Kennametal Inc. Form 10-K Summary
Reporting period: Fiscal year ended June 30, 2018. The source filing is a fiscal 2018 annual report, not a standalone 2017 fourth-quarter filing; quarterly data for the quarter ended June 30, 2018 is included.
Business Context
Kennametal develops and manufactures tungsten carbide, ceramic, super-hard material, metalworking tooling, engineered wear components and metallurgical powders. Its three reportable segments are Industrial, Widia and Infrastructure. End markets include general engineering, transportation, energy, earthworks, and aerospace and defense. International markets generated 59% of fiscal 2018 sales.
Financial Performance and Position
| Metric | FY2018 | FY2017 | Change |
|---|---|---|---|
| Sales | $2.368 billion | $2.058 billion | 15.0% increase |
| Gross profit | $832.3 million | $657.7 million | 26.5% increase |
| Gross margin | 35.1% | 32.0% | 310 basis-point increase |
| Operating income | $307.6 million | $112.9 million | 172% increase |
| Operating margin | 13.0% | 5.5% | 750 basis-point increase |
| Net income attributable to Kennametal | $200.2 million | $49.1 million | Increase |
| Diluted EPS | $2.42 | $0.61 | Increase |
| Cash flow from operations | $277.3 million | $195.3 million | Increase |
| Capital expenditures | $171.0 million | $118.0 million | Increase |
| Dividends paid | $65.1 million | $64.1 million | Increase |
Segment sales increased 15% in Industrial to $1.292 billion, 12% in Widia to $198.6 million, and 16% in Infrastructure to $877.2 million. Segment operating income was $187.5 million, $4.4 million and $119.7 million, respectively.
At June 30, 2018, cash and cash equivalents were $556.2 million, working capital was $659.6 million, total debt was $991.7 million, and Kennametal shareholders' equity was $1.194 billion. The company had no borrowings under its revolving credit facility and was in compliance with its financial covenants.
Material Changes Versus the Prior Comparable Period
- Sales growth reflected 12% organic growth and a 4% favorable currency impact, partly offset by a 1% unfavorable business-day impact.
- Profitability improved across all segments, supported by stronger end-market demand, pricing, favorable mix, currency effects, restructuring benefits and initial modernization benefits.
- Restructuring and related charges declined to $15.9 million from $76.2 million. Legacy restructuring programs produced approximately $165 million of annualized pretax savings, while Industrial simplification actions were expected to produce approximately $10 million of annualized savings in the first half of fiscal 2019.
- Capital expenditures increased substantially as the company invested in manufacturing modernization and capacity additions.
- The company issued $300 million of 4.625% senior unsecured notes due 2028 and subsequently redeemed its $400 million of 2.650% notes on July 9, 2018. The revolving credit facility was increased from $600 million to $700 million and extended to June 2023.
- Fiscal 2018 benefited from the release of $91.3 million of U.S. deferred tax valuation allowance, substantially offsetting the $80.9 million estimated Tax Cuts and Jobs Act toll tax charge and other tax-reform effects.
Outlook, Risks and Unusual Items
Management stated that fiscal 2019 was expected to remain on track with the multi-year profitability improvement plan. Price realization was expected to offset anticipated raw-material inflation, and additional modernization and simplification benefits were expected over the following several years. The filing does not provide a clear consolidated fiscal 2019 sales or EPS guidance figure.
- Key risks include cyclical industrial demand, economic downturns, international currency and political exposure, tariffs and trade barriers, raw-material availability and pricing, competition, labor disruptions, cybersecurity, product liability, environmental obligations and potential goodwill or intangible-asset impairment.
- Tungsten, cobalt and other raw-material costs may pressure margins if price increases cannot be passed through to customers. Management did not expect tariffs to have a material effect based on conditions at filing.
- Environmental reserves were $12.5 million at June 30, 2018. The company is a potentially responsible party at certain Superfund sites, and remediation estimates could change.
- The company reported a $109.953 million underfunded pension position and expected fiscal 2019 contributions of approximately $8.1 million to pension plans and $1.6 million to postretirement plans.
- An Italian tax dispute remains pending. No liability was recorded; an unfavorable outcome could increase income tax expense by approximately $25 million.
- Goodwill and other indefinite-lived intangible assets totaled approximately $319.4 million, or 11% of total assets. No impairment was recorded in fiscal 2018, but future underperformance could result in a non-cash charge.
- The company adopted the new revenue recognition standard on July 1, 2018 and expected no material effect on revenue timing or measurement other than additional disclosures.
Investor Verification Checklist
- Verify that fiscal 2018 margin expansion and segment profitability improvements persist after restructuring benefits and favorable currency effects.
- Monitor cash conversion as modernization capital spending, inventory and receivables increase.
- Assess leverage and refinancing requirements following the 2028 notes issuance and redemption of the 2.650% notes.
- Review fiscal 2019 guidance, including organic sales, operating margin, EPS, capital expenditures and free cash flow; the 10-K does not state clear consolidated numerical guidance.
- Track raw-material pricing, price realization, tariffs and demand trends in energy, mining, transportation and general engineering.
- Follow the final accounting for the TCJA toll tax, the permanent-reinvestment analysis for approximately $1.3 billion of unremitted foreign earnings, and the Italian tax litigation.
- Evaluate pension funding, environmental reserves, cybersecurity exposure and the sensitivity of goodwill and indefinite-lived intangible assets to weaker operating performance.