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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED JUNE 30, 2016
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.)
 
600 Grant Street
 
 
Suite 5100
 
 
Pittsburgh, Pennsylvania
 
15219-2706
(Address of Principal Executive Offices)
 
(Zip Code)
Registrant’s telephone number, including area code: (412) 248-8200
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
 
Name of each exchange on which registered
Capital Stock, par value $1.25 per share
 
New York Stock Exchange
Preferred Stock Purchase Rights
 
New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None.
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [X] No [  ]
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes [  ] No [X]
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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ]
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.
Large accelerated filer [X]
 
 
  
Accelerated filer [  ]
 
 
Non-accelerated filer [  ]  (Do not check if smaller reporting company)
  
Smaller reporting company [  ]
 
 
Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act). Yes [  ] No [X]
As of December 31, 2015, the aggregate market value of the registrant’s Capital Stock held by non-affiliates of the registrant, estimated solely for the purposes of this Form 10-K, was approximately $1,033,300,000. For purposes of the foregoing calculation only, all directors and executive officers of the registrant and each person who may be deemed to own beneficially more than 5% of the registrant’s Capital Stock have been deemed affiliates.
As of July 29, 2016, there were 79,700,981 of the Registrant’s Capital Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the 2016 Annual Meeting of Shareholders are incorporated by reference into Part III.
 


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FORWARD-LOOKING INFORMATION
This Annual Report on Form 10-K 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. For example, statements about Kennametal's outlook for earnings, sales volumes, and cash flow for its fiscal year 2017, its expectations regarding future growth and any statements regarding future operating or financial performance or events are forward-looking. We have also included forward looking statements in this Form 10-K 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; our ability to achieve all anticipated benefits of restructuring initiatives; 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; potential for future goodwill and other intangible asset impairment charges; our ability to protect and defend our intellectual property; continuity and security of information technology infrastructure; competition; our ability to retain our management and employees; demands on management resources; availability and cost of the raw materials we use to manufacture our products; product liability claims; integrating acquisitions and achieving the expected savings and synergies; global or regional catastrophic events; demand for and market acceptance of our products; business divestitures; energy costs; commodity prices; labor relations; and implementation of environmental remediation matters. We provide additional information about many of the specific risks we face in the “Risk Factors” Section of this 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

ITEM 1 - BUSINESS
OVERVIEW Kennametal Inc. was incorporated in Pennsylvania in 1943. As a global industrial leader, Kennametal delivers 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, construction, process industries 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 the 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 components; machine tool, light machinery and heavy machinery industries; airframe and aerospace components, 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.
Our product offering includes a wide selection of standard and customized technologies for metalworking, such as sophisticated metal cutting 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. We are a leading global supplier of tooling, engineered components and advanced materials consumed in production processes. We believe we are one of the largest global providers of consumable metal cutting tools and tooling supplies.
We specialize in developing and manufacturing metalworking tools and wear-resistant engineered components and coatings using a specialized type of powder metallurgy. Our metalworking tools are made of cemented tungsten carbides, ceramics, cermets and super-hard materials. We also manufacture and market a complete line of tool holders, tool-holding systems and rotary-cutting tools by machining and fabricating steel bars and other metal alloys. In addition, we produce specialized compacts and metallurgical powders, as well as products made from tungsten carbide or other hard materials that are used for custom-engineered and challenging applications, including mining and highway construction, among others. Further, we develop, manufacture and market engineered components and surface technology solutions with proprietary metal cladding capabilities.
Unless otherwise specified, any reference to a “year” refers to the fiscal year ending on June 30.
BUSINESS SEGMENT REVIEW The Company manages and reports its business in the following two segments: Industrial and Infrastructure. The Company's reportable operating segments have been determined in accordance with the Company's internal management structure, which is organized based on operating activities, the manner in which we organize segments for making operating decisions and assessing performance and the availability of separate financial results. Sales and operating income by segment are presented in Management’s Discussion and Analysis of Financial Condition and Results of Operations set forth in Item 7 of this annual report on Form 10-K (MD&A). Additional segment data is provided in Note 20 of our consolidated financial statements set forth in Item 8 of this annual report on Form 10-K (Item 8) which is incorporated herein by reference.
During fiscal 2017, we began operating under a new structure. See additional discussion included in MD&A.
INDUSTRIAL In the Industrial segment, we focus on customers in the transportation, general engineering, aerospace and defense market sectors, as well as the machine tool industry. Our customers in these end markets use our products and services in the manufacture of engines, airframes, automobiles, trucks, ships and other various types of industrial equipment. The technology and customization requirements we provide vary by customer, application and industry. The value we deliver to our Industrial segment customers centers on knowledge of our customers' processes, application expertise and our diverse offering of products and services.

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INFRASTRUCTURE In the Infrastructure segment, we focus on customers in the energy and earthworks market sectors who support primary industries such as oil and gas, power generation and chemicals; underground, surface and hard-rock mining; highway construction and road maintenance; and process industries such as food and beverage. Our success is determined by our associates gaining an in-depth understanding of our customers’ engineering and development needs, to be able to offer complete system solutions and high-performance capabilities to optimize and add value to their operations.
INTERNATIONAL OPERATIONS During 2016, we generated 57 percent of our sales in markets outside of the United States of America (U.S.), with principal international operations in Western Europe, Asia and Canada. In addition, we operate additional manufacturing and distribution facilities in Israel, Latin America and South Africa, while serving customers through sales offices, agents and distributors in Eastern Europe and other parts of the world. While geographic diversification helps to minimize the sales and earnings impact of respective demand changes in any one particular region, our international operations are subject to normal risks of doing business globally, including fluctuations in currency exchange rates and changes in social, political and economic environments.
Our international assets and sales are presented in Note 20 of the Company’s consolidated financial statements, set forth in Item 8 and are incorporated herein by reference. Further information about the effects and risks of currency exchange rates is presented in the Quantitative and Qualitative Disclosures About Market Risk section, as set forth in Item 7A of this annual report on Form 10-K (Item 7A).
GENERAL DEVELOPMENT OF BUSINESS In fiscal 2016 we continued to experience the effects of the further deterioration in customer demand in many of our end markets and certain geographies. Some areas of industrial production declined, in addition to further reductions in mining and oil and gas activity. In addition to restructuring actions, we took temporary cost reductions in various areas of the business.
In 2016, restructuring programs delivered incremental benefits of approximately $44 million. We substantially completed Phase 1 of restructuring programs. Estimated ongoing annualized savings for this phase is $40-$45 million. The company has identified additional actions to adjust the company's cost structure. These initiatives are expected to improve the alignment of our cost structure with the current operating environment through rationalization of three additional manufacturing facilities and through headcount reductions. Restructuring programs not yet completed are currently anticipated to deliver annual ongoing pre-tax savings of $75 million to $90 million once fully implemented.
Additionally, we have embarked on a workforce reduction initiative which should reduce employment by 1,000 with expected costs of $80-$95 million, expected to result in an annual run rate savings of $100-$110 million by fiscal year-end 2017. Consistent with our fix-in-place manufacturing strategy, we believe that there are further cost improvements possible through investments in automation and efficiency programs which are expected to yield savings of several hundred million dollars over the next three years.
We are implementing a more robust sales and marketing strategy while continuing to work on the cost structure, serving our customers and preserving our competitive strengths. At the same time, we continue to focus on cash flow and liquidity. Our operating flexibility was enhanced with an amendment to our $600 million five-year, multi-currency, revolving credit facility that extends to April 2021. Further discussion and analysis of the development in our business is set forth in MD&A.
ACQUISITIONS AND DIVESTITURES During the year ended June 30, 2016, we completed the sale of non-core businesses as defined in Note 4 of the Company’s consolidated financial statements for an aggregate price of $56.1 million, net of cash. The pre-tax net loss on divestiture during the year ended June 30, 2016 is $131.5 million, of which $127.9 million and $3.6 million were recorded in the Infrastructure and Industrial segments, respectively.
We continue to evaluate new opportunities for the expansion of existing product lines into new market areas where appropriate. We also continue to evaluate opportunities for the introduction of new and/or complementary product offerings into new and/or existing market areas where appropriate. Rather than evaluating potential acquisitions in the near term, we expect to continue to grow our business and further enhance our market position through the investment opportunities that exist within our core businesses.
We are currently exploring strategic alternatives for a remaining non-core Infrastructure business. The estimated net book value of the business is approximately $30 million as of June 30, 2016. As the strategic direction has not yet been determined for this business, the business is classified as held and used, and the Company cannot determine if additional impairment charges will be incurred.

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MARKETING AND DISTRIBUTION To market our products, we maintain two premium brands: Kennametal® and WIDIA®. We sell and market our products through the following sales channels: (i) a direct sales force; (ii) a network of independent distributors and sales agents in North America, Europe, Latin America, Asia and other regions around the world; (iii) integrated supply channels; and (iv) via the internet. Application engineers and technicians are critical to the sales process and directly assist our customers with specified product design, selection, application and support.
RAW MATERIALS AND SUPPLIES Our major metallurgical raw materials consist of ore concentrates, compounds and secondary materials containing tungsten, tantalum, titanium, niobium and cobalt. Although an adequate supply of these raw materials currently exists, our major sources for raw materials are located abroad and prices fluctuate at times. We have entered into extended raw material supply agreements and will implement product price increases as deemed necessary to mitigate rising costs. For these reasons, we exercise great care in selecting, purchasing and managing availability of raw materials. We also purchase steel bars and forgings for making toolholders and other tool parts, as well as for producing rotary cutting tools and accessories. We obtain products purchased for use in manufacturing processes and for resale from thousands of suppliers located in the U.S. and abroad. Our internal capabilities help mitigate our reliance on third parties for raw materials as they provide access to additional sources of raw materials and offer tungsten carbide recycling capabilities.
RESEARCH AND DEVELOPMENT Our product development efforts focus on providing solutions to our customers’ manufacturing challenges and productivity requirements. Our product development program provides discipline and focus for the product development process by establishing “gateways,” or sequential tests, during the development process to remove inefficiencies and accelerate improvements. This program speeds and streamlines development into a series of actions and decision points, combining efforts and resources to produce new and enhanced products faster. This program is designed to assure a strong link between customer requirements and corporate strategy, and to enable us to gain full benefit from our investment in new product development.
We hold a number of patents and trademarks which, in the aggregate, are material to the operation of our businesses.
Research and development expenses included in operating expense totaled $39.4 million, $45.1 million and $44.0 million in 2016, 2015 and 2014, respectively.
SEASONALITY Our business is affected by seasonal variations to varying degrees by traditional summer vacation shutdowns of customers’ plants and holiday shutdowns that affect our sales levels during the first and second quarters of our fiscal year.
BACKLOG Our backlog of orders generally is not significant to our operations.
COMPETITION As one of the world’s leading producers of engineered cemented carbide products and specialty wear-resistant components and coating solutions, we maintain a leading competitive position in major markets worldwide. We continually strengthen our competitive position by developing new and innovative metalworking and earth cutting products and services, innovative surface and wear solutions and innovative products for mining, construction and road milling applications to name a few. We actively compete in the sale of all our products with several large global competitors and with many smaller niche businesses offering various capabilities to customers around the world. While several of our competitors are divisions of larger corporations, our industry remains largely fragmented, containing several hundred fabricators, toolmakers and niche specialty coating businesses. Many of our competitors operate relatively small facilities, producing a limited selection of tools while buying cemented tungsten carbide components from original producers of cemented tungsten carbide products, including Kennametal. We also supply coating solutions and other engineered wear-resistant products to both larger corporations and smaller niche businesses. Given the fragmentation, opportunities for consolidation exist from both U.S.-based and internationally-based firms, as well as among thousands of industrial supply distributors.
The principal competitive differentiators in our businesses include customer focused technical application and support, custom and standard product innovation, product performance, quality and availability, as well as service, pricing and productivity delivered ascribed to our brands. We derive competitive advantage from our premium brand positions, global presence, application expertise and ability to address unique customer needs with new and improved tools, innovative surface and wear solutions, highly engineered components, consistent quality, traditional and digital customer service and technical assistance capabilities, state-of-the-art manufacturing and multiple sales channels. With these strengths, we are able to sell products based on the value-added productivity we deliver to our customers, rather than competing on price.
REGULATION From time to time, we are a party to legal claims and proceedings that arise in the ordinary course of business, which may relate to our operations or assets, including real, tangible, or intellectual property. While we currently believe that the amount of ultimate liability, if any, with respect to these actions will not materially affect our financial position, results of operations or liquidity, the ultimate outcome of any litigation is uncertain. Were an unfavorable outcome to occur or if protracted litigation were to ensue, the impact could be material to us.

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Compliance with government laws and regulations pertaining to the discharge of materials or pollutants into the environment or otherwise relating to the protection of the environment did not have a material effect on our capital expenditures or competitive position for the years covered by this report, nor is such compliance expected to have a material effect in the future.
Among other environmental laws, we are subject to the Comprehensive Environmental Response Compensation and Liability Act of 1980 (Superfund), under which we have been designated by the United States Environmental Protection Agency (USEPA) as a potentially responsible party (PRP) with respect to environmental remedial costs at certain Superfund sites. We have evaluated our claims and liabilities associated with these Superfund sites based upon best currently available information. We believe our environmental accruals are adequate to cover our portion of the environmental remedial costs at the Superfund sites where we have been designated a PRP, to the extent these expenses are probable and reasonably estimable.
Reserves for other potential environmental issues at June 30, 2016 and 2015 were $12.5 million and $12.6 million, respectively. The reserves that 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 take 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 U.S. 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 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.
EMPLOYEES We employed approximately 11,200 people at June 30, 2016, of which approximately 4,200 were located in the U.S. and 7,000 in other parts of the world, principally Europe, Asia Pacific and India. At June 30, 2016, approximately 3,900 of the above employees were represented by labor unions. We consider our labor relations to be generally good.
AVAILABLE INFORMATION Our Internet address is www.kennametal.com. On the SEC Filings page of our Web Site, which is accessible under the "About Us" tab, under Investor Relations, we post the following filings as soon as reasonably practicable after they are electronically filed with or furnished to the Securities and Exchange Commission (SEC): our annual report on Form 10-K, our annual proxy statement, our annual conflict minerals disclosure and report on Form SD, our annual reports on Form 11-K, our quarterly reports on Form 10-Q, our current reports on Form 8-K and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (Exchange Act). Our SEC Filings page of our Web Site also includes Forms 3, 4 and 5 filed pursuant to Section 16(a) of the Exchange Act. All filings posted on our SEC Filings page of our Web Site are available to be viewed on the Web page free of charge. On the Corporate Governance page of our Web Site, which is under the "About Us" tab, under Investor Relations, we post the following charters and guidelines: Audit Committee Charter, Compensation Committee Charter, Nominating/Corporate Governance Committee Charter, Kennametal Inc. Corporate Governance Guidelines and Kennametal Inc. Stock Ownership Guidelines. On the Ethics and Compliance page of our Web Site, which is under the "About Us" tab, under Company Profile, we post our Code of Conduct and our Conflict Minerals Statement. All charters and guidelines posted on our Web pages are available to be viewed on our Web page free of charge. Information contained on our Web site is not part of this annual report on Form 10-K or our other filings with the SEC. Copies of this annual report on Form 10-K and those items disclosed on the Corporate Governance and Ethics and Compliance pages of our Web Site are available without charge upon written request to: Investor Relations, Kelly Boyer, Kennametal Inc., 600 Grant Street, Suite 5100, Pittsburgh, Pennsylvania 15219-2706.


