Kennametal Inc. Fiscal 2020 Form 10-K Summary
Reporting period: Fiscal year ended June 30, 2020. The supplied filing is the fiscal 2020 Form 10-K, not a fiscal 2019 fourth-quarter filing. Comparisons are primarily to fiscal 2019.
Business context
Kennametal is a global industrial technology company producing tungsten-carbide, ceramic, super-hard-material and metal-cutting solutions. Its products serve aerospace, transportation, general engineering, energy, mining, construction and other wear-intensive applications. Fiscal 2020 was materially affected by a global manufacturing slowdown and the COVID-19 pandemic, particularly during the second half of the year. Approximately 59% of consolidated sales were generated outside the United States.
Fiscal 2020 reportable segments were Industrial, Widia and Infrastructure. Effective July 1, 2020, Industrial and Widia were combined into a Metal Cutting segment; Infrastructure remained unchanged.
Financial performance and key metrics
| Metric | Fiscal 2020 | Fiscal 2019 | Change |
|---|---|---|---|
| Sales | $1,885.3 million | $2,375.2 million | Down 20.6% |
| Gross profit | $529.5 million | $831.5 million | Down $302.0 million |
| Gross margin | 28.1% | 35.0% | Down 690 basis points |
| Operating income | $22.3 million | $328.9 million | Down $306.6 million |
| Operating margin | 1.2% | 13.8% | Down 1,260 basis points |
| Net income attributable to Kennametal | $(5.7) million | $241.9 million | Turned to a loss |
| Diluted EPS | $(0.07) | $2.90 | Down $2.97 |
| Operating cash flow | $223.7 million | $300.5 million | Down $76.8 million |
| Capital expenditures | $244.2 million | $212.3 million | Up $31.8 million |
| Dividends paid | $66.3 million | $65.7 million | Approximately flat |
Sales declined 18% organically, with an unfavorable currency effect of 2% and a 1% divestiture effect. Reported sales declines were 29% in Energy, 25% in Transportation, 19% in General Engineering, 17% in Aerospace and 9% in Earthworks.
Segment results
| Segment | Fiscal 2020 sales | Sales change | Fiscal 2020 operating margin |
|---|---|---|---|
| Industrial | $1,015.1 million | Down 20% | 3.5% |
| Widia | $163.0 million | Down 17% | (21.3)% |
| Infrastructure | $707.3 million | Down 22% | 3.3% |
Industrial and Infrastructure profitability declined due to lower volumes, unfavorable labor and fixed-cost absorption, restructuring costs and, for Infrastructure, a $6.5 million divestiture loss. Widia reported a $34.7 million operating loss, including $30.2 million of goodwill and indefinite-lived trademark impairment charges.
Liquidity, debt and cash flow
- Cash and cash equivalents were $606.7 million at June 30, 2020, compared with $182.0 million a year earlier.
- Total debt, including revolving borrowings and finance leases, was $1,094.5 million, compared with $592.6 million at June 30, 2019.
- The increase in debt primarily reflected a $500.0 million draw on the revolving credit facility, which had $200.0 million of additional availability at year-end.
- The revolving facility provides up to $700.0 million and matures in June 2023. Kennametal reported compliance with its covenants at June 30, 2020.
- Debt included $300 million of 3.875% senior notes due 2022 and $300 million of 4.625% senior notes due 2028, net of issuance costs.
- Working capital declined to $542.7 million from $729.1 million, primarily because of the revolving debt balance and lower accounts receivable and inventory.
- Operating cash flow of $223.7 million was below capital expenditures of $244.2 million before financing and divestiture proceeds.
Material changes and unusual items
- Fiscal 2020 restructuring and related charges totaled $83.3 million. The company substantially completed its FY20 actions, producing approximately $33 million of annualized savings.
- The company accelerated FY21 restructuring actions, increasing expected annualized benefits to $65 million-$75 million and expected pre-tax charges to $90 million-$100 million, primarily by the end of fiscal 2021.
- Management reported approximately $101 million of cumulative annualized simplification and modernization run-rate savings since inception.
- The company recorded $30.2 million of non-cash Widia impairment charges, eliminating all goodwill assigned to the Widia reporting unit.
- The company sold certain non-core specialty alloys and metals assets for $24.0 million and recorded a $6.5 million pre-tax loss.
- The effective tax rate was 357.5%, reflecting the low level of pre-tax income and the effects of restructuring, impairment and discrete tax items. Fiscal 2020 included a $14.5 million Swiss tax reform benefit and a $6.9 million CARES Act benefit.
- The company adopted the new lease accounting standard, recording approximately $49 million of lease liabilities and right-of-use assets without a material income-statement or cash-flow effect.
Outlook, management commentary and risks
Management expected COVID-19 to continue negatively affecting fiscal 2021 demand, particularly in Energy, Aerospace and Transportation. Kennametal facilities generally remained operational as an essential business, although facilities in India and Bolivia were closed for approximately six weeks because of government-mandated lockdowns. The company did not report a material supply-chain disruption from those closures.
Management stated that deteriorating market conditions could affect liquidity, borrowing availability and compliance with the maximum leverage covenant. If conditions failed to improve, potential actions included additional short-term cost controls, a temporary dividend reduction or suspension, additional restructuring and a possible capital-markets transaction or credit-agreement amendment. Management concluded that the company would remain in compliance and have adequate liquidity for at least one year after issuance of the financial statements.
- COVID-19 duration and effects on customer demand, operations, supply chains, cash flow and covenant compliance.
- Cyclical exposure to global manufacturing, transportation, aerospace, energy, mining and construction markets.
- Execution risk associated with restructuring, facility closures, workforce reductions and modernization investments.
- Potential future goodwill or intangible-asset impairments, particularly if demand or projected cash flows deteriorate.
- Foreign-currency, tariff, trade-policy, raw-material availability and international operating risks.
- Environmental remediation obligations, product liability, litigation, cybersecurity and tax exposures.
- An Italian tax assessment of up to approximately €36 million, including penalties and interest, for which payment was stayed and no liability was recorded because the company believes the assessment is baseless.
Important facts for investors to verify
- Whether fiscal 2021 demand and margins recovered sufficiently to offset COVID-19-related weakness and the fiscal 2020 decline.
- Actual cash costs, timing and realized savings from the $90 million-$100 million FY21 restructuring program.
- Revolving-credit borrowings, covenant headroom and refinancing plans for the $300 million of notes due in 2022.
- Whether the Widia trademark or Industrial reporting unit requires additional impairment charges.
- Whether the $0.80 annual dividend remained sustainable given negative fiscal 2020 earnings, capital expenditures and debt levels.
- Potential exposure from the Italian tax proceeding, environmental reserves of $15.6 million and other contingencies.
- Performance of the new Metal Cutting and Infrastructure reporting segments beginning in fiscal 2021.