1
FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED JUNE 30, 1999
Commission File Number 1-13059
JLK DIRECT DISTRIBUTION INC.
(Exact name of registrant as specified in its charter)
Pennsylvania 23-2896928
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1600 TECHNOLOGY WAY
P.O. BOX 231
LATROBE, PENNSYLVANIA 15650
(Address of principal executive offices)
Registrant's telephone number, including area code: 724-539-5000
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Title of each class on which registered
------------------- -------------------
Class A Common Stock, par value $.01 per share New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None.
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months, and (2) has been subject to such filing requirements
for the past 90 days. YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
As of September 8, 1999, the aggregate market value of the registrant's Common
Stock held by non-affiliates of the registrant, estimated solely for the
purposes of this Form 10-K, was approximately $13,700,000. For purposes of the
foregoing calculation only, all directors and executive officers of the
registrant and each person who may be deemed to own beneficially more than 5% of
the registrant's Common Stock have been deemed affiliates.
As of September 8, 1999, there were 4,273,390 shares of Class A Common Stock and
20,237,000 shares of Class B Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the 1999 Annual Meeting of Shareowners are
incorporated by reference into Parts III and IV.
2
TABLE OF CONTENTS
ITEM NO. PAGE
PART I
1. Business....................................... 1
2. Properties..................................... 5
3. Legal Proceedings.............................. 5
4. Submission of Matters to
a Vote of Security Holders..................... 5
PART II
5. Market for the Registrant's Capital
Stock and Related Shareowner Matters........... 6
6. Selected Financial Data........................ 6
7. Management's Discussion and
Analysis of Financial Condition and
Results of Operations.......................... 8
7a. Quantitative and Qualitative
Disclosure About Market Risk...................14
8. Financial Statements and
Supplementary Data.............................14
9. Changes in and Disagreements on
Accounting and Financial Disclosure............30
PART III
10. Directors and Executive Officers of
the Registrant.................................31
11. Executive Compensation.........................31
12. Security Ownership of Certain Beneficial
Owners and Management..........................31
13. Certain Relationships and Related
Transactions...................................31
PART IV
14. Exhibits, Financial Statement
Schedules and Reports on Form 8-K..............32
3
PART I
ITEM 1. BUSINESS
COMPANY OVERVIEW
JLK Direct Distribution Inc. (the company or JLK) is one of the largest
suppliers of a broad range of metalworking consumables and related products in
the United States, offering a full line of cutting tools, carbide and other tool
inserts, abrasives, drills, machine tool accessories, hand tools and other
industrial supplies. To meet the varying supply needs of small-, medium- and
large-sized customers, the company offers: (i) a direct-marketing program,
through J&L Industrial Supply (J&L), whereby the company supplies small- to
large-sized customers through catalog and showroom sales, and a direct field
sales force, and (ii) integrated industrial supply programs or Full Service
Supply (FSS) programs, whereby medium- and large-sized industrial manufacturers
engage the company to carry out all aspects of complex metalworking supply
processes, including needs assessment, cost analysis, procurement planning,
supplier selection, "just-in-time" restocking of supplies and ongoing technical
support. The company also conducts its direct-marketing program for small- and
medium-sized customers in the United Kingdom and Germany.
The company is a subsidiary of Kennametal Inc. (Kennametal). Kennametal Inc. is
a vertically integrated manufacturer and marketer of consumable tools and
related supplies for the metalworking, mining and highway construction
industries, as well as specially engineered products for a variety of other
industries. Kennametal specializes in developing and manufacturing metalcutting
tools and wear-resistant parts using a specialized type of powder metallurgy.
Kennametal's metalcutting tools are made of cemented carbides, ceramics,
cermets, high-speed steel and other hard materials. Kennametal also manufactures
and markets a complete line of toolholders, toolholding systems and rotary
cutting tools by machining and fabricating steel bars and other metal alloys.
This Form 10-K contains "forward-looking statements," as defined by Section 21E
of the Securities Exchange Act of 1934. Actual results may materially differ
from those expressed or implied in the forward-looking statements. Factors that
could cause actual results to differ materially include, but are not limited to,
the extent that the economic conditions in the United States and, to a lesser
extent, Europe, are not sustained, risks associated with integrating businesses,
demands on management resources, risks associated with international markets
such as currency exchange rates and competition and the effect of third party or
company failures to achieve timely remediation of year 2000 issues. The company
undertakes no obligation to publicly release any revisions to forward-looking
statements to reflect events or circumstances occurring after the date hereof.
