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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 2017
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) 248-8000
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
YES [X] NO [  ]
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES [X] NO [  ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer [X]
  
Accelerated filer [  ]
Non-accelerated filer [  ] (Do not check if a smaller reporting company)
  
Smaller reporting company [  ]
 
 
Emerging growth company [  ]
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [  ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES [  ] NO [X]
Indicate the number of shares outstanding of each of the issuer’s classes of capital stock, as of the latest practicable date.
Title of Each Class
 
Outstanding at January 31, 2018
Capital Stock, par value $1.25 per share     
 
81,573,415
 


Table of Contents


KENNAMETAL INC.
FORM 10-Q
FOR THE THREE AND SIX MONTHS ENDED DECEMBER 31, 2017
TABLE OF CONTENTS
 
Item No.
Page No.
 
 
 
 
 
 
1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2.
 
 
 
3.
 
 
 
4.
 
 
 
1.
 
 
 
2.
 
 
 
6.
 
 

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FORWARD-LOOKING INFORMATION
This Quarterly Report on Form 10-Q contains “forward-looking” statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements are statements that do not relate strictly to historical or current facts. You can identify forward-looking statements by the fact they use words such as “should,” “anticipate,” “estimate,” “approximate,” “expect,” “may,” “will,” “project,” “intend,” “plan,” “believe” and other words of similar meaning and expression in connection with any discussion of future operating or financial performance or events. We have also included forward looking statements in this Quarterly Report on Form 10-Q concerning, among other things, our strategy, goals, plans and projections regarding our financial position, liquidity and capital resources, results of operations, market position and product development. These statements are based on current estimates that involve inherent risks and uncertainties. Should one or more of these risks or uncertainties materialize, or should the assumptions underlying the forward-looking statements prove incorrect, our actual results could vary materially from our current expectations. There are a number of factors that could cause our actual results to differ from those indicated in the forward-looking statements. They include: downturns in the business cycle or economic downturns; our ability to achieve all anticipated benefits of our restructuring initiatives; risks related to our foreign operations and international markets, such as fluctuations in 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; 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 our Annual Report on Form 10-K. We can give no assurance that any goal or plan set forth in forward-looking statements can be achieved and readers are cautioned not to place undue reliance on such statements, which speak only as of the date made. Except as required by law, we do not intend to release publicly any revisions to forward-looking statements as a result of future events or developments.




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PART I – FINANCIAL INFORMATION

ITEM 1.    FINANCIAL STATEMENTS

KENNAMETAL INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
 
 
 
 
 
 
Three Months Ended December 31,
 
Six Months Ended December 31,
(in thousands, except per share amounts)
2017
 
2016
 
2017
 
2016
Sales
$
571,345

 
$
487,573

 
$
1,113,799

 
$
964,713

Cost of goods sold
378,800

 
339,950

 
736,261

 
673,560

Gross profit
192,545

 
147,623

 
377,538

 
291,153

Operating expense
120,649

 
111,004

 
239,980

 
230,869

Restructuring and asset impairment charges (Note 7)
45

 
8,456

 
5,570

 
37,061

Amortization of intangibles
3,677

 
4,150

 
7,338

 
8,421

Operating income
68,174

 
24,013

 
124,650

 
14,802

Interest expense
7,231

 
7,151

 
14,379

 
14,144

Other expense, net
1,313

 
726

 
1,401

 
844

Income (loss) before income taxes
59,630

 
16,136

 
108,870

 
(186
)
Provision for income taxes
17,472

 
8,221

 
27,074

 
13,100

Net income (loss)
42,158

 
7,915

 
81,796

 
(13,286
)
Less: Net income attributable to noncontrolling interests
557

 
653

 
1,011

 
1,108

Net income (loss) attributable to Kennametal
$
41,601

 
$
7,262

 
$
80,785

 
$
(14,394
)
PER SHARE DATA ATTRIBUTABLE TO KENNAMETAL SHAREHOLDERS
 
 
 
 
Basic earnings (loss) per share
$
0.51

 
$
0.09

 
$
0.99

 
$
(0.18
)
Diluted earnings (loss) per share
$
0.50

 
$
0.09

 
$
0.98

 
$
(0.18
)
Dividends per share
$
0.20

 
$
0.20

 
$
0.40

 
$
0.40

Basic weighted average shares outstanding
81,477

 
80,206

 
81,274

 
80,131

Diluted weighted average shares outstanding
82,778

 
81,026

 
82,446

 
80,131

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


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KENNAMETAL INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
 
 
 
 
 
 
Three Months Ended December 31,
Six Months Ended December 31,
(in thousands)
2017
 
2016
2017
 
2016
Net income (loss)
$
42,158

 
$
7,915

$
81,796

 
$
(13,286
)
Other comprehensive income (loss), net of tax
 
 
 
 
 
 
Unrealized (loss) gain on derivatives designated and qualified as cash flow hedges
(286
)
 
1,606

(905
)
 
1,480

Reclassification of unrealized loss on expired derivatives designated and qualified as cash flow hedges
1,007

 
382

1,403

 
769

Unrecognized net pension and other postretirement benefit (loss) gain
(625
)
 
3,471

(2,590
)
 
4,101

Reclassification of net pension and other postretirement benefit loss
1,569

 
1,796

3,348

 
3,630

Foreign currency translation adjustments
13,924

 
(41,428
)
33,793

 
(40,264
)
Total other comprehensive income (loss), net of tax
15,589

 
(34,173
)
35,049

 
(30,284
)
Total comprehensive income (loss)
57,747

 
(26,258
)
116,845

 
(43,570
)
Less: comprehensive income (loss) attributable to noncontrolling interests
1,445

 
(401
)
2,184

 
469

Comprehensive income (loss) attributable to Kennametal Shareholders
$
56,302

 
$
(25,857
)
$
114,661

 
$
(44,039
)
The accompanying notes are an integral part of these condensed consolidated financial statements.

