Kennametal Inc. — Form 10-Q Summary
Reporting period: Three months ended September 30, 2014, the first quarter of fiscal 2015. The filing was signed November 6, 2014. Kennametal manufactures tooling, engineered components and advanced materials through its Industrial and Infrastructure segments.
Financial performance and liquidity
| Metric | Q1 FY2015 | Q1 FY2014 | Change |
|---|---|---|---|
| Sales | $694.9 million | $619.8 million | Up 12.1% |
| Gross profit | $218.1 million | $198.2 million | Up 10.0% |
| Gross margin | 31.4% | 32.0% | Down 60 basis points |
| Operating income | $61.0 million | $58.8 million | Up 3.7% |
| Net income attributable to Kennametal | $39.5 million | $37.8 million | Up 4.4% |
| Diluted EPS | $0.49 | $0.48 | Up $0.01 |
| Cash flow from operations | $42.6 million | $44.4 million | Down $1.9 million |
- Sales growth reflected approximately 10% from the Tungsten Materials Business acquisition, 1% organic growth and 1% favorable currency exchange. TMB contributed $64.3 million of sales and $5.7 million of net income.
- Operating income benefited from TMB, organic growth and the absence of a prior-year nonrecurring inventory charge, but was partially offset by unfavorable Infrastructure mix, restructuring costs, higher employment costs and increased amortization.
- Interest expense increased to $8.2 million from $7.1 million, primarily because of acquisition-related borrowings. Other income was $1.8 million, compared with $0.6 million of other expense in the prior-year quarter, aided by currency gains.
- The effective tax rate increased to 26.5% from 24.6%, primarily because of losses in jurisdictions where tax benefits could not be recognized and expiration of certain U.S. tax provisions.
- Cash and cash equivalents were $156.2 million at September 30, 2014, compared with $177.9 million at June 30, 2014. Working capital was $926.0 million, down from $962.4 million.
- Total debt was $1.016 billion, including $908.6 million of long-term debt and capital leases and $100.4 million of notes payable to banks. Borrowings under the $600 million revolving credit facility were $213.5 million, down from $287.1 million at June 30, 2014.
- The company was in compliance with all credit agreement covenants. The revolving facility matures in April 2018. Management stated that current liquidity, financial position and investment-grade credit ratings provide access to capital markets.
- Capital expenditures were $30.8 million. Investing cash outflow was $30.0 million, while financing cash outflow was $40.2 million, including $14.2 million of dividends and substantial debt repayment.
Material changes versus the prior comparable period
- Industrial sales increased 12% to $377.9 million, and operating income increased to $44.0 million from $39.8 million. Industrial margin declined modestly to 11.6% from 11.8%.
- Infrastructure sales increased 13% to $317.1 million, primarily because of TMB, but organic sales declined 3%. Operating income fell to $19.2 million from $21.7 million, and margin declined to 6.0% from 7.7% because of lower organic sales, unfavorable mix and higher employment costs.
- Demand improved in general engineering, transportation and slightly in energy, while aerospace and defense, earthworks and mining remained weaker. Management reported continuing weakness in mining and lower road construction activity.
- Restructuring and related charges were $7.4 million in the quarter, compared with none disclosed for the prior-year quarter. Charges since program inception totaled $26.5 million. Prior-year results included a nonrecurring $5.7 million Infrastructure inventory charge.
- Comprehensive loss attributable to Kennametal shareholders was $4.3 million, compared with comprehensive income of $64.3 million in the prior-year quarter, primarily because of a $50.0 million unfavorable foreign-currency translation adjustment.
- Goodwill declined by $18.4 million and intangible assets declined by $11.8 million, primarily because of unfavorable currency effects and amortization.
Guidance, outlook, risks and unusual items
- Management expects total restructuring and related pre-tax charges of approximately $55 million to $60 million, with actions expected to be completed by the end of fiscal 2016. Expected annual permanent pre-tax benefits are approximately $50 million to $55 million.
- Current-quarter diluted EPS included approximately $0.07 per share of restructuring and related charges. Management reported approximately $5 million of restructuring-related pre-tax benefits in the quarter from manufacturing rationalization and workforce reductions.
- The company is evaluating strategic alternatives for an Infrastructure business and an Infrastructure technology intangible asset with estimated net book values of approximately $39 million and $6 million, respectively. The filing states that any potential impairment charge is not currently probable or estimable.
- Environmental reserves were $10.6 million at September 30, 2014. Certain Superfund matters remain at an early stage and could result in liabilities that cannot yet be estimated.
- Key risks include economic conditions, raw-material availability and costs, currency movements, international operations, commodity and energy prices, demand in mining and energy markets, competition, labor relations, product claims, environmental obligations, acquisition integration and achievement of expected synergies.
- Management’s assessment found disclosure controls effective; however, the internal-control assessment for the acquired TMB business was excluded under the SEC’s one-year acquisition transition guidance. No material changes to internal control were reported.
Facts investors should verify
- Whether TMB integration delivers the projected $50 million to $55 million of annual permanent pre-tax benefits and whether total restructuring costs remain within the $55 million to $60 million estimate.
- Infrastructure organic demand, particularly mining, earthworks and energy, and the segment’s ability to recover its margin.
- Debt reduction, revolving-credit utilization, interest expense and continued compliance with leverage and interest-coverage covenants.
- Potential impairment or divestiture outcomes for the Infrastructure business and technology intangible asset under strategic review.
- Foreign-exchange effects on comprehensive income, goodwill, intangible assets and shareholders’ equity.
- Final year-end LIFO inventory adjustments and the possible range of environmental remediation liabilities.