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FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED JUNE 30, 2003
Commission File Number 1-5318
KENNAMETAL INC.
(Exact name of registrant as specified in its charter)
Pennsylvania 25-0900168
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
World Headquarters
1600 TECHNOLOGY WAY
P. O. BOX 231
Latrobe, Pennsylvania 15650-0231
(Address of principal executive offices)
Registrant's telephone number, including area code: 724-539-5000
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
Capital Stock, par value $1.25 per share New York Stock Exchange
Preferred Stock Purchase Rights New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None.
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months, and (2) has been subject to such filing requirements
for the past 90 days. YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined by Rule 126-2 of the Exchange Act). YES [X] NO [ ]
As of December 31, 2002, the aggregate market value of the registrant's Capital
Stock held by non-affiliates of the registrant, estimated solely for the
purposes of this Form 10-K, was approximately $910,500,000. For purposes of the
foregoing calculation only, all directors and executive officers of the
registrant and each person who may be deemed to own beneficially more than 5% of
the registrant's Capital Stock have been deemed affiliates.
As of August 29, 2003, there were 35,915,232 shares of the Registrant's Capital
Stock outstanding.
Documents Incorporated by Reference
Portions of the Proxy Statement for the 2003 Annual Meeting of Shareowners are
incorporated by reference into Parts III and IV.
Table of Contents
Item No. Page
PART I
1. Business 3
2. Properties 10
3. Legal Proceedings 11
4. Submission of Matters to a Vote of Security Holders 11
Executive Officers of the Registrant 12
PART II
5. Market for the Registrant's Common Equity and Related Shareowner Matters 14
6. Selected Financial Data 15
7. Management's Discussion and Analysis of Financial Condition and Results of Operations 18
7A. Quantitative and Qualitative Disclosures About Market Risk 32
8. Financial Statements and Supplementary Data 34
9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 67
9A. Controls and Procedures 67
PART III
10. Directors and Executive Officers of the Registrant 68
11. Executive Compensation 68
12. Security Ownership of Certain Beneficial Owners and Management
and Related Shareowner Matters 68
13. Certain Relationships and Related Transactions 68
14. Principal Accountant Fees and Services 68
PART IV
15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 69
Signatures 72
FORWARD-LOOKING INFORMATION
This Form 10-K contains "forward-looking" statements within the meaning of
Section 21E of the Securities Exchange Act of 1934. You can identify these
forward-looking statements by the fact they use words such as "should,"
"anticipate," "estimate," "approximate," "expect," "may," "will," "project,"
"intend," "plan," "believe" and other words of similar meaning and expression in
connection with any discussion of future operating or financial performance. One
can also identify forward-looking statements by the fact that they do not relate
strictly to historical or current facts. These statements are likely to relate
to, among other things, our goals, plans and projections regarding our financial
position, results of operations, cash flows, market position and product
development, which are based on current expectations that involve inherent risks
and uncertainties, including factors that could delay, divert or change any of
them in the next several years. Although it is not possible to predict or
identify all factors, they may include the following: global economic
conditions; future terrorist attacks; epidemics; risks associated with
integrating and divesting businesses and achieving the expected savings and
synergies; demands on management resources; risks associated with international
markets such as currency exchange rates, and social and political environments;
competition; labor relations; commodity prices; demand for and market acceptance
of new and existing products; and risks associated with the implementation of
restructuring plans and environmental remediation matters. We can give no
assurance that any goal or plan set forth in forward-looking statements can be
achieved and readers are cautioned not to place undue reliance on such
statements, which speak only as of the date made. We undertake no obligation to
release publicly any revisions to forward-looking statements as a result of
future events or developments.
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Part I
ITEM 1 - BUSINESS
OVERVIEW Kennametal Inc. was incorporated in Pennsylvania in 1943. We are a
leading global manufacturer, marketer and distributor of a broad range of
cutting tools, tooling systems, supplies and technical services, as well as
wear-resistant parts. We believe that our reputation for manufacturing
excellence and technological expertise and innovation in our principal products
has helped us achieve a leading market presence in our primary markets. We
believe we are the second largest global provider of metalcutting tools and
tooling systems. End users of our products include metalworking manufacturers
and suppliers in the aerospace, automotive, machine tool and farm machinery
industries, as well as manufacturers and suppliers in the highway construction,
coal mining, quarrying and oil and gas exploration industries.
We specialize in developing and manufacturing metalworking tools and
wear-resistant parts using a specialized type of powder metallurgy. Our
metalworking tools are made of cemented tungsten carbides, ceramics, cermets,
high-speed steel and other hard materials. We also manufacture and market a
complete line of toolholders, toolholding systems and rotary cutting tools by
machining and fabricating steel bars and other metal alloys. We are one of the
largest suppliers of metalworking consumables and related products in the United
States and Europe. We also manufacture tungsten carbide products used in
engineered applications, mining and highway construction, and other similar
applications, including circuit board drills, compacts and metallurgical
powders.
BUSINESS SEGMENT REVIEW We operate four global business units consisting of
Metalworking Solutions & Services Group (MSSG), Advanced Materials Solutions
Group (AMSG), J&L Industrial Supply (J&L) and Full Service Supply (FSS). Segment
selection was based upon internal organizational structure, the manner in which
we organize segments for making operating decisions and assessing performance,
the availability of separate financial results, and materiality considerations.
Sales and operating income by segment are presented in Management's Discussion
and Analysis set forth in Item 7 in this annual report on Form 10-K and Note 18
"Segment Data" of our consolidated financial statements set forth in Item 8 in
this annual report on Form 10-K.
METALWORKING SOLUTIONS & SERVICES GROUP--MSSG In the MSSG segment, we provide
consumable metalcutting tools and tooling systems to manufacturing companies in
a wide range of industries throughout the world. Metalcutting operations include
turning, boring, threading, grooving, milling and drilling. Our tooling systems
consist of a steel toolholder and cutting tool such as an indexable insert or
drill made from cemented tungsten carbides, high speed steel and other hard
materials. We also provide solutions to our customers' metalcutting needs
through engineering services aimed at improving their competitiveness.
During a metalworking operation, the toolholder is positioned in a machine that
provides the turning power. While the workpiece or toolholder is rapidly
rotating, the cutting tool insert or drill contacts the workpiece and cuts or
shapes the workpiece. The cutting tool insert or drill is consumed during use
and must be replaced periodically.
We serve a wide variety of industries that cut and shape metal parts including
manufacturers of automobiles, trucks, aerospace components, farm equipment, oil
and gas drilling and processing equipment, railroad, marine, power generation
equipment, machinery, appliances, factory equipment and metal components, as
well as job shops and maintenance operations. We deliver our products to
customers through a direct field sales force, distribution, integrated supply
programs, mail-order and e-business.
With a global marketing organization and operations worldwide, we believe we are
the second largest global provider of consumable metalcutting tools and
supplies.
ADVANCED MATERIALS SOLUTIONS GROUP--AMSG In the AMSG segment, the principal
business is the production and sale of cemented tungsten carbide products used
in mining, highway construction, engineered applications requiring wear and
corrosion resistance, including circuit board drills, compacts and other similar
applications. These products have technical commonality to our core metalworking
products. We also sell metallurgical powders to manufacturers of cemented
tungsten carbide products. We also provide application specific component design
services and on-site application support services.
Our mining and construction tools are fabricated from steel parts and tipped
with cemented carbide. Mining tools, used primarily in the coal industry,
include longwall shearer and continuous miner drums, blocks, conical bits,
drills, pinning rods, augers and a wide range of mining tool accessories.
Highway construction cutting
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tools include carbide-tipped bits for ditching, trenching and road planing,
grader blades for site preparation and routine roadbed control, and snowplow
blades and shoes for winter road plowing. We produce these products for mine
operators and suppliers, highway construction companies, municipal governments
and manufacturers of mining equipment. We believe we are the worldwide market
leader in mining and highway construction tooling.
Our customers use engineered products in manufacturing or other operations where
extremes of abrasion, corrosion or impact require combinations of hardness or
other toughness afforded by cemented tungsten carbides or other hard materials.
We sell these products through a direct field sales force and distribution. We
believe we are the largest independent supplier of oil field compacts in the
world. Compacts are the cutting edges of oil well drilling bits, which are
commonly referred to as "rock bits."
J&L INDUSTRIAL SUPPLY--J&L In this segment, we provide metalworking consumables
and related products to small- and medium-sized manufacturers in the United
States and the United Kingdom. J&L markets products and services through annual
mail-order catalogs and monthly sales flyers, telemarketing, the Internet and
field sales. J&L distributes a broad range of metalcutting tools, abrasives,
drills, machine tool accessories, precision measuring tools, gages, hand tools
and other supplies used in metalcutting operations. The majority of industrial
supplies distributed by J&L are purchased from other manufacturers, although the
product offering does include Kennametal-manufactured items.
FULL SERVICE SUPPLY--FSS In the FSS segment, we provide metalworking consumables
and related products to medium- and large-sized manufacturers in the United
States and Canada. FSS offers integrated supply programs that provide inventory
management systems, just-in-time availability and programs that focus on total
cost savings. Through FSS programs, large commercially-oriented customers
seeking a single source of metalcutting supplies engage us to carry out all
aspects of complex metalworking supply processes, including needs assessment,
cost analysis, procurement planning, supplier selection, "just-in-time"
restocking of supplies and ongoing technical support.
INTERNATIONAL OPERATIONS Our international operations are subject to the usual
risks of doing business in those countries, including foreign currency exchange
fluctuations and changes in social, political and economic environments. Our
principal international operations in the MSSG and AMSG segments are conducted
in Western Europe, Canada, the Asia Pacific region, China, South Africa and
Mexico. In addition, we have manufacturing and/or distribution in Israel and
South America, and sales agents and distributors in Eastern Europe and other
areas of the world. Our Western European operations are integral to our U.S.
operations, however, the diversification of our overall operations tends to
minimize the impact of changes in demand on total sales and earnings in any one
particular geographic area.
Our international assets and sales are presented under Note 18 "Segment Data" of
our consolidated financial statements set forth in Item 8 in this annual report
on Form 10-K. Information pertaining to the effects of foreign exchange risk is
contained under the caption "Quantitative and Qualitative Disclosure about
Market Risk" in Management's Discussion and Analysis set forth in Item 7 in this
annual report on Form 10-K.
BUSINESS DEVELOPMENT On August 30, 2002, we purchased the Widia Group (Widia) in
Europe and India from Milacron Inc. for EUR 188 million ($185.3 million) subject
to a purchase price adjustment. On February 12, 2003, Milacron Inc. and
Kennametal signed a settlement agreement with respect to the calculation of the
post-closing purchase price adjustment for the Widia acquisition pursuant to
which Milacron paid Kennametal EUR 18.8 million ($20.1 million) in cash. The net
cash purchase price of $167.1 million includes the actual purchase price of
$185.3 million less the settlement of $20.1 million plus $6.2 million of direct
acquisition costs ($1.1 million paid in fiscal year 2002 and $5.1 million paid
during the twelve months ended June 30, 2003) less $4.3 million of acquired
cash. We financed the acquisition with funds borrowed under our three-year,
multi-currency, revolving credit facility (2002 Credit Agreement) which we
entered into on June 27, 2002 with a group of financial institutions. The
acquisition of Widia improves our global competitiveness, strengthens our
European position and represents a strong platform for increased penetration in
Asia. Widia's operating results have been included in our consolidated results
since the acquisition date of August 30, 2002.
We continue to evaluate new opportunities that allow for the expansion of
existing product lines into new market areas, either directly or indirectly
through joint ventures, where appropriate.
MARKETING AND DISTRIBUTION We sell our manufactured products through the
following distinct sales channels: (i) a direct sales force; (ii) integrated
supply and FSS programs; (iii) mail-order catalogs; (iv) a network of
independent distributors and sales agents in the United States and certain
international markets; and (v) the Internet. Service engineers and technicians
directly assist customers with product design, selection and application.
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We market our products under various trademarks and tradenames, such as
Kennametal*, the letter K combined with other identifying letters and/or
numbers*, Block Style K*, Kendex*, Kenloc*, KennaMAX*, JLK*, J&L*, Kennametal
Hertel*, Hertel*, KM Micro*, Widia*, Heinlein*, Widma*, Ecogrind*, Top Notch*,
Erickson*, Kyon*, KM*, Drill-Fix*, Fix-Perfect*, Disston*, Chicago Latrobe*,
Greenfield*, RTW* and Cleveland*. We also sell products to customers who resell
such products under the customers' names or private labels.
RAW MATERIALS AND SUPPLIES Major metallurgical raw materials consist of ore
concentrates, compounds and secondary materials containing tungsten, tantalum,
titanium, niobium and cobalt. Although adequate supply of these raw materials
currently exists, our major sources for raw materials are located abroad and
prices fluctuate at times. For these reasons, we exercise great care in the
selection, purchase and inventory availability of raw materials. We also
purchase steel bars and forgings for making toolholders, high speed steel and
other tool parts, rotary cutting tools and accessories. We obtain products
purchased for use in manufacturing processes and for resale from thousands of
suppliers located in the United States and abroad.
RESEARCH AND DEVELOPMENT Our product development efforts focus on providing
solutions to our customers' manufacturing problems and productivity
requirements. Our Achieving a Competitive Edge (ACE) Program provides discipline
and focus for the product development process by establishing "gateways," or
sequential tests, during the development process to remove inefficiencies and
accelerate improvements. ACE speeds and streamlines development into a series of
actions and decision points, combining effort and resources to produce new and
enhanced products, faster. ACE assures a strong link between customer needs and
corporate strategy, and enables us to gain full benefit from our investment in
new product development.
Research and development expenses totaled $23.6 million, $18.3 million and $18.9
million in 2003, 2002 and 2001, respectively. Additionally, certain costs
associated with improving manufacturing processes are included in cost of goods
sold. We hold a number of patents, which, in the aggregate, are material to the
operation of our businesses.
SEASONALITY Our business is not materially affected by seasonal variations.
However, to varying degrees, traditional summer vacation shutdowns of
metalworking customers' plants and holiday shutdowns often affect our sales
levels during the first and second quarters of our fiscal year.
BACKLOG Our backlog of orders generally is not significant to our operations. We
fill approximately 90 percent of all orders from stock, and the balance
generally is filled within short lead times.
COMPETITION We are one of the world's leading producers of cemented carbide
products and high-speed steel tools, and maintain a strong competitive position,
especially in North America and Europe. We actively compete in the sale of all
our products, with approximately 40 companies engaged in the cemented tungsten
carbide business in the United States and many more outside the United States.
Several competitors are divisions of larger corporations. In addition, several
hundred fabricators and toolmakers, many of whom operate out of relatively small
shops, produce tools similar to ours and buy the cemented tungsten carbide
components for such tools from cemented tungsten carbide producers, including
us. Major competition exists from both U.S.-based and international-based
concerns. In addition, we compete with thousands of industrial supply
distributors.
The principal elements of competition in our businesses are service, product
innovation, quality, availability and price. We believe that our competitive
strength rests on our customer service capabilities, including multiple
distribution channels, our global presence, state-of-the-art manufacturing
capabilities, ability to develop solutions to address customer needs through new
and improved tools, and the consistent high quality of our products. Based upon
our strengths, we are able to sell products based on the value added to the
customer rather than strictly on competitive prices.
REGULATION We are not currently party to any material legal proceedings,
however, we are periodically subject to legal proceedings and claims that arise
in the ordinary course of our business. While management currently believes the
amount of ultimate liability, if any, with respect to these actions will not
materially affect the financial position, results of operations, or liquidity of
the Company, the ultimate outcome of any litigation is uncertain. Were an
unfavorable outcome to occur, or if protracted litigation were to ensue, the
impact could be material to the Company.
* Trademark owned by Kennametal Inc. or a subsidiary of Kennametal Inc.
5
Compliance with government laws and regulations pertaining to the discharge of
materials or pollutants into the environment or otherwise relating to the
protection of the environment did not have a material effect on our capital
expenditures or competitive position for the years covered by this report, nor
is such compliance expected to have a material effect in the future.
We are involved in various environmental cleanup and remediation activities at
several of our manufacturing facilities. In addition, we are currently named as
a potentially responsible party (PRP) at the Li Tungsten Superfund site in Glen
Cove, New York. In December 1999, we recorded a remediation reserve of $3.0
million with respect to our involvement in these matters, which is recorded as a
component of operating expense. This represents our best estimate of the
undiscounted future obligation based on our evaluations and discussions with
outside counsel and independent consultants, and the current facts and
circumstances related to these matters. We recorded this liability because
certain events occurred, including the identification of other PRPs, an
assessment of potential remediation solutions and direction from the government
for the remedial action plan, that clarified our level of involvement in these
matters and our relationship to other PRPs. This led us to conclude that it was
probable that a liability had been incurred. At June 30, 2003, we have an
accrual of $2.8 million recorded relative to this environmental issue.
In addition to the amount currently reserved, we may be subject to loss
contingencies related to these matters estimated to be up to an additional $3.0
million. We believe that such undiscounted unreserved losses are reasonably
possible but are not currently considered to be probable of occurrence. The
reserved and unreserved liabilities for all environmental concerns could change
substantially in the near term due to factors such as the nature and extent of
contamination, changes in remedial requirements, technological changes,
discovery of new information, the financial strength of other PRPs, the
identification of new PRPs and the involvement of and direction taken by the
government on these matters.
Additionally, we also maintain reserves for other potential environmental issues
associated with our domestic operations and a location operated by our German
subsidiary. At June 30, 2003, the total of these accruals was $1.3 million and
represents anticipated costs associated with the remediation of these issues.
Cash payments of $0.1 million have been made against this reserve during the
year.
During the due diligence phase of the Widia acquisition, we identified certain
environmental exposures with Widia manufacturing locations in Europe and India.
The purchase price paid reflected our estimate of this exposure. As a result of
the Widia acquisition, we have established an environmental reserve of $6.2
million, which is consistent with our expectations determined during the due
diligence phase. This reserve will be used for environmental clean-up and
remediation activities at several Widia manufacturing locations. This liability
represents our best estimate of the future obligation based on our evaluations
and discussions with independent consultants and the current facts and
circumstances related to these matters. This liability has been recorded as part
of the Widia acquisition and has not been reflected in our operating results.
We maintain a Corporate Environmental, Health and Safety (EH&S) Department, as
well as an EH&S Policy Committee, to ensure compliance with environmental
regulations and to monitor and oversee remediation activities. In addition, we
have established an EH&S administrator at all our global manufacturing
facilities. Our financial management team periodically meets with members of the
Corporate EH&S Department and the Corporate Legal Department to review and
evaluate the status of environmental projects and contingencies. On a quarterly
basis, we establish or adjust financial provisions and reserves for
environmental contingencies in accordance with Statement of Financial Accounting
Standards (SFAS) No. 5, "Accounting for Contingencies."
PUBLIC OFFERINGS On June 19, 2002, we sold 3.5 million shares of capital stock
at a price of $36 per share. Net of issuance costs, this offering yielded
proceeds of $120.6 million. On the same date, we issued $300.0 million of 7.2%
Senior Unsecured Notes due 2012 at 99.629% of face amount for net proceeds of
$294.3 million after related financing costs. Proceeds of these offerings were
utilized to repay senior bank indebtedness.
EMPLOYEES We employed approximately 13,970 persons at June 30, 2003, of which
approximately 6,900 were located in the United States and 7,070 in other parts
of the world, principally Europe and Asia Pacific. At June 30, 2003,
approximately 3,690 of the above employees were represented by labor unions. We
consider our labor relations to be generally good.
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AVAILABLE INFORMATION Our Internet address is www.kennametal.com. On our
Investor Relations page on our Web site, we post the following filings as soon
as reasonably practicable after they are electronically filed with or furnished
to the Securities and Exchange Commission: our annual report on Form 10-K, our
quarterly reports on Form 10-Q, our current reports on Form 8-K and any
amendments to those reports filed or furnished pursuant to Section 13(a) or
15(d) of the Securities Exchange Act of 1934. All such filings on our Investor
Information Web page, which also includes Forms 3, 4 and 5 filed pursuant to
Section 16(a) of the Securities Exchange Act of 1934, are available to be viewed
on this page free of charge. Information contained on our Web site is not part
of this annual report on Form 10-K or our other filings with the Securities and
Exchange Commission. We assume no obligation to update or revise any
forward-looking statements in this annual report on Form 10-K, whether as a
result of new information, future events or otherwise. A copy of this annual
report on Form 10-K is available without charge upon written request to:
Investor Relations, Beth Riley, Kennametal Inc., 1600 Technology Way, P.O. Box
231, Latrobe, Pa. 15650-0231.
CORPORATE DIRECTORY Our consolidated subsidiaries and affiliated companies as of
June 30, 2003 are:
Consolidated Subsidiaries of Kennametal Inc.
Kennametal Australia Pty. Ltd.
Kennametal Foreign Sales Corporation
Kennametal Ltd.
Kennametal (Canada) Ltd.
Kennametal (Shanghai) Ltd.
Kennametal (Thailand) Co., Ltd.
Kennametal (Xuzhou) Company Ltd.
Kennametal Hardpoint Inc.
Kennametal Japan Ltd.
Kennametal (Malaysia) Sdn. Bhd.
Kennametal de Mexico, S.A. de C.V.
Kennametal SP. Z.o.o
Kennametal (Singapore) Pte. Ltd.
Kennametal South Africa (Proprietary) Ltd.
Kennametal Korea Ltd.
Kennametal Holding Cayman Islands Limited
Kennametal Co., Ltd.
Kennametal Financing I
Kennametal Financing II Corp.
Kennametal Holdings Europe Inc.
Adaptive Technologies Corp.
Circle Machine Company
Greenfield Industries, Inc.
Consolidated Subsidiaries of Kennametal Financing II
Kennametal PC Inc.
Kennametal TC Inc.
Kennametal Receivables Corporation
Consolidated Subsidiaries of Kennametal Holdings Europe Inc.
JLK Direct Distribution Inc.
Kennametal W Holdings Inc.
Consolidated Subsidiaries of Kennametal Widia Holdings Inc.
Kennametal Europe Holding GmbH
Kennametal Widia Beteiligungs GmbH
Kennametal Widia Holdings GmbH
Widia GmbH
V & S Werkzeuge GmbH
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Corporate Directory (continued)
Consolidated Subsidiaries of Kennametal Hardpoint, Inc.
Kennametal Hardpoint H.K. Ltd.
Kennametal Hardpoint (Taiwan) Inc.
Consolidated Subsidiary of Kennametal Hardpoint H.K. Ltd.
Kennametal Hardpoint (Shanghai) Ltd.
Consolidated Subsidiaries of Widia GmbH
Meturit AG
Widia Vetriebsgesellschaft mbH
Consolidated Subsidiary of Meturit AG
Widia (India) Limited
Consolidated Subsidiaries of Kennametal Holdings Cayman Islands Limited
Kennametal Argentina S.A.
Kennametal do Brasil Ltda.
Kennametal Chile Ltda.
Consolidated Subsidiary of Metruit AG
Widia India Ltd.
Consolidated Subsidiaries of Kennametal Europe Holdings GmbH
Cirbo Limited England
Kennametal Hertel Europe Holding GmbH
Consolidated Subsidiaries of JLK Direct Distribution Inc.
J&L America, Inc.
Full Service Supply Inc.
Consolidated Subsidiary of Full Service Supply Inc.
Full Service Supply Ltd.
Consolidated Subsidiaries of Kennametal Hertel Europe Holding GmbH
Kennametal Hertel AG
Kemmer Hartmetallwerkzeuge GmbH
Kennametal Hertel Hungaria Kft.
Kemmer Hartmetallwerkeeuge GmbH
Consolidated Subsidiaries of Kemmer Hartmetallwerkeeuge GmbH
Kemmer Prazisian GmbH
Kemmer Cirbo S.r.l. Italy
Consolidated Subsidiaries of Kennametal Hertel AG
Kennametal Hertel Belgium S.A.
Kennametal UK Limited
Kennametal France SAS
Kennametal Beteiligungs GmbH
Kennametal Europe GmbH
Kennametal Deutschland GmbH
Kennametal Hertel International GmbH
Kennametal GmbH & Co. K.G.
Kennametal Korea GmbH
Rubig G.m.b.H. & Co. K.G.
Kennametal Hertel S.p.A.
Kennametal Nederland B.V.
Nederland Hardmetal Fabrieken B.V.
Kennametal Kecisi Takimlar Sanayi ve Ticaret A.S.
Kennametal Hertel International GmbH
Kennametal Hertel Iberica S.L.
Kennametal Osterreich GmbH
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Consolidated Subsidiaries of Kennametal Osterreich GmbH
Kennametal Polska Sp. Z.o.o.
Kennametal Kft.
Consolidated Subsidiary of Kennametal UK Limited
Widia UK Ltd.
Consolidated Subsidiaries of Kennametal Hertel Nederland B.V.
Widia Nederland B.B.
Kennametal Engineered Products B.V.
Consolidated Subsidiary of Kennametal Hertel France S.L.
Widia France SAS
Consolidated Subsidiary of Kennametal Iberica S.L.
Kenci S.A.
Consolidated Subsidiary of Kennametal Italia S.p.A.
Kennametal Hertel Italia S.r.l.
Consolidated Subsidiary of Kennametal Hertel Italia S.r.L.
Widia Italia S.r.l.
Consolidated Subsidiaries of J&L America, Inc.
J&L Industrial Supply Ltd.
J&L Industrial Supply UK (branch)
Consolidated Subsidiaries of Greenfield Industries, Inc.
Greenfield Industries Canada Incorporated
Hanita Metal Works, Ltd.
Cleveland Twist Drill de Mexico, S.A. de C.V.
Carbidie Asia Pacific Pte. Ltd.
Kemmer International, Inc.
Rogers Tool Works, Inc.
South Deerfield Industrial, Inc.
Hanita Cutting Tools, Inc.
Hanita Metal Works GmbH (Germany)
Consolidated Subsidiaries of Rogers Tool Works Inc.
TCM Europe, Inc.
RTW Limited (England)
Kennametal Hungary Finance Services kft.
Kennametal Hungary Holdings Inc.
Consolidated Subsidiary of Cleveland Twist Drill de Mexico, S.A. de C.V.
Herramientas Cleveland, S.A. de C.V.
Consolidated Subsidiary of Herramientas Cleveland, S.A. de C.V.
Greenfield Tools de Mexico, S.A. de C.V.
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ITEM 2 - PROPERTIES
Our principal executive offices are located at 1600 Technology Way, P.O. Box
231, Latrobe, Pa., 15650.A summary of our principal owned and leased
manufacturing facilities is as follows:
Location Owned/Leased Principal Products
-------- ------------ ------------------
United States:
Bentonville, Arkansas Owned Carbide Round Tools
Rogers, Arkansas Owned Carbide Products
Monrovia, California Leased Boring Bars
Placentia, California Leased Wear Parts
Evans, Georgia Owned High Speed Steel Drills
Elk Grove Village, Illinois Leased Fixed Limited Gages
Rockford, Illinois Owned Indexable Tooling
Framingham, Massachusetts Leased Fixed Limited Gages
Greenfield, Massachusetts Owned High Speed Steel Taps
South Deerfield, Massachusetts Leased High Speed Steel Drills and Saw Blades
Traverse City, Michigan Owned Ceramic Wear Parts
Troy, Michigan Leased Metalworking Toolholders
Fallon, Nevada Owned Metallurgical Powders
Asheboro, North Carolina Owned High Speed Steel End Mills
Roanoke Rapids, North Carolina Owned Metalworking Inserts
Orwell, Ohio Owned Metalworking Inserts
Solon, Ohio Owned Metalworking Toolholders
Bedford, Pennsylvania Owned Mining and Construction Tools and Wear Parts
Irwin, Pennsylvania Owned Carbide Wear Parts
Latrobe, Pennsylvania Owned Metallurgical Powders and Wear Parts
Clemson, South Carolina Owned High Speed Steel Drills
Johnson City, Tennessee Owned Metalworking Inserts
Whitehouse, Tennessee Leased Fixed Limited Gages
Lyndonville, Vermont Owned High Speed Steel Taps
Chilhowie, Virginia Owned Mining and Construction Tools and Wear Parts
New Market, Virginia Owned Metalworking Toolholders
International:
Victoria, Canada Owned Wear Parts
Pudong, China Owned Metalworking Inserts and Circuit Boards
Xuzhou, China Owned Mining Tools
Bodmin, England Owned Circuit Board Drills and Routers
Kingswinford, England Leased Metalworking Toolholders
Sheffield, England Leased High Speed Steel Drills
Bordeaux, France Leased Metalworking Cutting Tools
Boutheon Cedex, France Owned Metalworking Inserts
Altenburg, Germany Leased High Speed Steel Taps
Ebermannstadt, Germany Owned Metalworking Inserts
Essen, Germany Owned/Leased Metallurgical Powders and Wear Parts
Koenigsee, Germany Leased Carbide and High Speed Steel Drills
Lichtenau, Germany Owned/Leased Metalworking Toolholders
Lorch, Germany Leased Circuit Board Drills
Mistelgau, Germany Owned Metallurgical Powders, Metalworking Inserts
and Wear Parts
10
Properties (continued)
Location Owned/Leased Principal Products
-------- ------------ ------------------
Nabburg, Germany Owned Metalworking Toolholders
Vohenstrauss, Germany Owned Metalworking Carbide Drills
Bangalore, India Owned Metalworking Inserts and Toolholders
and Wear Parts
Patancheru, India Owned Mining Tools and Wear Parts
Shlomi, Israel Owned High Speed Steel Endmills
Milan, Italy Owned Metalworking Cutting Tools
Pachuca, Mexico Owned High Speed Steel Drills
Arnhem, Netherlands Owned Wear Products
Hardenberg, Netherlands Owned Wear Products
Vitoria, Spain Leased Metalworking Carbide Drills
We also have a network of warehouses and customer service centers located
throughout North America, Western Europe, India, Asia, South America and
Australia, a significant portion of which are leased. The majority of our
research and development efforts are conducted in a corporate technology center
located adjacent to the world headquarters in Latrobe, Pa., and in Rogers, Ark.,
Furth, Germany and Essen, Germany.
