capital
stock

 
Additional
paid-in
capital

 
Retained
earnings

 
Accumulated
other
comprehensive loss

 
Non-
controlling
interests

 
Total equity

Balance as of June 30, 2014
$
98,340

 
$
395,890

 
$
1,501,157

 
$
(66,131
)
 
$
32,352

 
$
1,961,608

Net (loss) income

 

 
(348,814
)
 

 
1,236

 
(347,578
)
Other comprehensive loss

 

 

 
(69,352
)
 
(2,274
)
 
(71,626
)
Dividend reinvestment
5

 
163

 

 

 

 
168

Capital stock issued under employee benefit and stock plans
592

 
16,089

 

 

 

 
16,681

Purchase of capital stock
(5
)
 
(163
)
 

 

 

 
(168
)
Cash dividends paid

 

 
(28,451
)
 

 
(47
)
 
(28,498
)
Balance as of December 31, 2014
$
98,932

 
$
411,979

 
$
1,123,892

 
$
(135,483
)
 
$
31,267

 
$
1,530,587

 

17

Table of Contents

KENNAMETAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
 
 


 
Kennametal Shareholders’ Equity
 
 
 
 
(in thousands)
Capital
stock

 
Additional
paid-in
capital

 
Retained
earnings

 
Accumulated
other
comprehensive
loss

 
Non-
controlling
interests

 
Total equity

Balance as of June 30, 2013
$
97,303

 
$
374,300

 
$
1,399,227

 
$
(89,004
)
 
$
30,467

 
$
1,812,293

Net income

 

 
62,046

 

 
679

 
62,725

Other comprehensive income

 

 

 
37,571

 
227

 
37,798

Dividend reinvestment
3

 
149

 

 

 

 
152

Capital stock issued under employee benefit and stock plans
1,056

 
21,926

 

 

 

 
22,982

Purchase of capital stock
(128
)
 
(4,272
)
 

 

 

 
(4,400
)
Cash dividends paid

 

 
(28,180
)
 

 
(66
)
 
(28,246
)
Balance as of December 31, 2013
$
98,234

 
$
392,103

 
$
1,433,093

 
$
(51,433
)
 
$
31,307

 
$
1,903,304


The amounts of comprehensive income attributable to Kennametal Shareholders and noncontrolling interests are disclosed in the condensed consolidated statements of comprehensive income.

17.
ACCUMULATED OTHER COMPREHENSIVE (LOSS) INCOME

Total accumulated other comprehensive (loss) income (AOCL) consists of net (loss) income and other changes in equity from transactions and other events from sources other than shareholders. It includes postretirement benefit plan adjustments, currency translation adjustments and unrealized gains and losses from derivative instruments designated as cash flow hedges.

The components of, and changes in, AOCL were as follows (net of tax) for the three months ended December 31, 2014 (in thousands):
Attributable to Kennametal:
Postretirement benefit plans
Currency translation adjustment
Derivatives
Total
Balance, September 30, 2014
$
(89,347
)
$
(11,210
)
$
(9,329
)
$
(109,886
)
Other comprehensive loss before
  reclassifications
1,924

(29,427
)
1,206

(26,297
)
Amounts reclassified from AOCL
735


(35
)
700

Net current period other comprehensive
  loss
2,659

(29,427
)
1,171

(25,597
)
AOCL, December 31, 2014
$
(86,688
)
$
(40,637
)
$
(8,158
)
$
(135,483
)
 
 
 
 
 
Attributable to noncontrolling interests:
 
 
 
 
Balance, September 30, 2014
$

$
(405
)
$

$
(405
)
Other comprehensive loss before
  reclassifications

(782
)

(782
)
Net current period other comprehensive
  loss

(782
)

(782
)
AOCL, December 31, 2014
$

$
(1,187
)
$

$
(1,187
)


18

Table of Contents

KENNAMETAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
 
 


The components of, and changes in, AOCL were as follows (net of tax) for the six months ended December 31, 2014 (in thousands):
Attributable to Kennametal:
Postretirement benefit plans
Currency translation adjustment
Derivatives
Total
Balance, June 30, 2014
$
(93,742
)
$
38,811

$
(11,200
)
$
(66,131
)
Other comprehensive loss before
  reclassifications
5,565

