Back to GetFilings.com

Table of Contents

FORM 10-Q

SECURITIES AND EXCHANGE COMMISSION

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 2003

Commission file number 1-5318

KENNAMETAL INC.

World Headquarters
1600 Technology Way
P.O. Box 231
Latrobe, Pennsylvania 15650-0231
(Address of registrant’s principal executive offices)

Registrant’s telephone number, including area code: (724) 539-5000

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 (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [  ]

Indicate by check mark whether the registrant is an accelerated filer (as defined by Rule 12b-2 of the Exchange Act). YES [X] NO [  ]

Indicate the number of shares outstanding of each of the issuer’s classes of capital stock, as of the latest practicable date:

Table of Contents

KENNAMETAL INC.
FORM 10-Q
FOR THE QUARTER ENDED DECEMBER 31, 2003

TABLE OF CONTENTS

Table of Contents

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

KENNAMETAL INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(in thousands, except per share data)

The accompanying notes are an integral part of these condensed consolidated financial statements.

- 1 -

Table of Contents

KENNAMETAL INC.
CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

The accompanying notes are an integral part of these condensed consolidated financial statements.

- 2 -

Table of Contents

KENNAMETAL INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(in thousands)

The accompanying notes are an integral part of these condensed consolidated financial statements.

- 3 -

Table of Contents

KENNAMETAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1.		ORGANIZATION
		Kennametal Inc. was incorporated in Pennsylvania in 1943 and maintains its world headquarters in Latrobe, Pennsylvania. Kennametal Inc. and its subsidiaries (collectively, “Kennametal” or the “Company”) is 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 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.
2.		BASIS OF PRESENTATION
		The condensed consolidated financial statements, which include our accounts and those of our majority-owned subsidiaries, should be read in conjunction with the 2003 Annual Report on Form 10-K. The condensed consolidated balance sheet as of June 30, 2003 was derived from the audited balance sheet included in our 2003 Annual Report on Form 10-K. These interim statements are unaudited; however, we believe that all adjustments necessary for a fair statement of the results of the interim periods were made and all adjustments are normal, recurring adjustments. The results for the six months ended December 31, 2003 and 2002 are not necessarily indicative of the results to be expected for a full fiscal year. Unless otherwise specified, any reference to a “year” is to a fiscal year ended June 30. For example, a reference to 2004 is to the fiscal year ended June 30, 2004. When used in this Form 10-Q, unless the context requires otherwise, the terms “we,” “our” and “us” refer to Kennametal Inc. and its subsidiaries.
		Certain amounts have been reclassified to conform to current year presentation.
3.		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 Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“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 Amended and Restated Kennametal Inc. Stock and Incentive Plan of 2002 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 the restricted stock grants 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 and 2002, consistent with the methodology in SFAS No. 123 and Statement of Financial Accounting Standard No. 148 “Accounting for Stock-Based Compensation – Transition and Disclosure (“SFAS No. 148”) , our 2003 and 2002 net income and earnings per share for the quarter and six months would be reduced to the pro forma amounts indicated below:

- 4 -

Table of Contents

KENNAMETAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

4.		ACQUISITION
		On August 30, 2002, we purchased the Widia Group (Widia) in Europe and India from Milacron Inc. for EUR188 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 2002 and $5.1 million paid in 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. As a result of the acquisition, we have recorded approximately $58.4 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, “Goodwill and Other Intangible Assets,” the goodwill will not be amortized but will instead be subject to an annual impairment test.
		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 changed our accounting policy regarding machinery and equipment and have extended our useful lives from a maximum life of 10 years to 15 years.

- 5 -

Table of Contents

KENNAMETAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

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 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. The unaudited pro forma consolidated financial data should be read in conjunction with the historical consolidated financial statements and accompanying notes.

5.		OPERATIONS HELD FOR SALE
		Kennametal approved a plan to divest the Mining and Construction business of Kennametal Widia India Limited, which is part of the AMSG segment. We expect that this business will be sold within a one-year period. In accordance with SFAS 144, we recorded the assets of this business as held for sale. Due to management’s belief that we may enter into a supply agreement in connection with this sale, we recorded, as a component of operating income, in the current quarter a charge of approximately $0.2 million related to this transaction. This charge is related to recording the assets of this business at their estimated fair market value less cost to sell.
		The major classes of assets and liabilities of operations held for sale in the consolidated balance sheets are as follows:

