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, earthworks and related markets. The filing covers the three months ended September 30, 2012, the first quarter of fiscal 2013. Results are unaudited.
The company operates through Industrial and Infrastructure segments. Infrastructure includes Stellite, acquired on March 1, 2012, for $382.6 million net of cash acquired.
Key Financial Metrics
| Metric | Q1 FY2013 | Q1 FY2012 | Change |
|---|---|---|---|
| Sales | $629.5 million | $658.9 million | Down 4% |
| Gross profit | $208.3 million | $251.1 million | Down 17% |
| Gross margin | 33.1% | 38.1% | Down 5.0 percentage points |
| Operating income | $64.4 million | $101.6 million | Down 37% |
| Operating margin | 10.2% | 15.4% | Down 5.2 percentage points |
| Net income attributable to Kennametal | $46.4 million | $72.0 million | Down 36% |
| Diluted EPS | $0.57 | $0.88 | Down $0.31 |
| Cash flow from operations | $3.1 million | $(7.2) million | Improved $10.4 million |
| Capital expenditures | $15.8 million | $11.6 million | Increased |
Interest expense was $6.0 million, compared with $5.5 million in the prior-year quarter. The effective tax rate was 20.7%, compared with 23.0%, including a $4.2 million benefit from the settlement of a European tax audit. Dividends per share increased to $0.16 from $0.12.
At September 30, 2012, cash and equivalents were $110.5 million, total debt was $601.1 million and Kennametal shareholders’ equity was $1.687 billion. Current assets were $1.272 billion and current liabilities were $480.3 million, producing working capital of $791.8 million. Borrowings under the revolving credit facility were $236.9 million, and the company was in compliance with its debt covenants.
Material Changes Versus the Prior Comparable Period
- Sales declined 4%, consisting of a 7% organic decline, a 5% unfavorable currency effect and a 1% impact from fewer business days, partially offset by a 9% contribution from Stellite.
- Industrial sales fell 15% to $353.2 million and operating income fell 52% to $35.2 million. Industrial margin declined to 10.0% from 17.4%.
- Infrastructure sales increased 15% to $276.3 million due primarily to Stellite, while organic sales declined 5%. Operating income decreased slightly to $31.7 million, and margin declined to 11.5% from 13.5%.
- Gross profit was pressured by lower volume, lower manufacturing-cost absorption and $12.3 million of unfavorable currency effects. Cost reductions partially offset these factors.
- Operating expense declined 4.9% to $138.9 million, reflecting favorable currency effects and lower employment costs, partly offset by $7.2 million of additional Stellite-related operating expenses.
- Operating cash flow improved to $3.1 million from negative $7.2 million, although accounts payable and accrued liabilities declined by $89.2 million and inventories increased by $31.6 million.
- The company repurchased $26.0 million of common stock and paid $12.9 million of dividends during the quarter.
- Comprehensive income attributable to Kennametal shareholders was $71.7 million, compared with a $4.5 million loss in the prior-year quarter, primarily reflecting favorable foreign-currency translation movements.
Outlook, Risks, Contingencies and Unusual Items
Management described the quarter as challenging, citing macroeconomic uncertainty in the United States and Asia, fiscal concerns in Europe, weaker-than-expected demand, particularly in general engineering and earthworks, and unfavorable currency effects. Management initiated cost-containment actions across functions while continuing investment in technology and innovation; research and development expense was $10.7 million.
The filing does not provide specific quantitative earnings or revenue guidance. Management stated that raw-material prices were stabilizing, but realized costs generally lag market prices by several quarters.
- An Italian tax assessment related primarily to 2008 deductions is being litigated. The company believes the assessment is baseless and recorded no liability; settlement at face value would increase income tax expense by approximately $30 million.
- Environmental reserves were $5.2 million at September 30, 2012. Additional Superfund and remediation liabilities may change as facts, regulatory requirements and the positions of other potentially responsible parties develop.
- The company expects to recognize approximately $0.6 million of derivative losses in earnings over the next 12 months, assuming market rates remain unchanged.
- On November 2, 2012, after quarter-end, the company issued $400.0 million of 2.650% senior unsecured notes due 2019. Proceeds were intended primarily to repay revolving-credit borrowings and for general corporate purposes.
- Stellite represented approximately 17% of total assets at September 30, 2012. Management’s assessment of disclosure controls excluded Stellite’s internal control over financial reporting under the SEC’s acquisition-related transition guidance.
- Forward-looking results remain exposed to economic conditions, raw-material and energy costs, currency movements, international operations, competition, labor relations, regulatory and environmental matters, product claims, acquisitions and divestitures.
Investor Verification Checklist
- Verify whether demand weakness in general engineering, earthworks and energy persisted or reversed in subsequent quarters.
- Assess the sustainability of the 10.2% operating margin and the effectiveness of cost-containment actions.
- Separate Stellite’s acquisition-related contribution from organic sales, earnings and cash-flow trends.
- Review debt refinancing, post-quarter-end note issuance and the resulting leverage, interest expense and liquidity profile.
- Monitor the Italian tax litigation and potential exposure of approximately $30 million, as well as environmental contingencies.
- Evaluate inventory growth, working-capital requirements and the company’s ability to convert earnings into operating cash flow.
- Confirm foreign-exchange effects, derivative positions and their impact on reported earnings and accumulated other comprehensive income.