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BLOUNT INTERNATIONAL INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF

May 14, 2014

OPERATIONS

The following discussion and analysis should be read in conjunction with our unaudited Consolidated Financial Statements and notes included elsewhere in this report.

Consolidated Operating Results

Three Months Ended March 31, (Amounts in millions) 2014 2013 Change Contributing Factor (Amounts may not sum due to rounding) Sales $ 232.0$ 232.6$ (0.7 ) 1.0 Unit sales volume (0.7 ) Selling price and mix (0.9 ) Foreign currency translation Gross profit 66.9 63.1 3.8 Gross margin 28.8 % 27.1 % 0.6 Unit sales volume (0.7 ) Selling price and mix (0.2 ) Steel costs 0.4 Acquisition accounting effects 2.6 Other product costs and mix 1.0 Foreign currency translation SG&A 44.6 44.0 0.6 As a percent of sales 19.2 % 18.9 % 0.5 Compensation expense 0.4 Advertising (0.2 ) Foreign currency translation (0.1 ) Other Facility closure and 1.5 - 1.5 restructuring charges Operating income 20.8 19.1 1.6 Operating margin 9.0 % 8.2 % 3.8 Increase in gross profit (0.6 ) Increase in SG&A (1.5 ) Increase in facility closure and restructuring charges Net income $ 10.6$ 9.3$ 1.2 1.6 Increase in operating income (0.2 ) Increase in net interest expense (0.8 ) Change in other income (expense) 0.6 Decrease in income tax provision



Sales in the three months ended March 31, 2014 decreased by $0.7 million, or 0.3%, from the same period in 2013, due to the unfavorable effects of movements in foreign currency exchange rates and the net change in average selling prices and mix, partially offset by higher unit sales volume. The translation of foreign currency-denominated sales transactions decreased consolidated sales by $0.9 million in the first three months of 2014 compared to the first three months of 2013, primarily due to the relatively stronger U.S. Dollar in comparison to several foreign currencies in which we invoice, partially offset by a weaker dollar in relation to the Euro. International sales increased by $1.1 million, or 0.8%, net of the unfavorable currency effects

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described above, while domestic sales decreased by $1.7 million, or 1.8%. FLAG segment sales increased by $0.1 million, FRAG segment sales decreased by $0.4 million, or 0.6%, and sales of CCF products decreased by $0.4 million, or 5.0%. See further discussion about fluctuations in sales under Segment Results.

Gross profit increased by $3.8 million, or 6.0%, from the first three months of 2013 to the first three months of 2014. Higher unit sales volume of $0.6 million, lower acquisition accounting effects of $0.4 million, and reduced product costs and mix of $2.6 million all contributed to the increase in gross profit. The improvement in product cost and mix was primarily due to the closure of the higher cost FLAG manufacturing plant in Portland, Oregon announced in the third quarter of 2013, along with improved plant utilization and absorption of manufacturing overhead from higher production volumes in our FLAG segment. Partially offsetting these improvements in gross profit were lower average selling prices and mix of $0.7 million, due to targeted promotion programs in selected markets, and slightly higher steel costs. Gross margin in the first three months of 2014 was 28.8% compared to 27.1% in the first three months of 2013. The improvement in gross margin in the first three months of 2014 occurred primarily in the FLAG segment and was driven by the cost improvements described above. FRAG segment gross margins also improved slightly in the first three months of 2014 compared to the first three months of 2013. See further discussion of gross profit under Segment Results.

Fluctuations in currency exchange rates increased our gross profit in the first three months of 2014 compared to the first three months of 2013 by an estimated $1.0 million, primarily due to the favorable effect on cost of goods sold from a relatively stronger U.S. Dollar in comparison to the Brazilian Real and Canadian Dollar, partially offset by the unfavorable effect on reported sales described above.

SG&A increased by $0.6 million, or 1.4%, from the first three months of 2013 to the first three months of 2014. As a percentage of sales, SG&A increased from 18.9% in the first three months of 2013 to 19.2% in the first three months of 2014. Increased compensation expense of $0.5 million, reflecting annual merit increases, and increased advertising expense of $0.4 million were the primary drivers of the increase. Movement in foreign currency exchange rates reduced SG&A by $0.2 million.