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KENNAMETAL INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
 
 
 
 
 
(in thousands, except per share data)
December 31,
2017
 
June 30,
2017
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
159,940

 
$
190,629

Accounts receivable, less allowance for doubtful accounts of $13,332 and $13,693, respectively
392,923

 
380,425

Inventories (Note 10)
507,462

 
487,681

Other current assets
68,057

 
55,166

Total current assets
1,128,382

 
1,113,901

Property, plant and equipment:
 
 
 
Land and buildings
351,190

 
350,002

Machinery and equipment
1,660,218

 
1,577,776

Less accumulated depreciation
(1,231,743
)
 
(1,183,390
)
Property, plant and equipment, net
779,665

 
744,388

Other assets:
 
 
 
Assets held for sale (Note 7)
7,547

 
6,980

Goodwill (Note 17)
306,147

 
301,367

Other intangible assets, less accumulated amortization of $139,202 and $129,981, respectively (Note 17)
184,523

 
190,527

Deferred income taxes (Note 3)
21,667

 
28,349

Other
47,930

 
29,984

Total other assets
567,814

 
557,207

Total assets
$
2,475,861

 
$
2,415,496

LIABILITIES
 
 
 
Current liabilities:
 
 
 
Current maturities of long-term debt and capital leases
$
48

 
$
190

Notes payable to banks
1,312

 
735

Accounts payable
190,592

 
215,722

Accrued income taxes
17,370

 
6,202

Accrued expenses
64,631

 
85,682

Other current liabilities
133,668

 
152,947

Total current liabilities
407,621

 
461,478

Long-term debt and capital leases, less current maturities (Note 11)
695,722

 
694,991

Deferred income taxes
15,141

 
14,883

Accrued pension and postretirement benefits
164,701

 
160,860

Accrued income taxes
2,776

 
2,636

Other liabilities
25,952

 
27,995

Total liabilities
1,311,913

 
1,362,843

Commitments and contingencies
 
 
 
EQUITY (Note 15)
 
 
 
Kennametal Shareholders’ Equity:
 
 
 
Preferred stock, no par value; 5,000 shares authorized; none issued

 

Capital stock, $1.25 par value; 120,000 shares authorized; 81,517 and 80,665 shares issued, respectively
101,897

 
100,832

Additional paid-in capital
500,388

 
474,547

Retained earnings
813,936

 
765,607

Accumulated other comprehensive loss
(289,816
)
 
(323,692
)
Total Kennametal Shareholders’ Equity
1,126,405

 
1,017,294

Noncontrolling interests
37,543

 
35,359

Total equity
1,163,948

 
1,052,653

Total liabilities and equity
$
2,475,861

 
$
2,415,496

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

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KENNAMETAL INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW (UNAUDITED)
 
 
 
 
 
 
Six Months Ended December 31,
(in thousands)
2017
 
2016
OPERATING ACTIVITIES
 
 
 
Net income (loss)
$
81,796

 
$
(13,286
)
Adjustments for non-cash items:
 
 
 
Depreciation
46,061

 
45,994

Amortization
7,338

 
8,421

Stock-based compensation expense
11,995

 
13,275

Restructuring and asset impairment charges (Note 7)
3,172

 
781

Deferred income tax provision
7,241

 
1,274

Other
3,474

 
(2,773
)
Changes in certain assets and liabilities:
 
 
 
Accounts receivable
(3,290
)
 
20,423

Inventories
(9,080
)
 
(1,938
)
Accounts payable and accrued liabilities (Note 3)
(66,620
)
 
(5,497
)
Accrued income taxes
3,966

 
1,632

Accrued pension and postretirement benefits
(13,824
)
 
(11,298
)
Other
(5,455
)
 
(8,309
)
Net cash flow provided by operating activities
66,774

 
48,699

INVESTING ACTIVITIES
 
 
 
Purchases of property, plant and equipment
(85,223
)
 
(70,573
)
Disposals of property, plant and equipment
846

 
3,509

Other
244

 
100

Net cash flow used for investing activities
(84,133
)
 
(66,964
)
FINANCING ACTIVITIES
 
 
 
Net increase in notes payable
643

 
1,005

Term debt repayments
(141
)
 
(427
)
Purchase of capital stock
(109
)
 
(125
)
Dividend reinvestment and the effect of employee benefit and stock plans (Note 3)
15,020

 
1,341

Cash dividends paid to Shareholders
(32,456
)
 
(31,970
)
Other
(271
)
 
(6,626
)
Net cash flow used for financing activities
(17,314
)
 
(36,802
)
Effect of exchange rate changes on cash and cash equivalents
3,984

 
(4,511
)
CASH AND CASH EQUIVALENTS
 
 
 
Net decrease in cash and cash equivalents
(30,689
)
 
(59,578
)
Cash and cash equivalents, beginning of period
190,629

 
161,579

Cash and cash equivalents, end of period
$
159,940

 
$
102,001

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


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KENNAMETAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
 
 



1.ORGANIZATION
Kennametal Inc. was incorporated in Pennsylvania in 1943 as a manufacturer of tungsten carbide metal cutting tooling. From this beginning, Kennametal Inc. and its subsidiaries (collectively, Kennametal or the Company) has grown into a global leader in the development and application of tungsten carbides, ceramics, super-hard materials and solutions used in metal cutting and mission-critical wear applications to combat extreme conditions associated with wear fatigue, corrosion and high temperatures. The Company's reputation for material technology, metal cutting application knowledge, as well as expertise and innovation in the development of custom solutions and services, contributes to its leading position in its primary markets.
Our product offering includes a wide selection of standard and customized technologies for metalworking applications, such as turning, milling, hole making, tooling systems and services. End users of the Company's metalworking products include manufacturers engaged in a diverse array of industries including: the manufacturers of transportation vehicles and components, machine tools and light and heavy machinery; airframe and aerospace components; and energy-related components for the oil and gas industry, as well as power generation.
We also produce specialized wear components and metallurgical powders that are used for custom-engineered and challenging applications. End users of the Company's products include producers and suppliers in equipment-intensive operations such as coal mining, road construction, quarrying, oil and gas exploration, refining, production and supply.
 
2.BASIS OF PRESENTATION

The condensed consolidated financial statements, which include our accounts and those of our majority-owned subsidiaries, should be read in conjunction with our 2017 Annual Report on Form 10-K. The condensed consolidated balance sheet as of June 30, 2017 was derived from the audited balance sheet included in our 2017 Annual Report on Form 10-K. These interim statements are unaudited; however, we believe that all adjustments necessary for a fair statement of the results of the interim periods were made and all adjustments are normal recurring adjustments. The results for the six months ended December 31, 2017 and 2016 are not necessarily indicative of the results to be expected for a full fiscal year. Unless otherwise specified, any reference to a “year” is to a fiscal year ended June 30. For example, a reference to 2018 is to the fiscal year ending June 30, 2018. When used in this Quarterly Report on Form 10-Q, unless the context requires otherwise, the terms “we,” “our” and “us” refer to Kennametal Inc. and its subsidiaries.

3.NEW ACCOUNTING STANDARDS
Adopted
In March 2016, the Financial Accounting Standards Board (FASB) issued ASU No. 2016-09, "Improvements to Employee Share-Based Payment Accounting," which is intended to simplify equity-based award accounting and presentation. The guidance impacts income tax accounting related to equity-based awards, the classification of awards as either equity or liabilities, and the classification on the statement of cash flows. We adopted this guidance July 1, 2017. The adoption of this guidance resulted in three changes: (1) the increase to deferred tax assets of $1.4 million related to cumulative excess tax benefits previously unrecognized was offset by a valuation allowance, due to the valuation allowance position of our U.S. entity at the time of adoption of this standard; (2) excess tax benefits, previously reported in the financing activities section of the condensed consolidated statements of cash flow, is now reported in the operating activities section, adopted on a prospective basis. Therefore, prior period statements of cash flow were not retrospectively adjusted for this provision; and (3) employee taxes paid when Kennametal withholds shares for tax withholding purposes, previously reported in the operating activities section of the condensed consolidated statement of cash flows, is now reported in the financing activities section, adopted on a retrospective basis. Therefore, prior period statements of cash flow were retrospectively adjusted for this provision. Cash flow provided by operating activities and cash flow used for financing activities increased by $2.1 million for the six months ended December 31, 2016.
In July 2015, the FASB issued ASU No. 2015-11, "Simplifying the Measurement of Inventory," which requires that inventory other than LIFO be subsequently measured at the lower of cost and net realizable value, as opposed to the previous practice of lower of cost or market. Subsequent measurement is unchanged for inventory measured using LIFO. We adopted this guidance July 1, 2017. Adoption of this guidance did not have a material impact on our condensed consolidated financial statements.

