Kennametal Inc. Form 10-K Summary
Reporting period: Fiscal year ended June 30, 2019. The request metadata references “2018 Q4,” but the supplied filing is Kennametal’s fiscal 2019 annual report, filed August 13, 2019.
Business Context
Kennametal is a global industrial technology manufacturer serving aerospace and defense, earthworks, energy, general engineering and transportation markets. Its products include tungsten-carbide, ceramic and other super-hard materials; metalworking tools; wear components; earth-cutting tools; and metallurgical powders. Reportable segments are Industrial, Widia and Infrastructure. Approximately 57% of fiscal 2019 sales came from outside the United States.
Financial Performance and Position
| Metric | Fiscal 2019 | Fiscal 2018 | Change |
|---|---|---|---|
| Sales | $2,375.2 million | $2,367.9 million | 0.3% increase |
| Gross profit | $831.5 million | $820.1 million | 1.4% increase |
| Gross margin | 35.0% | 34.6% | Up 40 basis points |
| Operating income | $328.9 million | $290.3 million | 13.3% increase |
| Operating margin | 13.8% | 12.3% | Up 150 basis points |
| Net income attributable to Kennametal | $241.9 million | $200.2 million | 20.8% increase |
| Diluted EPS | $2.90 | $2.42 | 19.8% increase |
| Cash flow from operations | $300.5 million | $277.3 million | 8.4% increase |
| Capital expenditures | $212.3 million | $171.0 million | 24.2% increase |
Segment operating margins were 17.3% for Industrial, 1.5% for Widia and 12.0% for Infrastructure. Industrial operating income increased substantially, while Infrastructure operating income declined despite higher sales. Widia remained marginally profitable.
At June 30, 2019, cash and cash equivalents were $182.0 million, working capital was $729.1 million and total Kennametal shareholders’ equity was $1,335.2 million. Total debt, including capital leases and notes payable, was $592.6 million versus $991.7 million in 2018. The company had no borrowings under its $700 million revolving credit facility and was in compliance with its covenants. Less than 1% of debt was subject to variable interest rates.
Operating cash flow less capital expenditures was approximately $88.2 million. The company paid $65.7 million in shareholder dividends, or $0.80 per share.
Material Changes Versus the Prior Comparable Period
- Reported sales were essentially flat because 3% organic growth was offset by a 3% unfavorable foreign-currency effect.
- Aerospace and defense sales increased 12%, while transportation declined 9% and earthworks declined 6% on a reported basis. Energy increased 4% and general engineering increased 3%.
- Operating performance improved through organic growth, favorable mix, lower compensation expense and simplification/modernization savings. These benefits were partly offset by currency effects, higher raw-material costs and volume-related labor and fixed-cost absorption.
- Operating expense declined 5.8% to $474.2 million. Research and development expense was broadly stable at $39.0 million.
- Debt declined by approximately $399 million following the early extinguishment of the $400 million 2.650% senior unsecured notes. Remaining principal debt consisted primarily of $300 million of 3.875% notes due 2022 and $300 million of 4.625% notes due 2028.
- Capital spending increased materially as the company invested in plant modernization, equipment upgrades and simplification initiatives.
- Cash declined $374.1 million, primarily because of debt repayment, capital expenditures and dividends.
Guidance, Outlook, Risks and Unusual Items
- Management expected challenging macroeconomic conditions to continue through at least the first half of fiscal 2020, following softening in most end markets late in fiscal 2019. No specific fiscal 2020 sales or EPS guidance is provided in the supplied text.
- Fiscal 2020 restructuring actions were expected to generate $35 million to $40 million of annualized savings and incur $55 million to $65 million of pretax charges, primarily cash costs.
- Fiscal 2021 proposed facility closures were expected to generate $25 million to $30 million of annualized savings and incur $60 million to $75 million of pretax charges through fiscal 2020 and 2021. Most savings were expected in fiscal 2021, with full run-rate savings in fiscal 2022.
- Fiscal 2019 included $16.9 million of restructuring and related charges, net of a $4.8 million gain on the sale of a closed facility. Total restructuring and related charges were $17.5 million on a pretax basis according to management’s discussion.
- The effective tax rate declined to 20.4% from 25.4%, reflecting the Tax Cuts and Jobs Act, including a $9.3 million net benefit related to finalizing the toll tax, a $6.1 million charge from changes in the permanent reinvestment assertion and a $1.1 million Australian valuation allowance release.
- An Italian tax dispute remains pending. If the tax authority prevails, the potential additional tax, penalties and interest could be as much as €35 million, or approximately $40 million; no liability has been recorded because management considers the assessment baseless.
- Environmental remediation reserves were $12.4 million at year-end. Management believes current reserves are adequate, but environmental liabilities remain subject to uncertainty.
- Key risks include cyclical industrial demand, currency movements, tariffs and trade restrictions, raw-material availability and prices, restructuring execution, international operations, cybersecurity, competition, environmental regulation, product liability and potential goodwill or intangible-asset impairment.
- Goodwill and indefinite-lived intangible assets totaled $314.6 million. No impairment was recorded, but the Widia goodwill and trademark valuations were identified as a critical audit matter and are sensitive to revenue, margin and discount-rate assumptions.
- PricewaterhouseCoopers issued unqualified opinions on the financial statements and internal control over financial reporting. Management reported effective disclosure controls and internal control over financial reporting.
Important Facts for Investors to Verify
- Whether fiscal 2020 end-market weakness, particularly in transportation, earthworks and other cyclical markets, offsets planned restructuring and modernization savings.
- The timing, cash cost and realized savings from the announced facility closures and restructuring programs.
- Whether Industrial’s improved margin performance can be sustained while Widia remains at approximately 1.5% operating margin.
- The effect of tungsten, cobalt, steel, tariffs and other raw-material costs on pricing and margins.
- Liquidity after elevated capital expenditures, restructuring cash costs, pension contributions and debt maturities, including the $300 million note maturity in 2022.
- The sensitivity of Widia goodwill and trademark values to weaker demand or failure to achieve projected growth and profitability.
- The potential outcome of the Italian tax litigation and other uncertain tax positions.
- The impact of currency movements, given the company’s substantial international sales and the $0.17 reduction in fiscal 2019 diluted EPS from currency fluctuations.