Kennametal Inc. Form 10-Q Summary
Reporting period: Three and nine months ended March 31, 2013; filed May 9, 2013. The request metadata identifies “2012 Q3,” but the filing is for fiscal third quarter 2013. Kennametal manufactures tooling, engineered components and advanced materials through its Industrial and Infrastructure segments.
Financial Results and Key Metrics
| Metric | Three months ended March 31 | Nine months ended March 31 |
|---|---|---|
| Sales | $655.4 million, down 6% | $1,918.0 million, down 4% |
| Gross profit | $208.5 million | $616.3 million |
| Gross margin | 31.8%, versus 35.4% | 32.1%, versus 36.5% |
| Operating income | $75.0 million, versus $103.3 million | $205.8 million, versus $299.0 million |
| Operating margin | 11.4%, versus approximately 14.8% | 10.7%, versus approximately 15.0% |
| Net income attributable to Kennametal | $53.9 million, versus $75.5 million | $142.4 million, versus $221.2 million |
| Diluted EPS | $0.67, versus $0.93 | $1.76, versus $2.72 |
| Operating cash flow | Not separately provided | $150.4 million, versus $164.2 million |
- Interest expense was $7.5 million in the quarter and $20.4 million year to date. The quarterly effective tax rate was 18.5%; the nine-month rate was 21.7%.
- Cash and cash equivalents were $322.1 million at March 31, 2013, compared with $116.5 million at June 30, 2012. Working capital was $1.038 billion.
- Total debt was approximately $751.0 million, including $703.9 million of long-term debt and capital leases and $47.1 million of current debt and notes payable. Kennametal was in compliance with its credit agreement covenants.
- Capital expenditures were $53.8 million for the nine months. Cash flow used in investing activities was $52.2 million, compared with $448.4 million in the prior-year period, which included the $382.6 million Stellite acquisition.
- Cash dividends paid were $38.4 million and share repurchases were $78.5 million during the nine months. The company repurchased 786,000 shares under its public program during the quarter; approximately 6.5 million shares remained authorized for repurchase.
Material Changes Versus the Prior Comparable Period
- Quarterly sales declined 6%, reflecting a 6% organic decline, fewer business days and unfavorable currency, partly offset by two months of Stellite revenue. Nine-month sales declined 4% despite eight months of Stellite revenue.
- Gross margin contracted materially because of lower volumes, reduced manufacturing-cost absorption and inventory reduction actions. The inventory initiative reduced finished goods and work in process by approximately $40 million year to date and reduced quarterly gross profit by approximately $6.0 million.
- Operating expense declined 7.6% in the quarter and 5.8% year to date due to cost containment, lower incentive compensation and favorable currency effects.
- Industrial was the primary source of deterioration: quarterly sales fell 11% and operating income fell to $45.0 million from $71.2 million; nine-month operating income fell to $117.6 million from $206.8 million.
- Infrastructure quarterly sales increased 1% because of Stellite, but operating income declined to $32.3 million from $34.1 million. Stellite contributed $2.9 million of quarterly operating income versus a $4.6 million operating loss in the prior-year period.
- On an organic basis, energy, general engineering, earthworks and transportation weakened, while aerospace and defense grew 14% in the quarter and 10% year to date.
- Debt structure changed following issuance of $400 million of 2.65% senior unsecured notes due 2019. Long-term debt increased $213.3 million from June 30, 2012, while borrowings under the revolving credit facility declined to $3.7 million from $212.2 million.
Outlook, Commentary, Risks and Unusual Items
- Management did not provide a specific quantitative earnings or revenue guidance range in the filing. It reported sequential monthly growth in both segments during the quarter, continued cost containment and a focus on near-term cash flow and long-term growth.
- Management described the macro environment as mixed, with particular weakness in North American underground coal mining, energy project delays, lower drilling activity, customer inventory destocking and delayed road construction activity. Aerospace and defense remained a relative strength.
- The revolving credit facility maturity was extended to April 2018 on April 5, 2013; financial covenants and other key provisions were unchanged.
- The company sold 13% of its Indian subsidiary to meet public-float requirements, received approximately $27 million and retained 75% ownership.
- An Italian tax authority assessment related primarily to 2008 deductions is being litigated. No liability was recorded; settlement at face value could increase income tax expense by approximately $30 million.
- Environmental reserves were $5.1 million. Additional Superfund and remediation exposure remains uncertain and may change as facts and regulatory requirements develop.
- Forward-looking risks include economic recession, raw-material availability and cost, foreign exchange, international-market and regulatory risks, competition, labor and energy costs, commodity prices, product claims, acquisition integration, environmental remediation and demand for new and existing products.
- Goodwill impairment indicators were not identified during the period. Interim LIFO inventory values remain subject to final year-end adjustments.
- Disclosure controls and procedures were assessed as effective, and no material changes to internal control over financial reporting were reported.
Important Investor Verification Items
- Demand recovery: Verify whether weakness in energy, general engineering, earthworks and transportation markets persists and whether aerospace growth continues.
- Margin normalization: Track manufacturing-cost absorption, inventory reductions, cost actions and the ability to restore gross and operating margins.
- Stellite performance: Assess whether Stellite’s improved profitability is sustainable and whether integration benefits offset acquisition-related leverage.
- Leverage and liquidity: Reconcile total debt, cash balances, restricted cash availability outside the United States and compliance with credit agreement covenants.
- Tax contingency: Monitor the Italian tax litigation and potential exposure of approximately $30 million.
- Environmental obligations: Review developments at Superfund and other remediation sites beyond the recorded $5.1 million reserve.
- Capital allocation: Evaluate the effects of share repurchases, dividends, subsidiary share sales and capital expenditures on liquidity and leverage.