(79,448
)
2,713

(71,170
)
Amounts reclassified from AOCL
1,489


329

1,818

Net current period other comprehensive
  loss
7,054

(79,448
)
3,042

(69,352
)
AOCL, December 31, 2014
$
(86,688
)
$
(40,637
)
$
(8,158
)
$
(135,483
)
 
 
 
 
 
Attributable to noncontrolling interests:
 
 
 
 
Balance, June 30, 2014
$

$
1,087

$

$
1,087

Other comprehensive loss before
  reclassifications

(2,274
)

(2,274
)
Net current period other comprehensive
  loss

(2,274
)

(2,274
)
AOCL, December 31, 2014
$

$
(1,187
)
$

$
(1,187
)

The components of, and changes in, AOCL were as follows (net of tax) for the three months ended December 31, 2013 (in thousands):
Attributable to Kennametal:
Postretirement benefit plans
Currency translation adjustment
Derivatives
Total
Balance, September 30, 2013
$
(85,419
)
$
35,510

$
(12,642
)
$
(62,551
)
Other comprehensive (loss) income before reclassifications
(810
)
11,263

(273
)
10,180

Amounts reclassified from AOCL
498


440

938

Net current period other comprehensive
  (loss) income
(312
)
11,263

167

11,118

AOCL, December 31, 2013
$
(85,731
)
$
46,773

$
(12,475
)
$
(51,433
)
 
 
 
 
 
Attributable to noncontrolling interests:
 
 
 
 
Balance, September 30, 2013
$

$
535

$

$
535

Other comprehensive income before
  reclassifications

413


413

Net current period other comprehensive
  income

413


413

AOCL, December 31, 2013
$

$
948

$

$
948



19

Table of Contents

KENNAMETAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
 
 


The components of, and changes in, AOCL were as follows (net of tax) for the six months ended December 31, 2013 (in thousands):
Attributable to Kennametal:
Postretirement benefit plans
Currency translation adjustment
Derivatives
Total
Balance, June 30, 2013
$
(83,937
)
$
7,414

$
(12,481
)
$
(89,004
)
Other comprehensive (loss) income before reclassifications
(2,776
)
39,359

(843
)
35,740

Amounts reclassified from AOCL
982


849

1,831

Net current period other comprehensive
  (loss) income
(1,794
)
39,359

6

37,571

AOCL, December 31, 2013
$
(85,731
)
$
46,773

$
(12,475
)
$
(51,433
)
 
 
 
 
 
Attributable to noncontrolling interests:
 
 
 
 
Balance, June 30, 2013
$

$
721

$

$
721

Other comprehensive income before
  reclassifications

227


227

Net current period other comprehensive
  income

227


227

AOCL, December 31, 2013
$

$
948

$

$
948


Reclassifications out of AOCL for the three and six months ended December 31, 2014 and 2013, respectively consisted of the following (in thousands):
 
Three Months Ended December 31,
 
Six Months Ended December 31,
 
Details about AOCL components
2014
 
2013
 
2014
 
2013
Affected line item in the Income Statement
Gains and losses on cash flow hedges:
 
 
 
 
 
 
 
 
Forward starting interest rate swaps
$
505

 
$
486

 
$
1,010

 
$
973

Interest expense
Currency exchange contracts
(562
)
 
224

 
(474
)
 
396

Other expense, net
Total before tax
(57
)
 
710

 
536

 
1,369

 
Tax (expense) benefit
(22
)
 
270

 
207

 
520

Provision for income taxes
Net of tax
$
(35
)
 
$
440

 
$
329

 
$
849

 
 
 
 
 
 
 
 
 
 
Postretirement benefit plans:
 
 
 
 
 
 
 
 
Amortization of transition obligations
$
19

 
$
20

 
$
40

 
$
38

See note 10 for further details
Amortization of prior service credit
(99
)
 
(86
)
 
(196
)
 
(173
)
See note 10 for further details
Recognition of actuarial losses
1,144

 
749

 
2,351

 
1,470

See note 10 for further details
Total before taxes
1,064

 
683

 
2,195

 
1,335

 
Tax benefit
329

 
185

 
706

 
353

Provision for income taxes
Net of tax
$
735

 
$
498

 
$
1,489

 
$
982

 


20

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KENNAMETAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
 
 


18.
GOODWILL AND OTHER INTANGIBLE ASSETS

Goodwill represents the excess of cost over the fair value of the net assets of acquired companies. Goodwill and other intangible assets with indefinite lives are tested at least annually for impairment. We perform our annual impairment tests during the June quarter in connection with our annual planning process. We also perform specific impairment tests on an interim basis based on the results of an ongoing cumulative qualitative assessment if indicative of impairment of the goodwill for a reporting unit or an indefinite-lived intangible asset. We evaluate the recoverability of goodwill for 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. This evaluation is sensitive to changes in market interest rates and other external factors.

