Kennametal Inc. Form 10-Q Summary
Reporting period: Three and nine months ended March 31, 2020; filed May 5, 2020. The request metadata identifies “2019 Q3,” but the filing is for fiscal 2020 third quarter. Results are unaudited and should be read with the fiscal 2019 Form 10-K.
Business context
Kennametal is a global industrial technology company supplying tungsten carbide, ceramics, super-hard materials, metalworking tools, engineered wear components and metallurgical powders. Its reportable segments are Industrial, Widia and Infrastructure, serving aerospace, earthworks, energy, general engineering and transportation markets.
Financial performance
| Metric | Three months ended March 31, 2020 | Three months ended March 31, 2019 | Nine months ended March 31, 2020 | Nine months ended March 31, 2019 |
|---|---|---|---|---|
| Sales | $483.1 million | $597.2 million | $1,506.3 million | $1,771.3 million |
| Gross profit | $157.0 million | $208.1 million | $428.0 million | $617.8 million |
| Gross margin | 32.5% | 34.8% | 28.4% | 34.9% |
| Operating income | $37.9 million | $81.9 million | $6.6 million | $243.9 million |
| Operating margin | 7.8% | 13.7% | 0.4% | 13.8% |
| Net income attributable to Kennametal | $2.9 million | $68.6 million | $3.4 million | $179.9 million |
| Diluted EPS | $0.03 | $0.82 | $0.04 | $2.16 |
- Sales: Third-quarter sales declined 19%, including a 17% organic decline, 1% unfavorable currency effect and 1% divestiture impact. Nine-month sales declined 15%, including a 13% organic decline.
- Demand: Reported third-quarter sales declined across all regions and major end markets. Total end-market declines were 25% in energy, 20% in general engineering, 19% in transportation, 17% in aerospace and 8% in earthworks.
- Segments: Third-quarter Industrial sales declined 18% and operating margin fell to 11.6% from 18.0%. Widia sales declined 16% and its operating loss was $13.5 million. Infrastructure sales declined 21%, while operating margin increased to 12.2% from 11.0%, helped partly by lower costs.
- Taxes: The effective tax rate was 93.1% for the quarter and 143.5% for the nine-month period, reflecting restructuring, Widia impairment charges, jurisdictional mix and discrete tax items. The nine-month tax provision was a benefit of $11.3 million because the company reported a pretax loss.
Cash flow, liquidity and capital structure
- Operating cash flow was $146.1 million for the nine months, compared with $157.5 million in the prior-year period.
- Capital expenditures were $206.1 million, up from $145.9 million, primarily for simplification and modernization initiatives. Investing cash flow was negative $180.2 million.
- Financing cash flow was negative $54.0 million, including $49.7 million of dividends. The prior-year period included $400.0 million of term-debt repayments.
- Cash and cash equivalents were $85.2 million at March 31, 2020, down from $182.0 million at June 30, 2019. Working capital was $583.6 million, down from $729.1 million.
- Total debt was $598.1 million, including $4.5 million outstanding under the $700 million revolving credit facility. Long-term debt, including current maturities, was $598.1 million on the balance sheet.
- The company was in compliance with its maximum leverage and minimum interest-coverage covenants at March 31, 2020 and expected to remain compliant over the following 12 months. Subsequent to quarter-end, it drew $500.0 million under the revolving facility to preserve liquidity amid COVID-19-related market uncertainty.
- Operating lease liabilities totaled $47.2 million following adoption of the new lease standard on July 1, 2019.
Material changes and unusual items
- COVID-19: The pandemic contributed to deteriorating demand, particularly in energy, aerospace and transportation. Kennametal India and its Bolivian operations were closed during part of the quarter due to government mandates, although the company reported no material supply-chain disruption through March 31.
- Widia impairment: The company recorded a $15.6 million non-cash pretax impairment charge in the quarter, comprising $13.7 million of goodwill and $1.9 million of indefinite-lived trademark impairment. Nine-month impairment charges totaled $30.2 million. No goodwill remained for the Widia reporting unit after the quarter.
- Restructuring: Nine-month restructuring and related charges were $65.1 million, compared with $6.8 million in the prior-year period. Total charges since inception were $50.0 million for the fiscal 2020 program and $28.8 million for the fiscal 2021 program.
- Divestiture: Kennametal sold certain specialty alloys and metals assets for $24.0 million, recognizing a $6.5 million pretax loss. Proceeds were primarily used for capital expenditures.
- Cost savings: Management reported approximately $15 million of total quarterly benefits from simplification and modernization, approximately $87 million of annualized run-rate savings since inception, and expected annualized savings of $30 million to $35 million from fiscal 2020 actions and $25 million to $30 million from fiscal 2021 actions.
- Currency translation: Other comprehensive loss attributable to Kennametal shareholders was $33.2 million for the nine months, primarily reflecting foreign currency translation losses.
Outlook, risks and contingencies
- Management expected COVID-19 to have a more material negative effect on customer demand in the fourth quarter of fiscal 2020, but did not provide specific revenue or earnings guidance.
- Results remain exposed to the duration and severity of COVID-19, customer demand, facility closures, supply-chain interruptions, employee availability, access to financial markets and covenant compliance.
- Further weakness in demand or failure to achieve planned restructuring benefits could cause additional goodwill or intangible-asset impairment, particularly for Widia, whose trademark carrying value of approximately $10.9 million approximated fair value after the March impairment.
- Environmental reserves were $11.8 million at March 31, 2020. The company stated that reserves were adequate based on current estimates, but environmental obligations remain subject to uncertainty.
- Kennametal is contesting an Italian tax assessment of up to €36 million, or approximately $40 million, including penalties and interest. Payment is currently stayed, and no liability has been recorded.
- The company stated that no individual or aggregate pending legal proceeding was material, and that it believed available resources were sufficient to meet requirements for the next 12 months.
Investor verification checklist
- Verify the timing, amount and terms of the subsequent $500 million revolving-credit draw and its effect on leverage, interest expense and covenant headroom.
- Assess fourth-quarter and fiscal 2021 demand trends, especially in energy, aerospace, transportation and general engineering.
- Monitor Widia’s operating performance and the risk of additional trademark or other asset impairments.
- Compare restructuring cash expenditures with the stated annualized savings targets and confirm whether the savings are recurring.
- Review capital-expenditure levels, free cash flow and dividend sustainability after the significant sales decline.
- Track the Italian tax litigation and potential exposure of up to approximately $40 million, as well as environmental remediation obligations.