Kennametal Inc. — Fiscal 2014 Form 10-K Summary
Business context and reporting period
Kennametal is a global manufacturer of metalworking tools, engineered components, advanced materials, coatings and earth-cutting products serving industrial production, transportation, aerospace and defense, energy, mining, infrastructure and general engineering markets. The filing covers the fiscal year ended June 30, 2014. The company reports two segments: Industrial and Infrastructure. Approximately 60% of fiscal 2014 sales were generated outside the United States.
Fiscal 2014 included eight months of results from the acquisition of the Tungsten Materials Business (TMB) and substantially all of the year from the Emura tungsten-sourcing acquisition.
Key financial metrics
| Metric | Fiscal 2014 | Fiscal 2013 | Change |
|---|---|---|---|
| Sales | $2.837 billion | $2.589 billion | +9.6% |
| Gross profit | $897.0 million | $845.0 million | +6.2% |
| Gross margin | 31.6% | 32.6% | Down 100 bps |
| Operating income | $263.4 million | $296.4 million | -11.1% |
| Operating margin | 9.3% | 11.4% | Down 210 bps |
| Net income attributable to Kennametal | $158.4 million | $203.3 million | -22.1% |
| Diluted earnings per share | $1.99 | $2.52 | -21.0% |
| Cash flow from operations | $271.9 million | $284.2 million | -4.3% |
| Capital expenditures | $117.4 million | $82.8 million | +41.7% |
| Dividends per share | $0.72 | $0.64 | +12.5% |
Fiscal fourth-quarter sales were $772.2 million, compared with $671.4 million in the prior-year quarter. Fourth-quarter net income attributable to Kennametal was $45.5 million, or $0.57 diluted EPS, compared with $60.8 million, or $0.76 diluted EPS, in the prior-year quarter.
Segment performance and material changes
- Industrial: Sales increased 10% to $1.524 billion, reflecting 5% acquisition growth, 4% organic growth and an additional business day. Operating income declined to $177.0 million from $192.8 million, and operating margin decreased to 11.6% from 13.9%. Restructuring costs, TMB purchase-accounting effects, higher employment costs and acquisition expenses more than offset organic growth.
- Infrastructure: Sales increased 9% to $1.313 billion, primarily from TMB, while organic sales declined 1%. Energy sales grew 4%, but earthworks sales fell 6% amid weak global mining and road-construction activity. Operating income declined to $94.9 million from $111.5 million, and operating margin fell to 7.2% from 9.3%.
- Acquisitions: TMB was acquired in November 2013 for $607.0 million, net of cash acquired. It contributed $194.9 million of fiscal 2014 sales and a $10.5 million net loss attributable to Kennametal, including purchase-accounting and integration effects. Emura was acquired in August 2013 for $40.1 million, including contingent consideration, to diversify tungsten sourcing.
- Restructuring: The company recognized $19.1 million of restructuring and related charges in fiscal 2014. Total charges are expected to range from $40 million to $50 million over approximately two years, with anticipated ongoing annual benefits of $35 million to $45 million once fully implemented.
- Taxation: The effective tax rate increased to 29.1% from 22.4%, principally because of a $7.2 million charge associated with a change in the assertion that certain foreign earnings were permanently reinvested, as well as nondeductible restructuring and divestiture costs and expiration of an R&D credit.
Cash flow, debt and liquidity
Operating cash flow was $271.9 million. Investing cash flow used $740.2 million, including $634.6 million for acquisitions and $117.4 million for capital expenditures. Financing cash flow provided $270.4 million, primarily because of a $313.1 million net increase in borrowings, partly offset by $56.4 million of dividends and $14.2 million of share repurchases. Cash and cash equivalents declined to $177.9 million from $377.3 million.
Total debt, including capital leases and notes payable, increased to $1.062 billion from $747.9 million. Long-term debt and capital leases were $981.7 million. Borrowings under the $600 million revolving credit facility totaled $287.1 million at June 30, 2014, primarily supporting the TMB acquisition; the facility matures in April 2018. The company reported compliance with all debt covenants and stated that operating cash flow and available credit lines should be sufficient for the next 12 months. Approximately 34% of debt was exposed to variable interest rates, compared with 6% in the prior year.
Working capital was $962.4 million, down from $1.032 billion, while total assets increased to $3.868 billion, largely because of acquisitions. Shareowners’ equity increased to $1.929 billion.
Outlook, risks and unusual items
- The filing does not provide a clear numerical fiscal 2015 sales or earnings guidance range. Management cited sequential organic sales growth in every fiscal 2014 quarter and continued focus on cash flow, portfolio balance, innovation and cost improvement.
- Management expects restructuring and integration initiatives to produce $35 million to $45 million of annual ongoing benefits after implementation, but additional charges and execution risks remain.
- The company is exploring strategic alternatives for part of the Infrastructure business with an estimated net book value of approximately $39 million. The filing states that any impairment loss was not yet probable or estimable.
- Principal risks include cyclical industrial demand, weak mining and earthworks markets, raw-material availability and pricing, foreign-exchange volatility, international political and regulatory conditions, environmental and health-and-safety liabilities, competition, product liability, intellectual-property protection, labor availability, information-technology disruptions and acquisition integration.
- Environmental reserves increased to $11.0 million from $5.1 million. The company is also a potentially responsible party at certain Superfund sites, although some potential liabilities cannot yet be estimated.
- Unrecognized tax benefits totaled $20.4 million, excluding related interest and penalties. The company also reported $2.427 billion of unremitted foreign earnings treated as permanently reinvested.
- Management and PricewaterhouseCoopers concluded that internal control over financial reporting was effective, but the assessment excluded recently acquired TMB and Emura under applicable SEC guidance.
Important facts for investors to verify
- Whether TMB integration delivers the projected $35 million to $45 million of annual savings and improves Industrial and Infrastructure margins.
- The sustainability of organic growth, particularly given continued weakness in mining, earthworks and portions of aerospace and defense.
- Debt reduction capacity, variable-rate exposure and compliance with the revolving credit facility’s leverage and interest-coverage covenants.
- The eventual strategic outcome and potential impairment exposure for the Infrastructure business under review.
- Changes in tungsten and other raw-material prices, foreign-exchange effects and the company’s ability to recover cost increases through pricing.
- Potential changes to environmental reserves, Superfund obligations and unrecognized tax benefits.
- The filing’s unaudited pro forma TMB results and the extent to which reported fiscal 2014 growth reflects acquisition accounting rather than underlying organic performance.