Kennametal Inc. Form 10-Q Summary
Reporting period: Three and six months ended December 31, 2010, filed February 8, 2011. Kennametal manufactures tooling, engineered components and advanced materials through its Industrial and Infrastructure segments. Fiscal 2011 introduced a market-sector-based segment structure, with prior periods restated for comparison.
Financial Performance and Position
| Metric | Three months ended Dec. 31, 2010 | Three months ended Dec. 31, 2009 | Six months ended Dec. 31, 2010 | Six months ended Dec. 31, 2009 |
|---|---|---|---|---|
| Sales | $565.8 million | $442.9 million | $1,094.9 million | $852.3 million |
| Gross profit | $200.0 million | $140.1 million | $388.8 million | $257.9 million |
| Gross margin | 35.4% | 31.6% | 35.5% | 30.3% |
| Operating income | $61.6 million | $15.5 million | $119.1 million | $5.9 million |
| Operating margin | 10.9% | 3.5% | 10.9% | 0.7% |
| Net income attributable to Kennametal | $43.5 million | $6.0 million | $78.4 million | $(3.9) million |
| Diluted EPS | $0.52 | $0.07 | $0.94 | $(0.05) |
- Six-month operating cash flow was $67.4 million, compared with $53.4 million in the prior-year period.
- Capital expenditures were $21.2 million; net investing cash flow was an outflow of $12.6 million.
- Cash and cash equivalents were $147.2 million at December 31, 2010, up from $118.1 million at June 30, 2010.
- Total debt was $316.4 million, including $312.1 million of long-term debt and capital leases. The company had no borrowings under its $500 million revolving credit facility and was in compliance with its financial covenants.
- Working capital was $655.2 million, compared with $522.9 million at June 30, 2010. Total equity was $1.476 billion, including $1.455 billion attributable to Kennametal shareowners.
- Quarterly and year-to-date dividends were $0.12 and $0.24 per share, respectively. The company repurchased 316,675 shares during the quarter at an average price of $34.07 per share.
Material Changes Versus the Prior Comparable Period
- Sales increased 27.7% in the quarter and 28.5% for the six months. Organic sales growth was 31% and 33%, respectively, partially offset by unfavorable foreign currency effects and fewer business days.
- Growth occurred across major end markets and geographies. For the quarter, Industrial sales rose 32.9% and Infrastructure sales rose 19.1%.
- Industrial operating income increased to $42.2 million from $5.9 million for the quarter and to $78.3 million from a $11.9 million loss for the six months. Infrastructure operating income increased to $21.6 million from $18.3 million for the quarter and to $48.1 million from $29.9 million for the six months.
- Margin expansion reflected higher volume, favorable mix, improved manufacturing absorption and restructuring benefits. These gains were partly offset by higher raw-material and employment costs and the restoration of previously reduced compensation and other costs.
- Restructuring and related charges declined to $9.4 million for the six months from $12.7 million. Restructuring programs generated approximately $80 million of pretax benefits in the first six months, compared with approximately $60 million in the prior-year period.
- Inventory increased $61.7 million from June 30, 2010 as production rose to meet higher demand. The increase contributed to the difference between net income and operating cash flow.
- The prior-year period included $27.0 million of cash proceeds from the sale of the high-speed steel drills business; no comparable proceeds were received in 2010. Discontinued operations no longer generated a loss in 2010.
Outlook, Risks and Unusual Items
- Management expects restructuring programs to produce annual ongoing pretax savings of approximately $160 million to $165 million once fully implemented. Total restructuring and related charges were $138 million through December 31, 2010, with remaining charges expected within three to six months and expected to be mostly cash expenditures.
- Management stated that raw-material cost increases were expected to be recovered through pricing actions. The filing does not provide a specific revenue or EPS forecast.
- Key risks include economic recession, demand volatility, raw-material and commodity costs, foreign currency exposure, international regulatory and political conditions, competition, labor relations, product claims, intellectual-property matters, environmental obligations, acquisitions and divestitures, information-system upgrades and execution of the new segment structure.
- Environmental reserves were $6.1 million at December 31, 2010. Superfund and other remediation matters remain subject to uncertainty; certain proceedings were too preliminary to estimate potential costs. The company paid a $0.2 million civil penalty related to the closure of its Chestnut Ridge, Pennsylvania facility.
- The company uses foreign-currency and interest-rate derivatives for hedging, not speculation. Outstanding currency hedge notional amounts were $64.1 million, and forward-starting interest-rate swaps effectively converted $125 million of floating-rate exposure to fixed rates.
- The six-month effective tax rate was 24.3%, compared with a 2.5% benefit rate in the prior-year period. Management noted that a future valuation allowance release could materially reduce tax expense if realization of certain deferred tax assets becomes more likely than not.
- Management concluded that disclosure controls and procedures were effective as of December 31, 2010, with no material changes in internal control over financial reporting.
Investor Verification Items
- Verify whether sales growth and improved operating margins are sustained after restructuring benefits, higher raw-material costs and restored employment costs are fully reflected.
- Track completion, cash expenditures and realized savings from the remaining restructuring actions.
- Assess inventory growth, working-capital efficiency and conversion of earnings into operating cash flow.
- Review refinancing and liquidity plans for the $300 million of senior unsecured notes maturing in June 2012.
- Monitor foreign currency effects, commodity prices, pricing recovery and performance in the Industrial and Infrastructure end markets.
- Evaluate environmental remediation exposure beyond the $6.1 million recorded reserve and the potential effect of deferred-tax-asset valuation allowances.