Exhibit 13
MANAGEMENT'S DISCUSSION AND ANALYSIS
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, 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 $1,583.7 million in 2002 declined 11 percent, versus $1,807.9
million last year excluding unfavorable foreign exchange effects of less than
one percent due to a stronger U.S. dollar and the loss of sales through
divestitures of one percent. Sales in North America contributed to the majority
of the decline due to overall weak market conditions.
Sales of $1,807.9 million in 2001 increased two percent compared to sales of
$1,866.6 million in 2000, excluding unfavorable foreign exchange effects of
three percent due to the stronger U.S. dollar and the effects of fewer workdays
in 2001 of two percent. Sales benefited from broad-based end market growth in
Europe and sustained growth in Asia. Sales in the North American end markets
softened throughout 2001, particularly in automotive, due to the slowdown in the
U.S. manufacturing sector.
GROSS PROFIT MARGIN In 2002, our gross profit margin was 32.3 percent, down from
34.1 percent in 2001. Excluding special charges in each year, our gross profit
margin was 32.4 percent in 2002 versus 34.2 percent in 2001. The decline 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 that were discontinued as part of a
program to streamline and optimize the product offering of J&L Industrial Supply
(J&L) in 2001.
The consolidated gross profit margin for 2001 was 34.1 percent, 34.7 percent on
a constant currency basis. This includes the charge of $3.6 million associated
primarily with the write-down of certain product lines in the J&L segment.
Excluding this charge and period costs associated with facility rationalizations
for each period, the gross profit margin was flat compared with 34.3 percent in
the prior year, despite weaker sales. Gross margin benefited from productivity
improvements, continued implementation of lean manufacturing techniques and
pricing discipline. This was offset by higher material costs and energy prices.
Period costs included in gross profit in 2001 and 2000 were $0.6 million and
$2.9 million, respectively, related to the facility closures.
OPERATING EXPENSE Operating expense of $389.4 million in 2002 was $36.2 million
or nine percent lower than the operating expense level in 2001 of $425.6
million. 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. On a constant currency
basis, operating expense declined eight percent. Operating expense in 2002
includes $0.1 million of integration costs associated with the Widia acquisition
(see "Business Development").
In 2001, operating expense declined to $425.6 million from $434.1 million in
2000. However, operating expense increased one percent on a constant currency
basis. We offset inflationary pressures through restructuring benefits and other
productivity improvements. Despite the decline, we incurred incremental costs of
approximately $6.5 million on investments for strategic initiatives, including
new sales and marketing programs, productivity programs and our e-business
initiative. In 2001, operating expense includes $2.1 million of costs related to
the tender offer for the minority shares of JLK Direct Distribution Inc. (JLK).
Operating expense for 2000 includes a $3.0 million charge for environmental
remediation costs and $0.8 million for costs incurred and expensed for the
evaluation of strategic alternatives related to JLK.
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RESTRUCTURING AND ASSET IMPAIRMENT CHARGES
2002 AMSG AND MSSG RESTRUCTURING In November 2001, we announced a restructuring
program whereby we expected to recognize special charges of $15 to $20 million,
including period costs, for the closure of three manufacturing locations and the
relocation of the production of a certain product line to another plant, and
associated workforce reductions. This was done in response to continued steep
declines in the end market demand in the electronics and industrial products
groups businesses. Additionally, we implemented other worldwide workforce
reductions and facility closures in these segments in reaction to the declines
in our end markets. All initiatives under this program have been implemented and
completed and all charges have been taken.
We implemented the measures associated with the closing and consolidation of the
Advanced Materials Solutions Group (AMSG) electronics facility in Chicago, Ill.,
and Metalworking Solutions & Services Group (MSSG) industrial product 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 total charge to date of $17.3 million includes non-cash items
of $5.4 million. The components of the charges and the accrual at June 30, 2002
for this program are as follows:
(in thousands) 2002 Asset Cash Accrual at
Expense Write-Downs Expenditures June 30, 2002
- -----------------------------------------------------------------------------------------
Facility rationalizations $14,801 $(5,387) $(6,437) $ 2,977
Employee severance 2,525 -- (1,305) 1,220
- -----------------------------------------------------------------------------------------
Total $17,326 $(5,387) $(7,742) $ 4,197
- -----------------------------------------------------------------------------------------
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 12
months.
Additionally, as part of these actions, we recorded a non-cash charge of $1.0
million, net of salvage value, associated with the abandonment and scrapping of
inventory. This charge was recorded as a component of cost of goods sold. We
also incurred period costs associated with these actions of $1.5 million during
2002, which were expensed as incurred as a component of cost of goods sold.
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 of
severance of 115 individuals, $1.8 million associated with the closure of 11
underperforming satellite locations, including the 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 Full Service Supply (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
anticipation of migrating to a new business system, we capitalized costs
associated with the development of system functionality specifically designed
for the J&L business. In the December 2001 quarter, after further evaluation of
the development of the system, we determined it was no longer feasible that J&L
would use this portion of the business system because the vendor ceased
supporting the system. Therefore, we recorded the non-cash charge of $5.3
million representing the portion of costs capitalized in connection with system
enhancements specifically for the J&L business. In the FSS segment for 2002, we
recorded restructuring charges of $0.7 million for severance related to 34
individuals.
19
All initiatives under this business improvement program have been implemented
and completed and all charges have been taken. The components of the 2002 and
2001 charges and the restructuring accrual at June 30, 2002 and 2001 are as
follows:
2001 Asset Cash Accrual at
(in thousands) Expense Write-Downs Expenditures June 30, 2001
- -----------------------------------------------------------------------------------------------
J&L business improvement program:
Employee severance $ 2,475 $ -- $(2,224) $ 251
Facility closures 2,453 (987) (526) 940
FSS business improvement program 571 -- (430) 141
- -----------------------------------------------------------------------------------------------
Total $ 5,499 $ (987) $(3,180) $ 1,332
===============================================================================================
Accrual at 2002 Expense Asset Cash Accrual at
(in thousands) June 30, 2001 Expense Adjustments Write-Downs Expenditures June 30, 2002
- --------------------------------------------------------------------------------------------------------------------------------
J&L business improvement program:
Employee severance $ 251 $ 2,479 $ 6 $ -- $(2,370) $ 366
Facility closures 940 1,731 93 (572) (1,398) 794
Business system -- 5,257 -- (5,257) -- --
FSS business improvement program 141 706 (71) -- (548) 228
- --------------------------------------------------------------------------------------------------------------------------------
Total $ 1,332 $10,173 $ 28 $(5,829) $(4,316) $ 1,388
================================================================================================================================
The expense adjustments for the facility closures were due to incremental costs
incurred to exit these facilities. The other expense adjustments relate to
reductions in actual amounts paid for severance costs compared to what was
initially anticipated. We recorded expense adjustments as a component of
restructuring and asset impairment charges.
In connection with the 2001 J&L charge for exiting the warehouses and the
satellite closures, we recorded a non-cash write-down, net of salvage value, of
$0.6 million primarily related to inventory that was abandoned and not
relocated. J&L also finalized and implemented a program to optimize the overall
catalog product offering. We identified certain products that would no longer be
offered to customers and scrapped these products, resulting in a non-cash charge
of $3.0 million, net of salvage value. These charges were recorded as a
component of cost of goods sold.
As part of the J&L facility closures, in 2002 we recorded a charge of $0.6
million, net of salvage value, associated with the abandonment and scrapping of
inventory at these locations. This charge was recorded as a component of cost of
goods sold.
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 of $4.6 million related to severance for 209 individuals.
All employee benefit initiatives under this program have been implemented. Cash
expenditures were $1.9 million and $2.2 million in 2002 and 2001, respectively.
The restructuring accrual at June 30, 2002 of $0.4 million represents projected
payments, the majority of which are expected to occur over the next 12 months.
2000 RESTRUCTURING PROGRAM In 2000, we announced plans to close, consolidate or
downsize several plants, warehouses and offices, and associated workforce
reductions as part of our overall plan to increase asset utilization and
financial performance, and to reposition ourselves to become the premier tooling
solutions supplier. The components of the charges were $4.8 million for asset
impairment charges, $7.4 million for employee severance, $6.3 million for
facility rationalizations and $0.1 million for product rationalization.
The asset impairment charges of $4.8 million consisted of a charge of $1.7
million related to a metalworking manufacturing operation in Shanghai, China.
This operation became fully operational in 1998 and at the time of review, had
not generated the performance that was expected at the time we entered into this
market. We performed an in-depth review of the operations, capacity utilization
and the local management team, and engaged a consultant to perform an
independent review of the same. These reviews enabled us to determine that the
market served by this operation is not expected to develop to the extent
originally anticipated, but that the operations were in good working order,
utilized modern technology, and the management team in place was competent. We
also determined that this facility had excess capacity given the level of market
demand. In addition, we recorded an asset
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[LOGO] KENNAMETAL INC. / AR 2002
impairment charge of $2.8 million related to the write-down of equipment in our
North American metalworking operations and $0.3 million in our engineered
products operations. In connection with the repositioning of the company, we
completed an assessment of the assets currently being used in these operations
and determined that these assets were not going to be further utilized in
conducting these operations. This amount represents the write-down of the book
value of the assets, net of salvage value.
The $7.4 million in employee severance related to severance packages provided to
171 hourly and salaried employees terminated in connection with a global
workforce reduction. Included in this charge is an incremental pension
obligation of $0.8 million, incurred as a result of the severance packages
provided.
The $6.3 million charge for facility rationalizations relates to employee
severance for 153 employees and other exit costs associated with the closure or
downsizing of a metalworking manufacturing operation in Kingswinford, United
Kingdom; a circuit board drill plant in Janesville, Wisc.; a German warehouse
facility; and several offices in the Asia Pacific region and South America.
Included in this charge is an incremental pension obligation of $0.2 million due
to a plan curtailment. The charge also includes $3.4 million for employee
severance for 41 employees and other exit costs associated with the closure of a
mining and construction manufacturing operation in China and the exit of the
related joint venture.
The product rationalization charge of $0.1 million represents the write-down of
certain discontinued product lines manufactured in these operations. We
manufactured these products specifically for the market served by these
operations and we determined that these products are no longer salable. This
charge has been recorded as a component of cost of goods sold.
As of June 30, 2002, $0.3 million remains accrued for facility rationalizations
and is expected to be paid within the next 12 months. Adjustments to the
original amounts accrued were immaterial.
In 2001, we incurred period costs of $0.3 million related to these initiatives
which were included in cost of goods sold as incurred. In 2000, we incurred
period costs of $0.8 million related to these initiatives, and costs of $1.7
million associated with the implementation of lean manufacturing techniques,
both of which were included in cost of goods sold as incurred.
We continue to review our business strategies and pursue other cost-reduction
activities in all business segments, some of which could result in future
charges.
AMORTIZATION OF INTANGIBLES We adopted SFAS No. 142, "Goodwill and Other
Intangible Assets," (SFAS No. 142) on July 1, 2001. As a result of the
non-amortization provisions of SFAS No. 142, we ceased amortizing goodwill
resulting in amortization expense of $2.8 million for 2002, compared to $24.1
million and $26.5 million in 2001 and 2000, respectively. The amortization
expense incurred in 2002 relates to non-goodwill intangibles.
INTEREST EXPENSE Interest expense of $32.6 million in 2002 was $17.8 million
below the prior year due to ongoing debt reduction and lower average borrowing
rates. Overall debt levels declined to $411.4 million at June 30, 2002 from
$607.1 million a year ago. Our average domestic borrowing rate of 4.91 percent
was 202 basis points below 2001 due to Federal Reserve rate cuts and improved
pricing under our New Credit Agreement. Interest expense for 2002 included $0.3
million related to the write-down of the remaining deferred financing fees
associated with the prior Bank Credit Agreement.
Interest expense for 2001 declined $4.7 million to $50.4 million due primarily
to reduced borrowing levels. The 2001 results included $0.3 million related to
the write-down of a portion of deferred financing fees due to the reduction of
the availability under our Bank Credit Agreement. Excluding this item, interest
expense declined nine percent. Our average domestic borrowing rate of 6.93
percent was 32 basis points higher compared to 2000 due to higher interest rate
levels during the first six months of 2001. This was partially offset by
improved pricing.
OTHER (INCOME) EXPENSE, NET In 2002, we recorded other income, net of $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. Excluding these losses, other
income, net improved $9.8 million primarily due to a $3.2 million reduction in
fees in 2002 associated with the accounts receivable securitization program due
to a significant decline in commercial paper rates which are the basis for
determining the fees, and a $4.0 million increase in foreign exchange gains
resulting from contracts entered to hedge against cross border cash flows.
21
For 2001 and 2000, other expense, net of $11.7 million and $3.3 million,
respectively, included fees of $5.7 million and $5.2 million, respectively,
related to the accounts receivable securitization program. The increase in these
fees is due to higher levels of accounts receivable securitized through this
program. In 2001, other expense also included a loss of $5.8 million associated
with the divestiture of ATS. In 2000, other expense was partially offset by a
net one-time gain of $1.4 million from the sale of miscellaneous underutilized
assets.
INCOME TAXES The effective tax rate for 2002 was 32.0 percent compared to
effective rates of 39.5 percent and 43.5 percent, respectively, for 2001 and
2000. The significant decrease in the effective rate for the current year is due
mainly to the effects of the elimination of non-deductible goodwill expense due
to the adoption of SFAS No. 142, as well as the continued leverage from previous
years' European tax planning initiatives that were responsible for the effective
tax rate decline from 2000 to 2001. The effective tax rates for 2001 and 2000
without the impact of non-deductible goodwill are 33.9 percent and 37.4 percent,
respectively.
EXTRAORDINARY LOSS ON EARLY EXTINGUISHMENT OF DEBT In November 1999, we repaid
our term loan under the Bank Credit Agreement. This resulted in an acceleration
of the amortization of deferred financing fees of $0.4 million, which was
recorded as an extraordinary loss of $0.3 million, net of tax, or $0.01 per
diluted share.
CHANGES IN ACCOUNTING PRINCIPLES We adopted SFAS No. 142, "Goodwill and Other
Intangible Assets," effective July 1, 2001, which establishes 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,
including those affected by the restructuring program announced in November
2001, 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, net of tax charge of $250.4 million, or $7.92 per diluted
share specific to the electronics (AMSG segment - $82.1 million) and the
industrial product group (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.