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ITEM 1A – RISK FACTORS
This section describes material risks to our business that are currently known to us. Our business, financial condition or results of operations may be materially affected by a number of factors. Our management regularly monitors the risks inherent in our business, with input and assistance from our Enterprise Risk Management department. In addition to real time monitoring, we periodically conduct a formal enterprise-wide risk assessment to identify factors and circumstances that might present significant risk to the Company. Many of these factors are discussed throughout this report. The risks below, however, are not exhaustive. We operate in a rapidly changing environment. Other risks that we currently believe to be immaterial could become material in the future. We also are subject to legal and regulatory change. New factors can emerge, and it is not possible to predict the outcome of all other factors on our business, financial condition or results of operations. The following discussion details the material factors and uncertainties that we believe could cause Kennametal’s actual results to differ materially from those projected in any forward-looking statements:
Downturns in the business cycle could adversely affect our sales and profitability. Our business has historically been cyclical and subject to significant impact from economic downturns. Global economic downturn coupled with global financial and credit market disruptions have had a negative impact on our sales and profitability historically. These events could contribute to weak end markets, a sharp drop in demand and higher costs of borrowing and/or diminished credit availability. Although we believe that the long-term prospects for our business remain positive, we are unable to predict the future course of industry variables or the strength, pace or sustainability of economic recovery and the effects of government intervention.
There can be no assurance that our restructuring efforts will have the intended effects. We are in the process of implementing restructuring and other actions to improve our manufacturing costs and operating expenses. However, there is no assurance that these actions, or any others that we have taken or may take, will be sufficient to counter any future economic or industry disruptions. We cannot provide assurance that we will not incur additional restructuring charges or impairment charges, or that we will achieve all of the anticipated benefits from restructuring actions we have taken. If we are unable to effectively restructure our operations in the light of evolving market conditions, it could have a material adverse effect on our business, financial condition, results of operations and cash flows.
Our international operations pose certain risks that may adversely impact sales and earnings. We have manufacturing operations and assets located outside of the U.S., including but not limited to those in Western Europe, Brazil, Canada, China, India, Israel and South Africa. We also sell our products to customers and distributors located outside of the U.S. During the year ended June 30, 2016, 57 percent of our consolidated sales were derived from non-U.S. markets. These international operations are subject to a number of special risks, in addition to the risks of our domestic business, including currency exchange rate fluctuations, differing protections of intellectual property, trade barriers, exchange controls, regional economic uncertainty, differing (and possibly more stringent) labor regulations, labor unrest, risk of governmental expropriation, domestic and foreign customs and tariffs, current and changing regulatory environments (including, but not limited to, the risks associated with the importation and exportation of products and raw materials), risk of failure of our foreign employees to comply with both U.S. and foreign laws, including antitrust laws, trade regulations and the Foreign Corrupt Practices Act, difficulty in obtaining distribution support, difficulty in staffing and managing widespread operations, differences in the availability and terms of financing, political instability and unrest and risks of increases in taxes. Also, in some foreign jurisdictions, we may be subject to laws limiting the right and ability of entities organized or operating therein to pay dividends or remit earnings to affiliated companies unless specified conditions are met. To the extent we are unable to effectively manage our international operations and these risks, our international sales may be adversely affected, we may be subject to additional and unanticipated costs, and we may be subject to litigation or regulatory action. As a consequence, our business, financial condition and results of operations could be seriously harmed.
Changes in the regulatory environment, including environmental, health and safety regulations, could subject us to increased compliance and manufacturing costs, which could have a material adverse effect on our business.
Health and Safety Regulations. Certain of our products contain hard metals, including tungsten and cobalt. Hard metal dust is being studied for potential adverse health effects by organizations in several regions throughout the world, including the U.S., Europe and Japan. Future studies on the health effects of hard metals may result in our products being classified as hazardous to human health, which could lead to new regulations in countries in which we operate that may restrict or prohibit the use of, and/or exposure to, hard metal dust. New regulation of hard metals could require us to change our operations, and these changes could affect the quality of our products and materially increase our costs.

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Environmental Regulations. We are subject to various environmental laws, and any violation of, or our liabilities under, these laws could adversely affect us. Our operations necessitate the use and handling of hazardous materials and, as a result, we are subject to various federal, state, local and foreign laws, regulations and ordinances relating to the protection of the environment, including those governing discharges to air and water, handling and disposal practices for solid and hazardous wastes, the cleanup of contaminated sites and the maintenance of a safe workplace. These laws impose penalties, fines and other sanctions for noncompliance and liability for response costs, property damages and personal injury resulting from past and current spills, disposals or other releases of, or exposure to, hazardous materials. We could incur substantial costs as a result of noncompliance with or liability for cleanup or other costs or damages under these laws. We may be subject to more stringent environmental laws in the future. If more stringent environmental laws are enacted in the future, these laws could have a material adverse effect on our business, financial condition and results of operations.
Regulations affecting the mining and drilling industries or utilities industry. Some of our principal customers are mining and drilling and utility companies. Many of these customers supply coal, oil, gas or other fuels as a source for the production of utilities in the U.S. and other industrialized regions. The operations of these mining and drilling companies are geographically diverse and are subject to or affected by a wide array of regulations in the jurisdictions where they operate, such as applicable environmental laws and regulations governing the operations of utilities. As a result of changes in regulations and laws relating to such industries, our customers’ operations could be disrupted or curtailed by governmental authorities. The high cost of compliance with mining, drilling and environmental regulations may also induce customers to discontinue or limit their operations, and may discourage companies from developing new opportunities. As a result of these factors, demand for our mining- and drilling-related products could be substantially affected by regulations adversely impacting the mining and drilling industries or altering the consumption patterns of utilities.
Impairment of goodwill and other intangible assets with indefinite lives could result in a negative impact on our financial condition and results of operations. At June 30, 2016, goodwill and other indefinite-lived intangible assets totaled $315.3 million or 13% of our total assets. Goodwill results from acquisitions, representing the excess of cost over the fair value of the net tangible and other identifiable intangible assets we have acquired. At a minimum, we assess annually whether there has been impairment in the value of our intangible assets. If future operating performance at one or more of our reporting units were to fall significantly below current levels, we could record, under current applicable accounting rules, a non-cash impairment charge for goodwill or other intangible asset impairment. Any determination requiring the impairment of a significant portion of goodwill or other intangible assets would negatively affect our financial condition and results of operations.
Our continued success depends on our ability to protect and defend our intellectual property. Our future success depends in part upon our ability to protect and defend our intellectual property. We rely principally on nondisclosure agreements and other contractual arrangements and trade secret laws and, to a lesser extent, trademark and patent laws, to protect our intellectual property. However, these measures may be inadequate to protect our intellectual property from infringement by others or prevent misappropriation of our proprietary rights. In addition, the laws of some foreign countries do not protect proprietary rights to the same extent as do U.S. laws. If one of our patents is infringed upon by a third party, we may need to devote significant time and financial resources to attempt to halt the infringement. We may not be successful in defending the patents involved in such a dispute. Similarly, while we do not knowingly infringe on patents, copyrights or other intellectual property rights owned by other parties, we may be required to spend a significant amount of time and financial resources to resolve any infringement claims against us. We may not be successful in defending our position or negotiating an alternative remedy. Our inability to protect our proprietary information and enforce or defend our intellectual property rights in proceedings initiated by or against us could have a material adverse effect on our business, financial condition and results of operations.
Failure of, or a breach in security of, our information technology systems could adversely affect our business. We rely on information technology infrastructure to achieve our business objectives. Any disruption of this infrastructure could negatively impact our ability to record or process orders, manufacture and ship in a timely manner, or otherwise carry on business in the normal course. Any such events could cause us to lose customers or revenue and could require us to incur significant expense to remediate.
A security breach of our information technology could also interrupt or damage our operations or harm our reputation. In addition, we could be subject to liability if confidential information relating to customers, suppliers, employees or other parties is misappropriated from our computer system. Despite the implementation of security measures, these systems may be vulnerable to physical break-ins, computer viruses, programming errors or similar disruptive problems.
We operate in a highly competitive environment. Our domestic and foreign operations are subject to significant competitive pressures. We compete directly and indirectly with other manufacturers and suppliers of metalworking tools, engineered components and advanced materials. Some of our competitors are larger than we are and may have greater access to financial resources or be less leveraged than us. In addition, the industry in which our products are used is a large, fragmented industry that is highly competitive.

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If we are unable to retain our qualified management and employees, our business may be negatively affected. Our ability to provide high quality products and services depends in part on our ability to retain our skilled personnel in the areas of management, product engineering, servicing and sales. Competition for such personnel is intense, and our competitors can be expected to attempt to hire our management and skilled employees from time to time. In addition, our restructuring activities and strategies for growth have placed, and are expected to continue to place, increased demands on our management’s skills and resources. Additionally, we announced that we have embarked on a workforce reduction initiative which should reduce employment by 1,000. If we are unable to retain our management team and professional personnel, our customer relationships and level of technical expertise could be negatively affected, which may materially and adversely affect our business.
Any interruption of our workforce, including interruptions due to unionization efforts, changes in labor relations or shortages of appropriately skilled individuals could impact our business.
Our future operating results may be affected by fluctuations in the prices and availability of raw materials. The raw materials we use for our products include ore concentrates, compounds and secondary materials containing tungsten, tantalum, titanium, niobium and cobalt. A significant portion of our raw materials is supplied by sources outside of the U.S. The raw materials industry as a whole is highly cyclical and at times pricing and supply can be volatile due to a number of factors beyond our control, including natural disasters, general economic and political conditions, labor costs, competition, import duties, tariffs and currency exchange rate fluctuations. This volatility can significantly affect our raw material costs. In an environment of increasing raw material prices, competitive conditions can affect how much of the price increases in raw materials that we can recover in the form of higher sales prices for our products. To the extent we are unable to pass on any raw material price increases to our customers, our profitability could be adversely affected. Furthermore, restrictions in the supply of tungsten, cobalt and other raw materials could adversely affect our operating results. If the prices for our raw materials increase or we are unable to secure adequate supplies of raw materials on favorable terms, our profitability could be impaired. If the prices for our raw materials decrease, we could face product pricing challenges.
Product liability claims could have a material adverse effect on our business. The sale of metalworking, mining, highway construction and other tools and related products as well as engineered components and advanced materials entails an inherent risk of product liability claims. We cannot give assurance that the coverage limits of our insurance policies will be adequate or that our policies will cover any particular loss. Insurance can be expensive, and we may not always be able to purchase insurance on commercially acceptable terms, if at all. Claims brought against us that are not covered by insurance or that result in recoveries in excess of our insurance coverage could have a material adverse affect on our business, financial condition and results of operations.
We may not be able to complete, manage or integrate acquisitions successfully. In the past, we have acquired companies and we may continue to evaluate acquisition opportunities that have the potential to support and strengthen our business. We can give no assurances, however, that any acquisition opportunities will arise or if they do, that they will be consummated, or that additional financing, if needed, will be available on satisfactory terms. In addition, acquisitions involve inherent risks that the businesses acquired will not perform in accordance with our expectations. We may not be able to achieve the synergies and other benefits we expect from the integration of acquisitions as successfully or rapidly as projected, if at all. Our failure to consummate an acquisition or effectively integrate newly acquired operations could prevent us from realizing our expected strategic growth and rate of return on an acquired business and could have a material and adverse effect on our results of operations and financial condition.
Natural disasters or other global or regional catastrophic events could disrupt our operations and adversely affect results. Despite our concerted effort to minimize risk to our production capabilities and corporate information systems and to reduce the effect of unforeseen interruptions to us through business continuity planning, we still may be exposed to interruptions due to catastrophe, natural disaster, pandemic, terrorism or acts of war, which are beyond our control. Disruptions to our facilities or systems, or to those of our key suppliers, could also interrupt operational processes and adversely impact our ability to manufacture our products and provide services and support to our customers. As a result, our business, our results of operations, financial position, cash flows and stock price could be adversely affected.

ITEM 1B – UNRESOLVED STAFF COMMENTS
None.







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ITEM 2 – PROPERTIES
Our principal executive offices are located at 600 Grant Street, Suite 5100, Pittsburgh, Pennsylvania, 15219. Our corporate center and Technology Center are located at 1600 Technology Way, P.O. Box 231, Latrobe, Pennsylvania, 15650. A summary of our principal manufacturing facilities and other materially important properties is as follows:
Location
 
Owned/Leased
Principal Products
Segment
United States:
 
 
 
Gurley, Alabama
Owned
Metallurgical Powders
Infrastructure
Huntsville, Alabama
Owned
Metallurgical Powders
Infrastructure
Madison, Alabama
Owned
Tungsten Heavy Alloy
Infrastructure
Rogers, Arkansas
Owned/Leased
Carbide Products and Pelletizing Die Plates
Infrastructure
Rockford, Illinois
Owned
Indexable Tooling
Industrial
Goshen, Indiana
Leased
Powders; Welding Rods, Wires and Machines
Infrastructure
New Albany, Indiana
Leased
High Wear Coating for Steel Parts
Infrastructure
Greenfield, Massachusetts
Owned
High-Speed Steel Taps
Industrial
Traverse City, Michigan
Owned
Wear Parts
Infrastructure
Fallon, Nevada
Owned
Metallurgical Powders
Infrastructure
Asheboro, North Carolina
Owned
Carbide Round Tools
Industrial
Henderson, North Carolina
Owned
Metallurgical Powders
Infrastructure
Roanoke Rapids, North Carolina
Owned
Metalworking Inserts
Industrial
Cleveland, Ohio
Leased
Distribution
Industrial
Orwell, Ohio
Owned
Metalworking Inserts
Industrial
Solon, Ohio
Owned
Metalworking Toolholders
Industrial
Whitehouse, Ohio
Owned
Metalworking Inserts and Round Tools
Industrial
Bedford, Pennsylvania
Owned/Leased
Mining and Construction Tools, Wear Parts and Distribution
Infrastructure
Irwin, Pennsylvania
Owned
Carbide Wear Parts
Infrastructure
New Castle, Pennsylvania
Owned/Leased
Specialty Metals and Alloys
Infrastructure
Johnson City, Tennessee
Owned
Metalworking Inserts
Industrial
La Vergne, Tennessee
Owned
Metalworking Inserts
Industrial
Houston, Texas
Owned
Downhole Drilling Carbide Components
Infrastructure
Chilhowie, Virginia
Owned
Mining and Construction Tools and Wear Parts
Infrastructure
New Market, Virginia
Owned
Metalworking Toolholders
Industrial
International:
 
 
 
La Paz, Bolivia
Owned
Tungsten Concentrate
Infrastructure
Indaiatuba, Brazil
Leased
Metalworking Carbide Drills and Toolholders
Industrial
Belleville, Canada
Owned
Casting Components, Coatings and Powder Metallurgy Components
Infrastructure
Victoria, Canada
Owned
Wear Parts
Infrastructure
Fengpu, China
Owned
Intermetallic Composite Ceramic Powders and Parts
Infrastructure
Shanghai, China
Owned
Powders, Welding Rods and Wires and Casting Components
Infrastructure
Shanghai, China
Owned
Distribution
Industrial
Tianjin, China
Owned
Metalworking Inserts and Carbide Round Tools
Industrial
Xuzhou, China
Leased
Mining Tools
Infrastructure
Ebermannstadt, Germany
Owned
Metalworking Inserts
Industrial
Essen, Germany
Owned
Metalworking Inserts, Metallurgical Powders and Wear Parts
Industrial
Königsee, Germany
Leased
Metalworking Carbide Drills
Industrial
Lichtenau, Germany
Owned
Metalworking Toolholders
Industrial
Mistelgau, Germany
Owned
Metallurgical Powders, Metalworking Inserts and Wear Parts
Infrastructure
Nabburg, Germany
Owned
Metalworking Toolholders and Metalworking Round Tools, Drills and Mills
Industrial
Neunkirchen, Germany
Owned
Distribution
Industrial

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Location
 
Owned/Leased
Principal Products
Segment
Schongau, Germany
Owned
Ceramic Vaporizer Boats
Infrastructure
Vohenstrauss, Germany
Owned
Metalworking Carbide Drills
Industrial
Bangalore, India
Owned
Metalworking Inserts and Toolholders and Wear Parts
Industrial
Shlomi, Israel
Owned
High-Speed Steel and Carbide Round Tools
Industrial
San Giuliano Milanese, Italy
Leased
Indexable Inserts
Industrial
Zory, Poland
Leased
Mining and Construction Conicals
Infrastructure
Boksburg, South Africa
Leased
Mining and Construction Conicals
Infrastructure
Barcelona, Spain
Leased
Metalworking Cutting Tools
Industrial
Kingswinford, United Kingdom
Leased
Distribution
Industrial
Newport, United Kingdom
Owned
Intermetallic Composite Powders
Infrastructure

We also have a network of warehouses and customer service centers located throughout North America, Europe, India, Asia Pacific and Latin America, a significant portion of which are leased. The majority of our research and development efforts are conducted in a corporate technology center located in Latrobe, Pennsylvania, U.S., as well as in our facilities in Rogers, Arkansas, U.S.; Fürth, Germany and Bangalore, India.
We use all of our significant properties in the businesses of powder metallurgy, tools, tooling systems, engineered components and advanced materials. Our production capacity is adequate for our present needs. We believe that our properties have been adequately maintained, are generally in good condition and are suitable for our business as presently conducted.

