Kennametal Inc. Form 10-Q Summary
Reporting period: Three months ended September 30, 2018, the first quarter of fiscal 2019. The filing was submitted November 6, 2018. Results are unaudited and should be read with the fiscal 2018 Form 10-K.
Business Context and Financial Metrics
Kennametal develops and manufactures tungsten carbide, ceramic, super-hard material and wear-resistant solutions. Its reportable segments are Industrial, Widia and Infrastructure, serving metalworking, transportation, aerospace and defense, energy, earthworks and general engineering markets.
| Metric | Q1 FY2019 | Q1 FY2018 | Change |
|---|---|---|---|
| Sales | $586.7 million | $542.5 million | 8% increase |
| Gross profit | $211.1 million | $181.9 million | 16% increase |
| Gross margin | 36.0% | 33.5% | 250 basis-point increase |
| Operating income | $83.2 million | $52.2 million | 59% increase |
| Operating margin | 14.2% | 9.6% | 460 basis-point increase |
| Net income attributable to Kennametal | $56.7 million | $39.2 million | 45% increase |
| Diluted earnings per share | $0.68 | $0.48 | 42% increase |
| Cash flow from operations | $9.2 million | $(39.7) million | $48.9 million improvement |
| Capital expenditures | $43.3 million | $22.3 million | Increase |
Segment sales increased year over year by 8% in Industrial to $320.6 million, 8% in Widia to $48.7 million, and 9% in Infrastructure to $217.5 million. Segment operating margins were 18.3%, 4.3% and 11.0%, respectively.
At September 30, 2018, cash and cash equivalents were $102.1 million, total debt was approximately $592.1 million, and total Kennametal shareholders’ equity was $1.23 billion. The company had no borrowings under its $700 million revolving credit facility and was in compliance with its debt covenants. Working capital was $682.3 million.
The company paid $16.4 million in cash dividends during the quarter; the quarterly dividend was $0.20 per share.
Material Changes Versus the Prior Comparable Period
- Organic sales growth was 10%, partly offset by a 2% unfavorable foreign-exchange impact.
- Operating income benefited from stronger volume, favorable mix, pricing, modernization and simplification benefits, and $5.8 million less restructuring and related charges than in the prior-year quarter.
- Higher raw-material costs and temporary manufacturing inefficiencies related partly to strong demand and modernization efforts limited margin expansion.
- Operating expense increased to $123.3 million from $120.6 million, primarily because of higher employment costs.
- The effective tax rate increased to 24.9% from 19.5%, reflecting the return to tax-effecting U.S. income, GILTI and an incremental toll-tax estimate.
- Cash decreased by $454.1 million to $102.1 million, principally because the company repaid $400 million of 2.650% senior unsecured notes on July 9, 2018.
- Debt refinancing activity included the June 2018 issuance of $300 million of 4.625% senior unsecured notes due 2028, which contributed to higher interest expense.
- The company corrected the presentation of certain prior-year cash flow items. The correction increased previously reported operating cash outflow for the three months ended September 30, 2017 by $19.8 million and was determined not to be material to previously issued interim financial statements.
Outlook, Commentary, Risks and Unusual Items
Management described end-market demand as strong and expects continued benefits from growth and simplification/modernization initiatives. The company reported approximately $2 million of pre-tax cost savings in the quarter and expects approximately $10 million of annualized run-rate pre-tax savings from the programs, with additional benefits anticipated over the next few years.
Restructuring and related charges were $1.1 million in the quarter, compared with $6.9 million in the prior-year quarter. Total charges for the program since inception were $11.8 million through September 30, 2018. A small Infrastructure manufacturing-facility rationalization is expected to be completed in fiscal 2019.
The provisional Tax Cuts and Jobs Act toll-tax charge reached $81.9 million, including a $1.0 million current-quarter adjustment. The company estimates associated cash payments of $4.5 million over eight years. The toll-tax and deferred-tax calculations remained subject to finalization and additional regulatory guidance.
Environmental remediation reserves were $12.6 million. Management stated that current reserves appear sufficient but noted that environmental liabilities could change materially based on contamination, regulatory requirements, technology, new information and the financial condition of other potentially responsible parties.
Key disclosed risks include economic and business-cycle downturns, raw-material availability and costs, foreign-exchange and international-market exposure, trade barriers, competition, demand volatility, execution of restructuring and modernization initiatives, potential goodwill or intangible-asset impairments, product liability, intellectual-property protection, labor relations, information-technology disruption, environmental matters and catastrophic events.
Management stated that it believes available resources are sufficient to meet cash requirements for the next 12 months. The company had no material changes in market-risk exposures and concluded that disclosure controls and procedures were effective as of September 30, 2018.
Important Facts for Investors to Verify
- Confirm the sustainability of the 14.2% operating margin, including the effects of pricing, raw-material inflation, modernization benefits and temporary manufacturing inefficiencies.
- Monitor cash conversion and working-capital requirements, particularly the $48.6 million increase in inventories and the relatively low $9.2 million quarterly operating cash flow.
- Verify the impact of the debt refinancing and the higher interest burden following issuance of the 2028 notes and repayment of the 2019 notes.
- Track completion costs and realized savings from restructuring, simplification and modernization programs.
- Assess the finalization of the $81.9 million provisional toll-tax charge and the company’s permanent-reinvestment conclusions for foreign earnings.
- Review exposure to foreign currency, energy and earthworks demand, raw-material costs, environmental remediation and potential goodwill or intangible-asset impairment.
- Consider the impact of the July 1, 2018 adoption of revenue-recognition guidance and the upcoming adoption of the lease standard beginning July 1, 2019.