INDUSTRY OVERVIEW
The company operates in a large, fragmented industry characterized by multiple
channels of distribution. The company believes that there are numerous small
retailers, dealers and distributors, substantially most of which have annual
sales of less than $10.0 million, that supply a majority of this market. The
distribution channels in the metalworking consumables and related products
market include retail outlets, small dealers, regional and national distributors
utilizing direct sales forces and manufacturers' representatives.
The company believes that increasing numbers of industrial manufacturers are
searching for ways to reduce costs by eliminating the inefficiencies of
traditional industrial supply distribution. This growing recognition by
customers of the high costs and operational inefficiencies associated with
purchasing industrial supplies from traditional distributors has increased
demand for alternative methods of distribution, leading to the development of
programs that are generally referred to as integrated supply.
The traditional model for the distribution of industrial supplies is burdened by
both the duplication and the inefficient performance of multiple functions. In
the traditional model, the industrial distributor must (i) source and absorb the
freight costs for the item, (ii) receive, warehouse and account for the item,
(iii) invest in inventory and incur the associated carrying costs and (iv)
market and sell the item to the end user. Once the need for the item arises, the
manufacturing facility requiring the item must repeat many of the above steps.
Through the company's integrated FSS programs, which focus on the acquisition,
possession and use of metalworking consumables and related products, each
1
4
activity is performed only once. The procurement of industrial supplies is
generally outside the core activity of most manufacturers. For example,
industrial supplies are generally purchased by personnel whose expertise in
purchasing these items is limited. In addition, supplies are typically stored in
a number of locations within an industrial facility, resulting in excess
inventories and duplicate purchase orders. Finally, the company believes that
industrial supplies are frequently purchased by multiple personnel in
uneconomical quantities, and a substantial portion of most facilities'
industrial supplies are one-time purchases which entail higher per-item prices
and time-consuming administrative efforts. As a result, the company believes
there is often potential to manage the industrial supply procurement process
more efficiently and with greater cost savings.
Despite the apparent inefficiencies of the traditional industrial supply
purchasing process, long-standing relationships with local retailers and
distributors have generally perpetuated the status quo. Due to limited capital
availability, high operating cost structures and smaller sales volumes,
distributors are experiencing increasing pressure to consolidate and curtail
services and certain product lines in order to remain competitive. Even
distributors with extensive field sales forces are finding it increasingly
difficult to visit all buyers cost-effectively and to provide the support
necessary to satisfy their demands for cost containment and improved efficiency.
The company believes that the relative inability of traditional distribution
channels to respond to these changing industry dynamics has created a continuing
opportunity for the growth of direct marketing and integrated supply
organizations such as the company. As a result of these dynamics,
non-traditional distributors, such as the company, have captured an increasing
share of sales by providing lower total purchasing costs, better product
selection and a higher level of service. As a leading non-traditional supplier
with proven capabilities both in direct marketing and integrated supply, the
company believes it is well-positioned to continue to take advantage of present
market dynamics and enjoy continued growth in market share.
BUSINESS STRATEGY
The company's business strategy is to become the preferred supplier of
metalworking consumables and related products to the metalworking industry
by being a one-stop shop for metalworking products for customers of any size and
by offering managed solutions for larger customers.
J&L serves the needs of predominantly small- and medium-sized metalworking
customers by offering 130,000 stock keeping units (SKUs) through the company's
2,114-page master catalog, monthly promotional sales flyer (the "Advantage"),
additional mailings and advertisements, telemarketing efforts and direct sales
efforts. The company has 31 showrooms, including six distribution centers in the
United States and one distribution center in the United Kingdom. Additionally,
the company has one distribution center in Germany and 13 other locations added
through acquisitions. These other locations will be reported as such until they
have been converted into showrooms or distribution centers, or closed.
The company offers customers the advantages of (i) a single source of supply for
all metalworking consumables and related products, (ii) a tiered product
offering (such as "good," "better" and "best"), (iii) same-day pickup or
delivery for the most popular products stocked at showrooms, (iv) same-day
direct shipping and (v) a state-of-the-art order entry system that tracks
product availability and pricing, provides technical product information and
results in an order being completed in an average time of three minutes. The
company has a dedicated sales force based in each showroom who actively call on
targeted customers. In addition, the company serves the needs of medium- and
large-sized customers through a technically oriented outside sales force. This
sales force is largely comprised of employees of acquired companies.