- 6 -

Table of Contents

KENNAMETAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

6.		SALE OF MARKETABLE EQUITY SECURITIES
		During the December 2003 quarter, we sold our investment in Toshiba Tungaloy Co., Ltd. (Toshiba) resulting in cash proceeds of $17.4 million and a pre-tax gain of $4.4 million ($3.0 million after tax). The gain is recorded in other (income), net.
7.		BENEFIT AMENDMENTS
		On November 13, 2003, Kennametal announced modifications to certain employee benefits, including a plan amendment for selected participants in the Retirement Income Plan (the RIP Plan), new employer contributions to the defined contribution plan (Thrift Plus Plan) and changes to the retiree medical portion of the Other Postemployment Benefits Plan (OPEB). The RIP Plan currently covers the majority of the Company’s U.S. workforce. Effective, January 1, 2004, no new non-union employees will become eligible to participate in the RIP Plan. Benefits under the RIP Plan will continue to accrue after December 31, 2003 only for certain employees (“Grandfathered Participants”). Benefits for all other participants were frozen effective December 31, 2003. All eligible employees hired on or after January 1, 2004 and all non-Grandfathered Participants in the RIP Plan will be eligible to participate in the Thrift Plus Plan which will provide for an employer fixed contribution equal to three percent of the employee’s compensation and will allow for an additional variable contribution from zero percent up to three percent depending on the Company’s performance. The modification of the OPEB Plan will eliminate Kennametal’s obligation to provide a Company subsidy for employee medical costs for all employees who retire after January 1, 2009. The RIP Plan amendment resulted in a curtailment under SFAS 88 “Employers’ Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits” and resulted in a pre-tax charge of $1.3 million in the quarter ended December 31, 2003. These changes will result in a $2.3 million net reduction of the current year pension expense and a $1.3 million reduction to the current year OPEB expense that would otherwise be incurred without these changes.
8.		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 for the remainder of our inventories is determined under the first-in, first-out (FIFO) or average cost methods. We used the LIFO method of valuing inventories for approximately 38 percent of total inventories at both December 31, 2003 and June 30, 2003. Because inventory valuations under the LIFO method are based on an annual determination of quantities and costs as of June 30 of each year, the interim LIFO valuations are based on our projections of expected year-end inventory levels and costs. Therefore, the interim financial results are subject to any final year-end LIFO inventory adjustments.
		Inventories as of the balance sheet dates consisted of the following (in thousands):

- 7 -

Table of Contents

KENNAMETAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

9.		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 a liability had been incurred. At December 31, 2003, we have an accrual of $2.8 million remaining relative to this environmental issue. No cash payments have been made against this reserve during the quarter.
		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 government agencies 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 December 31, 2003, the total of these accruals was $1.1 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 quarter.
		As a result of the Widia acquisition, we established a separate 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. At December 31, 2003, we have an accrual of $5.8 million remaining relative to this environmental issue. Cash payments of $0.7 million have been made against this reserve during the quarter, offset by $0.3 million of unfavorable foreign currency translation effects.
		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 Standard (SFAS) No. 5, “Accounting for Contingencies.”

- 8 -

Table of Contents

KENNAMETAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

10.		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 diluted shares outstanding, weighted average shares outstanding for basic earnings per share calculations were increased due solely to the dilutive effect of unexercised stock options and restricted stock awards by 655,931 and 287,701 for the three months ended December 31, 2003 and 2002 and 654,722 and 292,918 for the six months ended December 31, 2003 and 2002, respectively. Unexercised stock options to purchase our capital stock of 0.6 million and 1.7 million shares for the three months ended December 31, 2003 and 2002, respectively, and 0.9 million and 1.7 million for the six months ended December 31, 2003 and 2002, respectively, are not included in the computation of diluted earnings per share because the option exercise price was greater than the average market price.
11.		COMPREHENSIVE INCOME
		Comprehensive income for the three and six months ended December 31, 2003 and 2002 is as follows (in thousands):

- 9 -

Table of Contents

KENNAMETAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

12.		GOODWILL AND OTHER INTANGIBLE ASSETS
		The carrying amount of goodwill attributable to each segment at December 31, 2003 and June 30, 2003 is as follows (in thousands):

		During the quarter ended September 30, 2003, we realigned certain operations to provide for enhanced marketing benefits. As a result we have transferred a portion of the goodwill from MSSG to AMSG. The increase in goodwill is associated with final purchase price accounting adjustments related to the acquisition of Widia, the impact of translation adjustments and the purchase of minority interest shares in India.
		The June 30, 2003 balance has been reclassified for goodwill that is associated with the India Mining and Construction business and therefore is included in assets held for sale.
		The components of our other intangible assets and useful lives are as follows (in thousands):

		During the September 30, 2003 quarter, we removed $2.4 million of fully amortized intangible assets.
13.		RESTRUCTURING AND ASSET IMPAIRMENT CHARGES
		2003 Facility Consolidation Program In June 2003, we approved a facility consolidation program. This program was expected to have restructuring charges of approximately $2.5 million. During the current quarter, we completed the program at a total cost of $1.8 million. The plan includes the closure of two regional operating centers and the Framingham manufacturing facility and a workforce reduction. All actions pertain to the MSSG segment. All costs associated with the restructuring program have been incurred and remaining cash payments are expected to be completed by June 30, 2004, except certain lease costs which extend to 2005.

- 10 -

Table of Contents

KENNAMETAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

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 and the plan was completed as of September 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. All remaining cash payments are expected to be completed by June 30, 2004. The components of the restructuring accrual are as follows:

		Widia Integration In addition to the 2003 Workforce Restructuring Program, we implemented two Widia acquisition-related integration programs described below (Kennametal Integration Restructuring Program and the Widia Integration Plan) which together resulted in a global headcount reduction of approximately 760 positions, 385 in Europe and 375 in India. We completed the integration plan in Europe and India and closed six sales offices, three manufacturing facilities and closed or consolidated four warehouses. All costs associated with the integration have been incurred and remaining cash payments are expected primarily to be completed by June 30, 2004, except certain lease and severance costs which will extend into 2005.
		Kennametal Integration Restructuring Program This program included employee severance costs associated with existing Kennametal facilities.
		The components of the restructuring accrual at December 31, 2003 for this program are as follows: