Kennametal Inc. Form 10-Q Summary
Reporting period: Three and nine months ended March 31, 2014. Although the request identifies “2013 Q3,” the filing is for fiscal 2014 third quarter and was filed May 8, 2014. Kennametal is a global manufacturer of tooling, engineered components and advanced materials, operating through Industrial and Infrastructure segments.
Financial Results and Position
| Metric | Q3 FY2014 | Q3 FY2013 | Nine months FY2014 | Nine months FY2013 |
|---|---|---|---|---|
| Sales | $755.2 million | $655.4 million | $2,065.0 million | $1,918.0 million |
| Gross profit | $239.0 million | $208.5 million | $644.2 million | $616.3 million |
| Gross margin | 31.6% | 31.8% | 31.2% | 32.1% |
| Operating income | $76.8 million | $75.0 million | $185.4 million | $205.8 million |
| Net income attributable to Kennametal | $50.9 million | $53.9 million | $112.9 million | $142.4 million |
| Diluted EPS | $0.64 | $0.67 | $1.42 | $1.76 |
- Q3 sales increased 15%, driven by the TMB acquisition contribution of 12%, organic growth of 3% and an additional business-day benefit of 1%, partly offset by a 1% currency headwind.
- Q3 operating margin was approximately 10.2%, compared with 11.4% in the prior-year quarter. The nine-month operating margin was approximately 9.0%, compared with 10.7%.
- Q3 effective tax rate increased to 24.1% from 18.5%. The nine-month rate increased to 28.5% from 21.7%, primarily because of a $7.2 million tax charge related to the repatriation of $57.0 million of foreign earnings.
- Nine-month operating cash flow was $153.2 million, compared with $150.4 million in the prior-year period. Capital expenditures were $86.0 million.
- Cash and cash equivalents were $161.8 million at March 31, 2014, compared with $377.3 million at June 30, 2013. Working capital was $949.7 million, down from $1,031.9 million.
- Total debt was $1,135.6 million, including $338.7 million outstanding under the $600 million revolving credit facility. Kennametal reported compliance with all credit covenants.
- Shareowners’ equity was $1,901.8 million at March 31, 2014. Cash dividends paid during the nine months were $42.3 million, and $14.1 million was used to repurchase capital stock.
Material Changes Versus the Prior Comparable Period
- The November 2013 acquisition of the Tungsten Materials Business contributed $77.7 million of Q3 sales and $122.5 million for the five months owned through March 31, 2014. TMB generated a Q3 operating loss of $4.3 million, including $7.7 million of inventory purchase-accounting costs and $3.9 million of incremental depreciation and amortization.
- TMB and related acquisitions significantly increased assets, goodwill and debt. Goodwill rose by $252.8 million to $974.6 million, while other intangible assets increased by $126.4 million to $349.2 million.
- Q3 operating income increased only $1.8 million despite higher sales, reflecting TMB purchase-accounting effects, acquisition costs, restructuring charges and higher operating expenses.
- Nine-month operating income declined $20.4 million, and diluted EPS declined $0.34, primarily because of acquisition-related costs and lower segment profitability.
- Q3 operating expense increased 18.7% to $152.3 million, including $12.0 million of additional TMB expenses, $4.8 million of higher professional fees, $3.6 million of higher employment costs and $2.4 million of TMB acquisition-related costs.
- Industrial Q3 sales increased 13%, but operating margin declined to 12.9% from 14.5%. Infrastructure sales increased 18%, while operating margin declined to 7.9% from 8.6%.
- Demand improved in general engineering, transportation and energy markets, while mining and earthworks remained weak. Excluding TMB, Q3 earthworks sales declined 6%, while energy sales increased 9%.
Outlook, Commentary, Risks and Unusual Items
- Management stated that TMB integration efforts were on track. Restructuring actions are expected to be completed over three years, with total pre-tax costs of $40 million to $50 million, mostly cash, and expected annual ongoing benefits of $35 million to $45 million after implementation.
- The filing does not provide a specific sales, earnings or EPS forecast for fiscal 2014.
- Kennametal is evaluating strategic alternatives for a portion of the Infrastructure business with an estimated net book value of approximately $39.0 million. The company had not determined whether an impairment loss was probable or estimable as of March 31, 2014.
- Environmental reserves increased to $11.3 million from $5.1 million, including a $6.0 million increase associated with a recent acquisition. Additional remediation costs could change as facts, regulatory requirements or other responsible parties’ circumstances develop.
- Risks identified include economic recession, raw-material availability and costs, currency fluctuations, international regulatory and political conditions, competition, labor relations, energy and commodity prices, product claims, acquisition integration, divestitures, environmental remediation and demand for new and existing products.
- Interim LIFO inventory valuations are based on projected year-end quantities and costs and remain subject to final year-end adjustments.
- Management concluded that disclosure controls and procedures were effective. The assessment excluded TMB and Emura internal controls because of the SEC’s acquisition-related one-year exclusion.
Important Facts for Investors to Verify
- Whether TMB achieves the expected restructuring savings and transitions from acquisition-related losses to sustainable profitability.
- The effect of higher leverage, interest expense and reduced cash balances on liquidity and covenant headroom.
- Progress on the $40 million to $50 million restructuring program and the timing of the anticipated $35 million to $45 million annual benefits.
- Demand trends in mining, earthworks, aerospace and defense, compared with improving energy, transportation and general engineering markets.
- The final purchase-price allocation for TMB, including goodwill, acquired intangibles and resulting amortization expense.
- The outcome of the strategic review of the Infrastructure business and whether an impairment charge becomes probable or estimable.
- Potential changes in environmental remediation obligations beyond the recorded $11.3 million reserve.