Kennametal Inc. — Fiscal 2012 First-Quarter 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 end markets, including aerospace, transportation, general engineering, energy, mining and construction. This unaudited filing covers the three months ended September 30, 2011, compared with the three months ended September 30, 2010. Fiscal years end June 30.
Key Financial Metrics
| Metric | Q1 FY2012 | Q1 FY2011 | Change |
|---|---|---|---|
| Sales | $658.9 million | $529.2 million | +25% |
| Gross profit | $251.1 million | $188.7 million | +33% |
| Gross margin | 38.1% | 35.7% | +240 basis points |
| Operating income | $101.6 million | $57.5 million | +77% |
| Operating margin | 15.4% | 10.9% | +450 basis points |
| Income before taxes | $95.5 million | $49.6 million | +93% |
| Net income attributable to Kennametal | $72.0 million | $34.9 million | +106% |
| Diluted EPS | $0.88 | $0.42 | +110% |
| Effective tax rate | 23.0% | 27.6% | Lower by 460 basis points |
| Cash flow from operations | $(7.2) million | $26.4 million | Declined $33.7 million |
| Capital expenditures | $11.6 million | $10.1 million | Increased $1.5 million |
| Cash and equivalents at period-end | $102.5 million | $124.2 million | Compared with prior-year period-end |
Sales growth included 17% organic growth, a 7% favorable foreign-currency effect and a benefit from more business days. Industrial sales increased 26% to $417.8 million, while Infrastructure sales increased 21% to $241.1 million. Operating income was $72.7 million for Industrial and $32.6 million for Infrastructure.
Liquidity, Debt and Balance Sheet
- Total debt was $312.7 million at September 30, 2011, consisting primarily of $300 million of Senior Unsecured Notes maturing in June 2012. The filing states that the notes were expected to be refinanced through a new corporate bond issuance.
- The company had no borrowings under its revolving credit facility at September 30, 2011 and was in compliance with its financial covenants.
- On October 21, 2011, the revolving credit facility was amended to increase capacity from $500 million to $600 million, extend the maturity to October 2016 and improve pricing; key covenants remained unchanged.
- Working capital was $429.7 million at September 30, 2011, down from $446.1 million at June 30, 2011. The decline primarily reflected the $102.0 million reduction in cash, partly offset by higher inventories.
- Inventory increased $39.6 million from June 30, 2011, while accounts payable declined $35.9 million and accrued expenses declined $15.4 million, contributing to weak operating cash flow.
Material Changes Versus the Prior Comparable Period
- Profitability improved substantially due to higher volume, price realization, cost containment and restructuring benefits, partially offset by higher raw-material costs.
- Restructuring charges were zero in the current quarter versus $4.3 million of restructuring-related charges in the prior-year quarter. Completed restructuring programs are expected to provide approximately $170 million of annual ongoing pretax savings.
- Operating expense increased 16.8% to $146.0 million, primarily due to foreign-currency effects, higher employment and sales compensation costs, and strategic initiatives.
- Operating cash flow became negative because of a $62.7 million inventory increase and a $64.7 million decrease in accounts payable and accrued liabilities, including a $27.0 million incentive-compensation payment.
- The company repurchased 2.0 million shares for $66.7 million during the quarter under its 8 million-share authorization. Cash dividends paid were $9.8 million, and the quarterly dividend remained $0.12 per share.
- Kennametal shareowners’ equity declined $69.8 million from June 30, 2011, mainly due to foreign-currency translation losses of $69.9 million, share repurchases and dividends, partially offset by net income.
- Total comprehensive loss was $4.6 million, despite net income of $73.6 million, primarily because of a $69.9 million foreign-currency translation loss and losses on cash-flow hedges.
Guidance, Outlook, Risks and Unusual Items
Management reported strong growth across both segments and all regions, with particularly strong demand in general engineering, energy, transportation and earthworks. The filing does not provide a clear quantitative earnings or revenue forecast for fiscal 2012. Management expects restructuring savings to continue at an annual pretax rate of approximately $170 million.
- Key risks include economic recession, demand volatility, raw-material and energy costs, foreign-currency movements, international operating risks, competition, labor relations, product claims, intellectual property matters, acquisitions and divestitures, environmental remediation and the ability to realize restructuring benefits.
- Environmental reserves were $4.8 million at September 30, 2011. Certain Superfund matters remain too early-stage for the company to estimate ultimate costs, timing or allocation of liability.
- Forward-starting interest-rate swaps with a cumulative notional amount of $150 million had a liability of $20.6 million at September 30, 2011, compared with $2.4 million at June 30, 2011. The company expects no significant related earnings impact over the next 12 months based on then-current market rates.
- The company used LIFO for approximately 50% of inventories; interim results remain subject to final year-end LIFO adjustments.
- The performance period for the Strategic Transformational Equity Program ended September 30, 2011. Minimum performance thresholds were not achieved, and all outstanding related restricted stock units were forfeited.
- Management concluded that disclosure controls and procedures were effective as of September 30, 2011, with no material changes to internal control over financial reporting.
Investor Verification Checklist
- Verify the refinancing or repayment of the $300 million Senior Unsecured Notes due June 2012 and the terms of any replacement debt.
- Monitor whether inventory growth converts into sales and operating cash flow, and whether working-capital pressure normalizes.
- Assess the sustainability of the 38.1% gross margin and 15.4% operating margin after restructuring benefits and amid higher raw-material costs.
- Confirm the realization of the approximately $170 million annual restructuring savings.
- Track foreign-currency effects, derivative valuations and the impact of comprehensive losses on equity.
- Review developments in environmental remediation matters and potential unreserved liabilities.
- Evaluate the company’s ability to realize deferred tax assets in jurisdictions with valuation allowances; management states that future realization remains uncertain.