Kennametal Inc. Form 10-Q Summary
Reporting period: Three and six months ended December 31, 2019, representing fiscal 2020 second quarter and first half. The filing is unaudited. Kennametal manufactures tooling, metalworking products, wear components and metallurgical powders through its Industrial, Widia and Infrastructure segments.
Key Financial Metrics
| Metric | Three months ended Dec. 31, 2019 | Prior year | Six months ended Dec. 31, 2019 | Prior year |
|---|---|---|---|---|
| Sales | $505.1 million | $587.4 million | $1,023.2 million | $1,174.1 million |
| Gross profit / margin | $132.0 million / 26.1% | $198.6 million / 33.8% | $271.0 million / 26.5% | $409.7 million / 34.9% |
| Operating income (loss) / margin | $(47.6) million / (9.4)% | $78.9 million / 13.4% | $(31.3) million / (3.1)% | $162.0 million / 13.8% |
| Net income attributable to Kennametal | $(5.9) million | $54.7 million | $0.5 million | $111.4 million |
| Diluted earnings per share | $(0.07) | $0.66 | $0.01 | $1.34 |
| Operating cash flow | Not separately provided | Not separately provided | $87.1 million | $61.5 million |
- Sales declined 14% in the quarter and 13% year to date. Quarterly organic sales declined 12%, with an additional 1% unfavorable currency impact and 1% divestiture impact.
- Quarterly gross margin declined 770 basis points, primarily from lower volumes, unfavorable labor and fixed-cost absorption, restructuring activity and higher raw-material costs.
- Quarterly results included $51.3 million of restructuring and related charges, $14.6 million of non-cash Widia goodwill and intangible impairment charges, and a $6.5 million divestiture loss.
- The quarterly effective tax rate was an 87.9% benefit rate, including a $14.5 million discrete benefit from Swiss tax reform. The six-month effective tax rate was a 102.9% benefit rate.
- Capital expenditures were $147.5 million year to date, compared with $88.1 million in the prior-year period, principally for simplification and modernization initiatives.
Liquidity, Debt and Financial Condition
- Cash and cash equivalents were $105.2 million at December 31, 2019, compared with $182.0 million at June 30, 2019.
- Total debt was approximately $595.3 million, including $593.2 million of long-term debt and $2.1 million of notes payable to banks. The company had no borrowings outstanding under its $700 million revolving credit facility.
- The revolving facility matures in June 2023. Kennametal was in compliance with all financial covenants at December 31, 2019.
- Working capital was $626.8 million, down from $729.1 million at June 30, 2019, principally because of lower cash, receivables and inventories and the addition of current operating lease liabilities.
- Operating cash flow of $87.1 million was more than offset by $123.7 million of investing cash outflows and $38.7 million of financing cash outflows, resulting in a $76.8 million decrease in cash.
- Cash dividends paid during the first six months were $33.1 million; the quarterly dividend remained $0.20 per share.
Material Changes Versus the Prior Comparable Period
- All three segments experienced lower sales and operating profitability. Second-quarter sales declined 12% in Industrial, 9% in Widia and 18% in Infrastructure.
- Industrial reported a $19.3 million operating loss versus $57.5 million of operating income; Widia reported a $15.9 million loss versus $1.7 million of income; Infrastructure reported an $11.6 million loss versus $20.6 million of income.
- Weakness was broad-based, particularly in energy, transportation, general engineering and aerospace. Management cited deteriorating conditions in the United States, Germany, India and China and headwinds related to the Boeing 737 MAX supply chain.
- The company adopted the new lease accounting standard on July 1, 2019, recognizing approximately $49 million of operating lease right-of-use assets and liabilities without materially affecting net income or cash flow.
- Kennametal completed the sale of certain non-core specialty alloys and metals assets for $24.0 million. The assets had a $29.5 million net book value, resulting in a $6.5 million pre-tax loss.
Outlook, Management Commentary and Risks
- Management stated that fiscal 2020 and fiscal 2021 restructuring actions were on track and expected profitability to improve in the second half of the fiscal year as restructuring benefits increase and raw-material costs abate.
- Simplification and modernization initiatives produced approximately $11 million of total benefits during the quarter and approximately $69 million of annualized run-rate savings since inception. Fiscal 2020 actions are expected to generate $35 million to $40 million of annualized savings by the end of fiscal 2020; fiscal 2021 actions are expected to generate $25 million to $30 million.
- Expected pre-tax charges were $55 million to $65 million for each of the fiscal 2020 and fiscal 2021 restructuring programs. The filing does not provide formal consolidated revenue or earnings guidance.
- Widia goodwill and indefinite-lived trademark carrying values approximated fair value after the impairment test, making the segment sensitive to further declines in demand, cash flows or projected earnings.
- Material risks include global economic and manufacturing weakness, energy and automotive demand, aerospace production changes, foreign currency movements, raw-material costs, execution of restructuring initiatives, potential future impairment charges, international operations and environmental liabilities.
- Kennametal is disputing an Italian tax assessment of up to €36 million, or approximately $40 million, including penalties and interest. Payment is currently stayed, and no liability has been recorded because management believes the assessment is baseless.
- Environmental reserves were $12.0 million at December 31, 2019. The company stated that reserves currently appear adequate but noted that remediation costs could change materially.
Most Important Facts for Investors to Verify
- Whether demand stabilizes in energy, transportation, general engineering and aerospace markets, particularly in the United States, Germany, India and China.
- Whether restructuring and modernization savings are realized on schedule and offset volume, labor, fixed-cost absorption and raw-material pressures.
- Whether the Widia reporting unit requires additional goodwill or intangible-asset impairment charges.
- Whether elevated capital spending can be supported by operating cash flow while maintaining dividends and debt-service capacity.
- The outcome and potential financial impact of the Italian tax dispute and environmental remediation matters.
- Whether the Swiss tax reform benefit is nonrecurring and whether the expected future Swiss tax expense impact develops as management anticipates.