On July 1, 2000, we adopted SFAS No. 133, "Accounting for Derivative Instruments
and Hedging Activities," (SFAS No. 133), resulting in the recording of a loss
from the cumulative effect from the change in accounting principle of $0.6
million, net of tax, or $0.02 per diluted share. The loss primarily relates to
the write-down of previously paid foreign currency option premiums.
NET INCOME Due largely to the goodwill impairment charge, we recorded a net loss
in 2002 of $211.9 million, or $6.70 per diluted share, compared to net income of
$53.3 million, or $1.73 per diluted share, in 2001. Excluding special charges
and goodwill amortization in both years, diluted earnings per share were $1.95
in 2002 compared to $2.79 in 2001. The decline in earnings is 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 or $0.86 per diluted share relate primarily to the MSSG and AMSG
restructuring initiated in 2002 and additional costs associated with new
restructuring actions made in the J&L business improvement program that was
started in 2001. Included in net income for 2001 and 2000, respectively, was
$19.0 million and $19.2 million of goodwill amortization, net of tax that was
not included in 2002 due to the non-amortization provisions of SFAS No. 142.
Net income for 2001 was $53.3 million, or $1.73 per diluted share, compared to
$51.7 million, or $1.70 per diluted share, in 2000. Excluding special charges
and goodwill amortization in both years, diluted earnings per share were $2.79
in 2001 compared to $2.76 in 2000. We experienced significant weakness in key
North American markets and unfavorable foreign exchange effects, however,
earnings improved due to continued cost control and cost reduction activities,
lower interest expense and a reduction in our effective tax rate. Special
charges in 2001 of $22.5 million, or $0.44 per diluted share, related primarily
to the J&L and FSS business improvement programs, the ATS divestiture, the
core-business resize program and costs associated with the tender offer for the
minority shares of JLK.
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The following table provides a comparison of our reported results and the
results excluding special charges and goodwill amortization for 2002, 2001 and
2000:
Diluted
Operating Net Income Earnings (Loss)
(in thousands, except per share amounts) Gross Profit Income (Loss) Per Share
- ---------------------------------------------------------------------------------------------------------------------------------
Reported results - 2002 $ 510,824 $ 91,317 $(211,908) $(6.70)
Adoption of SFAS No. 142 -- -- 250,406 7.92
MSSG facility rationalizations and employee severance 544 10,245 6,958 0.22
J&L business improvement program 529 10,093 6,863 0.22
Electronics facility rationalization and employee severance 1,654 7,997 5,430 0.17
Loss on divestiture of Strong Tool Company -- -- 2,390 0.08
Corporate restructuring -- 1,075 730 0.02
FSS business improvement program -- 635 430 0.01
Deferred financing fees -- -- 184 0.01
Widia integration costs -- 144 98 --
- ---------------------------------------------------------------------------------------------------------------------------------
Results excluding special charges - 2002 $ 513,551 $ 121,506 $ 61,581 $1.95
=================================================================================================================================
Reported results - 2001 $ 615,720 $ 156,400 $ 53,288 $1.73
Goodwill amortization -- 21,022 18,975 0.62
J&L business improvement program 3,643 7,952 4,726 0.16
Loss on divestiture of ATS -- -- 3,438 0.11
Core-business resize program -- 4,583 2,680 0.09
JLK tender offer costs -- 2,141 1,268 0.04
Adoption of SFAS No. 133 -- -- 599 0.02
FSS business improvement program -- 571 330 0.01
Reduction of credit facility availability -- -- 208 0.01
2000 and 1999 restructuring program adjustments -- 82 50 --
- ---------------------------------------------------------------------------------------------------------------------------------
Results excluding special charges
and goodwill amortization - 2001 $ 619,363 $ 192,751 $ 85,562 $2.79
=================================================================================================================================
Reported results - 2000 $ 637,893 $ 158,779 $ 51,710 $1.70
Goodwill amortization -- 21,759 19,198 0.63
2000 core-business restructuring programs 100 18,626 10,573 0.35
Environmental remediation -- 3,000 1,695 0.06
JLK strategic alternatives costs -- 786 444 0.01
Extraordinary loss on debt extinguishment -- -- 267 0.01
- ---------------------------------------------------------------------------------------------------------------------------------
Results excluding special charges
and goodwill amortization - 2000 $ 637,993 $ 202,950 $ 83,887 $2.76
=================================================================================================================================
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) 2002 2001 2000
- ---------------------------------------------------------------------
External sales $ 897,157 $ 999,813 $1,029,395
Intersegment sales 116,467 111,780 134,398
Operating income 97,323 130,558 131,676
- ---------------------------------------------------------------------
23
Sales in the MSSG segment of $897.2 million declined 10 percent from $999.8
million of a year ago. 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, all in local currency. Due to depressed market
conditions, sales of the North American operations contributed to nearly 90% of
the overall segment decline.
In 2002, operating income declined $33.2 million to $97.3 million, including
$10.2 million of charges related to this segment's restructuring. Additionally,
the lower sales levels contributed significantly to the reduced operating
profit, partially offset by operating expense reductions and lean initiatives.
In 2001, MSSG external sales increased one percent compared to 2000, excluding
unfavorable foreign exchange effects of four percent. International markets
experienced strong year-over-year growth, with particular strength in Europe.
However, in North America, sales were down four percent primarily due to a
decline in demand in the automotive market, coupled with significant weakness in
the light engineering market. In Europe, sales increased nine percent, in local
currency, due to broad-based growth reflecting strength in the machine tool and
engineering markets. Demand in the European automotive market remained strong,
though at a slightly diminished rate compared to 2000. Sales in Asia increased
eight percent in local currency, compared to 2000.
Operating income in 2001 was $130.6 million and was reduced by restructuring
charges of $3.3 million, primarily associated with severance costs for 129
people as part of the core-business resize program, and period costs of $0.2
million associated with facility closures. Operating income in 2000 of $131.7
million was reduced by restructuring and asset impairment charges of $11.0
million and period costs of $2.4 million. Excluding restructuring and period
costs in each period, operating income declined $11.0 million, or eight percent,
due to lower sales levels in the more profitable North American market, offset
in part by lean initiatives and ongoing cost controls.
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) 2002 2001 2000
- -------------------------------------------------------------------------
External sales $ 307,668 $ 352,933 $ 345,447
Intersegment sales 24,167 28,167 25,263
Operating income 26,781 43,270 41,204
- -------------------------------------------------------------------------
AMSG sales declined 12 percent in 2002, excluding foreign exchange effects of
one percent. 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 engineered products contributed
25 and 11 percent, respectively, to the overall sales decline due primarily to
declining rig counts and lower levels of industrial activity.
Operating income of $26.8 million in 2002 included $8.0 million of restructuring
charges related primarily to the closure of the electronics facility in Chicago,
Ill. compared to $0.9 million in 2001, primarily for severance costs. Excluding
these charges, operating income declined $9.4 million. 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.
AMSG sales for 2001 increased four percent compared to 2000, excluding
unfavorable foreign exchange effects of two percent. Sales benefited from robust
growth in energy, mining and engineered products groups due to increased gas and
oil exploration and production, and higher demand for coal. This was partially
offset by a decline in electronics which was due to a sharp decline in demand
from the telecommunication industry in the last half of 2001.
Operating income for 2001 was $43.3 million and was reduced by restructuring
costs of $0.9 million, associated primarily with severance costs for 80 people
as part of the core-business resize program, and period costs of $0.1 million
associated with a facility closure. Operating income for 2000 was reduced by
$4.8 million related to the closure of a manufacturing operation in China and
exit of the related joint venture, the closure of a circuit board drill plant in
Janesville, Wisc., employee severance and asset impairment charges.
Additionally, period costs of $0.5 million were incurred in 2000 related to the
drill
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[LOGO] KENNAMETAL INC. / AR 2002
plant closure. Excluding restructuring and period costs in each year, operating
income declined $2.2 million, or five percent, due to operating inefficiencies
in the electronics business caused by weak sales, partially offset by sales
growth in the other businesses and margin improvement in the energy and mining
businesses.
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, gauges, hand tools
and other supplies used in metalcutting operations.
(in thousands) 2002 2001 2000
- ----------------------------------------------------------------------------
External sales $ 226,010 $ 296,264 $ 333,061
Intersegment sales 2,083 3,823 5,038
Operating income (loss) (681) 3,689 17,208
- ----------------------------------------------------------------------------
Sales in this segment declined $70.3 million or 24 percent from a year ago,
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. Excluding the special charges in each period, operating income was $9.4
million and $13.8 million in 2002 and 2001, respectively. This decline occurred
primarily due to the reduction in sales despite significantly 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.
In 2001, J&L sales declined 11 percent excluding the effect of the ATS
disposition of one percent and unfavorable foreign exchange effects. Sales were
affected by the automotive downturn and weakening in the broader U.S. industrial
market. Operating income in 2001 of $3.7 million included costs of $8.0 million
associated with the business improvement program and $2.1 million primarily
related to the tender offer to acquire the minority shares of JLK. Excluding
special charges in each period, operating income declined $4.1 million due
primarily to lower sales levels, partially offset by operational improvements
resulting from the business improvement program. As part of the business
improvement plan, J&L recorded a restructuring and asset impairment charge
associated with costs related to product pruning initiatives, severance for 115
individuals, the closure of 11 underperforming satellite locations, including
the German operations, and the exit of three warehouse locations.
FULL SERVICE SUPPLY 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.
(in thousands) 2002 2001 2000
- -------------------------------------------------------------------------
External sales $ 152,907 $ 158,886 $ 158,675
Intersegment sales 2,747 5,278 7,827
Operating income 2,014 7,541 12,021
- -------------------------------------------------------------------------
FSS sales for 2002 declined four percent, or $6.0 million, compared to a year
ago 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, excluding restructuring charges of $0.6 million in each of the two years.
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.
In 2001, FSS sales were flat compared to 2000 as sales in existing accounts grew
five percent, but were tempered by the downturn in the automotive end market.
This growth also was offset by a decline in the integrated supply business
transferred to FSS in 2001 as this business has relatively higher exposure to
the automotive industry. Operating income for 2001, excluding restructuring
costs of $0.6 million, declined by $3.9 million due to overall lower gross
margins caused by a shift in end markets served and higher operating expense due
to higher shipping costs incurred to provide enhanced customer service.
Restructuring costs in 2001 relate to severance costs for eight people incurred
as part of the business improvement program.
25
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 low levels of demand. In June 2002, we entered into
a new three-year, multi-currency, $650 million revolving bank credit facility
with a group of financial institutions (New Credit Agreement). Our New 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, 2002,
outstanding borrowings under this agreement were $81.5 million and we had the
ability to borrow under this agreement or otherwise have additional debt of up
to $262.5 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). On August 30, 2002, we
borrowed approximately $185.0 million under this facility in connection with the
Widia acquisition. Additionally, we generally obtain local financing through
credit lines with commercial banks in the various countries in which we operate.
At June 30, 2002, these borrowings amounted to $7.3 million. 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, 2002 and 2001, 54 and 65 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, 2002:
2006 and
(in thousands) 2003 2004 2005 thereafter Total
- --------------------------------------------------------------------------------------------------
Cash Commitments
Long-term debt(1) $ 14,621 $ 240 $ 81,745 $298,852 $395,458
Notes payable 6,926 -- -- -- 6,926
Capital leases 1,933 1,780 1,359 3,911 8,983
Operating leases 18,825 14,716 11,551 27,588 72,680
- --------------------------------------------------------------------------------------------------
Total $ 42,305 $ 16,736 $ 94,655 $330,351 $484,047
==================================================================================================
(1) On August 30, 2002 we borrowed EUR 188.0 million (approximately $185.0
million) to finance the acquisition of Widia as further described in Note
19.
2006 and
(in thousands) 2003 2004 2005 thereafter Total
- -------------------------------------------------------------------------------------------------------------
Other Commercial Commitments
Letters of credit $11,936 $ -- $ -- $ -- $11,936
=============================================================================================================
During 2002, we generated $155.2 million in cash from operations, compared to
$187.6 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. We
believe the level of capital spending in 2002 was sufficient to improve
productivity and make necessary improvements to remain competitive.
Net cash flow used for financing activities was $118.2 million in 2002, compared
to $92.2 million in 2001. This increase of $26.0 million is primarily due to
higher debt repayments including the repayment of the borrowings under the
previous Bank Credit Agreement and the Euro Credit Agreement, partially offset
by $120.6 million in proceeds from the June 2002 stock offering.
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[LOGO] KENNAMETAL INC. / AR 2002
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, in June 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 and for general corporate purposes.
During 2001, we generated $187.6 million in cash flow from operations, a
decrease of $33.6 million from 2000. This reduction is due to a decline in
working capital improvements in 2001 after a robust reduction in 2000. The
continued reduction of working capital reflects our initiative to generate
strong cash flow.
Net cash used for investing activities was $102.5 million in 2001. Compared to
the prior year, the increase in net cash used for investing activities of $59.4
million is primarily due to the repurchase of JLK of $40.8 million and other
minority interests of $6.7 million and increased capital spending of $9.3
million. We believe the level of capital spending in 2001 was sufficient to
improve productivity and make necessary improvements to remain competitive.
Net cash flow used for financing activities was $92.2 million in 2001, which
compares to $173.3 million in 2000. This decline is due to lower debt repayments
of $86.4 million coupled with higher company contributions of capital stock to
U.S. defined contribution pension plans of $11.6 million. In 2001, these
contributions resulted in the issuance of 247,860 shares of our capital stock,
with a market value of $6.9 million. These declines were partially offset by
treasury stock repurchases of $16.5 million. Lower debt repayments are the
result of the purchase of the JLK and other minority interests, lower cash flow
from operations and the repurchase of treasury 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. Additionally, our Board of Directors authorized the
repurchase, from time to time, of up to a total of 2,000,000 additional shares
of our outstanding capital stock. During 2002 and 2001, we purchased 375,000
shares and 600,000 shares, respectively, of our capital stock at a total cost of
$12.4 million and $16.5 million, respectively, bringing the total number of
shares purchased under the authority of these 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 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 previous 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 then
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 previous Bank Credit Agreement. Subsequently, the
availability under the previous Bank Credit 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 New Credit
Agreement.
