Kennametal Inc. Fiscal 2015 Second-Quarter Form 10-Q Summary
Business context and reporting period
Kennametal is a global manufacturer of tooling, engineered components and advanced materials serving Industrial and Infrastructure markets, including aerospace, defense, transportation, general engineering, mining, earthworks and energy. This unaudited Form 10-Q covers the three and six months ended December 31, 2014, the second quarter of fiscal 2015. The company completed the acquisition of the Tungsten Materials Business in November 2013.
Key financial metrics
| Metric | Three months ended Dec. 31, 2014 | Three months ended Dec. 31, 2013 | Six months ended Dec. 31, 2014 | Six months ended Dec. 31, 2013 |
|---|---|---|---|---|
| Sales | $675.6 million | $689.9 million | $1,370.6 million | $1,309.7 million |
| Gross profit | $199.5 million | $207.0 million | $417.6 million | $405.2 million |
| Gross margin | 29.5% | 30.0% | 30.5% | 30.9% |
| Operating income (loss) | $(333.8) million | $49.7 million | $(272.8) million | $108.5 million |
| Net income attributable to Kennametal | $(388.3) million | $24.2 million | $(348.8) million | $62.0 million |
| Diluted earnings (loss) per share | $(4.89) | $0.30 | $(4.40) | $0.78 |
| Operating cash flow | Not separately provided | Not separately provided | $135.3 million | $84.6 million |
- Infrastructure sales declined 5% in the quarter to $304.1 million, while operating loss was $371.9 million, compared with operating income of $18.6 million in the prior-year quarter.
- Industrial sales were essentially flat at $371.6 million, but operating income increased to $41.8 million from $33.2 million. Industrial operating margin improved to 11.2% from 9.0%.
- Cash and cash equivalents were $146.3 million at December 31, 2014, compared with $177.9 million at June 30, 2014.
- Total debt was $962.6 million, including $867.1 million of long-term debt and capital leases and $86.9 million of notes payable to banks.
- The company had $174.1 million outstanding under its $600 million revolving credit facility and was in compliance with all debt covenants.
- Capital expenditures were $54.7 million for the six-month period, and cash dividends paid were $28.5 million.
Material changes versus the prior comparable period
- Quarterly sales decreased 2%, driven by a 4% unfavorable currency effect and a 2% organic decline, partly offset by acquisition contribution and additional business days. Six-month sales increased 5%, primarily because of the Tungsten Materials Business acquisition.
- Demand weakened materially in Infrastructure markets. Management cited persistent weakness in mining and earthworks and an abrupt deterioration in oil and gas demand late in the quarter.
- The company recorded preliminary non-cash Infrastructure impairment charges of $376.5 million, consisting of $375.0 million of goodwill and $1.5 million for an indefinite-lived trademark. A further $5.5 million non-cash impairment charge was recorded for a contract-based technology asset.
- Total restructuring and related charges were $12.9 million in the quarter and $20.4 million year to date. Phase 1 charges since inception totaled $39.5 million.
- Foreign currency translation reduced accumulated other comprehensive income by $79.4 million during the six-month period and contributed to lower reported sales.
- Shareholders’ equity declined to $1.499 billion from $1.929 billion at June 30, 2014, primarily because of the net loss, currency translation losses and dividends.
- Debt declined by approximately $114.6 million from June 30, 2014, mainly due to lower borrowings under the revolving credit facility.
Guidance, outlook, commentary, risks and unusual items
- Management expected the oil and gas demand decline and severe earthworks downturn to continue into the foreseeable future. Further deterioration or persistence in Infrastructure markets could result in additional impairment.
- In January 2015, the company announced Phase 2 restructuring actions expected to generate $40 million to $50 million of annualized savings and incur $90 million to $100 million of pre-tax charges over 12 to 24 months.
- Combined Phase 1 and Phase 2 restructuring programs are expected to generate $90 million to $105 million of annual ongoing pre-tax savings and incur approximately $145 million to $160 million of total charges. Phase 1 was expected to be completed by June 30, 2016, and Phase 2 by December 31, 2016.
- The company was exploring strategic alternatives for several Infrastructure businesses with estimated net book values of approximately $150 million to $200 million. At filing, management could not determine whether additional impairment charges were probable or estimable.
- The Infrastructure goodwill impairment was preliminary and subject to finalization of fair values for intangible assets and property, plant and equipment, expected in the third quarter of fiscal 2015.
- Environmental reserves were $12.6 million at December 31, 2014. The company noted that remediation costs and other environmental liabilities could change materially as facts, regulatory requirements and the involvement of other potentially responsible parties develop.
- Management identified risks including economic recession, commodity and raw-material costs, currency movements, international operating conditions, competition, labor relations, environmental matters, product claims, acquisitions and divestitures, and demand for products in energy, mining and other cyclical markets.
- The company revised its September 30, 2014 cash-flow presentation, increasing reported operating cash flow by $8.4 million and correspondingly reducing the effect of exchange-rate changes; management determined the error was not material.
Important facts for investors to verify
- Final valuation and accounting treatment of the $376.5 million preliminary Infrastructure impairment.
- Whether the Infrastructure downturn produces additional impairments or asset-sale losses, particularly for businesses with $150 million to $200 million of net book value.
- Actual timing, cash cost and realized savings from Phase 1 and Phase 2 restructuring programs.
- Trends in oil and gas, mining, earthworks and energy demand, including the effect of currency movements and business mix.
- Compliance with the revolving credit facility’s leverage and interest-coverage covenants as restructuring charges and operating losses affect results.
- Availability of cash held by foreign subsidiaries: $96.3 million of cash and $19.8 million of short-term intercompany advances were not expected to be available for long-term U.S. use without tax consequences.
- Potential changes in environmental remediation obligations beyond the $12.6 million recorded reserve.