We use all significant properties in the business of powder metallurgy, tools,
tooling systems and industrial supply. Our production capacity is adequate for
our present needs. We believe that our properties have been adequately
maintained, generally are in good condition and are suitable for our business as
presently conducted.
ITEM 3 - LEGAL PROCEEDINGS
Incorporated by reference is information set forth in Part I herein under the
caption "Regulation." Other than noted therein, there are no material pending
legal proceedings, other than litigation incidental to the ordinary course of
business, to which Kennametal or any of our subsidiaries is a party or of which
any of our property is the subject.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of 2003, there were no matters submitted to a vote of
security holders through the solicitation of proxies or otherwise.
11
EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding the officers of Kennametal Inc. is as follows (included
herein pursuant to Item 401(b) of Regulation S-K): Name, Age and Position,
Experience During Past Five Years(2)
Markos I. Tambakeras, 52(1)
Chairman, President and Chief Executive Officer
Chairman of the Board effective July 1, 2002. President and Chief Executive
Officer since July 1, 1999. Formerly employed by Honeywell Inc. as President of
Industrial Controls Business from 1997 to 1999.
R. Daniel Bagley, 43(1)
Vice President, Corporate Strategy and MSSG Marketing
Vice President since July 2002. Formerly, Business Development Director and
Industrial Consultant for Deloitte & Touche Consulting Group from 1997-2002;
Vice President, Global Sales & Sourcing for General Signal Corporation from
1993-1997; and Director, U.S. Marketing and Distribution for Robert Bosch Fluid
Power Corporation from 1992-1993.
James R. Breisinger, 53(1)
Vice President, President, Advanced Materials Solutions Group
Vice President, President, Advanced Materials Solutions Group since April 2003.
Chief Operating Officer, Advanced Materials Solutions Group from August 2000 to
April 2003. Chief Financial Officer from September 1998 to August 2000. Chief
Operating Officer, Greenfield Industries, Inc. from March through September
1998. Corporate Controller from 1994 to 1998.
Carlos M. Cardoso, 45(1)
Vice President, President, Metalworking Solutions and Services Group
Vice President, President, Metalworking Solutions and Services Group since April
2003. Formerly, President, Pump Division, Flowserve Corporation from August 2001
to March 2003; Vice President and General Manager, Engine Systems and
Accessories, of Honeywell International, Inc. (formerly Allied Signal, Inc.)
from March 1999 to August 2001; and Vice President and General Manager,
Marketing Sales and Services, Aerospace Services, Allied Signal, Inc. from March
1998 to March 1999.
M. Rizwan Chand, 39(1)
Vice President, Human Resources and Corporate Relations
Vice President, Human Resources and Corporate Relations since March 2003. Vice
President and Chief Human Resources Officer from May 2000 to February 2003.
Previously Vice President, Human Resources for Aetna International in 1999.
Previously with Mary Kay Inc. as Senior Vice President, Global Human Resources
from 1996 to 1999.
Stanley B. Duzy, Jr., 56(1)
Vice President, Chief Administrative Officer
Vice President since November 1999. Formerly employed by Honeywell Inc. as Vice
President of Industrial Controls Business from 1998 to 1999 and Vice President
and Controller, Asia Pacific from 1992 to 1997.
F. Nicholas Grasberger III, 39(1)
Vice President, Chief Financial Officer
Vice President and Chief Financial Officer since August 2000. Formerly,
Corporate Treasurer, H.J. Heinz Company from 1997 to 2000.
David W. Greenfield, 53(1)
Vice President, Secretary and General Counsel
Vice President, Secretary and General Counsel since October 2001. Formerly a
member of Buchanan Ingersoll Professional Corporation (attorneys-at-law) July
2000 to September 2001. Special Counsel for ArvinMeritor (a provider of
components for vehicles) from February 1999 to July 2000. Senior Vice President,
General Counsel and Secretary for Meritor Automotive, Inc. (predecessor to
ArvinMeritor) from May 1997 to February 1999.
12
Timothy A. Hibbard, 46(1)
Corporate Controller and Chief Accounting Officer
Corporate Controller and Chief Accounting Officer since February 2002. Director
of Finance for the Advanced Materials Solutions Group from September 2000 to
February 2002. Vice President and Controller of Greenfield Industries, Inc. from
October 1998 to September 2000. Division Controller of Mining & Construction
Division from April 1998 to October 1998.
Brian E. Kelly, 40
Assistant Treasurer and Director of Tax
Assistant Treasurer and Director of Tax since September 1998. Manager of
Corporate Tax from 1996 to 1998.
Lawrence J. Lanza, 54(1)
Corporate Treasurer
Elected Corporate Treasurer in July 2003. Formerly Assistant Treasurer and
Director of Treasury Services from April 1999 to July 2003. Manager, Treasury
Services from August 1998 to March 1999. Previously, Director, Global Capital
Markets for CBS Corporation, formerly Westinghouse Electric Corporation, from
1994 to 1998.
James E. Morrison, 52(1)
Vice President, Mergers and Acquisitions
Vice President, Mergers and Acquisitions, since July 2003. Vice President since
1994. Treasurer from 1987 to July 2003.
Wayne D. Moser, 50
Vice President, General Manager, Industrial Products Europe
Vice President since 1998. General Manager, Industrial Products Europe effective
July 2003. Integration Director from May 2002 to June 2003. Formerly, General
Manager, Mining & Construction from 1997 to 2002.
Ralph G. Niederst, 52(1)
Vice President, Chief Information Officer
Vice President since May 2000. Formerly, Director of Management Information
Technology at Harsco Corporation's Heckett Multiserv Division from 1995 to 2000.
Kevin G. Nowe, 51
Assistant Secretary, Assistant General Counsel
Assistant General Counsel since 1992 and Assistant Secretary since 1993.
Ajita G. Rajendra, 51
Vice President, Director, Industrial Products Group
Vice President since 1998. Director, Industrial Products Group since 1997. Vice
President of the Electronic Products Group of Greenfield Industries, Inc. from
1996 to 1997.
P. Mark Schiller, 55
Vice President, Director of Distribution Services
Vice President since 1992. Director of Distribution Services since
1990.
Michael P. Wessner, 42(1)
Vice President, President, J&L Industrial Supply
Vice President, President, J&L Industrial Supply since April 2003 and formerly
Vice President, Chief Operating Officer from January 2001 to April 2003.
Formerly Chief Executive Officer, Emco/ESS Holdings from 1999 to 2000 and Vice
President, Midwest Region for Office Depot from 1995 to 1999.
Notes
(1) Executive officer of the Registrant.
(2) Each officer has been elected by the Board of Directors to serve until
removed or until a successor is elected and qualified, and has served
continuously as an officer since first elected.
13
Part II
ITEM 5 - MARKET FOR THE REGISTRANT'S COMMON EQUITY AND
RELATED SHAREOWNER MATTERS
Our common stock is traded on the New York Stock Exchange (symbol KMT). The
number of shareowners of record as of August 29, 2003 was 3,145. Stock price
ranges and dividends declared and paid were as follows:
Quarter ended Sep. 30 Dec. 31 Mar. 31 Jun. 30
- -----------------------------------------------------------------------------------
FISCAL 2003
High $ 36.80 $ 36.15 $ 35.56 $ 35.50
Low 27.73 28.75 27.10 27.75
Dividends 0.17 0.17 0.17 0.17
- -----------------------------------------------------------------------------------
FISCAL 2002
High $ 39.79 $ 41.37 $ 42.70 $ 43.00
Low 28.43 30.12 35.15 34.65
Dividends 0.17 0.17 0.17 0.17
===================================================================================
14
ITEM 6 - SELECTED FINANCIAL DATA
(in thousands, except per share data) 2003 2002 2001
- ----------------------------------------------------------------------------------------------------------
OPERATING RESULTS
Sales (1) $ 1,758,957 $ 1,583,742 $1,807,896
Cost of goods sold (1) 1,190,053 1,072,918 1,192,176
Operating expense (1) 464,861 389,396 425,641
Interest expense 36,166 32,627 50,381
Restructuring, asset impairment and other charges (2) 31,954 27,307 9,545
Income taxes 14,300 18,900 37,300
Accounting changes, net of tax (3) - 250,406 599
Net income (loss) 18,130 (211,908) 53,288
- ----------------------------------------------------------------------------------------------------------
FINANCIAL POSITION
Net working capital $ 428,332 $ 375,284 $ 386,711
Inventories 392,255 345,076 373,221
Property, plant and equipment, net 493,373 435,116 472,874
Total assets 1,779,092 1,523,611 1,825,442
Long-term debt, including capital leases 514,842 387,887 582,585
Total debt, including capital leases and notes payable 525,687 411,367 607,115
Total shareowners' equity (4) 721,577 713,962 796,769
- ----------------------------------------------------------------------------------------------------------
PER SHARE DATA
Basic earnings (loss) $ 0.52 $ (6.80) $ 1.74
Diluted earnings (loss) 0.51 (6.70) 1.73
Dividends 0.68 0.68 0.68
Book value (at June 30) 20.34 20.51 25.84
Market price (at June 30) 33.84 36.60 36.90
- ----------------------------------------------------------------------------------------------------------
OTHER DATA
Capital expenditures $ 49,413 $ 44,040 $ 59,929
Number of employees (at June 30) 13,970 11,660 12,570
Average sales per employee (1) $ 131 $ 131 $ 139
Basic weighted average shares outstanding (000) (4) 35,202 31,169 30,560
Diluted weighted average shares outstanding (000) (4) 35,479 31,627 30,749
- ----------------------------------------------------------------------------------------------------------
KEY RATIOS
Sales growth (1) 11.1% (12.4)% (3.1)%
Gross profit margin (1) 32.3 32.3 34.1
Operating profit margin (1) 3.9 5.8 8.7
- ----------------------------------------------------------------------------------------------------------
15
Selected Financial Data (continued)
2000 1999
- ---------------------------------------------------------------------------------------
OPERATING RESULTS
Sales $ 1,866,578 $ 1,914,961
Cost of goods sold 1,228,685 1,272,090
Operating expense 434,136 455,903
Interest expense 55,079 68,594
Restructuring, asset impairment and other special charges 18,526 13,937
Income taxes 43,700 32,900
Accounting changes, net of tax - -
Net income (loss) 51,710 39,116
- ---------------------------------------------------------------------------------------
FINANCIAL POSITION
Net working capital $ 397,403 $ 373,582
Inventories 410,885 434,462
Property, plant and equipment, net 498,784 539,800
Total assets 1,941,121 2,000,480
Long-term debt, including capital leases 637,686 717,852
Total debt, including capital leases and notes payable 699,242 861,291
Total shareowners' equity 780,254 745,131
- ---------------------------------------------------------------------------------------
PER SHARE DATA
Basic earnings (loss) $ 1.71 $ 1.31
Diluted earnings (loss) 1.70 1.31
Dividends 0.68 0.68
Book value (at June 30) 25.56 24.78
Market price (at June 30) 21.44 31.00
- ---------------------------------------------------------------------------------------
OTHER DATA
Capital expenditures $ 50,663 $ 94,993
Number of employees (at June 30) 13,210 13,640
Average sales per employee $ 140 $ 137
Basic weighted average shares outstanding (000) 30,263 29,917
Diluted weighted average shares outstanding (000) 30,364 29,960
- ---------------------------------------------------------------------------------------
KEY RATIOS
Sales growth (2.5)% 13.5%
Gross profit margin 34.2 33.6
Operating profit margin 8.5 7.7
- ---------------------------------------------------------------------------------------
Notes
(1) Amounts and percentages for 2000, 1999, 1998 and 1997 were adjusted to
reclassify shipping and handling fees to net sales and shipping and handling
costs to cost of goods sold as required by Emerging Issues Task Force 00-10,
"Accounting for Shipping and Handling Fees and Costs." It was not
practicable to restate periods prior to 1997.
(2) In 2003, restructuring, asset impairment and other charges related to the
2003 Workforce Restructuring Program, Kennametal Integration Restructuring
Program, Electronics impairment and the 2003 Facility Consolidation Program.
In 2002, restructuring, asset impairment and other charges related primarily
to the MSSG facility rationalizations and employee severance, J&L business
improvement program, electronics facility rationalization and FSS business
improvement program and other operational improvement programs.
In 2001, restructuring, asset impairment and other charges related primarily
to the J&L business improvement program, core business resize program and
FSS business improvement program and other operational improvement programs.
In 2000, restructuring, asset impairment and other charges are associated
with strategic alternatives and operational improvement programs.
In 1999, restructuring, asset impairment and other charges are associated
with charges related to operational improvement programs.
In 1996, restructuring, asset impairment and other charges were related to
the relocation of the North America Metalworking Headquarters from Raleigh,
N.C. to Latrobe, Pa., and to close a manufacturing facility.
In 1994, restructuring, asset impairment and other charges included
integration costs associated with the acquisition of Hertel AG in 1994.
16
1998 1997 1996 1995 1994 1993
- ---------------------------------------------------------------------------------
$1,687,516 $1,160,452 $1,079,963 $ 983,873 $ 802,513 $ 598,496
1,057,089 713,182 625,473 560,867 472,533 352,773
419,182 317,315 328,377 293,868 263,300 200,912
59,536 10,393 11,296 12,793 13,811 9,549
- - 2,666 - 24,749 -
53,900 44,900 43,900 45,000 15,500 14,000
- - - - 15,003 -
71,197 72,032 69,732 68,294 (4,088) 20,094
- ---------------------------------------------------------------------------------
$ 447,992 $ 175,877 $ 217,651 $ 184,072 $ 130,777 $ 120,877
436,472 210,111 204,934 200,680 158,179 115,230
525,927 300,386 267,107 260,342 243,098 192,305
2,091,520 851,243 799,491 781,609 697,532 448,263
840,932 40,445 56,059 78,700 90,178 87,891
967,667 174,464 131,151 149,730 147,295 110,628
735,460 459,608 438,949 391,885 322,836 255,141
- ---------------------------------------------------------------------------------
$ 2.61 $ 2.71 $ 2.62 $ 2.58 $ (0.17) $ 0.93
2.58 2.69 2.60 2.56 (0.17) 0.92
0.68 0.66 0.60 0.60 0.58 0.58
24.66 17.61 16.44 14.75 12.25 11.64
41.75 43.00 34.00 34.50 24.63 16.75
- ---------------------------------------------------------------------------------
$ 104,774 $ 73,779 $ 57,556 $ 43,371 $ 27,313 $ 23,099
14,380 7,550 7,260 7,030 6,600 4,850
$ 153 $ 159 $ 152 $ 146 $ 125 $ 122
27,263 26,575 26,635 26,486 24,304 21,712
27,567 26,786 26,825 26,640 24,449 21,753
- ---------------------------------------------------------------------------------
45.4% 7.5% 9.8% 22.6% 34.1% 0.7%
37.4 38.5 42.1 43.0 41.1 41.1
11.6 10.9 11.3 12.9 4.7 7.2
- ---------------------------------------------------------------------------------
(3) Accounting changes in 2002 reflect the non-cash charge related to goodwill
impairment recorded as a result of the adoption of SFAS No. 142. In 2001,
this charge reflects the change in the method of accounting for derivative
financial instruments (SFAS No. 133) and in 1994, the changes in the methods
of accounting for postretirement health care and life insurance benefits
(SFAS No. 106) and income taxes (SFAS No. 109) are reflected.
(4) During 2002 and 1998, we issued 3.5 million and 3.45 million shares of
capital stock for net proceeds of $120.6 million and $171.4 million,
respectively.
17
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS The following discussion should be read in connection with
the consolidated financial statements of Kennametal Inc. and the related
footnotes. Unless otherwise specified, any reference to a "year" is to a fiscal
year ended June 30. Additionally, when used in this annual report on Form 10-K,
unless the context requires otherwise, the terms "we," "our" and "us" refer to
Kennametal Inc. and its subsidiaries.
BUSINESS OVERVIEW We are a leading global manufacturer, marketer and distributor
of a broad range of cutting tools, tooling systems, supplies and technical
services, as well as wear-resistant parts. We believe that our reputation for
manufacturing excellence and technological expertise and innovation in our
principal products has helped us achieve a leading market presence in our
primary markets. We believe we are the second largest global provider of
metalcutting tools and tooling systems. End users of our products include
metalworking manufacturers and suppliers in the aerospace, automotive, machine
tool and farm machinery industries, as well as manufacturers and suppliers in
the highway construction, coal mining, quarrying and oil and gas exploration
industries.
SALES Sales of $1,759.0 million in 2003 increased 11.1 percent, versus $1,583.7
million last year. The increase in sales is attributed to the positive benefit
of $163.9 million from the Widia acquisition and the favorable foreign currency
effects of $68.9 million. Additionally, Metalworking South America, a component
of MSSG, showed continued growth with a $8.3 million increase in revenue. For
Industrial Products Group (IPG), which is a component of MSSG, revenue increased
$10.6 million due to market share gains made in the high-speed steel business.
This was offset by the sale of Strong Tool which comprised $25.9 million of 2002
revenue. After taking these factors into consideration, the significant
components of the remaining change was attributed to a decline in sales in
Metalworking North America, which is a component of MSSG, of $10.0 million;
Metalworking Europe, which is a component of MSSG, of $5.5 million; Energy,
which is a component of AMSG, of $8.5 million; J&L of $6.0 million and FSS of
$32.6 million. The decline in sales in North America and Europe is due to
overall weak market conditions that were experienced throughout 2003. The
decline in FSS sales is due to the loss of sales associated with the
discontinuance of certain customer relationships.
Sales of $1,583.7 million in 2002 decreased 12.4 percent compared to sales of
$1,807.9 million in 2001. The decline in sales is attributed to unfavorable
foreign currency effects of $14.3 million and $10.7 million related to the
decrease in revenue year-over-year due to the sale of Strong Tool. Lower sales
in North America, due to overall weak market conditions, contributed to the
remaining decline in sales.
GROSS PROFIT MARGIN In 2003 our gross profit margin remained flat at 32.3
percent. The gross margin was negatively impacted by lower Widia margins which
decreased margins by $5.5 million, a decrease in domestic pension income of $4.2
million, unfavorable product mix and pricing pressures. This was offset by a
positive benefit from foreign exchange of $31.6 million, favorable raw material
prices and lean manufacturing efficiencies. The 2003 gross margin includes
charges associated with the Widia integration of $2.2 million. The 2002 gross
margin includes inventory abandonment charges of $2.7 million associated with
facility closures in 2002.
The gross profit margin for 2002 was 32.3 percent, down from 34.1 percent in
2001. The decrease was due primarily to underutilized capacity and unfavorable
manufacturing variances associated with the lower sales volume. Additionally,
unfavorable product mix contributed to the lower margins. These unfavorable
items were partially offset by efficiencies derived from our lean initiatives.
Gross margins for 2002 and 2001 included $2.7 million and $3.6 million,
respectively, of inventory abandonment charges primarily associated with
facility closures in 2002 and the rationalization of certain product lines
discontinued as part of a program to streamline and optimize the product
offering of J&L in 2001.
OPERATING EXPENSE Operating expense of $464.9 million in 2003 was $75.5 million
or 19.4 percent higher than the operating expense level in 2002 of $389.4
million. The increase in operating expenses is associated with the Widia
acquisition, $20.1 million of unfavorable foreign currency effects, a decrease
in domestic pension income of $4.5 million and reinstatement of salary increases
and the company match on 401(k) contributions. These amounts were offset, in
part, by the Strong Tool divestiture which comprised $5.1 million of the 2002
operating expense. Operating expenses included charges of $5.5 million in 2003
related to the Widia integration.
18
In 2002, operating expense declined to $389.4 million from $425.6 million in
2001. Ongoing cost-cutting and lean initiatives, combined with several
short-term savings actions, including the curtailment of salary increases and
the company match on 401(k) contributions, mitigated the impact of reduced
sales. Although overall operating expense declined, our spending on growth
programs and research and development was sustained.
RESTRUCTURING AND ASSET IMPAIRMENT CHARGES Impairment In June 2003, we completed
an assessment of the carrying value of certain long-lived assets in the
Electronics business, a component of AMSG. As a result of this assessment, we
recorded a pre-tax charge of $16.1 million ($15.3 million after tax) as a
component of restructuring and asset impairment charges. The charge is a result
of price declines caused by persistent global over-capacity and low-cost Asian
competition. The fixed asset impairment charge reduced the book value of the
Electronics business' assets to $2.6 million. This remaining value was
determined based on cash flow and estimated realizable value of the assets.
2003 Facility Consolidation Program In June 2003, we approved a facility
consolidation program. This program is expected to have restructuring charges of
approximately $2.5 million and is anticipated to generate in excess of $1.5
million in cash savings annually. The plan includes the closure of two regional
operating centers and the Framingham manufacturing facility and a workforce
reduction. In conjunction with the program, we recorded an asset write-down
related to fixed assets that will be disposed of as a result of the
restructuring program. All actions pertain to the MSSG segment. All costs
associated with the restructuring program are expected to be incurred and paid
by December 31, 2003, except certain lease costs which may extend to June 2004.
Accrual at Asset Cash Accrual at
(in thousands) June 30, 2002 Expense Write-down Expenditures June 30, 2003
- ------------------------------------------------------------------------------------------------------------
Employee severance $ - $ 1,188 $ - $ - $ 1,188
Facility rationalization - 460 (316) - 144
- ------------------------------------------------------------------------------------------------------------
Total $ - $ 1,648 $ (316) $ - $ 1,332
============================================================================================================
2003 Workforce Restructuring Program In October 2002, we announced a global
salaried workforce reduction of approximately five percent. The reduction as
announced was expected to cost between $9 million and $10 million. The expected
cost was revised to $8.0 million as the plan was substantially completed as of
June 30, 2003. As previously announced, the plan generated in excess of $10
million in cash savings during fiscal 2003. The program resulted in $2.8 million
of charges for the MSSG segment, $2.6 million for AMSG, $1.3 million for J&L,
$0.1 million for FSS and $1.2 million for Corporate. The components of the
restructuring accrual at June 30, 2003 for this program are as follows:
Accrual at Expense Cash Accrual at
(in thousands) June 30, 2002 Expense Adjustment Expenditures June 30, 2003
- ------------------------------------------------------------------------------------------------------------
Employee severance $ - $ 8,345 $ (434) $ (6,076) $ 1,835
- ------------------------------------------------------------------------------------------------------------
Total $ - $ 8,345 $ (434) $ (6,076) $ 1,835
============================================================================================================
The restructuring accrual at June 30, 2003 represents expected future cash
payments for these obligations over the next six months. The expense adjustments
represent revisions in the original cost estimates related to this plan.
Widia Integration In addition to the 2003 Workforce Restructuring Program, we
have implemented two Widia acquisition-related integration programs (Kennametal
Integration Restructuring Program and the Widia Integration Plan) which together
are expected to result in a global headcount reduction of between 650 and 700
positions. The integration plan is expected to result in annual cost savings of
$30 million annually. We have substantially completed the integration plan and,
as of June 30, have closed six sales offices, two manufacturing facilities and
closed or consolidated four warehouses. As of June 30, 2003 we have terminated
approximately 545 employees in Europe and India and expect the remaining
workforce reduction to be within our original estimates. We expect the
completion of all integration activities in the second quarter of 2004.
Kennametal Integration Restructuring Program This program includes employee
severance costs associated with existing Kennametal facilities.
19
The components of the restructuring accrual at June 30, 2003 for this program
are as follows:
Accrual at Cash Accrual at
(in thousands) June 30, 2002 Expense Expenditures June 30, 2003
- -----------------------------------------------------------------------------------------------
Employee severance $ - $ 6,956 $ (3,316) $ 3,640
- -----------------------------------------------------------------------------------------------
Total $ - $ 6,956 $ (3,316) $ 3,640
===============================================================================================
Widia Integration Plan In connection with the acquisition, we have established a
Widia integration plan to develop centers of excellence in functional areas and
enable long-term growth and competitive advantages. Costs that are incurred
under this plan will be accounted for under EITF 95-3, "Recognition of
Liabilities in Connection with a Purchase Business Combination." As a result,
these costs have been recorded as part of the Widia purchase price allocation.
Accrual at Adjustment Cash Accrual at
(in thousands) June 30, 2002 to Goodwill Expenditures June 30, 2003
- -------------------------------------------------------------------------------------------------
Facility rationalizations $ - $ 4,678 $ (3,321) $ 1,357
Employee severance - 19,783 (4,849) 14,934
Terminated contracts - 1,401 (938) 463
- -------------------------------------------------------------------------------------------------
Total $ - $ 25,862 $ (9,108) $ 16,754
=================================================================================================
Widia Restructuring In connection with our acquisition of Widia, we assumed $2.4
million of restructuring accruals related to restructuring programs initiated by
Widia prior to the acquisition date. These programs, initiated in December 2001,
relate to the severance of 156 European employees in both production and
administration. The accrual balance at June 30, 2003 of $0.2 million represents
a decrease of $2.2 million related to cash payments made during the period since
acquisition.
2002 AMSG and MSSG Restructuring In November 2001, we announced a restructuring
program whereby we recognized special charges of $18 million. This was done in
response to continued steep declines in the end market demand in the Electronics
and Industrial Products Group businesses. All initiatives under this program
have been implemented and completed.
These costs are related to the closing and consolidation of the AMSG electronics
facility in Chicago, Ill., and MSSG Industrial Products Group's Pine Bluff, Ark.
and Monticello, Ind. locations, the production of a particular line of products
in Rogers, Ark. and several customer service centers. As a result, we recorded
restructuring charges of $14.8 million during 2002 related to exit costs
associated with these actions, including severance for substantially all 337
employees at the closed facilities. We also recorded a charge of $2.5 million
related to severance for 84 individuals, primarily in the MSSG segment. The
components of the charges and the accrual at June 30, 2003 for this program are
as follows:
Accrual at Expense Cash Accrual at
(in thousands) June 30, 2002 Expense Adjustment Expenditures June 30, 2003
- ------------------------------------------------------------------------------------------------------------
Facility rationalizations $ 2,977 $ 15 $ (511) $ (2,180) $ 301
Employee severance 1,220 110 (2) (1,229) 99
- ------------------------------------------------------------------------------------------------------------
Total $ 4,197 $ 125 $ (513) $ (3,409) $ 400
============================================================================================================
The restructuring accrual at June 30, 2003 represents future cash payments for
these obligations, of which the majority are expected to occur over the next six
months. The expense adjustments represent revisions in the original cost
estimates related to this plan.
