Kennametal Inc. — Fiscal 2014 Second-Quarter Form 10-Q Summary
Business context and reporting period
Kennametal is a global manufacturer and supplier of tooling, engineered components and advanced materials serving industrial, aerospace, defense, transportation, energy, mining and earthworks markets. The filing covers the three and six months ended December 31, 2013, representing the second quarter of fiscal 2014. Results are unaudited.
The company operates through Industrial and Infrastructure segments. Prior-year segment information was restated to reflect an enhanced organizational structure implemented at the beginning of fiscal 2014.
Financial performance and liquidity
| Metric | Three months ended Dec. 31, 2013 | Three months ended Dec. 31, 2012 | Six months ended Dec. 31, 2013 | Six months ended Dec. 31, 2012 |
|---|---|---|---|---|
| Sales | $689.9 million | $633.1 million | $1,309.7 million | $1,262.6 million |
| Gross profit | $207.0 million | $199.4 million | $405.2 million | $407.8 million |
| Gross margin | 30.0% | 31.5% | 30.9% | 32.3% |
| Operating income | $49.7 million | $66.5 million | $108.5 million | $130.9 million |
| Net income attributable to Kennametal | $24.2 million | $42.1 million | $62.0 million | $88.5 million |
| Diluted EPS | $0.30 | $0.52 | $0.78 | $1.09 |
- Second-quarter sales increased 9%, driven by 7% acquisition-related growth and 2% organic growth. Six-month sales increased 4%, including 4% acquisition-related growth and 1% organic growth, partly offset by one fewer business day.
- Operating income declined 25% in the quarter and 17% for the six-month period. Management cited higher employment costs, TMB operating losses, restructuring charges, acquisition-related costs and, for the six-month period, a $5.7 million non-recurring mining inventory adjustment.
- Second-quarter operating margin was approximately 7.2%, compared with approximately 10.5% in the prior-year quarter. Six-month operating margin was approximately 8.3%, compared with approximately 10.4% previously.
- Second-quarter Industrial sales rose 10%, while operating income declined to $33.2 million from $40.7 million; Industrial operating margin was 9.0% versus 12.1%. Infrastructure sales rose 7%, while operating income declined to $18.6 million from $27.9 million; Infrastructure operating margin was 5.8% versus 9.4%.
- Six-month operating cash flow was $84.6 million, compared with $54.2 million in the prior-year period. Capital expenditures were $48.8 million, and investing cash flow was negative $683.0 million, primarily due to acquisitions.
- Cash and cash equivalents were $163.3 million at December 31, 2013, compared with $377.3 million at June 30, 2013. Working capital was $939.5 million, down from $1,031.9 million.
- Total debt was $1,145.7 million at December 31, 2013, including $1,035.6 million of long-term debt and capital leases and $110.1 million of current debt and notes payable. Borrowings under the $600 million revolving credit facility were $360.7 million, compared with $3.6 million at June 30, 2013.
- The revolving credit facility matures in April 2018. Kennametal was in compliance with its financial covenants at December 31, 2013 and reported investment-grade credit ratings.
- The quarterly dividend increased to $0.18 per share from $0.16 per share in the prior-year quarter. Cash dividends paid during the six months were $28.2 million.
Material changes versus the prior comparable period
- Kennametal completed the $607.0 million acquisition of ATI’s Tungsten Materials Business on November 4, 2013. TMB contributed $44.8 million of sales and a $7.2 million net loss during the two months included in the quarter, including acquisition-related costs.
- TMB added approximately $242.4 million of goodwill, $124.2 million of other intangible assets and $125.3 million of property and equipment in the preliminary purchase price allocation. The allocation remains subject to revision.
- The company also acquired Emura, a Bolivian tungsten sourcing business, for total consideration of $40.1 million, including $14.0 million of contingent consideration, and completed another $2.0 million acquisition.
- Operating expenses increased 16.2% in the quarter, primarily from higher employment and commission costs, TMB operating expenses and acquisition-related costs.
- Interest expense increased to $8.0 million in the quarter and $15.1 million for six months, principally because of higher borrowings and the cost of the $400 million of 2.65% senior unsecured notes issued in November 2012.
- The effective tax rate increased to 40.8% for the quarter and 31.8% for six months, primarily because of a $7.2 million tax charge related to the planned repatriation of $57.0 million of foreign subsidiary earnings.
- Inventory increased to $730.7 million from $578.8 million at June 30, 2013, largely because of inventory acquired with TMB.
Guidance, outlook, risks and unusual items
- Management expects restructuring actions related to TMB integration and broader operational consolidation to generate total pre-tax charges of approximately $40 million to $50 million over three years. Charges recorded in the quarter were $2.3 million. Expected annual savings after full implementation are approximately $35 million to $45 million.
- Management identified improved Industrial demand and distribution sales, stable raw material prices and lower raw material costs as favorable factors. Mining remained weak, particularly underground coal mining, and certain energy, earthworks, transportation, aerospace and defense markets experienced softness.
- The filing does not provide formal full-year revenue or earnings guidance.
- Unusual or potentially non-recurring items included the TMB operating loss, acquisition-related costs, restructuring charges, the $5.7 million mining inventory adjustment and the $7.2 million tax charge.
- Environmental reserves were $5.2 million at December 31, 2013. The company is also involved in Superfund and other environmental matters for which ultimate costs cannot always be estimated.
- Key disclosed risks include economic conditions, raw-material availability and prices, foreign currency and international operations, regulation, environmental remediation, competition, labor relations, product claims, intellectual property, acquisition integration, divestitures and demand in cyclical end markets.
- Management’s disclosure controls were assessed as effective. The internal-control assessment excluded TMB and Emura because they were acquired during fiscal 2014 and represented approximately 17% and 1%, respectively, of total assets at December 31, 2013.
Important facts for investors to verify
- Progress integrating TMB, including whether the projected $35 million to $45 million of annual savings is achieved and whether restructuring costs remain within the $40 million to $50 million estimate.
- TMB’s operating performance, purchase-accounting effects and final allocation of goodwill and intangible assets.
- Leverage, borrowing costs, liquidity and covenant headroom following the acquisition-financing increase in debt.
- Whether weakness in mining, earthworks and selected energy markets persists or broadens.
- Inventory levels, working-capital requirements and conversion of earnings into operating cash flow.
- The final tax consequences of foreign-earnings repatriation and any additional changes to the company’s tax assertions.
- Potential changes in environmental remediation obligations beyond the recorded $5.2 million reserve.