ITEM 3 - LEGAL PROCEEDINGS

The information set forth in Part I, Item 1, of this annual report on Form 10-K under the caption “Regulation” is incorporated into this Item 3. From time to time, we are party to legal claims and proceedings that arise in the ordinary course of business, which may relate to our operations or assets, including real, tangible or intellectual property. Although certain of these actions are currently pending, we do not believe that any individual proceeding is material or that our pending legal proceedings in the aggregate are material to Kennametal.

ITEM 4 - MINE SAFETY DISCLOSURES
Not applicable.

EXECUTIVE OFFICERS OF THE REGISTRANT
Incorporated by reference into this Part I is the information set forth in Part III, Item 10 under the caption “Executive Officers of the Registrant” of this annual report on Form 10-K.

PART II
ITEM 5 - MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our capital stock is traded on the New York Stock Exchange (symbol KMT). The number of Shareholders of record as of July 29, 2016 was 1,698. Stock price ranges and dividends declared and paid were as follows:
Quarter ended
 
September 30

 
December 31

 
March 31

 
June 30

Fiscal 2016
 
 
 
 
 
 
 
 
High
 
$
34.61

 
$
29.45

 
$
23.61

 
$
26.24

Low
 
23.77

 
17.71

 
15.11

 
20.98

Dividends
 
0.20

 
0.20

 
0.20

 
0.20

Fiscal 2015
 
 
 
 
 
 
 
 
High
 
$
46.76

 
$
42.18

 
$
36.25

 
$
39.91

Low
 
40.00

 
33.23

 
27.63

 
33.09

Dividends
 
0.18

 
0.18

 
0.18

 
0.18


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The information incorporated by reference in Part III, Item 12 of this annual report on Form 10-K from our 2016 Proxy Statement under the heading “Equity Compensation Plans – Equity Compensation Plan Information” is hereby incorporated by reference into this Item 5.
PERFORMANCE GRAPH
The following graph compares cumulative total shareholder return on our capital stock with the cumulative total shareholder return on the common stock of the companies in the Standard & Poor’s Mid-Cap 400 Market Index (S&P Midcap 400), the Standard & Poor’s Composite 1500 Market Index (S&P 1500 Composite), the Standard & Poor's Global 1200 Industrials Index (S&P Global 1200 Industrials) and the peer groups of companies determined by us for the period from July 1, 2011 to June 30, 2016.
The Peer Group consists of the following companies: Actuant Corporation; Allegheny Technologies Incorporated; Ametek, Inc.; Carpenter Technology Corporation; Crane Co.; Donaldson Company, Inc.; Flowserve Corporation; Greif; Harsco Corporation; IDEX Corporation; Joy Global Inc.; Lincoln Electric Holdings, Inc.; Pall Corporation; Parker Hannifin Corporation; Sandvik AB, Corp.; Teleflex Incorporated; The Timken Company; and Woodward, Inc.
Assumes $100 Invested on July 1, 2011 and All Dividends Reinvested
 
2011
2012
2013
2014
2015
2016
Kennametal
$
100.00

$
79.61

$
94.81

$
114.80

$
86.23

$
57.78

Peer Group Index
100.00

84.92

98.84

127.49

110.49

102.11

S&P Midcap 400
100.00

97.67

122.27

153.12

162.92

165.09

S&P 1500 Super Composite
100.00

104.63

126.73

158.04

169.60

175.77

S&P Global 1200 Industrials
100.00

90.16

109.30

138.46

136.64

138.43



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ISSUER PURCHASES OF EQUITY SECURITIES
Period
Total Number
of Shares Purchased(1) 

 
Average Price
Paid per Share

 
Total Number of 
Shares Purchased as Part of Publicly Announced Plans or Programs

 
Maximum Number
of Shares that May
Yet Be Purchased
Under the Plans or
Programs (2) 

April 1 through April 30, 2016
1,465

 
$
22.82

 

 
10,100,100

May 1 through May 31, 2016
2,873

 
24.56

 

 
10,100,100

June 1 through June 30, 2016
81

 
24.28

 

 
10,100,100

Total
4,419

 
$
23.98

 

 
 

(1) 
During the fourth quarter of 2016, 2,593 shares were purchased on the open market on behalf of Kennametal to fund the Company’s dividend reinvestment program. Also, during the current period employees delivered 1,826 shares of restricted stock to Kennametal, upon vesting, to satisfy tax withholding requirements.
(2) 
On July 25, 2013, the Company publicly announced an open-ended, amended repurchase program for up to 17 million shares of its outstanding capital stock.

UNREGISTERED SALES OF EQUITY SECURITIES
None.


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ITEM 6 - SELECTED FINANCIAL DATA
 
 
2016
2015
2014
2013
2012
OPERATING RESULTS (in thousands)
 
 
 
Sales
 
$
2,098,436

$
2,647,195

$
2,837,190

$
2,589,373

$
2,736,246

Cost of goods sold
 
1,482,369

1,841,202

1,940,187

1,744,369

1,741,996

Operating expense
 
494,975

554,895

589,768

527,850

561,490

Restructuring and asset impairment charges
(1
)
143,810

582,235

17,608



Loss on divestiture
(2
)
131,463





Interest expense
 
27,752

31,466

32,451

27,472

27,215

Provision (benefit) for income taxes
 
25,313

(16,654
)
66,611

59,693

79,136

(Loss) income from continuing operations attributable to Kennametal
 
(225,968
)
(373,896
)
158,366

203,265

307,230

Net (loss) income attributable to Kennametal
 
(225,968
)
(373,896
)
158,366

203,265

307,230

FINANCIAL POSITION (in thousands)
 
 
 
 
 
 
Working capital
 
$
648,066

$
775,802

$
962,440

$
1,031,880

$
704,340

Total assets
 
2,368,793

2,849,529

3,868,086

3,301,039

3,034,188

Long-term debt, including capital leases, excluding current maturities
 
699,558

735,885

981,666

703,626

490,608

Total debt, including capital leases and notes payable
 
701,453

751,587

1,061,783

747,945

565,745

Total Kennametal shareholders' equity
 
964,323

1,345,807

1,929,256

1,781,826

1,643,850

PER SHARE DATA ATTRIBUTABLE TO KENNAMETAL SHAREHOLDERS
 
 
Basic (loss) earnings from continuing operations
(3
)
$
(2.83
)
$
(4.71
)
$
2.01

$
2.56

$
3.83

Basic (loss) earnings
(3
)
(2.83
)
(4.71
)
2.01

2.56

3.83

Diluted (loss) earnings from continuing operations
(3
)
(2.83
)
(4.71
)
1.99

2.52

3.77

Diluted (loss) earnings
(3
)
(2.83
)
(4.71
)
1.99

2.52

3.77

Dividends
 
0.80

0.72

0.72

0.64

0.54

Book value (at June 30)
 
12.10

16.96

24.52

22.89

20.53

Market Price (at June 30)
 
22.11

34.12

46.28

38.83

33.15

OTHER DATA (in thousands, except number of employees)
 
 
 
Capital expenditures
 
$
110,697

$
100,939

$
117,376

$
82,835

$
103,036

Number of employees (at June 30)
 
11,178

12,718

13,521

12,648

12,932

Basic weighted average shares outstanding
79,835

79,342

78,678

79,463

80,216

Diluted weighted average shares outstanding
79,835

79,342

79,667

80,612

81,439

KEY RATIOS
 
 
 
 
 
 
Sales (decline) growth
(4
)
(20.7
)%
(6.7
)%
9.6
%
(5.4
)%
13.8
%
Gross profit margin
 
29.4

30.4

31.6

32.6

36.3

Operating margin
(5
)
(8.3
)
(13.5
)
9.3

11.4

15.2

(1)
In 2016, the charges related to goodwill and other intangible asset impairment charges of $108.5 million, restructuring charges of $30.0 million and fixed asset disposal charges of $5.4 million. In 2015, the charges related to goodwill and other intangible asset impairment charges of $541.7 million and restructuring charges of $40.5 million. In 2014, the charges related to restructuring activity.
(2)
In 2016, the charge related to the loss on divestiture of non-core businesses.
(3)
In 2016, basic and diluted loss per share included U.S. deferred tax valuation allowance of $1.02 per share, divestiture and related charges of $1.39 per share, goodwill and other intangible asset impairment charges of $0.96 per share and restructuring and related charges of $0.50 per share. In 2015, basic and diluted loss per share included goodwill and other intangible asset impairment charges of $6.13 per share and restructuring and related charges of $0.56 per share.
(4)
In 2016, divestiture impact of sales decline was negative 5 percent.
(5)
In 2016, operating margin included divestiture and related charges of $131.5 million, goodwill and other intangible asset impairment charges of $108.5 million and restructuring and related charges of $53.5 million. In 2015, operating margin included goodwill and other intangible asset impairment charges of $541.7 million and restructuring and related charges of $58.1 million.

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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, construction, process industries 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 components; machine tool, light machinery and heavy machinery industries; airframe and aerospace components; 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 2016, sales were $2,098.4 million, a decrease of 21 percent compared to prior year sales of $2,647.2 million, driven by organic sales decline, impact of divestiture and unfavorable currency exchange. Operating loss was $174.9 million compared to operating loss of $357.8 million in the prior year. The decrease in operating loss was driven primarily by higher non-cash goodwill and other intangible asset impairment charges in the prior year. Other drivers include current year lower material costs, incremental restructuring benefits, manufacturing productivity improvements and lower restructuring and related charges, offset partially by the current year loss on divestiture, organic sales decline, unfavorable product mix, lower fixed cost absorption and unfavorable currency exchange. The Company reported loss per diluted share of $2.83 in 2016.
Our operating flexibility was enhanced with an amendment to our revolving credit facility that extends maturity from April 2018 to April 2021. Similar to the prior agreement, the amendment permits revolving loans of up to $600 million for working capital, capital expenditures and general corporate purposes. The definition of the maximum leverage ratio was temporarily increased under the 2016 Amendment as defined in the agreement in order to increase operating flexibility. Further, the earnings before interest, taxes, depreciation and amortization (EBITDA) definition in the 2016 Amendment now allows for up to $120 million of aggregate cash restructuring payment add-backs through December 31, 2017. Other material provisions, including the minimum consolidated interest coverage ratio, remain unchanged.
During the year the Company completed the sale of several non-core businesses related to certain castings, steel-plate fabrication and deburring for an aggregate price of $56.1 million, net of cash acquired. Annual sales for these non-core businesses were approximately $220 million. A portion of the transaction proceeds were used to pay down revolver debt with the remaining balance being held as cash on hand. The transaction resulted in a pre-tax loss on the sale of $131.5 million.
We generated cash flow from operating activities of $219.3 million in the current year, driven by improved working capital management. We have actively managed our capital structure by decreasing our debt by $50.1 million and by returning $63.7 million to Shareholders through dividends. In addition, we made capital expenditures of $110.7 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 $39.4 million for 2016.
The permanent savings that we are realizing from restructuring are the result of programs that we have undertaken over the past 33 months. Pre-tax benefits from these restructuring actions were approximately $79 million in 2016, of which approximately $44 million were incremental to prior year. We substantially completed Phase 1 of our restructuring programs. We also have identified additional actions to adjust the company's cost structure. Refer to the Results of Continuing Operations section of Item 7 for further discussion and analysis of our restructuring programs.

NEW OPERATING STRUCTURE IMPLEMENTED IN FISCAL 2017 In order to take advantage of the growth opportunities of our WIDIA brand, we implemented a new operating structure.

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A key attribute of the new structure is the establishment of the WIDIA operating segment. In order to better lever the opportunities that lie in this business, in addition to being more agile and competitive in the marketplace, we are placing higher levels of focus, determination and leadership in the business. Industrial and WIDIA in 2017 will be formed from the 2016 Industrial segment. We will have three reportable operating segments going forward: Industrial, WIDIA and Infrastructure.

RESULTS OF CONTINUING OPERATIONS
SALES Sales of $2,098.4 million in 2016 decreased 21 percent from $2,647.2 million in 2015 reflecting an 11 percent organic sales decline, a 5 percent divestiture impact, and a 5 percent unfavorable currency exchange impact. Sales decreased by 30 percent in the Infrastructure segment and 13 percent in the Industrial segment. Drivers of the organic sales decrease were 28 percent in energy, 15 percent in earthworks, 11 percent in general engineering and 4 percent in transportation, while aerospace and defense remained flat.
Sales of $2,647.2 million in 2015 decreased 7 percent from $2,837.2 million in 2014 reflecting an 5 percent organic sales decline and a 4 percent unfavorable currency exchange impact, offset by 2 percent increase from prior year acquisition and divestiture activity. Sales decreased by 10 percent in the Infrastructure segment and 4 percent in the Industrial segment. Drivers of the organic sales decrease, were earthworks of 10 percent, energy markets of 10 percent, aerospace and defense of 6 percent, transportation of 1 percent and general engineering of 1 percent.
GROSS PROFIT Gross profit decreased $189.9 million to $616.1 million in 2016 from $806.0 million in 2015. This decrease was primarily due to organic sales decline, unfavorable business mix in both segments, lower fixed cost absorption, unfavorable currency exchange and divestiture impact, offset partially by lower raw material costs and restructuring benefits. The gross profit margin for 2016 was 29.4 percent compared to 30.4 percent in 2015.
Gross profit decreased $91.0 million to $806.0 million in 2015 from $897.0 million in 2014. The decrease was primarily due to organic sales decline, unfavorable currency exchange and unfavorable business mix in the Infrastructure segment, offset partially by restructuring benefits, contributions from the TMB acquisition and the benefits of a nonrecurring inventory charge of $6.4 million that occurred in the prior year. The gross profit margin for 2015 was 30.4 percent compared to 31.6 percent in 2014.
OPERATING EXPENSE Operating expense in 2016 was $495.0 million, a decrease of $59.9 million, or 10.8 percent, compared to $554.9 million in 2015. The decrease is primarily due to divestiture impact of $18.6 million, favorable foreign currency exchange impacts of $23.3 million, restructuring benefits and the impact of cost reduction initiatives, offset partially by $8.3 million higher restructuring related charges.
Operating expense in 2015 was $554.9 million, a decrease of $34.9 million, or 5.9 percent, compared to $589.8 million in 2014. The decrease is primarily due to foreign currency exchange impacts of $24.7 million, restructuring benefits and the impact of cost reduction initiatives, offset partially by annual merit increase.
RESTRUCTURING AND RELATED CHARGES AND ASSET IMPAIRMENT CHARGES
Restructuring and Related Charges
During 2016, we recorded restructuring and related charges of $53.5 million. Of this amount, restructuring charges totaled $30.0 million. Restructuring-related charges of $7.3 million were recorded in cost of goods sold and $16.2 million in operating expense during 2016. Total restructuring and related charges since the inception of our restructuring plans through 2016 were $130.7 million. See Note 15 in our consolidated financial statements set forth in Item 8 (Note 15).
During 2015, we recorded restructuring and related charges of $58.1 million. Of this amount, restructuring charges totaled $42.1 million, of which $1.5 million were charges related to inventory disposals and were recorded in cost of goods sold. Restructuring-related charges of $8.2 million were recorded in cost of goods sold and $7.8 million in operating expense during 2015.
During 2014, we recorded restructuring and related charges of $19.1 million. Of this amount, restructuring charges totaled $17.8 million, of which $0.2 million were charges related to inventory disposals and were recorded in cost of goods sold. Restructuring-related charges of $1.2 million were recorded in cost of goods sold and $0.1 million in operating expense during 2014.

