Kennametal Inc. Fiscal 2023 Second-Quarter 10-Q Summary
Business context and reporting period
Kennametal manufactures engineered tooling, tungsten carbide and ceramic components, earth-cutting tools, and metallurgical powders. Its reportable segments are Metal Cutting and Infrastructure, serving aerospace, transportation, energy, earthworks, and general engineering markets. This Form 10-Q covers the three and six months ended December 31, 2022, the second quarter and first half of fiscal 2023. Results are unaudited.
Key financial metrics
| Metric | Three months ended Dec. 31, 2022 | Three months ended Dec. 31, 2021 | Six months ended Dec. 31, 2022 | Six months ended Dec. 31, 2021 |
|---|---|---|---|---|
| Sales | $497.1 million | $486.7 million | $991.9 million | $970.2 million |
| Gross profit | $142.9 million | $153.0 million | $302.9 million | $313.7 million |
| Gross margin | 28.7% | 31.4% | 30.5% | 32.3% |
| Operating income | $35.5 million | $47.5 million | $84.0 million | $102.1 million |
| Operating margin | 7.1% | 9.8% | 8.5% | 10.5% |
| Net income attributable to Kennametal | $21.9 million | $31.4 million | $50.1 million | $67.6 million |
| Diluted EPS | $0.27 | $0.37 | $0.61 | $0.80 |
| Operating cash flow | Not provided for the quarter | Not provided for the quarter | $52.5 million | $57.8 million |
At December 31, 2022, cash and cash equivalents were $76.8 million, total debt was $673.6 million, and Kennametal shareholders’ equity was $1.25 billion. Working capital was $554.0 million, compared with $539.1 million at June 30, 2022.
The $700 million revolving credit facility matures in June 2027. Borrowings outstanding were $76.8 million, with $623.2 million of additional availability. The company was in compliance with its covenants, including the maximum leverage ratio covenant.
Capital expenditures were $50.6 million for the first six months, compared with $37.7 million in the prior-year period. The company paid $32.4 million in dividends and repurchased $30.1 million of common stock during the period.
Material changes versus the prior comparable period
- Quarterly sales increased 2%, while first-half sales increased 2%. Organic sales growth was 11% for the quarter and 10% for the first half, but foreign-currency effects reduced reported growth by 8% and 7%, respectively.
- Quarterly operating income decreased $12.0 million, or 25%, and first-half operating income decreased $18.1 million, or 18%.
- Gross and operating margins contracted materially, primarily because of higher raw-material costs, wage and broader inflation, unfavorable currency effects, and Infrastructure under-absorption.
- Infrastructure sales increased 5% in both the quarter and first half, but operating income declined to $10.1 million from $20.0 million in the quarter and to $30.9 million from $46.0 million in the first half. Infrastructure margins fell to 5.1% and 7.9%, respectively.
- Metal Cutting sales were flat year over year in both periods. Operating income declined to $26.2 million from $27.9 million in the quarter and to $54.8 million from $57.1 million in the first half.
- Interest expense increased to $7.0 million for the quarter and $13.7 million for the first half, primarily because of higher Credit Agreement borrowings.
- Other income in the prior-year periods became other expense, primarily because of lower net periodic pension income.
- The effective tax rate declined to 17.8% from 25.9% for the quarter and to 23.6% from 26.5% for the first half, including a $2.2 million benefit related to Swiss tax reform and geographical mix.
Guidance, outlook, commentary, risks, and unusual items
The filing does not provide a clear quantitative full-year earnings or sales guidance figure. Management reported strong underlying demand and organic growth, particularly in aerospace, transportation, energy, and earthworks, while noting that reported results remain exposed to inflation, foreign exchange, supply-chain disruption, and macroeconomic conditions.
- Higher raw-material costs were approximately $23 million in the quarter and $41 million in the first half. Management stated that pricing actions only partially offset inflationary pressures.
- Infrastructure reduced powder production to manage the drawdown of safety stock, resulting in approximately $5 million of under-absorption in both the quarter and first half discussions.
- The company ceased operations in Russia and expects to liquidate its Russian legal entity during fiscal 2023.
- COVID-19-related labor shortages, supply-chain constraints, and conditions in China continued to affect operations and demand.
- Environmental remediation accruals were $12.2 million at December 31, 2022, including $1.9 million classified as current.
- An Italian tax assessment remains in litigation. The company has obtained a stay and recorded no liability; an adverse outcome could increase income tax expense by as much as €36.8 million, or approximately $39.3 million, including penalties and interest.
- Restructuring and related charges were not recorded in the current-year periods. Other charges included a net $1.5 million benefit, primarily from a property sale. The prior-year quarter benefited from restructuring reversals and a $1.0 million divestiture gain.
- Management stated that it expects available resources to meet cash requirements for the next 12 months and that there were no material changes in contractual obligations since June 30, 2022.
- Disclosure controls and procedures were assessed as effective, with no material changes to internal control over financial reporting.
Important facts for investors to verify
- Whether pricing actions can offset raw-material, labor, energy, and other inflationary costs.
- Whether Infrastructure margins recover after safety-stock reductions and production under-absorption.
- The effect of foreign-exchange movements, particularly in EMEA and Asia Pacific, on reported sales and earnings.
- Progress on the Russia liquidation and any related costs or operational effects.
- The outcome and potential cash or tax impact of the Italian tax assessment.
- Debt levels, interest costs, covenant compliance, and remaining revolver availability as borrowing rates change.
- Inventory growth, working-capital requirements, capital expenditures, share repurchases, and dividend funding relative to operating cash flow.
- Potential environmental remediation costs beyond the $12.2 million accrued balance and any future impairment or restructuring charges.