2002 and 2001 J&L and FSS Business Improvement Program In the J&L segment for
2001, we recorded a restructuring and asset impairment charge of $2.5 million
for severance of 115 individuals, $1.8 million associated with the closure of 11
underperforming satellite locations, including certain German operations, and
$0.7 million for the exiting of three warehouses. This includes a $0.4 million
non-cash write-down of the book value of certain property, plant and equipment,
net of salvage value, that we determined would no longer be utilized in ongoing
operations. In the FSS segment for 2001, we recorded restructuring charges of
$0.6 million for severance related to eight individuals.
20
In 2002, we continued our J&L and FSS business improvement programs initiated in
2001. In the J&L segment during 2002, we recorded restructuring and asset
impairment charges of $5.3 million related to the write-down of a portion of the
value of a business system, $2.5 million for severance for 81 individuals and
$1.7 million related to the closure of 10 satellites and two call centers. In
the FSS segment for 2002, we recorded restructuring charges of $0.7 million for
severance related to 34 individuals. Total charges related to this plan were $19
million which are consistent with our original estimate of $15 to $20 million.
During the third quarter of 2003, we completed the 2001 J&L and FSS Business
Improvement Programs and have incurred cash payments of $1.2 million, $3.2
million and $4.4 million related to this program in 2003, 2002 and 2001,
respectively.
2001 Core-Business Resize Program In 2001, we took actions to reduce our
salaried workforce in response to the weakened U.S. manufacturing sector. As a
result of implementing this core-business resize program, we recorded a
restructuring charge in 2001 of $4.6 million related to severance for 209
individuals. All employee benefit initiatives under this program have been
implemented and the program has been completed. Cash expenditures were $0.3
million, $1.9 million and $2.2 million in 2003, 2002 and 2001, respectively.
AMORTIZATION OF INTANGIBLES The provision for amortization expense was $4.2
million in 2003 compared with $2.8 million in 2002. The increase in amortization
expense of $1.4 million or 48.5 percent, is attributed to the Widia acquisition,
which was completed on August 30, 2002. As a result of the acquisition, we have
recorded $27.2 million of identifiable intangible assets of which $6.4 million
has a definite life and therefore will be amortized over its remaining useful
life.
The provision for amortization expense was $2.8 million in 2002 compared with
$24.1 million in 2001. The decrease was primarily the result of ceasing
amortization of goodwill in 2002 under the provisions of SFAS 142, "Goodwill and
Other Intangible Assets," which was adopted on July 1, 2001.
INTEREST EXPENSE Interest expense was $36.2 million in 2003 compared with $32.6
million in 2002. This increase in interest expense is due to the greater average
level of borrowings to fund the Widia acquisition. Total debt and capital leases
has increased from $404.4 million in 2002 to $517.8 million in 2003. Our average
domestic borrowing rate was 5.36 percent in 2003 compared to 4.91 percent in
2002. The increase in average borrowing rate is a result of the issuance of
Senior Unsecured Notes and the related interest rate swaps. Interest expense for
2003 and 2002 included $0.5 million and $0.3 million, respectively, related to
the write-down of the remaining deferred financing fees. The write-down of
financing fees in 2003 was a result of our decision to reduce the size of our
2002 Credit Agreement from $650 million to $500 million. The write-down in 2002
related to deferred financing fees from the Bank Credit Agreement entered into
in 1998 (Bank Credit Agreement) that was replaced in June 2002 with the 2002
Credit Agreement.
Interest expense for 2002 was $32.6 million compared with $50.4 million in 2001.
The decrease was due to debt reduction and lower average borrowing rates.
Overall debt levels declined to $404.4 million at June 30, 2002 from $584.6
million in 2001. Our average domestic borrowing rate of 4.91 percent in 2002 was
202 basis points below 2001 due to Federal Reserve rate cuts and improved
pricing under the Bank Credit Agreement.
OTHER (INCOME) EXPENSE, NET In 2003, other income, net increased by $2.2 million
to $2.5 million compared with $0.4 million in 2002. The prior year income of
$0.4 million includes the negative impact of the loss on divestiture of Strong
Tool of $3.5 million. Included in other income, net for 2003 were $1.9 million
in fees associated with the account receivable securitization program, which
decreased $0.6 million from the $2.5 million recorded in 2002. The decline in
account receivable securitization fees is attributable to lower interest rates
in the commercial paper market. Additionally, interest income has increased from
$1.5 million in 2002 to $2.8 million in 2003. The benefits associated with the
securitization program and increased interest income were offset by foreign
exchange losses, which increased $2.8 million during the current year from
income of $1.8 million in 2002 to expense of $1.0 million in 2003.
In 2002, other income, net increased by $12.1 million to $0.4 million, compared
to other expense, net of $11.7 million in 2001. These amounts include losses of
$3.5 million associated with our divestiture of Strong Tool Company and $5.8
million associated with our divestiture of ATS Industrial Supply, Inc. (ATS) in
2002 and 2001, respectively. Account receivable securitization fees were reduced
by $3.2 million during 2002 due to a significant decline in commercial paper
rates which are the basis for determining the fees. Additionally, during 2002
foreign exchange gains increased by $4.0 million resulting from contracts
entered to hedge against cross-border cash flows.
21
INCOME TAXES The effective tax rate for 2003 was 41.7 percent compared to an
effective rate of 32.0 percent for 2002. The 2003 effective rate included an
11.7 percentage point negative impact related to the impairment charge for our
Electronics business unit. Partially offsetting this was a 9.7 percentage point
favorable impact related to the utilization of capital losses that were
previously reserved. Also included in our effective rate is the net impact of
our European tax planning initiatives offset by losses from our foreign
subsidiaries for which no tax benefit has been provided.
The effective tax rate in 2002 was 32.0 percent compared to the effective rate
of 39.5 percent in 2001. The significant decrease in the effective tax rate was
due to the effects of the elimination of non-deductible goodwill expense due to
the adoption of SFAS 142, as well as European tax planning.
CHANGES IN ACCOUNTING PRINCIPLES We adopted SFAS No. 142, effective July 1,
2001, which established new accounting and reporting requirements for goodwill
and other intangible assets, including new measurement techniques for evaluating
the recoverability of such assets. Under SFAS No. 142, all goodwill amortization
ceased effective July 1, 2001. Material amounts of recorded goodwill
attributable to each of our reporting units in 2002 were tested for impairment
by comparing the fair value of each reporting unit with its carrying value. As a
result of the adoption of this rule, we recorded a non-cash charge in 2002, net
of tax, of $250.4 million, specific to the Electronics (AMSG segment--$82.1
million) and the IPG (MSSG segment--$168.3 million) businesses, which were
acquired in 1998 as part of the acquisition of Greenfield Industries. The fair
values of these reporting units were determined using a combination of
discounted cash flow analysis and market multiples based upon historical and
projected financial information. Under SFAS No. 142, the impairment adjustment
recognized at adoption of this standard was reflected as a cumulative effect of
a change in accounting principle, effective July 1, 2001.
NET INCOME We reported net income of $18.1 million for 2003 compared with net
loss of $211.9 million in 2002. Net income in the current year included a $15.3
million after-tax charge associated with the Electronics impairment. The net
loss reported in 2002 was due largely to the goodwill impairment charges, which
was $250.4 million. The increase in net income, in the current year, is due to a
reduction in impairment charges from $250.4 million in 2002 to $15.3 million in
2003, offset by an increase in operating expense related to the Widia
integration, a $3.5 million increase in interest expense and a 9.7 percentage
point increase in the effective tax rate.
Due largely to the goodwill impairment charge, we recorded a net loss in 2002 of
$211.9 million, compared to net income of $53.3 million in 2001. Additionally,
in 2002 earnings declined due to lower sales levels and margins, partially
offset by lower operating and interest expense, and a decline in our effective
tax rate. Outside of the goodwill impairment charge, other restructuring and
asset impairment charges of $27.3 million in 2002 related primarily to the MSSG
and AMSG restructuring initiated in 2002 and additional costs associated with
restructuring actions made in the J&L business improvement program that was
started in 2001. Included in net income for 2001 was $19.0 million of goodwill
amortization, net of tax that was not included in 2002 due to the
non-amortization provisions of SFAS No. 142.
BUSINESS SEGMENT REVIEW Our operations are organized into four global business
units consisting of MSSG, AMSG, J&L and FSS, and corporate functional shared
services. The presentation of segment information reflects the manner in which
we organize segments for making operating decisions and assessing performance.
METALWORKING SOLUTIONS & SERVICES GROUP In the MSSG segment, we provide
consumable metalcutting tools and tooling systems to manufacturing companies in
a wide range of industries throughout the world. Metalcutting operations include
turning, boring, threading, grooving, milling and drilling. Our tooling systems
consist of a steel toolholder and a cutting tool such as an indexable insert or
drill made from cemented tungsten carbides, high speed steel or other hard
materials. Other cutting tools include end mills, reamers and taps. We provide
solutions to our customers' metalcutting needs through engineering services
aimed at improving their competitiveness. We also manufacture cutting tools,
drill bits, saw blades and other tools for the consumer market which are
marketed under private label and other proprietary brands.
(in thousands) 2003 2002 2001
- --------------------------------------------------------------------------------
External sales $1,123,175 $ 897,157 $ 999,813
Intersegment sales 107,486 116,467 111,780
Operating income 90,627 97,323 130,558
- --------------------------------------------------------------------------------
22
MSSG external sales increased by $226.0 million, or 25.2 percent, from 2002. The
increase in MSSG external sales is primarily related to the acquisition of Widia
which increased sales by $163.9 million and favorable foreign exchange effects
of $57.3 million. The other significant components that affected the MSSG
segment included North America, which had a decrease in external sales of $10.0
million, Europe, which had a $5.5 million decrease offset by a $8.3 million
increase in South America and the Industrial Products Group which had a $10.6
million increase in sales.
Operating income declined from $97.3 million in 2002 to $90.6 million in 2003,
representing a decrease of $6.7 million or 6.9 percent. The decrease in
operating income is directly related to the dilutive effect of the Widia margins
which decreased margins by $5.5 million and unfavorable product mix and pricing
pressures. We continue to expect Widia to be accretive to MSSG margins during
2004 as the synergy benefits from our Widia Integration Program are realized.
Included in operating income is $9.1 million and $10.2 million of restructuring
costs for 2003 and 2002, respectively. The 2003 restructuring expense pertains
to the 2003 Workforce Restructuring Program and 2003 Facility Consolidation
Program. The restructuring expense has declined due to the completion of the
2002 AMSG and MSSG Restructuring Program. This reduction was offset, in part, by
$6.5 million of Widia integration costs.
In 2002, external sales in the MSSG segment of $897.2 million declined 10
percent from $999.8 million in 2001. In the North America Metalworking Group,
sales declined $45.5 million or 13 percent while Industrial Products Group sales
declined $46.3 million or 19 percent. Due to depressed market conditions, sales
of the North American operations contributed to nearly 90% of the overall
segment decline. Additionally, unfavorable foreign exchange effects accounted
for $11.6 million of the decrease in sales.
In 2002, operating income declined $33.2 million to $97.3 million, including
$10.2 million of charges related to MSSG restructuring. Additionally, the lower
sales levels contributed significantly to the reduced operating profit,
partially offset by operating expense reductions and lean initiatives.
ADVANCED MATERIALS SOLUTIONS GROUP This segment's principal business is the
production and sale of cemented tungsten carbide products used in mining,
highway construction and engineered applications including circuit board drills,
compacts and other similar applications. These products have technical
commonality to our core metalworking products. We also sell metallurgical
powders to manufacturers of cemented tungsten carbide products. In addition, we
provide application specific component design services and on-site application
support services.
(in thousands) 2003 2002 2001
- --------------------------------------------------------------------------------
External sales $319,223 $307,668 $352,933
Intersegment sales 29,137 24,167 28,167
Operating income 17,348 26,781 43,270
- --------------------------------------------------------------------------------
AMSG external sales for 2003 increased by $11.6 million, or 3.8 percent, from
$307.7 million in 2002 to $319.2 million in 2003. The increase in external sales
is attributed to favorable foreign exchange effects of $9.5 million; an increase
in Engineered Products Group which increased $5.4 million, and the Carmet
acquisition which contributed $4.3 million to sales. This was offset, in part,
by a $8.5 million decline in Energy Products.
Operating income decreased from $26.8 million in 2002 to $17.3 million to 2003.
Restructuring expense in 2003 was $4.4 million compared to the prior year of
$8.0 million. Additionally, 2003 operating income includes integration costs
associated with the Widia acquisition of $1.2 million, and the Electronics
impairment charge of $16.1 million (pre-tax). Operating income benefited from
manufacturing efficiencies, reduced restructuring costs, lower raw material
costs and benefits derived from previously implemented restructuring programs.
AMSG external sales declined $45.3 million or 12.8 percent from $352.9 million
in 2001 to $307.7 million in 2002. Unfavorable foreign exchange effects
accounted for $2.3 million of the decline. A continued weak demand in the
Electronics business due to a depressed market accounted for 64 percent of the
overall sales decline of this segment. Additionally, lower sales in Energy and
the Engineered Products Group contributed 25 and 11 percent, respectively, to
the overall sales decline due primarily to declining rig counts and lower levels
of industrial activity.
23
Operating income declined by $16.5 million from $43.3 million in 2001 to $26.8
million in 2002. A portion of the decrease is attributed to restructuring
charges which increased from $0.9 million in 2001 to $8.0 million in 2002. The
remainder of the decline was due to lower gross profit due to under-utilization
of capacity caused by the volume declines which was partially offset by
operating expense reductions.
J&L INDUSTRIAL SUPPLY In this segment, we provide metalworking consumables and
related products to small- and medium-sized manufacturers in the United States
and the United Kingdom. J&L markets products and services through annual
mail-order catalogs and monthly sales flyers, telemarketing, the Internet and
field sales. J&L distributes a broad range of metalcutting tools, abrasives,
drills, machine tool accessories, precision measuring tools, gages, hand tools
and other supplies used in metalcutting operations.
(in thousands) 2003 2002 2001
- --------------------------------------------------------------------------------
External sales $ 196,170 $ 226,010 $ 296,264
Intersegment sales 1,989 2,083 3,823
Operating income (loss) 6,140 (681) 3,689
- --------------------------------------------------------------------------------
External sales in this segment have decreased by $29.8 million, or 13.2 percent,
from $226.0 million in 2002 to $196.2 million in 2003. The decrease in sales is
due to the sale of Strong Tool Company which comprised $25.9 million in sales in
2002 and due to slower sales in automotive and aerospace markets offset, in
part, by favorable foreign exchange of $2.0 million.
Operating income increased by $6.8 million from a loss of $0.7 million in 2002
to income of $6.1 million in 2003. The increase is due to restructuring expense
declining from $10.1 million in 2002 to $1.2 million in 2003.
In 2002, external sales in this segment declined $70.3 million or 24 percent
from 2001, including eight percent due to the ATS and Strong Tool Company
divestitures. The remainder of the decline is due to weak demand in the broad
U.S. industrial market. The decline occurred primarily due to the reduction in
sales despite reduced operating expense as a result of the initiatives related
to the business improvement plan implemented in both 2002 and 2001.
Operating income in 2002 and 2001 included $10.1 million and $8.0 million,
respectively, associated with the business improvement program begun in 2001.
Additionally, 2001 included $2.1 million related to the tender offer to acquire
the minority shares of JLK.
FULL SERVICE SUPPLY In the FSS segment, we provide metalworking consumables and
related products to large- and medium-sized manufacturers in the United States
and Canada. FSS offers integrated supply programs that provide inventory
management systems, just-in-time availability and programs that focus on total
cost savings.
(in thousands) 2003 2002 2001
- --------------------------------------------------------------------------------
External sales $ 120,389 $ 152,907 $ 158,886
Intersegment sales 3,134 2,747 5,278
Operating income (56) 2,014 7,541
- --------------------------------------------------------------------------------
FSS external sales for 2003 declined by $32.5 million, or 21.3 percent, from
$152.9 million in 2002 to $120.4 million in 2003. The decline in sales is due to
the discontinuance of certain customer relationships.
FSS had an operating loss for 2003 which is a $2.1 million decline from 2002.
The operating loss is due to the inability of the reduced volume to cover fixed
costs. We are addressing this issue through right-sizing efforts and through a
continuous program to reduce operating expenses. New business and marketing
programs have been developed to offset the lost sales. At the end of 2003 and
during the first quarter of 2004, we have obtained new customers that have an
annualized sales value in excess of the revenue associated with the customers
lost during the current year.
FSS external sales for 2002 declined four percent, or $6.0 million, compared to
2001 due primarily to the weakening in the North American industrial market.
Operating income of $2.0 million in 2002, declined $5.5 million compared to
2001. The decline is due to lower sales levels coupled with slightly lower gross
margins due to a higher percentage of sales in the automotive sector.
24
LIQUIDITY AND CAPITAL RESOURCES Our cash flow from operations is the primary
source of financing for capital expenditures and internal growth. The most
significant risks associated with our ability to generate sufficient cash flow
from operations is the overall level of demand for our products. However, we
believe we can adequately control costs and manage our working capital to meet
our cash flow needs, despite changes in the economic cycle. In June 2002, we
entered into a three-year, multi-currency, $650 million revolving bank credit
facility with a group of financial institutions (2002 Credit Agreement).
Following a review of anticipated borrowing requirements, in June 2003, we
notified the administrative agent of our decision to permanently reduce the 2002
Credit Agreement from $650 million to $500 million resulting in lower facility
fees for the remaining two years of the agreement. This resulted in a write-down
of a portion of deferred financing fees of $0.5 million. The 2002 Credit
Agreement replaced the previous Bank Credit Agreement, Euro Credit Agreement and
the Yen Credit Facility. The 2002 Credit Agreement allows for borrowings in U.S.
dollars, Euro, Canadian dollars, Pound Sterling or Japanese Yen. The 2002 Credit
Agreement contains various covenants with which we must be in compliance,
including three financial covenants: a maximum leverage ratio, a maximum fixed
charge coverage ratio and a minimum consolidated net worth. As of June 30, 2003
and 2002, outstanding borrowings under this agreement were $181.2 and $81.5
million, respectively. As of June 30, 2003, $75.0 million of the borrowings were
denominated in U.S. dollars, $92.2 million were denominated in Euro and $14.0
million were denominated in Yen. We had the ability to borrow under this
agreement or otherwise have additional debt of up to $108.7 and $262.5 million
as of June 30, 2003 and 2002, respectively, and be in compliance with the
maximum leverage ratio financial covenant. The $262.5 million of available debt
at the end of June 30, 2002 did not reflect the $165.2 million of net borrowings
incurred to fund the Widia acquisition. The maximum leverage ratio financial
covenant requires that we maintain at the end of each fiscal quarter a specified
consolidated leverage ratio (as that term is defined in this agreement). At June
30, 2003 and 2002, we were in compliance with all debt covenants.
Additionally, we generally obtain local financing through credit lines with
commercial banks in the various countries in which we operate. At June 30, 2003,
these borrowings amounted to $7.9 million for notes payable and $10.2 million
for term debt and capital leases. We believe that cash flow from operations and
the availability under our credit lines will be sufficient to meet our cash
requirements over the next 12 months.
Based upon our debt structure at June 30, 2003 and 2002, 69 and 54 percent,
respectively, of our debt was exposed to floating rates of interest, which is
consistent with our target range for floating versus fixed interest rate debt.
We periodically review the target range and the strategies designed to maintain
the mix of floating to fixed interest rate debt within that range. In the
future, we may decide to adjust the target range or the strategies to achieve
it.
Following is a summary of our contractual obligations and other commercial
commitments as of June 30, 2003 (in thousands):
2007 and
Contractual Obligations 2004 2005 2006 thereafter Total
- --------------------------------------------------------------------------------
CASH COMMITMENTS
Long-term debt $ 311 $ 353 $181,556 $323,581 $505,801
Notes payable 7,938 - - - 7,938
Capital leases 2,596 2,174 3,322 3,856 11,948
Operating leases 18,305 14,867 10,357 40,379 83,908
- --------------------------------------------------------------------------------
Total $ 29,150 $ 17,394 $195,235 $367,816 $609,595
================================================================================
Amount of Committed Expiration Per Period
-------------------------------------------
Total Amount Less than Over
Other Commercial Commitments Committed 1 Year 1-3 Years 4-5 Years 5 Years
- ---------------------------------------------------------------------------------------
Standby letters of credit $12,293 $10,293 $ 2,000 $ - $ -
Guarantees 7,089 6,138 636 - 315
- ---------------------------------------------------------------------------------------
Total commercial commitments $19,382 $16,431 $ 2,636 $ - $ 315
=======================================================================================
The standby letters of credit are related to insurance and other activities.
25
During 2003, we generated $181.5 million in cash from operations, compared to
$162.4 million in 2002. The $181.5 million was driven by operating performance
including $11.5 million, derived from accounts receivable, $38.2 million from
inventory and $10.6 million from tax refunds. This was offset, in part, by a
decrease in other accrued liabilities of $11.6 million. The increase in
operating cash flow in 2003 is primarily related to cash generated from
reductions in working capital.
Net cash used for investing activities was $219.4 million in 2003, an increase
of $176.1 million compared to $43.3 million used in 2002. The increase in cash
used for investing activities is primarily due to the net cash paid for Widia of
$166.1 million and purchase of subsidiary stock which increased $5.8 million.
Additionally, capital expenditures increased by $5.4 million from $44.0 million
to $49.4 million. We believe the level of capital spending in 2003 was
sufficient to enhance productivity and make necessary improvements to remain
competitive.
Net cash flow provided by financing activities was $37.5 million in 2003,
compared to cash flow used of $125.5 million in 2002. The increase of $163.0
million is due primarily to the incremental borrowings required to finance the
Widia acquisition and $15.5 million received from the termination of the fair
value interest rate swaps. This was partially offset by debt repayments, lower
purchases of treasury stock and increased cash payments for dividends due to
additional shares being issued in June 2002.
During 2002, we generated $162.4 million in cash from operations, compared to
$197.8 million in 2001. Lower income from operations and depreciation and
amortization charges were partially offset by a net reduction in working
capital. The continued reduction of working capital reflects our initiatives to
generate strong cash flow. Both receivables and inventories were reduced when
compared to the prior year as a result of the above initiatives and the lower
sales levels experienced in 2002.
Net cash used for investing activities was $43.3 million in 2002. Compared to
the prior year, net cash used for investing activities declined by $59.2 million
primarily due to a reduction in the repurchase of minority interests of $46.3
million from 2001 and decreased capital spending of $15.9 million in 2002.
Net cash flow used for financing activities was $125.5 million in 2002, compared
to $102.5 million in 2001. This increase of $23.1 million was due primarily to
higher debt repayments including the repayment of the borrowings under the Bank
Credit Agreement and the Euro Credit Agreement, partially offset by $120.6
million in proceeds from the June 2002 stock offering.
On June 19, 2002, we issued $300.0 million of 7.2% Senior Unsecured Notes due
2012 (Senior Unsecured Notes). These notes were issued at 99.629% of the face
amount and yielded $294.3 million of net proceeds after related financing costs.
Additionally, on June 19, 2002, we issued 3.5 million shares of our capital
stock at a price of $36 per share. Net of issuance costs, this offering yielded
proceeds of $120.6 million. Proceeds from these offerings were utilized to repay
senior bank indebtedness.
During 2003, we did not purchase any shares of our outstanding capital stock. In
2002, we continued our program to repurchase, from time to time, up to a total
of 1,600,000 shares of our outstanding capital stock for investment or other
general corporate purposes under the repurchase program announced on January 31,
1997. We completed the program announced in 1997 and the Board of Directors
authorized the repurchase of up to a total of 2,000,000 additional shares of our
outstanding capital stock. During 2002, we purchased 375,000 shares of our
capital stock at a total cost of $12.4 million bringing the total number of
shares purchased under the authority of both programs to 1,755,900 shares. The
repurchases were financed principally by cash from operations and short-term
borrowings. Repurchases may be made from time to time in the open market, in
negotiated or other permissible transactions.
In December 2000, we entered into a EUR 212.0 million ($179.1 million at June
30, 2001 exchange rates) Euro-denominated revolving credit facility (Euro
Credit Agreement) to partially hedge the foreign exchange exposure of our net
investment in Euro-based subsidiaries and to diversify our interest rate
exposure. Amounts borrowed under the Euro Credit Agreement were required to be
used to repay indebtedness under the Bank Credit Agreement. To the extent the
Bank Credit Agreement was fully repaid, these funds were available for working
capital and general corporate purposes. On January 8, 2001, we borrowed EUR
212.0 million under this facility to meet our obligation under the outstanding
Euro-denominated forward exchange contracts. The proceeds from the
Euro-denominated forward exchange contracts of $191.1 million were used to repay
amounts borrowed under the Bank Credit Agreement. Subsequently, the availability
under the Bank Credit
26
Agreement was permanently reduced from $900.0 million to $700.0 million,
resulting in a write-down of a portion of deferred financing fees of $0.3
million. This was recorded as a component of interest expense. The Bank Credit
Agreement and the Euro Credit Agreement were cancelled in June 2002 when we
repaid both facilities using proceeds raised from the public debt offering, the
capital stock issuance and the 2002 Credit Agreement.
OFF-BALANCE SHEET ARRANGEMENTS Since 1999 we have had an agreement with a
financial institution whereby we securitize, on a continuous basis, an undivided
interest in a specific pool of our domestic trade accounts receivable. We were
permitted to securitize up to $100.0 million of accounts receivable under this
agreement. In July 2003, we entered into a new securitization program (2003
Securitization Program) which also permitted us to securitize up to $100.0
million of accounts receivable. The 2003 Securitization Program was amended on
September 11, 2003, permitting us to securitize up to $125.0 million of accounts
receivable. The 2003 Securitization Program provides for a co-purchase
arrangement whereby two financial institutions participate in the purchase of
our accounts receivables. The actual amount of accounts receivable securitized
each month is a function of the net change (new billings less collections) in
the specific pool of domestic accounts receivable, the impact of detailed
eligibility requirements in the agreement (e.g. the aging, terms of payment,
quality criteria and customer concentration), and the application of various
reserves which are typically in trade receivable securitization transactions. A
decrease in the amount of eligible accounts receivable could result in our
inability to continue to securitize all or a portion of our accounts receivable.
It is not unusual, however, for the amount of our eligible accounts receivable
to vary by up to $5.0 to $10.0 million per month.
The financial institution charges us fees based on the level of accounts
receivable securitized under this agreement and the commercial paper market
rates plus the financial institution's cost to administer the program. The costs
incurred under this program, $1.9 million, $2.5 million and $5.7 million in
2003, 2002 and 2001, respectively, are accounted for as a component of other
expense, net and represent attractive funding costs compared to existing bank
and public debt transactions. At June 30, 2003 and 2002, we securitized accounts
receivable of $99.3 million and $95.9 million, respectively, under this program.
The 2003 Securitization Program is required to be renewed periodically, and it
is our intention to continuously obtain that renewal when required. The prior
agreement expired on June 30, 2003 and was renewed to July 3, 2003, when the
2003 Securitization Program became effective. The 2003 Securitization Program is
a three-year program, which contains certain provisions that require annual
approval. Non-renewal or non-annual approval of this securitization program
would result in our requirement to otherwise finance the amounts securitized. We
anticipate that the risk of non-renewal or non-annual approval of this
securitization program with the current providers or some other providers is
very low. In the event of a decrease of our eligible accounts receivable or
non-renewal or non-annual approval of our securitization program, we would have
to utilize alternative sources of capital to fund that portion of our working
capital needs.
Capital expenditures for 2004 are estimated to be $70 million and will be used
primarily to support new strategic initiatives, new products and to upgrade
machinery and equipment, almost all of which are discretionary.
FINANCIAL CONDITION At June 30, 2003, total assets were $1,779.1 million, an
increase of 16.8 percent from June 30, 2002 due predominantly to the acquisition
of Widia which increased total assets by $327.7 million on August 30, 2002. Net
working capital was $428.3 million, an increase of 14.1 percent from $375.3
million for 2002, due to the Widia acquisition and the impact of foreign
exchange translation. In 2003, accounts receivable increased $56.5 million to
$235.6 million; inventories also increased $47.2 million to $392.3 million
compared to 2002. The increase in accounts receivable and inventory are directly
related to the Widia acquisition. Inventory turnover was 3.2 in 2003 compared to
3.0 in 2002. Account receivable turnover increased from 8.2 in 2002 to 8.5 in
2003. The increase in account receivable and inventory turnover is a result of
our continued focus on improving working capital and our successful integration
of Widia.
