Kennametal Inc. Fiscal 2021 First Quarter Form 10-Q Summary
Business context and reporting period
Kennametal is a global manufacturer of metal-cutting tools, engineered wear components, tungsten carbide and ceramic products, and metallurgical powders serving aerospace, transportation, energy, earthworks and general engineering markets. This unaudited Form 10-Q covers the three months ended September 30, 2020, the first quarter of fiscal 2021, compared with the first quarter of fiscal 2020.
Effective July 1, 2020, the former Industrial and Widia businesses were combined into the Metal Cutting segment. Prior-period segment information was retrospectively restated.
Financial performance and liquidity
| Metric | Q1 FY2021 | Q1 FY2020 | Change |
|---|---|---|---|
| Sales | $400.3 million | $518.1 million | Down 23% |
| Gross profit | $105.1 million | $139.0 million | Down $33.9 million |
| Gross margin | 26.2% | 26.8% | Down 60 basis points |
| Operating income (loss) | $(17.2) million | $16.4 million | Decline of $33.6 million |
| Operating margin | (4.3)% | 3.2% | Down 750 basis points |
| Net income (loss) attributable to Kennametal | $(21.7) million | $6.5 million | Loss versus income |
| Diluted earnings (loss) per share | $(0.26) | $0.08 | Down $0.34 |
| Cash flow from operations | $9.6 million | $27.5 million | Down $17.9 million |
| Capital expenditures | $39.3 million | $72.5 million | Down $33.2 million |
Reported sales declined 23%, consisting of a 21% organic decline, a 1% unfavorable currency effect and a 1% divestiture effect. End-market declines were led by aerospace at 45%, energy at 26%, transportation at 22%, general engineering at 21% and earthworks at 12%.
- Metal Cutting: Sales were $247.9 million, down 24%; operating loss was $23.6 million versus operating income of $19.3 million, primarily due to lower volume, unfavorable fixed-cost absorption and $19.7 million of additional restructuring-related charges.
- Infrastructure: Sales were $152.4 million, down 21%; operating income was $7.3 million versus an operating loss of $2.7 million, supported by lower raw-material costs, cost controls and simplification benefits.
- Restructuring: Total restructuring and related charges were $28.6 million, including $25.6 million of restructuring charges, compared with $8.0 million in the prior-year quarter. Restructuring charges reduced current-quarter diluted EPS by approximately $0.30.
- Interest and taxes: Interest expense increased to $10.6 million from $7.9 million. The effective tax rate was a 12.1% benefit on the pretax loss, compared with a 33.7% provision in the prior-year quarter.
At September 30, 2020, cash and cash equivalents were $98.3 million, total debt was $639.7 million, and Kennametal shareholders’ equity was $1.225 billion. The company had $38.5 million outstanding under its revolving credit facility and $661.5 million of additional availability. Working capital was $520.1 million.
The amended revolving credit facility provides up to $700 million and matures in June 2023. The amendment temporarily increased the maximum leverage covenant from 3.5 times to 4.25 times trailing-twelve-month EBITDA through December 31, 2021 and increased the permitted restructuring-charge add-back to $120 million. The company reported compliance with all covenants at quarter-end.
Material changes versus the prior comparable period
- COVID-19-related economic disruption materially reduced demand across all major end markets, most severely affecting aerospace, energy and transportation.
- Sales fell 23%, while operating results moved from income to loss. Lower volume and fixed-cost absorption more than offset approximately $22 million of incremental simplification and modernization benefits, lower raw-material costs and cost controls.
- Operating expenses declined to $93.3 million from $114.2 million, and research and development expense declined to $8.8 million from $10.4 million.
- Operating cash flow declined to $9.6 million from $27.5 million, while capital expenditures were reduced substantially.
- Cash decreased by $508.4 million, principally because the company repaid $461.5 million of revolving and other credit borrowings and paid $16.6 million in dividends.
- Foreign currency translation produced $31.9 million of other comprehensive income, compared with a $35.4 million loss in the prior-year quarter.
Guidance, outlook, commentary and risks
Management stated that quarterly sales outperformed typical seasonal trends, providing some optimism that economic recovery was beginning. However, the company expects COVID-19 to continue negatively affecting fiscal 2021 demand, particularly in energy, aerospace and transportation. The filing does not provide formal revenue or earnings guidance.
Kennametal remains on track for $180 million of cumulative annualized simplification and modernization savings by the end of fiscal 2021. FY21 restructuring actions are expected to produce annualized savings of $65 million to $75 million and require estimated pretax charges of $90 million to $100 million. Annualized savings achieved since inception were approximately $123 million.
The company plans to refinance its $300 million of 3.875% senior unsecured notes due February 2022. Management believes projected cash and available revolver capacity could repay the notes if refinancing is not completed, but provides no assurance because of COVID-19 and capital-market uncertainty. Additional cost controls or restructuring could be required if market conditions deteriorate.
Other material risks include covenant compliance and borrowing availability, foreign-exchange exposure, raw-material costs, potential goodwill or intangible-asset impairment, environmental remediation, supply-chain and operational disruption, and litigation. An Italian tax assessment remains under litigation; no liability has been recorded. If the tax authority prevails, the potential exposure could be up to €36 million, or approximately $42 million including penalties and interest.
Important facts for investors to verify
- Whether demand recovery, particularly in aerospace, energy and transportation, offsets continuing COVID-19-related weakness.
- Progress toward the $65 million to $75 million annualized FY21 restructuring savings and the remaining $90 million to $100 million pretax charges.
- Future compliance with the amended leverage and interest-coverage covenants as EBITDA and cash balances change.
- Timing and terms of refinancing for the $300 million of senior notes due February 2022.
- Whether operating cash flow improves sufficiently to fund capital expenditures, dividends and debt obligations without increased borrowing.
- The outcome and potential financial impact of the Italian tax litigation and environmental remediation matters.
- Whether currency movements, divestitures and segment reorganization affect comparability of future results.