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Phase 1
We implemented 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 were substantially completed in fiscal 2016 and were mostly cash expenditures. Estimated ongoing annualized savings for this phase is $40-$45 million, and we incurred inception to date charges of $59.3 million.
Ongoing restructuring programs
We are currently implementing restructuring actions to streamline the Company's cost structure. These initiatives are expected to improve the alignment of our cost structure with the current operating environment through rationalization and consolidation of certain manufacturing facilities and through headcount reductions; enhancement of operational efficiencies through an enterprise-wide cost reduction program; and other employment and cost reduction programs. These restructuring actions are currently anticipated to deliver annual ongoing pre-tax savings of $75 million to $90 million once completed by December of fiscal 2019 and are anticipated to be mostly cash expenditures. The total pre-tax charges for these programs are expected to be in the range of $105 million to $125 million.
Asset Impairment Charges
During 2016 and 2015, we recorded non-cash pre-tax goodwill and other intangible asset impairment charges of $108.5 million and $541.7 million, respectively. There were no asset impairment charges during 2014. See Note 2 in our consolidated financial statements set forth in Item 8 (Note 2).
During 2016, we identified specific machinery and equipment that was no longer being utilized in the manufacturing organization of which we disposed by abandonment. As a result of this review, we recorded property, plant, and equipment impairment charges of $5.4 million during 2016, which has been presented as restructuring and asset impairment charges in our consolidated statement of income.
LOSS ON DIVESTITURE We recognized a pre-tax loss on the sale of non-core businesses of $131.5 million in 2016, which includes the impact of estimated working capital adjustments, deal costs and transaction costs. Of this amount, $127.9 million and $3.6 million were recorded in the Infrastructure and Industrial segments, respectively. See Note 4 in our consolidated financial statements set forth in Item 8 (Note 4).
AMORTIZATION OF INTANGIBLES Amortization expense was $20.8 million, $26.7 million and $26.2 million in 2016, 2015 and 2014, respectively. The decrease of $5.9 million from 2015 to 2016 is driven primarily by the impact of divestiture.
INTEREST EXPENSE Interest expense decreased $3.7 million to $27.8 million in 2016, compared with $31.5 million in 2015 due to lower average borrowings throughout the current period. The portion of our debt subject to variable rates of interest was less than 1 percent and approximately 7 percent at June 30, 2016 and 2015, respectively. The decrease in the portion of our debt subject to variable rates was due to the decrease in the balance outstanding on our revolving credit facility.
Interest expense decreased $1.0 million to $31.5 million in 2015, compared with $32.5 million in 2014 due to lower average borrowings throughout the current period. The portion of our debt subject to variable rates of interest was approximately 7 percent and 34 percent at June 30, 2015 and 2014, respectively. The decrease in the portion of our debt subject to variable rates was due to the decrease in the balance outstanding on our revolving credit facility.
OTHER (INCOME) EXPENSE, NET In 2016, other income, net was $4.1 million compared to other income, net of $1.7 million in 2015. The year-over-year increase is due primarily to the reduction of a contingent liability associated with a prior acquisition and income from transition services provided to the acquirer of our non-core businesses, partially offset by a loss on sale of assets and lower interest income.
In 2015, other income, net was $1.7 million compared to other expense, net of $2.2 million in 2014. The year-over-year change was due primarily to gains on derivatives in 2015.
INCOME TAXES The effective tax rate for 2016 was 12.7 percent (provision on a loss) compared to 4.3 percent (benefit on a loss) for 2015. The change in the effective rate from 2015 to 2016 was primarily driven by a 2016 discrete tax charge for a valuation allowance recorded against our net deferred tax assets in the U.S., primarily related to asset impairment charges and restructuring charges in both periods and the loss on divestiture in the current year, as well as an overall decrease in demand in U.S. operations.

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The effective tax rate for 2015 was 4.3 percent (benefit on a loss) compared to 29.1 percent (provision on income) for 2014. The change in the effective rate from 2014 to 2015 was primarily driven by the asset impairment charges recorded in the current year, non-deductible restructuring and divestiture costs recorded in the prior year and charges related to a change in assertion with respect to certain foreign subsidiaries' undistributed earnings which are no longer considered permanently reinvested. All earnings of other non U. S. subsidiaries are permanently reinvested and no deferred taxes have been provided on those earnings.
(LOSS) INCOME ATTRIBUTABLE TO KENNAMETAL SHAREHOLDERS Loss attributable to Kennametal Shareholders was $226.0 million, or $2.83 per diluted share, in 2016, compared to $373.9 million, or $4.71 per diluted share, in 2015. The decrease in loss from continuing operations is a result of the factors previously discussed.
Loss from continuing operations attributable to Kennametal Shareholders was $373.9 million or $4.71 per diluted share, in 2015, compared to income of $158.4 million, or $1.99 per diluted share, in 2014. The change in (loss) 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 and the availability of separate financial results.
INDUSTRIAL
(in thousands)
 
2016
 
2015
 
2014
External sales
 
$
1,269,162

 
$
1,461,744

 
$
1,524,075

Operating income
 
81,243

 
160,894

 
177,040

External sales of $1,269.2 million in 2016 decreased by $192.6 million, or 13 percent, from 2015. The decrease in sales is attributable to a 7 percent organic sales decline and a 6 percent unfavorable currency exchange impact. Excluding the impact of currency exchange and divestiture, sales decreased approximately 27 percent in energy, 8 percent in general engineering and 4 percent in transportation, while sales increased in aerospace and defense approximately 1 percent. The oil and gas downturn caused a decline in the energy market, must acutely in the Americas, where there was spillover into the broader general engineering market. The downturn was somewhat amplified as inventory levels in the indirect channel were lowered. Sales in the transportation market benefited from strong global unit sales offset by lower sales in Asia in part due to fewer tooling package sales in the current year. Aerospace sales increased modestly as favorable developments in Europe and Asia where somewhat offset by our decision to exit certain low margin business. On a segment regional basis excluding the impact of currency exchange and divestiture, sales decreased by 11 percent in the Americas, 10 percent in Asia and 1 percent in Europe. The sales decrease in the Americas was driven by general engineering and energy and to a lesser extent transportation. The sales decrease in Asia was driven by transportation, general engineering and energy, offset partially by an increase in aerospace and defense. The sales decrease in Europe was driven by energy and aerospace and defense, offset partially by an increase in transportation.
In 2016, Industrial operating income was $81.2 million and decreased by $79.7 million from 2015. The primary drivers of the decrease in operating income were organic sales decline, unfavorable currency exchange of $11.9 million, lower fixed cost absorption, unfavorable mix, loss on divestiture of $3.6 million, fixed asset disposal charges of $3.4 million and intangible asset impairment of $2.3 million, offset partially by incremental restructuring program benefits of $26.7 million, lower raw material costs and $3.0 million less restructuring and related charges. Industrial operating margin was 6.4 percent compared with 11.0 percent in the prior year.

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External sales of $1,461.7 million in 2015 decreased by $62.3 million, or 4 percent, from 2014. The decrease in sales is attributable to unfavorable currency exchange impact of 5 percent, offset partially by an increase of 1 percent due to prior year net acquisition and divestiture activity. Excluding the impact of currency exchange, sales increased in both general engineering and transportation by approximately 2 percent while the aerospace and defense served markets decreased approximately 4 percent and energy decreased approximately 6 percent. In general engineering, sales growth in the indirect channel was partially offset by weak demand in the energy market due to the downturn in the oil and gas markets. Transportation end market sales increased due to strong growth in Asia from our component solutions focus, partially offset by fewer new tooling programs sales in the Americas and slower market conditions in Europe. Sales in aerospace and defense declined due to our decision to exit certain low margin business. On a regional basis, excluding impacts of acquisition and divestiture, sales increased by approximately 8 percent in Asia and remained flat in the Americas, while sales decreased 2 percent in Europe. The sales increase in Asia was driven primarily by transportation and to a lesser extent aerospace and defense and general engineering. The Americas sales benefited from increases in general engineering, offset by decreases in aerospace and defense and transportation. The sales decrease in Europe was driven primarily by aerospace and defense and to a lesser extent transportation.
In 2015, Industrial operating income was $160.9 million and decreased by $16.1 million from 2014. The primary drivers of the decrease in operating income were driven by increased restructuring and related charges of $16.6 million and lower absorption of manufacturing cost sue to an inventory reduction initiative, offset partially by the impact of acquisition, restructuring benefits and decreased operating expense as a result of cost reduction efforts. Industrial operating margin was 11.0 percent compared with 11.6 percent in 2014.
INFRASTRUCTURE
(in thousands)
 
2016
 
2015
 
2014
External sales
 
$
829,274

 
$
1,185,451

 
$
1,313,115

Operating (loss) income
 
(246,306
)
 
(509,381
)
 
94,940

External sales of $829.3 million in 2016 decreased by $356.2 million, or 30 percent, from 2015. The decrease in sales was attributed to organic sales decline of 16 percent, divestiture impact of 11 percent and unfavorable currency exchange impact of 3 percent. Excluding the impact of divestiture and currency exchange, sales decreased approximately 28 percent in energy, 21 percent in general engineering and 15 percent in earthworks. Sales were lower year-over-year due to persistent weak demand in oil and gas, mining, industrial applications and processing end markets. On a segment regional basis excluding the impact of divestiture and currency exchange, sales decreased 25 percent in the Americas, 10 percent in Asia, and 1 percent in Europe. The sales decrease in the Americas was driven by energy, earthworks and general engineering. The sales decrease in Asia was driven by earthworks and general engineering, offset partially by an increase in energy. The sales decrease in Europe was driven primarily by energy, while general engineering remained flat and earthworks increased.
In 2016, Infrastructure operating loss in 2016 was $246.3 million, a decrease of $263.1 million from 2015 operating loss of $509.4 million. The decrease in operating loss was primarily driven by lower impairment charges in the current verses prior year period. See Notes 2 and see Note 8 in our consolidated financial statements set forth in Item 8 (Note 8). The current year also includes a loss on divestiture for the sale of non-core businesses of $127.9 million, see Note 4. In addition to the aforementioned impairment charge and loss on divestiture, operating results for the current period were negatively impacted by lower organic sales, lower fixed cost absorption and unfavorable mix, offset partially by an increase in lower raw material costs and incremental restructuring program benefits of $18.1 million.
We are currently exploring strategic alternatives for a remaining non-core Infrastructure business. The estimated net book value of the business is approximately $30 million as of June 30, 2016. As the strategic direction has not yet been determined for this business, the Company cannot determine if additional impairment charges will be incurred.
External sales of $1,185.5 million in 2015 decreased by $127.7 million, or 10 percent, from 2014. The decrease in sales was attributed to organic sales decline of 11 percent and unfavorable currency exchange impact of 4 percent, offset partially by the impact of acquisition of 5 percent. Excluding the impact of currency exchange, sales decreased approximately 11 percent in the energy market and approximately 10 percent in the earthworks markets. The energy market was impacted by the severe downturn in oil and gas markets. In the earthworks markets, underground mining remained weak throughout 2015, while construction sales were down in all regions, particularly in Europe and Asia due to lower infrastructure project work year over year. General industrial sales decreased, tied largely to the impacts of the downturn in oil and gas markets, while weakness in machine demand resulted in lower surface finishing sales. On a regional basis, excluding impacts of acquisition, sales decreased 12 percent in Asia, 10 percent in Europe and 9 percent in the Americas. The sales decrease in all geographic regions were driven by the energy markets and the earthworks markets.

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In 2015, Infrastructure operating loss in 2015 was $509.4 million, a decrease of $604.3 million from 2014 operating income of $94.9 million. In addition to the previously mentioned impairment charges of $541.7 million, operating results for the current period were negatively impacted by lower organic sales, higher restructuring and related charges of $17.7 million, lower manufacturing absorption due to lower sales volumes and an inventory reduction initiative and unfavorable mix, partly offset by the impacts of the TMB acquisition and restructuring benefits. 2014 operating income included a non-recurring inventory charge of $6.4 million.
CORPORATE 
(in thousands)
 
2016
 
2015
 
2014
Corporate unallocated expense
 
$
(9,880
)
 
$
(9,336
)
 
$
(8,548
)
In 2016, Corporate unallocated expense increased $0.5 million, or 5.8 percent, from 2015, primarily due to higher restructuring-related charges in 2016 than in 2015. In 2015, Corporate unallocated expense increased $0.8 million, or 9.2 percent, from 2014, primarily due to higher restructuring-related charges in 2015 than in 2014.

LIQUIDITY AND CAPITAL RESOURCES Cash flow from operations is the primary source of funding for capital expenditures and internal growth. During the year ended June 30, 2016, cash flow provided by operating activities was $219.3 million.
Our five-year, multi-currency, revolving credit facility, as amended and restated in April 2016 (Credit Agreement) is used to augment cash from operations and as an additional source of funds. The Credit Agreement permits revolving credit loans of up to $600.0 million for working capital, capital expenditures and general corporate purposes. The Credit Agreement allows for borrowings in U.S. dollars, euro, Canadian dollars, pound sterling and Japanese yen. Interest payable under the Credit Agreement is based upon the type of borrowing under the facility and may be (1) LIBOR plus an applicable margin, (2) the greater of the prime rate or the Federal Funds effective rate plus an applicable margin or (3) fixed as negotiated by us. The Credit Agreement matures in April 2021. We had no outstanding borrowings on our Credit Agreement as of June 30, 2016.
The Credit Agreement requires us to comply with various restrictive and affirmative covenants, including two financial covenants: a maximum leverage ratio and a minimum consolidated interest coverage ratio (as those terms are defined in the agreement). We were in compliance with all covenants as of June 30, 2016. For the year ended June 30, 2016, average daily borrowings outstanding under the Credit Agreement were approximately $20.6 million. Borrowings under the Credit Agreement are guaranteed by our significant domestic subsidiaries.
Additionally, we obtain local financing through credit lines with commercial banks in the various countries in which we operate. At June 30, 2016, these borrowings amounted to $1.2 million of notes payable and $0.7 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, 2016 and 2015, less than 1 percent and approximately 7 percent of our debt, respectively, was exposed to variable rates of interest. The decrease in the portion of our debt subject to variable rates was due to the decrease in the balance outstanding on our revolving credit facility.
Except as noted below, we consider substantially all of 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, 2016, cash and cash equivalents of $55.3 million would not be available for use in the U.S. on a long-term basis without incurring U.S. federal and state income tax consequences. We have not repatriated, 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 or associated with our domestic debt service requirements. Notwithstanding the above, we redeployed cash from certain non-U.S. subsidiaries related to the transaction specified in Note 4. As such, the year ended June 30, 2016 includes a tax charge of $4.7 million related to this change in assertion with respect to a portion of our foreign subsidiaries' undistributed earnings, which are no longer considered permanently reinvested. The remaining undistributed earnings of our foreign subsidiaries continue to be indefinitely reinvested and 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.
At June 30, 2016, we had cash and cash equivalents of $161.6 million. Total Kennametal Shareholders’ equity was $964.3 million and total debt was $701.5 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.

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The following is a summary of our contractual obligations and other commercial commitments as of June 30, 2016 (in thousands): 
Contractual Obligations
 
  
 
Total
 
2017
 
2018-2019
 
2020-2021
 
Thereafter
Long-term debt
 
(1
)
 
$
800,949

 
$
22,225

 
$
44,450

 
$
426,901

 
$
307,373

Notes payable
 
(2
)
 
1,268

 
1,268

 

 

 

Pension benefit payments
 
 
 
(3)
 
52,172

 
98,290

 
105,311

 
(3)
Postretirement benefit payments
 
 
 
(3)
 
2,036

 
3,685

 
3,286

 
(3)
Capital leases
 
(4
)
 
800

 
775

 
25

 

 

Operating leases
 
 
 
77,274

 
18,623

 
22,922

 
14,793

 
20,936

Purchase obligations
 
(5
)
 
367,969

 
150,905

 
157,289

 
29,898

 
29,877

Unrecognized tax benefits
 
(6
)
 
3,765

 
560

 
2,809

 

 
396

Total
 
 
 
 
 
$
248,564

 
$
329,470

 
$
580,189

 


(1)
Long-term debt includes interest obligations of $101.0 million. Interest obligations were determined assuming interest rates as of June 30, 2016
remain constant.
(2)
Notes payable includes interest obligations of $0.1 million. Interest obligations were determined assuming interest rates as of June 30, 2016 remain constant.
(3)
Annual payments are expected to continue into the foreseeable future at the amounts noted in the table.
(4)
Capital leases include interest obligations of $0.1 million.
(5)
Purchase obligations consist of purchase commitments for materials, supplies and machinery and equipment as part of the ordinary conduct of business. Purchase obligations with variable price provisions were determined assuming market prices as of June 30, 2016 remain constant.
(6)
Unrecognized tax benefits are positions taken or expected to be taken on an income tax return that may result in additional payments to tax authorities. These amounts include interest of $0.3 million and penalty of $0.3 million accrued related to such positions as of June 30, 2016. Positions for which we are not able to reasonably estimate the timing of potential future payments are included in the ‘Thereafter’ column. If a tax authority agrees with the tax position taken or expected to be taken or the applicable statute of limitations expires, then additional payments will not be necessary.