Total debt (including capital lease obligations and notes payable) increased
$114.3 million or 27.8 percent to $525.7 million in 2003. Higher debt was
attributed primarily to the Widia acquisition which resulted in net borrowings
of $165.2 million, the impact of changes in foreign exchange rates of
approximately $40.0 million, fixed to floating rate swaps of $24.9 million and
acquired debt from Widia of $4.6 million. This was offset by repayments of
$123.7 million. The ratio of debt to equity was 42.1 percent at June 30, 2003
compared with 36.6 percent at June 30, 2002. The increase is related to
additional borrowings to fund the Widia acquisition. Cash from operations and
our debt capacity are expected to continue to be sufficient to fund capital
expenditures, debt service obligations, share repurchases, dividend payments and
operating requirements.
27
During 2003, our accrued pension obligation increased $71.4 million to $111.7
million. The significant increase in the pension obligation was due to
approximately $40.0 million from the Widia acquisition and foreign exchange of
$9.5 million. The remainder of the increase is due to a decrease in discount
rates and expected returns on assets. Additionally during 2003, we recorded an
additional minimum pension liability associated with our pension plans. This
resulted in a charge to equity of $54.7 million, net of tax, which is reflected
in accumulated other comprehensive loss.
ACQUISITION AND DIVESTITURES On August 30, 2002, we purchased the Widia Group
(Widia) in Europe and India from Milacron Inc. for EUR 188 million ($185.3
million) subject to a purchase price adjustment. On February 12, 2003, Milacron
Inc. and Kennametal signed a settlement agreement with respect to the
calculation of the post-closing purchase price adjustment for the Widia
acquisition pursuant to which Milacron paid Kennametal EUR 18.8 million ($20.1
million) in cash. The net cash purchase price of $167.1 million includes the
actual purchase price of $185.3 million less the settlement of $20.1 million
plus $6.2 million of direct acquisition costs ($1.1 million paid in fiscal year
2002 and $5.1 million paid during the twelve months ended June 30, 2003) less
$4.3 million of acquired cash. We financed the acquisition with funds borrowed
under the 2002 Credit Agreement. The acquisition of Widia improves our global
competitiveness, strengthens our European position and represents a strong
platform for increased penetration in Asia. Widia's operating results have been
included in our consolidated results since August 30, 2002. In accordance with
SFAS No. 141, "Business Combinations," we accounted for the acquisition using
the purchase method of accounting. Accordingly, the preliminary purchase price
allocations have been made based upon an estimated fair value of net assets
acquired resulting in the recognition of approximately $53.0 million of goodwill
and $27.2 million of other intangibles. Of the $27.2 million of identifiable
intangible assets approximately $6.4 million have a definite life and therefore
will be amortized over its remaining useful life. In accordance with SFAS No.
142 the goodwill will not be amortized but will instead be subject to an annual
impairment test. All goodwill and intangible assets resulting from the
acquisition will be included in the MSSG segment. The preliminary purchase price
allocations are subject to adjustment and may be modified within one year from
the acquisition. Subsequent changes are not expected to have a material effect
on our consolidated financial position.
In April 2002, we sold Strong Tool Company, our industrial supply distributor
based in Cleveland, Ohio, for $8.6 million comprised of cash proceeds of $4.0
million and a seller note for $4.6 million. This action resulted in a pretax
loss of $3.5 million and is in line with our strategy to refocus the J&L segment
on its core catalog business. Annualized sales of this business were
approximately $34 million.
In January 2002, we acquired Carmet Company for $5.1 million. Located in Duncan,
S.C., this entity is a producer of tungsten carbide cutting tools and wear parts
and is included in our AMSG segment.
In April 2001, we sold ATS, our industrial supply distributor based in Salt Lake
City, Utah, for $6.8 million comprised of cash proceeds of $1.0 million and a
seller note for $5.8 million. This action resulted in a pretax loss of $5.8
million and is in line with our strategy to refocus the J&L segment on its core
catalog business. Annualized sales of this business were approximately $17
million.
In 2000, we engaged an investment bank to explore strategic alternatives
regarding our 83 percent-owned subsidiary, JLK Direct Distribution Inc. (JLK),
including a possible divestiture. At that time, we believed a divestiture might
enhance growth prospects for both ourselves and JLK by allowing each company to
focus on its core competencies. We completed a thorough and disciplined process
of evaluating strategic alternatives and on May 2, 2000, decided to terminate
consideration of a possible divestiture at that time. We incurred and expensed
$0.8 million in costs associated with this evaluation in 2000.
On July 20, 2000, we proposed to the Board of Directors of JLK to acquire the
outstanding shares of JLK we did not already own. On September 11, 2000, we
announced a definitive merger agreement with JLK to acquire all the outstanding
minority shares. Pursuant to the agreement, JLK agreed to initiate a cash tender
offer for all of its shares of Class A Common Stock at a price of $8.75 per
share. The tender offer commenced on October 3, 2000 and expired on November 15,
2000 resulting in JLK reacquiring 4.3 million shares for $37.5 million.
Following JLK's purchase of shares in the tender offer, we acquired the minority
shares at the same price in a merger. We incurred transaction costs of $3.3
million, which were included in the total cost of the transaction. JLK incurred
costs of $2.1 million associated with the transaction, which were expensed as
incurred. The transaction was unanimously approved by the JLK Board of
Directors, including a special committee comprised of independent directors of
the JLK Board.
We continue to evaluate new opportunities that allow for the expansion of
existing product lines into new market areas, either directly or indirectly
through joint ventures, where appropriate.
28
ENVIRONMENTAL MATTERS We are involved in various environmental cleanup and
remediation activities at several of our manufacturing facilities. In addition,
we are currently named as a potentially responsible party (PRP) at the Li
Tungsten Superfund site in Glen Cove, New York. In December 1999, we recorded a
remediation reserve of $3.0 million with respect to our involvement in these
matters, which was recorded as a component of operating expense. This represents
our best estimate of the undiscounted future obligation based on our evaluations
and discussions with outside counsel and independent consultants, and the
current facts and circumstances related to these matters. We recorded this
liability because certain events occurred, including the identification of other
PRPs, an assessment of potential remediation solutions and direction from the
government for the remedial action plan, that clarified our level of involvement
in these matters and our relationship to other PRPs. This led us to conclude
that it was probable that a liability had been incurred. At June 30, 2003, we
have an accrual of $2.8 million recorded relative to this environmental issue.
In addition to the amount currently reserved, we may be subject to loss
contingencies related to these matters estimated to be up to an additional $3.0
million. We believe that such undiscounted unreserved losses are reasonably
possible but are not currently considered to be probable of occurrence. The
reserved and unreserved liabilities for all environmental concerns could change
substantially in the near term due to factors such as the nature and extent of
contamination, changes in remedial requirements, technological changes,
discovery of new information, the financial strength of other PRPs, the
identification of new PRPs and the involvement of and direction taken by the
government on these matters.
Additionally, we also maintain reserves for other potential environmental issues
associated with our domestic operations and a location operated by our German
subsidiary. At June 30, 2003, the total of these accruals was $1.3 million and
represents anticipated costs associated with the remediation of these issues.
Cash payments of $0.1 million have been made against this reserve during the
year.
During the due diligence phase of the Widia acquisition, we identified certain
environmental exposures with Widia manufacturing locations in Europe and India.
The purchase price paid reflected our estimate of this exposure. As a result of
the Widia acquisition, we have established an environmental reserve of $6.2
million which is consistent with our expectations determined during the due
diligence process. This reserve will be used for environmental clean-up and
remediation activities at several Widia manufacturing locations. This liability
represents our best estimate of the future obligation based on our evaluations
and discussions with independent consultants and the current facts and
circumstances related to these matters. This liability has been recorded as part
of the Widia acquisition and has not been reflected in our operating results.
We maintain a Corporate Environmental, Health and Safety (EH&S) Department, as
well as an EH&S Policy Committee, to ensure compliance with environmental
regulations and to monitor and oversee remediation activities. In addition, we
have established an EH&S administrator at each of our global manufacturing
facilities. Our financial management team periodically meets with members of the
Corporate EH&S Department and the Corporate Legal Department to review and
evaluate the status of environmental projects and contingencies. On a quarterly
basis, we establish or adjust financial provisions and reserves for
environmental contingencies in accordance with SFAS No. 5, "Accounting for
Contingencies."
EFFECTS OF INFLATION Despite modest inflation in recent years, rising costs
continue to affect our operations throughout the world. We strive to minimize
the effects of inflation through cost containment, productivity improvements and
price increases under highly competitive conditions.
DISCUSSION OF CRITICAL ACCOUNTING POLICIES In preparing our financial statements
in conformity with accounting principles generally accepted in the United States
of America, we make judgments and estimates about the amounts reflected in our
financial statements. As part of our financial reporting process, our management
collaborates to determine the necessary information on which to base our
judgments and develops estimates used to prepare the financial statements. We
use historical experience and available information to make these judgments and
estimates. However, different amounts could be reported using different
assumptions and in light of different facts and circumstances. Therefore, actual
amounts could differ from the estimates reflected in our financial statements.
Our significant accounting policies are described in Note 2 of our consolidated
financial statements. We believe that the following discussion addresses our
critical accounting policies.
Accounting for Contingencies We accrue for contingencies in accordance with SFAS
No. 5, "Accounting for Contingencies," when it is probable that a liability or
loss has been incurred and the amount can be reasonably estimated. Contingencies
by their nature relate to uncertainties that require our exercise of judgment
both in assessing whether or not a liability or loss has been incurred and
estimating the amount of
29
probable loss. The significant contingencies affecting our financial statements
include accounts and notes receivable collectibility, inventory valuation,
environmental health and safety matters, pending litigation and the realization
of deferred tax assets.
Long-Lived Assets As required under SFAS No. 144, "Accounting for the Impairment
or Disposal of Long-Lived Assets," we evaluate the recoverability of property,
plant and equipment and intangible assets other than goodwill that are amortized
whenever events or changes in circumstances indicate the carrying amount of any
such assets may not be fully recoverable. Changes in circumstances include
technological advances, changes in our business model, capital structure,
economic conditions or operating performance. Our evaluation is based upon,
among other things, our assumptions about the estimated future undiscounted cash
flows these assets are expected to generate. When the sum of the undiscounted
cash flows is less than the carrying value, we will recognize an impairment
loss. We continually apply our best judgment when performing these evaluations
to determine the timing of the testing, the undiscounted cash flows used to
assess recoverability and the fair value of the asset.
In conjunction with the Widia acquisition, we reviewed the estimated lives
currently being used for existing Kennametal assets, and have determined that
the current useful lives should be extended to more appropriately match the life
of the asset. Starting July 1, 2003, we have extended our useful lives of
machinery and equipment from a maximum life of 10 years to 15 years. We expect
this change to result in an annual benefit of approximately $17 million.
Goodwill and Other Intangible Assets We evaluate the recoverability of the
goodwill and other intangibles of each of our reporting units as required under
SFAS No. 142 by comparing the fair value of each reporting unit with its
carrying value. The fair values of our reporting units are determined using a
combination of a discounted cash flow analysis and market multiples based upon
historical and projected financial information. We apply our best judgment when
assessing the reasonableness of the financial projections used to determine the
fair value of each reporting unit.
Pension and Other Postretirement and Postemployment Benefits We sponsor these
types of benefit plans for a majority of our employees and retirees. We account
for these plans as required under SFAS No. 87, "Employers' Accounting for
Pensions," SFAS No. 106, "Employers' Accounting for Postretirement Benefits
Other than Pensions" and SFAS No. 112, "Employers' Accounting for Postemployment
Benefits." Accounting for the cost of these plans requires the estimation of the
cost of the benefits to be provided well into the future and attributing that
cost over the expected work life of employees participating in these plans. This
estimation requires our judgment about the discount rate used to determine these
obligations, expected return on plan assets, rate of future compensation
increases, rate of future health care costs, withdrawal and mortality rates and
participant retirement age. Differences between our estimates and actual results
may significantly affect the cost of our obligations under these plans.
Due to the changes in assumptions and return on plan assets, we expect our
pension and supplemental early executive retirement income to decrease from $1.0
million in 2003 to expense of $13.3 million in 2004.
Restructuring Activities We accrue the cost of our restructuring activities in
accordance with SFAS No. 146, "Accounting for Costs Associated with Exit or
Disposal Activities." We exercise our judgment in estimating the total costs of
each of these activities. As we implement these activities, the actual costs may
differ from the estimated costs due to changes in the facts and circumstances
that were not foreseen at the time of our initial cost accrual.
Allowance for Doubtful Accounts We record allowances for estimated losses
resulting from the liability of our customers to make required payments. We
assess the credit worthiness of our customers based on multiple sources of
information and analyze such factors as our historical bad debt experiences,
industry and geographic concentrations of credit risk, current economic trends
and changes in customer payment terms. This assessment requires significant
judgment. If the financial condition of our customers were to worsen, additional
allowances may be required, resulting in future operating losses that are not
included in the allowance for doubtful accounts at June 30, 2003.
Income Taxes Realization of our deferred tax assets is primarily dependent on
future taxable income, the timing and amount of which are uncertain in part due
to the expected profitability of certain foreign subsidiaries. As of June 30,
2003, the deferred tax assets with valuation allowances are primarily
attributable
30
to postretirement benefits, inventory reserves and net operating loss
carryforwards. In the event that we were to determine that we would not be able
to realize our deferred tax assets in the future, an increase in the valuation
allowance would be required.
NEW ACCOUNTING STANDARDS In June 2001, the Financial Accounting Standards Board
(FASB) issued SFAS No. 143, "Accounting for Asset Retirement Obligations." SFAS
No. 143 addresses financial accounting and reporting for obligations associated
with the retirement of tangible long-lived assets and the associated asset
retirement costs. It applies to legal obligations associated with the retirement
of long-lived assets that result from the acquisition, construction, development
and/or the normal operation of a long-lived asset. The adoption of this
standard, effective July 1, 2002, had no material impact on the results of our
operations or financial position.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets," which addresses financial accounting and
reporting for the impairment of long-lived assets and for long-lived assets to
be disposed of and supersedes SFAS No. 121. This statement retains the
fundamental provisions of SFAS No. 121 for recognition and measurement of the
impairment of long-lived assets to be held and used and measurement of
long-lived assets to be disposed of by sale. The provisions of this statement
are effective for fiscal years beginning after December 15, 2001, and interim
periods within those fiscal years. The adoption of this standard effective July
1, 2002, did not have a material impact on our consolidated financial
statements.
In April 2002, SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64,
Amendment of FASB Statement No. 13, and Technical Corrections," was issued. This
statement updates, clarifies and simplifies existing accounting pronouncements.
While the technical corrections to existing pronouncements are not substantive
in nature, in some instances they may change accounting practice. The provisions
of this standard related to SFAS No. 13 are effective for transactions occurring
after May 15, 2002. Prospectively, as a result of the adoption of SFAS No. 145,
debt extinguishment costs previously classified as extraordinary items will be
reclassified as interest expense.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Exit or Disposal
Activities," which addresses significant issues regarding the recognition,
measurement and reporting of costs that are associated with exit and disposal
activities, including restructuring activities. SFAS No. 146 nullifies Emerging
Issues Task Force (EITF) Issue No. 94-3, "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity," under which
a liability for an exit cost was recognized at the date of an entity's
commitment to an exit plan. SFAS No. 146 requires that a liability for a cost
associated with an exit or disposal activity be recognized at fair value when
the liability is incurred. The provisions of this statement have been applied to
any exit or disposal activities entered into after January 1, 2003.
In November 2002, the FASB issued FASB Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others." FIN 45 clarifies the requirements of FASB
Statement No. 5, "Accounting for Contingencies," relating to a guarantor's
accounting for, and disclosure of, the issuance of certain types of guarantees.
FIN 45 requires that upon issuance of a guarantee, the guarantor must recognize
a liability for the fair value of the obligation it assumes under that
guarantee; FIN 45 also requires enhanced disclosures in a company's interim and
annual filings. FIN 45 is effective for guarantees issued or modified after
December 31, 2002. The disclosure requirements were effective for financial
statements of both interim and fiscal years ending after December 15, 2002. The
adoption of this standard did not have a material impact on our consolidated
financial statements.
In January 2003, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation Transition and Disclosure," to provide alternative methods of
transition for an entity that voluntarily changes to the fair value- based
method of accounting for stock-based employee compensation. This statement also
amends the disclosure provisions of that statement to require prominent
disclosure about the effects on reported net income of an entity's accounting
policy decisions with respect to stock-based employee compensation. Finally, the
statement amends APB Opinion No. 28, "Interim Financial Reporting," to require
disclosure about those effects in interim financial information. The amendments
to APB Opinion No. 28 are effective for financial reports containing condensed
financial statements for interim periods beginning after December 15, 2002. The
disclosure provisions of this statement were adopted on January 1, 2003.
31
In January 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities--an interpretation of ARB No. 51."
FIN 46 clarifies the application of Accounting Research Bulletin No. 51,
"Consolidated Financial Statements," to certain entities in which equity
investors do not have the characteristics of a controlling financial interest or
do not have sufficient equity at risk for the entity to finance its activities
without additional subordinated financial support from other parties. FIN 46 is
effective for the Company July 1, 2003 and will not have a material impact on
the Company's results of operations or financial condition.
In January 2003, the EITF released Issue No. 00-21 ("EITF 00-21"), "Revenue
Arrangements with Multiple Deliverables," which addresses certain aspects of the
accounting by a vendor for arrangement under which it will perform multiple
revenue-generating activities. Specifically, EITF 00-21 addresses whether an
arrangement contains more than one unit of accounting and the measurement and
allocation to the separate units of accounting in the arrangement. EITF 00-21 is
effective for revenue arrangements entered into in fiscal periods beginning
after June 15, 2003. The adoption of this standard did not have a material
impact on our consolidated financial statements.
In May 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under SFAS
No. 133. SFAS No. 149 is effective for contracts entered into or modified after
June 30, 2003 and for hedging relationships designated after June 30, 2003. The
Company is currently analyzing the provisions of SFAS No. 149 to determine if
there will be any impact of adoption, but does not believe that there will be
any material impact on its consolidated financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150
establishes standards for how companies classify and measure certain financial
instruments with characteristics of both liabilities and equity. It requires
companies to classify a financial instrument that is within its scope as a
liability (or an asset in some circumstances). SFAS No. 150 is effective for
financial instruments entered into or modified after May 31, 2003. The standard
will not impact our consolidated financial statements.
ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RISK We are exposed to certain market risks arising from transactions
that are entered into in the normal course of business. As part of our formal
documented risk management program, we use certain derivative financial
instruments to manage these risks. We do not enter into derivative transactions
for speculative purposes and therefore hold no derivative instruments for
trading purposes. We use derivative financial instruments to dampen the effects
of changes in foreign exchange rates on our consolidated results and to achieve
our targeted mix of fixed and floating interest rates on outstanding debt. Our
objective in managing foreign exchange exposures with derivative instruments is
to reduce both earnings and cash flow volatility, allowing us to focus our
attention on business operations. With respect to interest rate management,
these derivative instruments allow us to achieve our targeted fixed-to-floating
interest rate mix as a separate decision from funding arrangements in the bank
and public debt markets. We measure hedge effectiveness by assessing the changes
in the fair value or expected future cash flows of the hedged item. The
ineffective portions are recorded in other income or expense in the current
period. See Notes 2 and 13 to our consolidated financial statements for
additional information.
We are exposed to counterparty credit risk for nonperformance of derivative
contracts and, in the event of nonperformance, to market risk for changes in
interest and currency rates. We manage exposure to counterparty credit risk
through credit standards, diversification of counterparties and procedures to
monitor concentrations of credit risk. We do not anticipate nonperformance by
any of the counterparties.
The following provides additional information on our use of derivative
instruments. Included below is a sensitivity analysis that is based upon a
hypothetical 10 percent weakening or strengthening in the U.S. dollar compared
to the June 30, 2003 foreign currency rates, the effective interest rates under
our current borrowing arrangements and the market value of our
available-for-sale securities. We compared the contractual derivative
32
and borrowing arrangements in effect at June 30, 2003 to the hypothetical
foreign exchange or interest rates in the sensitivity analysis to determine the
effect on interest expense, pretax income, fair value of the available-for-sale
securities or the accumulated other comprehensive loss. Our analysis takes into
consideration the different types of derivative instruments and the
applicability of hedge accounting.
CASH FLOW HEDGES Currency A portion of our operations consists of investments in
foreign subsidiaries. Our exposure to market risk for changes in foreign
exchange rates arises from these investments, inter-company loans utilized to
finance these subsidiaries, trade receivables and payables, and firm commitments
arising from international transactions. We manage our foreign exchange
transaction risk to reduce the volatility of cash flows caused by currency
fluctuations through natural offsets, where appropriate, and foreign exchange
contracts. These contracts are designated as hedges of transactions that will
settle in future periods, and otherwise would expose us to foreign currency
risk.
Our foreign exchange hedging program minimizes our exposure to foreign exchange
rate movements. This exposure arises largely from anticipated cash flows from
cross-border intercompany sales of products and services. This program utilizes
purchased options, range forwards and forward contracts primarily to sell
foreign currency. The notional amounts of the contracts translated into U.S.
dollars at June 30, 2003 and 2002 rates are $123.4 million and $62.5 million,
respectively. At June 30, 2003 and 2002, a hypothetical 10 percent strengthening
or weakening of the U.S. dollar would not materially change pretax income
related to these positions; however, accumulated other comprehensive loss would
change by $4.6 million and $4.4 million, respectively.
In addition, we may enter into forward contracts to hedge transaction exposures
or significant cross-border intercompany loans by either purchasing or selling
specified amounts of foreign currency at a specified date. At June 30, 2003 and
2002, we had several outstanding forward contracts to purchase and sell foreign
currency, with notional amounts, translated into U.S. dollars at June 30, 2003
and 2002 rates, of $13.1 million and $135.2 million, respectively. A
hypothetical 10 percent change in the applicable 2003 and 2002 year-end exchange
rates would result in an increase or decrease in pretax income of $1.3 million
and $5.5 million, respectively, related to these positions.
Interest Rate Our exposure to market risk for changes in interest rates relates
primarily to our long-term debt obligations. We seek to manage our interest rate
risk in order to balance our exposure between fixed and floating rates while
attempting to minimize our borrowing costs. To achieve these objectives, we
primarily use interest rate swap agreements to manage exposure to interest rate
changes related to these borrowings. At June 30, 2003 and 2002, we had interest
rate swap agreements outstanding that effectively convert a notional amount of
$50 million and $150.0 million, respectively, of debt from floating to fixed
interest rates. At June 30, 2003, these agreements mature in June of 2008.
FAIR VALUE HEDGES Interest Rate As discussed above, our exposure to market risk
for changes in interest rates relates primarily to our long-term debt
obligations. We seek to manage this risk through the use of interest rate swap
agreements. At June 30, 2003, we had interest rate swap agreements outstanding
that effectively convert a notional amount of $200 million of the Senior
Unsecured Notes from fixed to floating interest rates. These agreements mature
in June 2012 but provide for a one-time optional early termination for the bank
counterparty in June 2008 at the then prevailing market value of the swap
agreements.
DEBT AND NOTES PAYABLE At June 30, 2003 and 2002, we had $525.7 million and
$411.4 million, respectively, of debt and notes payable outstanding at effective
interest rates of 6.9 percent and 7.9 percent, respectively, including the
effect of interest rate swaps. A hypothetical change of 10 percent in interest
rates from year-end 2003 and 2002 levels would increase or decrease interest
expense by approximately $1.4 million and $2.2 million, respectively. In
addition to outstanding debt, at June 30, 2003 and 2002 we had $7.9 million and
$6.9 million, respectively, of outstanding notes payable.
OTHER Our investment in Toshiba Tungaloy is classified as an available-for-sale
security and, therefore, is carried at its quoted market value, adjusted for
changes in currency exchange rates. At June 30, 2003 and 2002, the carrying and
fair value of our investment was $11.4 million and $10.7 million, respectively.
A hypothetical change of 10 percent in the quoted market value of this common
stock at June 30, 2003 and 2002 would result in a $1.1 million increase or
decrease in fair value for both periods.
33
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
SELECTED QUARTERLY FINANCIAL DATA (unaudited)
Quarter Ended
------------------------------------------------
(in thousands, except per share data) Sep. 30 Dec. 31 Mar. 31 Jun. 30
- ------------------------------------------------------------------------------------------------------
FISCAL 2003
Sales $ 404,218 $ 431,731 $ 459,243 $ 463,765
Gross profit 130,969 137,483 151,661 148,791
Net income (loss) 10,829 2,470 9,699 (4,868)
Basic earnings (loss) per share 0.31 0.07 0.28 (0.14)
Diluted earnings (loss) per share 0.31 0.07 0.27 (0.14)
- -----------------------------------------------------------------------------------------------------
FISCAL 2002
Sales $ 406,654 $ 380,338 $ 393,852 $ 402,898
Gross profit 129,839 116,465 127,647 136,873
Income (loss) before cumulative effect of change
in accounting principle 12,444 (2,460) 13,144 15,370
Net (loss) income (237,962) (2,460) 13,144 15,370
Basic earnings (loss) per share before cumulative
effect of change in accounting principle 0.40 (0.08) 0.42 0.49
Diluted earnings (loss) per share before cumulative
effect of change in accounting principle 0.40 (0.08) 0.42 0.48
Basic (loss) earnings per share (7.68) (0.08) 0.42 0.49
Diluted (loss) earnings per share (7.57) (0.08) 0.42 0.48
- -----------------------------------------------------------------------------------------------------
Earnings per share amounts for each quarter are required to be computed
independently and, therefore, may not equal the amount computed for the year.
34
Consolidated Statements of Income
Year ended June 30 (in thousands, except per share data) 2003 2002 2001
- -------------------------------------------------------------------------------------------------------
OPERATIONS
Sales (Note 2) $ 1,758,957 $ 1,583,742 $ 1,807,896
Cost of goods sold 1,190,053 1,072,918 1,192,176
- -------------------------------------------------------------------------------------------------------
Gross profit 568,904 510,824 615,720
Operating expense 464,861 389,396 425,641
Restructuring and asset impairment charges (Note 12) 31,954 27,307 9,545
Amortization of intangibles 4,164 2,804 24,134
- -------------------------------------------------------------------------------------------------------
Operating income 67,925 91,317 156,400
Interest expense 36,166 32,627 50,381
Other (income) expense, net (2,531) (361) 11,690
- -------------------------------------------------------------------------------------------------------
Income before provision for income taxes and
minority interest 34,290 59,051 94,329
Provision for income taxes (Notes 2 and 9) 14,300 18,900 37,300
Minority interest 1,860 1,653 3,142
- -------------------------------------------------------------------------------------------------------
Income before cumulative effect of change in
accounting principles 18,130 38,498 53,887
Cumulative effect of change in accounting principles,
net of tax of $2,389 and $399, respectively - (250,406) (599)
- -------------------------------------------------------------------------------------------------------
Net income (loss) $ 18,130 $ (211,908) $ 53,288
=======================================================================================================
PER SHARE DATA
Basic earnings per share before cumulative effect of
change in accounting principles $ 0.52 $ 1.24 $ 1.76
Cumulative effect of change in accounting principles - (8.04) (0.02)
- -------------------------------------------------------------------------------------------------------
Basic earnings (loss) per share $ 0.52 $ (6.80) $ 1.74
=======================================================================================================
Diluted earnings per share before cumulative effect
of change in accounting principles $ 0.51 $ 1.22 $ 1.75
Cumulative effect of change in accounting principles - (7.92) (0.02)
- -------------------------------------------------------------------------------------------------------
Diluted earnings (loss) per share (Note 2) $ 0.51 $ (6.70) $ 1.73
=======================================================================================================
Dividends per share $ 0.68 $ 0.68 $ 0.68
=======================================================================================================
Basic weighted average shares outstanding (Note 2) 35,202 31,169 30,560
=======================================================================================================
Diluted weighted average shares outstanding 35,479 31,627 30,749
=======================================================================================================
The accompanying notes are an integral part of these consolidated financial
statements.