In August 2013, the Company announced that its two manufacturing facilities in Portland, Oregon would be consolidated into one location, and its Milwaukie, Oregon facility would be closed, to reduce costs and further improve efficiencies. Direct costs associated with this facility closure and restructuring activity were $0.8 million in the first quarter of 2014, consisting of costs for impairment of additional property, plant, and equipment ("PP&E") identified in the first quarter of 2014 that will not be utilized in the future, and moving costs to relocate machinery and equipment to other Blount facilities. We do not expect to incur significant further costs associated with this activity after March 31, 2014.

In January 2014, the Company announced plans to consolidate its North American lawn and garden blade manufacturing into its Kansas City, Missouri plant and close a small facility acquired with PBL in 2011 in Queretaro, Mexico in order to reduce operating costs and improve efficiencies. Direct costs associated with this facility closure and restructuring activity were $0.7 million in the first quarter of 2014, consisting of costs for severance benefits, impairment of PP&E that will not be utilized in the future, moving costs to relocate inventory and machinery and equipment to our Kansas City, Missouri manufacturing facility, and lease exit costs. We expect to incur an additional $0.6 million to $0.8 million in direct costs as we complete this transition in the second quarter of 2014.

Operating income increased by $1.6 million, or 8.6%, from the first three months of 2013 to the first three months of 2014. Operating margin was 9.0% of sales in the first three months of 2014 compared to 8.2% of sales in the first three months of 2013. The increase in operating income and operating margin reflects higher gross profit, primarily due to lower product costs and the favorable effects of foreign currency exchange rates. Partially offsetting these favorable factors were reduced average selling prices, higher SG&A expenses, and facility closure and restructuring charges.

Interest expense, net of interest income, was $4.5 million in the first three months of 2014 compared to $4.3 million in the first three months of 2013. Increased interest expense was primarily due to higher average interest rates on our borrowing driven by interest rate swap agreements which went into effect in June 2013.

Other income (expense), net decreased by $0.8 million in the first quarter of 2014 compared to the first quarter of 2013, primarily due to foreign exchange impacts on non-operating assets.

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Income Tax Provision

The following table summarizes our income tax provisions in 2014 and 2013:

Effective Tax Rate Three Months Ended March 31, (Amounts in thousands) 2014 2013 Income before income taxes $ 16,302$ 15,652 Provision for income taxes 5,716 6,312 Effective tax rate 35.1 % 40.3 %



The effective tax rate for the three months ended March 31, 2014 was comparable to the federal statutory rate of 35%. The effective rate includes the offsetting impacts of increases for state income taxes and foreign withholding taxes on dividends, and decreases for foreign income taxes and the domestic production deduction. The impact of foreign income taxes reduces our effective tax rate because our foreign operations are generally subject to lower statutory tax rates compared with our U.S. operations.

The effective tax rate for the three months ended March 31, 2013 was higher than the federal statutory rate of 35% primarily due to foreign withholding taxes on dividends, a charge of $0.9 million from a change in the estimated average state tax rate applied to U.S. deferred tax assets and liabilities, and state income taxes. Partially offsetting these increases in the effective tax rate were the favorable effects of foreign income taxes and the domestic production deduction.

Net Income and Net Income per Share

Net income in the first quarter of 2014 was $10.6 million, or $0.21 per diluted share, compared to $9.3 million, or $0.19 per diluted share, in the first quarter of 2013.

Consolidated Sales Order Backlog

Consolidated sales order backlog at March 31, 2014 was $180.4 million compared to $182.6 million at December 31, 2013 and $180.0 million at March 31, 2013. The decrease in consolidated backlog during the first quarter of 2014 reflects reduced backlog in our FRAG segment, partially offset by increased sales order backlog in our FLAG segment. See further discussion of backlog under Segment Results.