Other Commercial Commitments
 
Total
 
2017
 
2018-2019
 
2020-2021
 
Thereafter
Standby letters of credit
 
$
14,156

 
$
14,156

 
$

 
$

 
$

Guarantees
 
19,010

 
12,895

 
1,367

 
216

 
4,532

Total
 
$
33,166

 
$
27,051

 
$
1,367

 
$
216

 
$
4,532

The standby letters of credit relate to insurance and other activities. The guarantees are non-debt guarantees with financial institutions, which are required primarily for security deposits, product performance guarantees and advances.
Cash Flow Provided by Operating Activities
During 2016, cash flow provided by operating activities was $219.3 million, compared to $351.4 million in 2015. During 2016, cash flow provided by operating activities for the current year consisted of net income and non-cash items amounting to $163.8 million and changes in certain assets and liabilities netting to $55.5 million. These changes were primarily driven by a decrease in inventory of $69.6 million due to our continued focus on working capital management and a decrease in accounts receivable of $32.7 million due to lower sales volume. Partially offsetting these inflows were a decrease in accrued income taxes of $25.2 million driven by payment of a capital gains tax related to a prior period tax reorganization and a decrease in accounts payable and accrued liabilities of $2.2 million.
During 2015, cash flow provided by operating activities was $351.4 million, compared to $271.9 million in 2014. During 2015, cash flow provided by operating activities for the current year consisted of net income and non-cash items amounting to $279.1 million, offset by changes in certain assets and liabilities netting to $72.4 million. These changes were primarily driven by a decrease in inventory of $70.9 million due to improved working capital management, a decrease in accounts receivable of $46.6 million due to lower sales volumes and a decrease in accounts payable and accrued liabilities of $8.2 million.
During 2014, cash flow provided by operating activities was $271.9 million. Cash flow provided by operating activities consisted of net income and non-cash items amounting to $338.7 million, offset by changes in certain assets and liabilities netting to $66.8 million. These changes were primarily driven by an increase in accounts receivable of $45.0 million due to higher sales volumes and a decrease in accrued income taxes of $12.5 million.

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Cash Flow Used for Investing Activities
Cash flow used for investing activities was $47.9 million for 2016, a decrease of $36.6 million, compared to $84.6 million in 2015. During 2016, cash flow used for investing activities included capital expenditures, net of $104.7 million, which consisted primarily of equipment upgrades. Partially offsetting this outflow was an inflow of $56.1 million of proceeds from the divestiture of non-core businesses.
Cash flow used for investing activities was $84.6 million for 2015, a decrease of $655.6 million, compared to $740.2 million in 2014. During 2015, cash flow used for investing activities included capital expenditures, net were $84.8 million, which consisted primarily of equipment upgrades.
Cash flow used for investing activities was $740.2 million for 2014. During 2014, cash flow used for investing activities included the TMB acquisition for $607.0 million, net of cash acquired, the Emura acquisition for $25.6 million cash paid in 2014 and $2.0 million related to a small acquisition in the Infrastructure segment. Capital expenditures, net were $116.1 million, which consisted primarily of equipment upgrades. These cash outflows were partially offset by $10.2 million of proceeds from sale of a small non-core business acquired as part of the TMB acquisition.
Cash Flow (Used for) Provided by Financing Activities
Cash flow used for financing activities was $110.5 million for 2016, compared to $333.0 million in 2015. During 2016, cash flow used for financing activities included $63.7 million of cash dividends paid to Shareholders and $50.8 million net decrease in borrowings, partially offset by $4.5 million of dividend reinvestment and the effect of employee benefit and stock plans.
Cash flow used for financing activities was $333.0 million for 2015, compared to cash flow provided by financing activities of $270.4 million in 2014. During 2015, cash flow used for financing activities included $282.5 million net decrease in borrowings and $57.0 million of cash dividends paid to Shareholders, partially offset by $13.8 million of dividend reinvestment and the effect of employee benefit and stock plans.
Cash flow provided by financing activities was $270.4 million for 2014. During 2014, cash flow provided by financing activities included a $313.1 million net increase in borrowings, which included $287.1 million of borrowings outstanding under our Credit Agreement, and $26.7 million of dividend reinvestment and the effect of employee benefit and stock plans, partially offset by $56.4 million of cash dividends paid to Shareholders and $14.2 million used for the purchase of capital stock.

FINANCIAL CONDITION At June 30, 2016, total assets were $2,368.8 million, a decrease of $480.7 million from $2,849.5 million at June 30, 2015. Total liabilities decreased $101.1 million from $1,474.1 million at June 30, 2015 to $1,373.0 million at June 30, 2016.
Working capital was $648.1 million at June 30, 2016, a decrease of $127.7 million, or 16.5 percent from $775.8 million at June 30, 2015. Inventory decreased $116.7 million due to lower work in process and powder blends, finished goods and raw materials driven by improved working capital management. Accounts receivable decreased $74.5 million due to lower sales volume and deferred income taxes decreased $45.7 million due primarily to effects from recording of a valuation allowance against our net deferred tax assets in the U.S. Partially offsetting these items were an increase in cash and cash equivalents $56.1 million; a decrease in other current liabilities of $26.4 million due primarily to lower restructuring liabilities and lower accrued compensation; and a decrease in current maturities of long-term debt, capital leases and notes payable of $13.8 million due to debt reduction initiatives. Currency exchange rate effects accounted for $20.5 million of the decrease in working capital, and $32.9 million of the decrease in working capital is related to the sale of non-core businesses.
Property, plant and equipment, net decreased $85.2 million from $815.8 million at June 30, 2015 to $730.6 million at June 30, 2016, primarily due to depreciation expense of $96.7 million, $67.6 million sold as part of sale of non-core businesses, unfavorable currency exchange impacts of $10.7 million and capital disposals of $6.0 million. Partially offsetting these items was capital expenditures of $110.7 million, which includes a net $1.0 million change which was included in accounts payable at June 30, 2016 related to purchases of property, plant and equipment.
At June 30, 2016, other assets were $562.8 million, a decrease of $212.3 million from $775.2 million at June 30, 2015. The primary drivers for the decrease were a decrease in goodwill of $118.9 million, a decrease in other intangible assets of $79.5 million and a decrease in deferred income taxes of $9.6 million. The decrease in goodwill was due to impairment charges in the Infrastructure segment of $105.7 million, $7.5 million of goodwill written off as part of the sale of non-core businesses and unfavorable currency exchange effects of $5.7 million. The change in other intangible assets was due to $52.7 million intangibles sold as part of the sale of non-core businesses, amortization expense of $20.8 million, impairments of $2.7 million and unfavorable currency exchange effects of $1.7 million. The decrease in deferred income taxes is due primarily to recording of a valuation allowance against our net deferred tax assets in the U.S.

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Long-term debt and capital leases decreased $36.3 million to $699.6 million at June 30, 2016 from $735.9 million at June 30, 2015. This change was driven by the $42.8 million decrease of borrowings outstanding on the revolver, a portion of which is deemed current maturities. Accrued pension benefits increased $38.8 million to $182.6 million, driven primarily by actuarial losses due to discount rate changes.
Kennametal Shareholders’ equity was $964.3 million at June 30, 2016, a decrease of $381.5 million from $1,345.8 million in the prior year. The decrease was primarily due to net loss attributable to Kennametal of $226.0 million, cash dividends paid to Shareholders of $63.7 million, unrecognized net pension and other postretirement benefit loss of $78.3 million and unfavorable currency exchange of $51.5 million, partially offset by a reclassification of foreign currency translation adjustment loss into earnings upon sale of non-core businesses of $15.1 million and capital stock issued under employee benefit and stock plans of $14.7 million.

ENVIRONMENTAL MATTERS The operation of our business has exposed us to certain liabilities and compliance costs related to environmental matters. We are involved in various environmental cleanup and remediation activities at certain of our locations.
Superfund Sites Among other environmental laws, we are subject to Superfund, under which we have been designated by the USEPA as a PRP with respect to environmental remedial costs at certain Superfund sites. We have evaluated our claims and liabilities associated with these Superfund sites based upon best currently available information. We believe our environmental accruals are adequate to cover our portion of the environmental remedial costs at the Superfund sites where we have been designated a PRP, to the extent these expenses are probable and reasonably estimable.
Other Environmental Issues We establish and maintain reserves for other potential environmental issues. At June 30, 2016 and 2015, the total of accruals for these reserves was $12.5 million and $12.6 million, respectively. 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 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.

EFFECTS OF INFLATION Despite modest inflation in recent years, rising costs, including the cost of certain raw materials, continue to affect our operations throughout the world. We strive to minimize the effects of inflation through cost containment, productivity improvements and price increases.

DISCUSSION OF CRITICAL ACCOUNTING POLICIES In preparing our financial statements in conformity with accounting principles generally accepted in the U.S., we make judgments and estimates about the amounts reflected in our financial statements. As part of our financial reporting process, our management collaborates to determine the necessary information on which to base our judgments and develops estimates used to prepare the financial statements. We use historical experience and available information to make these judgments and estimates. However, different amounts could be reported using different assumptions and in light of different facts and circumstances. Therefore, actual amounts could differ from the estimates reflected in our financial statements. Our significant accounting policies are described in Note 2. We believe that the following discussion addresses our critical accounting policies.
Revenue Recognition We recognize revenue for our products and assembled machines when title and all risks of loss and damages pass to the buyer. Our general conditions of sale explicitly state that the delivery of our products and assembled machines is freight on board shipping point and that title and all risks of loss and damages pass to the buyer upon delivery of the sold products or assembled machines to the common carrier.

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Our general conditions of sale explicitly state that acceptance of the conditions of shipment is considered to have occurred unless written notice of objection is received by Kennametal within 10 calendar days of the date specified on the invoice. We do not ship products or assembled machines unless we have documentation authorizing shipment to our customers. Our products are consumed by our customers in the manufacture of their products. Historically, we have experienced very low levels of returned products and assembled machines and do not consider the effect of returned products and assembled machines to be material. We have recorded an estimated returned goods allowance to provide for any potential returns.
We warrant that products and services sold are free from defects in material and workmanship under normal use and service when correctly installed, used and maintained. This warranty terminates 30 days after delivery of the product to the customer and does not apply to products that have been subjected to misuse, abuse, neglect or improper storage, handling or maintenance. Products may be returned to Kennametal only after inspection and approval by Kennametal and upon receipt by the customer of shipping instructions from Kennametal. We have included an estimated allowance for warranty returns in our returned goods allowance discussed above.
We recognize revenue related to the sale of specialized assembled machines upon customer acceptance and installation, as installation is deemed essential to the functionality of a specialized assembled machine. Sales of specialized assembled machines were immaterial for 2016, 2015 and 2014.
Stock-Based Compensation We recognize stock-based compensation expense for all stock options, restricted stock awards and restricted stock units over the period from the date of grant to the date when the award is no longer contingent on the employee providing additional service (substantive vesting period). We utilize the Black-Scholes valuation method to establish the fair value of all stock option awards. Time vesting stock units are valued at the market value of the stock on the grant date. Performance vesting stock units with a market condition are valued using a Monte Carlo model.
Accounting for Contingencies We accrue for contingencies when it is probable that a liability or loss has been incurred and the amount can be reasonably estimated. Contingencies by their nature relate to uncertainties that require the exercise of judgment in both assessing whether or not a liability or loss has been incurred and estimating the amount of probable loss. The significant contingencies affecting our financial statements include environmental, health and safety matters and litigation.
Long-Lived Assets We evaluate the recoverability of property, plant and equipment and intangible assets that are amortized whenever events or changes in circumstances indicate the carrying amount of such assets may not be fully recoverable. Changes in circumstances include technological advances, changes in our business model, capital structure, economic conditions or operating performance. Our evaluation is based upon, among other things, our assumptions about the estimated future undiscounted cash flows these assets are expected to generate. When the sum of the undiscounted cash flows is less than the carrying value, we will recognize an impairment loss to the extent that carrying value exceeds fair value. We apply our best judgment when performing these evaluations to determine if a triggering event has occurred, the undiscounted cash flows used to assess recoverability and the fair value of the asset.
Goodwill and Indefinite-Lived Intangible Assets We evaluate the recoverability of goodwill of each of our reporting units by comparing the fair value of each reporting unit with its carrying value. The fair values of our reporting units are determined using a combination of a discounted cash flow analysis and market multiples based upon historical and projected financial information. We apply our best judgment when assessing the reasonableness of the financial projections used to determine the fair value of each reporting unit. We evaluate the recoverability of indefinite-lived intangible assets using a discounted cash flow analysis based on projected financial information. We perform our annual impairment tests during the June quarter in connection with our annual planning process, unless there are impairment indicators based on the results of an ongoing cumulative qualitative assessment that warrant a test prior to that.
The $298.5 million of goodwill allocated to the Industrial reporting unit is not at risk of failing Step 1 of the impairment test since fair value substantially exceeded the carrying value as of the date of the last impairment test. There is no goodwill allocated to the Infrastructure reporting unit.
Pension and Other Postretirement Benefits We sponsor these types of benefit plans for certain employees and retirees. Accounting for the cost of these plans requires the estimation of the cost of the benefits to be provided well into the future and attributing that cost over the expected work life of employees participating in these plans. This estimation requires our judgment about the discount rate used to determine these obligations, expected return on plan assets, rate of future compensation increases, rate of future health care costs, withdrawal and mortality rates and participant retirement age. Differences between our estimates and actual results may significantly affect the cost of our obligations under these plans.

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In the valuation of our pension and other postretirement benefit liabilities, management utilizes various assumptions. Our discount rates are derived by identifying a theoretical settlement portfolio of high quality corporate bonds sufficient to provide for a plan’s projected benefit payments. This rate can fluctuate based on changes in the corporate bond yields. At June 30, 2016, a hypothetical 25 basis point increase in our discount rates would increase our pre-tax income by approximately $1.7 million, and a hypothetical 25 basis point decrease in our discount rates would decrease our pre-tax income by approximately $2.3 million.
The long-term rate of return on plan assets is estimated based on an evaluation of historical returns for each asset category held by the plans, coupled with the current and short-term mix of the investment portfolio. The historical returns are adjusted for expected future market and economic changes. This return will fluctuate based on actual market returns and other economic factors.
The rate of future health care cost increases is based on historical claims and enrollment information projected over the next fiscal year and adjusted for administrative charges. This rate is expected to decrease until 2027. At June 30, 2016, a hypothetical 1 percent increase or decrease in our health care cost trend rates would be immaterial to our pre-tax income.
Future compensation rates, withdrawal rates and participant retirement age are determined based on historical information. These assumptions are not expected to significantly change. Mortality rates are determined based on a review of published mortality tables.
We expect to contribute approximately $12.1 million and $2.0 million to our pension and other postretirement benefit plans, respectively, in 2017.
In 2016, substantially all plan participants of the U.S. Retirement Income Plan (RIP) became inactive. As a result, the average remaining life expectancy of the inactive participants will be used to amortize the unrecognized net gain or loss instead of the average remaining service period of active plan participants in fiscal 2017.
Allowance for Doubtful Accounts We record allowances for estimated losses resulting from the inability of our customers to make required payments. We assess the creditworthiness of our customers based on multiple sources of information and analyze additional factors such as our historical bad debt experience, industry and geographic concentrations of credit risk, current economic trends and changes in customer payment terms. This assessment requires significant judgment. If the financial condition of our customers was to deteriorate, additional allowances may be required, resulting in future operating losses that are not included in the allowance for doubtful accounts at June 30, 2016.
Inventories Inventories are stated at the lower of cost or market. We use the last-in, first-out method for determining the cost of a significant portion of our U.S. inventories. The cost of the remainder of our inventories is determined under the first-in, first-out or average cost methods. When market conditions indicate an excess of carrying costs over market value, a lower-of-cost-or-market provision is recorded. Excess and obsolete inventory reserves are established based upon our evaluation of the quantity of inventory on hand relative to demand.
Income Taxes Realization of our deferred tax assets is primarily dependent on future taxable income, the timing and amount of which are uncertain, in part, due to the expected profitability of certain foreign subsidiaries. A valuation allowance is recognized if it is “more likely than not” that some or all of a deferred tax asset will not be realized. As of June 30, 2016, the deferred tax assets net of valuation allowances relate primarily to net operating loss carryforwards, pension benefits, accrued employee benefits and inventory reserves. In the event that we were to determine that we would not be able to realize our deferred tax assets in the future, an increase in the valuation allowance would be required. In the event we were to determine that we are able to use our deferred tax assets and a valuation allowance had been recorded against the deferred tax assets, a decrease in the valuation allowance would be required.