35
Consolidated Balance Sheets
As of June 30 (in thousands, except per share data) 2003 2002
- ------------------------------------------------------------------------------------------------
ASSETS
Current assets:
Cash and cash equivalents (Note 2) $ 15,093 $ 10,385
Marketable equity securities available-for-sale (Note 2) 11,365 10,728
Accounts receivable, less allowance for doubtful accounts
of $23,405 and $12,671 (Notes 2 and 4) 235,648 179,101
Inventories (Notes 2 and 5) 392,255 345,076
Deferred income taxes (Notes 2 and 9) 79,564 71,375
Other current assets 30,754 20,719
- ------------------------------------------------------------------------------------------------
Total current assets 764,679 637,384
- ------------------------------------------------------------------------------------------------
Property, plant and equipment (Note 2):
Land and buildings 261,345 227,539
Machinery and equipment 948,260 847,196
Less accumulated depreciation (716,232) (639,619)
- ------------------------------------------------------------------------------------------------
Net property, plant and equipment 493,373 435,116
- ------------------------------------------------------------------------------------------------
Other assets:
Investments in affiliated companies 16,788 11,681
Goodwill (Note 2) 434,431 359,055
Intangible assets, less accumulated amortization
of $15,037 and $11,911 (Note 2) 39,501 8,937
Other 30,320 71,438
- ------------------------------------------------------------------------------------------------
Total other assets 521,040 451,111
- ------------------------------------------------------------------------------------------------
Total assets $ 1,779,092 $ 1,523,611
================================================================================================
LIABILITIES
Current liabilities:
Current maturities of long-term debt and capital leases (Note 7) $ 2,907 $ 16,554
Notes payable to banks (Note 8) 7,938 6,926
Accounts payable 119,853 101,586
Accrued income taxes 22,511 4,066
Accrued vacation pay 31,459 28,190
Accrued payroll 32,592 22,696
Other current liabilities (Note 6) 119,087 82,082
- ------------------------------------------------------------------------------------------------
Total current liabilities 336,347 262,100
- ------------------------------------------------------------------------------------------------
Long-term debt and capital leases, less current maturities (Note 7) 514,842 387,887
Deferred income taxes (Note 9) 8,748 52,570
Postretirement benefits (Note 10) 44,030 42,604
Accrued pension benefits (Note 10) 111,690 40,307
Other liabilities 22,978 13,510
- ------------------------------------------------------------------------------------------------
Total liabilities 1,038,635 798,978
- ------------------------------------------------------------------------------------------------
Commitments and contingencies (Note 16) - -
- ------------------------------------------------------------------------------------------------
Minority interest in consolidated subsidiaries 18,880 10,671
- ------------------------------------------------------------------------------------------------
SHAREOWNERS' EQUITY
Preferred stock, no par value; 5,000 shares authorized; none issued - -
Capital stock, $1.25 par value; 70,000 shares authorized;
37,649 and 37,383 shares issued 47,061 46,729
Additional paid-in capital 507,343 491,263
Retained earnings 301,263 307,631
Treasury stock, at cost; 2,176 and 2,573 shares held (67,268) (72,026)
Unearned compensation (9,109) (4,856)
Accumulated other comprehensive loss (Note 11) (57,713) (54,779)
- ------------------------------------------------------------------------------------------------
Total shareowners' equity 721,577 713,962
- ------------------------------------------------------------------------------------------------
Total liabilities and shareowners' equity $ 1,779,092 $ 1,523,611
================================================================================================
The accompanying notes are an integral part of these consolidated
financial statements.
36
Consolidated Statements of Cash Flows
Year ended June 30 (in thousands) 2003 2002 2001
- --------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income (loss) $ 18,130 $(211,908) $ 53,288
Adjustments for non-cash items:
Depreciation 79,879 70,825 73,163
Amortization 4,164 2,804 24,134
Loss on divestitures - 3,522 5,781
Stock-based compensation expense 9,477 7,768 11,775
Restructuring and asset impairment charges 14,998 12,712 4,325
Cumulative effect of change in accounting
principles, net of tax - 250,406 599
Other 10,981 505 9,792
Changes in certain assets and liabilities, excluding effects
of acquisition and divestitures:
Accounts receivable 8,064 33,603 9,620
Proceeds from accounts receivable securitization 3,416 2,200 5,200
Inventories 38,171 40,251 19,894
Accounts payable and accrued liabilities (12,070) (29,033) (827)
Other 6,334 (21,207) (18,947)
- --------------------------------------------------------------------------------------------------
Net cash flow from operating activities 181,544 162,448 197,797
- --------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Purchases of property, plant and equipment (49,413) (44,040) (59,929)
Disposals of property, plant and equipment 1,875 10,905 4,227
Divestitures, net of cash - 3,309 729
Purchase of subsidiary stock (6,984) (1,161) (47,505)
Acquisition of business assets, net of cash acquired (166,077) (5,385) -
Investment in affiliates (3) (5,770) -
Other 1,223 (1,129) (26)
- --------------------------------------------------------------------------------------------------
Net cash flow used for investing activities (219,379) (43,271) (102,504)
- --------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Net (decrease) increase in notes payable (17,324) (4,778) 4,038
Net (decrease) in revolving and other lines of credit (105,001) (84,151) (78,905)
Term debt borrowings 1,653 549,950 1,216
Term debt repayments (4,706) (677,563) (2,941)
Borrowings for Widia acquisition, net 165,240 - -
Proceeds from interest rate swap termination 15,546 - -
Net proceeds from issuance of capital stock - 120,584 -
Dividend reinvestment, employee benefit and stock plans 7,606 15,981 12,613
Purchase of treasury stock - (12,417) (16,494)
Cash dividends paid to shareowners (24,498) (21,426) (21,056)
Financing fees - (10,448) -
Other (1,060) (1,268) (949)
- --------------------------------------------------------------------------------------------------
Net cash flow provided by (used) for financing activities 37,456 (125,536) (102,478)
- --------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash and equivalents 5,087 3,804 (2,198)
- --------------------------------------------------------------------------------------------------
CASH AND EQUIVALENTS
Net increase (decrease) in cash and equivalents 4,708 (2,555) (9,383)
Cash and equivalents, beginning of year 10,385 12,940 22,323
- --------------------------------------------------------------------------------------------------
Cash and equivalents, end of year $ 15,093 $ 10,385 $ 12,940
==================================================================================================
SUPPLEMENTAL DISCLOSURES
Interest paid $ 33,434 $ 33,861 $ 51,480
Income taxes (refunded) paid (10,652) 31,949 36,608
Contribution of stock to employee defined
contribution benefit plans 4,361 5,788 9,205
Change in fair value of interest rate swaps 8,386 934 -
Notes received from sale of subsidiaries - 4,587 5,809
- --------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial
statements.
37
Consolidated Statements of Shareholders' Equity
Year ended June 30 (in thousands) 2003 2002 2001
- ------------------------------------------------------------------------------------------
CAPITAL STOCK
Balance at beginning of year $ 46,729 $ 42,018 $ 41,500
Issuance of capital stock - 4,428 -
Issuance of capital stock under employee
benefit and stock plans 332 283 518
- ------------------------------------------------------------------------------------------
Balance at end of year 47,061 46,729 42,018
- ------------------------------------------------------------------------------------------
ADDITIONAL PAID-IN CAPITAL
Balance at beginning of year 491,263 353,804 335,314
Issuance of capital stock - 116,156 -
Dividend reinvestment 1,476 1,672 1,511
Issuance of capital stock under employee
benefit and stock plans 14,604 19,631 16,979
- ------------------------------------------------------------------------------------------
Balance at end of year 507,343 491,263 353,804
- ------------------------------------------------------------------------------------------
RETAINED EARNINGS
Balance at beginning of year 307,631 540,965 508,733
Net income (loss) 18,130 (211,908) 53,288
Cash dividends to shareowners (24,498) (21,426) (21,056)
- ------------------------------------------------------------------------------------------
Balance at end of year 301,263 307,631 540,965
- ------------------------------------------------------------------------------------------
TREASURY STOCK
Balance at beginning of year (72,026) (65,963) (55,236)
Purchase of treasury stock, at cost - (12,417) (16,494)
Dividend reinvestment 1,290 854 1,284
Issuance of capital stock under employee
benefit and stock plans 3,468 5,500 4,483
- ------------------------------------------------------------------------------------------
Balance at end of year (67,268) (72,026) (65,963)
- ------------------------------------------------------------------------------------------
UNEARNED COMPENSATION
Balance at beginning of year (4,856) (2,165) (2,814)
Issuance of capital stock under employee
benefit and stock plans (9,136) (4,671) (1,921)
Amortization of unearned compensation 4,883 1,980 2,570
- ------------------------------------------------------------------------------------------
Balance at end of year (9,109) (4,856) (2,165)
- ------------------------------------------------------------------------------------------
ACCUMULATED OTHER COMPREHENSIVE (LOSS) INCOME
Balance at beginning of year (54,779) (71,890) (47,243)
Unrealized gain (loss) on marketable equity
securities available-for-sale, net of tax 321 (1,774) (7,379)
Cumulative effect of change in accounting principle,
net of tax - - 1,571
Unrealized gain (loss) on derivatives designated
and qualified as cash flow hedges, net of tax (4,879) (1,372) (2,044)
Reclassification of unrealized gains or losses
on expired derivatives, net of tax 5,157 (1,902) (2,049)
Minimum pension liability adjustment, net of tax (54,696) (945) (2,670)
Foreign currency translation adjustments 51,163 23,104 (12,076)
- ------------------------------------------------------------------------------------------
Other comprehensive (loss) income (2,934) 17,111 (24,647)
- ------------------------------------------------------------------------------------------
Balance at end of year (57,713) (54,779) (71,890)
- ------------------------------------------------------------------------------------------
Total shareowners' equity, June 30 $ 721,577 $ 713,962 $ 796,769
==========================================================================================
COMPREHENSIVE INCOME (LOSS)
Net income (loss) $ 18,130 $(211,908) $ 53,288
Other comprehensive (loss) income (2,934) 17,111 (24,647)
- ------------------------------------------------------------------------------------------
Comprehensive income (loss) $ 15,196 $(194,797) $ 28,641
==========================================================================================
The accompanying notes are an integral part of these consolidated financial
statements.
38
Notes to Consolidated Financial Statements
NOTE 1 - NATURE OF OPERATIONS
We are a leading global manufacturer, marketer and distributor of a broad range
of cutting tools, tooling systems, supplies and technical services, as well as
wear-resistant parts. We believe that our reputation for manufacturing
excellence and technological expertise and innovation in our principal products
has helped us achieve a leading market presence in our primary markets. We
believe we are the second largest global provider of metalcutting tools and
tooling systems. End users of our products include metalworking manufacturers
and suppliers in the aerospace, automotive, machine tool and farm machinery
industries, as well as manufacturers and suppliers in the highway construction,
coal mining, quarrying and oil and gas exploration industries.
Unless otherwise specified, any reference to a "year" is to a fiscal year ended
June 30. When used in this annual report on Form 10-K, unless the context
requires otherwise, the terms "we," "our" and "us" refer to Kennametal Inc. and
its subsidiaries.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The summary of our significant accounting policies is presented below to assist
in evaluating our consolidated financial statements.
PRINCIPLES OF CONSOLIDATION The consolidated financial statements include our
accounts and those of majority-owned subsidiaries. All significant intercompany
balances and transactions are eliminated. Investments in entities over which we
have significant influence are accounted for on an equity basis. Widia's
operating results have been included in our consolidated results since the
acquisition date of August 30, 2002.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS In preparing our
financial statements in conformity with accounting principles generally accepted
in the United States of America, we make judgments and estimates about the
amounts reflected in our financial statements. As part of our financial
reporting process, our management collaborates to determine the necessary
information on which to base our judgments and develop estimates used to prepare
the financial statements. We use historical experience and available information
to make these judgments and estimates. However, different amounts could be
reported using different assumptions and in light of different facts and
circumstances. Therefore, actual amounts could differ from the estimates
reflected in our financial statements.
CASH AND CASH EQUIVALENTS Cash investments having original maturities of three
months or less are considered cash equivalents. Cash equivalents principally
consist of investments in money market funds.
MARKETABLE EQUITY SECURITIES AVAILABLE-FOR-SALE Our investment in Toshiba
Tungaloy Co., Ltd. (Toshiba) is accounted for as an available-for-sale security
under SFAS No. 115, "Accounting for Certain Investments in Debt and Equity
Securities." This investment in Toshiba, a leading Japanese manufacturer of
consumable metalcutting products, is reported at fair value, as determined
through quoted market sources. The unrealized gain or loss on this investment is
recorded as a component of accumulated other comprehensive loss, net of tax. The
gross unrealized loss on this investment was $0.3 million and $0.8 million at
June 30, 2003 and June 30, 2002, respectively.
ACCOUNTS RECEIVABLE Sales to affiliated companies were $17.5 million and $13.3
million in 2003 and 2002. Accounts receivable includes $4.3 million and $3.3
million of receivables from affiliates at June 30, 2003 and 2002, respectively.
We market our products to a diverse customer base throughout the world. Trade
credit is extended based upon evaluations of each customer's ability to satisfy
its obligations, which are updated periodically. We make judgments as to our
ability to collect outstanding receivables and provide allowances for the
portion of receivables when collection becomes doubtful. Accounts receivable
reserves are determined based upon an aging of accounts and a review of specific
accounts.
INVENTORIES Inventories are stated at the lower of cost or market. We use the
last-in, first-out (LIFO) method for determining the cost of a significant
portion of our U.S. inventories. The cost of the remainder of inventories is
determined under the first-in, first-out (FIFO) or average cost methods. When
market conditions indicate an excess of carrying costs over market value, a
lower-of-cost-or-market provision is recorded. Excess and obsolete inventory
reserves are established based upon our evaluation of the quantity of inventory
on hand relative to demand. The excess and obsolete inventory reserve at June
30, 2003 and 2002, was $70.9 million and $46.7 million, respectively.
39
PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment are carried at cost.
Major improvements are capitalized, while maintenance and repairs are expensed
as incurred. Retirements and disposals are removed from cost and accumulated
depreciation accounts, with the gain or loss reflected in income. Interest
related to the construction of major facilities is capitalized as part of the
construction costs and is amortized over its estimated useful life.
Depreciation for financial reporting purposes is computed using the
straight-line method over the following estimated useful lives:
Building and improvements 15-40 years
Machinery and equipment 4-10 years
Furniture and fixtures 5-10 years
Computer hardware and software 3-5 years
Leased property and equipment under capital leases are amortized using the
straight-line method over the terms of the related leases.
Under the provisions of SOP 98-1, "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use," we capitalize costs associated with
software developed or obtained for internal use when both the preliminary
project stage is completed and we have authorized further funding for projects
which we believe will be completed and used to perform the function intended.
In conjunction with the Widia acquisition, we reviewed the estimated useful
lives currently being used for existing Kennametal assets, and have determined
that the current useful lives should be extended to more appropriately match the
life of the asset. Starting July 1, 2003, we have extended our useful lives of
machinery and equipment from a maximum life of 10 years to 15 years.
LONG-LIVED ASSETS We periodically perform ongoing reviews of underperforming
businesses and other long-lived assets, including amortizable intangible assets,
for impairment pursuant to the provisions of SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." These reviews may include an
analysis of the current operations and capacity utilization, in conjunction with
the markets in which the businesses are operating. A comparison is performed of
the undiscounted projected cash flows of the current operating forecasts to the
net book value of the related assets. If it is determined that the full value of
the assets may not be recoverable, an appropriate charge to adjust the carrying
value of the long-lived assets to fair value may be required.
As a result of continued price declines caused by persistent global
over-capacity and low-cost Asian competition, we completed an assessment in June
2003 of the carrying value of certain long-lived assets in the Electronics
business and recorded a pre-tax charge of $16.1 million as a component of
restructuring and asset impairment charges. The fixed asset impairment charge
reduced the book value of the Electronics business' assets to $2.6 million. This
remaining value was determined based on cash flow and estimated realizable value
of the assets.
GOODWILL AND INTANGIBLE ASSETS Goodwill represents the excess of cost over the
fair value of acquired companies. Prior to our adoption of SFAS No. 142,
goodwill was amortized using the straight-line method. Under SFAS No. 142, all
goodwill amortization ceased effective July 1, 2001. Goodwill and intangible
assets with indefinite useful lives will be tested at least annually for
impairment. On an ongoing basis (absent of any impairment indicators), we
perform our impairment tests during the June quarter, in connection with our
planning process. As a result of the Widia acquisition, we have recorded $27.2
million of identifiable intangible assets of which $6.4 million has a definite
life and therefore will be amortized over its remaining life.
40
We adopted SFAS No. 142 effective July 1, 2001. Goodwill attributable to each of
our reporting units was tested for impairment by comparing the fair value of
each reporting unit with its carrying value. As a result of the adoption of this
rule, we recorded a non-cash pre-tax charge of $252.8 million specific to the
Electronics (AMSG segment--$82.1 million) and the Industrial Products Group
(MSSG segment--$170.7 million) businesses, which were acquired in 1998 as part
of Greenfield Industries. The fair values of these reporting units were
determined using a combination of discounted cash flow analysis and market
multiples based upon historical and projected financial information. The initial
phase of the impairment tests were performed within six months of adoption of
SFAS No. 142 or December 31, 2001, and are required at least annually
thereafter.
Under SFAS No. 142, the impairment adjustment recognized at adoption of this
standard was reflected as a cumulative effect of a change in accounting
principle, effective July 1, 2001. Impairment adjustments recognized after
adoption, if any, are required to be recognized as a component of operating
expense.
The carrying amount of goodwill attributable to each segment at June 30, 2002
and 2003 is as follows:
(in thousands) June 30, 2001 Impairment Disposals Translation June 30, 2002
- ---------------------------------------------------------------------------------------------------
MSSG $ 315,463 $(170,682) $ - $ 2,376 $ 147,157
AMSG 249,345 (82,113) - 310 167,542
J&L Industrial Supply 45,748 - (6,099) - 39,649
Full Service Supply 4,707 - - - 4,707
- ---------------------------------------------------------------------------------------------------
Total $ 615,263 $(252,795) $ (6,099) $ 2,686 $ 359,055
===================================================================================================
(in thousands) June 30, 2002 Acquisition Disposals Translation June 30, 2003
- ---------------------------------------------------------------------------------------------------
MSSG $147,157 $ 58,624 $ - $ 16,528 $ 222,309
AMSG 167,542 197 - 27 167,766
J&L Industrial Supply 39,649 - - - 39,649
Full Service Supply 4,707 - - - 4,707
- ---------------------------------------------------------------------------------------------------
Total $359,055 $ 58,821 $ - $ 16,555 $ 434,431
===================================================================================================
In connection with the adoption of SFAS No. 142, we also reassessed the useful
lives and the classification of our identifiable intangible assets and
determined that they continue to be appropriate. The components of our
intangible assets are as follows:
June 30, 2003 June 30, 2002
---------------------------- ----------------------------
Estimated Gross Carrying Accumulated Gross Carrying Accumulated
(in thousands) Useful Life Amount Amortization Amount Amortization
- ---------------------------------------------------------------------------------------------------------------------
Contract based 4-15 years $ 11,218 $ (10,230) $ 11,910 $ (9,488)
Technology based and other 4-15 years 10,799 (4,807) 3,374 (2,423)
Trademarks Indefinite 24,139 - - -
Intangible pension asset and other Indefinite 8,382 - 5,564 -
- ---------------------------------------------------------------------------------------------------------------------
Total $ 54,538 $ (15,037) $ 20,848 $ (11,911)
=====================================================================================================================
Amortization expense for intangible assets, other than goodwill, was $4.2
million, $2.8 million and $3.1 million for 2003, 2002 and 2001, respectively.
Goodwill amortization was $19.0 million, net of tax, in 2001; no amortization
was recorded in 2002 or 2003 due to the adoption of SFAS 142.
41
The effects of adopting SFAS No. 141 and 142 on net income and basic and diluted
earnings per share for the years ended June 30, 2003, 2002 and 2001 are as
follows:
June 30
-------------------------------------
(in thousands, except per share amounts) 2003 2002 2001
- ----------------------------------------------------------------------------------
Reported net income (loss) $ 18,130 $ (211,908) $ 53,288
Goodwill impairment, net of tax - 250,406 -
Goodwill amortization, net of tax - - 18,975
- ----------------------------------------------------------------------------------
Adjusted net income $ 18,130 $ 38,498 $ 72,263
==================================================================================
Basic earnings per share:
Reported net income (loss) $ 0.52 $ (6.80) $ 1.74
Goodwill impairment - 8.04 -
Goodwill amortization - 0.62
- ----------------------------------------------------------------------------------
Adjusted net income $ 0.52 $ 1.24 $ 2.36
==================================================================================
Diluted earnings per share:
Reported net income (loss) $ 0.51 $ (6.70) $ 1.73
Goodwill impairment - 7.92 -
Goodwill amortization - - 0.62
- ----------------------------------------------------------------------------------
Adjusted net income $ 0.51 $ 1.22 $ 2.35
==================================================================================
Deferred Financing Fees Fees incurred in connection with new borrowings are
capitalized and amortized to interest expense over the life of the related
obligation.
Earnings Per Share Basic earnings per share is computed using the weighted
average number of shares outstanding during the period, while diluted earnings
per share is calculated to reflect the potential dilution that occurs related to
issuance of capital stock under stock option grants and restricted stock awards.
The difference between basic and diluted earnings per share relates solely to
the effect of capital stock options and restricted stock awards.
For purposes of determining the number of dilutive shares outstanding, weighted
average shares outstanding for basic earnings per share calculations were
increased due solely to the dilutive effect of unexercised capital stock options
and restricted stock awards by 0.3 million, 0.5 million and 0.2 million shares
in 2003, 2002 and 2001, respectively. Unexercised stock options to purchase our
capital stock of 1.7 million, 1.2 million and 1.5 million shares at June 30,
2003, 2002 and 2001, respectively, are not included in the computation of
diluted earnings per share because the option exercise price was greater than
the average market price.
Revenue Recognition Revenue from the sale of products is generally recognized
when risk of loss, title and insurable risk have transferred to the customer,
which in most cases coincides with shipment of the related products. We do not
ship product unless we have documentation authorizing shipment to our customers.
Historically, we have experienced very low levels of returned product and do not
consider the effect of returned product to be material.
Stock-Based Compensation Stock options generally are granted to eligible
employees with a stock price equal to fair market value at the date of grant.
Options are exercisable under specific conditions for up to 10 years from the
date of grant. As permitted under the SFAS No. 123 we have elected to measure
compensation expense related to stock options in accordance with Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and
related interpretations which uses the intrinsic value method. In addition to
stock option grants, the 2002 plan permits the award of restricted stock to
directors, officers and key employees. Expense associated with restricted stock
grants is amortized over the vesting period. The expense for these awards is the
same under the fair value method or intrinsic value method, and therefore is not
included in the table below. If compensation expense was determined based on the
estimated fair value of options granted in 2003, 2002 and 2001, consistent with
the methodology in SFAS No. 123 and 148, our 2003, 2002 and 2001 net income and
earnings per share would be reduced to the pro forma amounts indicated on the
following page:
42
Fiscal Year Ended June 30,
----------------------------------
(in thousands, except per share data) 2003 2002 2001
- ----------------------------------------------------------------------------------------------------
Net income (loss), as reported $ 18,130 $(211,908) $ 53,288
Deduct: Total stock-based employee compensation expense
determined under fair value based method for all awards,
net of related tax effects (5,591) (3,603) (2,486)
Add: Total stock-based employee compensation expense
determined under intrinsic value based method for all
awards, net of related tax effects 158 - -
- ----------------------------------------------------------------------------------------------------
Total stock-based compensation (5,433) (3,603) (2,486)
- ----------------------------------------------------------------------------------------------------
Pro forma net income (loss) $ 12,697 $(215,511) $ 50,802
====================================================================================================
Earnings (loss) per share:
Basic-as reported $ 0.52 $ (6.80) $ 1.74
====================================================================================================
Basic-pro forma $ 0.36 $ (6.91) $ 1.66
====================================================================================================
Diluted-as reported $ 0.51 $ (6.70) $ 1.73
====================================================================================================
Diluted-pro forma $ 0.36 $ (6.86) $ 1.65
====================================================================================================
The fair values of the options granted were estimated on the date of their grant
using the Black-Scholes option- pricing model based on the following weighted
average assumptions:
2003 2002 2001
- ----------------------------------------------------------------------------
Risk-free interest rate 3.1% 4.6% 5.9%
Expected life (years) 5 5 5
Expected volatility 34.2% 34.0% 33.2%
Expected dividend yield 2.1% 1.8% 2.4%
- ---------------------------------------------------------------------------
Research and Development Costs Research and development costs of $23.6 million,
$18.3 million and $18.9 million in 2003, 2002 and 2001, respectively, were
expensed as incurred.
Shipping and Handling Fees and Costs All fees billed to customers for shipping
and handling are classified as a component of net sales. All costs associated
with shipping and handling are classified as a component of cost of goods sold.
Income Taxes Deferred income taxes are recognized based on the future income tax
effects (using enacted tax laws and rates) of differences in the carrying
amounts of assets and liabilities for financial reporting and tax purposes. A
valuation allowance is recognized if it is "more likely than not" that some or
all of a deferred tax asset will not be realized. The valuation allowance was
$36.0 million and $6.6 million at June 30, 2003 and 2002, respectively. The
increase is primarily attributable to net operating loss carryforwards acquired
in the Widia acquisition.
FINANCIAL INSTRUMENTS AND DERIVATIVES On July 1, 2000, we adopted SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," as amended. The
adoption of SFAS No. 133 resulted in the recording of current assets of $1.6
million, long-term assets of $1.4 million, current liabilities of $1.3 million,
long-term liabilities of $0.7 million, a decrease in accumulated other
comprehensive loss of $1.6 million, net of tax, and a loss from the cumulative
effect from the change in accounting principle of $0.6 million, net of tax. As
part of our formal documented risk management program, we use certain derivative
financial instruments. We do not enter into derivative transactions for
speculative purposes and therefore hold no derivative instruments for trading
purposes. We use derivative financial instruments to dampen the effects of
changes in foreign exchange rates on our consolidated results and to achieve our
targeted mix of fixed and floating interest rates on outstanding debt. We
account for derivative instruments as a hedge of the related asset, liability,
firm commitment or anticipated transaction when the derivative is specifically
designated as a hedge of such items. Our objective in managing foreign exchange
exposures with derivative instruments is to reduce both earnings and cash flow
volatility, allowing us to focus our attention on business operations. With
respect to interest rate management, these derivative instruments allow us to
achieve our targeted fixed-to-floating interest rate mix as a separate decision
from funding arrangements in the bank and public debt markets. We measure hedge
effectiveness by assessing the changes in the fair value or expected future cash
flows of the
43
hedged item. The ineffective portions are recorded in other income or expense in
the current period. In addition, other forward contracts hedging significant
cross-border intercompany loans are considered other derivatives and therefore,
not eligible for hedge accounting under SFAS No. 133. These contracts are
recorded at fair value in the balance sheet, with the offset to other (income)
expense, net.
CASH FLOW HEDGES Currencies Forward contracts, purchased options and range
forward contracts (a transaction where both a put option is purchased and a call
option is sold), designated as cash flow hedges, hedge anticipated cash flows
from cross-border intercompany sales of product and services. Gains and losses
realized on these contracts at maturity are recorded in accumulated other
comprehensive loss, net of tax, and are recognized as a component of other
(income) expense, net when the underlying sale of product or services are
recognized into earnings. We recognized expense of $0.7 million and $0.1 million
as a component of other income, net, in 2003 and 2002, respectively, related to
hedge ineffectiveness. The time value component of the fair value of purchased
options and range forwards is excluded from the assessment of hedge
effectiveness. Assuming market rates remain constant with the rates at June 30,
2003, we expect to recognize into earnings in the next 12 months losses on
outstanding derivatives of $2.9 million.
Interest Rates Floating-to-fixed interest rate swap agreements, designated as
cash flow hedges, hedge our exposure to interest rate changes on a portion of
our floating rate debt. The interest rate swap converts a portion of our
floating rate debt to fixed rate debt. We record the fair value of these
contracts in the balance sheet, with the offset to accumulated other
comprehensive loss, net of tax. During 2003, we entered into interest rate swap
agreements to convert $53.5 million of our floating rate debt to fixed rate
debt. As of June 30, 2003, we have recorded a loss of $1.0 million on these
contracts which has been recorded in other comprehensive loss. The contracts
require periodic settlement; the difference between the amounts to be received
and paid under interest rate swap agreements is recognized in interest expense.