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Segment Results

See description of the Company's reporting segments in Note 13 to the Consolidated Financial Statements. The following table reflects segment sales and operating results for the comparable periods of 2014 and 2013: Segment Information Three Months Ended March 31, (Amounts in thousands) 2014 2013 Sales: FLAG $ 165,215$ 165,143 FRAG 59,881 60,249 Corporate and Other 6,863 7,223 Total sales $ 231,959$ 232,615 Contribution to operating income (loss): FLAG $ 28,077$ 24,568 FRAG (899 ) (1,086 ) Corporate and Other (6,390 ) (4,339 ) Operating income $ 20,788$ 19,143 Depreciation and amortization: FLAG $ 6,516$ 6,985 FRAG 3,832 4,298 Corporate and Other 796 543 Depreciation and amortization $ 11,144$ 11,826 Forestry, Lawn, and Garden Segment. The following table reflects the factors contributing to the change in sales and contribution to operating income for the FLAG segment between the comparable periods of 2014 and 2013: FLAG Segment Results Three Months Ended March 31, Contribution to (Amounts in thousands) Sales Operating Income 2013 reporting period $ 165,143 $ 24,568 Unit sales volume 2,268 986 Selling price and mix (1,051 ) (1,051 ) Average steel cost - 24 Other product costs and mix - 2,809 SG&A expense - (662 ) Acquisition accounting effects - 177 Foreign currency translation (1,145 ) 1,226 2014 reporting period $ 165,215 $ 28,077



Sales in the FLAG segment increased by $0.1 million from the first quarter of 2013 to the first quarter of 2014 due to increased unit sales volume of $2.3 million, partially offset by lower average selling prices of $1.1 million due to targeted sales promotions in select markets, and unfavorable foreign currency effects of $1.1 million. The foreign currency effects were primarily due to the relatively stronger U.S. Dollar in comparison to several foreign currencies in which we invoice, partially offset by a weaker dollar in relation to the Euro.

Sales of forestry products were up 1.7% in the quarter while sales of lawn and garden products were down 6.4%. Sales to the replacement market were up 3.2% while sales to OEMs were down 4.3%. FLAG sales decreased by 3.6% in North America in the quarter compared to relatively strong sales in the first quarter of 2013. FLAG sales increased by 5.4% in Europe and Russia in the quarter; reflecting improvement in the economy and market conditions in Western Europe. FLAG sales decreased by 8.0% in the Asia Pacific Region in the quarter; reflecting timing of near-term customer demand. FLAG sales decreased by 12.6% in South America; primarily due to unfavorable foreign currency translation effects from a relatively stronger U.S. Dollar compared with the Brazilian Real.

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Sales order backlog for the FLAG segment at March 31, 2014 was $156.8 million compared to $150.9 million at December 31, 2013 and $162.8 million as of March 31, 2013. The increase in backlog in the FLAG segment during the first quarter of 2014 compared with December 31, 2013 reflects improving market conditions and customer demand. The decrease in FLAG backlog from March 31, 2013 reflects a shift in timing of customer order intake.

The contribution to operating income from the FLAG segment increased by $3.5 million, or 14.3%, from the first quarter of 2013 to the first quarter of 2014. Higher unit sales volume, improved product cost, and the favorable net effects of foreign currency movements all contributed to the improved operating results. Partially offsetting these positive factors were lower average selling prices due to targeted sales promotions and increased SG&A costs.

FLAG product costs were lower primarily due to the favorable effects of closing our higher cost FLAG manufacturing plant in Milwaukie, Oregon during the second half of 2013, as well as higher plant utilization and improved manufacturing efficiency and overhead absorption from higher production volumes. FLAG production facilities for the first quarter of 2014 were operated at an average of approximately 88% of capacity, compared to approximately 85% of capacity in the first quarter of 2013. In addition, amortization of acquired intangible assets was $0.2 million lower and depreciation expense was $0.3 million lower in the first quarter of 2014 compared to the first quarter of 2013. The increase in SG&A expense was primarily driven by increased compensation costs, reflecting annual merit increases, and increased advertising expense.