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


Issued
In May 2014, the FASB issued ASU No. 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. It also requires additional disclosures. We will adopt this standard on July 1, 2018. Currently, we are analyzing the standard's impact on our customer arrangements and evaluating the new standard against our historical accounting policies and practices, including the timing of revenue recognition. In particular, we are assessing the identification of performance obligations and the impact of variable consideration on the transaction price determination. Further, we continue to assess certain marketing programs and expect to identify more performance obligations under ASC 606 as compared with deliverables and separate units of account previously identified, primarily in the Industrial and Widia segments. We are evaluating the timing of revenue to determine if it will occur in the same or different periods. We have a project team that is performing a detailed review of the terms and provisions of our customer contracts. We have not yet determined the complete impact of adoption of this standard on our condensed consolidated financial statements.

4.
SUPPLEMENTAL CASH FLOW DISCLOSURES
 
Six Months Ended December 31,
(in thousands)
2017
 
2016
Cash paid during the period for:
 
 
 
Income taxes
$
15,866

 
$
10,191

Interest
13,714

 
13,480

Supplemental disclosure of non-cash information:
 
 
 
Changes in accounts payable related to purchases of property, plant and equipment
11,477

 
15,404


5.FAIR VALUE MEASUREMENTS
Fair value is defined as the price that would be received on the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair value hierarchy consists of three levels to prioritize the inputs used in valuations, as defined below:
Level 1: Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.
Level 2: Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly, including quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; inputs other than quoted prices that are observable for the asset or liability (e.g., interest rates); and inputs that are derived principally from or corroborated by observable market data by correlation or other means.
Level 3: Inputs that are unobservable.
As of December 31, 2017, the fair values of the Company’s financial assets and financial liabilities are categorized as follows: 
(in thousands)
Level 1

 
Level 2

 
Level 3

 
Total

Assets:
 
 
 
 
 
 
 
Derivatives (1)
$

 
$
212

 
$

 
$
212

Total assets at fair value
$

 
$
212

 
$

 
$
212

 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
Derivatives (1)
$

 
$
1,253

 
$

 
$
1,253

Total liabilities at fair value
$

 
$
1,253

 
$

 
$
1,253

 

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


As of June 30, 2017, the fair values of the Company’s financial assets and financial liabilities are categorized as follows:
(in thousands)
Level 1

 
Level 2

 
Level 3

 
Total

Assets:
 
 
 
 
 
 
 
Derivatives (1)
$

 
$
359

 
$

 
$
359

Total assets at fair value
$

 
$
359

 
$

 
$
359

 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
Derivatives (1)
$

 
$
910

 
$

 
$
910

Total liabilities at fair value
$

 
$
910

 
$

 
$
910

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

There have been no changes in classification and transfers between levels in the fair value hierarchy in the current period.
 
6.
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
As part of our financial risk management program, we use certain derivative financial instruments. We do not enter into derivative transactions for speculative purposes and, therefore, hold no derivative instruments for trading purposes. We account for derivative instruments as a hedge of the related asset, liability, firm commitment or anticipated transaction, when the derivative is specifically designated and qualifies as a hedge of such items. Our objective in managing foreign exchange exposures with derivative instruments is to reduce volatility in cash flow. We measure hedge effectiveness by assessing the changes in the fair value or expected future cash flows of the hedged item. The ineffective portions are recorded in other expense, net.
The fair value of derivatives designated and not designated as hedging instruments in the condensed consolidated balance sheet are as follows:
(in thousands)
December 31,
2017
 
June 30,
2017
Derivatives designated as hedging instruments
 
 
 
Other current assets - range forward contracts
$
25

 
$
1

Other current liabilities - range forward contracts
(1,224
)
 
(671
)
Other assets - range forward contracts
3

 

Other liabilities - range forward contracts
(6
)
 
(101
)
Total derivatives designated as hedging instruments
(1,202
)
 
(771
)
Derivatives not designated as hedging instruments
 
 
 
Other current assets - currency forward contracts
184

 
358

Other current liabilities - currency forward contracts
(23
)
 
(138
)
Total derivatives not designated as hedging instruments
161

 
220

Total derivatives
$
(1,041
)
 
$
(551
)
Certain currency forward contracts that hedge significant cross-border intercompany loans are considered as other derivatives and therefore do not qualify for hedge accounting. These contracts are recorded at fair value in the condensed consolidated balance sheet, with the offset to other expense, net. Gains related to derivatives not designated as hedging instruments have been recognized as follows:
 
Three Months Ended December 31,
 
Six Months Ended December 31,
(in thousands)
2017
 
2016
 
2017
 
2016
Other expense, net - currency forward contracts
$
(92
)
 
$
(59
)
 
$
(208
)
 
$
(377
)
 

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


CASH FLOW HEDGES
Range forward contracts (a transaction where both a put option is purchased and a call option is sold) are designated as cash flow hedges and hedge anticipated cash flows from cross-border intercompany sales of products and services. Gains and losses realized on these contracts are recorded in accumulated other comprehensive loss and are recognized as a component of other expense, net when the underlying sale of products or services is recognized into earnings. The notional amount of the contracts translated into U.S. dollars at December 31, 2017 and June 30, 2017, was $77.9 million and $75.3 million, respectively. The time value component of the fair value of range forward contracts is excluded from the assessment of hedge effectiveness. Assuming the market rates remain constant with the rates at December 31, 2017, we expect to recognize into earnings in the next 12 months $1.6 million of expense on outstanding derivatives.
The following represents gains and losses related to cash flow hedges:
 
Three Months Ended December 31,
 
Six Months Ended December 31,
(in thousands)
2017
 
2016
 
2017
 
2016
(Losses) gains recognized in other comprehensive loss, net
$
(287
)
 
$
1,606

 
$
(906
)
 
$
1,481

Losses reclassified from accumulated other comprehensive loss into other expense, net
$
870

 
$
382

 
$
1,262

 
$
768

No portion of the gains or losses recognized in earnings was due to ineffectiveness and no amounts were excluded from our effectiveness testing for the six months ended December 31, 2017 and 2016.
NET INVESTMENT HEDGES
As of December 31, 2017, we had certain foreign currency-denominated intercompany loans payable with total aggregate principal amounts of €33.0 million as net investment hedges to hedge the foreign exchange exposure of our net investment in Euro-based subsidiaries. Losses of $0.5 million and $1.9 million were recorded as a component of foreign currency translation adjustments in other comprehensive income for the three and six months ended December 31, 2017, respectively. We did not have net investment hedges during the three and six months ended December 31, 2016.

As of December 31, 2017, the foreign currency-denominated intercompany loans payable designated as net investment hedges consisted of:
Instrument
Notional (EUR in thousands)(2)
Notional (USD in thousands)(2)
Maturity
Foreign currency-denominated intercompany loan payable
26,929

$
32,279

June 26, 2022
Foreign currency-denominated intercompany loan payable
8,667

10,388

November 20, 2018
Foreign currency-denominated intercompany loan payable
2,004

2,402

October 11, 2019
(2) Includes principal and accrued interest.

7.
RESTRUCTURING AND RELATED CHARGES
In prior years, we implemented restructuring actions to streamline the Company's cost structure. The purpose of these initiatives was to improve the alignment of our cost structure with the current operating environment through employment reductions, as well as rationalization and consolidation of certain manufacturing facilities. These restructuring actions were substantially completed in the first quarter of fiscal 2018 and were mainly cash expenditures.
Total restructuring and related charges since inception of $156.0 million have been recorded for these programs through December 31, 2017: $84.6 million in Industrial, $50.3 million in Infrastructure, $13.8 million in Widia and $7.3 million in Corporate.
We recorded restructuring and related charges of $1.5 million and $11.8 million for the three months ended December 31, 2017 and 2016, respectively. Of these amounts, restructuring charges were less than $0.1 million for the three months ended December 31, 2017 and totaled $8.8 million for the three months ended December 31, 2016, of which expense of $0.3 million was related to inventory and was recorded in cost of good sold. Restructuring-related charges of $1.3 million and $2.1 million were recorded in cost of goods sold and $0.2 million and $0.9 million in operating expense for the three months ended December 31, 2017 and 2016, respectively.

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


We recorded restructuring and related charges of $8.4 million and $43.4 million for the six months ended December 31, 2017 and 2016, respectively. Of these amounts, restructuring charges totaled $5.6 million and $37.3 million, respectively, of which expense of $0.3 million for the six months ended December 31, 2016 was related to inventory and was recorded in cost of goods sold. Restructuring-related charges of $2.5 million and $4.1 million were recorded in cost of goods sold and $0.3 million and $2.0 million in operating expense for the six months ended December 31, 2017 and 2016, respectively.
As of December 31, 2017 and June 30, 2017, property, plant, and equipment of $7.5 million and $7.0 million, respectively, for certain closed manufacturing locations that are part of our restructuring programs met held for sale criteria. We expect to sell these assets within one year from the balance sheet date. These assets are recorded at the lower of carrying amount or fair value less cost to sell. We have also ceased depreciating these assets.
As of December 31, 2017 and June 30, 2017, $15.8 million and $27.3 million of the restructuring accrual is recorded in other current liabilities and $0.7 million and $2.5 million is recorded in other liabilities, respectively, in our condensed consolidated balance sheet. The amount attributable to each segment is as follows:
(in thousands)
June 30, 2017
 
Expense
 
Asset Write-Down
 
Translation
 
Cash Expenditures
 
December 31, 2017
Industrial
 
 
 
 
 
 
 
 
 
 
 
Severance
$
17,639

 
$
1,618

 
$

 
$
820

 
$
(11,214
)
 
$
8,863

Facilities

 
2,356

 
(2,356
)
 

 

 

Other
94

 
(29
)
 

 
2

 
(28
)
 
39

Total Industrial
$
17,733

 
$
3,945

 
$
(2,356
)
 
$
822

 
$
(11,242
)
 
$
8,902

 
 
 
 
 
 
 
 
 
 
 
 
Widia
 
 
 
 
 
 
 
 
 
 
 
Severance
$
2,434

 
$
414

 
$

 
$
209

 
$
(2,865
)
 
$
192

Facilities

 
747

 
(747
)
 

 

 

Other

 
(7
)
 

 
1

 
7

 
1

Total Widia
$
2,434

 
$
1,154

 
$
(747
)
 
$
210

 
$
(2,858
)
 
$
193

 
 
 
 
 
 
 
 
 
 
 
 
Infrastructure
 
 
 
 
 
 
 
 
 
 
 
Severance
$
9,573

 
$
409

 
$

 
$
207

 
$
(2,831
)
 
$
7,358

Facilities
21

 
69

 
(69
)
 

 
(21
)
 

Other
45

 
(7
)
 

 

 
(21
)
 
17

Total Infrastructure
$
9,639

 
$
471

 
$
(69
)
 
$
207

 
$
(2,873
)
 
$
7,375

Total
$
29,806

 
$
5,570

 
$
(3,172
)
 
$
1,239

 
$
(16,973
)
 
$
16,470


8.
STOCK-BASED COMPENSATION
Stock Options
There were no grants made during the six months ended December 31, 2017 and 2016.


12

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


Changes in our stock options for the six months ended December 31, 2017 were as follows:
 
Options
 
Weighted
Average
Exercise Price
 
Weighted Average Remaining Life (years)
 
Aggregate
Intrinsic value
(in thousands)
Options outstanding, June 30, 2017
1,726,791

 
$
34.08

 
 
 
 
Granted

 

 
 
 
 
Exercised
(521,259
)
 
36.63

 
 
 
 
Lapsed or forfeited
(62,763
)
 
39.46

 
 
 
 
Options outstanding, December 31, 2017
1,142,769

 
$
32.62

 
5.4
 
$
18,049

Options vested and expected to vest, December 31, 2017
1,136,169

 
$
32.64

 
5.4
 
$
17,916

Options exercisable, December 31, 2017
888,358

 
$
34.36

 
4.7
 
$
12,485

During the six months ended December 31, 2017 and 2016, compensation expense related to stock options was $0.4 million and $1.0 million, respectively. As of December 31, 2017, the total unrecognized compensation cost related to options outstanding was $0.5 million and is expected to be recognized over a weighted average period of 0.8 years.
Fair value of options vested during the six months ended December 31, 2017 and 2016 was $1.7 million and $3.1 million, respectively.
Tax benefits relating to excess stock-based compensation deductions are presented in the operating activities section of the condensed consolidated statements of cash flow for the six months ended December 31, 2017. Tax benefits resulting from stock-based compensation deductions were less than the amounts reported for financial reporting purposes by $0.2 million for the six months ended December 31, 2017, and no tax benefits were realized for the six months ended December 31, 2016 due to the valuation allowance on U.S. deferred tax assets.
The amount of cash received from the exercise of capital stock options during the six months ended December 31, 2017 and 2016 was $19.1 million and $3.1 million, respectively. The related tax benefit was $1.1 million for the six months ended December 31, 2017, and there was no related tax benefit realized for the six months ended December 31, 2016 due to the valuation allowance on U.S. deferred tax assets. The total intrinsic value of options exercised during the six months ended December 31, 2017 was $4.8 million and was immaterial for the six months ended December 31, 2016.
Under the provisions of the Kennametal Inc. Stock and Incentive Plan of 2010, as amended and restated on October 22, 2013 and as further amended January 27, 2015, and the Kennametal Inc. 2016 Stock and Incentive Plan, plan participants may deliver stock, owned by the holder for at least six months, in payment of the option price and receive credit for the fair market value of the shares on the date of delivery. The fair market value of shares delivered during the six months ended December 31, 2017 and 2016 was immaterial.