We have 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 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 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.
27
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, $2.5 million, $5.7 million and $5.2 million in
2002, 2001 and 2000, 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, 2002 and 2001, we securitized accounts
receivable of $95.9 million and $93.7 million, respectively, under this program.
This agreement is required to be renewed periodically, and it is our intention
to continuously obtain that renewal when required. The current agreement has an
expiration date of June 30, 2003. Non-renewal of this agreement would result in
our requirement to otherwise finance the amounts securitized. We anticipate that
the risk of non-renewal of this securitization program with the provider or some
other provider is very low. In the event of a decrease of our eligible accounts
receivable or non-renewal 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 2003 are estimated to be $50 to $60 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, 2002, total assets were $1,523.6 million, a
decline of 17 percent from June 30, 2001 due predominantly to the net goodwill
impairment charge of $250.4 million associated with the adoption of SFAS No. 142
(See "Change in Accounting Principles" in Note 2 to the Consolidated Financial
Statements). Net working capital was $375.3 million, a decline of three percent
from $386.7 million for 2001 due primarily to lower accounts receivable and
inventory levels. In 2002, accounts receivable declined $27.1 million to $179.1
million, while inventories declined $28.1 million to $345.1 million compared to
2001. Inventory turnover was 2.9 in 2002 compared to 3.1 in 2001. The
improvement in net working capital is due to our initiatives to reduce accounts
receivable and inventory levels as well as the lower sales levels experienced in
2002.
One of the features of our management incentive program is the focus on more
efficient use of working capital to generate sales. Our ratio of primary working
capital as a percentage of sales (PWC%) was 27.9 percent and 27.3 percent at
June 30, 2002 and 2001, respectively. Primary working capital (PWC) is defined
as inventory plus accounts receivable, less accounts payable. PWC% is calculated
by averaging beginning of the year and quarter-end balances for PWC, divided by
sales for the most recent 12-month period. While PWC% is not an alternative
measure of asset utilization efficiency under accounting principles generally
accepted in the United States of America and may not be comparable to other
similarly titled measures of other companies, we believe PWC% is a meaningful
measure of our efficiency in utilizing working capital to support sales.
Total debt (including capital lease obligations) decreased 32.2 percent to
$411.4 million in 2002, primarily as a result of the repayment of borrowings
under the Euro Credit Agreement and previous Bank Credit Agreement from proceeds
obtained in the equity public offering and cash from operations. The ratio of
total debt-to-capital was 36.2 percent at June 30, 2002, compared with 42.9
percent at June 30, 2001. The decline in the total debt-to-capital ratio is due
to reduced debt levels, partially offset by lower shareowners' equity and
minority interest. 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.
The debt-to-capital ratio at June 30, 2002 does not include amounts that were
borrowed to fund the Widia acquisition.
ACQUISITION OF JLK MINORITY INTEREST 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
28
[LOGO] KENNAMETAL INC. / AR 2002
commence 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 its special committee comprised of independent
directors of the JLK Board.
BUSINESS DEVELOPMENT On May 3, 2002, we signed a definitive agreement to
purchase the Widia Group (Widia) in Europe and India from Milacron Inc. for EUR
188 million (approximately $185 million) subject to a purchase price adjustment
based on the change in the net assets of Widia from December 31, 2001 to the
closing date. The acquisition closed on August 30, 2002.
Widia, with approximately $240 million in sales in calendar 2001, is a leading
manufacturer and marketer of metalworking tools, engineered products and related
services in Europe and India. Widia has an extensive product line of
metalworking consumables, and is a recognized leader in milling applications.
Widia employs approximately 3,400 employees, and operates eight manufacturing
facilities in Europe and two in India. We currently intend on integrating the
operations of the Widia Group with existing operations. Widia sells primarily
through direct sales and has sales and service personnel in many European
countries.
The funding of the Widia acquisition was taken into consideration as part of the
recently-completed comprehensive refinancing of our capital structure, the key
components of which were the establishment of a new $650 million three-year,
multi-currency, revolving credit facility, the issuance of $300 million of 7.2%
Senior Unsecured Notes due 2012, and the sale of 3.5 million shares of Capital
Stock at a public offering price of $36 per share.
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.
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, 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.
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.
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.
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. At June 30, 2002, we have an accrual of $2.8
million recorded relative to this environmental issue.
29
Additionally, we also maintain reserves for other potential environmental issues
associated with our Greenfield operations and a location operated by our German
subsidiary. At June 30, 2002, the total of these accruals was $1.4 million and
represents anticipated costs associated with the remediation of these issues.
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."
MARKET RISK We are exposed to certain market risks arising from transactions
that are entered into in the normal course of business. We seek to minimize
these risks through our normal operating and financing activities and, when
considered appropriate, through the use of derivative financial instruments. We
do not enter into derivative transactions for speculative purposes and therefore
hold no derivative instruments for trading purposes. Our objective in managing
these exposures is to reduce both earnings and cash flow volatility to allow us
to focus our attention on our business operations. We hedge our foreign exchange
and interest rate exposures for changes in foreign exchange and interest rates
on consolidated results. See Notes 2 and 13 to the consolidated financial
statements for additional information.
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, intercompany 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 internal
natural offsets, to the fullest extent possible, and foreign exchange contracts.
These contracts are designated as hedges of transactions which will settle in
future periods, that otherwise would expose us to foreign currency risk.
The following sensitivity analyses were based upon a hypothetical 10 percent
weakening or strengthening in the U.S. dollar compared to the June 30, 2002
foreign currency rates, the effective interest rates under our current borrowing
arrangements and the market value of our available-for-sale security. We
compared the contractual derivative and borrowing arrangements in effect at June
30, 2002 to the hypothetical foreign exchange or interest rates in the
sensitivity analyses to determine the effect on interest expense, pretax income,
fair value of the available-for-sale security or the accumulated other
comprehensive loss. Our analyses take into consideration the different types of
derivative instruments and the applicability of hedge accounting.
Our foreign exchange hedging program protects portions of our currency exposure
from unfavorable exchange rate movements. This exposure arises from anticipated
cash collections from foreign subsidiaries on transactions between domestic and
foreign subsidiaries. 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, 2002 and 2001 rates
are $62.5 million and $77.9 million, respectively. At June 30, 2002 and 2001, 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 $4.4 million and $1.5 million,
respectively.
In June 2001, we accelerated the payment of intercompany sales of product from
certain foreign subsidiaries. While this transaction did not affect consolidated
June 30, 2001 results, it eliminated a significant portion of hedged anticipated
transactions, and therefore, we unwound and discontinued hedge accounting for
the related derivative contracts. This resulted in the recognition of gains of
$0.6 million, net of hedge ineffectiveness of $0.2 million, as a component of
other expense, net. A portion of the gain, $0.2 million, has been deferred in
accumulated other comprehensive loss and was recognized in 2002 as the remaining
portion of the anticipated transactions occurred in 2002.
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, 2002 and
2001, we had several outstanding forward contracts to purchase and sell foreign
currency, with notional amounts, translated into U.S. dollars at June 30, 2002
and 2001 rates, of
30
[LOGO] KENNAMETAL INC. / AR 2002
$135.2 million and $31.8 million, respectively. A hypothetical 10 percent change
in the applicable 2002 and 2001 year-end exchange rates would result in an
increase or decrease in pretax income of $5.5 million and $1.6 million,
respectively, related to these positions.
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, 2002 and 2001, we had interest rate
swap agreements outstanding that effectively convert a notional amount of $150.0
million and $200.0 million, respectively, of debt from floating to fixed
interest rates. At June 30, 2002, these agreements mature at various times
between July 2002 and June 2003. Additionally, at June 30, 2002, we had interest
rate swap agreements outstanding that effectively convert a notional amount of
$200 million of the ten-year term 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 2007 at the then prevailing market
value of the swap agreements.
At June 30, 2002 and 2001, we had $411.4 million and $607.1 million,
respectively, of debt outstanding at effective interest rates of 7.9 percent and
5.6 percent, respectively, including the effect of interest rate swaps. A
hypothetical change of 10 percent in interest rates from year-end 2002 and 2001
levels would increase or decrease interest expense by approximately $2.2 million
and $2.1 million, respectively.
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.
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, 2002 and 2001, the carrying and
fair value of our investment was $10.7 million and $12.4 million, respectively.
A hypothetical change of 10 percent in the quoted market value of this common
stock at June 30, 2002 and 2001 would result in a $1.1 million and $1.2 million,
respectively, increase or decrease in fair value.
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 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. 121, "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to be Disposed of," 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
31
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.
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.
RESTRUCTURING ACTIVITIES We accrue the cost of our restructuring activities in
accordance with Emerging Issues Task Force Issue 94-3, "Liability Recognition
for Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including certain costs incurred in a restructuring)." 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.
NEW ACCOUNTING STANDARDS In June 2001, the Financial Accounting Standards Board
(FASB) issued SFAS No. 141, "Business Combinations," SFAS No. 142, "Goodwill and
Other Intangible Assets," and SFAS No. 143, "Accounting for Asset Retirement
Obligations." SFAS No. 141 requires that the purchase method of accounting be
used for all business combinations initiated after June 30, 2001.
SFAS No. 142 changes the accounting for goodwill and certain other intangible
assets from an amortization method to an impairment only approach. We adopted
SFAS No. 142 effective July 1, 2001 and therefore, goodwill will no longer be
amortized to earnings. We will continue to amortize non-goodwill intangible
assets (i.e. patents, non-compete agreements) over their existing remaining
useful lives. As required by SFAS No. 142, we completed the initial phase of the
impairment tests within six months of adoption of SFAS No. 142 or December 31,
2001 (see "Changes in Accounting Principles" in Note 2 of the Consolidated
Financial Statements). On an ongoing basis, (absent of any impairment
indicators), we expect to perform our impairment tests during each June quarter,
in connection with our annual planning process. We incurred expense in 2001 and
2000 of $21.0 million and $21.8 million, respectively, related to the
amortization of goodwill.
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. We are required
to adopt this standard on July 1, 2002 and are preparing a plan of
implementation.
32
[LOGO] KENNAMETAL INC. / AR 2002
In August 2001, SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets," was issued. SFAS No. 144 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 standard are
effective for fiscal years beginning after December 15, 2001, and interim
periods within those fiscal years. We are currently evaluating the effects of
this standard and are preparing a plan of implementation.
In April 2002, SFAS No. 145, "Rescission of the 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.
SFAS No. 146, "Accounting for Exit or Disposal Activities," was issued in July
2002. SFAS No. 146 addresses significant issues regarding the recognition,
measurement and reporting of costs that are associated with exit and disposal
activities, including restructuring activities. The scope of SFAS No. 146
includes (1) costs to terminate contracts that are not capital leases; (2) costs
to consolidate facilities or relocate employees; and (3) termination benefits
provided to employees who are involuntarily terminated under the terms of a
one-time benefit arrangement that is not an ongoing benefit arrangement or an
individual deferred-compensation contract. The provisions of this statement will
be effective for disposal activities initiated after December 31, 2002, with
early application encouraged.
FORWARD-LOOKING STATEMENTS This annual report 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; 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.
33
Consolidated Statements of Income
Year ended June 30 (in thousands, except per share data) 2002 2001 2000
- -----------------------------------------------------------------------------------------------------------
Operations
Net sales (Note 2) $1,583,742 $1,807,896 $1,866,578
Cost of goods sold 1,072,918 1,192,176 1,228,685
- -----------------------------------------------------------------------------------------------------------
Gross profit 510,824 615,720 637,893
Operating expense 389,396 425,641 434,136
Restructuring and asset impairment charges (Note 12) 27,307 9,545 18,526
Amortization of intangibles 2,804 24,134 26,452
- -----------------------------------------------------------------------------------------------------------
Operating income 91,317 156,400 158,779
Interest expense 32,627 50,381 55,079
Other (income) expense, net (361) 11,690 3,289
- -----------------------------------------------------------------------------------------------------------
Income before provision for income taxes and minority interest 59,051 94,329 100,411
Provision for income taxes (Notes 2 and 9) 18,900 37,300 43,700
Minority interest 1,653 3,142 4,734
- -----------------------------------------------------------------------------------------------------------
Income before extraordinary loss and cumulative effect
of change in accounting principles 38,498 53,887 51,977
Extraordinary loss on early extinguishment
of debt, net of tax of $178 - - (267)
Cumulative effect of change in accounting principles,
net of tax of $2,389 and $399, respectively (250,406) (599) -
- -----------------------------------------------------------------------------------------------------------
Net (loss) income $ (211,908) $ 53,288 $ 51,710
===========================================================================================================
Per Share Data
Basic earnings per share before extraordinary loss
and cumulative effect of change in accounting principles $ 1.24 $ 1.76 $ 1.72
Extraordinary loss - - (0.01)
Cumulative effect of change in accounting principles (8.04) (0.02) -
- -----------------------------------------------------------------------------------------------------------
Basic (loss) earnings per share $ (6.80) $ 1.74 $ 1.71
===========================================================================================================
Diluted earnings per share before extraordinary loss
and cumulative effect of change in accounting principles $ 1.22 $ 1.75 $ 1.71
Extraordinary loss - - (0.01)
Cumulative effect of change in accounting principles (7.92) (0.02) -
- -----------------------------------------------------------------------------------------------------------
Diluted (loss) earnings per share (Note 2) $ (6.70) $ 1.73 $ 1.70
===========================================================================================================
Dividends per share $ 0.68 $ 0.68 $ 0.68
===========================================================================================================
Basic weighted average shares outstanding (Note 2) 31,169 30,560 30,263
===========================================================================================================
Diluted weighted average shares outstanding 31,627 30,749 30,364
===========================================================================================================
The accompanying notes are an integral part of these statements.
