Kennametal Inc. Form 10-Q Summary
Reporting period: Three and nine months ended March 31, 2018; filed May 8, 2018. The request metadata identifies “2017 Q3,” but the filing is for fiscal third quarter 2018. Results are unaudited and should be read with the fiscal 2017 Form 10-K.
Business context
Kennametal develops and manufactures tungsten carbide, ceramic, super-hard material and wear-resistant solutions. Its three reportable segments are Industrial, Widia and Infrastructure, serving metalworking, transportation, aerospace, energy, mining, construction and other industrial markets.
Management reported robust end-market conditions and continued execution of its growth, simplification and modernization initiatives.
Key financial metrics
| Metric | Three months ended March 31, 2018 | Three months ended March 31, 2017 | Nine months ended March 31, 2018 | Nine months ended March 31, 2017 |
|---|---|---|---|---|
| Sales | $607.9 million | $528.6 million | $1,721.7 million | $1,493.3 million |
| Gross profit | $219.5 million | $186.3 million | $597.0 million | $477.4 million |
| Gross margin | 36.1% | 35.2% | 34.7% | 32.0% |
| Operating income | $85.4 million | $57.9 million | $210.0 million | $72.7 million |
| Operating margin | 14.0% | 11.0% | 12.2% | 4.9% |
| Net income attributable to Kennametal | $50.9 million | $38.9 million | $131.7 million | $24.5 million |
| Diluted EPS | $0.61 | $0.48 | $1.59 | $0.30 |
Quarterly sales increased 15.0%, including 11% organic growth and a 6% favorable currency impact, partially offset by a 2% unfavorable business-days impact. Nine-month sales also increased 15.0%, including 13% organic growth and a 3% favorable currency impact.
Nine-month operating cash flow was $180.6 million versus $82.8 million in the prior-year period. Capital expenditures were $128.3 million versus $94.1 million, primarily reflecting equipment upgrades and modernization. Cash dividends paid were $48.8 million, or $0.60 per share year to date.
At March 31, 2018, cash and cash equivalents were $221.9 million, total debt was approximately $697.5 million, and Kennametal shareholders’ equity was $1.187 billion. Long-term debt was $696.1 million. The company had no borrowings under its $600 million revolving credit facility and was in compliance with all debt covenants. Working capital was $762.8 million.
Material changes versus the prior comparable period
- All three segments increased sales and operating profitability in the quarter and year to date.
- Industrial quarterly sales rose 15% and operating margin improved to 15.9% from 13.3%; nine-month margin increased to 13.9% from 7.5%.
- Widia quarterly operating margin improved to 3.1% from 1.3%; nine-month results improved to operating income of $2.6 million from an operating loss of $7.8 million.
- Infrastructure quarterly sales rose 15% and operating margin improved to 14.3% from 10.3%; nine-month margin increased to 12.5% from 4.2%.
- Restructuring and related charges declined to $1.7 million from $9.6 million in the quarter and to $10.0 million from $53.1 million year to date. Existing restructuring programs were substantially completed in the first fiscal quarter and have generated approximately $165 million of annual run-rate pretax savings.
- Higher raw-material costs, salary inflation, variable compensation and temporary manufacturing inefficiencies related partly to modernization offset some operating improvement.
- Cash from operations more than doubled year to date, while capital spending increased by approximately $34.2 million.
Guidance, outlook, risks and unusual items
Management characterized end markets as robust and expected price realization to continue exceeding raw-material cost inflation in the June quarter. Modernization and simplification benefits are expected to build over the next several years. The filing does not provide a clear formal revenue or earnings-per-share guidance range.
The Tax Cuts and Jobs Act resulted in a provisional toll-tax estimate of $83 million after foreign tax credits, including a $6 million adjustment recorded in the March 2018 quarter. Management estimated a related cash payment of $6.4 million, payable over eight years. The estimate remains subject to further interpretation, regulatory guidance and finalization. The company also expects its longer-term tax rate to decline from the mid-20% range to the low-20% range, while fiscal 2018 taxes are affected by the loss of the U.S. valuation allowance.
Quarterly diluted EPS included approximately $0.08 per share related to the toll-tax adjustment and $0.01 per share of restructuring and related charges. The filing also disclosed a nonmaterial out-of-period tax adjustment related to deferred-tax calculations on intra-entity product transfers.
Key risks include economic and business-cycle downturns, raw-material availability and costs, foreign-exchange movements, international and trade risks, execution of restructuring and modernization programs, competition, demand volatility, environmental remediation, potential goodwill or intangible-asset impairment, labor relations, cybersecurity and information-technology continuity, product liability, and acquisition or divestiture execution.
Environmental reserves were $12.8 million at March 31, 2018. Management believes reserves are adequate for probable and reasonably estimable matters, but noted that remediation obligations could change materially. Pending legal proceedings were not considered material individually or in the aggregate.
Important facts for investors to verify
- Confirm the fiscal-period designation: this filing covers fiscal Q3 2018, not 2017 Q3.
- Assess the sustainability of sales growth and margin expansion after adjusting for favorable foreign exchange, restructuring savings and temporary business-day effects.
- Monitor execution, timing and returns from the modernization program, including increased capital expenditures and temporary efficiency pressure.
- Reconcile the provisional $83 million toll-tax estimate and related deferred-tax accounting as the TCJA measurement period progresses.
- Review debt maturities, fixed-rate debt fair value, covenant headroom and availability under the $600 million revolving facility.
- Track working-capital investment, inventory growth, pension funding and the conversion of operating income into cash flow.
- Evaluate environmental reserves and potential changes in unreserved remediation liabilities.
- Confirm adoption impacts from the planned July 1, 2018 revenue-recognition standard, including potential operating-expense reclassification and additional disclosures.