Late in the December quarter, the Company experienced an abrupt change in customer demand in the oil and gas markets that is expected to continue into the foreseeable future, coupled with the severe and persistent decline in the earthworks markets. In view of the severe downturn in the global Infrastructure markets in the December quarter, we made an assessment of the possible impairment of the goodwill and other long-lived assets of our Infrastructure reporting unit. As a result of this assessment, we determined that the magnitude and duration of the economic downturn of the Infrastructure end markets, as well as other factors, necessitated an interim impairment test of our Infrastructure reporting unit. As a result of our test, we recorded a preliminary non-cash pre-tax impairment charge of $376.5 million in the Infrastructure segment, of which $375.0 million was for goodwill and $1.5 million was for an indefinite-lived trademark intangible asset. The goodwill impairment charge is subject to finalization of fair values related to intangibles and property, plant and equipment, which we expect to complete in the third quarter of fiscal 2015. Goodwill of $266.2 million remains on the books of our Infrastructure segment.

Identifiable assets with finite lives are reviewed for impairment whenever events or circumstances indicate that the carrying value may not be recoverable. During the December quarter, we performed a preliminary review of our identifiable assets with finite lives and preliminarily determined that the assets were not impaired. The review is subject to finalization, which we expect to complete in the third quarter of fiscal 2015.

The further acceleration or extended persistence of the current downturn in the global end markets could have a further negative impact on our business and financial performance. We are currently in the beginning stages of exploring strategic alternatives for several businesses within the Infrastructure segment, which have total estimated net book values of approximately $150 million to $200 million as of December 31, 2014. As the strategic direction has not yet been determined for these businesses, the Company cannot determine if additional impairment charges are either probable or estimable.
A summary of the carrying amount of goodwill attributable to each segment, as well as the changes in such, is as follows:
(in thousands)
Industrial

 
Infrastructure

 
Total

Gross goodwill
$
472,337

 
$
654,081

 
$
1,126,418

Accumulated impairment losses
(150,842
)
 

 
(150,842
)
Balance as of June 30, 2014
$
321,495

 
$
654,081

 
$
975,576

 
 
 
 
 
 
Activity for the six months ended December 31, 2014:
 
 
 
 
 
Acquisition
2,984

 

 
2,984

Translation
(11,082
)
 
(12,911
)
 
(23,993
)
Change in gross goodwill
(8,098
)
 
(12,911
)
 
(21,009
)
Impairment charge

 
(375,000
)
 
(375,000
)
 
 
 
 
 
 
Gross goodwill
464,239

 
641,170

 
1,105,409

Accumulated impairment losses
(150,842
)
 
(375,000
)
 
(525,842
)
Balance as of December 31, 2014
$
313,397

 
$
266,170

 
$
579,567



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KENNAMETAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
 
 


The components of our other intangible assets were as follows:
 
 
Estimated
Useful Life
(in years)
 
December 31, 2014
June 30, 2014
(in thousands)
 
Gross Carrying
Amount

 
Accumulated
Amortization

 
 
Gross Carrying
Amount

 
Accumulated
Amortization

Contract-based
3 to 15
 
$
8,534

 
$
(7,624
)
 
 
$
23,446

 
$
(10,820
)
Technology-based and other
4 to 20
 
53,657

 
(28,361
)
 
 
54,842

 
(28,516
)
Customer-related
10 to 21
 
278,993

 
(82,567
)
 
 
285,751

 
(76,376
)
Unpatented technology
10 to 30
 
60,201

 
(13,395
)
 
 
61,867

 
(12,549
)
Trademarks
5 to 20
 
18,764

 
(11,408
)
 
 
19,256

 
(10,984
)
Trademarks
Indefinite
 
33,457

 

 
 
37,259

 

Total
 
 
$
453,606

 
$
(143,355
)
 
 
$
482,421

 
$
(139,245
)

During the three months ended December 31, 2014, an impairment of $10.5 million was recorded for a contract-based technology intangible asset that was part of the Infrastructure segment, resulting in a non-cash impairment charge of $5.5 million and a reduction in a liability of $5.0 million. As previously mentioned, we recorded a $1.5 million impairment for an indefinite-lived trademark intangible asset as a result of our interim impairment test of our Infrastructure segment.
During the six months ended December 31, 2014, we recorded amortization expense of $14.0 million related to our other intangible assets and unfavorable currency translation adjustments of $7.1 million.