34
[LOGO] KENNAMETAL INC. / AR 2002
Consolidated Balance Sheets
As of June 30 (in thousands, except per share data) 2002 2001
- -----------------------------------------------------------------------------------------------------------
Assets
Current assets:
Cash and equivalents (Note 2) $ 10,385 $ 12,940
Marketable equity securities available-for-sale (Note 2) 10,728 12,419
Accounts receivable, less allowance for doubtful accounts
of $12,671 and $7,999 (Notes 2 and 4) 179,101 206,175
Inventories (Notes 2 and 5) 345,076 373,221
Deferred income taxes (Notes 2 and 9) 71,375 57,452
Other current assets 20,719 18,989
- -----------------------------------------------------------------------------------------------------------
Total current assets 637,384 681,196
- -----------------------------------------------------------------------------------------------------------
Property, plant and equipment (Note 2):
Land and buildings 227,539 227,382
Machinery and equipment 847,196 776,494
Less accumulated depreciation (639,619) (531,002)
- -----------------------------------------------------------------------------------------------------------
Net property, plant and equipment 435,116 472,874
- -----------------------------------------------------------------------------------------------------------
Other assets:
Investments in affiliated companies 11,681 3,875
Intangible assets, less accumulated amortization
of $75,390 and $88,514 (Note 2) 367,992 624,760
Other 71,438 42,737
- -----------------------------------------------------------------------------------------------------------
Total other assets 451,111 671,372
- -----------------------------------------------------------------------------------------------------------
Total assets $1,523,611 $1,825,442
===========================================================================================================
Liabilities
Current liabilities:
Current maturities of long-term debt and capital leases (Note 7) $ 16,554 $ 2,031
Notes payable to banks (Note 8) 6,926 22,499
Accounts payable 101,586 118,073
Accrued income taxes 4,066 16,425
Accrued vacation pay 28,190 29,134
Accrued payroll 22,696 22,189
Other current liabilities (Note 6) 82,082 84,134
- -----------------------------------------------------------------------------------------------------------
Total current liabilities 262,100 294,485
- -----------------------------------------------------------------------------------------------------------
Long-term debt and capital leases, less current maturities (Notes 7 and 8) 387,887 582,585
Deferred income taxes (Note 9) 52,570 53,844
Other liabilities 96,421 87,898
- -----------------------------------------------------------------------------------------------------------
Total liabilities 798,978 1,018,812
- -----------------------------------------------------------------------------------------------------------
Commitments and contingencies (Note 16) - -
- -----------------------------------------------------------------------------------------------------------
Minority interest in consolidated subsidiaries 10,671 9,861
- -----------------------------------------------------------------------------------------------------------
Shareowners' Equity
Preferred stock, no par value; 5,000 shares authorized; none issued - -
Capital stock, $1.25 par value; 70,000 shares authorized;
37,383 and 33,615 shares issued 46,729 42,018
Additional paid-in capital 491,263 353,804
Retained earnings 307,631 540,965
Treasury stock, at cost; 2,573 and 2,774 shares held (72,026) (65,963)
Unearned compensation (4,856) (2,165)
Accumulated other comprehensive loss (Note 11) (54,779) (71,890)
- -----------------------------------------------------------------------------------------------------------
Total shareowners' equity 713,962 796,769
- -----------------------------------------------------------------------------------------------------------
Total liabilities and shareowners' equity $1,523,611 $1,825,442
===========================================================================================================
The accompanying notes are an integral part of these statements.
35
Consolidated Statements of Cash Flows
Year ended June 30 (in thousands) 2002 2001 2000
- -----------------------------------------------------------------------------------------------------------
Operating Activities
Net (loss) income $ (211,908) $ 53,288 $ 51,710
Adjustments for non-cash items:
Depreciation 70,825 73,163 75,194
Amortization 2,804 24,134 26,452
Loss on divestitures 3,522 5,781 -
Restructuring and asset impairment charges 12,712 4,325 6,378
Cumulative effect of change in accounting principles,
net of tax 250,406 599 -
Loss on early extinguishment of debt, net of tax - - 267
Other 2,485 12,362 11,472
Changes in certain assets and liabilities,
net of effects of acquisition and divestitures:
Accounts receivable 33,603 9,620 (17,257)
Proceeds from accounts receivable securitization 2,200 5,200 6,500
Inventories 40,251 19,894 14,331
Accounts payable and accrued liabilities (29,033) (827) 44,968
Other (22,707) (19,983) 1,192
- -----------------------------------------------------------------------------------------------------------
Net cash flow from operating activities 155,160 187,556 221,207
- -----------------------------------------------------------------------------------------------------------
Investing Activities
Purchases of property, plant and equipment (44,040) (59,929) (50,663)
Disposals of property, plant and equipment 10,905 4,227 8,109
Divestitures, net of cash 3,309 729 -
Purchase of subsidiary stock (1,161) (47,505) -
Acquisition of business assets (5,385) - -
Investment in affiliates (5,770) - -
Other (1,129) (26) (531)
- -----------------------------------------------------------------------------------------------------------
Net cash flow used for investing activities (43,271) (102,504) (43,085)
- -----------------------------------------------------------------------------------------------------------
Financing Activities
Net (decrease) increase in notes payable (4,778) 4,038 (18,491)
Net decrease in revolving and other lines of credit (84,151) (78,905) (15,100)
Term debt borrowings 549,950 1,216 378
Term debt repayments (677,563) (2,941) (129,810)
Net proceeds from issuance of capital stock 120,584 - -
Dividend reinvestment and employee benefit and stock plans 23,269 22,854 11,276
Purchase of treasury stock (12,417) (16,494) -
Cash dividends paid to shareowners (21,426) (21,056) (20,570)
Financing fees (10,448) - -
Other (1,268) (949) (1,018)
- -----------------------------------------------------------------------------------------------------------
Net cash flow used for financing activities (118,248) (92,237) (173,335)
- -----------------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash and equivalents 3,804 (2,198) 128
- -----------------------------------------------------------------------------------------------------------
Cash and Equivalents
Net (decrease) increase in cash and equivalents (2,555) (9,383) 4,915
Cash and equivalents, beginning of year 12,940 22,323 17,408
- -----------------------------------------------------------------------------------------------------------
Cash and equivalents, end of year $ 10,385 $ 12,940 $ 22,323
==========================================================================================================
Supplemental Disclosures
Interest paid (net of amount capitalized) $ 33,861 $ 51,480 $ 55,000
Income taxes paid 31,949 36,608 17,092
Contribution of stock to employee benefit plans 9,405 13,364 9,170
Notes received from sale of subsidiaries 4,587 5,809 -
- -----------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these statements.
36
[LOGO] KENNAMETAL INC. / AR 2002
Consolidated Statements of Shareowners' Equity
Year ended June 30 (in thousands) 2002 2001 2000
- --------------------------------------------------------------------------------------------------
Capital Stock
Balance at beginning of year $ 42,018 $ 41,500 $ 41,128
Issuance of capital stock 4,428 - -
Issuance of capital stock under employee benefit and stock plans 283 518 372
- --------------------------------------------------------------------------------------------------
Balance at end of year 46,729 42,018 41,500
- --------------------------------------------------------------------------------------------------
Additional Paid-In Capital
Balance at beginning of year 353,804 335,314 325,382
Issuance of capital stock 116,156 - -
Dividend reinvestment 1,672 1,511 1,250
Issuance of capital stock under employee benefit and stock plans 19,631 16,979 8,682
- --------------------------------------------------------------------------------------------------
Balance at end of year 491,263 353,804 335,314
- --------------------------------------------------------------------------------------------------
Retained Earnings
Balance at beginning of year 540,965 508,733 477,593
Net (loss) income (211,908) 53,288 51,710
Cash dividends to shareowners (21,426) (21,056) (20,570)
- --------------------------------------------------------------------------------------------------
Balance at end of year 307,631 540,965 508,733
- --------------------------------------------------------------------------------------------------
Treasury Stock
Balance at beginning of year (65,963) (55,236) (57,199)
Purchase of treasury stock, at cost (12,417) (16,494) -
Dividend reinvestment 854 1,284 1,236
Issuance of capital stock under employee benefit and stock plans 5,500 4,483 727
- --------------------------------------------------------------------------------------------------
Balance at end of year (72,026) (65,963) (55,236)
- --------------------------------------------------------------------------------------------------
Unearned Compensation
Balance at beginning of year (2,165) (2,814) (3,330)
Issuance of capital stock under employee benefit and stock plans (4,671) (1,921) (1,094)
Amortization of unearned compensation 1,980 2,570 1,610
- --------------------------------------------------------------------------------------------------
Balance at end of year (4,856) (2,165) (2,814)
- --------------------------------------------------------------------------------------------------
Accumulated Other Comprehensive Loss
Balance at beginning of year (71,890) (47,243) (38,443)
Unrealized (loss) gain on marketable equity
securities available-for-sale, net of tax (1,774) (7,379) 7,503
Cumulative effect of change in accounting principle, net of tax - 1,571 -
Unrealized losses on derivatives designated and qualified
as cash flow hedges, net of tax (1,372) (2,044) -
Reclassification of unrealized gains or losses
on expired derivatives, net of tax (1,902) (2,049) -
Minimum pension liability adjustment, net of tax (945) (2,670) 415
Foreign currency translation adjustments 23,104 (12,076) (16,718)
- --------------------------------------------------------------------------------------------------
Other comprehensive income (loss) 17,111 (24,647) (8,800)
- --------------------------------------------------------------------------------------------------
Balance at end of year (54,779) (71,890) (47,243)
- --------------------------------------------------------------------------------------------------
Total shareowners' equity, June 30 $ 713,962 $ 796,769 $ 780,254
==================================================================================================
Comprehensive (Loss) Income
Net (loss) income $ (211,908) $ 53,288 $ 51,710
Other comprehensive income (loss) 17,111 (24,647) (8,800)
- --------------------------------------------------------------------------------------------------
Comprehensive (loss) income $ (194,797) $ 28,641 $ 42,910
==================================================================================================
The accompanying notes are an integral part of these statements.
37
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 to Shareowners, 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.
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 EQUIVALENTS Temporary cash investments having original maturities of
three months or less are considered cash equivalents. Cash equivalents
principally consist of investments in money market funds and certificates of
deposit.
MARKETABLE EQUITY SECURITIES AVAILABLE-FOR-SALE Our investment in marketable
equity securities is accounted for as an available-for-sale security under
Statement of Financial Accounting Standards (SFAS) No. 115, "Accounting for
Certain Investments in Debt and Equity Securities." This investment in Toshiba
Tungaloy Co., Ltd., 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. A gross
unrealized loss on this investment of $0.8 million is recorded at June 30, 2002
while a gross unrealized gain of $2.1 million was recorded at June 30, 2001.
ACCOUNTS RECEIVABLE Accounts receivable includes $3.3 million and $2.8 million
of receivables from affiliates at June 30, 2002 and 2001, 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. 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.
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 is
capitalized during the construction of major facilities. Capitalized interest is
included in the cost of the constructed asset and is amortized over its
estimated useful life.
38
[LOGO] KENNAMETAL INC. / AR 2002
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.
Routine maintenance, repairs and replacements are charged to operations.
Expenditures that materially increase values, change capacities or extend useful
lives are capitalized.
Under the provisions of SOP 98-1, 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.
LONG-LIVED ASSETS We periodically perform ongoing reviews of underperforming
businesses and other long-lived assets for impairment pursuant to the provisions
of SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed of." These in-depth reviews may include an
analysis of the current operations, capacity utilization etc., 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.
INTANGIBLE ASSETS Intangible assets primarily include goodwill, which represents
the excess of cost over the fair value of acquired companies. Prior to our
adoption of SFAS No. 142 on July 1, 2001, goodwill was amortized using the
straight-line method over periods ranging from two to forty years. Under SFAS
No. 142, all goodwill amortization ceased effective July 1, 2001. SFAS No. 142
is not permitted to be applied retroactively to financial statements of prior
periods. Prospectively, 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 expect to perform our impairment tests
during the June quarter, in connection with our planning process.
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. The difference between
basic and diluted earnings per share relates solely to the effect of capital
stock options.
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
by 0.5 million, 0.2 million and 0.1 million shares in 2002, 2001 and 2000,
respectively. Unexercised stock options to purchase our capital stock of 1.2
million, 1.5 million and 1.7 million shares at June 30, 2002, 2001 and 2000,
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.
RESEARCH AND DEVELOPMENT COSTS Research and development costs of $18.3 million,
$18.9 million and $19.2 million in 2002, 2001 and 2000, respectively, were
expensed as incurred.
39
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.
CHANGES IN ACCOUNTING PRINCIPLES On July 1, 2000, we adopted SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," resulting 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.
In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No.
141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible
Assets." SFAS No. 141 requires that the purchase method of accounting be used
for all business combinations initiated after June 30, 2001.
We adopted SFAS No. 142, "Goodwill and Other Intangible Assets," effective July
1, 2001, which establishes 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. 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 product 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. On an ongoing basis (absent of any impairment indicators), we expect
to perform our impairment tests during the June quarter, in connection with our
annual planning process.
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, after the non-cash
charges for the adoption of SFAS No. 142 at June 30, 2002 and 2001 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 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 remaining lives of these
assets, excluding the intangible pension asset, range from one to four years.
The components of our intangible assets are as follows:
June 30, 2002 June 30, 2001
----------------------------- -----------------------------
Gross Gross
Carrying Accumulated Carrying Accumulated
(in thousands) Amount Amortization Amount Amortization
- ------------------------------------------------------------------------------------------------------------------------
Contract based $ 11,910 $ (9,488) $ 12,098 $ (7,969)
Technology based and other 3,374 (2,423) 5,098 (2,817)
Intangible pension asset 5,564 -- 3,087 --
- ------------------------------------------------------------------------------------------------------------------------
Total $ 20,848 $ (11,911) $ 20,283 $ (10,786)
========================================================================================================================
40
[LOGO] KENNAMETAL INC. / AR 2002
Amortization expense for intangible assets, other than goodwill, was $2.8
million, $3.1 million and $4.7 million for 2002, 2001 and 2000, respectively.