NEW ACCOUNTING STANDARDS
Adopted
In April 2014, the Financial Accounting Standards Board (FASB) issued guidance on reporting discontinued operations and disclosures of disposals of components of an entity. Under the guidance, only disposals representing a strategic shift in operations should be presented as discontinued operations. Additionally, the guidance requires expanded disclosures about discontinued operations that will provide financial statement users with more information about the assets, liabilities, income and expenses of discontinued operations. The guidance also requires disclosure of the pre-tax income attributable to a disposal of a significant part of an organization that does not qualify for discontinued operations reporting. This guidance was effective for Kennametal beginning July 1, 2015. The divestiture of non-core businesses outlined in Note 4 was evaluated under this guidance.

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Issued
In June 2016, the FASB issued guidance on measurement of credit losses on financial instruments. The new guidance introduces an approach based on expected losses to estimate credit losses on certain types of financial instruments. It also modifies the impairment model for available-for-sale debt securities and provides for a simplified accounting model for purchased financial assets with credit deterioration since their origination. The scope of this amendment includes valuation of trade receivables. This standard is effective for Kennametal beginning July 1, 2020. We are in the process of assessing the impact the adoption of this guidance will have on our consolidated financial statements.

In May 2016, the FASB issued guidance on narrow scope improvements and practical expedients as part of Topic 606: Revenue from Contracts with Customers. The amendments address collectability criterion and accounting for contracts that do not meet the criteria, presentation of sales taxes and other similar taxes collected from customers, noncash consideration, contract modifications at transition and completed contracts at transition, in addition to a technical correction. This standard is effective for Kennametal beginning July 1, 2018, in conjunction with the adoption of Accounting Standards Update 2014-09, “Revenue from Contracts with Customers: Topic 606.” We are in the process of assessing the impact the adoption of this guidance will have on our consolidated financial statements.

In April 2016, the FASB issued guidance on identifying performance obligations and licensing as part of Topic 606: Revenue from Contracts with Customers. The amendments in this update clarify identifying performance obligations and the licensing implementation guidance, while retaining the related principles for those areas. This standard is effective for Kennametal beginning July 1, 2018, in conjunction with the adoption of Accounting Standards Update 2014-09, “Revenue from Contracts with Customers: Topic 606.” We are in the process of assessing the impact the adoption of this guidance will have on our consolidated financial statements.
In March 2016, the FASB issued guidance intended to simplify equity-based award accounting and presentation. The guidance impacts income tax accounting related to equity-based awards, the classification of awards as either equity or liabilities, and the classification on the statement of cash flows. This standard is effective for Kennametal beginning July 1, 2017. We are in the process of assessing the impact the adoption of this guidance will have on our consolidated financial statements.
In March 2016, the FASB issued guidance on principal versus agent considerations in reporting revenue gross versus net. This guidance is intended to improve the operability and understandability of the implementation guidance on principal versus agent considerations. As this update serves to clarify existing guidance, it is not expected to have a material impact on our consolidated financial statements.
In February 2016, the FASB issued guidance on lease accounting, which replaces the existing guidance in ASC 840, Leases. The standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. This standard is effective for Kennametal beginning July 1, 2019. We are in the process of assessing the impact the adoption of this guidance will have on our consolidated financial statements.
In November 2015, the FASB issued guidance on balance sheet classification of deferred taxes. The amendments in this Update require that deferred tax liabilities and assets be classified as noncurrent in a classified statement of financial position, as opposed to the current practice of separating deferred income tax liabilities and assets into current and noncurrent amounts on the balance sheet. This standard is effective for Kennametal beginning July 1, 2017. We are in the process of assessing the impact the adoption of this ASU will have on our consolidated financial statements.
In August 2015, the FASB issued guidance that defers the effective date of previously issued ASU 2014-09, “Revenue from Contracts with Customers: Topic 606.” Under this guidance, the effective date for Kennametal was deferred from July 1, 2017 to July 1, 2018. We are in the process of assessing the impact the adoption of this ASU will have on our consolidated financial statements.
In July 2015, the FASB issued guidance on subsequent measurement of inventory. The amendments in this update require that inventory other than LIFO be subsequently measured at the lower of cost and net realizable value, as opposed to the current practice of lower of cost or market. Subsequent measurement is unchanged for inventory measured using LIFO. This standard is effective for Kennametal beginning July 1, 2017. We are in the process of evaluating the impact of adoption on our consolidated financial statements.

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In April 2015, the FASB issued guidance on the presentation of debt issuance costs. The guidance requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct reduction from the carrying amount of that debt liability, consistent with debt discounts. This standard is effective for Kennametal beginning July 1, 2016 and will be retrospectively applied. The guidance did not have a material impact on our consolidated financial position, results of operations and cash flows.
In April 2015, the FASB issued guidance on accounting for fees paid in a cloud computing arrangement. The amendments in this update provide guidance to customers about whether a cloud computing arrangement includes a software license and accounting for the arrangement as capitalized and amortized as an intangible asset or expensed as incurred as a service contract. This standard is effective for Kennametal beginning July 1, 2016. The provisions of the guidance may be applied prospectively or retrospectively. We plan to adopt this guidance prospectively, and adoption of this ASU is not expected to have a material impact on our consolidated financial position, results of operations and cash flows.
In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers: Topic 606.” This ASU replaces nearly all existing U.S. GAAP guidance on revenue recognition. The standard prescribes a five-step model for recognizing revenue, the application of which will require significant judgment. This standard is effective for Kennametal July 1, 2017. We are in the process of assessing the impact the adoption of this ASU will have on our consolidated financial statements.

ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RISK We are exposed to certain market risks arising from transactions that are entered into in the normal course of business. As part of our financial risk management program, we use certain derivative financial instruments to manage these risks. We do not enter into derivative transactions for speculative purposes and, therefore, hold no derivative instruments for trading purposes. We use derivative financial instruments to provide predictability to the effects of changes in foreign exchange rates on our consolidated results and to achieve our targeted mix of fixed and floating interest rates on outstanding debt. Our objective in managing foreign exchange exposures with derivative instruments is to reduce volatility in cash flow, allowing us to focus more of our attention on business operations. With respect to interest rate management, these derivative instruments allow us to achieve our targeted fixed-to-floating interest rate mix as a separate decision from funding arrangements in the bank and public debt markets. 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 (income) expense, net. See Notes 2 and 16 of our consolidated financial statements set forth in Item 8.
We are exposed to counterparty credit risk for nonperformance of derivative contracts and, in the event of nonperformance, to market risk for changes in interest and currency exchange rates, as well as settlement risk. We manage exposure to counterparty credit risk through credit standards, diversification of counterparties and procedures to monitor concentrations of credit risk. We do not anticipate nonperformance by any of the counterparties.
The following provides additional information on our use of derivative instruments. Included below is a sensitivity analysis that is based upon a hypothetical 10 percent weakening or strengthening in the U.S. dollar compared to the June 30, 2016 currency exchange rates and the effective interest rates under our current borrowing arrangements. We compared the contractual derivative and borrowing arrangements in effect at June 30, 2016 to the hypothetical foreign exchange or interest rates in the sensitivity analysis to determine the effect on interest expense, pre-tax income or accumulated other comprehensive (loss) income. Our analysis takes into consideration the different types of derivative instruments and the applicability of hedge accounting.
CASH FLOW HEDGES Currency A portion of our operations consists of investments in foreign subsidiaries. Our exposure to market risk from changes in foreign exchange rates arises from these investments, intercompany loans utilized to finance these subsidiaries, trade receivables and payables and firm commitments arising from international transactions. We manage our foreign exchange transaction risk to reduce the volatility of cash flows caused by currency exchange rate fluctuations through natural offsets where appropriate and through foreign exchange contracts. These contracts are designated as hedges of forecasted transactions that will settle in future periods and that would otherwise expose us to currency risk.

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Our foreign exchange hedging program is intended to mitigate our exposure to currency exchange rate movements. This exposure arises largely from anticipated cash flows from cross-border intercompany sales of products and services. This program utilizes range forwards and forward contracts primarily to sell foreign currency. The notional amounts of the contracts translated into U.S. dollars at June 30, 2016 and 2015 were $53.3 million and $53.8 million, respectively. We would have received $0.3 million and $2.6 million at June 30, 2016 and 2015, respectively to settle these contracts representing the fair value of these agreements. At June 30, 2016, a hypothetical 10 percent strengthening or weakening of the U.S. dollar would have changed accumulated other comprehensive (loss) income, net of tax, by $1.7 million.
In addition, we may enter into forward contracts to hedge transaction exposures or significant cross-border intercompany loans by either purchasing or selling specified amounts of foreign currency at a specified date. At June 30, 2016 and 2015, we had outstanding forward contracts to purchase and sell foreign currency with notional amounts, translated into U.S. dollars at June 30, 2016 and 2015 rates, of $57.5 million and $93.4 million, respectively. At June 30, 2016, a hypothetical 10 percent change in the year-end exchange rates would have resulted in an increase or decrease in pre-tax income of $5.8 million related to these positions.
Interest Rate Our exposure to market risk for changes in interest rates relates primarily to our long-term debt obligations. We seek to manage our interest rate risk in order to balance our exposure between fixed and floating rates, while attempting to minimize our borrowing costs. To achieve these objectives, we primarily use interest rate swap contracts to manage exposure to interest rate changes related to these borrowings. We had no swaps in place as of June 30, 2016 and 2015.
DEBT AND NOTES PAYABLE At June 30, 2016 and 2015, we had $701.5 million and $751.6 million, respectively, of outstanding debt, including capital leases and notes payable. Effective interest rates as of June 30, 2016 and 2015 were 3.6 percent and 3.0 percent, respectively. A hypothetical change of 10 percent in market interest rates from June 30, 2016 levels would have no impact on our interest expense.
CURRENCY EXCHANGE RATE FLUCTUATIONS Currency exchange rate fluctuations increased diluted earnings per share by $0.08 in 2016, did not have a material impact in 2015 and decreased diluted earnings per share by $0.07 in 2014. Currency exchange rate fluctuations may have a material impact on future earnings in the short term and long term.

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ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management is responsible for establishing and maintaining adequate internal control over financial reporting. Management has conducted an assessment of the Company’s internal controls over financial reporting as of June 30, 2016 using the criteria in Internal Control – Integrated Framework (2013), issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Based on its assessment, management has concluded that the Company maintained effective internal control over financial reporting as of June 30, 2016, based on criteria in Internal Control – Integrated Framework (2013) issued by the COSO. The effectiveness of the Company’s internal control over financial reporting as of June 30, 2016 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears herein.

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Report of Independent Registered Public Accounting Firm
    
To the Shareholders of Kennametal Inc.

In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, comprehensive income, cash flow and shareholders' equity present fairly, in all material respects, the financial position of Kennametal Inc. and its subsidiaries at June 30, 2016 and 2015, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 2016 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 15(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of June 30, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management's Report on Internal Control over Financial Reporting appearing under Item 8. Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Company's internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
Pittsburgh, Pennsylvania
August 11, 2016


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CONSOLIDATED STATEMENTS OF INCOME
Year ended June 30 (in thousands, except per share data)
2016
 
2015
 
2014
Sales
$
2,098,436

 
$
2,647,195

 
$
2,837,190

Cost of goods sold
1,482,369

 
1,841,202

 
1,940,187

Gross profit
616,067

 
805,993

 
897,003

Operating expense
494,975

 
554,895

 
589,768

Restructuring and asset impairment charges (Notes 2 and 15)
143,810

 
582,235

 
17,608

Loss on divestiture (Note 4)
131,463

 

 

Amortization of intangibles
20,762

 
26,686

 
26,195

Operating (loss) income
(174,943
)
 
(357,823
)
 
263,432

Interest expense
27,752

 
31,466

 
32,451

Other (income) expense, net
(4,124
)
 
(1,674
)
 
2,172

(Loss) income before income taxes
(198,571
)
 
(387,615
)
 
228,809

Provision (benefit) for income taxes
25,313

 
(16,654
)
 
66,611

Net (loss) income
(223,884
)
 
(370,961
)
 
162,198

Less: Net income attributable to noncontrolling interests
2,084

 
2,935

 
3,832

Net (loss) income attributable to Kennametal
$
(225,968
)
 
$
(373,896
)
 
$
158,366

PER SHARE DATA ATTRIBUTABLE TO KENNAMETAL SHAREHOLDERS
 
 
Basic (loss) earnings per share
$
(2.83
)
 
$
(4.71
)
 
$
2.01

Diluted (loss) earnings per share
$
(2.83
)
 
$
(4.71
)
 
$
1.99

Dividends per share
$
0.80

 
$
0.72

 
$
0.72

Basic weighted average shares outstanding
79,835

 
79,342

 
78,678

Diluted weighted average shares outstanding
79,835

 
79,342

 
79,667


CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
 
2016
 
2015
 
2014
Net (loss) income
 
$
(223,884
)
 
$
(370,961
)
 
$
162,198

Other comprehensive (loss) income, net of tax
 
 
 
 
 
 
Unrealized (loss) gain on derivatives designated and qualified as cash flow hedges
 
(150
)
 
6,652

 
(706
)
Reclassification of unrealized (gain) loss on expired derivatives designated and qualified as cash flow hedges
 
(1,563
)
 
(2,873
)
 
1,987

Unrecognized net pension and other postretirement benefit loss
 
(78,295
)
 
(47,982
)
 
(11,990
)
Reclassification of net pension and other postretirement benefit loss
 
4,925

 
2,931

 
2,184

Foreign currency translation adjustments
 
(52,695
)
 
(139,465
)
 
31,763

Reclassification of foreign currency translation adjustment loss realized upon sale
 
15,088

 

 

Total other comprehensive (loss) income, net of tax
 
(112,690
)
 
(180,737
)
 
23,238

Total comprehensive (loss) income
 
(336,574
)
 
(551,698
)
 
185,436

Less: comprehensive income (loss) attributable to noncontrolling interests
 
896

 
(410
)
 
4,198

Comprehensive (loss) income attributable to Kennametal Shareholders
 
$
(337,470
)
 
$
(551,288
)
 
$
181,238

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


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CONSOLIDATED BALANCE SHEETS
 As of June 30 (in thousands, except per share data)
2016
 
2015
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
161,579

 
$
105,494

Accounts receivable, less allowance for doubtful accounts of $12,724 and $13,560 respectively
370,916

 
445,373

Inventories (Note 7)
458,830

 
575,531

Deferred income taxes (Note 12)
26,713

 
72,449

Other current assets
57,303

 
59,699

Total current assets
1,075,341

 
1,258,546

Property, plant and equipment:
 
 
 
Land and buildings
353,789

 
401,207

Machinery and equipment
1,511,462

 
1,573,597

Less accumulated depreciation
(1,134,611
)
 
(1,158,979
)
Property, plant and equipment, net
730,640

 
815,825

Other assets:
 
 
 
Investments in affiliated companies
2

 
361

Goodwill (Notes 2 and 8)
298,487

 
417,389

 Other intangible assets, less accumulated amortization of $114,093 and $153,370, respectively (Notes 2 and 8)
207,208

 
286,669

Deferred income taxes (Note 12)
14,459

 
24,091

Other
42,656

 
46,648

Total other assets
562,812

 
775,158

Total assets
$
2,368,793

 
$
2,849,529

LIABILITIES
 
 
 