Assuming market rates remain constant with rates at June 30, 2003, we expect to
recognize into earnings in the next 12 months losses on outstanding derivatives
of $0.2 million.
FAIR VALUE HEDGES Interest Rates Fixed-to-floating interest rate swap
agreements, designated as fair value hedges, hedge our exposure to fair value
fluctuations on a portion of our fixed rate ten-year Senior Unsecured Notes due
to changes in the overall interest rate environment. These interest rate swap
agreements convert a portion of our fixed rate debt to floating rate debt.
During 2002, we entered into interest rate swap agreements which mature in 2012,
to convert $200 million of our fixed rate debt to floating rate debt. These
contracts require periodic settlement; the difference between amounts to be
received and paid under the interest rate swap agreements is recognized in
interest expense. In April 2003, we terminated these contracts and received a
cash payment of $15.5 million. This gain will be amortized as a component of
interest expense over the life of the debt using the effective interest rate
method. Upon termination of the contracts in April, we entered into a new
interest rate swap agreement with a notional amount of $200 million and a
maturity date of June 2012. As of June 30, 2003, we have recorded a gain of $8.4
million related to these contracts. We record the gain or loss of these
contracts in the balance sheet, with the offset to the carrying value of the
Senior Unsecured Notes. Any gain or loss resulting from changes in the fair
value of these contracts offset the corresponding gains or losses from changes
in the fair values of the Senior Unsecured Notes. As a result, changes in the
fair value of these contracts had no net impact on current year earnings.
Foreign Currency Translation Assets and liabilities of international operations
are translated into U.S. dollars using year-end exchange rates, while revenues
and expenses are translated at average exchange rates throughout the year. The
resulting net translation adjustments are recorded as a component of accumulated
other comprehensive loss. The local currency is the functional currency of most
of our locations.
NEW ACCOUNTING STANDARDS In June 2001, the Financial Accounting Standards Board
(FASB) issued SFAS No. 143, "Accounting for Asset Retirement Obligations." SFAS
No. 143 addresses financial accounting and reporting for obligations associated
with the retirement of tangible long-lived assets and the associated asset
retirement costs. It applies to legal obligations associated with the retirement
of long-lived assets that result from the acquisition, construction, development
and/or the normal operation of a long-lived asset. The adoption of this
standard, effective July 1, 2002, had no material impact on the results of our
operations or financial position.
44
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets," which addresses financial accounting and
reporting for the impairment of long-lived assets and for long-lived assets to
be disposed of and supersedes SFAS No. 121. This statement retains the
fundamental provisions of SFAS No. 121 for recognition and measurement of the
impairment of long-lived assets to be held and used and measurement of
long-lived assets to be disposed of by sale. The provisions of this statement
are effective for fiscal years beginning after December 15, 2001, and interim
periods within those fiscal years. The adoption of this standard effective July
1, 2002, did not have a material impact on our consolidated financial
statements.
In April 2002, SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64,
Amendment of FASB Statement No. 13, and Technical Corrections," was issued. This
statement updates, clarifies and simplifies existing accounting pronouncements.
While the technical corrections to existing pronouncements are not substantive
in nature, in some instances they may change accounting practice. The provisions
of this standard related to SFAS No. 13 are effective for transactions occurring
after May 15, 2002. Prospectively, as a result of the adoption of SFAS No. 145,
debt extinguishment costs previously classified as extraordinary items will be
reclassified as interest expense.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Exit or Disposal
Activities," which addresses significant issues regarding the recognition,
measurement and reporting of costs that are associated with exit and disposal
activities, including restructuring activities. SFAS No. 146 nullifies Emerging
Issues Task Force (EITF) Issue No. 94-3, "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity," under which
a liability for an exit cost was recognized at the date of an entity's
commitment to an exit plan. SFAS No. 146 requires that a liability for a cost
associated with an exit or disposal activity be recognized at fair value when
the liability is incurred. The provisions of this statement have been applied to
any exit or disposal activities entered into after January 1, 2003.
In November 2002, the FASB issued FASB Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others." FIN 45 clarifies the requirements of FASB
Statement No. 5, "Accounting for Contingencies," relating to a guarantor's
accounting for, and disclosure of, the issuance of certain types of guarantees.
FIN 45 requires that upon issuance of a guarantee, the guarantor must recognize
a liability for the fair value of the obligation it assumes under that
guarantee. FIN 45 also requires enhanced disclosures in a company's interim and
annual filings. FIN 45 is effective for guarantees issued or modified after
December 31, 2002. The disclosure requirements were effective for financial
statements of both interim and fiscal years ending after December 15, 2002. The
adoption of this standard did not have a material impact on our consolidated
financial statements.
In January 2003, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation Transition and Disclosure," to provide alternative methods of
transition for an entity that voluntarily changes to the fair value- based
method of accounting for stock-based employee compensation. This statement also
amends the disclosure provisions of that statement to require prominent
disclosure about the effects on reported net income of an entity's accounting
policy decisions with respect to stock-based employee compensation. Finally, the
statement amends APB Opinion No. 28, "Interim Financial Reporting," to require
disclosure about those effects in interim financial information. The amendments
to APB Opinion No. 28 are effective for financial reports containing Condensed
Financial Statements for interim periods beginning after December 15, 2002. The
disclosure provisions of this statement were adopted on January 1, 2003.
In January 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities--an interpretation of ARB No. 51."
FIN 46 clarifies the application of Accounting Research Bulletin No. 51,
"Consolidated Financial Statements," to certain entities in which equity
investors do not have the characteristics of a controlling financial interest or
do not have sufficient equity at risk for the entity to finance its activities
without additional subordinated financial support from other parties. FIN 46 is
effective for the Company July 1, 2003 and is not expected to have a material
impact on the Company's results of operations or financial condition.
45
In January 2003, the EITF released Issue No. 00-21 ("EITF 00-21"), "Revenue
Arrangements with Multiple Deliverables," which addresses certain aspects of the
accounting by a vendor for arrangement under which it will perform multiple
revenue-generating activities. Specifically, EITF 00-21 addresses whether an
arrangement contains more than one unit of accounting and the measurement and
allocation to the separate units of accounting in the arrangement. EITF 00-21 is
effective for revenue arrangements entered into in fiscal periods beginning
after June 15, 2003. The adoption of this standard did not have a material
impact on our consolidated financial statements.
In May 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under SFAS
No. 133. SFAS No. 149 is effective for contracts entered into or modified after
June 30, 2003 and for hedging relationships designated after June 30, 2003. The
Company is currently analyzing the provisions of SFAS No. 149 to determine if
there will be any impact of adoption, but does not believe that there will be
any material impact on its consolidated financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150
establishes standards for how companies classify and measure certain financial
instruments with characteristics of both liabilities and equity. It requires
companies to classify a financial instrument that is within its scope as a
liability (or an asset in some circumstances). SFAS No. 150 is effective for
financial instruments entered into or modified after May 31, 2003. The standard
will not impact the consolidated financial statements.
RECLASSIFICATIONS Certain amounts in the prior years' consolidated financial
statements have been reclassified to conform with the current-year presentation.
NOTE 3 - ACQUISITIONS AND DIVESTITURES
On August 30, 2002, we purchased the Widia Group (Widia) in Europe and India
from Milacron Inc. for EUR 188 million ($185.3 million) subject to a purchase
price adjustment. On February 12, 2003, Milacron Inc. and Kennametal signed a
settlement agreement with respect to the calculation of the post-closing
purchase price adjustment for the Widia acquisition pursuant to which Milacron
paid Kennametal EUR 18.8 million ($20.1 million) in cash. The net cash purchase
price of $167.1 million includes the actual purchase price of $185.3 million
less the settlement of $20.1 million plus $6.2 million of direct acquisition
costs ($1.1 million paid in fiscal year 2002 and $5.1 million paid during the
twelve months ended June 30, 2003) less $4.3 million of acquired cash. We
financed the acquisition with funds borrowed under the 2002 Credit Agreement.
The acquisition of Widia improves our global competitiveness, strengthens our
European position and represents a strong platform for increased penetration in
Asia. Widia's operating results have been included in our consolidated results
since August 30, 2002. The fair market value of the Widia tangible and
intangible assets were determined by an independent appraiser.
In accordance with SFAS No. 141, "Business Combinations," we accounted for the
acquisition using the purchase method of accounting. Accordingly, the
preliminary purchase price allocations have been made based upon an estimated
fair value of net assets acquired resulting in the recognition of approximately
$53.0 million of goodwill and $27.2 million of other intangibles. Of the $27.2
million of identifiable intangible assets approximately $6.4 million has a
definite life and therefore will be amortized over its remaining useful life. In
accordance with SFAS No. 142, "Goodwill and Other Intangible Assets," the
goodwill will not be amortized but will instead be subject to an annual
impairment test. All goodwill and intangible assets resulting from the
acquisition will be included in the MSSG segment. The preliminary purchase price
allocations are subject to adjustment and may be modified within one year from
the acquisition. Subsequent changes are not expected to have a material effect
on our consolidated financial position.
46
The following summarizes the estimated fair values at the date of acquisition:
(in thousands)
- -----------------------------------------------------------------------------------------
Cash $ 4.3
Accounts receivable, net 49.4
Inventory, net 65.4
Other current assets 24.8
Property, plant and equipment, net 83.7
Trademarks 20.8
Patented technology 6.4
Other assets 19.9
Goodwill 53.0
- -----------------------------------------------------------------------------------------
Total assets acquired $ 327.7
=========================================================================================
Accounts payable and accrued wages 22.5
Notes payable 18.1
Other current liabilities 48.0
Long-term liabilities 60.8
Minority interest 6.9
- -----------------------------------------------------------------------------------------
Total liabilities and minority interest 156.3
- -----------------------------------------------------------------------------------------
Net assets acquired $ 171.4
=========================================================================================
The unaudited pro forma consolidated financial data presented below gives effect
to the Widia acquisition as if it had occurred as of the beginning of each
period presented. The pro forma adjustments are based upon available information
and certain assumptions that we believe are reasonable, including additional
interest expense and amortization that resulted from the transaction, net of any
applicable income tax effects. The unaudited pro forma consolidated financial
data is not necessarily indicative of the operating results that would have
occurred had the acquisition been consummated on the date indicated, nor are
they indicative of future operating results. Except for actions actually taken
as of and since the close of the transaction and for which any related impact
would be included in the actual results through the period end, anticipated cost
savings have not been reflected in this pro forma presentation. The unaudited
pro forma consolidated financial data should be read in conjunction with the
historical consolidated financial statements and accompanying notes.
Twelve Months Ended June 30, 2003 2002
- ------------------------------------------------------------------------------------------------------
PRO FORMA CONSOLIDATED FINANCIAL DATA
Net sales $ 1,794,351 $ 1,807,135
Income before cumulative effect of change
in accounting principle 13,489 26,786
Net income (loss) 13,489 (223,620)
Basic earnings per share before cumulative
effect of change in accounting principle 0.38 0.86
Basic earnings (loss) per share 0.38 (7.17)
Diluted earnings per share before cumulative
effect of change in accounting principle 0.38 0.85
Diluted earnings (loss) per share 0.38 (7.07)
- ------------------------------------------------------------------------------------------------------
Additionally, during the first quarter of the current year, we acquired the
remaining nine percent minority interest of our subsidiary in Poland for total
consideration of $0.2 million. This subsidiary is now wholly-owned by
Kennametal. During 2003 we acquired an additional one percent ownership interest
from minority shareowners of our subsidiary in Germany for total consideration
of $4.5 million bringing our ownership to 99.3 percent. An additional payment of
$2.3 million was made during the second quarter related to minority shareowners
that sold their shares in the prior year. Total goodwill resulting from these
transactions was $5.6 million.
In January 2002, we acquired Carmet Company for $5.1 million. Located in Duncan,
S.C., this entity is a producer of tungsten cutting tools and wear parts and is
included in our AMSG segment.
47
On April 19, 2002, we sold Strong Tool Company, our industrial supply
distributor based in Cleveland, Ohio, for $8.6 million comprised of cash
proceeds of $4.0 million and a seller note for $4.6 million. This action
resulted in a pretax loss of $3.5 million and is in line with our strategy to
refocus the J&L segment on its core catalog business. Annualized sales of this
business were approximately $34 million.
In April 2001, we sold ATS Industrial Supply, Inc., our industrial supply
distributor based in Salt Lake City, Utah, for $6.8 million comprised of cash
proceeds of $1.0 million and a seller note for $5.8 million. This action
resulted in a pretax loss of approximately $5.8 million and is in line with our
strategy to refocus the J&L segment on its core catalog business. Annualized
sales of this business were approximately $17 million.
On July 20, 2000, we proposed to the Board of Directors of JLK to acquire the
outstanding shares of JLK we did not already own. On September 11, 2000, we
announced a definitive merger agreement with JLK to acquire all the outstanding
minority shares. Pursuant to the agreement, JLK agreed to initiate a cash tender
offer for all of its shares of Class A Common Stock at a price of $8.75 per
share. The tender offer commenced on October 3, 2000 and expired on November 15,
2000 resulting in JLK reacquiring 4.3 million shares for $37.5 million.
Following JLK's purchase of shares in the tender offer, we acquired these shares
at the same price in a merger. We incurred transaction costs of $3.3 million,
which were included in the total cost of the transaction. JLK incurred costs of
$2.1 million associated with the transaction, which were expensed as incurred.
The transaction was unanimously approved by the JLK Board of Directors,
including its special committee comprised of independent directors of the JLK
Board.
NOTE 4 - ACCOUNTS RECEIVABLE SECURITIZATION PROGRAM
Since 1999, we had an agreement with a financial institution whereby we
securitize, on a continuous basis, an undivided interest in a specific pool of
our domestic trade accounts receivable. This agreement expired on June 30, 2003,
and was renewed to July 3, 2003. On July 3, 2003, we entered into a new
three-year securitization program (2003 Securitization Program) which also
permitted us to securitize up to $100.0 million of accounts receivable. The 2003
Securitization Program provides for a co-purchase arrangement whereby two
financial institutions participate in the purchase of our accounts receivable.
Pursuant to this agreement, we, and several of our domestic subsidiaries, sell
our domestic accounts receivable to Kennametal Receivables Corporation, a
wholly-owned, bankruptcy-remote subsidiary (KRC). A bankruptcy-remote subsidiary
is a company that has been structured to make it highly unlikely that it would
be drawn into a bankruptcy of Kennametal Inc., or any of our other subsidiaries.
KRC was formed to purchase these accounts receivable and sell participating
interests in such accounts receivable to the financial institutions which, in
turn, purchases and receives ownership and security interests in those assets.
As collections reduce the amount of accounts receivable included in the pool, we
sell new accounts receivable to KRC which, in turn, securitizes these new
accounts receivable with the financial institutions.
We are permitted to securitize up to $100.0 million of accounts receivable under
this agreement. The actual amount of accounts receivable securitized each month
is a function of the net change (new billings less collections) in the specific
pool of domestic accounts receivable, the impact of detailed eligibility
requirements in the agreement (e.g. the aging, terms of payment, quality
criteria and customer concentrations), and the application of various reserves
which are typically in trade receivable securitization transactions. A decrease
in the amount of eligible accounts receivable could result in our inability to
continue to securitize all or a portion of our accounts receivable. It is not
unusual, however, for the amount of our eligible accounts receivable to vary by
up to $5.0 to $10.0 million per month. The financial institutions charge us fees
based on the level of accounts receivable securitized under this agreement and
the commercial paper market rates plus the financial institution's cost to
administer the program. The costs incurred under this program, $1.9 million,
$2.5 million and $5.7 million in 2003, 2002 and 2001, respectively, are
accounted for as a component of other expense, net and represent attractive
funding costs compared to existing bank and public debt transactions. At June
30, 2003 and 2002, we securitized accounts receivable of $99.3 million and $95.9
million, respectively, under this program. Our retained interests in accounts
receivable available for securitization and recorded as a component of accounts
receivable were $36.4 million and $37.1 million at June 30, 2003 and 2002,
respectively.
The 2003 Securitization Program is required to be renewed periodically, and it
is our intention to continuously obtain that renewal when required. However,
certain provisions of the 2003 Securitization Program will require annual
approval. Non-renewal or non-annual approval of this agreement would result in
our requirement to otherwise finance the amounts securitized. In the event of a
decrease of our eligible accounts receivable or non-renewal or non-annual
approval of our securitization program, we would have to utilize alternative
sources of capital to fund that portion of our working capital needs.
48
NOTE 5 - INVENTORIES
Inventories consisted of the following:
(in thousands) 2003 2002
- -------------------------------------------------------------------------------------------
Finished goods $ 273,803 $ 260,783
Work in process and powder blends 109,295 91,871
Raw materials and supplies 36,514 34,452
- -------------------------------------------------------------------------------------------
Inventories at current cost 419,612 387,106
Less LIFO valuation (27,357) (42,030)
- -------------------------------------------------------------------------------------------
Total inventories $ 392,255 $ 345,076
===========================================================================================
We used the LIFO method of valuing our inventories for approximately 40 and 49
percent of total inventories at June 30, 2003 and 2002, respectively. We use the
LIFO method in order to more closely match current costs with current revenues,
thereby reducing the effects of inflation on earnings.
NOTE 6 - OTHER CURRENT LIABILITIES
Other current liabilities consisted of the following:
(in thousands) 2003 2002
- ------------------------------------------------------------------------------------------
Accrued employee benefits $ 28,898 $ 21,378
Payroll, state and local taxes 7,799 5,234
Accrued interest expense 1,687 1,355
Derivative financial instruments 3,539 6,944
Environmental reserve 6,310 3,723
Restructuring reserve 24,868 8,456
Other accrued expenses 45,986 34,992
- ------------------------------------------------------------------------------------------
Total other current liabilities $ 119,087 $ 82,082
==========================================================================================
NOTE 7 - LONG-TERM DEBT AND CAPITAL LEASES
Long-term debt and capital lease obligations consisted of the following:
(in thousands) 2003 2002
- ----------------------------------------------------------------------------------------------------------
7.2% Senior Unsecured Notes due 2012 net of discount of $1.0 million and
$1.1 million for 2003 and 2002, respectively. Also including interest rate
swap adjustments in 2003 of $23.7 million and ($0.9 million) in 2002. $ 322,667 $ 297,958
- ----------------------------------------------------------------------------------------------------------
2002 Credit Agreement:
U.S. Dollar-denominated borrowings, 2.055% to 2.625% in 2003, due 2005 75,000 81,500
Euro-denominated borrowings, 3.165% to 3.44375% in 2003, due 2005 92,184 -
Yen-denominated borrowings, 1.0875% in 2003, due 2005 14,036 -
- ----------------------------------------------------------------------------------------------------------
Total 2002 Credit Agreement borrowings 181,220 81,500
Yen Credit Facility, 0.83% in 2002, due 2003 - 14,083
Lease of office facilities and equipment with terms expiring
through 2008 at 3.25% to 4.73% 11,948 8,982
Other 1,914 1,918
- ----------------------------------------------------------------------------------------------------------
Total debt and capital leases 517,749 404,441
- ----------------------------------------------------------------------------------------------------------
Less current maturities:
Long-term debt (311) (14,621)
Capital leases (2,596) (1,933)
- ----------------------------------------------------------------------------------------------------------
Total current maturities (2,907) (16,554)
- ----------------------------------------------------------------------------------------------------------
Long-term debt and capital leases $ 514,842 $ 387,887
==========================================================================================================
49
Senior Unsecured Notes On June 19, 2002, we issued $300 million of 7.2% Senior
Unsecured Notes due 2012 (Senior Unsecured Notes). These notes were issued at
99.629% of the face amount and yielded $294.3 million of net proceeds after
related financing fees. The proceeds of this debt issuance were utilized to
repay senior bank indebtedness. Interest is payable semi-annually on June 15th
and December 15th of each year commencing December 15, 2002. The Senior
Unsecured Notes contain covenants that restrict our ability to create liens,
enter into sale-leaseback transactions or certain consolidations or mergers, or
sell all or substantially all of our assets. As discussed under "Financial
Instruments and Derivatives," in April 2003, we terminated interest rate swap
agreements that converted the interest rate on $200 million of the Senior
Unsecured Notes from fixed to floating interest rates. This transaction resulted
in cash proceeds of $15.5 million which is included in the Senior Unsecured Note
balance of $322.7 million at June 30, 2003. This gain will be amortized as a
component of interest expense over the life of the debt using the effective
interest rate method. During 2003, we entered into a new interest rate swap
agreement with a notional amount of $200 million, and a maturity date of June
2012. As of June 30, 2003, we recorded a gain of $8.4 million related to these
contracts. We record the gain or loss on these contracts in the balance sheet,
with the offset to the carrying value of the Senior Unsecured Notes.
2002 Credit Agreement We also entered into a three-year, multi-currency,
revolving credit facility with a group of financial institutions (2002 Credit
Agreement). The 2002 Credit Agreement originally permitted revolving credit
loans of up to $650 million for working capital, capital expenditures and
general corporate purposes and replaced the previous Bank Credit Agreement, the
Euro Credit Agreement and the Yen Credit Facility discussed below. The 2002
Credit Agreement allows for borrowings in U.S. dollars, Euro, Canadian dollars,
Pound Sterling and Japanese Yen.
In June 2003, we provided written notice to the administrative agent indicating
our decision to reduce the 2002 Credit Agreement from $650 million to $500
million. This resulted in a write-down of a portion of deferred financing fees
of $0.5 million. Interest payable under the 2002 Credit Agreement is based upon
the type of borrowing under the facility and may be (1) the greater of the prime
rate and the federal funds effective rate plus 0.50%, (2) Euro-currency rates
plus an applicable margin or (3) a quoted fixed rate offered by one or more
lenders at the time of borrowing.
The 2002 Credit Agreement contains various covenants with which we must be in
compliance including three financial covenants: a maximum leverage ratio, a
maximum fixed charge coverage ratio and a minimum consolidated net worth. As of
June 30, 2003, outstanding borrowings under this agreement were $181.2 million
and we had the ability to borrow under this agreement or otherwise have
additional debt of up to $108.7 million and be in compliance with the maximum
leverage ratio financial covenant. The maximum leverage ratio financial covenant
requires that we maintain at the end of each fiscal quarter a specified
consolidated leverage ratio (as that term is defined in this agreement).
Previous Debt Agreements In 1998, we entered into a $1.4 billion Bank Credit
Agreement. Subject to certain conditions, the Bank Credit Agreement permitted
term loans of up to $500 million and revolving credit loans of up to $900
million for working capital, capital expenditures and general corporate
purposes.
The Yen Credit Facility was entered into on January 28, 1999 and allowed for
Japanese Yen-denominated borrowings up to JPY 1.68 billion. The facility matured
on July 27, 2002 and was not renewed. The proceeds from the 2002 Credit
Agreement were used to pay the outstanding balance.
On December 20, 2000, we entered into a EUR 212 million Euro-denominated
revolving credit facility (Euro Credit Agreement) to partially hedge the foreign
exchange exposure of our net investment in Euro-based subsidiaries and to
diversify our interest rate exposure. Amounts borrowed under the Euro Credit
Agreement were required to be used to repay indebtedness under the Bank Credit
Agreement and, to the extent the Bank Credit Agreement was repaid, for working
capital and general corporate purposes. On January 8, 2001, we borrowed EUR 212
million under this facility to meet our obligation under then outstanding
Euro-denominated forward foreign exchange contracts. The proceeds from the
Euro-denominated forward foreign exchange contracts of $191.1 million were used
to repay amounts borrowed under the Bank Credit Agreement. Subsequently, the
availability under the Bank Credit Agreement was permanently reduced from $900
million to $700 million, resulting in a write-down of a portion of deferred
financing fees of $0.3 million. This charge was recorded as a component of
interest expense.
50
The Bank Credit Agreement and the Euro Credit Agreement were cancelled in June
2002 when we repaid both facilities using proceeds raised from the public debt
offering, the capital stock issuance and the 2002 Credit Agreement.
Future principal maturities of long-term debt are $0.3 million, $0.4 million,
$181.6 million, $0.2 million and $0.1 million, respectively, in 2004 through
2008.
Future minimum lease payments under capital leases for the next five years and
thereafter in total are as follows:
(in thousands)
- ------------------------------------------------------------------------------------------
2004 $ 3,263
2005 2,627
2006 3,749
2007 1,325
2008 1,459
After 2008 1,671
- ------------------------------------------------------------------------------------------
Total future minimum lease payments 14,094
Less amount representing interest (2,146)
==========================================================================================
Amount recognized as capital lease obligation $ 11,948
==========================================================================================
Our secured debt at June 30, 2003 are industrial revenue bond obligations of
$1.3 million and the capitalized lease obligations of $11.9 million. These
obligations are secured by the underlying assets.
NOTE 8 - NOTES PAYABLE AND LINES OF CREDIT
Notes payable to banks of $7.9 million and $6.9 million at June 30, 2003 and
2002, respectively, represent short-term borrowings under international credit
lines with commercial banks. These credit lines, translated into U.S. dollars at
June 30, 2003 exchange rates, totaled $125.9 million at June 30, 2003, of which
$117.8 million was unused. The weighted average interest rate for notes payable
and lines of credit was 5.84 percent and 2.78 percent at June 30, 2003 and 2002,
respectively. The increase in the weighted average interest rate is associated
with notes payable that were acquired during the Widia acquisition. These notes
carried a significantly higher interest rate than Kennametal's historical rates.
NOTE 9 - INCOME TAXES
Income before income taxes and the provision for income taxes consisted of the
following:
(in thousands) 2003 2002 2001 (1)
- -----------------------------------------------------------------------------------------------------------
Income before provision for income taxes:
United States $ 15,954 $ 11,564 $ 35,108
International 18,336 47,487 59,221
- -----------------------------------------------------------------------------------------------------------
Total income before provision for income taxes and minority interest $ 34,290 $ 59,051 $ 94,329
===========================================================================================================
Current income taxes:
Federal $ (5,362) $ (17,303) $ 26,435
State 55 1,070 5,034
International 12,258 19,255 15,234
- -----------------------------------------------------------------------------------------------------------
Total current income taxes 6,951 3,022 46,703
Deferred income taxes 7,349 15,878 (9,403)
- -----------------------------------------------------------------------------------------------------------
Provision for income taxes $ 14,300 $ 18,900 $ 37,300
===========================================================================================================
Effective tax rate 41.7% 32.0% 39.5%
===========================================================================================================
(1) Taxes of $16.8 million in the 2001 annual report were previously classified
as current and have been reclassified to deferred taxes.
51
The reconciliation of income taxes computed using the statutory U.S. income tax
rate and the provision for income taxes was as follows:
(in thousands) 2003 2002 2001
- ------------------------------------------------------------------------------------
Income taxes at U.S. statutory rate $ 12,002 $ 20,668 $ 33,015
State income taxes, net of federal tax benefits 915 2,656 2,696
Nondeductible goodwill - - 5,557
Combined tax effects of international income (7,465) (5,773) (4,899)
International losses with no related tax benefits 8,003 990 1,135
Capital loss utilization (3,344) - -
Electronics impairment charge 4,765 - -
Other (576) 359 (204)
- ------------------------------------------------------------------------------------
Provision for income taxes $ 14,300 $ 18,900 $ 37,300
====================================================================================
Deferred tax assets and liabilities consisted of the following:
(in thousands) 2003 2002
- ---------------------------------------------------------------------------
Deferred tax assets:
Net operating loss carryforwards $ 42,643 $ 9,602
Inventory valuation and reserves 24,025 23,630
Pension benefits 12,218 -
Other postretirement benefits 19,318 18,721
Accrued employee benefits 16,663 17,962
Hedging activities 20,031 3,315
FTC carryforward 3,314 3,525
Other 21,659 20,602
- ---------------------------------------------------------------------------
Total 159,871 97,357
Valuation allowance (35,998) (6,600)
- ---------------------------------------------------------------------------
Total deferred tax assets $ 123,873 $ 90,757
===========================================================================
Deferred tax liabilities:
Tax depreciation in excess of book $ 44,091 $ 47,321
Pension benefits - 16,827
Other 8,966 7,804
- ---------------------------------------------------------------------------
Total deferred tax liabilities $ 53,057 $ 71,952
===========================================================================
Deferred income taxes were not provided on cumulative undistributed earnings of
international subsidiaries and affiliates. At June 30, 2003, unremitted earnings
of non-U.S. subsidiaries were determined to be permanently reinvested. It is not
practical to estimate the income tax effect that might be incurred if earnings
were remitted to the United States.