Restricted Stock Units – Time Vesting and Performance Vesting
Performance vesting restricted stock units are earned pro rata each year if certain performance goals are met over a three-year period and are also subject to a service condition that requires the individual to be employed by the Company at the vesting date after the three-year performance period has ended, with the exception of retirement eligible grantees, who upon retirement are entitled to vest in any units that have been earned, including a prorated portion for the partially completed fiscal year in which the retirement occurs. Time vesting stock units are valued at the market value of the stock on the grant date. Performance vesting stock units with a market condition are valued using a Monte Carlo model.

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


Changes in our time vesting and performance vesting restricted stock units for the six months ended December 31, 2017 were as follows:
 
Performance Vesting Stock Units
 
Performance Vesting Weighted Average Fair Value
 
Time Vesting
Stock Units
 
Time Vesting Weighted Average Fair Value
Unvested, June 30, 2017
280,250

 
$
27.62

 
1,153,444

 
$
27.66

Granted
158,397

 
38.81

 
424,754

 
37.64

Vested
(10,031
)
 
42.83

 
(390,874
)
 
30.67

Performance metric adjustments, net
16,766

 
25.84

 

 

Forfeited

 

 
(20,192
)
 
31.89

Unvested, December 31, 2017
445,382

 
$
31.19

 
1,167,132

 
$
30.20

During the six months ended December 31, 2017 and 2016, compensation expense related to time vesting and performance vesting restricted stock units was $11.0 million and $12.3 million, respectively. As of December 31, 2017, the total unrecognized compensation cost related to unvested time vesting and performance vesting restricted stock units was $23.2 million and is expected to be recognized over a weighted average period of 2.1 years.

9.
BENEFIT PLANS
We sponsor several defined benefit pension plans. Additionally, we provide varying levels of postretirement health care and life insurance benefits to some U.S. employees.
The table below summarizes the components of net periodic pension income:
 
Three Months Ended December 31,
 
Six Months Ended December 31,
(in thousands)
2017
 
2016
 
2017
 
2016
Service cost
$
406

 
$
727

 
$
810

 
$
1,460

Interest cost
7,678

 
7,770

 
15,335

 
15,579

Expected return on plan assets
(14,132
)
 
(14,672
)
 
(28,221
)
 
(29,429
)
Amortization of transition obligation
23

 
22

 
46

 
45

Amortization of prior service (credit) cost
(41
)
 
(113
)
 
132

 
(226
)
Recognition of actuarial losses
1,718

 
2,088

 
3,428

 
4,200

Net periodic pension income
$
(4,348
)
 
$
(4,178
)
 
$
(8,470
)
 
$
(8,371
)
The table below summarizes the components of net periodic other postretirement benefit cost:
 
Three Months Ended December 31,
 
Six Months Ended December 31,
(in thousands)
2017
 
2016
 
2017
 
2016
Interest cost
$
157

 
$
168

 
$
314

 
$
337

Amortization of prior service credit
(6
)
 
(6
)
 
(11
)
 
(11
)
Recognition of actuarial loss
70

 
89

 
140

 
177

Net periodic other postretirement benefit cost
$
221

 
$
251

 
$
443

 
$
503


10.
INVENTORIES
We used the last-in, first-out (LIFO) method of valuing inventories for 41 percent and 43 percent of total inventories at December 31, 2017 and June 30, 2017, respectively. Since inventory valuations under the LIFO method are based on an annual determination of quantities and costs as of June 30 of each year, the interim LIFO valuations are based on our projections of expected year-end inventory levels and costs. Therefore, the interim financial results are subject to any final year-end LIFO inventory adjustments.

14

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


Inventories consisted of the following: 
(in thousands)
December 31, 2017
 
June 30, 2017
Finished goods
$
283,812

 
$
290,817

Work in process and powder blends
210,265

 
166,857

Raw materials
86,944

 
87,627

Inventories at current cost
581,021

 
545,301

Less: LIFO valuation
(73,559
)
 
(57,620
)
Total inventories
$
507,462

 
$
487,681


11.
LONG-TERM DEBT
Our five-year, multi-currency, revolving credit facility, as amended and restated in April 2016 (Credit Agreement), provides for revolving credit loans of up to $600 million for working capital, capital expenditures and general corporate purposes. The Credit Agreement requires us to comply with various restrictive and affirmative covenants, including two financial covenants: a maximum leverage ratio and a minimum consolidated interest coverage ratio (as those terms are defined in the Credit Agreement). We were in compliance with all such covenants as of December 31, 2017. We had no borrowings outstanding under the Credit Agreement as of December 31, 2017 and June 30, 2017. Borrowings under the Credit Agreement are guaranteed by our significant domestic subsidiaries. The Credit Agreement matures in April 2021.
Fixed rate debt had a fair market value of $702.1 million and $704.0 million at December 31, 2017 and June 30, 2017, respectively. The Level 2 fair value is determined based on the quoted market price of this debt as of December 31, 2017 and June 30, 2017, respectively.

12.
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 the Comprehensive Environmental Response Compensation and Liability Act of 1980 (CERCLA), under which we have been designated by the United States Environmental Protection Agency (USEPA) as a Potentially Responsible Party (PRP) with respect to environmental remedial costs at certain Superfund sites. We have evaluated our claims and 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 Matters We establish and maintain reserves for other potential environmental issues. At December 31, 2017 and June 30, 2017, the balances of these reserves were $12.7 million and $12.4 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.

15

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


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 analysts who are responsible for each of our global manufacturing facilities. Our financial management team periodically meets with members of the Corporate EHS Department and the Corporate Legal Department to review and evaluate the status of environmental projects and contingencies. On a quarterly basis, we review financial provisions and reserves for environmental contingencies and adjust these reserves when appropriate.