Current liabilities:
 
 
 
Current maturities of long-term debt and capital leases (Note 10)
$
732

 
$
8,129

Notes payable to banks (Note 11)
1,163

 
7,573

Accounts payable
182,039

 
187,381

Accrued income taxes
16,602

 
25,237

Accrued vacation pay
24,709

 
26,566

Accrued payroll
49,761

 
49,180

Other current liabilities (Note 9)
152,269

 
178,678

Total current liabilities
427,275

 
482,744

Long-term debt and capital leases, less current maturities (Note 10)
699,558

 
735,885

Deferred income taxes (Note 12)
17,126

 
59,744

Accrued postretirement benefits (Note 13)
18,876

 
19,230

Accrued pension benefits (Note 13)
182,597

 
143,799

Accrued income taxes
3,100

 
3,002

Other liabilities
24,460

 
29,690

Total liabilities
1,372,992

 
1,474,094

Commitments and contingencies (Note 19)

 

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

 

Capital stock, $1.25 par value; 120,000 shares authorized; 79,694 and 79,375 shares issued, respectively
99,618

 
99,219

Additional paid-in capital
436,617

 
419,829

Retained earnings
780,597

 
1,070,282

Accumulated other comprehensive loss
(352,509
)
 
(243,523
)
Total Kennametal Shareholders’ Equity
964,323

 
1,345,807

Noncontrolling interests
31,478

 
29,628

Total equity
995,801

 
1,375,435

Total liabilities and equity
$
2,368,793

 
$
2,849,529

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

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CONSOLIDATED STATEMENTS OF CASH FLOW
Year ended June 30 (in thousands)
2016
 
2015
 
2014
OPERATING ACTIVITIES
 
 
 
 
 
Net (loss) income
$
(223,884
)
 
$
(370,961
)
 
$
162,198

Adjustments for non-cash items:
 
 
 
 
 
Depreciation
96,704

 
104,978

 
104,027

Amortization
20,762

 
26,686

 
26,195

Stock-based compensation expense
18,129

 
16,827

 
17,641

Restructuring and asset impairment charges (Notes 2 and 15)
118,779

 
548,028

 
3,408

Loss on divestiture (Note 4)
131,124

 

 

Deferred income tax provision
8,328

 
(48,575
)
 
23,119

Other
(6,113
)
 
2,098

 
2,106

Changes in certain assets and liabilities:
 
 
 
 
 
Accounts receivable
32,661

 
46,552

 
(45,041
)
Inventories
69,552

 
70,874

 
(5,310
)
Accounts payable and accrued liabilities
(2,180
)
 
(8,218
)
 
13,748

Accrued income taxes
(25,247
)
 
(10,163
)
 
(12,485
)
Accrued pension and postretirement benefits
(15,013
)
 
4,863

 
(16,592
)
Other
(4,280
)
 
(31,552
)
 
(1,141
)
Net cash flow provided by operating activities
219,322

 
351,437

 
271,873

INVESTING ACTIVITIES
 
 
 
 
 
Purchases of property, plant and equipment
(110,697
)
 
(100,939
)
 
(117,376
)
Disposals of property, plant and equipment
5,978

 
16,122

 
1,236

Business acquisition, net of cash acquired (Note 4)

 

 
(634,615
)
Proceeds from divestiture (Note 4)
56,127

 

 
10,225

Other
659

 
263

 
356

Net cash flow used for investing activities
(47,933
)
 
(84,554
)
 
(740,174
)
FINANCING ACTIVITIES
 
 
 
 
 
Net (decrease) increase in notes payable
(6,288
)
 
(63,647
)
 
31,568

Net increase (decrease) in short-term revolving and other lines of credit

 
200

 
(3,600
)
Term debt borrowings
50,070

 
89,712

 
736,079

Term debt repayments
(94,577
)
 
(308,736
)
 
(450,928
)
Purchase of capital stock
(295
)
 
(318
)
 
(14,165
)
Dividend reinvestment and the effect of employee benefit and stock plans
4,519

 
13,844

 
26,676

Cash dividends paid to Shareholders
(63,717
)
 
(56,979
)
 
(56,436
)
Other
(181
)
 
(7,039
)
 
1,214

Net cash flow (used for) provided by financing activities
(110,469
)
 
(332,963
)
 
270,408

Effect of exchange rate changes on cash and cash equivalents
(4,835
)
 
(6,355
)
 
(1,494
)
CASH AND CASH EQUIVALENTS
 
 
 
 
 
Net increase (decrease) in cash and cash equivalents
56,085

 
(72,435
)
 
(199,387
)
Cash and cash equivalents, beginning of year
105,494

 
177,929

 
377,316

Cash and cash equivalents, end of year
$
161,579

 
$
105,494

 
$
177,929

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


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CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
 
2016
 
2015
 
2014
Year ended June 30 (in thousands)
Shares

 
Amount

 
Shares

 
Amount

 
Shares

 
Amount

CAPITAL STOCK
 
 
 
 
 
 
 
 
 
 
 
Balance at beginning of year
79,375

 
$
99,219

 
78,672

 
$
98,340

 
77,842

 
$
97,303

Dividend reinvestment
12

 
15

 
7

 
9

 
7

 
9

Capital stock issued under employee benefit and stock plans
319

 
399

 
703

 
879

 
1,155

 
1,443

Purchase of capital stock
(12
)
 
(15
)
 
(7
)
 
(9
)
 
(332
)
 
(415
)
Balance at end of year
79,694

 
99,618

 
79,375

 
99,219

 
78,672

 
98,340

ADDITIONAL PAID-IN CAPITAL
 
 
 
 
 
 
 
 
 
 
 
Balance at beginning of year
 
 
419,829

 
 
 
395,890

 
 
 
374,300

Dividend reinvestment
 
 
279

 
 
 
311

 
 
 
319

Capital stock issued under employee benefit and stock plans
 
 
14,271

 
 
 
23,939

 
 
 
35,019

Sale of subsidiary stock to noncontrolling interests
 
 
2,517

 
 
 

 
 
 

Purchase of capital stock
 
 
(279
)
 
 
 
(311
)
 
 
 
(13,748
)
Balance at end of year
 
 
436,617

 
 
 
419,829

 
 
 
395,890

RETAINED EARNINGS
 
 
 
 
 
 
 
 
 
 
 
Balance at beginning of year
 
 
1,070,282

 
 
 
1,501,157

 
 
 
1,399,227

Net (loss) income
 
 
(225,968
)
 
 
 
(373,896
)
 
 
 
158,366

Cash dividends paid to Shareholders
 
 
(63,717
)
 
 
 
(56,979
)
 
 
 
(56,436
)
Balance at end of year
 
 
780,597

 
 
 
1,070,282

 
 
 
1,501,157

ACCUMULATED OTHER COMPREHENSIVE (LOSS) INCOME
 
 
 
 
 
 
 
 
 
 
 
Balance at beginning of year
 
 
(243,523
)
 
 
 
(66,131
)
 
 
 
(89,004
)
Unrealized (loss) gain on derivatives designated and qualified as cash flow hedges
 
 
(150
)
 
 
 
6,652

 
 
 
(706
)
Reclassification of unrealized (gain) loss on expired derivatives designated and qualified as cash flow hedges
 
 
(1,563
)
 
 
 
(2,873
)
 
 
 
1,987

Unrecognized net pension and other postretirement benefit loss
 
 
(78,295
)
 
 
 
(47,982
)
 
 
 
(11,990
)
Reclassification of net pension and other postretirement benefit loss
 
 
4,925

 
 
 
2,931

 
 
 
2,184

Foreign currency translation adjustments
 
 
(51,508
)
 
 
 
(136,120
)
 
 
 
31,398

Reclassification of foreign currency translation adjustment loss realized upon sale
 
 
15,088

 
 
 

 
 
 

Other comprehensive (loss) income, net of tax
 
 
(111,503
)
 
 
 
(177,392
)
 
 
 
22,873

Sale of subsidiary stock to noncontrolling interests
 
 
2,517

 
 
 

 
 
 

Balance at end of year
 
 
(352,509
)
 
 
 
(243,523
)
 
 
 
(66,131
)
NONCONTROLLING INTERESTS
 
 
 
 
 
 
 
 
 
 
 
Balance at beginning of year
 
 
29,628

 
 
 
32,352

 
 
 
30,467

Net income
 
 
2,084

 
 
 
2,935

 
 
 
3,832

Other comprehensive (loss) income, net of tax
 
 
(1,188
)
 
 
 
(3,345
)
 
 
 
366

Sale of subsidiary stock to noncontrolling interests
 
 
2,566

 
 
 

 
 
 

Cash dividends paid to noncontrolling interests
 
 
(1,612
)
 
 
 
(2,314
)
 
 
 
(2,313
)
Balance at end of year
 
 
31,478

 
 
 
29,628

 
 
 
32,352

Total equity, June 30
 
 
$
995,801

 
 
 
$
1,375,435

 
 
 
$
1,961,608

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

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 — NATURE OF OPERATIONS
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, construction, process industries 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 components; machine tool, light machinery and heavy machinery industries; airframe and aerospace components; 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.
Our product offering includes a wide selection of standard and customized technologies for metalworking, such as sophisticated metal cutting 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. We are a leading global supplier of tooling, engineered components and advanced materials consumed in production processes. We believe we are one of the largest global providers of consumable metal cutting tools and tooling supplies.
We specialize in developing and manufacturing metalworking tools and wear-resistant engineered components and coatings using a specialized type of powder metallurgy. Our metalworking tools are made of cemented tungsten carbides, ceramics, cermets and super-hard materials. We also manufacture and market a complete line of tool holders, tool-holding systems and rotary-cutting tools by machining and fabricating steel bars and other metal alloys. In addition, we produce specialized compacts and metallurgical powders, as well as products made from tungsten carbide or other hard materials that are used for custom-engineered and challenging applications, including mining and highway construction, among others. Further, we develop, manufacture and market engineered components and surface technology solutions with proprietary metal cladding capabilities.
Unless otherwise specified, any reference to a “year” is to a fiscal year ended June 30. 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.
 
NOTE 2 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The summary of our significant accounting policies is presented below to assist in evaluating our consolidated financial statements.
PRINCIPLES OF CONSOLIDATION The consolidated financial statements include our accounts and those of our majority-owned subsidiaries. All significant intercompany balances and transactions are eliminated. Investments in entities of less than 50 percent of the voting stock over which we have significant influence are accounted for on an equity basis. The factors used to determine significant influence include, but are not limited to, our management involvement in the investee, such as hiring and setting compensation for management of the investee, the ability to make operating and capital decisions of the investee, representation on the investee’s board of directors and purchase and supply agreements with the investee. Investments in entities of less than 50 percent of the voting stock in which we do not have significant influence are accounted for on the cost basis.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS In preparing our consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (U.S. GAAP), we make judgments and estimates about the amounts reflected in our financial statements. As part of our financial reporting process, our management collaborates to determine the necessary information on which to base our judgments and develop estimates used to prepare the financial statements. We use historical experience and available information to make these judgments and estimates. However, different amounts could be reported using different assumptions and in light of different facts and circumstances. Therefore, actual amounts could differ from the estimates reflected in our financial statements.
CASH AND CASH EQUIVALENTS Cash investments having original maturities of three months or less are considered cash equivalents. Cash equivalents principally consist of investments in money market funds and bank deposits at June 30, 2016.

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ACCOUNTS RECEIVABLE We market our products to a diverse customer base throughout the world. Trade credit is extended based upon periodically updated evaluations of each customer’s ability to satisfy its obligations. We make judgments as to our ability to collect outstanding receivables and provide allowances for the portion of receivables when collection becomes doubtful. Accounts receivable reserves are determined based upon an aging of accounts and a review of specific accounts.
INVENTORIES Inventories are stated at the lower of cost or market. We use the last-in, first-out (LIFO) method for determining the cost of a significant portion of our United States (U.S.) inventories. The cost of the remainder of our inventories is determined under the first-in, first-out or average cost methods. When market conditions indicate an excess of carrying costs over market value, a lower-of-cost-or-market provision is recorded. Excess and obsolete inventory reserves are established based upon our evaluation of the quantity of inventory on hand relative to demand. The excess and obsolete inventory reserve at June 30, 2016 and 2015 was $36.7 million and $45.0 million, respectively.
PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment are carried at cost. Major improvements are capitalized, while maintenance and repairs are expensed as incurred. Retirements and disposals are removed from cost and accumulated depreciation accounts, with the gain or loss reflected in operating income. Interest related to the construction of major facilities is capitalized as part of the construction costs and is depreciated over the facilities' estimated useful lives.
Depreciation for financial reporting purposes is computed using the straight-line method over the following estimated useful lives: building and improvements over 15-40 years; machinery and equipment over 4-15 years; furniture and fixtures over 5-10 years and computer hardware and software over 3-5 years.
Leased property and equipment under capital leases are depreciated using the straight-line method over the terms of the related leases.
LONG-LIVED ASSETS We evaluate the recoverability of property, plant and equipment and intangible assets that are amortized, whenever events or changes in circumstances indicate the carrying amount of any such assets may not be fully recoverable. Changes in circumstances include technological advances, changes in our business model, capital structure, economic conditions or operating performance. Our evaluation is based upon, among other things, our assumptions about the estimated future undiscounted cash flows these assets are expected to generate. When the sum of the undiscounted cash flows is less than the carrying value of the asset or asset group, we will recognize an impairment loss to the extent that carrying value exceeds fair value. We apply our best judgment when performing these evaluations to determine if a triggering event has occurred, the undiscounted cash flows used to assess recoverability and the fair value of the asset.
GOODWILL AND 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, unless there are impairment indicators based on the results of an ongoing cumulative qualitative assessment that warrant a test prior to that. 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.
Identifiable assets with finite lives are reviewed for impairment when events or circumstances indicate that the carrying value may not be recoverable. During the December quarter of fiscal 2016, we performed an interim review of our identifiable assets with finite lives and preliminarily determined that the assets were not impaired. During the March quarter of fiscal 2016, we completed the finalization of fair values related to intangibles and property, plant and equipment. We also completed a review of our identifiable assets with finite lives and determined that the assets were not impaired.
Acquisition Impact on Goodwill
On November 4, 2013, we acquired TMB from Allegheny Technologies Incorporated (ATI), the operations of which are included in both the Industrial and Infrastructure segments. As a result of the acquisition, we increased goodwill by $246.6 million in based on our purchase price allocations, $3.0 million of which was recorded in the Industrial segment in 2015 based on finalization of the purchase price allocation. The goodwill recorded relates to operating synergies associated with the acquisition that we expected to realize. Goodwill of $202.1 million was deductible for tax purposes.