Actual results of operations for the year ended June 30, 2002 and pro forma
results of operations for the years ended June 30, 2001 and 2000 had we applied
the non-amortization provisions of SFAS No. 142 in these periods are as follows:
June 30
------------------------------------
(in thousands, except per share amounts) 2002 2001 2000
- -------------------------------------------------------------------------------
Reported net (loss) income $ (211,908) $ 53,288 $ 51,710
Goodwill impairment, net of tax 250,406 -- --
Goodwill amortization, net of tax -- 18,975 19,198
- -------------------------------------------------------------------------------
Adjusted net income $ 38,498 $ 72,263 $ 70,908
===============================================================================
Basic earnings per share:
Reported net (loss) income $ (6.80) $ 1.74 $ 1.71
Goodwill impairment 8.04 -- --
Goodwill amortization -- 0.62 0.63
- -------------------------------------------------------------------------------
Adjusted net income $ 1.24 $ 2.36 $ 2.34
===============================================================================
Diluted earnings per share:
Reported net (loss) income $ (6.70) $ 1.73 $ 1.70
Goodwill impairment 7.92 -- --
Goodwill amortization -- 0.62 0.63
- -------------------------------------------------------------------------------
Adjusted net income $ 1.22 $ 2.35 $ 2.33
===============================================================================
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.
DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES From time to time, 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. We do not enter into derivative transactions for
speculative purposes and therefore hold no derivative instruments for trading
purposes. 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.
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. These contracts mature at various times through
August 2003. 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 expense (income), net when the underlying sale of
product or services are recognized into earnings. We recognized expense of $0.1
million and $0.8 million as a component of other expense, net, in 2002 and 2001,
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. Based upon foreign exchange and interest
rates at June 30, 2002, we expect to recognize into earnings in the next 12
months losses on outstanding derivatives of $2.9 million related to outstanding
derivative instruments.
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, and mature at various times through June 2003. We record the fair value of
these contracts in the balance sheet, with the offset to accumulated other
comprehensive loss, net of tax. The difference between the amounts to be
received and paid under interest rate swap agreements is recognized in interest
expense.
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
41
in the overall interest rate environment. These contracts mature in June 2012.
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 impact on current year earnings.
Forward contracts hedging significant cross-border intercompany loans are
considered other derivatives and therefore, not eligible for hedge accounting.
These contracts are recorded at fair value in the balance sheet, with the offset
to other expense (income), net.
In June 2001, we accelerated the payment of certain intercompany sales of
product from foreign subsidiaries. While this transaction did not affect
consolidated June 30, 2001 results, it eliminated a significant portion of
hedged anticipated transactions, and therefore, we unwound and discontinued
hedge accounting for the related derivative contracts. This resulted in the
recognition of gains of $0.6 million, net of hedge ineffectiveness of $0.2
million, as a component of other expense, net. A portion of the gain, $0.2
million, was deferred in accumulated other comprehensive loss and was recognized
in 2002 as the remaining portion of the transactions occurred in 2002.
New Accounting Standards In June 2001, the 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. We are required to adopt this standard on July 1, 2002 and are
preparing a plan of implementation.
In August 2001, SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets," was issued. SFAS No. 144 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 standard are
effective for the fiscal years beginning after December 15, 2001, and interim
periods within those fiscal years. We are currently evaluating the effects of
this standard and are preparing a plan for its implementation.
In April 2002, SFAS No. 145, "Rescission of the 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.
In July 2002, SFAS No. 146, "Accounting for Exit or Disposal Activities," was
issued. SFAS No. 146 addresses significant issues regarding the recognition,
measurement and reporting of costs that are associated with exit and disposal
activities, including restructuring activities. The scope of SFAS No. 146
includes (1) costs to terminate contracts that are not capital leases; (2) costs
to consolidate facilities or relocate employees; and (3) termination benefits
provided to employees who are involuntarily terminated under the terms of a
one-time benefit arrangement that is not an ongoing benefit arrangement or an
individual deferred-compensation contract. The provisions of this statement will
be effective for disposal activities initiated after December 31, 2002, with
early application encouraged. We are currently evaluating the effects of the
standard and are preparing a plan for its implementation.
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 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 Kennametal 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.
42
[LOGO] KENNAMETAL INC. / AR 2002
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 commence 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.
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.
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 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.
On May 3, 2002, we signed a definitive agreement to purchase the Widia Group
(Widia) in Europe and India from Milacron Inc. for EUR 188.0 million
(approximately $185 million) subject to a purchase price adjustment based on the
change in the net assets of Widia from December 31, 2001 to the closing date.
NOTE 4 ACCOUNTS RECEIVABLE SECURITIZATION PROGRAM We have 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. 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 institution 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 institution.
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 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, $2.5 million,
$5.7 million and $5.2 million in 2002, 2001 and 2000, 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, 2002 and 2001, we securitized accounts receivable of $95.9 million and $93.7
million, respectively, under this program. Our retained interests in accounts
receivable available for securitization and recorded as a component of accounts
receivable were $37.1 million and $35.8 million at June 30, 2002 and 2001,
respectively.
This agreement is required to be renewed periodically, and it is our intention
to continuously obtain that renewal when required. The current agreement has an
expiration date of June 30, 2003. Non-renewal of this agreement would result in
our requirement to otherwise finance the amounts securitized.
43
We anticipate that the risk of non-renewal of this securitization program with
the provider or some other provider is very low. In the event of a decrease of
our eligible accounts receivable or non-renewal of our securitization program,
we would have to utilize alternative sources of capital to fund that portion of
our working capital needs.
NOTE 5 INVENTORIES Inventories consisted of the following:
(in thousands) 2002 2001
- --------------------------------------------------------------------
Finished goods $ 260,783 $ 284,801
Work in process and powder blends 91,871 94,231
Raw materials and supplies 34,452 32,130
- --------------------------------------------------------------------
Inventories at current cost 387,106 411,162
Less LIFO valuation (42,030) (37,941)
- --------------------------------------------------------------------
Total inventories $ 345,076 $ 373,221
====================================================================
We used the LIFO method of valuing our inventories for approximately 49 and 44
percent of total inventories at June 30, 2002 and 2001, 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) 2002 2001
- --------------------------------------------------------------------
Accrued employee benefits $21,378 $21,829
Payroll, state and local taxes 5,234 9,568
Accrued interest expense 1,355 2,803
Other accrued expenses 54,115 49,934
- --------------------------------------------------------------------
Total other current liabilities $82,082 $84,134
====================================================================
NOTE 7 LONG-TERM DEBT AND CAPITAL LEASES Long-term debt and capital lease
obligations consisted of the following:
(in thousands) 2002 2001
- -------------------------------------------------------------------------------------------------
7.2% Senior Unsecured Notes due 2012 net of discount of $1,108
and the fair value of certain interest rate swaps of $934 $ 297,958 $ --
New Credit Agreement, revolving credit loans, 2.905% to
4.775% in 2002, due 2005 81,500 --
Bank Credit Agreement, revolving credit loans, 4.355% to 5.805%
in 2001 -- 375,000
Euro Credit Agreement, revolving credit loans, 5.389% in 2001 -- 179,140
Yen Credit Facility, 0.83% and 1.11% in 2002 and 2001, due 2003 14,083 13,482
Lease of office facilities and equipment with terms expiring
through 2008 at 4.45% to 4.73% 8,982 7,906
Other 1,918 9,088
- -------------------------------------------------------------------------------------------------
Total debt and capital leases 404,441 584,616
- -------------------------------------------------------------------------------------------------
Less current maturities:
Long-term debt (14,621) (524)
Capital leases (1,933) (1,507)
- -------------------------------------------------------------------------------------------------
Total current maturities (16,554) (2,031)
- -------------------------------------------------------------------------------------------------
Long-term debt and capital leases $ 387,887 $ 582,585
=================================================================================================
SENIOR UNSECURED NOTES AND NEW CREDIT AGREEMENT 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 and for general corporate
purposes. 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 loans, enter into sale-leaseback
transactions or certain consolidations or mergers, or sell all or substantially
all of our assets.
We also entered into a new three-year, multi-currency, revolving credit facility
with a group of financial institutions (New Credit Agreement). This New Credit
Agreement permits revolving credit loans of up to $650 million for working
capital, capital expenditures and general corporate purposes and replaces the
previous Bank Credit
44
[LOGO] KENNAMETAL INC. / AR 2002
Agreement and Euro Credit Agreement discussed below. Interest payable under this
New 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 New
Credit Agreement contains various restrictive and affirmative covenants
including some requiring the maintenance of certain financial ratios.
Our New 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, 2002, outstanding borrowings under this agreement were $81.5 million
and we had the ability to borrow under this agreement or otherwise have
additional debt of up to $262.5 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.
On December 20, 2000, we entered into a EUR 212.0 million Euro-denominated
revolving credit facility (Euro Credit Agreement) to 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 previous Bank Credit
Agreement and, to the extent the previous Bank Credit Agreement was repaid, 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 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 our previous Bank Credit Agreement.
Subsequently, the availability under the previous Bank Credit 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 charge
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 New Credit Agreement.
Future principal maturities of long-term debt are $14.6 million, $0.2 million,
$81.7 million, $0.2 million and $0.2 million, respectively, in 2003 through
2007.
Future minimum lease payments under capital leases for the next five years and
thereafter in total are as follows:
(in thousands)
- -------------------------------------------------------------------------------
2003 $ 2,343
2004 2,125
2005 1,622
2006 2,488
2007 660
After 2007 942
- -------------------------------------------------------------------------------
Total future minimum lease payments 10,180
Less amount representing interest (1,198)
- -------------------------------------------------------------------------------
Amount recognized as capital lease obligation $ 8,982
===============================================================================
Our secured debt at June 30, 2002 are industrial revenue bond obligations of
$1.5 million and the capitalized lease obligations of $9.0 million. These
obligations are secured by the underlying assets.
NOTE 8 NOTES PAYABLE AND LINES OF CREDIT. Notes payable to banks of $6.9 million
and $22.5 million at June 30, 2002 and 2001, respectively, represent short-term
borrowings under international credit lines with commercial banks. These credit
lines, translated into U.S. dollars at June 30, 2002 rates, totaled $81.5
million at June 30, 2002, of which $74.6 million was unused. The weighted
average interest rate for short-term borrowings was 2.78 percent and 5.13
percent at June 30, 2002 and 2001, respectively.
45
NOTE 9 INCOME TAXES Income before income taxes and the provision for income
taxes consisted of the following:
(in thousands) 2002 2001(1) 2000
- ------------------------------------------------------------------------------------------
Income before provision for income taxes:
United States $ 11,564 $ 35,108 $ 59,679
International 47,487 59,221 40,732
- ------------------------------------------------------------------------------------------
Total income before provision for
income taxes and minority interest $ 59,051 $ 94,329 $ 100,411
==========================================================================================
Current income taxes:
Federal $ (17,303) $ 26,435 $ 16,053
State 1,070 5,034 1,729
International 19,255 15,234 19,861
- ------------------------------------------------------------------------------------------
Total current income taxes 3,022 46,703 37,643
Deferred income taxes 15,878 (9,403) 6,057
- ------------------------------------------------------------------------------------------
Provision for income taxes $ 18,900 $ 37,300 $ 43,700
==========================================================================================
Effective tax rate 32.0% 39.5% 43.5%
==========================================================================================
(1) Taxes of $16.8 million in 2001 were previously classified as current
and have been reclassified to deferred taxes in the 2001 presentation.
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) 2002 2001 2000
- -----------------------------------------------------------------------------------------
Income taxes at U.S. statutory rate $ 20,668 $ 33,015 $ 35,144
State income taxes, net of federal tax benefits 2,656 2,696 528
Nondeductible goodwill -- 5,557 5,605
International tax rate differences (5,773) (4,899) (123)
International losses with no related tax benefits 990 1,135 2,527
Other 359 (204) 19
- -----------------------------------------------------------------------------------------
Provision for income taxes $ 18,900 $ 37,300 $ 43,700
==========================================================================================
Deferred tax assets and liabilities consisted of the following:
(in thousands) 2002 2001(1)
- -----------------------------------------------------------------------------------------
Deferred tax assets:
Net operating loss carryforwards $ 9,602 $ 11,820
Inventory valuation and reserves 23,630 39,507
Other postretirement benefits 18,721 18,087
Accrued employee benefits 17,962 16,771
FTC carryforward 3,525 --
Other 23,917 10,575
- -----------------------------------------------------------------------------------------
Total 97,357 96,760
Valuation allowance (6,600) (7,411)
- -----------------------------------------------------------------------------------------
Total deferred tax assets $ 90,757 $ 89,349
==========================================================================================
Deferred tax liabilities:
Tax depreciation in excess of book $ 47,321 $ 43,088
Pension benefits 16,827 9,967
Other 7,804 15,914
- -----------------------------------------------------------------------------------------
Total deferred tax liabilities $ 71,952 $ 68,969
==========================================================================================
(1) Taxes of $16.8 million in 2001 were previously classified as current
and have been reclassified to deferred taxes in the 2001 presentation.
Deferred income taxes were not provided on cumulative undistributed earnings of
international subsidiaries and affiliates. At June 30, 2002, 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.
46
[LOGO] KENNAMETAL INC. / AR 2002
Included in deferred tax assets at June 30, 2002 are unrealized tax benefits
totaling $9.6 million related to net operating loss carryforwards. The
realization of these tax benefits is contingent on future taxable income in
certain international operations. Of this amount, $2.6 million (net of a $2.1
million valuation allowance) relates to net operating loss carryforwards in the
United Kingdom and Germany, which can be carried forward indefinitely. The
remaining unrealized tax benefits relate to net operating loss carryforwards in
certain other international operations that are fully reserved and the majority
of which expire over the next five years.
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. Pension
costs are determined in accordance with SFAS No. 87, "Employers' Accounting for
Pensions." 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. In 2000, we made a qualified transfer of pension assets of $2.2 million
from a U.S. pension plan to pay for medical benefit claims and administrative
expenses incurred for postretirement health care benefits.
