Kennametal Inc. Form 10-Q Summary
Business context and reporting period
Kennametal is a global manufacturer of tooling, engineered components and advanced materials serving industrial, aerospace and defense, transportation, energy, mining and earthworks markets. The filing covers the three and six months ended December 31, 2012, the second quarter and first six months of fiscal 2013. The statements are unaudited.
The company operates through two reportable segments: Industrial and Infrastructure. Infrastructure includes Stellite, acquired on March 1, 2012 for $382.6 million, net of cash acquired.
Key financial metrics
| Metric | Three months ended Dec. 31, 2012 | Prior year | Six months ended Dec. 31, 2012 | Prior year |
|---|---|---|---|---|
| Sales | $633.1 million | $641.7 million | $1,262.6 million | $1,300.6 million |
| Gross profit | $199.4 million | $231.9 million | $407.8 million | $482.9 million |
| Gross margin | 31.5% | 36.1% | 32.3% | 37.1% |
| Operating income | $66.5 million | $94.0 million | $130.9 million | $195.7 million |
| Net income attributable to Kennametal | $42.1 million | $73.7 million | $88.5 million | $145.7 million |
| Diluted EPS | $0.52 | $0.91 | $1.09 | $1.79 |
Second-quarter operating margin was 10.5%, compared with 14.7% in the prior-year quarter. The effective tax rate increased to 26.4% from 17.3%, primarily because the prior year included a favorable $4.2 million valuation allowance adjustment and because Europe contributed a smaller share of earnings.
For the six months, operating cash flow was $54.2 million, compared with $71.1 million in the prior-year period. Capital expenditures were $34.4 million, versus $35.6 million. Cash and cash equivalents increased to $216.8 million from $116.5 million at June 30, 2012.
At December 31, 2012, total debt was $706.9 million, including $704.2 million of long-term debt and capital leases. Total Kennametal shareholders’ equity was $1.720 billion. Working capital was $993.8 million. The company had no borrowings outstanding under its $600 million revolving credit facility and was in compliance with its debt covenants.
Material changes versus the prior comparable period
- Second-quarter sales declined 1%, reflecting a 10% organic decline and a 1% unfavorable currency effect, partly offset by 9% growth from Stellite and 1% from additional business days.
- Six-month sales declined 3%, reflecting an 8% organic decline and a 4% unfavorable currency effect, partly offset by 9% growth from Stellite.
- Gross profit and margins contracted materially because of lower production-volume absorption, unfavorable mix, currency effects and an approximately $5.0 million impact from an inventory-reduction initiative.
- Operating expense decreased 5% in both the quarter and six-month period, primarily from lower employment and incentive compensation costs, cost containment and favorable currency effects.
- Industrial sales fell 12% in the quarter and 14% for the six months; Industrial operating margin fell to 10.4% and 10.2%, respectively, from 15.3% and 16.4%.
- Infrastructure sales increased 17% in the quarter and 16% for the six months because of Stellite, but organic sales declined 8% and 7%, respectively. Infrastructure operating margin declined to 11.5% from 14.4% for the quarter and from 13.9% for the six months.
- The company issued $400 million of 2.65% senior unsecured notes due 2019 and used the proceeds to repay credit-facility borrowings and for general corporate purposes. Long-term debt increased $213.6 million from June 30, 2012.
- The company repurchased $46.6 million of capital stock during the six months and paid $25.7 million in cash dividends. The quarterly dividend per share increased to $0.16 from $0.14.
Guidance, outlook, commentary, risks and unusual items
Management described the quarter as more challenging than anticipated. Demand weakened across most served markets, with destocking in general engineering, extended European automotive shutdowns affecting transportation, delayed energy projects, lower North American oil and gas rig activity, and weak underground coal demand. Aerospace and defense was a relative area of strength, with sales growth of 10% organically in the quarter and 9% for the six months.
Management highlighted cost control, a reduction of approximately $17 million in finished-goods and work-in-process inventory from the September quarter, liquidity improvement and continued investment in technology and innovation. The filing does not provide a specific sales or earnings forecast.
The American Taxpayer Relief Act of 2012 was expected to reduce the income tax provision by approximately $3 million to $4 million during the second half of fiscal 2013. An Italian tax assessment relating primarily to 2008 deductions is being litigated. The company recorded no liability because it believes the assessment is baseless; an adverse settlement at face value could increase income tax expense by approximately $30 million.
Environmental remediation reserves were $5.2 million at December 31, 2012. Certain Superfund matters remain at an early stage and the ultimate cost, timing and allocation of liability cannot yet be estimated. Other risks include economic recession, raw-material and energy costs, foreign exchange, international operations, competition, labor relations, product claims, acquisitions and integration, intellectual property, environmental compliance and market acceptance of products.
The company settled forward-starting interest-rate swaps in February 2012 with a $22.4 million cash payment; the related loss is being amortized through interest expense. Stellite represented approximately 17% of total assets at December 31, 2012, and management excluded Stellite from its internal-control effectiveness assessment under the SEC’s acquired-business guidance.
Facts investors should verify
- Whether weak demand, customer destocking and delayed energy projects persist and further affect sales and manufacturing-cost absorption.
- The sustainability of operating margins after the inventory-reduction initiative and lower incentive compensation benefits.
- Stellite’s standalone sales, profitability, integration progress and contribution to Infrastructure results.
- Debt maturities, interest expense, leverage and compliance with the revolving-credit covenants.
- The outcome and potential financial exposure of the Italian tax assessment.
- Whether environmental remediation obligations or early-stage Superfund matters require additional reserves.
- The effects of foreign exchange, raw-material costs and the interim LIFO inventory valuation, which remains subject to final year-end adjustments.