13.
INCOME TAXES
On December 22, 2017, the Tax Cuts and Jobs Act of 2017 (TCJA) was signed into law in the U.S. TCJA amends the Internal Revenue Code of 1986 to reduce tax rates and modify policies, credits and deductions for individuals and corporations. For corporations, TCJA reduces the federal tax rate from a maximum of 35.0 percent to a flat 21.0 percent rate and transitions from a worldwide tax system to a territorial tax system. TCJA also adds many new provisions including changes to bonus depreciation, the deduction for executive compensation and interest expense, a tax on global intangible low-taxed income (GILTI), the base erosion anti-abuse tax (BEAT) and a deduction for foreign-derived intangible income (FDII). We are assessing the impact of certain provisions, including the tax on GILTI, the BEAT and the deduction for FDII, which do not apply to the Company until fiscal 2019. This assessment includes the evaluation of our accounting election relative to GILTI as either a period cost or an adjustment to deferred tax assets or liabilities of our foreign subsidiaries for the new tax. The two material items that effect the Company for fiscal 2018 are the reduction in the tax rate and a one-time tax that is imposed on our unremitted foreign earnings (toll tax).
On December 22, 2017, the SEC issued Staff Accounting Bulletin 118 (SAB 118) that includes additional guidance allowing companies to use a measurement period, similar to that used in business combinations, to account for the impacts of TCJA in their financial statements. We have accounted for the impacts of TCJA to the extent a reasonable estimate could be made during the three months ended December 31, 2017. We will continue to refine our estimates throughout the measurement period, which will not extend beyond 12 months from the enactment of TCJA, or until the accounting is complete.
The U.S. federal tax rate reduction is effective as of January 1, 2018. As a June 30 fiscal year-end taxpayer, our 2018 fiscal year U.S. federal statutory tax rate is expected to be a blended rate of 28.1 percent. We expect our U.S. federal statutory tax rate to be 21.0 percent in 2019.
As a result of the reduction in the U.S. corporate income tax rate from 35.0 percent to 21.0 percent under TCJA, we recorded a provisional reduction to our net deferred tax assets with a corresponding decrease to the valuation allowance prior to its release on December 31, 2017. The result of this reduction had no impact on our condensed consolidated statement of income for the six months ended December 31, 2017. The revaluation of our deferred tax assets and liabilities are subject to further adjustments during the measurement period due to the complexity of determining our net deferred tax liability as of the enactment date. Some of the information necessary to determine the accounting impacts of the tax rate change includes final calculations related to our 2017 tax return as well as refining the analysis of which existing deferred balances at the enactment date will reverse in 2018 at the 28.1 percent tax rate and which deferred balances will reverse after 2018 at the 21.0 percent tax rate.
We have estimated the toll tax charge to be $77 million after available foreign tax credits. The toll tax charge consumed our entire U.S. federal net operating loss carryforward and other credit carryforwards, which represent a significant portion of our previously available deferred tax assets, and was offset by the release of the valuation allowance associated with these assets. As a result, we do not expect to make a cash payment associated with the toll charge. The toll tax charge is preliminary, and subject to finalization of collecting all information and analyzing the calculation in reasonable detail to complete the accounting.
During the three months ended December 31, 2017, we released a valuation allowance of $3.9 million that was previously recorded against our net deferred tax assets in the U.S. A benefit of $6.8 million would have been recorded in the provision for income taxes; however, because of a current period charge of $2.9 million due to an out of period adjustment, a $3.9 million benefit was recorded in the provision for income taxes. The valuation allowance release was driven by utilization of a significant portion of our deferred tax assets to satisfy the toll tax provision in TCJA. Along with expected full-year income in the U.S. in fiscal 2018, we anticipate our domestic deferred taxes to be in a net liability position by June 30, 2018.

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


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 a result of TCJA, which among other provisions allows for a 100% dividends received deduction from controlled foreign subsidiaries, we will re-evaluate our assertion with respect to permanent reinvestment. As part of this evaluation, we will consider our global working capital and capital investment requirements, among other considerations including the potential tax liabilities that would be incurred if the non-U.S. subsidiaries distribute cash to the U.S. parent. If we determine that an entity should no longer remain subject to the permanent reinvestment assertion, we will accrue additional tax charges, including but not limited to state income taxes, withholding taxes and other relevant foreign taxes in the period the conclusion is determined. In accordance with SAB 118, we expect to complete our evaluation by December 22, 2018.
The effective income tax rates for the three months ended December 31, 2017 and 2016 were 29.3 percent and 50.9 percent, respectively. The effective income tax rate for the six months ended December 31, 2017 was 24.9 percent, and the effective income tax rate for the six months ended December 31, 2016 was not meaningful as the prior year loss before income taxes was negligible. The change in both periods was primarily driven by prior year U.S. losses not being tax-effected and current year U.S. income being subject to tax. This is the result of the valuation allowance, originally recorded in the fourth quarter of fiscal 2016, being released in the current quarter.
During the three months ended December 31, 2017, we identified an error related to the tax rate that had historically been used to calculate the deferred tax charge on intra-entity product transfers. This resulted in an overstatement of deferred tax assets of $8.2 million as of June 30, 2017. During the current quarter, $2.9 million of this amount was corrected in connection with the release of the U.S. valuation allowance. Therefore, the out of period adjustment recorded resulted in a further increase of $5.3 million to the provision for income taxes for the three and six months ended December 31, 2017. The remaining balance related to this item has been reclassified and included in other current assets as of December 31, 2017. The impact to the effective tax rate was 8.9 percent and 4.9 percent for the three and six months ended December 31, 2017, respectively. After evaluation, we determined that the impact of the adjustment was not material to the previously issued financial statements, nor are the out of period adjustments material to the estimated results of this fiscal year.

14.
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 would occur related to the issuance of capital stock under stock option grants, performance awards and restricted stock units. The difference between basic and diluted earnings per share relates solely to the effect of capital stock options, performance awards and restricted stock units.
For purposes of determining the number of diluted shares outstanding, weighted average shares outstanding for basic earnings per share calculations were increased due solely to the dilutive effect of unexercised capital stock options, unvested performance awards and unvested restricted stock units by 1.3 million shares and 0.8 million shares for the three months ended December 31, 2017 and 2016, respectively, and 1.2 million shares for the six months ended December 31, 2017. Unexercised capital stock options, performance awards and restricted stock units of 0.2 million shares and 1.7 million shares for the three months ended December 31, 2017 and 2016, respectively, and 0.5 million shares for the six months ended December 31, 2017, 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. For the six months ended December 31, 2016, the effect of unexercised capital stock options, unvested performance awards and unvested restricted stock units was anti-dilutive as a result of a net loss in the period and therefore has been excluded from diluted shares outstanding as well as from the diluted earnings per share calculation.


