Kennametal Inc. — Fiscal 2018 First Quarter Form 10-Q
Business context and reporting period
Kennametal is a global manufacturer of tungsten carbide, ceramic, super-hard material and wear-resistant solutions serving metalworking, transportation, aerospace and defense, energy, mining, construction and other industrial markets. The filing covers the unaudited three months ended September 30, 2017, compared with the three months ended September 30, 2016.
Key financial metrics
| Metric | Q1 FY2018 | Q1 FY2017 |
|---|---|---|
| Sales | $542.5 million | $477.1 million |
| Gross profit / margin | $185.0 million / 34.1% | $143.5 million / 30.1% |
| Operating income (loss) / margin | $56.5 million / 10.4% | $(9.2) million / (1.9)% |
| Net income (loss) | $39.6 million | $(21.2) million |
| Net income attributable to Kennametal | $39.2 million | $(21.7) million |
| Diluted EPS | $0.48 | $(0.27) |
| Cash flow from operating activities | $(19.9) million | $23.6 million |
| Capital expenditures | $42.1 million | $42.3 million |
Sales increased 13.7%, comprising 13% organic growth and a 2% favorable currency impact, partly offset by 1% fewer business days. Estimated net margin was approximately 7.3% based on consolidated net income and sales. Interest expense was $7.1 million, and the effective tax rate was 19.5%.
Segment sales and operating income were: Industrial $297.5 million and $34.8 million; Infrastructure $199.7 million and $22.1 million; and Widia $45.2 million and $0.1 million. Segment operating margins were 11.7%, 11.0% and 0.1%, respectively.
At September 30, 2017, cash and cash equivalents were $110.7 million, total debt was approximately $696.6 million, and total shareholders’ equity was $1.062 billion. The company had no borrowings under its $600 million revolving credit facility and was in compliance with its debt covenants. Working capital was $678.9 million. Cash declined $79.9 million during the quarter to $110.7 million.
Material changes versus the prior comparable period
- Profitability improved substantially, with operating income of $56.5 million versus an operating loss of $9.2 million.
- Gross margin expanded to 34.1% from 30.1%, supported by sales growth, restructuring benefits, favorable mix, productivity and fixed-cost absorption.
- Operating expense was broadly flat at $119.3 million versus $119.9 million.
- Restructuring and related charges declined to $6.9 million from $31.7 million; reported restructuring charges were $5.5 million versus $28.6 million.
- Management reported approximately $40 million of pretax restructuring benefits in the quarter, including approximately $22 million incremental to the prior-year quarter. Cumulative restructuring charges were $154.5 million, with ongoing annualized savings estimated at approximately $165 million.
- Operating cash flow deteriorated to a $19.9 million use from a $23.6 million source, primarily due to a $62.7 million decrease in accounts payable and accrued liabilities, a $19.7 million inventory increase and other working-capital outflows.
- Infrastructure sales increased 20%, Industrial sales increased 11% and Widia sales increased 10%. Each segment improved operating profitability, although Widia remained near breakeven.
- Foreign currency translation increased other comprehensive income by $19.9 million and contributed to higher reported equity.
Outlook, commentary, risks and unusual items
Management stated that first-quarter performance surpassed expectations and that sales growth occurred across all segments, regions and end markets. The existing restructuring programs were substantially completed during the quarter. Additional benefits from modernization, product simplification and process simplification initiatives are expected to accrue over the next several years. The filing does not provide a specific numerical full-year revenue or earnings guidance figure.
Management believes available cash, liquidity, investment-grade credit ratings and access to capital markets are sufficient to meet cash requirements for the next 12 months. Capital expenditures remain a significant cash use, and operating cash flow was negative despite the return to profitability.
Principal disclosed risks include economic and business-cycle downturns, demand volatility in energy and industrial markets, foreign exchange movements, raw-material availability and costs, international regulatory and political conditions, environmental compliance and remediation, product liability, competition, intellectual property protection, information-technology security, labor relations, restructuring execution and potential goodwill or intangible-asset impairment.
Environmental reserves were $12.6 million at September 30, 2017. The company is involved in environmental remediation matters and CERCLA Superfund sites, but stated that no individual pending legal proceeding, or the proceedings in aggregate, was material. The company adopted employee share-based payment and inventory accounting updates effective July 1, 2017; neither had a material adverse impact on the financial statements. Revenue standard ASC 606 was scheduled for adoption on July 1, 2018, with the complete impact not yet determined.
Important facts for investors to verify
- Whether restructuring savings of approximately $165 million annualized are sustainable and whether additional modernization initiatives generate the expected benefits.
- Whether negative operating cash flow reverses as inventory, payables and accrued liabilities normalize.
- Widia’s ability to improve from approximately breakeven profitability and sustain the strong Industrial and Infrastructure margins.
- Exposure to energy, mining, construction and other cyclical end markets, including the durability of the reported recovery.
- The effect of currency movements, raw-material costs and fewer or changing business days on future margins.
- The eventual accounting and timing effects of ASC 606 adoption, particularly for customized products and marketing programs.
- The adequacy of environmental reserves and the potential for future remediation, impairment or other unusual charges.