Farm, Ranch, and Agriculture Segment. The following table reflects the factors contributing to the change in sales and contribution to operating income (loss) in the FRAG segment between the comparable periods of 2014 and 2013: FRAG Segment Results Three Months Ended March 31, Contribution to Operating Income (Amounts in thousands) Sales (Loss) 2013 reporting period $ 60,249 $ (1,086 ) Unit sales volume (854 ) (63 ) Selling price and mix 361 361 Steel cost - (191 ) Other product costs and mix - (286 ) SG&A expense - 22 Acquisition accounting effects - 344 Foreign currency translation 125 - 2014 reporting period $ 59,881 $ (899 )



Sales in the FRAG segment decreased by $0.4 million, or 0.6%, from the first quarter of 2013 to the first quarter of 2014, primarily due to lower sales volume, driven by lower shipments of agricultural cutting parts in Europe, partially offset by higher average pricing. Sales of log splitters were up 22.8% in the first quarter of 2014 compared with the first quarter of 2013 reflecting strong customer demand. FRAG sales in North America increased by 0.6% while sales in Europe, consisting primarily of agricultural cutting parts, were down 10.0%.

Sales order backlog for the FRAG segment at March 31, 2014 was $22.9 million compared to $31.4 million at December 31, 2013 and $16.6 million at March 31, 2013. The decrease in backlog in the first quarter of 2014 compared with December 31, 2013 reflects the typical seasonal ordering patterns in the agricultural equipment market. The increase in FRAG backlog from March 31, 2013 reflects improved market conditions and increased demand for our FRAG products, particularly log splitters and tractor attachments.

The negative contribution to operating income from the FRAG segment improved from $1.1 million in the first quarter of 2013 to $0.9 million in the first quarter of 2014 primarily due to improved average pricing and product mix and reduced acquisition accounting effects. These positive factors were partially offset by higher average steel costs and higher product cost and mix in the comparable quarters. The higher product costs were primarily driven by temporary equipment outages and marginally higher labor costs as increased production volumes required overtime and training expense for new personnel. The reported results of the FRAG segment are significantly affected by non-cash charges for acquisition accounting, because the entire segment is composed of recently acquired businesses. Acquisition accounting effects in the segment were $2.8 million and $3.2 million in the three months ended March 31, 2014 and 2013, respectively. Depreciation expense in the FRAG segment was $1.2 million in both three-month periods.

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Corporate and Other. In the first quarter of 2014, sales of CCF products were down $0.4 million, or 5.0%, compared with the first quarter of 2013, primarily due to reduced demand in North America, partially offset by slightly higher sales in Europe. North American demand for CCF products was adversely affected by the downturn in general and utility construction activity due to severe weather experienced in much of the U.S. The net operating loss in the corporate and other category increased by $2.1 million in the quarter, reflecting the lower sales unit volume in the CCF business unit and the $1.5 million of facility closure and restructuring costs incurred in the first quarter of 2014 compared to no such costs incurred in the first quarter of 2013.

Financial Condition, Liquidity, and Capital Resources

Debt consisted of the following: Debt March 31, December 31, (Amounts in thousands) 2014 2013 Revolving credit facility $ 182,650$ 175,000 Term loans 256,443 260,107 Capital lease obligations 2,791 2,881 Total debt 441,884 437,988 Less current maturities (15,019 ) (15,016 )



Long-term debt, net of current maturities $ 426,865$ 422,972 Weighted average interest rate at end of period 2.68 %

2.68 %



Senior Credit Facilities. The Company, through its wholly-owned subsidiary, Blount, Inc., maintains a senior credit facility with General Electric Capital Corporation as Agent for the Lenders and also as a lender, which has been amended and restated on several occasions. As of March 31, 2014 and December 31, 2013, the senior credit facilities consisted of a revolving credit facility and a term loan.

The revolving credit facility provides for total available borrowings of up to $400.0 million, reduced by outstanding letters of credit, and further limited by a specific leverage ratio. As of March 31, 2014, the Company had the ability to borrow an additional $93.0 million under the terms of the revolving credit agreement. The revolving credit facility bears interest at a floating rate, which, at the option of the Company, may be either LIBOR or an Index Rate, as defined in the credit agreement, plus an additional amount as outlined in the table below.

Maximum Leverage Ratio



Less than 4.00 Between 4.00 and 4.50 Above 4.50

LIBOR + 2.50% LIBOR + 3.00% LIBOR + 3.50%



Index Rate + 1.50% Index Rate + 2.00% Index Rate + 2.50%

Interest is payable on the individual maturity dates for each LIBOR-based borrowing and monthly on index rate-based borrowings. Any outstanding principal is due in its entirety on the maturity date of August 31, 2016.