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) 2002 2001
- -----------------------------------------------------------------------------------------------
Change in benefit obligation:
Benefit obligation, beginning of year $ 373,695 $ 354,314
Service cost 10,706 11,317
Interest cost 26,286 26,368
Participant contributions 642 722
Actuarial (gains) losses 1,865 4,562
Benefits paid (19,489) (18,649)
Effect of curtailment and other 489 305
Foreign currency translation adjustments 5,950 (5,244)
Other 516 -
- -----------------------------------------------------------------------------------------------
Benefit obligation, end of year $ 400,660 $ 373,695
===============================================================================================
Change in plan assets:
Fair value of plan assets, beginning of year $ 443,217 $ 472,208
Actual return on plan assets (25,245) (10,433)
Company contributions 1,947 2,501
Participant contributions 642 722
Benefits paid (19,489) (18,649)
Other 21 (660)
Foreign currency translation adjustments 2,295 (2,472)
- -----------------------------------------------------------------------------------------------
Fair value of plan assets, end of year $ 403,388 $ 443,217
===============================================================================================
Funded status of plans $ 2,728 $ 69,522
Unrecognized transition obligation 963 (1,268)
Unrecognized prior service cost 4,538 4,451
Unrecognized actuarial losses (gains) 20,379 (55,860)
Minimum pension liability (12,759) (8,906)
- -----------------------------------------------------------------------------------------------
Net accrued benefit $ 15,849 $ 7,939
===============================================================================================
Amounts recognized in the balance sheet consist of:
Prepaid benefit $ 48,665 $ 32,205
Accrued benefit obligation (32,816) (24,266)
- -----------------------------------------------------------------------------------------------
Net accrued benefit $ 15,849 $ 7,939
===============================================================================================
47
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 international pension plans with
accumulated benefit obligations exceeding the fair value of plan assets as
follows:
(in thousands) 2002 2001
- -----------------------------------------------------------------------------------------------
Projected benefit obligation $ 58,343 $ 54,279
Accumulated benefit obligation 54,534 53,283
Fair value of plan assets 28,709 28,263
- -----------------------------------------------------------------------------------------------
The components of net pension (benefit) cost include the following:
(in thousands) 2002 2001 2000
- -----------------------------------------------------------------------------------------------
Service cost $ 10,706 $ 11,317 $ 13,414
Interest cost 26,286 26,368 25,187
Expected return on plan assets (44,879) (43,526) (39,388)
Amortization of transition obligation (1,998) (2,052) (2,030)
Amortization of prior service cost 477 428 514
Recognition of actuarial gains (2,821) (2,836) (1,662)
Other (488) - -
- -----------------------------------------------------------------------------------------------
Net benefit $ (12,717) $ (10,301) $ (3,965)
===============================================================================================
The significant actuarial assumptions used to determine the present value of net
pension obligations were as follows:
(in thousands) 2002 2001 2000
- ---------------------------------------------------------------------------------------------------
Discount rate:
U.S. plans 7.3% 7.5% 8.0%
International plans 6.0 - 6.8% 5.5 - 6.8% 5.5 - 7.0%
Rates of future salary increases:
U.S. plans 4.5% 4.5% 4.5%
International plans 3.3 - 4.0% 3.0 - 4.3% 3.5 - 4.3%
Rates of return on plan assets:
U.S. plans 9.5% 10.0% 10.0%
International plans 6.5 - 7.3% 6.5 - 8.0% 6.5 - 8.0%
- ---------------------------------------------------------------------------------------------------
The funded status of our other postretirement benefit plan and amounts
recognized in the consolidated balance sheets were as follows:
(in thousands) 2002 2001
- -----------------------------------------------------------------------------------------------
Change in benefit obligation:
Benefit obligation, beginning of year $ 41,122 $ 36,064
Service cost 1,291 1,130
Interest cost 2,950 2,744
Actuarial losses 165 4,667
Benefits paid (3,408) (3,483)
- -----------------------------------------------------------------------------------------------
Benefit obligation, end of year $ 42,120 $ 41,122
- -----------------------------------------------------------------------------------------------
Funded status of plans $ (42,120) $ (41,122)
Unrecognized prior service cost 1,078 1,484
Unrecognized actuarial gains (4,279) (4,823)
- -----------------------------------------------------------------------------------------------
Net accrued obligation $ (45,321) $ (44,461)
==============================================================================================
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[LOGO] KENNAMETAL INC. / AR 2002
The components of other postretirement cost include the following:
(in thousands) 2002 2001 2000
- ---------------------------------------------------------------------------------------------
Service cost $ 1,291 $ 1,130 $ 1,168
Interest cost 2,950 2,744 2,536
Amortization of prior service cost 406 406 406
Recognition of actuarial gains (247) (753) (465)
- ---------------------------------------------------------------------------------------------
Net cost $ 4,400 $ 3,527 $ 3,645
=============================================================================================
Accrued postretirement benefit obligations of $42.1 million and $41.1 million at
June 30, 2002 and 2001, respectively, are included in other long-term
liabilities. The discount rate used to determine the present value of the other
postretirement benefit obligation was 7.3%, 7.5% and 8.0% in 2002, 2001 and
2000, 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
10.0% in 2002 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, 2002:
(in thousands) 1% Increase 1% Decrease
- -----------------------------------------------------------------------------------------------
Effect on total of service and interest cost components $ 190 $ (170)
Effect on other postretirement benefit obligation 1,750 (1,540)
- -----------------------------------------------------------------------------------------------
In addition we maintain a supplemental early retirement plan for various
eligible executives. The accrued benefit obligation of $13.9 million related to
this plan, is included as a component of other long-term liabilities at June 30,
2002. We do not maintain any assets to fund the obligations under this plan.
We also sponsor several defined contribution pension plans. Pension costs for
defined contribution plans were $9.1 million, $12.1 million and $9.8 million in
2002, 2001 and 2000, 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 102,013 and 247,860 shares
during 2002 and 2001, respectively, with a market value of $3.8 million and $6.9
million, respectively. We temporarily suspended all company contributions to the
defined contribution plans effective January 1, 2002.
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 2002,
2001 and 2000.
NOTE 11 ACCUMULATED OTHER COMPREHENSIVE LOSS The components of accumulated other
comprehensive loss consist of the following:
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)
======================================================================================================
As of June 30, 2001 (in thousands) Pre-tax Tax After-tax
- ------------------------------------------------------------------------------------------------------
Unrealized gain on marketable equity securities available-for-sale $ 2,104 $ 820 $ 1,284
Unrealized loss on derivatives designated and qualified
as cash flow hedges (4,203) (1,681) (2,522)
Minimum pension liability adjustment (5,819) (2,299) (3,520)
Foreign currency translation adjustments (62,602) 4,530 (67,132)
- ------------------------------------------------------------------------------------------------------
Total accumulated other comprehensive loss $ (70,520) $ 1,370 $ (71,890)
======================================================================================================
49
NOTE 12 RESTRUCTURING AND ASSET IMPAIRMENT CHARGES
2002 AMSG AND MSSG RESTRUCTURING. In November 2001, we announced a restructuring
program whereby we expected to recognize special charges of $15 to $20 million,
including period costs, for the closure of three manufacturing locations and the
relocation of the production of a certain product line to another plant, and
associated workforce reductions. This was done in response to continued steep
declines in the end market demand in the electronics and industrial products
groups businesses. Additionally, we implemented other worldwide workforce
reductions and facility closures in these segments in reaction to the declines
in our end markets. All initiatives under this program have been implemented and
completed and all charges have been taken.
We implemented the measures associated with the closing and consolidation of the
Advanced Materials Solutions Group (AMSG) electronics facility in Chicago, Ill.,
and Metalworking Solutions & Services Group (MSSG) industrial product 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 total charge to date of $17.3 million includes non-cash items
of $5.4 million. The components of the charges and the accrual at June 30, 2002
for this program are as follows:
2002 Asset Cash Accrual at
(in thousands) Expense Write-Downs Expenditures June 30, 2002
- -------------------------------------------------------------------------------------------------------
Facility rationalizations $ 14,801 $ (5,387) $ (6,437) $ 2,977
Employee severance 2,525 - (1,305) 1,220
- -------------------------------------------------------------------------------------------------------
Total $ 17,326 $ (5,387) $ (7,742) $ 4,197
- -------------------------------------------------------------------------------------------------------
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 12
months. Additionally, as part of these actions, we recorded a non-cash charge of
$1.0 million, net of salvage value, associated with the abandonment and
scrapping of inventory. This charge was recorded as a component of cost of goods
sold. We also incurred period costs associated with these actions of $1.5
million during 2002, which were expensed as incurred as a component of cost of
goods sold.
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 the 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 Full Service Supply (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
anticipation of migrating to a new business system, we capitalized costs
associated with the development of system functionality specifically designed
for the J&L business. In the December 2001 quarter, after further evaluation of
the development of the system, we determined it was no longer feasible that J&L
would use this portion of the business system because the vendor ceased
supporting the system. Therefore, we recorded the non-cash charge of $5.3
million representing the portion of costs capitalized in connection with system
enhancements specifically for the J&L business. In the FSS segment for 2002, we
recorded restructuring charges of $0.7 million for severance related to 34
individuals.
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[LOGO] KENNAMETAL INC. / AR 2002
All initiatives under this business improvement program have been implemented
and completed and all charges have been taken. The components of the 2002 and
2001 charges and the restructuring accrual at June 30, 2002 and 2001, are as
follows:
2001 Asset Cash Accrual at
(in thousands) Expense Write-Downs Expenditures June 30, 2001
- -------------------------------------------------------------------------------------------------------
J&L business improvement program:
Employee severance $ 2,475 $ - $ (2,224) $ 251
Facility closures 2,453 (987) (526) 940
FSS business improvement program 571 - (430) 141
- -------------------------------------------------------------------------------------------------------
Total $ 5,499 $ (987) $ (3,180) $ 1,332
=======================================================================================================
Accrual at 2002 Expense Asset Cash Accrual at
(in thousands) June 30, 2001 Expense Adjustments Write-Downs Expenditures June 30, 2002
- -------------------------------------------------------------------------------------------------------
J&L business improvement
program:
Employee severance $ 251 $ 2,479 $ 6 $ - $ (2,370) $ 366
Facility closures 940 1,731 93 (572) (1,398) 794
Business system - 5,257 - (5,257) - -
FSS business
improvement program 141 706 (71) - (548) 228
- -------------------------------------------------------------------------------------------------------
Total $ 1,332 $ 10,173 $ 28 $ (5,829) $ (4,316) $ 1,388
=======================================================================================================
The expense adjustments for the facility closures were due to incremental costs
incurred to exit these facilities. The other expense adjustments relate to
reductions in actual amounts paid for severance costs compared to what was
initially anticipated. We recorded expense adjustments as a component of
restructuring and asset impairment charges.
In connection with the 2001 J&L charge for exiting the warehouses and the
satellite closures, we recorded a non-cash write-down, net of salvage value, of
$0.6 million primarily related to inventory that was abandoned and not
relocated. J&L also finalized and implemented a program to optimize the overall
catalog product offering. We identified certain products that would no longer be
offered to customers and scrapped these products, resulting in a non-cash charge
of $3.0 million, net of salvage value. These charges were recorded as a
component of cost of goods sold.
As a part of the J&L facility closures, in 2002 we recorded a charge of $0.6
million, net of salvage value, associated with the abandonment and scrapping of
inventory at these locations. This charge was recorded as a component of cost of
goods sold.
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 of $4.6 million related to severance for 209 individuals.
All employee benefit initiatives under these programs have been implemented.
Cash expenditures were $1.9 million and $2.2 million in 2002 and 2001,
respectively. The restructuring accrual at June 30, 2002 of $0.4 million
represents projected payments, the majority of which are expected to occur over
the next 12 months.
2000 RESTRUCTURING PROGRAM In 2000, we announced plans to close, consolidate or
downsize several plants, warehouses and offices, and associated workforce
reductions as part of our overall plan to increase asset utilization and
financial performance, and to reposition ourselves to become the premier tooling
solutions supplier. The components of the charges were $4.8 million for asset
impairment charges, $7.4 million for employee severance, $6.3 million for
facility rationalizations and $0.1 million for product rationalization.
The asset impairment charges of $4.8 million consisted of a charge of $1.7
million related to a metalworking manufacturing operation in Shanghai, China.
This operation became fully operational in 1998 and at the time of review, had
not generated the performance that was expected at the time we entered into this
market. We performed an in-depth review of the operations, capacity utilization
and the local management team, and engaged a consultant to perform an
independent review of the same. These reviews enabled us to determine that the
market served by this operation is not expected to develop to the extent
originally anticipated, but that the operations were in good working order,
utilized modern technology, and the management team in place was competent. We
also determined that this facility had excess capacity given the level of market
demand. In addition, we recorded an asset
51
impairment charge of $2.8 million related to the write-down of equipment in our
North American metalworking operations and $0.3 million in our engineered
products operations. In connection with the repositioning of the company, we
completed an assessment of the assets currently being used in these operations
and determined that these assets were not going to be further utilized in
conducting these operations. This amount represents the write-down of the book
value of the assets, net of salvage value.
The $7.4 million in employee severance related to severance packages provided to
171 hourly and salaried employees terminated in connection with a global
workforce reduction. Included in this charge is an incremental pension
obligation of $0.8 million, incurred as a result of the severance packages
provided.
The $6.3 million charge for facility rationalizations relates to employee
severance for 153 employees and other exit costs associated with the closure or
downsizing of a metalworking manufacturing operation in Kingswinford, United
Kingdom; a circuit board drill plant in Janesville, Wisc.; a German warehouse
facility; and several offices in the Asia Pacific region and South America.
Included in this charge is an incremental pension obligation of $0.2 million due
to a plan curtailment. The charge also includes $3.4 million for employee
severance for 41 employees and other exit costs associated with the closure of a
mining and construction manufacturing operation in China and the exit of the
related joint venture.
The product rationalization charge of $0.1 million represents the write-down of
certain discontinued product lines manufactured in these operations. We
manufactured these products specifically for the market served by these
operations and we determined that these products are no longer salable. This
charge has been recorded as a component of cost of goods sold.
In 2001, we incurred period costs of $0.3 million related to these initiatives
which were included in cost of goods sold as incurred. In 2000, we incurred
period costs of $0.8 million related to these initiatives, and costs of $1.7
million associated with the implementation of lean manufacturing techniques,
both of which were included in cost of goods sold as incurred. As of June 30,
2002, $0.3 million remains accrued for facility rationalizations and is expected
to be paid within the next 12 months. Adjustments to the original amounts
accrued were immaterial.
We continue to review our business strategies and pursue other cost-reduction
activities in all business segments, some of which could result in future
charges.
NOTE 13 FINANCIAL INSTRUMENTS The fair values of our financial instruments at
June 30, 2002 and 2001 approximate the carrying values of such 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.
LONG-TERM DEBT 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 $197.7 million and $109.7
million at June 30, 2002 and 2001, respectively. We would have received $2.5
million and $1.6 million at June 30, 2002 and 2001, respectively, 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,
2002 and 2001. Fair value was estimated based on quoted market prices of
comparable instruments.
