Kennametal Inc. Form 10-Q Summary
Reporting period: Three and nine months ended March 31, 2019, filed May 7, 2019. The supplied metadata identifies “2018 Q3,” but the filing covers Kennametal’s fiscal 2019 third quarter.
Business Context
Kennametal manufactures tungsten carbide, ceramic, super-hard material and engineered wear products used in metalworking, transportation, aerospace and defense, energy, mining, earthworks and general engineering. Reportable segments are Industrial, Widia and Infrastructure.
Financial Results and Liquidity
| Metric | Three months ended March 31, 2019 | Three months ended March 31, 2018 | Nine months ended March 31, 2019 | Nine months ended March 31, 2018 |
|---|---|---|---|---|
| Sales | $597.2 million | $607.9 million | $1,771.3 million | $1,721.7 million |
| Gross profit | $208.1 million | $216.4 million | $617.8 million | $587.9 million |
| Gross margin | 34.8% | 35.6% | 34.9% | 34.1% |
| Operating income | $81.9 million | $80.8 million | $243.9 million | $196.6 million |
| Operating margin | 13.7% | 13.3% | 13.8% | 11.4% |
| Net income attributable to Kennametal | $68.6 million | $50.9 million | $179.9 million | $131.7 million |
| Diluted EPS | $0.82 | $0.61 | $2.16 | $1.59 |
- Quarterly sales declined 2%, primarily from a 4% unfavorable currency impact and 1% fewer business days, partly offset by 3% organic growth. Nine-month sales increased 3%, including 5% organic growth and a 3% unfavorable currency impact.
- Quarterly operating income increased modestly despite lower sales. Nine-month operating income rose 24% year over year.
- Quarterly net income benefited from an 11.0% effective tax rate versus 31.2% in the prior-year quarter. The current period included a $6.8 million discrete tax benefit related to the Tax Cuts and Jobs Act.
- Nine-month operating cash flow was $157.5 million, essentially flat with $157.9 million in the prior-year period. Capital expenditures increased to $145.9 million from $105.6 million, primarily for equipment upgrades and modernization.
- At March 31, 2019, cash and equivalents were $112.6 million, total debt was $592.1 million, and shareholders’ equity was $1.325 billion. The company had no borrowings under its $700 million revolving credit facility and was in compliance with debt covenants.
- Working capital was $732.8 million, compared with $659.6 million at June 30, 2018. Inventories increased $63.1 million to $588.6 million.
- Quarterly and nine-month dividends were $0.20 and $0.60 per share, respectively.
Material Changes Versus Prior Comparable Period
- Industrial quarterly sales decreased 4%, but operating income increased to $57.2 million from $50.2 million; operating margin improved to 18.0% from 15.1%.
- Widia quarterly sales decreased 2% and operating income was approximately break-even, compared with $1.3 million in the prior-year quarter. Management cited one-time simplification costs and higher restructuring charges.
- Infrastructure quarterly sales increased 2%, while operating income fell to $24.9 million from $30.1 million; margin declined to 11.0% from 13.5%, primarily because of higher raw material and manufacturing costs.
- Gross margin declined in the quarter because of unfavorable volume-related labor and fixed-cost absorption, higher raw material costs and currency effects. Price realization exceeded raw material inflation.
- Interest expense increased because of the $300 million of 4.625% senior notes issued in June 2018. The company redeemed its $400 million of 2.650% senior notes due 2019 on July 9, 2018.
- Cash declined $443.6 million during the nine-month period, mainly because of the $400 million debt repayment, capital expenditures and dividends.
- The company corrected the previously reported nine-month 2018 cash flow presentation, reducing operating cash flow and investing cash flow by $22.7 million. Management determined the correction was not material to previously issued interim financial statements.
Guidance, Outlook, Risks and Unusual Items
- A new restructuring and simplification/modernization phase is expected to generate $35–$40 million of annualized savings by the end of fiscal 2020, with estimated pre-tax charges of $55–$65 million through fiscal 2019 and 2020, primarily cash costs.
- The prior restructuring program had generated approximately $12 million of annualized run-rate pre-tax benefits through the quarter, with $17.4 million of cumulative charges recorded through March 31, 2019.
- Management reported generally positive end markets, with strength in aerospace and defense and general engineering, but weakness in transportation and earthworks. Currency movements remained a significant headwind.
- Management believes current liquidity, investment-grade credit ratings and access to capital markets are sufficient to meet cash requirements for the next 12 months.
- Widia’s excess fair value over carrying value likely decreased from the prior impairment test. No impairment-triggering event was identified as of March 31, 2019, but the annual impairment test was scheduled for the June 2019 quarter.
- Environmental reserves were $12.4 million. The company is involved in remediation activities and Superfund matters and stated that liabilities could change materially with new information or regulatory developments.
- The finalized estimate of the Tax Cuts and Jobs Act toll tax was $71.2 million. The company recorded cumulative net benefits of $9.7 million during the nine-month period and does not expect a related cash payment.
- Risks include economic and business-cycle weakness, foreign exchange, raw material costs, trade and regulatory changes, restructuring execution, goodwill impairment, competition, environmental liabilities, product liability and cybersecurity or information technology disruptions.
Investor Verification Checklist
- Verify the filing period, since the supplied metadata says 2018 Q3 while the document reports fiscal 2019 third-quarter results.
- Assess whether the $55–$65 million restructuring investment can deliver the targeted $35–$40 million annualized savings by fiscal 2020.
- Monitor Widia’s profitability and the outcome of the fiscal 2019 annual goodwill and intangible-asset impairment testing.
- Evaluate inventory growth, capital spending and cash conversion following the substantial debt repayment.
- Separate underlying operating performance from currency effects and the discrete tax benefit when modeling earnings.
- Review transportation and earthworks demand, raw material inflation, manufacturing absorption and foreign-exchange exposure.
- Confirm future debt maturities, covenant compliance, environmental reserves and the expected balance-sheet impact of adopting lease accounting on July 1, 2019.