Kennametal Inc. 10-Q Summary
Business Context and Reporting Period
Kennametal is a global manufacturer and supplier of tooling, engineered components and advanced materials serving Industrial and Infrastructure markets. This unaudited report covers the three months ended September 30, 2015, the first quarter of fiscal 2016, compared with the prior-year quarter.
Financial Performance and Position
| Metric | Q1 FY2016 | Q1 FY2015 |
|---|---|---|
| Sales | $555.4 million | $694.9 million |
| Gross profit / margin | $151.2 million / 27.2% | $218.1 million / 31.4% |
| Operating income / margin | $6.6 million / 1.2% | $61.0 million / 8.8% |
| Net income attributable to Kennametal | $(6.2) million | $39.5 million |
| Diluted EPS | $(0.08) | $0.49 |
| Operating cash flow | $38.7 million | $51.0 million |
| Capital expenditures | $37.2 million | $30.8 million |
Industrial sales were $313.3 million, down 17%, and operating income was $20.2 million, compared with $44.0 million. Infrastructure sales were $242.0 million, down 24%, and the segment reported an $8.9 million operating loss, compared with $19.2 million of operating income.
At September 30, 2015, cash and cash equivalents were $97.2 million, total debt was approximately $750.8 million, and total Kennametal shareholders’ equity was $1.31 billion. Working capital was $730.1 million. The company had $42.1 million outstanding under its $600 million revolving credit facility, which matures in April 2018, and was in compliance with its financial covenants. Management stated that available resources were sufficient to meet cash requirements for the next 12 months.
Cash decreased by $8.3 million during the quarter to $97.2 million. Financing cash outflows included $15.9 million of dividends, while the company reduced borrowings on a net basis by approximately $0.7 million. The quarterly dividend was $0.20 per share.
Material Changes Versus the Prior Comparable Period
- Sales declined 20%, consisting of a 13% organic decline and a 7% unfavorable currency impact.
- Energy demand was particularly weak, with additional pressure from general engineering, earthworks and transportation markets.
- Gross margin declined 420 basis points because of lower volume and fixed-cost absorption, unfavorable mix, currency effects and restructuring charges.
- Operating income declined $54.4 million. Results were partially supported by restructuring benefits and lower raw-material costs.
- Foreign-currency translation produced an $18.8 million other comprehensive loss, compared with a $51.5 million loss in the prior-year quarter.
- Operating cash flow fell $12.2 million, although working-capital reductions in receivables and inventories provided cash.
- Interest expense declined to $7.0 million from $8.2 million because of lower borrowings.
Guidance, Outlook, Risks and Unusual Items
The company did not provide conventional full-year revenue or earnings guidance in the filing. Management expects restructuring programs to generate additional efficiencies but noted that weak energy, mining and industrial demand, currency movements and lower volume remain significant pressures.
Restructuring and related charges were $15.1 million in the quarter, including $9.1 million of restructuring charges. Cumulative charges under three restructuring phases totaled approximately $92 million. Estimated total charges for the programs are $185 million to $205 million, with expected annualized savings of $115 million to $135 million once implemented. Management reported approximately $21 million of pretax restructuring benefits in the quarter.
On October 30, 2015, after quarter-end, Kennametal signed an agreement to sell specified non-core businesses to Madison Industries for approximately $70 million in cash. The businesses had an aggregate net book value of approximately $170 million to $200 million at September 30, 2015. The company estimated an after-tax loss on sale of approximately $100 million to $120 million. The transaction was expected to close within 30 days of signing and required board approval, which was obtained on October 27, 2015.
The quarter included a $4.2 million discrete tax charge related to a change in the assertion that certain foreign earnings were permanently reinvested. The resulting effective tax rate was negative 292.8% because tax expense was recorded on a pretax loss.
Key risks include continued economic weakness, particularly in energy and mining; foreign-exchange volatility; execution of restructuring initiatives; potential goodwill and intangible-asset impairment; raw-material and energy costs; environmental remediation; product liability; competition; labor and supply-chain issues; and the ability to realize expected divestiture and restructuring benefits. Environmental reserves were $12.5 million at September 30, 2015, while certain Superfund matters remained too early to estimate reliably.
Investor Verification Checklist
- Verify the timing, closing conditions and final proceeds and loss from the Madison Industries divestiture.
- Assess whether the anticipated $115 million to $135 million of annualized restructuring savings are being realized and whether additional charges remain.
- Monitor Industrial and Infrastructure demand, especially energy, mining and general engineering exposure.
- Reconcile reported cash flow with working-capital reductions and recurring capital expenditure requirements.
- Review debt covenant headroom and the April 2018 maturity of the revolving credit facility.
- Evaluate currency effects, the tax consequences of foreign cash repatriation and the company’s ability to maintain its dividend.
- Track Infrastructure goodwill and other intangible assets, including the potential for future impairment charges.