The term loan facility bears interest under the same terms as the revolving credit facility. The term loan facility also matures on August 31, 2016 and requires quarterly principal payments of $3.7 million, with a final payment of $219.8 million due on the maturity date. Once repaid, principal under the term loan facility may not be re-borrowed.

The amended and restated senior credit facilities contain financial covenants, including, as of March 31, 2014: Minimum fixed charge coverage ratio, defined as Adjusted EBITDA divided by cash payments for interest, taxes, capital expenditures, scheduled debt principal payments, and certain other items, calculated on a trailing twelve-month basis. The minimum fixed charge coverage ratio is set at 1.15. Maximum leverage ratio, defined as total debt divided by Adjusted EBITDA, calculated on a trailing twelve-month basis. The maximum leverage ratio is set at 4.35 through March 31, 2014, 4.25 through June 30, 2014, 4.00 through December 31, 2014, 3.75 through June 30, 2015, 3.50 through September 30, 2015, 3.25 through December 31, 2015, and 3.00 thereafter. 24



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The status of financial covenants was as follows:

As of March 31, 2014 Financial Covenants Requirement Actual Minimum fixed charge coverage ratio 1.15 1.53 Maximum leverage ratio 4.35 3.60



In addition, there are covenants, restrictions, or limitations relating to acquisitions, investments, loans and advances, indebtedness, dividends on our stock, the sale or repurchase of our stock, the sale of assets, and other categories. In the opinion of management, we were in compliance with all financial covenants as of March 31, 2014. Non-compliance with these covenants is an event of default under the terms of the credit agreement, and could result in severe limitations to our overall liquidity, and the term loan lenders could require immediate repayment of outstanding amounts, potentially requiring sale of a sufficient amount of our assets to repay the outstanding loans.

The amended and restated senior credit facilities may be prepaid at any time without penalty. There can also be additional mandatory repayment requirements related to the sale of Company assets, the issuance of stock under certain circumstances, or upon the Company's annual generation of excess cash flow, as defined in the credit agreement. No payments were required in the three months ended March 31, 2014 or March 31, 2013 under the excess cash flow requirement in the credit agreement. Our senior credit facility agreement does not contain any provisions that would require early payment due to any adverse change in our credit rating.

We intend to fund working capital, operations, capital expenditures, acquisitions, debt service requirements, and obligations under our post-employment benefit plans for the next twelve months through cash and cash equivalents, expected cash flows generated from operating activities, and amounts available under our revolving credit agreement. We expect our financial resources will be sufficient to cover any additional increases in working capital, capital expenditures, and acquisitions; however, there can be no assurance that these resources will be sufficient to meet our needs, particularly if we make significant acquisitions. We may also consider other options available to us in connection with future liquidity needs, including, but not limited to, the postponement of discretionary contributions to post-employment benefit plans, the postponement of capital expenditures, restructuring of our credit facilities, and issuance of new debt or equity securities.

Our interest expense may vary in the future because the revolving credit facility and term loan interest rates are variable. The senior credit facility agreement includes a requirement to cover 35% of the outstanding principal on our term loan with fixed or capped interest rates for certain specified periods, and we have entered into interest rate cap and swap agreements to meet this requirement. We entered into an interest rate cap agreement which matured June 1, 2013 and we entered into interest rate swap agreements effective June 2013. The weighted average interest rate on all debt was 2.68% as of March 31, 2014 and December 31, 2013. The weighted average interest rate at March 31, 2014, including the effect of the interest rate swaps, would be 3.07%.

Cash and cash equivalents at March 31, 2014 were $38.7 million, compared to $42.8 million at December 31, 2013. As of March 31, 2014, $35.7 million of our cash and cash equivalents was held in accounts at our foreign locations. The potential repatriation of foreign cash to the U.S. under current U.S. income tax law would most likely result in the payment of significant taxes. It is the intention of management for this cash to remain at or be used by our foreign locations indefinitely. This foreign cash is currently being used or is expected to be used to fund foreign operations and working capital, additions to property, plant, and equipment at foreign locations, and foreign acquisitions.

Cash provided by operating activities is summarized as follows:


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