Kennametal Inc. Form 10-Q Summary
Reporting period: Three and nine months ended March 31, 2015; filed May 8, 2015. The request metadata identifies “2014 Q3,” but the filing is for Kennametal’s fiscal 2015 third quarter. Kennametal manufactures tooling, engineered components and advanced materials through its Industrial and Infrastructure segments.
Financial Performance and Position
| Metric | Three months ended March 31 | Change | Nine months ended March 31 | Change |
|---|---|---|---|---|
| Sales | $639.0 million | Down 15.4% | $2,009.5 million | Down 2.7% |
| Gross profit | $199.5 million | Down $39.5 million | $617.0 million | Down $27.1 million |
| Gross margin | 31.2% | Down 0.4 percentage points | 30.7% | Down 0.5 percentage points |
| Operating income/(loss) | $(120.4) million | Prior year: $76.8 million income | $(393.1) million | Prior year: $185.4 million income |
| Net income/(loss) attributable to Kennametal | $(46.2) million | Prior year: $50.9 million income | $(395.0) million | Prior year: $112.9 million income |
| Diluted EPS | $(0.58) | Prior year: $0.64 | $(4.98) | Prior year: $1.42 |
- Cash flow: Operating cash flow was $219.6 million for the nine-month period, compared with $153.2 million in the prior-year period. Investing cash flow was $(76.3) million, principally capital expenditures of $77.6 million. Financing cash flow was $(164.8) million, including $129.0 million of net debt repayment and $42.7 million of dividends.
- Liquidity: Cash and cash equivalents were $146.2 million at March 31, 2015, compared with $177.9 million at June 30, 2014. Working capital was $816.8 million, down from $962.4 million.
- Debt: Total debt was $903.8 million. Long-term debt and capital leases were $804.1 million, and notes payable to banks were $88.4 million. Revolving-credit borrowings were $113.9 million versus $287.1 million at June 30, 2014. The company was in compliance with all credit-facility covenants.
- Equity: Kennametal shareholders’ equity was $1.371 billion, down from $1.929 billion, primarily because of the year-to-date net loss and unfavorable currency translation.
Material Changes Versus the Prior Comparable Period
- Third-quarter sales declined 15%, driven by a 9% organic decline and 6% unfavorable currency translation. Energy, mining and earthworks markets were particularly weak.
- Industrial sales fell 11% in the quarter and operating margin declined to 10.0% from 12.9%. Nine-month Industrial sales were approximately flat and operating margin was 11.0% versus 11.2%.
- Infrastructure sales fell 20% in the quarter and 5% for the nine-month period. Infrastructure recorded an operating loss of $153.1 million in the quarter and $505.8 million year to date, compared with operating income of $28.0 million and $68.3 million, respectively, in the prior-year periods.
- The company recorded $159.7 million of non-cash pre-tax goodwill and intangible-asset impairment charges in the quarter and $541.7 million year to date, substantially affecting operating results and equity. Infrastructure goodwill declined to $112.3 million from $654.1 million at June 30, 2014.
- Restructuring and related charges were $16.7 million in the quarter and $37.1 million year to date. Restructuring savings partially offset the effects of lower sales, adverse mix and currency movements.
- The effective tax rate was a 64.4% benefit rate for the quarter and a 5.7% benefit rate year to date, primarily reflecting impairment charges and geographic earnings mix. A $2.1 million tax charge resulted from changing the assertion regarding certain foreign earnings.
Outlook, Commentary, Risks and Unusual Items
- Management cited an abrupt and continuing downturn in oil and gas demand, persistent weakness in earthworks and mining, unfavorable currency, and adverse Infrastructure mix. Future energy-market weakness was described as more severe than previously expected.
- Management announced Phase 3 restructuring in May 2015, expected to generate $25 million to $30 million of annualized savings and incur $40 million to $45 million of pre-tax charges over approximately 24 months. Combined restructuring programs are expected to produce $115 million to $135 million of annual ongoing savings and approximately $185 million to $205 million of total charges.
- Phase 1 and Phase 2 programs were expected to be completed by June 30, 2016 and December 31, 2016, respectively; Phase 3 was expected to be completed by March 31, 2017.
- Management was exploring strategic alternatives for several primarily Infrastructure businesses with estimated net book values of approximately $170 million to $250 million. Additional impairment charges were not considered probable or estimable at the filing date, but could arise depending on the eventual strategic direction and market conditions.
- Infrastructure goodwill and certain indefinite-lived trademarks had limited excess fair value over carrying value after impairment testing, creating sensitivity to lower growth assumptions, higher discount rates or further market deterioration.
- Environmental remediation reserves were $12.2 million. Certain Superfund matters remained at an early stage and could not yet be reasonably estimated.
- Key stated risks include economic conditions, raw-material availability and costs, foreign exchange, international operations, regulation, competition, labor relations, product claims, acquisitions and divestitures, energy and commodity prices, intellectual property, environmental matters and demand for new and existing products.
Investor Verification Checklist
- Verify the sustainability of cash generation after excluding non-cash impairment charges and considering restructuring-related cash expenditures.
- Monitor Infrastructure demand, especially oil and gas, mining, earthworks and road-construction markets, and assess the risk of further impairment.
- Reconcile the timing and total cost of Phases 1 through 3 restructuring against the projected $115 million to $135 million of annual savings.
- Review debt maturities, revolving-credit availability, covenant headroom and the planned $50 million to $100 million redeployment of foreign cash to reduce debt.
- Assess the effect of currency movements and the tax consequences of repatriating or redeploying foreign subsidiary earnings.
- Evaluate potential environmental liabilities and the strategic alternatives for businesses with $170 million to $250 million of net book value.