Kennametal Inc. Form 10-K Summary
Reporting period: Fiscal year ended June 30, 2013. The provided filing is an annual Form 10-K, not a 2012 fourth-quarter filing; quarterly data for the quarters ended September 30, December 31, March 31 and June 30 are included.
Business Context
Kennametal manufactures metalworking tools, engineered components, surface technologies and earth-cutting products using advanced materials and powder metallurgy. Its two reportable segments are Industrial, serving aerospace, defense, transportation and general engineering markets, and Infrastructure, serving energy, mining, highway construction and related earthworks markets. International markets represented 59% of fiscal 2013 sales, with sales mix of 44% North America, 30% Western Europe and 26% the rest of the world.
The company had approximately 12,600 employees at June 30, 2013. Fiscal 2013 followed record sales and profitability in fiscal 2012 and was affected by slowing global industrial production, which declined 1.5% for markets relevant to Kennametal.
Financial Performance and Position
| Metric | Fiscal 2013 | Fiscal 2012 | Change |
|---|---|---|---|
| Sales | $2,589.4 million | $2,736.2 million | Down 5.4% |
| Gross profit | $845.0 million | $994.3 million | Down $149.3 million |
| Gross margin | 32.6% | 36.3% | Down 370 basis points |
| Operating income | $296.4 million | $416.4 million | Down $120.0 million |
| Operating margin | 11.4% | 15.2% | Down 380 basis points |
| Net income attributable to Kennametal | $203.3 million | $307.2 million | Down 33.8% |
| Diluted EPS | $2.52 | $3.77 | Down $1.25 |
| Cash flow from operations | $284.2 million | $289.6 million | Down $5.4 million |
| Capital expenditures | $82.8 million | $103.0 million | Down $20.2 million |
Sales declined organically by 8%, with a 2% unfavorable currency effect and 1% fewer business days, partially offset by 6% growth from the Stellite acquisition. Organic declines included general engineering of 12%, energy of 11%, earthworks of 6% and transportation of 5%; aerospace and defense increased 6% organically.
- Industrial: Sales were $1,471.9 million, down 12%; operating income was $173.7 million, down 39%, and operating margin decreased to 11.8% from 17.0%.
- Infrastructure: Sales were $1,117.5 million, up 5% because of acquisition growth, while organic sales declined 8%; operating income was $130.5 million, down 8%, and operating margin decreased to 11.7% from 13.2%.
- Operating expense declined 6.0% to $527.9 million, primarily because of lower employment costs, favorable currency effects, lower Stellite acquisition costs and discretionary spending controls.
- No restructuring charges were recorded in fiscal 2013 or 2012. Amortization expense increased to $20.8 million from $16.4 million because of the Stellite acquisition.
- Research and development expense was $39.7 million, and approximately 45% of fiscal 2013 sales came from new products.
Cash Flow, Liquidity and Debt
Cash and cash equivalents increased to $377.3 million from $116.5 million. Working capital rose to $1,031.9 million from $704.3 million. Operating cash flow was $284.2 million, investing cash flow was an $80.7 million outflow, and financing cash flow was a $52.1 million inflow.
Kennametal returned more than $172.4 million to shareowners through approximately $121.4 million of share repurchases and $51.0 million of dividends. The annual dividend per share increased to $0.64 from $0.54. The company repurchased approximately 3.1 million shares during the year.
- Total debt, including capital leases and notes payable, was $747.9 million, compared with $565.7 million at June 30, 2012.
- Long-term debt and capital leases were $703.6 million. Debt consisted primarily of $400 million of 2.65% senior unsecured notes due 2019, $300 million of 3.875% senior unsecured notes due 2022 and $3.6 million outstanding under the revolving credit facility.
- The $600 million revolving credit facility was amended to extend its maturity to April 2018. The company was in compliance with all financial covenants at June 30, 2013.