INTEREST RATE SWAP AGREEMENTS At June 30, 2002 and 2001, we had interest rate
swap agreements outstanding that effectively convert a notional amount of $150.0
million and $200.0 million, respectively, of debt from floating to fixed
interest rates. The agreements outstanding at June 30, 2002 mature at various
times between July 2002 and June 2003. At June 30, 2002 and 2001, we would have
paid $5.5 million and $6.6 million, respectively, to settle these interest rate
swap agreements, which represents the fair value of these agreements.
Additionally, at June 30, 2002, we had interest rate swap agreements outstanding
that effectively convert a notional amount of $200 million of the ten-year
Senior Unsecured Notes from fixed to floating interest rates. These agreements
mature in June 2012 but provide for a one time optional early termination by the
bank counterparty in June 2007 at the then prevailing market value of the swap
agreements. At June 30, 2002, we would have received $0.9 million to settle
these interest rate swap agreements, which represents the fair value of these
agreements.
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Under SFAS No. 133, the carrying value equals the fair value for these contracts
at June 30, 2002 and 2001. 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, 2002 and 2001, 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. We have four plans under which options may be granted: the 1992 plan, the
1996 plan and two 1999 plans. No options may be granted under the 1992 plan
after October 2002, no options may be granted under the 1996 plan after October
2006 and no options may be granted under the 1999 plans after April and October
2009. No charges to income have resulted from grants under any of the plans.
Under provisions of the plans, 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 2000 were not significant.
We measure compensation expense related to stock options in accordance with
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees." Accordingly, at the time options are granted, no compensation
expense was recognized in the accompanying consolidated financial statements due
to the option strike price being greater than or equal to the market value of
the stock on the grant date. If compensation expense was determined based on the
estimated fair value _of options granted in 2002, 2001 and 2000, consistent with
the methodology in SFAS No. 123, "Accounting for Stock Based Compensation," our
2002, 2001 and 2000 net income and earnings per share would be reduced to the
pro forma amounts indicated below:
(in thousands, except per share data) 2002 2001 2000
- --------------------------------------------------------------------------------
Net (loss) income:
As reported $ (211,908) $ 53,288 $ 51,710
Pro forma (215,511) 50,802 50,287
Basic (loss) earnings per share:
As reported (6.80) 1.74 1.71
Pro forma (6.91) 1.66 1.66
Diluted (loss) earnings per share:
As reported (6.70) 1.73 1.70
Pro forma (6.86) 1.65 1.66
- --------------------------------------------------------------------------------
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:
2002 2001 2000
- --------------------------------------------------------------------------------
Risk-free interest rate 4.6% 5.9% 6.6%
Expected life (years) 5 5 5
Expected volatility 34.0% 33.2% 31.1%
Expected dividend yield 1.8% 2.4% 2.5%
- --------------------------------------------------------------------------------
53
Stock option activity for 2002, 2001 and 2000 is set forth below:
2002 2001 2000
---------------------------- ----------------------------- -----------------------------
Weighted Weighted Weighted
Average Average Average
(number of options) Options Exercise Price Options Exercise Price Options Exercise Price
- -------------------------------------------------------------------------------------------------------------------------------
Options outstanding,
beginning of year 2,913,436 $ 32.08 2,856,298 $ 33.05 2,635,256 $ 33.84
Granted 964,025 38.67 726,850 25.51 317,600 27.01
Exercised (382,542) 28.54 (263,719) 22.48 (20,808) 19.81
Lapsed and forfeited (187,065) 45.24 (405,993) 34.40 (75,750) 38.86
- -------------------------------------------------------------------------------------------------------------------------------
Options outstanding,
end of year 3,307,854 $ 33.75 2,913,436 $ 32.08 2,856,298 $ 33.05
- -------------------------------------------------------------------------------------------------------------------------------
Options exercisable,
end of year 1,882,539 $ 33.37 1,959,311 $ 34.99 2,025,723 $ 35.30
- -------------------------------------------------------------------------------------------------------------------------------
Weighted average fair
value of options granted
during the year $ 12.24 $ 7.95 $ 8.30
- -------------------------------------------------------------------------------------------------------------------------------
Stock options outstanding at June 30, 2002:
Options Outstanding Options Exercisable
---------------------------------------- ------------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Contractual Life Exercise Exercise
Range of Exercise Prices Options (years) Price Options Price
- -----------------------------------------------------------------------------------------------
$ 20.63 - $23.94 330,733 6.90 $ 22.88 300,733 $ 22.79
24.47 438,839 8.06 24.47 132,574 24.47
24.75 - 26.41 421,644 7.21 25.98 350,145 26.04
26.88 - 31.69 450,113 6.50 30.48 369,953 30.69
31.84 - 38.30 360,800 4.72 36.81 303,334 38.86
38.44 640,850 9.08 38.44 2,000 38.44
38.51 - 48.56 528,875 7.22 44.89 287,800 48.56
49.25 - 53.97 136,000 5.50 51.61 136,000 51.61
- -----------------------------------------------------------------------------------------------
3,307,854 7.22 $ 33.75 1,882,539 $ 33.37
===============================================================================================
In addition to stock option grants, several plans permit the award of restricted
stock to directors, officers and key employees. During 2002, 2001 and 2000, we
granted restricted stock awards of 124,298, 75,790 and 34,800 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. Accordingly, a portion of the total cost of these awards of $4.7 million,
$1.9 million and $1.1 million for 2002, 2001 and 2000, respectively, is
considered unearned compensation. Unearned compensation is amortized to expense
over the vesting period. Compensation expense related to these awards was $2.0
million, $2.6 million and $1.6 million in 2002, 2001 and 2000, 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 24,944 and 9,241 shares under the ESPP during 2002
and 2001, respectively.
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
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[LOGO] KENNAMETAL INC. / AR 2002
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.
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. At June 30, 2002, we have an accrual of $2.8
million recorded relative to this environmental issue.
Additionally, we also maintain reserves for other potential environmental issues
associated with our Greenfield operations and a location operated by our German
subsidiary. At June 30, 2002, the total of these accruals was $1.4 million and
represents anticipated costs associated with the remediation of these issues.
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 $23.5 million, $24.2
million and $22.3 million in 2002, 2001 and 2000, respectively. Future minimum
lease payments for non-cancelable operating leases are $18.8 million, $14.7
million, $11.5 million, $9.6 million and $5.4 million for the years 2003 through
2007 and $12.6 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.
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.
55
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 the consolidated financial statements.
Sales to a single customer did not aggregate 10 percent or more of total sales
in 2002, 2001 or 2000. Export sales from U.S. operations to unaffiliated
customers were $65.1 million, $78.7 million and $75.8 million in 2002, 2001 and
2000, 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 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.
Segment detail is summarized as follows:
(in thousands) 2002 2001 2000
- -----------------------------------------------------------------------------------------------
External sales:
MSSG $ 897,157 $ 999,813 $ 1,029,395
AMSG 307,668 352,933 345,447
J&L 226,010 296,264 333,061
FSS 152,907 158,886 158,675
- -----------------------------------------------------------------------------------------------
Total external sales $ 1,583,742 $ 1,807,896 $ 1,866,578
===============================================================================================
Intersegment sales:
MSSG $ 116,467 $ 111,780 $ 134,398
AMSG 24,167 28,167 25,263
J&L 2,083 3,823 5,038
FSS 2,747 5,278 7,827
- -----------------------------------------------------------------------------------------------
Total intersegment sales $ 145,464 $ 149,048 $ 172,526
===============================================================================================
Total sales:
MSSG $ 1,013,624 $ 1,111,593 $ 1,163,793
AMSG 331,835 381,100 370,710
J&L 228,093 300,087 338,099
FSS 155,654 164,164 166,502
- -----------------------------------------------------------------------------------------------
Total sales $ 1,729,206 $ 1,956,944 $ 2,039,104
===============================================================================================
56
[LOGO] KENNAMETAL INC. / AR 2002
Segment detail (continued)
(in thousands) 2002 2001 2000
- -----------------------------------------------------------------------------------------------
Operating income (loss):
MSSG $ 97,323 $ 130,558 $ 131,676
AMSG 26,781 43,270 41,204
J&L (681) 3,689 17,208
FSS 2,014 7,541 12,021
Corporate (34,120) (28,658) (43,330)
- -----------------------------------------------------------------------------------------------
Total operating income 91,317 156,400 158,779
Interest expense 32,627 50,381 55,079
Other (income) expense, net (361) 11,690 3,289
- -----------------------------------------------------------------------------------------------
Income before income taxes and minority interest $ 59,051 $ 94,329 $ 100,411
===============================================================================================
Depreciation and amortization:
MSSG $ 51,897 $ 62,374 $ 64,727
AMSG 12,065 21,024 21,892
J&L 2,398 8,400 9,044
FSS 1,852 804 342
Corporate 5,417 4,695 5,641
- -----------------------------------------------------------------------------------------------
Total depreciation and amortization $ 73,629 $ 97,297 $ 101,646
===============================================================================================
Equity income (loss):
MSSG $ 629 $ 470 $ 615
AMSG (16) (15) (18)
- -----------------------------------------------------------------------------------------------
Total equity income $ 613 $ 455 $ 597
===============================================================================================
Total assets:
MSSG $ 738,654 $ 937,863 $ 978,188
AMSG 361,122 429,981 475,741
J&L 178,728 224,939 218,247
FSS 56,078 63,056 69,435
Corporate 189,029 169,603 199,510
- -----------------------------------------------------------------------------------------------
Total assets $ 1,523,611 $ 1,825,442 $ 1,941,121
===============================================================================================
Capital expenditures:
MSSG $ 26,257 $ 32,913 $ 35,125
AMSG 8,168 7,947 7,235
J&L 2,537 2,679 6,939
FSS 437 439 760
Corporate 6,641 15,951 604
- -----------------------------------------------------------------------------------------------
Total capital expenditures $ 44,040 $ 59,929 $ 50,663
===============================================================================================
Investments in affiliated companies:
MSSG $ 8,354 $ 3,688 $ 3,006
AMSG 3,327 187 (435)
- -----------------------------------------------------------------------------------------------
Total investments in affiliated companies $ 11,681 $ 3,875 $ 2,571
===============================================================================================
During 2002, all operating segments experienced lower operating income as a
result of reduced sales levels as compared to the prior year. Additionally, MSSG
and AMSG operating income was reduced by $10.2 million and $8.0 million,
respectively, in restructuring charges associated with the closing and
consolidation of various facilities (see Note 12). The operating income for J&L
and FSS reflects $10.1 million and $0.6 million, respectively, in charges
related to those segments' business improvement programs and $1.0 million of
restructuring charges were included in the corporate operating loss (see Note
12).
Total assets of both MSSG and AMSG are lower due to the effects of the goodwill
impairment charges of $170.7 million and $82.1 million, respectively, recognized
in 2002 (see Note 2).
J&L operating income for 2001 was reduced by $5.0 million related to
restructuring and asset impairment charges, $3.0 million related to product
pruning initiatives (see Note 12), and $2.1 million of costs primarily related
to the tender offer to acquire the minority shares of JLK (see Note 3). MSSG,
AMSG, FSS and Corporate operating income for 2001 was reduced by $3.3 million,
$0.9 million, $0.6 million and $0.4 million, respectively, related to
restructuring charges (see Note 12).
57
MSSG operating income for 2000 was reduced by $11.0 million related to asset
impairment charges, costs associated with facility and product rationalizations,
and employee severance (see Note 12). AMSG operating income for 2000 was reduced
by $4.8 million related to costs associated with facility rationalizations
including costs to exit a related joint venture, employee severance and asset
impairment charges (see Note 12). J&L operating income for 2000 was reduced by
$0.6 million related to employee severance costs (see Note 12) and $0.2 million
related to the evaluation of strategic alternatives _(see Note 3). Corporate
operating income for 2000 was reduced by $3.0 million related to environmental
remediation costs (see Note 15), $2.2 million related to employee severance
costs (see Note 12), and $0.6 million related to the evaluation of strategic
alternatives (see Note 3).
Geographic information for sales, based on country of origin, and assets is
follows:
(in thousands) 2002 2001 2000
- --------------------------------------------------------------------------------
External sales:
United States $1,085,297 $1,267,506 $1,318,806
Germany 171,199 192,283 196,533
United Kingdom 79,906 86,670 96,220
Canada 51,814 61,335 60,823
Other 195,526 200,102 194,196
- --------------------------------------------------------------------------------
Total external sales $1,583,742 $1,807,896 $1,866,578
================================================================================
Total assets:
United States $1,087,716 $1,368,055 $1,485,695
Germany 162,900 166,259 154,534
United Kingdom 91,548 93,432 92,463
Canada 20,776 33,982 28,203
Other 160,671 163,714 180,226
- --------------------------------------------------------------------------------
Total assets $1,523,611 $1,825,442 $1,941,121
================================================================================
NOTE 19 SUBSEQUENT EVENT
On August 30, 2002, we completed the acquisition of the Widia Group from
Milacron, Inc. for approximately EUR 188 million (approximately $185 million) in
cash, subject to a purchase price adjustment based upon the change in the net
assets of Widia from December 31, 2001 to the closing date.
Widia, with approximately $240 million in sales in calendar 2001, is a leading
manufacturer and marketer of metalworking tools, engineered products and related
services in Europe and India. Widia has an extensive product line of
metalworking consumables, and is a recognized leader in milling applications.
Widia employs approximately 3,400 employees, and operates eight manufacturing
facilities in Europe and two in India. We currently intend on integrating the
operations of the Widia Group with existing operations. Widia sells primarily
through direct sales and service personnel in many European countries.
The funding of the Widia acquisition was taken into consideration as part of the
recently completed comprehensive refinancing of our capital structure.
58
[LOGO] KENNAMETAL INC. / AR 2002
SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
Quarter Ended
--------------------------------------------------
(in thousands, except per share data) Sep. 30 Dec. 31 Mar. 31 Jun. 30
- ---------------------------------------------------------------------------------------------------------
Fiscal 2002
Net 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
- ---------------------------------------------------------------------------------------------------------
Fiscal 2001
Net sales $ 453,635 $ 443,565 $ 468,191 $ 442,505
Gross profit 152,616 151,416 164,507 147,181
Net income 9,342 13,524 20,394 10,028
Basic earnings per share 0.30 0.44 0.67 0.32
Diluted earnings per share 0.30 0.44 0.66 0.32
- ---------------------------------------------------------------------------------------------------------
Earnings per share amounts for each quarter are required to be computed
independently and, therefore, may not equal the amount computed for the year.
