Kennametal Inc. Fiscal 2019 Q1 Form 10-Q Summary
Business context and reporting period
Kennametal is a global industrial technology company serving aerospace, earthworks, energy, general engineering and transportation markets through its Industrial, Widia and Infrastructure segments. The filing covers the three months ended September 30, 2019, the first quarter of fiscal 2020. Results are unaudited and compared with the three months ended September 30, 2018.
Key financial metrics
| Metric | Q1 FY2020 | Q1 FY2019 | Change |
|---|---|---|---|
| Sales | $518.1 million | $586.7 million | Down 12% |
| Gross profit / margin | $139.0 million / 26.8% | $211.1 million / 36.0% | Margin down 920 basis points |
| Operating income / margin | $16.4 million / 3.2% | $83.2 million / 14.2% | Down $66.8 million |
| Net income attributable to Kennametal | $6.5 million | $56.7 million | Down 89% |
| Diluted EPS | $0.08 | $0.68 | Down $0.60 |
| Operating cash flow | $27.5 million | $9.2 million | Up $18.3 million |
| Capital expenditures | $72.5 million | $43.3 million | Up $29.2 million |
Interest expense was $7.9 million versus $8.1 million in the prior-year quarter. The effective tax rate increased to 33.7% from 24.9%, primarily due to jurisdictional mix, restructuring-related effects and the Base Erosion Anti-Abuse Tax.
At September 30, 2019, cash and cash equivalents were $113.5 million, total debt was $596.4 million, and Kennametal shareholders’ equity was $1.299 billion. The company had no borrowings under its $700 million revolving credit facility, which matures in June 2023, and was in compliance with its financial covenants. Working capital was $646.7 million.
Material changes versus the prior comparable period
- Sales declined 12%, consisting of an 11% organic decline and a 2% unfavorable currency impact, partially offset by a 1% favorable business-day effect.
- Market weakness was broad-based. Reported end-market declines included energy of 20%, transportation of 19%, general engineering of 9%, earthworks of 3% and aerospace of 3%.
- Industrial sales declined 13% and operating margin fell to 7.6% from 18.3%. Widia sales declined 9% and moved to a 4.5% operating loss from a 4.3% operating margin. Infrastructure sales declined 11% and moved to a 1.4% operating loss from an 11.0% margin.
- Gross and operating margins were pressured by lower volumes, higher raw-material costs, unfavorable labor and fixed-cost absorption, unfavorable mix, currency effects and restructuring activity. Management estimated that higher raw-material costs reduced year-over-year gross margin by approximately 360 basis points.
- Restructuring and related charges increased to approximately $8.0 million from $1.1 million. Current-quarter diluted EPS included approximately $0.09 per share of restructuring and related charges.
- Operating cash flow improved despite sharply lower earnings, primarily because of working-capital inflows, including a $41.6 million reduction in accounts receivable and a $2.7 million reduction in inventories.
- Investing cash outflows increased because capital spending accelerated for simplification, modernization and equipment upgrades. Financing outflows declined materially because the prior-year period included a $400 million term-debt repayment.
- The company adopted the new lease standard on July 1, 2019, recording approximately $49 million of lease liabilities and a corresponding right-of-use asset without a material income-statement or cash-flow impact.
Outlook, commentary, risks and unusual items
- Management reported that market conditions were significantly slower than expected across regions and end markets, particularly general engineering, energy and transportation.
- Management expects higher raw-material costs to abate in the second half of fiscal 2020. No clear consolidated revenue or EPS guidance is provided in the filing.
- Simplification and modernization initiatives were described as on schedule. Management reported approximately $58 million of annualized run-rate savings since inception and approximately $8 million of total quarterly benefits, including restructuring initiatives.
- FY2020 restructuring actions are expected to generate $35 million to $40 million of annualized savings by the end of fiscal 2020, with estimated pre-tax charges of $55 million to $65 million. Separate FY2021 Germany actions are expected to generate $25 million to $30 million of annualized savings and incur $60 million to $75 million of pre-tax charges.
- Production at the Lichtenau, Germany facility was discontinued at the end of October 2019. The company is also selling certain non-core specialty alloys and metals assets in New Castle, Pennsylvania; the transaction is expected to close in the December quarter of fiscal 2020, with assets carried at approximately $27 million at September 30, 2019.
- Management identified increased impairment sensitivity for Widia goodwill of $27.0 million and its indefinite-lived trademark of $14.4 million, although no impairment-triggering event was identified as of September 30, 2019.
- An Italian tax assessment remains in litigation. The tax authority has demanded payment of €36 million, or approximately $40 million, but the company expects to seek a stay and has recorded no liability, believing the assessment is baseless.
- Environmental reserves were $12.2 million. Management believes reserves are adequate for probable and reasonably estimable obligations but notes that remediation costs could change materially.
- Other principal risks include cyclical demand, foreign currency movements, international operations, raw-material availability and costs, trade conditions, execution of restructuring initiatives, goodwill impairment, environmental matters, product liability, labor relations and information-technology security.
Important facts for investors to verify
- Whether demand weakness in transportation, energy and general engineering persists or broadens.
- Progress toward the stated restructuring savings, facility closures and the related cash charges.
- Whether raw-material cost pressure abates as management expects in the second half of fiscal 2020.
- Widia’s future operating performance and the potential for goodwill or trademark impairment.
- Liquidity, debt covenant compliance and the company’s ability to fund elevated capital expenditures and restructuring costs.
- The outcome and potential financial exposure from the Italian tax litigation and environmental remediation matters.
- Completion and proceeds of the planned New Castle specialty alloys asset sale.