- Short-term bank credit lines totaled $89.6 million, of which $49.0 million was unused.
- Approximately 6% of debt was subject to variable interest rates at year-end, compared with 46% in the prior year. Management stated that operating cash flow and available credit are sufficient for the next 12 months.
- Cash and cash equivalents of $349.8 million, plus $11.5 million of short-term intercompany advances, were not available for long-term U.S. use without tax consequences.
Material Changes Versus the Prior Comparable Period
- Fiscal 2013 sales, operating income, net income and diluted EPS all declined substantially from fiscal 2012 as end-market demand weakened and manufacturing-cost absorption deteriorated.
- Gross and operating margins contracted despite cost controls, primarily because of lower volume, inventory reduction efforts, unfavorable currency effects and lower factory utilization.
- Infrastructure sales benefited from a full year of Stellite ownership, but Stellite experienced weak demand and contributed $238.0 million of sales and only $2.4 million of net income attributable to Kennametal.
- Debt increased following the issuance of the $400 million 2019 notes, while borrowings under the revolving facility declined by approximately $208.6 million.
- Cash flow from investing activities improved materially because fiscal 2013 included only $0.5 million of acquisition spending, compared with $382.6 million for the Stellite acquisition in fiscal 2012.
- The company sold 13% of its Indian subsidiary for approximately $27 million in net proceeds and retained 75% ownership.
- At the start of fiscal 2014, Kennametal implemented an enhanced operating structure intended to improve cross-selling, customer focus, product innovation and technology-based reporting.
Outlook, Risks and Unusual Items
Management remained focused on maximizing cash flow, integrating Stellite, realizing commercial and operational synergies, and balancing geographic and end-market exposure. The filing does not provide a clear quantified fiscal 2014 sales, earnings or cash-flow guidance value in the supplied text.
- Key risks include cyclical demand, recessionary conditions, international operations and currency movements, raw-material availability and pricing, competition, labor relations, product liability, intellectual-property protection and catastrophic disruptions.
- Raw materials include tungsten, tantalum, titanium, niobium and cobalt. Supply is concentrated abroad and prices can be volatile; the company uses supply agreements and price increases to mitigate exposure.
- Environmental reserves were $5.1 million at June 30, 2013, unchanged from the prior year. Additional Superfund liabilities remain uncertain because certain proceedings are at an early stage.
- The company was litigating an Italian tax assessment. Management believed the assessment was baseless and recorded no liability; settlement at face value could increase income tax expense by approximately $30 million.
- Pension plans were underfunded by $94.8 million at year-end. Expected fiscal 2014 contributions were $12.2 million for pensions and $2.1 million for postretirement benefits.
- Contractual obligations included $836.2 million of long-term debt obligations, $631.5 million of purchase obligations, $75.5 million of operating lease obligations and $27.9 million of unrecognized tax benefits.
- No goodwill or other intangible-asset impairment was recorded in fiscal 2013, 2012 or 2011.
- PricewaterhouseCoopers LLP issued an unqualified opinion on the financial statements and internal control over financial reporting. Management reported effective disclosure controls and internal controls.
Investor Verification Points
- Confirm that the intended period is fiscal year 2013 rather than 2012 fourth quarter, because the filing covers the year ended June 30, 2013.
- Assess whether the sales decline and margin compression were temporary cyclical effects or evidence of sustained weakness in general engineering, energy and earthworks markets.
- Evaluate Stellite’s post-acquisition profitability and the timing and magnitude of expected integration synergies.
- Reconcile the increase in total debt with cash balances, scheduled maturities, credit-facility availability and covenant headroom.
- Review the potential exposure from the Italian tax assessment, unrecognized tax benefits and environmental remediation matters.
- Monitor international currency effects, raw-material costs and the company’s ability to recover cost inflation through pricing.
- Review fiscal 2014 guidance and subsequent filings for evidence that the enhanced operating structure and ERP integration improved growth and profitability.