Included in deferred tax assets at June 30, 2003 are unrealized tax benefits
totaling $42.6 million related to net operating loss carryforwards. Of that
amount, $3.7 million expire through June 2008, $1.0 expire through June 2013,
another $1.0 million expire through June 2018 and the remaining $36.9 million do
not expire. The realization of these tax benefits is contingent on future
taxable income in certain international operations. A valuation allowance of
$30.4 million has been placed against certain losses resulting in a net deferred
asset related to net operating loss carryforwards of $12.2 million. Of this
amount, $10.0 million relates to net operating loss carryforwards in Germany,
$0.7 million are associated with Brazil, and $1.5 million related to Spain,
Belgium and South Africa. A valuation allowance of $5.5 million has been placed
on other deferred tax assets in the United Kingdom.
52
NOTE 10 - PENSION AND OTHER POSTRETIREMENT AND POSTEMPLOYMENT BENEFITS
We sponsor several pension plans that cover substantially all employees. Pension
benefits under defined benefit pension plans are based on years of service and,
for certain plans, on average compensation immediately preceding retirement. We
fund pension costs in accordance with the funding requirements of the Employee
Retirement Income Security Act of 1974 (ERISA), as amended, for U.S. plans and
in accordance with local regulations or customs for non-U.S. plans.
Additionally, we maintain a supplemental early executive retirement plan for
various executives. The liability associated with this plan is also included in
the pension disclosure below.
We presently provide varying levels of postretirement health care and life
insurance benefits to most U.S. employees. Postretirement health care benefits
are available to employees and their spouses retiring on or after age 55 with 10
or more years of service after age 40. Beginning with retirements on or after
January 1, 1998, our portion of the costs of postretirement health care benefits
are capped at 1996 levels.
The funded status of our pension plans and amounts recognized in the
consolidated balance sheets were as follows:
(in thousands) 2003 2002
- ----------------------------------------------------------------------------------
Change in benefit obligation:
Benefit obligation, beginning of year $ 417,070 $ 387,977
Service cost 13,098 11,195
Interest cost 30,103 27,328
Participant contributions 729 642
Actuarial (gains) losses 65,389 3,705
Benefits paid (19,288) (20,450)
Effect of curtailment and other - 63
Effect of acquired businesses 40,475 516
Foreign currency translation adjustments 14,992 5,950
Plan amendments - 144
- ----------------------------------------------------------------------------------
Benefit obligation, end of year $ 562,568 $ 417,070
==================================================================================
Change in plan assets:
Fair value of plan assets, beginning of year $ 403,388 $ 443,217
Actual return on plan assets 5,591 (25,245)
Company contributions 5,021 1,947
Participant contributions 729 642
Benefits paid (19,288) (19,489)
Other (435) 21
Effect of acquired businesses 6,625 -
Foreign currency translation adjustments 3,799 2,295
- ----------------------------------------------------------------------------------
Fair value of plan assets, end of year $ 405,430 $ 403,388
==================================================================================
Funded status of plans $(157,138) $ (13,682)
Unrecognized transition obligation 2,483 963
Unrecognized prior service cost 5,283 6,009
Unrecognized actuarial losses 134,058 27,190
==================================================================================
Net accrued (liability) benefit $ (15,314) $ 20,480
==================================================================================
Amounts recognized in the balance sheet consist of:
Prepaid benefit $ 1,589 $ 48,666
Intangible assets 8,382 4,926
Accumulated other comprehensive income 86,405 7,195
Accrued benefit obligation (111,690) (40,307)
- ----------------------------------------------------------------------------------
Net accrued (liability) benefit $ (15,314) $ 20,480
==================================================================================
53
Prepaid pension benefits are included in other long-term assets. Accrued pension
benefit obligations are included in other long-term liabilities. U.S. defined
benefit pension plan assets consist principally of common stocks, corporate
bonds and U.S. government securities. International defined benefit pension plan
assets consist principally of common stocks, corporate bonds and government
securities.
To the best of our knowledge and belief, the asset portfolios of our defined
benefit plans do not contain our capital stock. We do not issue insurance
contracts to cover future annual benefits of defined benefit plan participants.
Transactions between us and our defined benefit plans include the reimbursement
of plan expenditures incurred by us on behalf of the plans. To the best of our
knowledge and belief, the reimbursement of cost is permissible under current
ERISA or local government law.
Included in the above information are pension plans with accumulated benefit
obligations exceeding the fair value of plan assets as follows:
(in thousands) 2003 2002
- ----------------------------------------------------------
Projected benefit obligation $551,382 $ 74,753
Accumulated benefit obligation 504,590 68,758
Fair value of plan assets 393,739 28,709
- ----------------------------------------------------------
The components of net pension (benefit) cost include the following:
(in thousands) 2003 2002 2001
- ------------------------------------------------------------------------
Service cost $ 13,098 $ 11,195 $ 11,317
Interest cost 30,103 27,328 26,368
Expected return on plan assets (43,166) (45,367) (43,526)
Amortization of transition obligation (1,355) (1,998) (2,052)
Amortization of prior service cost 772 757 428
Recognition of actuarial gains (495) (2,317) (2,836)
- ------------------------------------------------------------------------
Net benefit $ (1,043) $(10,402) $(10,301)
========================================================================
The significant actuarial assumptions used to determine the present value of net
pension obligations were as follows:
(in thousands) 2003 2002 2001
- -------------------------------------------------------------------------------------
Discount rate:
U.S. plans 6.0% 7.3% 7.5%
International plans 5.0-6.3% 6.0-6.8% 5.5-6.8%
Rates of future salary increases:
U.S. plans 4.5% 4.5% 4.5%
International plans 3.0-4.0% 3.3-4.0% 3.0-4.3%
Rates of return on plan assets:
U.S. plans 8.5% 9.5% 10.0%
International plans 6.5-7.3% 6.5-7.3% 6.5-8.0%
- -------------------------------------------------------------------------------------
54
The funded status of our other postretirement benefit plan and amounts
recognized in the consolidated balance sheets were as follows:
(in thousands) 2003 2002
- ----------------------------------------------------------------------------
Change in benefit obligation:
Benefit obligation, beginning of year $ 42,120 $ 41,122
Service cost 1,259 1,291
Interest cost 2,930 2,950
Actuarial losses 2,359 165
Benefits paid (3,403) (3,408)
- ----------------------------------------------------------------------------
Benefit obligation, end of year $ 45,265 $ 42,120
- ----------------------------------------------------------------------------
Funded status of plans $(45,265) $(42,120)
Unrecognized prior service cost 672 1,078
Unrecognized actuarial gains (2,053) (4,279)
- ----------------------------------------------------------------------------
Net accrued obligation $(46,646) $(45,321)
============================================================================
The components of other postretirement cost include the following:
(in thousands) 2003 2002 2001
- ----------------------------------------------------------------------------
Service cost $ 1,259 $ 1,291 $ 1,130
Interest cost 2,930 2,950 2,744
Amortization of prior service cost 406 406 406
Recognition of actuarial gains (108) (247) (753)
- ----------------------------------------------------------------------------
Net cost $ 4,487 $ 4,400 $ 3,527
============================================================================
The discount rate used to determine the present value of the other
postretirement benefit obligation was 6.0%, 7.3% and 7.5% in 2003, 2002 and
2001, respectively. The annual assumed rate of increase in the per capita cost
of covered benefits (the health care cost trend rate) for health care plans was
9% in 2003 and was assumed to decrease gradually to 5.0% in 2007 and remain at
that level thereafter. Assumed health care cost trend rates have a significant
effect on the cost components and obligation for the health care plans. A change
of one percentage point in the assumed health care cost trend rates would have
the following effects on the total service and interest cost components of other
postretirement cost and the other postretirement benefit obligation at June 30,
2003:
(in thousands) 1% Increase 1% Decrease
- -----------------------------------------------------------------------------------------------------
Effect on total of service and interest cost components $ 200 $ (170)
Effect on other postretirement benefit obligation 2,140 (1,850)
- -----------------------------------------------------------------------------------------------------
We also sponsor several defined contribution pension plans. Pension costs for
defined contribution plans were $12.4 million, $9.1 million and $12.1 million in
2003, 2002 and 2001, respectively. Effective October 1, 1999, company
contributions to U.S. defined contribution pension plans are made primarily in
our capital stock, resulting in the issuance of 146,350, 155,097 and 331,960
shares during 2003, 2002 and 2001, respectively, with a market value of $4.4
million, $5.8 million and $9.2 million, respectively. We temporarily suspended
all company contributions to certain defined contribution plans from January 1,
2002 through January 1, 2003.
We provide for postemployment benefits pursuant to SFAS No. 112, "Employers'
Accounting for Postemployment Benefits." We accrue the cost of separation and
other benefits provided to former or inactive employees after employment but
before retirement. Postemployment benefit costs were not significant in 2003,
2002 and 2001.
55
NOTE 11 - ACCUMULATED OTHER COMPREHENSIVE LOSS
The components of accumulated other comprehensive income (loss) consist of the
following:
Twelve Months Ended June 30 (in thousands), 2003 2002
- ------------------------------------------------------------------------------------------------------
Income before cumulative effect of change in accounting principle $ 18,130 $ 38,498
Cumulative effect of change in accounting principle, net of tax - (250,406)
Unrealized (loss) gain on derivatives designated and
qualified as cash flow hedges, net of tax (4,879) (1,372)
Reclassification of unrealized gain (loss) on matured derivatives, net of tax 5,157 (1,902)
Unrealized gain (loss) on marketable equity securities available-for-sale,
net of tax 321 (1,774)
Minimum pension liability adjustment, net of tax (54,696) 945
Foreign currency translation adjustments 51,163 23,104
- ------------------------------------------------------------------------------------------------------
Comprehensive income (loss) $ 15,196 $(194,797)
======================================================================================================
As of June 30, 2003 (in thousands) Pre-tax Tax After-tax
- -----------------------------------------------------------------------------------------------------
Unrealized loss on marketable equity securities
available-for-sale $ (273) $ 104 $ (169)
Unrealized loss on derivatives designated and qualified
as cash flow hedges (8,900) 3,382 (5,518)
Minimum pension liability adjustment (86,405) 27,244 (59,161)
Foreign currency translation adjustments (25,819) 32,954 7,135
- -----------------------------------------------------------------------------------------------------
Total accumulated other comprehensive (loss) $(121,397) $ 63,684 $ (57,713)
=====================================================================================================
As of June 30, 2002 (in thousands) Pre-tax Tax After-tax
- -----------------------------------------------------------------------------------------------------
Unrealized loss on marketable equity securities available-for-sale $ (791) $ 301 $ (490)
Unrealized loss on derivatives designated and qualified
as cash flow hedges (9,339) 3,543 (5,796)
Minimum pension liability adjustment (7,195) 2,730 (4,465)
Foreign currency translation adjustments (47,520) 3,492 (44,028)
- -----------------------------------------------------------------------------------------------------
Total accumulated other comprehensive (loss) $(64,845) $ 10,066 $(54,779)
====================================================================================================
NOTE 12 - RESTRUCTURING AND ASSET IMPAIRMENT CHARGES
In accordance with SFAS No. 144, in June 2003, we completed an assessment of the
carrying value of certain long-lived assets in the Electronics business. As a
result of this assessment, we recorded a pre-tax charge of $16.1 million ($15.3
million after-tax) as a component of restructuring and asset impairment charges.
The charge is a result of price declines caused by persistent global
over-capacity and low-cost Asia competition. The fixed asset impairment charge
reduced the book value of the Electronics business' assets to $2.6 million.
2003 Facility Consolidation Program In June 2003, we approved a facility
consolidation program. This program is expected to have restructuring charges of
approximately $2.5 million. The plan includes the closure of two regional
operating centers and the Framingham manufacturing facility and a workforce
reduction. In conjunction with the program we recorded an asset write-down
related to fixed assets that will be disposed of as a result of the
restructuring program. All actions pertain to the MSSG segment. All costs
associated with the restructuring program are expected to be incurred and paid
by December 31, 2003, except certain lease costs which may extend to 2004.
Accrual at Asset Cash Accrual at
(in thousands) June 30, 2002 Expense Write-down Expenditures June 30, 2003
- --------------------------------------------------------------------------------------------------------------
Employee severance $ - $ 1,188 $ - $ - $ 1,188
Facility rationalization - 460 (316) - 144
- --------------------------------------------------------------------------------------------------------------
Total $ - $ 1,648 $(316) $ - $ 1,332
==============================================================================================================
56
2003 Workforce Restructuring Program In October 2002, we announced a global
salaried workforce reduction of approximately five percent. The reduction as
announced was expected to cost between $9 million and $10 million. The expected
cost was revised to $8.0 million as the plan was subsequently completed as of
June 30, 2003. The program resulted in $2.8 million of charges for the MSSG
segment, $2.6 million for AMSG, $1.3 million for J&L, $0.1 million for FSS and
$1.2 million for Corporate. The components of the restructuring accrual at June
30, 2003 for this program are as follows:
Accrual at Expense Cash Accrual at
(in thousands) June 30, 2002 Expense Adjustment Expenditures June 30, 2003
- -------------------------------------------------------------------------------------------------------------
Employee severance $ - $ 8,345 $ (434) $ (6,076) $ 1,835
- -------------------------------------------------------------------------------------------------------------
Total $ - $ 8,345 $ (434) $ (6,076) $ 1,835
=============================================================================================================
The restructuring accrual at June 30, 2003 represents expected future cash
payments for these obligations over the next six months. The expense adjustments
represent revision in original cost estimates related to this plan.
Widia Integration In addition to the 2003 Workforce Restructuring Program, we
have implemented two Widia acquisition-related integration programs (Kennametal
Integration Restructuring Program and the Widia Integration Plan) which together
are expected to result in a global headcount reduction of between 650 and 700
positions. We have substantially completed the integration plan and, as of June
30, we have closed six sales offices, two manufacturing facilities and closed or
consolidated four warehouses. As of June 30, 2003, we have terminated
approximately 545 employees in Europe and India and expect the remaining
workforce reduction to be within our original estimates. We expect the
completion of all integration activities in the second quarter of 2004.
Kennametal Integration Restructuring Program This program includes employee
severance costs associated with existing Kennametal facilities.
The components of the restructuring accrual at June 30, 2003 for this program
are as follows:
Accrual at Cash Accrual at
(in thousands) June 30, 2002 Expense Expenditures June 30, 2003
- -------------------------------------------------------------------------------------------------------------
Employee severance $ - $ 6,956 $ (3,316) $ 3,640
- -------------------------------------------------------------------------------------------------------------
Total $ - $ 6,956 $ (3,316) $ 3,640
=============================================================================================================
Widia Integration Plan In connection with the acquisition, we have established a
Widia integration plan to develop centers of excellence in functional areas and
enable long-term growth and competitive advantages. Costs that are incurred
under this plan will be accounted for under EITF 95-3, "Recognition of
Liabilities in Connection with a Purchase Business Combination." As a result,
these costs have been recorded as part of the Widia purchase price allocation.
Accrual at Adjustment Cash Accrual at
(in thousands) June 30, 2002 to Goodwill Expenditures June 30, 2003
- ---------------------------------------------------------------------------------------------------------------
Facility rationalizations $ - $ 4,678 $ (3,321) $ 1,357
Employee severance - 19,783 (4,849) 14,934
Terminated contracts - 1,401 (938) 463
- ---------------------------------------------------------------------------------------------------------------
Total $ - $ 25,862 $ (9,108) $ 16,754
===============================================================================================================
Widia Restructuring In connection with our acquisition of Widia, we assumed $2.4
million of restructuring accruals related to restructuring programs initiated by
Widia prior to the acquisition date. These programs, initiated in December 2001,
relate to the severance of 156 European employees in both production and
administration. The accrual balance at June 30, 2003 of $0.2 million represents
a decrease of $2.2 million related to cash payments made during the period since
acquisition.
57
2002 AMSG and MSSG Restructuring In November 2001, we announced a restructuring
program whereby we recognized special charges of $18 million. This was done in
response to continued steep declines in the end market demand in the Electronics
and Industrial Products Group businesses. All initiatives under this program
have been implemented and completed.
These costs are related to the closing and consolidation of the AMSG electronics
facility in Chicago, IL., and MSSG Industrial Products Group's Pine Bluff, Ark.
and Monticello, Ind. locations, the production of a particular line of products
in Rogers, Ark. and several customer service centers. As a result, we recorded
restructuring charges of $14.8 million during 2002 related to exit costs
associated with these actions, including severance for substantially all 337
employees at the closed facilities. We also recorded a charge of $2.5 million
related to severance for 84 individuals, primarily in the MSSG segment. The
components of the charges and the accrual at June 30, 2002 for this program are
as follows:
Accrual at Expense Cash Accrual at
(in thousands) June 30, 2002 Expense Adjustment Expenditures June 30, 2003
- ----------------------------------------------------------------------------------------------------------------------
Facility rationalizations $ 2,977 $ 15 $ (511) $ (2,180) $ 301
Employee severance 1,220 110 (2) (1,229) 99
- ----------------------------------------------------------------------------------------------------------------------
Total $ 4,197 $ 125 $ (513) $ (3,409) $ 400
======================================================================================================================
The restructuring accrual at June 30, 2002 represents future cash payments for
these obligations, of which the majority are expected to occur over the next six
months. The expense adjustments represent revisions in original cost estimates
related to this plan.
2002 and 2001 J&L and FSS Business Improvement Programs In the J&L segment for
2001, we recorded a restructuring and asset impairment charge of $2.5 million
for severance of 115 individuals, $1.8 million associated with the closure of 11
underperforming satellite locations, including certain German operations, and
$0.7 million for the exiting of three warehouses. This includes a $0.4 million
non-cash write-down of the book value of certain property, plant and equipment,
net of salvage value, that we determined would no longer be utilized in ongoing
operations. In the FSS segment for 2001, we recorded restructuring charges of
$0.6 million for severance related to eight individuals.
In 2002, we continued our J&L and FSS business improvement programs initiated in
2001. In the J&L segment during 2002, we recorded restructuring and asset
impairment charges of $5.3 million related to the write-down of a portion of the
value of a business system, $2.5 million for severance for 81 individuals and
$1.7 million related to the closure of 10 satellites and two call centers. In
the FSS segment for 2002, we recorded restructuring charges of $0.7 million for
severance related to 34 individuals. Total special charges related to this plan
were $19 million which are consistent with our original estimates of $15 to $20
million. During the third quarter of 2003, we completed the 2001 J&L and FSS
Business Improvement Programs and have incurred cash payments of $1.2 million,
$3.2 million and $4.4 million related to this program in 2003, 2002 and 2001,
respectively.
2001 Core-Business Resize Program In 2001, we took actions to reduce our
salaried workforce in response to the weakened U.S. manufacturing sector. As a
result of implementing this core-business resize program, we recorded a
restructuring charge in 2001 of $4.6 million related to severance for 209
individuals. All employee benefit initiatives under these programs have been
implemented and the program has been completed. Cash expenditures were $0.3
million, $1.9 million and $2.2 million in 2003, 2002 and 2001, respectively.
NOTE 13 - FINANCIAL INSTRUMENTS
The methods used to estimate the fair value of our financial instruments are as
follows:
Cash and Equivalents, Current Maturities of Long-Term Debt and Notes Payable to
Banks The carrying amounts approximate their fair value because of the short
maturity of the instruments.
Marketable Equity Securities The fair value is estimated based on the quoted
market price of this security, as adjusted for the currency exchange rate at
June 30.
58
Long-Term Debt Fixed rate debt has a fair market value of $334 million and $298
million in 2003 and 2002, respectively. Fair value was determined using
discounted cash flow analysis and our incremental borrowing rates for similar
types of arrangements.
Foreign Exchange Contracts The notional amount of outstanding foreign exchange
contracts, translated at current exchange rates, was $136.5 million and $197.7
million at June 30, 2003 and 2002, respectively. We would have received $2.5
million at June 30, 2002, and would have paid $3.1 million at June 30, 2003, to
settle these contracts, representing the fair value of these agreements. Under
SFAS No. 133, the carrying value equals the fair value for these contracts at
June 30, 2003 and 2002. Fair value was estimated based on quoted market prices
of comparable instruments.
Interest Rate Swap Agreements At June 30, 2003 and 2002, we had interest rate
swap agreements outstanding that effectively convert a notional amount of $53.6
million and $150.0 million, respectively, of debt from floating to fixed
interest rates. At June 30, 2003 and 2002, we would have paid $1.6 million and
$5.5 million, respectively, to settle these interest rate swap agreements, which
represents the fair value of these agreements.
During 2002, we entered into interest rate swap agreements which mature in 2012,
to convert $200 million of our fixed rate debt to floating rate debt. These
contracts require periodic settlement; the difference between amounts to be
received and paid under the interest rate swap agreements is recognized in
interest expense. In April 2003, we terminated these contracts and received a
cash payment of $15.5 million. This gain will be amortized as a component of
interest expense over the life of the debt using the effective interest rate
method. Upon termination of the contracts in April, we entered into a new
interest rate swap agreement with a notional amount of $200 million and a
maturity date of June 2012. As of June 30, 2003, we have recorded a gain of $8.4
million related to these contracts. We record the gain or loss of these
contracts in the balance sheet, with the offset to the carrying value of the
Senior Unsecured Notes. Any gain or loss resulting from changes in the fair
value of these contracts offset the corresponding gains or losses from changes
in the fair values of the Senior Unsecured Notes. As a result, changes in the
fair value of these contracts had no net impact on current year earnings.
Under SFAS No. 133, the carrying value equals the fair value for these contracts
at June 30, 2003 and 2002. Fair value was estimated based on the mark-to-market
value of the contracts which closely approximates the amount that we would
receive or pay to terminate the agreements at year end.
Concentrations of Credit Risk Financial instruments that potentially subject us
to concentrations of credit risk consist primarily of temporary cash investments
and trade receivables. By policy, we make temporary cash investments with high
credit quality financial institutions. With respect to trade receivables,
concentrations of credit risk are significantly reduced because we serve
numerous customers in many industries and geographic areas.
We are exposed to counterparty credit risk for nonperformance of derivatives
and, in the unlikely event of nonperformance, to market risk for changes in
interest and currency rates. We manage exposure to counterparty credit risk
through credit standards, diversification of counterparties and procedures to
monitor concentrations of credit risk. We do not anticipate nonperformance by
any of the counterparties. As of June 30, 2003 and 2002, we had no significant
concentrations of credit risk.
NOTE 14 - STOCK OPTIONS, AWARDS AND PURCHASE PLAN
Stock options generally are granted to eligible employees at fair market value
at the date of grant. Options are exercisable under specified conditions for up
to 10 years from the date of grant. During 2002, Kennametal established the
Kennametal Inc. Stock and Incentive Plan of 2002 ("the 2002 Plan") pursuant to
which eligible individuals may be granted awards. The 2002 Plan eliminated
grants or awards under any prior stock option plan. Prior to the approval of the
2002 Plan, Kennametal had four plans under which options were granted: the 1992
Plan, the 1996 Plan and two 1999 Plans.
Under provisions of the 2002 Plan, participants may deliver our stock, owned by
the holder for at least six months, in payment of the option price and receive
credit for the fair market value of the shares on the date of delivery. The fair
value of shares delivered in each of 2002 and 2001 was $0.2 million. Shares
delivered in 2003 were not significant.
59
Stock option activity for 2003, 2002 and 2001 is set forth below:
2003 2002 2001
-------------------------- -------------------------- --------------------------
Weighted Weighted Weighted
Average Average Average
Number of Options Options Exercise Price Options Exercise Price Options Exercise Price
- --------------------------------------------------------------------------------------------------------------------
Options outstanding,
beginning of year 3,307,854 $ 32.08 2,913,436 $ 32.08 2,856,298 $ 33.05
Granted 1,029,975 30.57 964,025 38.67 726,850 25.51
Exercised (63,672) 26.49 (382,542) 28.54 (263,719) 22.48
Lapsed and forfeited (248,740) 35.98 (187,065) 45.24 (405,993) 34.40
- --------------------------------------------------------------------------------------------------------------------
Options outstanding,
end of year 4,025,417 $ 32.91 3,307,854 $ 33.75 2,913,436 $ 32.08
- --------------------------------------------------------------------------------------------------------------------
Options exercisable,
end of year 2,276,984 $ 33.20 1,882,539 $ 33.37 1,959,311 $ 34.99
- --------------------------------------------------------------------------------------------------------------------
Weighted average fair
value of options granted
during the year $ 8.77 $ 12.24 $ 7.95
====================================================================================================================
Stock options outstanding at June 30, 2003:
Options Outstanding Options Exercisable
----------------------------------------- --------------------------
Weighted
Remaining Weighted Weighted
Contractual Average Average
Range of Exercise Prices Options Life (years) Exercise Price Options Exercise Price
- --------------------------------------------------------------------------------------------------------------
$ 20.63- $ 24.47 717,540 6.53 $23.74 553,064 $23.56
24.75- 28.13 490,727 6.35 26.28 459,814 26.31
28.16- 29.64 133,000 9.29 29.50 20,501 29.16
29.81 700,275 9.06 29.81 0 0
29.82- 36.15 490,614 6.43 32.58 302,033 31.64
36.28- 38.30 296,200 3.34 37.16 273,405 37.17
38.44 590,352 8.08 38.44 202,180 38.44
38.51- 48.56 479,709 6.22 44.94 338,987 46.75
49.25- 53.97 127,000 4.51 51.44 127,000 51.44
- --------------------------------------------------------------------------------------------------------------
4,025,417 6.92 $32.91 2,276,984 $33.20
==============================================================================================================
In addition to stock option grants, the 2002 Plan permits the award of
restricted stock to directors, officers and key employees. During 2003, 2002 and
2001, we granted restricted stock awards of 286,075, 124,298 and 75,790 shares,
respectively, which vest over periods of one to six years from the grant date.
For some grants, vesting may accelerate due to achieving certain performance
goals. Restricted stock awards are considered unearned compensation until
vesting occurs due to the passage of time or achievement of certain performance
goals. As of June 30, 2003, 2002 and 2001, unearned compensation related to
restricted stock was $9.1 million, $4.7 million and $1.9 million, respectively.
Unearned compensation is amortized to expense over the vesting period.
Compensation expense related to these awards was $4.9 million, $2.0 million and
$2.6 million in 2003, 2002 and 2001, respectively.
On October 24, 2000, our shareowners approved the Employee Stock Purchase Plan
(ESPP), which provides for the purchase by employees of up to 1.5 million shares
of capital stock through payroll deductions. Employees who choose to participate
in the ESPP receive an option to purchase capital stock at a discount equal to
the lower of 85 percent of the fair market value of the capital stock on the
first or last day of a purchase period. The ESPP was launched on February 1,
2001 and employees purchased 31,580 and 24,944 shares under the ESPP during 2003
and 2002, respectively.
60
NOTE 15 - ENVIRONMENTAL MATTERS
We are involved in various environmental cleanup and remediation activities at
several of our manufacturing facilities. In addition, we are currently named as
a potentially responsible party (PRP) at the Li Tungsten Superfund site in Glen
Cove, New York. In December 1999, we recorded a remediation reserve of $3.0
million with respect to our involvement in these matters, which is recorded as a
component of operating expense. This represents our best estimate of the
undiscounted future obligation based on our evaluations and discussions with
outside counsel and independent consultants, and the current facts and
circumstances related to these matters. We recorded this liability because
certain events occurred, including the identification of other PRPs, an
assessment of potential remediation solutions and direction from the government
for the remedial action plan, that clarified our level of involvement in these
matters and our relationship to other PRPs. This led us to conclude that it was
probable that a liability had been incurred. At June 30, 2003, we have an
accrual of $2.8 million recorded relative to this environmental issue.
In addition to the amount currently reserved, we may be subject to loss
contingencies related to these matters estimated to be up to an additional $3.0
million. We believe that such undiscounted unreserved losses are reasonably
possible but are not currently considered to be probable of occurrence. The
reserved and unreserved liabilities for all environmental concerns could change
substantially in the near term due to factors such as the nature and extent of
contamination, changes in remedial requirements, technological changes,
discovery of new information, the financial strength of other PRPs, the
identification of new PRPs and the involvement of and direction taken by the
government on these matters.
Additionally, we also maintain reserves for other potential environmental issues
associated with our domestic operations and a location operated by our German
subsidiary. At June 30, 2003, the total of these accruals was $1.3 million and
represents anticipated costs associated with the remediation of these issues.
