Kennametal Inc. 2017 Form 10-K Summary
Reporting period: Fiscal year ended June 30, 2017. The request references “2016 Q4,” but the supplied filing is the fiscal 2017 annual report, not a fiscal 2016 quarterly filing.
Business Context
Kennametal develops and manufactures tungsten carbide, ceramic, super-hard material, metalworking tools, engineered wear components and metallurgical powders. Its three reportable segments are Industrial, Widia and Infrastructure. Approximately 56% of fiscal 2017 sales were generated outside the United States.
Fiscal 2017 included a new operating structure separating Widia from Industrial, continued restructuring, workforce reductions, manufacturing modernization and sales-channel changes. The company employed approximately 10,700 people at year-end.
Financial Performance and Position
| Metric | Fiscal 2017 | Fiscal 2016 |
|---|---|---|
| Sales | $2,058.4 million | $2,098.4 million |
| Organic sales growth | 4% | (11)% |
| Gross profit | $657.7 million | $616.1 million |
| Gross margin | 32.0% | 29.4% |
| Operating income (loss) | $112.9 million | $(174.9) million |
| Operating margin | 5.5% | (8.3)% |
| Net income (loss attributable to Kennametal) | $49.1 million | $(226.0) million |
| Diluted EPS | $0.61 | $(2.83) |
| Operating cash flow | $192.2 million | $219.3 million |
| Capital expenditures | $118.0 million | $110.7 million |
| Cash and equivalents | $190.6 million | $161.6 million |
| Total debt, including capital leases and notes payable | $695.9 million | $695.4 million |
| Working capital | $652.4 million | $648.1 million |
Cash dividends paid were $64.1 million, or $0.80 per share. Shareholders’ equity attributable to Kennametal was $1,017.3 million at June 30, 2017. Pension and postretirement obligations totaled approximately $162.9 million, including $144.0 million of accrued pension benefits and $16.9 million of postretirement benefits.
Segment Results
- Industrial: Sales of $1,126.3 million, up 3% year over year; operating income of $82.8 million versus $90.3 million. Operating margin declined to 7.4% from 8.2%.
- Widia: Sales of $177.7 million, up 4%; operating loss of $9.6 million versus $9.1 million. Operating loss margin was 5.4%.
- Infrastructure: Sales of $754.4 million, down 9%, including a 9% divestiture impact; organic sales grew 1%. Operating income was $40.0 million versus a $246.3 million loss, primarily reflecting the absence of prior-year impairment and divestiture charges.
Material Changes Versus the Prior Comparable Period
- Sales declined 2% on a reported basis because of a 4% divestiture impact and 2% unfavorable currency effect, partially offset by 4% organic growth.
- Profitability improved substantially as fiscal 2016 included $131.5 million of divestiture losses, $108.5 million of goodwill and intangible impairment charges and $5.4 million of fixed-asset disposal charges. No asset impairment or divestiture loss was recorded in fiscal 2017.
- Gross margin expanded 260 basis points, supported by restructuring benefits, improved absorption and productivity, organic growth and lower raw-material costs.
- Operating cash flow decreased $27.1 million, while capital expenditures increased $7.3 million as the company invested in equipment upgrades and manufacturing modernization.
- Cash increased $29.1 million despite $118.0 million of capital expenditures and $64.1 million of dividends.
- Fiscal 2017 restructuring and related charges were $76.2 million, compared with $53.5 million in fiscal 2016. Employment costs were reduced on a run-rate basis by approximately $80 million.
Liquidity, Debt and Capital Resources
Kennametal had no borrowings outstanding under its $600 million revolving credit facility at June 30, 2017. The facility matures in April 2021, and the company was in compliance with its financial covenants. The principal senior unsecured notes were $400 million due in 2019 at 2.65% and $300 million due in 2022 at 3.875%. Less than 1% of total debt was exposed to variable interest rates.
Management stated that operating cash flow and available credit lines should be sufficient to meet cash requirements over the following 12 months. Approximately $115.4 million of cash and equivalents was not available for long-term U.S. use without potential tax consequences because of permanently reinvested foreign earnings.
Outlook, Commentary and Unusual Items
- Management reported improving market conditions and positive organic growth in all segments during fiscal 2017.
- Restructuring programs are expected to generate annual ongoing pretax savings of $165 million to $180 million when completed, with completion targeted by December 31, 2018. Total program charges are expected to reach $165 million to $195 million.
- The company expects modernization and End-to-End manufacturing initiatives to generate an additional $200 million to $300 million of annual savings over the next two to three years, although these initiatives are expected to pressure near-term cash flow.
- The filing does not provide a clear fiscal 2018 sales, EPS or cash-flow guidance range.
- Infrastructure markets showed sequential improvement, but underground mining and portions of construction remained weak.
- Effective August 1, 2017, Christopher Rossi became President and Chief Executive Officer, while Ronald M. De Feo became Executive Chairman.
- Environmental reserves were $12.4 million at June 30, 2017. The company is also a potentially responsible party at certain Superfund sites and cautions that remediation costs could change.
- An Italian tax assessment remains in litigation. No liability has been recorded; an unfavorable outcome could increase income tax expense by approximately €22 million, or $25 million.
- Key risks include cyclical demand, execution of restructuring and modernization, international and currency exposure, raw-material availability and pricing, environmental liabilities, goodwill impairment, information-technology disruption, competition and labor-related risks.
Important Facts for Investors to Verify
- Whether the projected $165 million to $180 million of restructuring savings are realized without materially disrupting customer service or production.
- The timing, cash cost and return on investment of the planned factory modernization and End-to-End initiatives.
- Whether Infrastructure organic growth and mining-related demand continue to improve.
- The company’s ability to refinance or repay the $400 million of senior notes due in 2019 while maintaining dividends and capital investment.
- Exposure to tungsten, cobalt and other raw-material price or supply volatility, as well as foreign-exchange movements.
- Potential changes to environmental reserves and the outcome of the Italian tax litigation.
- Future goodwill or intangible impairment risk, particularly if operating performance weakens.
- The impact of adopting the new revenue-recognition, lease, pension-cost presentation and credit-loss accounting standards.