17

Table of Contents

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


15.
EQUITY
A summary of the changes in the carrying amounts of total equity, Kennametal Shareholders’ equity and equity attributable to noncontrolling interests as of December 31, 2017 and 2016 is as follows:
 
Kennametal Shareholders’ Equity
 
 
 
 
(in thousands)
Capital
stock
 
Additional
paid-in
capital
 
Retained
earnings
 
Accumulated
other
comprehensive loss
 
Non-
controlling
interests
 
Total equity
Balance as of June 30, 2017
$
100,832

 
$
474,547

 
$
765,607

 
$
(323,692
)
 
$
35,359

 
$
1,052,653

Net income

 

 
80,785

 

 
1,011

 
81,796

Other comprehensive income

 

 

 
33,876

 
1,173

 
35,049

Dividend reinvestment
3

 
106

 

 

 

 
109

Capital stock issued under employee benefit and stock plans(3)
1,065

 
25,841

 

 

 

 
26,906

Purchase of capital stock
(3
)
 
(106
)
 

 

 

 
(109
)
Cash dividends paid

 

 
(32,456
)
 

 

 
(32,456
)
Balance as of December 31, 2017
$
101,897

 
$
500,388

 
$
813,936

 
$
(289,816
)
 
$
37,543

 
$
1,163,948

 
 
Kennametal Shareholders’ Equity
 
 
 
 
(in thousands)
Capital
stock
 
Additional
paid-in
capital
 
Retained
earnings
 
Accumulated
other
comprehensive
loss
 
Non-
controlling
interests
 
Total equity
Balance as of June 30, 2016
$
99,618

 
$
436,617

 
$
780,597

 
$
(352,509
)
 
$
31,478

 
$
995,801

Net (loss) income

 

 
(14,394
)
 

 
1,108

 
(13,286
)
Other comprehensive income

 

 

 
(29,645
)
 
(639
)
 
(30,284
)
Dividend reinvestment
5

 
122

 

 

 

 
127

Capital stock issued under employee benefit and stock plans(3)
464

 
14,028

 

 

 

 
14,492

Purchase of capital stock
(5
)
 
(122
)
 

 

 

 
(127
)
Cash dividends paid

 

 
(31,970
)
 

 
(72
)
 
(32,042
)
Balance as of December 31, 2016
$
100,082

 
$
450,645

 
$
734,233

 
$
(382,154
)
 
$
31,875

 
$
934,681

(3) Net of restricted stock units delivered upon vesting to satisfy tax withholding requirements.

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

16.
ACCUMULATED OTHER COMPREHENSIVE LOSS

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


18

Table of Contents

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


The components of, and changes in, AOCL were as follows, net of tax, for the six months ended December 31, 2017 (in thousands):
Attributable to Kennametal:
Postretirement benefit plans
Currency translation adjustment
Derivatives
Total
Balance, June 30, 2017
$
(189,038
)
$
(126,606
)
$
(8,048
)
$
(323,692
)
Other comprehensive income before reclassifications
(2,590
)
32,620

(905
)
29,125

Amounts reclassified from AOCL
3,348


1,403

4,751

Net current period other comprehensive
  income
758

32,620

498

33,876

AOCL, December 31, 2017
$
(188,280
)
$
(93,986
)
$
(7,550
)
$
(289,816
)
 
 
 
 
 
Attributable to noncontrolling interests:
 
 
 
 
Balance, June 30, 2017
$

$
(2,164
)
$

$
(2,164
)
Other comprehensive income before
  reclassifications

1,173


1,173

Net current period other comprehensive
  income

1,173


1,173

AOCL, December 31, 2017
$

$
(991
)
$

$
(991
)

The components of, and changes in, AOCL were as follows, net of tax, for the six months ended December 31, 2016 (in thousands):
Attributable to Kennametal:
Postretirement benefit plans
Currency translation adjustment
Derivatives
Total
Balance, June 30, 2016
$
(212,163
)
$
(131,212
)
$
(9,134
)
$
(352,509
)
Other comprehensive income before reclassifications
4,101

(39,625
)
1,480

(34,044
)
Amounts reclassified from AOCL
3,630


769

4,399

Net current period other comprehensive
  income
7,731

(39,625
)
2,249

(29,645
)
AOCL, December 31, 2016
$
(204,432
)
$
(170,837
)
$
(6,885
)
$
(382,154
)
 
 
 
 
 
Attributable to noncontrolling interests:
 
 
 
 
Balance, June 30, 2016
$

$
(3,446
)
$

$
(3,446
)
Other comprehensive income before
  reclassifications

(639
)

(639
)
Net current period other comprehensive
  income

(639
)

(639
)
AOCL, December 31, 2016
$

$
(4,085
)
$

$
(4,085
)


19

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


Reclassifications out of AOCL for the three and six months ended December 31, 2017 and 2016 consisted of the following (in thousands):
 
Three Months Ended December 31,
Six Months Ended December 31,
 
 
Details about AOCL components
2017
 
2016
2017
 
2016
 
Affected line item in the Income Statement
Gains and losses on cash flow hedges:
 
 
 
 
 
 
 
 
Forward starting interest rate swaps
$
566

 
$
545

$
1,132

 
$
1,090

 
Interest expense
Currency exchange contracts
768

 
(163
)
726

 
(321
)
 
Other expense, net
Total before tax
1,334

 
382

1,858

 
769

 
 
Tax impact
(327
)
 

(455
)
 

 
Provision for income taxes
Net of tax
$
1,007

 
$
382

$
1,403

 
$
769

 
 
 
 
 
 
 
 
 
 
 
Postretirement benefit plans:
 
 
 
 
 
 
 
 
Amortization of transition obligations
$
23

 
$
22

$
46

 
$
45

 
See note 9 for further details
Amortization of prior service (credit) cost
(47
)
 
(119
)
121

 
(237
)
 
See note 9 for further details
Recognition of actuarial losses
1,788

 
2,177

3,568

 
4,377

 
See note 9 for further details
Total before tax
1,764

 
2,080

3,735

 
4,185

 
 
Tax impact
(195
)
 
(284
)
(387
)
 
(555
)
 
Provision for income taxes
Net of tax
$
1,569

 
$
1,796

$
3,348

 
$
3,630

 
 

The amount of income tax allocated to each component of other comprehensive income (loss) for the three months ended December 31, 2017 and 2016:
 
 
2017
 
 
 
 
2016
 
(in thousands)
Pre-tax
Tax impact
Net of tax
 
 
Pre-tax
Tax impact
Net of tax
Unrealized (loss) gain on derivatives designated and qualified as cash flow hedges
$
(379
)
$
93

$
(286
)
 
 
$
1,606

$

$
1,606

Reclassification of unrealized loss on expired derivatives designated and qualified as cash flow hedges
1,334

(327
)
1,007

 
 
382


382

Unrecognized net pension and other postretirement benefit (loss) gain
(834
)
209

(625
)
 
 
4,639

(1,168
)
3,471

Reclassification of net pension and other postretirement benefit loss
1,764

(195
)
1,569

 
 
2,080

(284
)
1,796

Foreign currency translation adjustments
13,996

(72
)
13,924

 
 
(41,428
)

(41,428
)
Other comprehensive income (loss)
$
15,881

$
(292
)
$
15,589

 
 
$
(32,721
)
$
(1,452
)
$
(34,173
)

20

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



The amount of income tax allocated to each component of other comprehensive income (loss) for the six months ended December 31, 2017 and 2016:
 
 
2017
 
 
 
