KENNAMETAL INC quarterly report, Q3 FY2016

Kennametal Inc. Form 10-Q Summary

Reporting period: Three and nine months ended March 31, 2016. The request metadata identifies “2015 Q3,” but the filing is for fiscal 2016 third quarter. Kennametal is a global manufacturer of tooling, engineered components and advanced materials, reported through Industrial and Infrastructure segments.

Financial performance and position

MetricThree months ended March 31Nine months ended March 31
Sales$497.8 million, down 22%$1.577 billion, down 22%
Gross profit$157.4 million; 31.6% margin$449.4 million; 28.5% margin
Operating income (loss)$27.3 million; 5.5% margin$(200.0) million
Net income (loss)$16.7 million$(157.8) million
Net income (loss attributable to Kennametal)$16.0 million; $0.20 diluted EPS$(159.5) million; $(2.00) diluted EPS
Operating cash flowNot separately provided$145.4 million, versus $219.6 million
  • Quarterly sales declined due to a 10% divestiture impact, 8% organic decline and 4% unfavorable currency impact. Nine-month sales declined due to 12% organic decline, 6% currency impact and 4% divestiture impact.
  • Quarterly gross margin increased from 31.2% to 31.6%, while nine-month gross margin declined from 30.7% to 28.5%.
  • Quarterly results benefited from lower raw-material costs, restructuring savings and the absence of prior-year impairment charges. These benefits were partly offset by weaker demand, unfavorable mix, lower fixed-cost absorption and currency effects.
  • Industrial quarterly sales were $316.4 million and operating income was $24.7 million, producing a 7.8% margin versus 10.0% in the prior-year quarter. Infrastructure sales were $181.5 million and operating income was $3.7 million, versus a $153.1 million loss.
  • Cash and cash equivalents were $136.6 million at March 31, 2016, compared with $105.5 million at June 30, 2015. Working capital was $677.8 million, down $98.0 million from June 30, 2015.
  • Total debt was approximately $703.9 million, including $699.8 million of long-term debt and capital leases and $4.1 million of current debt-related liabilities. Long-term debt declined by $36.1 million from June 30, 2015.
  • Capital expenditures were $83.3 million for the nine-month period. Cash dividends paid were $47.8 million, and dividends per share increased to $0.20 for the quarter from $0.18.

Material changes versus the prior comparable period

  • The company returned to quarterly operating and net profitability, primarily because the prior-year quarter included $159.7 million of non-cash asset impairment charges, including $152.5 million related to Infrastructure goodwill.
  • Sales declined substantially across most end markets. Excluding currency and divestitures, quarterly declines included approximately 24% in energy, 22% in earthworks and 9% in general engineering. Aerospace and defense was relatively stable.
  • For the nine-month period, the company recorded $108.5 million of non-cash asset impairment charges, compared with $541.7 million in the prior-year period.
  • Operating cash flow declined $74.2 million year over year, reflecting lower cash earnings and higher restructuring and pension payments, partly offset by working-capital reductions.
  • The company completed the sale of non-core businesses for $61.1 million of cash. It recorded a nine-month pre-tax net loss on divestiture of $130.8 million, including a $133.3 million loss in the December quarter and an approximately $2.6 million gain in the March quarter.
  • Goodwill declined to $302.1 million from $417.4 million, primarily because of a $105.7 million Infrastructure impairment and divestiture-related reductions. Infrastructure has no remaining goodwill.

Outlook, management commentary, risks and unusual items

  • Management reported approximately $20 million of pre-tax restructuring benefits in the quarter and approximately $97 million of cumulative savings since program inception.
  • Restructuring charges totaled $14.0 million in the quarter and $38.0 million year to date. Total restructuring and related charges since inception were $115.2 million. Estimated total charges across three programs are $188 million to $205 million, with expected annualized savings of $105 million to $125 million.
  • Management expects weakness in oil and gas, mining and certain industrial markets to continue. U.S. rig counts declined 58% year over year at quarter end, and North American underground mining sales declined 58% year over year.
  • The company is exploring strategic alternatives for a remaining non-core Infrastructure business with an estimated net book value of approximately $40 million. Additional impairment charges may result depending on the strategic outcome.
  • On April 15, 2016, after quarter end, the revolving credit facility was amended to extend maturity from April 2018 to April 2021. The amendment increased the permitted maximum leverage ratio for a limited period and allows up to $120 million of cash restructuring-payment add-backs through December 31, 2017. The company was in compliance with its covenants at March 31, 2016.
  • Management stated that liquidity and credit ratings were sufficient to meet cash requirements for the next 12 months. However, $53.0 million of foreign cash was not available for long-term U.S. use without additional tax consequences.
  • Environmental reserves were $12.5 million. Certain Superfund and other environmental matters remain subject to uncertainty, and ultimate costs could change.
  • Principal risks include prolonged end-market weakness, commodity and energy exposure, currency movements, restructuring execution, potential further goodwill or intangible impairment, raw-material costs, environmental obligations, and compliance with debt covenants.

Investor verification priorities

  • Verify the extent to which the quarterly return to profitability reflects recurring operating improvement versus prior-year impairment comparability, divestiture gains and restructuring effects.
  • Assess demand trends in oil and gas, mining, earthworks and general engineering, including whether organic sales declines are stabilizing.
  • Review the amended credit agreement, leverage flexibility, restructuring add-backs and covenant headroom.
  • Monitor restructuring cash costs, realized savings and whether the $105 million to $125 million annualized savings target is achieved.
  • Evaluate potential additional impairment or divestiture losses related to the remaining non-core Infrastructure business and the company’s $40 million carrying value estimate.
  • Reconcile operating cash flow with reported earnings and assess working-capital sustainability, pension payments and future capital expenditures.