Kennametal Inc. — Fiscal 2014 First Quarter Form 10-Q
Reporting period: Three months ended September 30, 2013; filed November 7, 2013. The interim financial statements are unaudited. Kennametal manufactures tooling, engineered components and advanced materials through its Industrial and Infrastructure segments.
Financial performance and position
| Metric | Q1 FY2014 | Q1 FY2013 | Change |
|---|---|---|---|
| Sales | $619.8 million | $629.5 million | Down 2% |
| Gross profit | $198.2 million | $208.3 million | Down $10.1 million |
| Gross margin | 32.0% | 33.1% | Down 110 bps |
| Operating income | $58.8 million | $64.4 million | Down $5.6 million |
| Operating margin | 9.5% | 10.2% | Down approximately 80 bps |
| Net income attributable to Kennametal | $37.8 million | $46.4 million | Down 18% |
| Diluted EPS | $0.48 | $0.57 | Down $0.09 |
| Operating cash flow | $44.4 million | $3.1 million | Up $41.3 million |
- Industrial sales increased 1% to $338.2 million, with operating income of $39.8 million and an 11.8% operating margin.
- Infrastructure sales declined 4% to $281.6 million, while operating income fell 21% to $21.7 million and the operating margin decreased to 7.7% from 9.4%.
- Interest expense increased to $7.1 million from $6.0 million. Other expense was $0.6 million versus other income of $0.9 million in the prior-year quarter.
- The effective tax rate increased to 24.6% from 20.7%, primarily because the prior-year period benefited from a favorable European tax audit settlement.
- Cash and equivalents were $333.3 million at September 30, 2013, compared with $377.3 million at June 30, 2013. Working capital was $1.069 billion.
- Total debt was $706.3 million, including $703.4 million of long-term debt and capital leases. No borrowings were outstanding under the $600 million revolving credit facility at quarter-end, and all debt covenants were satisfied.
- Capital expenditures were approximately $25.0 million. Investing cash outflows also included $17.5 million for acquisitions in the Infrastructure segment.
- Cash dividends paid were $14.1 million, and the company repurchased $4.3 million of capital stock.
Material changes versus the prior comparable period
- Sales declined due to a 3% organic decrease, partly offset by a 1% favorable effect from more business days. Management cited continuing weakness in mining and softer near-term energy demand.
- Earthworks sales declined approximately 8%, aerospace and defense declined 4%, and energy declined 3%; general engineering and transportation increased 3% and 2%, respectively.
- Gross profit and margin were pressured by lower organic sales, unfavorable mix and a non-recurring $5.7 million physical inventory adjustment related to the mining business. Lower raw-material costs and reduced operating expense provided partial offsets.
- Operating expense decreased 3.3% to $134.3 million, although it included $1.1 million of acquisition-related charges.
- Operating cash flow improved materially, primarily because the prior-year period reflected unusually large reductions in accounts payable and accrued liabilities.
- The company implemented an enhanced operating structure effective July 1, 2013 and restated prior segment information for comparability.
Outlook, transactions, risks and unusual items
- The filing does not provide a specific quarterly or annual earnings or revenue guidance figure.
- On August 1, 2013, Kennametal acquired Emura assets in its Infrastructure segment. The transaction generated approximately $17.5 million of acquisition-related investing cash outflow, added $16.0 million of intangible assets and resulted in $14.0 million of contingent consideration at September 30, 2013.
- On November 4, 2013, after quarter-end, the company completed its approximately $605 million acquisition of ATI’s Tungsten Materials business, subject to purchase price adjustment. Management expects strategic sourcing benefits, significant synergies and a reduction in planned capital expenditures of approximately $30 million to $35 million, but the filing states that purchase accounting values were not yet available.
- Management identified economic conditions, raw-material availability and costs, foreign currency, international markets, regulation, competition, labor relations, product claims, acquisition integration, energy and commodity prices, demand conditions, catastrophic events and environmental remediation as key risks.
- Environmental reserves were $5.2 million at September 30, 2013. Certain Superfund matters remained at an early stage and could not yet be estimated reliably; management stated that environmental liabilities may change substantially.
- Cash of $232.6 million held by non-U.S. subsidiaries was considered unavailable for long-term U.S. use without additional tax consequences.
- Disclosure controls were assessed as effective. The assessment excluded Emura’s internal controls because it had been acquired within the first year.
Investor verification checklist
- Verify the sustainability of demand recovery in mining, earthworks and energy markets, particularly in China and the Americas.
- Reconcile reported operating performance excluding the $5.7 million inventory adjustment and $1.1 million of acquisition-related charges.
- Review financing used for the ATI transaction, resulting leverage, covenant headroom and integration costs in subsequent filings.
- Assess whether expected ATI synergies and $30 million to $35 million of planned capital-expenditure reductions are achieved.
- Monitor inventory growth, working-capital requirements and the decline in quarter-end cash.
- Review the final purchase accounting for Emura and ATI, including goodwill, intangible assets and contingent consideration.
- Track environmental remediation obligations and developments at unresolved Superfund sites.