 
2016
 
(in thousands)
Pre-tax
Tax impact
Net of tax
 
 
Pre-tax
Tax impact
Net of tax
Unrealized (loss) gain on derivatives designated and qualified as cash flow hedges
$
(1,199
)
$
294

$
(905
)
 
 
$
1,480

$

$
1,480

Reclassification of unrealized loss on expired derivatives designated and qualified as cash flow hedges
1,858

(455
)
1,403

 
 
769


769

Unrecognized net pension and other postretirement benefit (loss) gain
(3,434
)
844

(2,590
)
 
 
5,401

(1,300
)
4,101

Reclassification of net pension and other postretirement benefit loss
3,735

(387
)
3,348

 
 
4,185

(555
)
3,630

Foreign currency translation adjustments
34,058

(265
)
33,793

 
 
(40,264
)

(40,264
)
Other comprehensive income (loss)
$
35,018

$
31

$
35,049

 
 
$
(28,429
)
$
(1,855
)
$
(30,284
)

17.
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.
A summary of the carrying amount of goodwill attributable to each segment, as well as the changes in such, is as follows:
(in thousands)
Industrial
 
Widia
 
Infrastructure
 
Total
Gross goodwill
$
410,694

 
$
41,515

 
$
633,211

 
$
1,085,420

Accumulated impairment losses
(137,204
)
 
(13,638
)
 
(633,211
)
 
(784,053
)
Balance as of June 30, 2017
$
273,490

 
$
27,877

 
$

 
$
301,367

 
 
 
 
 
 
 
 
Activity for the six months ended December 31, 2017:
 
 
 
 
 
 
 
Change in gross goodwill due to translation
4,382

 
398

 

 
4,780

 
 
 
 
 
 
 
 
Gross goodwill
415,076

 
41,913

 
633,211

 
1,090,200

Accumulated impairment losses
(137,204
)
 
(13,638
)
 
(633,211
)
 
(784,053
)
Balance as of December 31, 2017
$
277,872

 
$
28,275

 
$

 
$
306,147


21

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


The components of our other intangible assets were as follows:
 
Estimated
Useful Life
(in years)
 
December 31, 2017
June 30, 2017
(in thousands)
 
Gross Carrying
Amount
 
Accumulated
Amortization
 
 
Gross Carrying
Amount
 
Accumulated
Amortization
Contract-based
3 to 15
 
$
7,070

 
$
(7,033
)
 
 
$
7,064

 
$
(7,014
)
Technology-based and other
4 to 20
 
47,032

 
(30,497
)
 
 
46,461

 
(29,061
)
Customer-related
10 to 21
 
207,102

 
(80,872
)
 
 
205,502

 
(74,669
)
Unpatented technology
10 to 30
 
31,924

 
(11,888
)
 
 
31,754

 
(10,589
)
Trademarks
5 to 20
 
12,530

 
(8,912
)
 
 
12,401

 
(8,648
)
Trademarks
Indefinite
 
18,067

 

 
 
17,326

 

Total
 
 
$
323,725

 
$
(139,202
)
 
 
$
320,508

 
$
(129,981
)
During the six months ended December 31, 2017 and 2016, we recorded amortization expense of $7.3 million and $8.4 million, respectively, related to our other intangible assets.

18.
SEGMENT DATA
Kennametal delivers productivity to customers seeking peak performance in demanding environments by providing innovative custom and standard wear-resistant solutions. To provide these solutions, we harness our knowledge of advanced materials and application development with a commitment to environmental sustainability. Our product offering includes a wide selection of standard and customized technologies for metalworking, such as sophisticated 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.
Our reportable operating segments have been determined in accordance with our 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. We do not allocate certain corporate expenses related to executive retirement plans, our Board of Directors and strategic initiatives, as well as certain other costs and report them in Corporate. None of our three reportable operating segments represent the aggregation of two or more operating segments.
The Industrial segment generally serves customers that operate in industrial end markets such as transportation, general engineering, aerospace and defense market sectors, as well as the machine tool industry, delivering high performance metalworking tools for specified purposes. 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. Industrial goes to market under the Kennametal® brand through its direct sales force, a network of independent and national chain distributors, integrated supplier channels and 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.
The Widia segment offers a focused assortment of standard custom metal cutting solutions to general engineering, aerospace, energy and transportation customers. We serve our customers primarily through a network of value added resellers, integrated supplier channels and via the Internet. Widia markets its products under the WIDIA®, WIDIA Hanita® and WIDIA GTD® brands.
The Infrastructure segment generally serves customers that operate in the energy and earthworks market sectors that 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 feed. Our success is determined by our ability to gain an in-depth understanding of our customers’ engineering and development needs, to provide complete system solutions and high-performance capabilities to optimize and add value to their operations. Infrastructure markets its products primarily under the Kennametal® brand and sells through a direct sales force as well as distributors.

22

Table of Contents

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


Our sales and operating income (loss) by segment are as follows:
 
Three Months Ended December 31,
 
Six Months Ended December 31,
(in thousands)
2017
 
2016
 
2017
 
2016
Sales:
 
 
 
 
 
 
 
Industrial
$
312,448

 
$
267,492

 
$
609,912

 
$
536,536

Widia
47,744

 
42,874

 
92,987

 
83,888

Infrastructure
211,153

 
177,207

 
410,900

 
344,289

Total sales
$
571,345

 
$
487,573

 
$
1,113,799

 
$
964,713

Operating income (loss):
 
 
 
 
 
 
 
Industrial
$
43,292

 
$
18,067

 
$
78,104

 
$
23,603

Widia
856

 
(2,666
)
 
918

 
(8,403
)
Infrastructure
25,511

 
10,274

 
47,580

 
2,687

Corporate
(1,485
)
 
(1,662
)
 
(1,952
)
 
(3,085
)
Total operating income
68,174

 
24,013

 
124,650

 
14,802

Interest expense
7,231

 
7,151

 
14,379

 
14,144

Other expense, net
1,313

 
726

 
1,401

 
844

Income (loss) from continuing operations before income taxes
$
59,630

 
$
16,136

 
$
108,870

 
$
(186
)


23

Table of Contents

Item 2.     MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (MD&A)
 
 
 


OVERVIEW
Kennametal Inc. was incorporated in Pennsylvania in 1943 as a manufacturer of tungsten carbide metal cutting tooling. From this beginning, the Company has grown into a global leader in the development and application of tungsten carbides, ceramics, super-hard materials and solutions used in metal cutting and mission-critical wear applications to combat extreme conditions associated with wear fatigue, corrosion and high temperatures. The Company's reputation for material technology, metal cutting application knowledge, as well as expertise and innovation in the development of custom solutions and services, contributes to its leading position in its primary markets.
Our product offering includes a wide selection of standard and customized technologies for metalworking applications, such as turning, milling, hole making, tooling systems and services. End users of the Company's metalworking products include manufacturers engaged in a diverse array of industries including: the manufacturers of transportation vehicles and components, machine tools and light and heavy machinery; airframe and aerospace components; and energy-related com