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2015 December Quarter Impairment Charge
As previously disclosed, we recorded a non-cash pre-tax impairment charge during the three months ended December 31, 2014 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.
2015 March Quarter Impairment Charge
As previously disclosed, we recorded an additional non-cash pre-tax impairment charge during the three months ended March 31, 2015 of $152.9 million in the Infrastructure reporting unit, of which $152.5 million was for goodwill and $0.4 million was for an indefinite-lived trademark intangible asset.
In addition, we recorded an additional $6.8 million charge during the three months ended March 31, 2015 for an indefinite-lived trademark intangible asset based upon completion of the 2015 December valuation.
During 2015, 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.
2016 December Quarter Impairment Charge
Late in the December quarter of fiscal 2016, the Company experienced a further unexpected deterioration in customer demand in many of its end markets and certain geographies at that time. Industrial production indices in the U.S. and China declined, as well as further reductions in mining and oil and gas activity. In view of these declines and the significant impact on our near term financial forecasts as well as a significant and sustained decline in the Company’s stock price, we determined an interim impairment test of our goodwill and other long-lived assets of our Industrial and Infrastructure reporting units was required. As a result of this interim test, we recorded a preliminary non-cash pre-tax impairment charge during the three months ended December 31, 2015 of $106.1 million in the Infrastructure segment, of which $105.7 million was for goodwill and $0.4 million was for an indefinite-lived trademark intangible asset. We also recorded a preliminary non-cash pre-tax impairment charge during the three months ended December 31, 2015 of $2.3 million in the Industrial segment for an indefinite-lived trademark intangible asset. These impairment charges are recorded in restructuring and asset impairment charges in our consolidated statements of income. There is $298.5 million of goodwill at the Industrial reporting unit. The Industrial reporting unit passed the 2016 interim and annual goodwill impairment tests with fair value substantially exceeded the carrying value. No goodwill remains with the Infrastructure reporting unit as of June 30, 2016.
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 cannot provide assurance that we will achieve all of the anticipated benefits from restructuring actions we have taken and expect to continue to take. If we are unable to effectively restructure our operations in the light of evolving market conditions, it could have a material adverse effect on our business, financial condition, results of operations and cash flows. We are currently exploring strategic alternatives for a remaining non-core Infrastructure business. The estimated net book value of the business is approximately $30 million as of June 30, 2016. As the strategic direction has not yet been determined for these businesses, the Company cannot determine if additional impairment charges will be incurred.
We recorded no goodwill and other intangible asset impairment charges in 2014.
Divestiture Impact on Goodwill
During 2016, we completed the sale of non-core businesses, see Note 4. As a result of this transaction, goodwill decreased by $1.1 million and $6.5 million in our Industrial and Infrastructure segments, respectively. These decreases are recorded in loss on divestiture in our consolidated statements of income.
Divestiture Impact on Other Intangible Assets
The divestiture of non-core businesses completed during 2016 resulted in a reduction of $30.0 million in customer-related, $15.4 million in unpatented technology, $5.0 million in indefinite-lived trademarks, $1.1 million in definite-lived trademarks, $0.8 million in technology-based and other and $0.5 million in contract-based.
PENSION AND OTHER POSTRETIREMENT BENEFITS We sponsor these types of benefit plans for certain employees and retirees. Accounting for the cost of these plans requires the estimation of the cost of the benefits to be provided well into the future and attributing that cost over the expected work life of employees participating in these plans. This estimation requires our judgment about the discount rate used to determine these obligations, expected return on plan assets, rate of future compensation increases, rate of future health care costs, withdrawal and mortality rates and participant retirement age. Differences between our estimates and actual results may significantly affect the cost of our obligations under these plans.
In the valuation of our pension and other postretirement benefit liabilities, management utilizes various assumptions. Discount rates are derived by identifying a theoretical settlement portfolio of high quality corporate bonds sufficient to provide for a plan’s projected benefit payments. This rate can fluctuate based on changes in the corporate bond yields.

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The long-term rate of return on plan assets is estimated based on an evaluation of historical returns for each asset category held by the plans, coupled with the current and short-term mix of the investment portfolio. The historical returns are adjusted for expected future market and economic changes. This return will fluctuate based on actual market returns and other economic factors.
The rate of future health care costs is based on historical claims and enrollment information projected over the next year and adjusted for administrative charges. This rate is expected to decrease until 2027.
Future compensation rates, withdrawal rates and participant retirement age are determined based on historical information. These assumptions are not expected to significantly change. Mortality rates are determined based on a review of published mortality tables.

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, restricted stock awards and restricted stock units. The difference between basic and diluted earnings per share relates solely to the effect of capital stock options, restricted stock awards and restricted stock units.
In 2016 and 2015, 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 at June 30, 2014, weighted average shares outstanding for basic earnings per share calculations were increased due solely to the dilutive effect of unexercised capital stock options, unvested restricted stock awards and unvested restricted stock units by 1.0 million shares. Unexercised capital stock options, unvested restricted stock awards and restricted stock units of 0.3 million shares at June 30, 2014 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.

REVENUE RECOGNITION We recognize revenue for our products and assembled machines when title and all risks of loss and damages pass to the buyer. Our general conditions of sale explicitly state that the delivery of our products and assembled machines is freight on board shipping point and that title and all risks of loss and damage pass to the buyer upon delivery of the sold products or assembled machines to the common carrier.
Our general conditions of sale explicitly state that acceptance of the conditions of shipment are considered to have occurred unless written notice of objection is received by Kennametal within 10 calendar days of the date specified on the invoice. We do not ship products or assembled machines unless we have documentation from our customers authorizing shipment. Our products are consumed by our customers in the manufacture of their products. Historically, we have experienced very low levels of returned products and assembled machines and do not consider the effect of returned products and assembled machines to be material. We have recorded an estimated returned goods allowance to provide for any potential returns.
We warrant that products and services sold are free from defects in material and workmanship under normal use and service when correctly installed, used and maintained. This warranty terminates 30 days after delivery of the product to the customer and does not apply to products that have been subjected to misuse, abuse, neglect or improper storage, handling or maintenance. Products may be returned to Kennametal, only after inspection and approval by Kennametal and upon receipt by the customer of shipping instructions from Kennametal. We have included an estimated allowance for warranty returns in our returned goods allowance.
We recognize revenue related to the sale of specialized assembled machines upon customer acceptance and installation, as installation is deemed essential to the functionality of a specialized assembled machine. Sales of specialized assembled machines were immaterial for 2016, 2015 and 2014.
STOCK-BASED COMPENSATION We recognize stock-based compensation expense for all stock options, restricted stock awards and restricted stock units over the period from the date of grant to the date when the award is no longer contingent on the employee providing additional service (substantive vesting period). We utilize the Black-Scholes valuation method to establish the fair value of all stock option awards. Time vesting stock units are valued at the market value of the stock on the grant date. Performance vesting stock units with a market condition are valued using a Monte Carlo model.

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Capital stock options are granted to eligible employees at fair market value at the date of grant. Capital stock options are exercisable under specified conditions for up to 10 years from the date of grant. The Kennametal Inc. Stock and Incentive Plan of 2010, as Amended and Restated on October 22, 2013, and as further amended January 27, 2015 (A/R 2010 Plan) authorizes the issuance of up to 9,500,000 shares of the Company’s capital stock plus any shares remaining unissued under the Kennametal Inc. Stock and Incentive Plan of 2002, as amended (2002 Plan). Under the provisions of the A/R 2010 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 2016, 2015 and 2014 was immaterial. In addition to stock option grants, the A/R 2010 Plan permits the award of stock appreciation rights, performance share awards, performance unit awards, restricted stock awards, restricted unit awards and share awards to directors, officers and key employees.
RESEARCH AND DEVELOPMENT COSTS Research and development costs of $39.4 million, $45.1 million and $44.0 million in 2016, 2015 and 2014, respectively, were expensed as incurred. These costs are included in operating expense in the consolidated statements of income.
SHIPPING AND HANDLING FEES AND COSTS All fees billed to customers for shipping and handling are classified as a component of sales. All costs associated with shipping and handling are classified as a component of cost of goods sold.
INCOME TAXES Deferred income taxes are recognized based on the future income tax effects (using enacted tax laws and rates) of differences in the carrying amounts of assets and liabilities for financial reporting and tax purposes. A valuation allowance is recognized if it is “more likely than not” that some or all of a deferred tax asset will not be realized.
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 use derivative financial instruments to provide predictability to the effects of changes in foreign exchange rates on our consolidated results, achieve our targeted mix of fixed and floating interest rates on outstanding debt. Our objective in managing foreign exchange exposures with derivative instruments is to reduce volatility in cash flow, allowing us to focus more of our attention on business operations. With respect to interest rate management, these derivative instruments allow us to achieve our targeted fixed-to-floating interest rate mix, as a separate decision from funding arrangements, in the bank and public debt markets.
We account for derivative instruments as a hedge of the related asset, liability, firm commitment or anticipated transaction, when the derivative is specifically designated as a hedge of such items. 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 (income) expense, net. Certain currency forward contracts hedging significant cross-border intercompany loans are considered other derivatives and, therefore, do not qualify for hedge accounting. These contracts are recorded at fair value in the balance sheet, with the offset to other (income) expense, net.
CASH FLOW HEDGES Currency Forward contracts and 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) income, and are recognized as a component of other (income) expense, net when the underlying sale of products or services is recognized into earnings.
Interest Rate Floating-to-fixed interest rate swap contracts, designated as cash flow hedges, are entered into from time to time to hedge our exposure to interest rate changes on a portion of our floating rate debt. These interest rate swap contracts convert a portion of our floating rate debt to fixed rate debt. We record the fair value of these contracts as an asset or a liability, as applicable, in the balance sheet, with the offset to accumulated other comprehensive (loss) income.
FAIR VALUE HEDGES Interest Rate Fixed-to-floating interest rate swap contracts, designated as fair value hedges, are entered into from time to time to hedge our exposure to fair value fluctuations on a portion of our fixed rate debt. These interest rate swap contracts convert a portion of our fixed rate debt to floating rate debt. When in place, these contracts require periodic settlement, and the difference between amounts to be received and paid under the contracts is recognized in interest expense.

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CURRENCY TRANSLATION Assets and liabilities of international operations are translated into U.S. dollars using year-end exchange rates, while revenues and expenses are translated at average exchange rates throughout the year. The resulting net translation adjustments are recorded as a component of accumulated other comprehensive (loss) income. The local currency is the functional currency of most of our locations. A gain of $1.6 million, a gain of $1.7 million and a loss of $2.5 million from currency transactions were included in other (income) expense, net in 2016, 2015 and 2014, respectively.
NEW ACCOUNTING STANDARDS
Adopted
In April 2014, the Financial Accounting Standards Board (FASB) issued guidance on reporting discontinued operations and disclosures of disposals of components of an entity. Under the guidance, only disposals representing a strategic shift in operations should be presented as discontinued operations. Additionally, the guidance requires expanded disclosures about discontinued operations that will provide financial statement users with more information about the assets, liabilities, income and expenses of discontinued operations. The guidance also requires disclosure of the pre-tax income attributable to a disposal of a significant part of an organization that does not qualify for discontinued operations reporting. This guidance was effective for Kennametal beginning July 1, 2015. The divestiture of non-core businesses outlined in Note 4 was evaluated under this guidance.
Issued
In June 2016, the FASB issued guidance on measurement of credit losses on financial instruments. The new guidance introduces an approach based on expected losses to estimate credit losses on certain types of financial instruments. It also modifies the impairment model for available-for-sale debt securities and provides for a simplified accounting model for purchased financial assets with credit deterioration since their origination. The scope of this amendment includes valuation of trade receivables. This standard is effective for Kennametal beginning July 1, 2020. We are in the process of assessing the impact the adoption of this guidance will have on our consolidated financial statements.

In May 2016, the FASB issued guidance on narrow scope improvements and practical expedients as part of Topic 606: Revenue from Contracts with Customers. The amendments address collectability criterion and accounting for contracts that do not meet the criteria, presentation of sales taxes and other similar taxes collected from customers, noncash consideration, contract modifications at transition and completed contracts at transition, in addition to a technical correction. This standard is effective for Kennametal beginning July 1, 2018, in conjunction with the adoption of Accounting Standards Update 2014-09, “Revenue from Contracts with Customers: Topic 606.” We are in the process of assessing the impact the adoption of this guidance will have on our consolidated financial statements.

In April 2016, the FASB issued guidance on identifying performance obligations and licensing as part of Topic 606: Revenue from Contracts with Customers. The amendments in this update clarify identifying performance obligations and the licensing implementation guidance, while retaining the related principles for those areas. This standard is effective for Kennametal beginning July 1, 2018, in conjunction with the adoption of Accounting Standards Update 2014-09, “Revenue from Contracts with Customers: Topic 606.” We are in the process of assessing the impact the adoption of this guidance will have on our consolidated financial statements.
In March 2016, the FASB issued guidance intended to simplify equity-based award accounting and presentation. The guidance impacts income tax accounting related to equity-based awards, the classification of awards as either equity or liabilities, and the classification on the statement of cash flows. This standard is effective for Kennametal beginning July 1, 2017. We are in the process of assessing the impact the adoption of this guidance will have on our consolidated financial statements.
In March 2016, the FASB issued guidance on principal versus agent considerations in reporting revenue gross versus net. This guidance is intended to improve the operability and understandability of the implementation guidance on principal versus agent considerations. As this update serves to clarify existing guidance, it is not expected to have a material impact on our consolidated financial statements.
In February 2016, the FASB issued guidance on lease accounting, which replaces the existing guidance in ASC 840, Leases. The standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. This standard is effective for Kennametal beginning July 1, 2019. We are in the process of assessing the impact the adoption of this guidance will have on our consolidated financial statements.

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In November 2015, the FASB issued guidance on balance sheet classification of deferred taxes. The amendments in this Update require that deferred tax liabilities and assets be classified as noncurrent in a classified statement of financial position, as opposed to the current practice of separating deferred income tax liabilities and assets into current and noncurrent amounts on the balance sheet. This standard is effective for Kennametal beginning July 1, 2017. We are in the process of assessing the impact the adoption of this ASU will have on our consolidated financial statements.
In August 2015, the FASB issued guidance that defers the effective date of previously issued ASU 2014-09, “Revenue from Contracts with Customers: Topic 606.” Under this guidance, the effective date for Kennametal was deferred from July 1, 2017 to July 1, 2018. We are in the process of assessing the impact the adoption of this ASU will have on our consolidated financial statements.
In July 2015, the FASB issued guidance on subsequent measurement of inventory. The amendments in this update require that inventory other than LIFO be subsequently measured at the lower of cost and net realizable value, as opposed to the current practice of lower of cost or market. Subsequent measurement is unchanged for inventory measured using LIFO. This standard is effective for Kennametal beginning July 1, 2017. We are in the process of evaluating the impact of adoption on our consolidated financial statements.
In April 2015, the FASB issued guidance on the presentation of debt issuance costs. The guidance requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct reduction from the carrying amount of that debt liability, consistent with debt discounts. This standard is effective for Kennametal beginning July 1, 2016 and will be retrospectively applied. The guidance did not have a material impact on our consolidated financial position, results of operations and cash flows.
In April 2015, the FASB issued guidance on accounting for fees paid in a cloud computing arrangement. The amendments in this update provide guidance to customers about whether a cloud computing arrangement includes a software license and accounting for the arrangement as capitalized and amortized as an intangible asset or expensed as incurred as a service contract. This standard is effective for Kennametal beginning July 1, 2016. The provisions of the guidance may be applied prospectively or retrospectively. We plan to adopt this guidance prospectively, and adoption of this ASU is not expected to have a material impact on our consolidated financial position, results of operations and cash flows.
In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers: Topic 606.” This ASU replaces nearly all existing U.S. GAAP guidance on revenue recognition. The standard prescribes a five-step model for recognizing revenue, the application of which will require significant judgment. This standard is effective for Kennametal July 1, 2017. We are in the process of assessing the impact the adoption of this ASU will have on our consolidated financial statements.

NOTE 3 — SUPPLEMENTAL CASH FLOW DISCLOSURES
Year ended June 30 (in thousands)
2016
 
2015
 
2014
Cash paid during the period for:
 
 
 
 
 
Interest
$
26,250

 
$
30,984

 
$
29,836

Income taxes
43,733

 
40,295

 
49,393

 
 
 
 
 
 
Supplemental disclosure of non-cash information:
 
 
 
 
 
Changes in accounts payable related to purchases of property, plant and equipment
1,000

 
(9,900
)
 
2,100


NOTE 4 — ACQUISITIONS AND DIVESTITURES
Divestiture of Non-Core Businesses
In 2016, Kennametal completed the transaction to sell all of the outstanding capital stock of: Kennametal Extrude Hone LLC and its wholly owned subsidiaries, Kennametal Stellite S.r.l. (Bellusco, Italy), Kennametal Stellite S.p.A. (Milan, Italy), Kennametal Stellite GmbH (Koblenz, Germany); and all of the assets of the businesses of: Tricon (manufacturing operations in Birmingham, Alabama; Chicago, Illinois; and Elko, Nevada), Landis (manufacturing operation in Waynesboro, Pennsylvania); and all of the assets located at the Biel, Switzerland manufacturing facility ("non-core businesses") to Madison Industries for an aggregate price of $56.1 million cash, net of cash. A portion of the transaction proceeds were used to pay down revolver debt and the remaining balance is being held as cash on hand.

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The net book value of these non-core businesses was $191.9 million. The pre-tax net loss on divestiture recognized in 2016 was $131.5 million, of which $127.9 million and $3.6 million were recorded in the Infrastructure and Industrial segments, respectively. The pre-tax income attributable to the non-core businesses was assessed and determined to be immaterial for disclosure for the periods presented.
TMB Acquisition
On November