Kennametal Inc. Form 10-Q Summary
Reporting period: Three and nine months ended March 31, 2012, representing fiscal 2012 third-quarter reporting. The request metadata identifies “2011 Q3,” but the filing itself reports fiscal 2012 results.
Business Context
Kennametal is a global manufacturer and supplier of tooling, engineered components and advanced materials. Its reportable segments are Industrial and Infrastructure, serving aerospace, defense, transportation, general engineering, energy, mining, construction and related markets.
Financial Performance and Position
| Metric | Three months ended March 31, 2012 | Three months ended March 31, 2011 | Nine months ended March 31, 2012 | Nine months ended March 31, 2011 |
|---|---|---|---|---|
| Sales | $696.4 million | $614.8 million | $1,997.0 million | $1,709.8 million |
| Gross profit | $246.4 million | $230.0 million | $729.4 million | $618.7 million |
| Gross margin | 35.4% | 37.4% | 36.5% | 36.2% |
| Operating income | $103.3 million | $87.8 million | $299.0 million | $206.9 million |
| Net income attributable to Kennametal | $75.5 million | $64.7 million | $221.2 million | $143.1 million |
| Diluted EPS | $0.93 | $0.77 | $2.72 | $1.72 |
| Dividends per share | $0.14 | $0.12 | $0.40 | $0.36 |
Cash flow: Nine-month operating cash flow was $164.2 million, compared with $125.0 million in the prior-year period. Capital expenditures were $60.7 million. Investing cash flow was $(448.4) million, primarily because of the $382.6 million Stellite acquisition. Financing cash flow was $216.5 million, including new borrowings and the issuance of $300 million of 3.875% senior notes due 2022.
Liquidity and debt: Cash and cash equivalents were $125.5 million at March 31, 2012, compared with $204.6 million at June 30, 2011. Total debt, including notes payable and capital leases, was $640.9 million. The company had $29.2 million outstanding under its $600 million revolving credit facility and was in compliance with its financial covenants. Working capital was $493.2 million.
Balance sheet: Total assets were $3.20 billion and total Kennametal shareowners’ equity was $1.72 billion. Inventories increased to $630.9 million from $520.0 million at June 30, 2011, reflecting higher activity and demand.
Material Changes Versus the Prior Comparable Period
- Quarterly sales increased 13%, driven by 8% organic growth, a 4% acquisition contribution, 3% more business days and an unfavorable currency effect.
- Nine-month sales increased 17%, with 13% organic growth.
- Quarterly operating income increased $15.5 million, while diluted EPS increased $0.16. Growth reflected higher volume and pricing, partly offset by raw-material inflation and acquisition costs.
- Gross margin declined to 35.4% from 37.4% in the quarter because of higher raw-material costs; nine-month gross margin improved modestly to 36.5% from 36.2%.
- Industrial quarterly sales rose 6.8% and operating income increased $17.1 million. Infrastructure sales rose 24.6%, but operating income declined $1.6 million because of acquisition-related costs and higher raw-material costs.
- There were no restructuring charges in the current-year periods. Prior-year periods included $5.5 million of quarterly and $14.9 million of nine-month restructuring and related charges.
- Interest expense increased 38.8% in the quarter to $8.0 million because of increased borrowings.
- The company repurchased $66.8 million of capital stock during the nine months, compared with $26.5 million in the prior-year period.
Acquisition, Outlook and Risks
On March 1, 2012, Kennametal acquired U.K.-based Deloro Stellite Holdings 1 Limited for approximately $382.6 million net of cash acquired. Stellite contributed $22.5 million of sales and a $4.7 million net loss during the month of March, including $5.7 million of acquisition-related costs. The company expects the transaction to be accretive to earnings in fiscal 2013. The purchase price allocation remained preliminary, including $235.9 million of goodwill and $102.7 million of intangible assets.
Management reported strong growth across both segments and all regions, continued cost discipline and ongoing monitoring of raw-material costs for potential pricing actions. Restructuring programs were fully implemented and are expected to provide approximately $170 million of annual pretax savings.
The company issued $300 million of 3.875% senior unsecured notes due 2022 and intended to use the proceeds to repay $300 million of 7.20% senior notes maturing June 15, 2012. Management stated that it remained committed to maintaining investment-grade ratings.
Key risks include economic recession, raw-material availability and pricing, foreign currency movements, international operating risks, energy and commodity costs, competition, labor relations, product claims, acquisition integration and expected synergies, environmental remediation, regulatory changes, intellectual property protection and demand for new and existing products. Environmental reserves were $4.3 million at March 31, 2012, while some Superfund-related exposures remained too preliminary to estimate.
The filing contains no specific quantitative earnings or revenue guidance. Management indicated that the Stellite acquisition was expected to be accretive in fiscal 2013 and that the company was monitoring demand, costs, liquidity and capital markets.
Investor Verification Priorities
- Confirm the final purchase price allocation and integration performance of Stellite, including the significant goodwill and intangible assets recorded.
- Verify repayment of the 7.20% senior notes at their June 15, 2012 maturity and the resulting interest-cost and leverage effects.
- Assess whether raw-material inflation can be offset through pricing and whether gross margins recover from the quarterly decline.
- Monitor inventory growth, working-capital usage and conversion of operating income into cash flow.
- Evaluate Infrastructure profitability excluding acquisition-related costs and determine whether expected synergies are being realized.
- Review environmental remediation developments and potential changes to the $4.3 million reserve.
- Consider foreign-exchange exposure, pension and postretirement obligations, and the effect of the company’s investment-grade debt strategy.