The first quarter loss in 2002 reflects the charge for the recognition of $250.4
million ($7.97 per share), net of tax, of goodwill impairment resulting from the
adoption of SFAS No. 142. December 2001 earnings were reduced by special charges
of $18.3 million ($0.40 per share) related to business improvement plans and
asset impairment charges. March 2002 earnings were lower due to reduced revenue,
as compared to the prior year, partially offset by lower operating expense,
interest costs and the elimination of goodwill amortization. June 2002 earnings
included $2.4 million less in special charges than did the same quarter of 2001,
primarily associated with the J&L business improvement program.
September 2000 earnings were reduced by pretax charges of $3.3 million ($0.06
per share), including $1.6 million ($0.03 per share) related to restructuring
charges and $1.7 million ($0.03 per share) primarily related to the tender offer
to acquire the minority shares of JLK Direct Distribution Inc., and an after-tax
charge of $0.6 million ($0.02 per share) related to a change in accounting
principle. December 2000 earnings were reduced by pretax charges of $1.1 million
($0.03 per share) primarily related to restructuring charges. March 2001
earnings were reduced by pretax charges of $3.2 million ($0.06 per share)
primarily related to restructuring and asset impairment charges. June 2001
earnings were reduced by pretax charges of $13.9 million ($0.27 per share)
primarily related to a loss on divestiture and restructuring and product pruning
charges.
STOCK PRICE RANGES AND DIVIDENDS PAID (UNAUDITED) Our common stock is traded on
the New York Stock Exchange (symbol KMT). The number of shareowners of record as
of August 9, 2002 was 3,206. Stock price ranges and dividends declared and paid
were as follows:
Quarter Ended
----------------------------------------------------
Sep. 30 Dec. 31 Mar. 31 Jun. 30
- --------------------------------------------------------------------------------
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
- --------------------------------------------------------------------------------
Fiscal 2001
High $ 26.44 $ 30.69 $ 33.00 $ 37.37
Low 21.19 24.44 25.30 26.67
Dividends 0.17 0.17 0.17 0.17
- --------------------------------------------------------------------------------
59
REPORT OF MANAGEMENT
TO THE SHAREOWNERS OF KENNAMETAL INC. We are responsible for the integrity of
all information contained in this report. We prepared these financial statements
and related information in accordance with accounting principles generally
accepted in the United States of America and, as such, amounts contained in this
report are based on our best judgment and estimates.
We maintain a system of policies, procedures and controls designed to provide
reasonable, but not absolute, assurance that the financial data and records are
reliable in all material respects and that assets are safeguarded from improper
or unauthorized use. We maintain an active internal audit department that
monitors compliance with this system.
The Board of Directors, acting through its Audit Committee, is ultimately
responsible for determining that we fulfill our responsibilities in the
preparation of the financial statements. The Audit Committee meets periodically
with us, the internal auditors and the independent public accountants to discuss
auditing and financial reporting matters. The internal auditors and independent
public accountants have full access to the Audit Committee without our presence.
We have always placed the utmost importance on conducting our business
activities in accordance with the spirit and letter of the law and the highest
ethical standards. This philosophy is embodied in a code of business ethics and
conduct that is distributed to all employees.
/s/ Markos I. Tambakeras /s/ F. Nicholas Grasberger III
Markos I. Tambakeras F. Nicholas Grasberger III
Chairman of the Board, Vice President and
President and Chief Executive Officer Chief Financial Officer
Shareowner Shareowner
July 26, 2002
REPORT OF AUDIT COMMITTEE
TO THE SHAREOWNERS OF KENNAMETAL INC. The Audit Committee of the Board of
Directors, composed of four independent directors, met seven times during the
year ended June 30, 2002.
The Audit Committee monitors the financial reporting process for accuracy,
completeness and timeliness. In fulfilling our responsibility, the committee
recommended to the Board of Directors the appointment of PricewaterhouseCoopers
LLP as independent public accountants. The Audit Committee reviewed with
management, the internal auditors and the independent public accountants the
overall scope and specific plans for their respective audits. The committee
evaluated with management, Kennametal's annual and quarterly reporting process
and the adequacy of internal controls. The committee met with the internal
auditors and independent public accountants, with and without management
present, to review the results of their examinations, their evaluations of
internal controls and the overall quality of Kennametal's financial reporting.
The Audit Committee participates in a self-assessment program whereby the
composition, activities and interactions of the committee are periodically
evaluated by the committee. The purpose of the program is to provide guidance
with regard to the continual fulfillment of the committee's responsibilities.
/s/ Kathleen J. Hempel
Kathleen J. Hempel
Chairperson, Audit Committee
Shareowner
July 22, 2002
60
[LOGO] KENNAMETAL INC. / AR 2002
REPORT OF INDEPENDENT ACCOUNTANTS
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, 2002, and
the results of their operations and their cash flows for the year ended June 30,
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 audit. We conducted our audit of these
statements in accordance with auditing standards generally accepted in the
United States of America, which 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, 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, and for each of the two years in the period
ended 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 above, the financial statements of Kennametal Inc. as of June 30,
2001, and for each of the two years in the period ended June 30, 2001, 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 and 2000 in Note 2
are appropriate. However, we were not engaged to audit, review or apply any
procedures to the 2001 or 2000 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 or 2000 financial statements
taken as a whole.
/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
Pittsburgh, Pennsylvania
July 26, 2002, except for Note 19 as to which the date is August 30, 2002
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.
REPORT OF PREVIOUS INDEPENDENT PUBLIC ACCOUNTANTS
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.
/s/ Arthur Andersen LLP
Arthur Andersen LLP
Pittsburgh, Pennsylvania
July 20, 2001
61
ELEVEN-YEAR FINANCIAL HIGHLIGHTS
(dollars in thousands, except per share data) 2002 2001 2000
- ----------------------------------------------------------------------------------------------------------------------------------
OPERATING RESULTS
Net sales (1) $ 1,583,742 $ 1,807,896 $ 1,866,578
Cost of goods sold (1) 1,072,918 1,192,176 1,228,685
Operating expense (1) 389,396 425,641 434,136
Interest expense 32,627 50,381 55,079
Restructuring, asset impairment and other special charges (2) 30,189 21,458 22,412
Income taxes 18,900 37,300 43,700
Accounting changes, net of tax (3) 250,406 599 -
Net (loss) income (4) (211,908) 53,288 51,710
- ----------------------------------------------------------------------------------------------------------------------------------
FINANCIAL POSITION
Net working capital $ 375,284 $ 386,711 $ 397,403
Inventories 345,076 373,221 410,885
Property, plant and equipment, net 435,116 472,874 498,784
Total assets 1,523,611 1,825,442 1,941,121
Long-term debt, including capital leases 387,887 582,585 637,686
Total debt, including capital leases 411,367 607,115 699,242
Total shareowners' equity (5) 713,962 796,769 780,254
- ----------------------------------------------------------------------------------------------------------------------------------
PER SHARE DATA
Basic (loss) earnings $ (6.80) $ 1.74 $ 1.71
Diluted (loss) earnings (4) (6.70) 1.73 1.70
Dividends 0.68 0.68 0.68
Book value (at June 30) 20.51 25.84 25.56
Market price (at June 30) 36.60 36.90 21.44
- ----------------------------------------------------------------------------------------------------------------------------------
OTHER DATA
Capital expenditures $ 44,040 $ 59,929 $ 50,663
Number of employees (at June 30) 11,660 12,570 13,210
Average sales per employee (1) $ 131 $ 139 $ 140
Basic weighted average shares outstanding (000) (5) 31,169 30,560 30,263
Diluted weighted average shares outstanding (000) (5) 31,627 30,749 30,364
- ----------------------------------------------------------------------------------------------------------------------------------
KEY RATIOS
Sales growth (1) (12.4)% (3.1)% (2.5)%
Gross profit margin (1) 32.3 34.1 34.2
Operating profit margin (1) 5.8 8.7 8.5
Return on sales (1)(4) (13.4) 2.9 2.8
Return on average shareowners' equity (4) (38.3) 6.8 6.9
Total debt to total capital 36.2 42.9 45.6
Inventory turnover (1) 2.9x 3.1x 2.9x
- ----------------------------------------------------------------------------------------------------------------------------------
n.m. - Not meaningful
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 2002, unusual or nonrecurring items primarily reflect restructuring
charges incurred related to operational improvement programs and a loss on
divestiture. Unusual or nonrecurring items reflect costs associated with
restructuring and asset impairment charges related to operational
improvement programs, a loss on divestiture and costs primarily associated
with the JLK tender offer in 2001; costs associated with environmental
remediation, strategic alternatives and restructuring and asset impairment
charges related to operational improvement programs initiated in 2000; costs
associated with the acquisition of shares of Toshiba Tungaloy and
restructuring and asset impairment charges related to operational
improvement programs initiated in 1999; deferred financing costs related to
a postponed public offering intended to have been offered in connection with
the acquisition of Greenfield in 1998; restructuring costs for the
relocation of the North America Metalworking Headquarters from Raleigh, N.C.
to Latrobe, Pa., and to close a manufacturing facility in 1996;
restructuring and integration costs associated with the acquisition of
Hertel AG in 1994; and settlement and partial reversal of accrued patent
litigation costs in 1993.
(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 reflect 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.
62
[LOGO] KENNAMETAL INC. / AR 2002
1999 1998 1997 1996 1995 1994 1993 1992
- --------------------------------------------------------------------------------------------------------------
$1,914,961 $1,687,516 $1,160,452 $1,079,963 $ 983,873 $ 802,513 $ 598,496 $ 594,533
1,272,090 1,057,089 713,182 625,473 560,867 472,533 352,773 362,967
455,903 419,182 317,315 328,377 293,868 263,300 200,912 196,992
68,594 59,536 10,393 11,296 12,793 13,811 9,549 10,083
24,617 4,595 - 2,666 - 24,749 (1,738) -
32,900 53,900 44,900 43,900 45,000 15,500 14,000 8,100
- - - - - 15,003 - -
39,116 71,197 72,032 69,732 68,294 (4,088) 20,094 12,872
- --------------------------------------------------------------------------------------------------------------
$ 373,582 $ 447,992 $ 175,877 $ 217,651 $ 184,072 $ 130,777 $ 120,877 $ 108,104
434,462 436,472 210,111 204,934 200,680 158,179 115,230 118,248
539,800 525,927 300,386 267,107 260,342 243,098 192,305 200,502
2,000,480 2,091,520 851,243 799,491 781,609 697,532 448,263 472,167
717,852 840,932 40,445 56,059 78,700 90,178 87,891 95,271
861,291 967,667 174,464 131,151 149,730 147,295 110,628 127,954
745,131 735,460 459,608 438,949 391,885 322,836 255,141 251,511
- --------------------------------------------------------------------------------------------------------------
$ 1.31 $ 2.61 $ 2.71 $ 2.62 $ 2.58 $ (0.17) $ 0.93 $ 0.60
1.31 2.58 2.69 2.60 2.56 (0.17) 0.92 0.60
0.68 0.68 0.66 0.60 0.60 0.58 0.58 0.58
24.78 24.66 17.61 16.44 14.75 12.25 11.64 11.64
31.00 41.75 43.00 34.00 34.50 24.63 16.75 17.13
- --------------------------------------------------------------------------------------------------------------
$ 94,993 $ 104,774 $ 73,779 $ 57,556 $ 43,371 $ 27,313 $ 23,099 $ 36,555
13,640 14,380 7,550 7,260 7,030 6,600 4,850 4,980
$ 137 $ 153 $ 159 $ 152 $ 146 $ 125 $ 122 $ 116
29,917 27,263 26,575 26,635 26,486 24,304 21,712 21,452
29,960 27,567 26,786 26,825 26,640 24,449 21,753 21,551
- --------------------------------------------------------------------------------------------------------------
13.5% 45.4% 7.5% 9.8% 22.6% 34.1% 0.7% (3.8)%
33.6 37.4 38.5 42.1 43.0 41.1 41.1 38.9
7.7 11.6 10.9 11.3 12.9 4.7 7.2 5.2
2.0 4.2 6.2 6.5 6.9 n.m. 3.4 2.2
5.3 12.2 15.8 17.0 19.3 n.m. 8.1 5.2
51.9 55.4 27.1 22.5 27.0 30.6 30.2 33.7
2.8x 3.2x 3.4x 3.0x 3.1x 3.1x 3.1x 3.0x
- --------------------------------------------------------------------------------------------------------------
(4) Excluding unusual or nonrecurring items in 2002 and the charge for the SFAS
No. 142 accounting principle change of $250.4 million, net of tax, net
income was $61.6 million; diluted earnings per share were $1.95; return on
sales was 3.9 percent; and return on average shareowners' equity was 11.1
percent. All periods prior to 2002 include goodwill amortization. Excluding
unusual or nonrecurring items in 2001 and the charge for the accounting
principle change of $0.6 million, net of tax, net income was $66.6 million;
diluted earnings per share were $2.17; return on sales was 3.7 percent; and
return on average shareowners' equity was 8.4 percent. Excluding unusual or
nonrecurring items in 2000 and an extraordinary loss of $0.3 million, net of
tax, net income was $64.7 million; diluted earnings per share were $2.13;
return on sales was 3.5 percent; and return on average shareowners' equity
was 8.6 percent. Excluding unusual or nonrecurring items in 1999, net income
was $54.3 million; diluted earnings per share were $1.82; return on sales
was 2.8 percent; and return on average shareowners' equity was 7.3 percent.
Excluding unusual or nonrecurring items in 1998 and the effects of the
Greenfield acquisition, net income was $88.7 million; diluted earnings per
share were $3.23; return on sales was 5.3 percent; and return on average
shareowners' equity was 15.2 percent. Excluding unusual or nonrecurring
items in 1996, net income was $71.4 million; diluted earnings per share were
$2.66; return on sales was 6.6 percent; and return on average shareowners'
equity was 17.4 percent.
(5) 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.
63