19.
SEGMENT DATA
Kennametal delivers 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 product offering includes a wide selection of standard and customized technologies for metalworking, such as sophisticated metalcutting tools, tooling systems and services, as well as advanced, high-performance materials, such as cemented tungsten carbide products, super alloys, coatings and investment castings to address customer demands. We offer these products through a variety of channels to meet customer-specified needs.
The Industrial segment generally serves customers that operate in industrial end markets such as aerospace and defense, transportation and general engineering. The customers in these end markets manufacture engines, airframes, automobiles, trucks, ships and various types of industrial equipment. The technology and customization requirements for customers we serve vary by customer, application and industry. The value we deliver to our Industrial segment customers centers on our application expertise and our diverse offering of products and services.
The Infrastructure segment generally serves customers that operate in the earthworks and energy sectors who support primary industries such as oil and gas, power generation, underground, surface and hard-rock mining, highway construction and road maintenance. Generally, we rely on customer intimacy to serve this segment. By gaining an in-depth understanding of our customers’ engineering and development needs, we are able to offer complete system solutions and high-performance capabilities to optimize and add value to their operations.
Corporate expenses related to executive retirement plans, the Company’s Board of Directors and strategic initiatives, as well as certain other costs, are reported as Corporate.

22

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KENNAMETAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
 
 


Our sales and operating income (loss) by segment are as follows: 
 
Three Months Ended December 31,
 
Six Months Ended December 31,
(in thousands)
2014

 
2013

 
2014

 
2013

Sales:
 
 
 
 
 
 
 
Industrial
$
371,557

 
$
370,647

 
$
749,415

 
$
708,876

Infrastructure
304,074

 
319,289

 
621,157

 
600,867

Total sales
$
675,631

 
$
689,936

 
$
1,370,572

 
$
1,309,743

Operating (loss) income:
 
 
 
 
 
 
 
Industrial
$
41,795

 
$
33,218

 
$
85,812

 
$
73,038

Infrastructure (5)
(371,920
)
 
18,604

 
(352,699
)
 
40,294

Corporate
(3,646
)
 
(2,106
)
 
(5,864
)
 
(4,787
)
Total operating (loss) income
(333,771
)
 
49,716

 
(272,751
)
 
108,545

Interest expense
7,960

 
8,037

 
16,170

 
15,118

Other expense, net
2,223

 
856

 
409

 
1,466

(Loss) income from continuing operations before income taxes
$
(343,954
)
 
$
40,823

 
$
(289,330
)
 
$
91,961

 (5) See Note 18 regarding Infrastructure segment impairment charges for goodwill and other intangible assets.


23

Table of Contents

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 solutions to customers seeking peak performance in demanding environments. The Company provides 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. Kennametal 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 its leading position in its primary industrial and infrastructure markets. End users of the Company’s 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 metalcutting tools and tooling supplies.

Our sales of $675.6 million for the quarter ended December 31, 2014 decreased 2 percent compared to sales for the December quarter one year ago. Operating loss was $333.8 million, compared to operating income of $49.7 million in the prior year quarter. Our operating results were negatively impacted by impairment charges of $382.0 million, organic sales decline and unfavorable mix in Infrastructure, offset partially by lower employment costs.

Raw material price fluctuations did not materially impact the quarter, although we have seen a change in commodity prices in the Infrastructure segment, it has not significantly impacted us due to our contractual arrangements with our suppliers.

The permanent savings that we are realizing from restructuring are the result of Phase 1 programs that we have undertaken over the past 12 months. Pre-tax benefits from these restructuring actions reached approximately $6 million in the current quarter due to manufacturing rationalization and workforce reduction programs. These benefits were incremental to the same quarter one year ago. Kennametal has made significant progress in integrating TMB, and we have continued to accelerate restructuring actions to reduce costs and improve efficiencies.

We reported current quarter loss per diluted share of $4.89, which included $5.28 per share of goodwill and other intangible asset impairment charges and $0.13 per share of restructuring and related charges.

We generated strong cash flow from operating activities of $135.3 million