Cash payments of $0.1 million have been made against this reserve during the
year.
As a result of the Widia acquisition, we have established an environmental
reserve of $6.2 million. This reserve will be used for environmental clean-up
and remediation activities at several Widia manufacturing locations. This
liability represents our best estimate of the future obligation based on our
evaluations and discussions with independent consultants and the current facts
and circumstances related to these matters. This liability has been recorded as
part of the Widia acquisition and has not been reflected in our operating
results.
We maintain a Corporate Environmental, Health and Safety (EH&S) Department, as
well as an EH&S Policy Committee, to ensure compliance with environmental
regulations and to monitor and oversee remediation activities. In addition, we
have established an EH&S administrator at each of our global manufacturing
facilities. Our financial management team periodically meets with members of the
Corporate EH&S Department and the Corporate Legal Department to review and
evaluate the status of environmental projects and contingencies. On a quarterly
basis, we establish or adjust financial provisions and reserves for
environmental contingencies in accordance with SFAS No. 5, "Accounting for
Contingencies."
NOTE 16 - COMMITMENTS AND CONTINGENCIES
Legal Matters Various lawsuits arising during the normal course of business are
pending against us. In our opinion, the ultimate liability, if any, resulting
from these matters will have no significant effect on our consolidated financial
positions or results of operations.
Lease Commitments We lease a wide variety of facilities and equipment under
operating leases, primarily for warehouses, production and office facilities and
equipment. Lease expense under these rentals amounted to $26.7 million, $23.5
million and $24.2 million in 2003, 2002 and 2001, respectively. Future minimum
lease payments for non-cancelable operating leases are $18.3 million, $14.9
million, $10.4 million, $8.9 million and $7.1 million for the years 2004 through
2008 and $24.3 million thereafter.
Purchase Commitments We have purchase commitments for materials, supplies, and
machinery and equipment as part of the ordinary conduct of business. A few of
these commitments extend beyond one year and are based on minimum purchase
requirements. In the aggregate, we believe these commitments are not at prices
in excess of current market.
61
Other Contractual Obligations We do not have material financial guarantees or
other contractual commitments that are reasonably likely to adversely affect our
liquidity.
Related Party Transactions We do not have any related party transactions that
affect our operations, results of operations, cash flow or financial condition.
NOTE 17 - RIGHTS PLAN
On July 24, 2000, our Board of Directors adopted a new shareowner rights plan to
replace our previous plan, which had been in effect since 1990. The new plan
became effective upon the expiration of the previous plan on November 2, 2000
and provided for the distribution to shareowners of one stock purchase right for
each share of capital stock held as of September 5, 2000. Each right entitles a
shareowner to buy 1/100th of a share of a new series of preferred stock at a
price of $120 (subject to adjustment).
The rights are exercisable only if a person or group of persons acquires or
intends to make a tender offer for 20 percent or more of our capital stock. If
any person acquires 20 percent of the capital stock, each right will entitle the
other shareowners to receive that number of shares of capital stock having a
market value of two times the exercise price. If we are acquired in a merger or
other business combination, each right will entitle the shareowners to purchase
at the exercise price that number of shares of the acquiring company having a
market value of two times the exercise price. The rights will expire on November
2, 2010 and are subject to redemption at $0.01 per right.
NOTE 18 - SEGMENT DATA
We operate four global business units consisting of Metalworking Solutions &
Services Group (MSSG), Advanced Materials Solutions Group (AMSG), J&L Industrial
Supply (J&L) and Full Service Supply (FSS), and corporate functional shared
services. The presentation of segment information reflects the manner in which
we organize segments for making operating decisions and assessing performance.
Intersegment sales are accounted for at arm's-length prices, reflecting
prevailing market conditions within the various geographic areas. Such sales and
associated costs are eliminated in our consolidated financial statements.
Sales to a single customer did not aggregate 10 percent or more of total sales
in 2003, 2002 or 2001. Export sales from U.S. operations to unaffiliated
customers were $64.6 million, $65.1 million and $78.7 million in 2003, 2002 and
2001, respectively.
METALWORKING SOLUTIONS & SERVICES GROUP In the MSSG segment, we provide
consumable metalcutting tools and tooling systems to manufacturing companies in
a wide range of industries throughout the world. Metalcutting operations include
turning, boring, threading, grooving, milling and drilling. Our tooling systems
consist of a steel toolholder and a cutting tool such as an indexable insert or
drill made from cemented tungsten carbides, high-speed steel and other hard
materials. We also provide solutions to our customers' metalcutting needs
through engineering services aimed at improving their competitiveness.
ADVANCED MATERIALS SOLUTIONS GROUP In the AMSG segment, the principal business
is the production and sale of cemented tungsten carbide products used in mining,
highway construction, engineered applications, including circuit board drills,
compacts and other similar applications. These products have technical
commonality to our core metalworking products. We also sell metallurgical
powders to manufacturers of cemented tungsten carbide products.
J&L INDUSTRIAL SUPPLY In this segment, we provide metalworking consumables and
related products to small- and medium-sized manufacturers in the United States
and the United Kingdom. J&L markets products and services through annual
mail-order catalogs and monthly sale flyers, telemarketing, the Internet and
field sales.
FULL SERVICE SUPPLY In the FSS segment, we provide metalworking consumables and
related products to large- and medium-sized manufacturers in the United States
and Canada. FSS offers integrated supply programs that provide inventory
management systems, just-in-time availability and programs that focus on total
cost savings.
62
Segment data is summarized as follows:
(in thousands) 2003 2002 2001
- --------------------------------------------------------------------------------------------
External sales:
MSSG $ 1,123,175 $ 897,157 $ 999,813
AMSG 319,223 307,668 352,933
J&L 196,170 226,010 296,264
FSS 120,389 152,907 158,886
- --------------------------------------------------------------------------------------------
Total external sales $ 1,758,957 $ 1,583,742 $ 1,807,896
============================================================================================
Intersegment sales:
MSSG $ 107,486 $ 116,467 $ 111,780
AMSG 29,137 24,167 28,167
J&L 1,989 2,083 3,823
FSS 3,134 2,747 5,278
- --------------------------------------------------------------------------------------------
Total intersegment sales $ 141,746 $ 145,464 $ 149,048
============================================================================================
Total sales:
MSSG $ 1,230,661 $ 1,013,624 $ 1,111,593
AMSG 348,360 331,835 381,100
J&L 198,159 228,093 300,087
FSS 123,523 155,654 164,164
- --------------------------------------------------------------------------------------------
Total sales $ 1,900,703 $ 1,729,206 $ 1,956,944
============================================================================================
Operating income (loss):
MSSG $ 90,627 $ 97,323 $ 130,558
AMSG 17,348 26,781 43,270
J&L 6,140 (681) 3,689
FSS (56) 2,014 7,541
Corporate (46,134) (34,120) (28,658)
- --------------------------------------------------------------------------------------------
Total operating income 67,925 91,317 156,400
Interest expense 36,166 32,627 50,381
Other (income) expense, net (2,531) (361) 11,690
- --------------------------------------------------------------------------------------------
Income before income taxes and minority interest $ 34,290 $ 59,051 $ 94,329
============================================================================================
Depreciation and amortization:
MSSG $ 57,674 $ 51,897 $ 62,374
AMSG 12,325 12,065 21,024
J&L 2,654 2,398 8,400
FSS 1,658 1,852 804
Corporate 9,732 5,417 4,695
- --------------------------------------------------------------------------------------------
Total depreciation and amortization $ 84,043 $ 73,629 $ 97,297
============================================================================================
Equity income (loss):
MSSG $ 849 $ 629 $ 470
AMSG (447) (16) (15)
- --------------------------------------------------------------------------------------------
Total equity income $ 402 $ 613 $ 455
============================================================================================
Total assets:
MSSG $ 1,061,505 $ 738,654 $ 937,863
AMSG 365,215 361,122 429,981
J&L 174,148 178,728 224,939
FSS 41,330 56,078 63,056
Corporate 136,894 189,029 169,603
- --------------------------------------------------------------------------------------------
Total assets $ 1,779,092 $ 1,523,611 $ 1,825,442
============================================================================================
63
Segment data (continued):
(in thousands) 2003 2002 2001
- -------------------------------------------------------------------------------------------------
Capital expenditures:
MSSG $ 33,992 $ 26,257 $ 32,913
AMSG 5,921 8,168 7,947
J&L 2,281 2,537 2,679
FSS 281 437 439
Corporate 6,938 6,641 15,951
- -------------------------------------------------------------------------------------------------
Total capital expenditures $ 49,413 $ 44,040 $ 59,929
=================================================================================================
Investments in affiliated companies:
MSSG $ 13,911 $ 8,354 $ 3,688
AMSG 2,877 3,327 187
- -------------------------------------------------------------------------------------------------
Total investments in affiliated companies $ 16,788 $ 11,681 $ 3,875
=================================================================================================
Geographic information for sales, based on country of origin, and assets is
follows:
(in thousands) 2003 2002 2001
- -------------------------------------------------------------------------------------------------
External sales:
United States $ 1,011,222 $ 1,085,297 $ 1,267,506
Germany 281,378 171,199 192,283
United Kingdom 92,635 79,906 86,670
Canada 55,516 51,814 61,335
Other 318,206 195,526 200,102
- -------------------------------------------------------------------------------------------------
Total external sales $ 1,758,957 $ 1,583,742 $ 1,807,896
=================================================================================================
Total assets:
United States $ 946,151 $ 1,087,716 $ 1,368,055
Germany 441,289 162,900 166,259
United Kingdom 77,803 91,548 93,432
Canada 23,740 20,776 33,982
Other 290,109 160,671 163,714
- -------------------------------------------------------------------------------------------------
Total assets $ 1,779,092 $ 1,523,611 $ 1,825,442
=================================================================================================
64
REPORT OF INDEPENDENT AUDITORS
TO THE SHAREOWNERS OF KENNAMETAL INC. In our opinion, the accompanying
consolidated balance sheet and the related consolidated statements of income,
shareowners' equity and cash flows present fairly, in all material respects, the
financial position of Kennametal Inc. and its subsidiaries at June 30, 2003 and
2002, and the results of their operations and their cash flows for the years
ended June 30, 2003 and 2002 in conformity with accounting principles generally
accepted in the United States of America. These financial statements are the
responsibility of Kennametal Inc.'s management; our responsibility is to express
an opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with auditing standards generally
accepted in the United States of America, which require that we plan and perform
the audits to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audit provides a reasonable basis for our opinion. The
financial statements of Kennametal Inc. as of June 30, 2001 were audited by
other independent accountants who have ceased operations. Those independent
accountants expressed an unqualified opinion on those financial statements,
before the revision described in Note 2, in their report dated July 20, 2001.
As discussed in Note 2 to the financial statements, Kennametal Inc. changed its
method of accounting for goodwill and other intangible assets in conformity with
Statement of Financial Accounting Standard No. 142, "Goodwill and Other
Intangible Assets" which was adopted July 1, 2001.
As discussed above, the financial statements of Kennametal Inc. as of June 30,
2001 and the year then ended were audited by other independent accountants who
have ceased operations. As described in Note 2, these financial statements have
been revised to include the transitional disclosures required by Statement of
Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets,"
which was adopted by Kennametal Inc. as of July 1, 2001. We audited the
transitional disclosures described in Note 2. In our opinion, the transitional
disclosures for 2001 in Note 2 are appropriate. However, we were not engaged to
audit, review or apply any procedures to the 2001 financial statements of
Kennametal Inc. other than with respect to such disclosures and, accordingly, we
do not express an opinion or any other form of assurance on the 2001 financial
statements taken as a whole.
(PRICEWATERHOUSECOOPERS LLP)
PricewaterhouseCoopers LLP
Pittsburgh, Pennsylvania
August 1, 2003
65
The following report is a copy of a previously issued report by Arthur Andersen
LLP and it has not been reissued by Arthur Andersen LLP. Arthur Andersen LLP has
not consented to its inclusion; therefore, an investor's ability to recover any
potential damage may be limited.
TO THE SHAREOWNERS OF KENNAMETAL INC. We have audited the accompanying
consolidated balance sheets of Kennametal Inc. (a Pennsylvania corporation) and
subsidiaries as of June 30, 2001 and 2000*, and the related consolidated
statements of income, shareowners' equity and cash flows for each of the three*
years in the period ended June 30, 2001. These financial statements are the
responsibility of the company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Kennametal Inc. and
subsidiaries as of June 30, 2001 and 2000*, and the results of their operations
and their cash flows for each of the three* years in the period ended June 30,
2001, in conformity with accounting principles generally accepted in the United
States.
(ARTHUR ANDERSEN LLP)
Arthur Andersen LLP
Pittsburgh, Pennsylvania
July 20, 2001
* The 1999 and 2000 consolidated financial statements are not required to be
presented in the 2003 annual report on Form 10-K.
66
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Effective May 14, 2002, the Board of Directors, upon the recommendation of the
Audit Committee, approved the engagement of PricewaterhouseCoopers LLP as its
independent accountants for the fiscal year ending June 30, 2002 and dismissed
the firm of Arthur Andersen LLP.
The reports of Arthur Andersen LLP on our consolidated financial statements for
the 2000 fiscal year did not contain an adverse opinion or disclaimer of
opinion, nor were such reports qualified or modified as to uncertainty, audit
scope or accounting principle.
Through May 14, 2002 and for the 2001 audit, there were no disagreements between
us and Arthur Andersen LLP on any matter of accounting principles or practices,
financial statement disclosure or auditing scope or procedure which, if not
resolved to Arthur Andersen LLP's satisfaction, would have caused the firm to
make reference to the subject matter thereof in connection with their report on
our consolidated financial statements and there were no reportable events as
described in Item 304(a)(1)(v) of Regulation S-K.
During the years ended June 30, 2001 and through May 14, 2002, we did not
consult with PricewaterhouseCoopers LLP with respect to the application of
accounting principles to a specified transaction, either completed or proposed,
or the type of audit opinion that might be rendered on our consolidated
financial statements, or any other matters or reportable events as set forth in
Items 304(a)(2)(i) and (ii) of Regulation S-K.
ITEM 9A - CONTROLS AND PROCEDURES
As of the end of the period covered by this annual report on Form 10-K, the
Company's management evaluated, with the participation of the Company's Chief
Executive Officer and Chief Financial Officer, the effectiveness of the
Company's disclosure controls and procedures (as defined in Exchange Act Rules
13a-15(e) and 15d-15(e)). The Company's disclosure controls were designed to
provide a reasonable assurance that information required to be disclosed in
reports that we file or submit under the Securities Exchange Act of 1934 is
recorded, processed, summarized and reported within the time periods specified
in the rules and forms of the Securities and Exchange Commission. It should be
noted that the design of any system of controls is based in part upon certain
assumptions about the likelihood of future events, and there can be no assurance
that any design will succeed in achieving its stated goals under all potential
future conditions, regardless of how remote. However, the controls have been
designed to provide reasonable assurance of achieving the controls' stated
goals. Based on that evaluation, the Company's Chief Executive Officer and Chief
Financial Officer concluded that the Company's disclosure controls and
procedures are effective at the reasonable assurance level. There were no
changes in the Company's internal control over financial reporting that occurred
during the Company's most recent fiscal quarter that have materially affected or
are reasonably likely to materially affect the Company's internal control over
financial reporting.
67
Part III
ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Incorporated herein by reference is the information set forth in Part I under
the caption "Executive Officers of the Registrant" and the information under the
captions "Election of Directors" and "Compliance with Section 16(a) of the
Exchange Act" in our definitive proxy statement to be filed with the Securities
and Exchange Commission within 120 days after June 30, 2003 ("2003 Proxy
Statement").
Incorporated herein by reference is the information set forth under the caption
"Ethics and Corporate Governance--Code of Business Ethics and Conduct" in the
2003 Proxy Statement.
The Company has a separately-designated standing audit committee established in
accordance with Section 3(a)(58)(A) of the Securities Exchange Act of 1934. The
members of the Audit Committee of the Company's Board of Directors include:
Kathleen J. Hempel, Ronald M. DeFeo, A. Peter Held, Aloysius T. McLaughlin, Jr.
and Lawrence W. Stranghoener.
ITEM 11 - EXECUTIVE COMPENSATION
Incorporated herein by reference is the information set forth under the caption
"Compensation of Executive Officers" and certain information regarding
directors' fees under the caption "Board of Directors and Board Committees" in
the 2003 Proxy Statement.
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED SHAREOWNER MATTERS
Incorporated herein by reference is the information set forth under the caption
"Ownership of Capital Stock by Directors, Nominees and Executive Officers" with
respect to the directors' and officers' shareholdings, under the caption
"Principal Holders of Voting Securities" with respect to other beneficial owners
in the 2003 Proxy Statement and under the caption "Equity Compensation Plan
Information" with respect to disclosure regarding the number of outstanding
options, warrants and rights granted under equity compensation plans and the
number of shares remaining for issuance under such plans.
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated herein by reference is certain information set forth in the notes
to the tables under the captions "Election of Directors" and "Compensation of
Executive Officers" in the 2003 Proxy Statement.
ITEM 14 - PRINCIPAL ACCOUNTANT FEES AND SERVICES
Incorporated herein by reference is the information with respect to principal
accountant fees and services set forth under the caption "Independent Auditors"
in the 2003 Proxy Statement.
68
Part IV
ITEM 15 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Documents filed as part of this Form 10-K report.
1. Financial Statements
2. Financial Statement Schedule
The financial statement schedule required by Part II, Item 8 of this
document is filed as part of this report. All of the other schedules
are omitted as the required information is inapplicable or the
information is presented in our consolidated financial statements or
related notes.
Separate financial statements of Kennametal are omitted because
Kennametal is primarily an operating company, and all significant
subsidiaries included in our consolidated financial statements are
wholly owned, with the exception of Kennametal Hertel AG, in which
Kennametal has over a 99 percent ownership interest.
FINANCIAL STATEMENT SCHEDULE: Page
Reports of Independent Auditors 73
Schedule II--Valuation and Qualifying Accounts and Reserves for the
Three Years Ended June 30, 2003 74
3. Exhibits
(2) Plan of Acquisition,
Reorganization, Arrangement,
Liquidation, or Succession
(2.1) Stock Purchase Agreement dated Exhibit 2.1 of the May 6, 2002 Form
May 3, 2002 among Milacron Inc., 8-K is incorporated herein by reference.
Milacron B.V. and Kennametal Inc.
(3) Articles of Incorporation and
Bylaws
(3.1) Bylaws of Kennametal Inc. as Exhibit 3.1 of December 31, 2001
amended through January 29, Form 10-Q is incorporated herein by
2002 reference.
(3.2) Amended and Restated Articles Exhibit 3.1 of the September 30, 1994
of Incorporation as Amended Form 10-Q (SEC file no. reference 1-5318;
docket entry date--November 14, 1994)
is incorporated herein by reference.
(4) Instruments Defining the Rights of
Security Holders, Including
Indentures
(4.1) Rights Agreement effective Exhibit 1 of the Form 8-A dated October 10,
as of November 2, 2002 2000 is incorporated herein by reference.
(10) Material Contracts
(10.1)* Prime Bonus Plan The discussion regarding the Prime Bonus
Plan under the caption "Report of the
Compensation Committee of the Board of
Directors" contained in the 2003 Proxy
Statement is incorporated herein by reference.
(10.2)* Stock Option and Exhibit 10.1 of the December 31, 1988
Incentive Plan of 1988 Form 10-Q (SEC file no. reference
1-5318; docket entry date--February 9,
1989) is incorporated herein by reference.
69
Item 15 (continued)
(10.3)* Deferred Fee Plan Exhibit 10.4 of the June 30, 1988
for Outside Directors Form 10-K (SEC file no. reference 1-5318;
docket entry date--September 23, 1988) is
incorporated herein by reference.
(10.4)* Executive Deferred Exhibit 10.5 of the June 30, 1988
Compensation Trust Agreement Form 10-K (SEC file no. reference 1-5318;
docket entry date--September 23, 1988) is
incorporated herein by reference.
(10.5)* Directors Stock Incentive Filed herewith.
Plan, as amended
(10.6)* Performance Bonus Stock Exhibit 10.6 of the June 30, 1999 Form 10-K
Plan of 1995, as amended is incorporated herein by reference.
(10.7)* Stock Option and Incentive Exhibit 10.14 of the September 30, 1996 Form
Plan of 1996 10-Q is incorporated herein by reference.
(10.8)* Stock Option and Incentive Plan Exhibit 10.8 of the December 31, 1996 Form
of 1992, as amended 10-Q is incorporated herein by reference.
(10.9)* Form of Employment Agreement Exhibit 10.9 of the June 30, 2000 Form
with Named Executive Officers 10-K is incorporated herein by reference.
(other than Mr. Tambakeras)
(10.10)* Supplemental Executive Exhibit 10.10 of the June 30, 1999 Form
Retirement Plan, as amended 10-K is incorporated herein by reference.
(10.11)* Executive Employment Exhibit 10.11 of the June 30, 2002 Form
Agreement dated May 1, 2002 10-K is incorporated herein by reference.
between Kennametal Inc. and
Markos I. Tambakeras
(10.12)* Kennametal Inc. 1999 Stock Plan Exhibit 10.5 of the June 11, 1999 Form 8-K
is incorporated herein by reference.
(10.13)* Kennametal Inc. Stock Option and Exhibit A of the 1999 Proxy Statement
Incentive Plan of 1999 is incorporated herein by reference.
(10.14) Credit Agreement dated as of Exhibit 10.1 of the September 11, 2002
June 27, 2002 among Kennametal Form 8-K is incorporated herein by reference.
Inc., and the several lenders from
time to time parties thereto,
Bank of Tokyo-Mitsubishi Trust
Company; Bank One, N.A.; Fleet
National Bank; and PNC Bank, N.A.
as the Co-Syndication Agents, and
JP Morgan Chase Bank, as the
Administrative Agent
(10.15)* Executive Employment Agreement Filed herewith.
dated April 29, 2003 between
Kennametal Inc. and Carlos M. Cardoso
(10.16)* Amended and Restated Kennametal Filed herewith.
Inc. Stock and Incentive Plan of 2002
70
(10.17)* Post Employment Compensation The discussion regarding Mr. Mahanes'
Arrangement between Kennametal arrangement under the caption
Inc. and H. Patrick Mahanes Jr. "Employment Agreements and Termination
of Employment and Change in Control
Arrangements" in the 2003 Proxy Statement
is incorporated herein by reference.
(21) Subsidiaries of the Registrant Filed herewith.
(23) Consent of Independent Auditors Filed herewith.
(31) Certifications
(31.1) Certification executed by Markos I. Filed herewith.
Tambakeras, Chief Executive Officer
of Kennametal Inc.
(31.2) Certification executed by F. Nicholas Filed herewith.
Grasberger III, Chief Financial Officer
of Kennametal Inc.
(32) Section 1350 Certifications
(32.1) Certification Pursuant to 18 U.S.C. Filed herewith.
Section 1350 as Adopted Pursuant
to Section 906 of the Sarbanes-Oxley
Act of 2002, executed by Markos I.
Tambakeras, Chief Executive Officer
of Kennametal Inc., and F. Nicholas
Grasberger III, Chief Financial Officer
of Kennametal Inc.
* Denotes management contract or compensatory plan or arrangement.
(b) Reports on Form 8-K and 8-K/A.
The following was furnished and not deemed to be filed during the
quarter ended June 30, 2003:
Form 8-K dated April 30, 2003, reported under Item 9. Regulation FD
Disclosure reporting the press release announcing third quarter 2003
financial results.
The following were furnished and not deemed to be filed subsequent to
the quarter ended June 30, 2003:
Form 8-K dated July 30, 2003, reported under Item 12. Results of
Operations and Financial Condition regarding the fourth quarter and
fiscal year ended June 30, 2003 financial results.
Form 8-K/A dated July 30, 2003, reported under Item 12. Results of
Operations and Financial Condition regarding the fourth quarter and
fiscal year ended June 30, 2003 financial results.
71
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange
Act of 1934, the company has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
KENNAMETAL INC.
By: /s/ TIMOTHY A. HIBBARD
Timothy A. Hibbard
Corporate Controller and Chief Accounting Officer
Date: September 18, 2003
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
/s/ MARKOS I. TAMBAKERAS Chairman, President and September 18, 2003
Markos I. Tambakeras Chief Executive Officer
/s/ F. NICHOLAS GRASBERGER III Vice President and September 18, 2003
F. Nicholas Grasberger III Chief Financial Officer
/s/ RICHARD C. ALBERDING Director September 18, 2003
Richard C. Alberding
/s/ PETER B. BARTLETT Director September 18, 2003
Peter B. Bartlett
/s/ RONALD M. DEFEO Director September 18, 2003
Ronald M. DeFeo
/s/ A. PETER HELD Director September 18, 2003
A. Peter Held
/s/ KATHLEEN J. HEMPEL Director September 18, 2003
Kathleen J. Hempel
/s/ ALOYSIUS T. MCLAUGHLIN, JR. Director September 18, 2003
Aloysius T. McLaughlin, Jr.
/s/ WILLIAM R. NEWLIN Director September 18, 2003
William R. Newlin
/s/ LAWRENCE W. STRANGHOENER Director September 18, 2003
Lawrence W. Stranghoener
/s/ LARRY D. YOST Director September 18, 2003
Larry D. Yost
72
REPORT OF INDEPENDENT AUDITORS ON FINANCIAL STATEMENT SCHEDULE
TO THE SHAREOWNERS OF KENNAMETAL INC. Our audits of the consolidated financial
statements referred to in our report dated August 1, 2003 appearing in this
annual report on Form 10-K also included an audit of the financial statement
schedule listed in Item 15(a)(2) of this Form 10-K. In our opinion, this
financial statement schedule for the years ended June 30, 2003 and 2002 presents
fairly, in all material respects, the information set forth therein when read in
conjunction with the related consolidated financial statements. The financial
statement schedule of Kennametal Inc. for the year ended June 30, 2001 was
audited by other independent accountants who have ceased operations. Those
independent accountants expressed an unqualified opinion on that financial
statement schedule in their report dated July 20, 2001.
/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
Pittsburgh, Pennsylvania
August 1, 2003
The following report is a copy of a previously issued report by Arthur Andersen
LLP and it has not been reissued by Arthur Andersen LLP. Arthur Andersen LLP has
not consented to its inclusion; therefore an investor's abilities to recover any
potential damage may be limited.
REPORT ON PREVIOUS INDEPENDENT PUBLIC ACCOUNTANTS ON FINANCIAL STATEMENTS
SCHEDULE
TO THE SHAREOWNERS OF KENNAMETAL INC. We have audited in accordance with
auditing standards generally accepted in the United States, the consolidated
financial statements included in Kennametal Inc.'s annual report to shareowners
incorporated by reference in this Form 10-K, and have issued our report thereon
dated July 20, 2001. Our audits were made for the purpose of forming an opinion
on those statements taken as a whole. The schedule listed in the index in Item
14*(a) 2 of this Form 10-K is the responsibility of the Company's management and
is presented for purposes of complying with the Securities and Exchange
Commission's rules and is not part of the basic financial statements. The
schedule has been subjected to the auditing procedures applied in the audits of
the basic financial statements and, in our opinion, fairly states in all
material respects the financial data required to be set forth therein in
relation to the basic financial statements taken as a whole.
/s/ Arthur Andersen LLP
Arthur Andersen LLP
Pittsburgh, Pennsylvania
July 20, 2001
* The schedule is listed in the index in Item 15(a)2 of the 2003 annual report
on Form 10-K.
73
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
Additions
------------------------------------
Balance at Charged to Deductions
(in thousands) Beginning Costs and Other from Balance at
For the Three Years Ended June 30, of Year Expenses Recoveries Adjustments Reserves End of Year
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2003
Allowance for doubtful accounts $ 12,671 $ 6,204 $ 307 $ 11,652(a) $ 7,429(b) $ 23,405
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2002
Allowance for doubtful accounts $ 7,999 $ 7,137 $ 640 $ 315(a) $ 3,420(b) $ 12,671
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2001
Allowance for doubtful accounts $ 12,214 $ 2,576 $ 324 $ (918)(a) $ 6,197(b) $ 7,999
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(a) Represents foreign currency translation adjustment and reserves
acquired through business combinations.
(b) Represents uncollected accounts charged against the allowance.
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