FSS programs allow customers to achieve substantial cost savings in metalworking
consumables and overall manufacturing processes by outsourcing the entire
process of acquiring and possessing metalworking and related products at
manufacturing facilities. Customers, such as General Motors Corporation, Allied
Signal and Baker Hughes, use FSS programs at designated manufacturing facilities
to (i) consolidate all their metalworking consumables and related product
purchases with one vendor, (ii) eliminate a significant portion of the
administrative overhead burden associated with the internal purchasing function,
(iii) ensure appropriate technical expertise in the selection and use of
supplies for complex metalworking processes and (iv) minimize the level of
investment in tooling inventory, thereby reducing inventory carrying costs. The
company's technical experts customize and manage a comprehensive computerized
product identification, tracking and purchasing system that analyzes and
optimizes supply
2
5
usage, helps select appropriate products and allows for "just-in-time"
replacement of inventory. To increase efficiency and maximize cost savings for
its customers, the company also provides ongoing application assistance in the
usage of metalworking tools. The company believes that its FSS programs
typically reduce customers' costs of acquiring, possessing and using
metalworking products by approximately 5 to 20 percent per year.
Two important trends are now affecting the industrial supply industry. First,
the industrial supply industry is experiencing consolidation of currently
fragmented distribution channels, as customers seek and technology makes
possible the convenience, cost savings and economies of scale associated with
single sources of supplies. Second, to achieve even greater cost savings and
efficiencies, manufacturers are outsourcing complex procurement and possession
processes needed to supply metalworking products that are critical to their
manufacturing operations. As a market leader with a broad range of products and
services and proven capabilities, the company is well-positioned to continue
taking advantage of these industry trends.
COMPETITION
The metalworking supply industry is a large, fragmented industry that is highly
competitive. The company faces competition (i) in the small- and medium-sized
metalworking markets from traditional channels of distribution such as retail
outlets, small dealers, regional or national distributors utilizing direct sales
forces, and manufacturers' representatives and (ii) in the large industrial
metalworking market from large distributors and other companies that offer
varying degrees and types of integrated industrial supply programs. The company
believes that sales of metalworking products will become more concentrated over
the next few years, which may make the industry more competitive. Certain of the
company's competitors offer a greater variety of products (including
non-metalworking products) and have greater financial and other resources than
the company. The company believes that customer purchasing decisions are
primarily based on one or more of the following criteria: product price, product
selection, product availability, superior customer service, total cost of
acquisition, possession and use of products and convenience. The company seeks
to distinguish itself from other direct marketers and distributors of industrial
supplies through its national presence and metalworking focus, its application
of information technology and its attractive, modern showrooms.
SUPPLIERS
The company purchases substantially all of its products for its direct-marketing
and FSS programs from approximately 800 vendors. In fiscal 1999, approximately
15 percent of the company's sales were of Kennametal products. In fiscal 1998
and 1997, approximately 16 percent of the company's sales were of Kennametal
products. Other than Kennametal, the company is not materially dependent on any
one supplier or small group of suppliers. If an FSS program customer desires to
continue ordering a particular brand of metalworking tool or obtains or has a
contract providing for more favorable pricing than the company generally
obtains, the company will assume that contract or enter into a similar contract
for the limited purpose of supplying such product to that customer. Other than
Kennametal, no single supplier accounted for more than 5 percent of the
company's total purchases in fiscal 1999, 1998 or 1997.
ACQUISITIONS AND DIVESTITURE
During fiscal 1998 and 1997, the company acquired the following distributors of
metalcutting tools and industrial supplies:
ACQUISITION
DATE ACQUIRED ACQUISITION HEADQUARTERS
- --------------------------------------------------------------------------------
Fiscal 1998:
October 1997 Car-Max Tool & Cutter, Inc. Rockford, Ill.
December 1997 GRS Industrial Supply Co. Grand Rapids, Mich.
January 1998 Production Tools Sales, Inc. Dallas, Texas
March 1998 Dalworth Tool & Supply, Inc. Arlington, Texas
March 1998 ATS Industrial Supply Co. Salt Lake City, Utah
May 1998 Strong Tool Co. Cleveland, Ohio
- --------------------------------------------------------------------------------
Fiscal 1997:
April 1997 Strelinger Company Troy, Mich.
May 1997 Mill & Abrasive Supply, Inc. Roseville, Mich.
- --------------------------------------------------------------------------------
There were no acquisitions during fiscal 1999. All acquisitions were accounted
for under the purchase method of accounting. In the third quarter of 1999, the
company sold the assets of the steel mill business of its subsidiary, Strong
Tool Co. Because this business was marginally profitable, there was a slightly
unfavorable impact on earnings as a result of this sale.
3
6
As the industrial supply industry continues to consolidate, the company will
consider acquisitions to supplement its growth strategy if opportunities arise.
From time to time, the company has engaged in, and will continue to engage in,
preliminary discussions with respect to potential acquisitions. The company is
not currently a party to any oral or written acquisition agreement with respect
to any material acquisition candidate.
INFORMATION SYSTEMS
The information systems used by the company allow centralized management of key
functions, including communication links between distribution centers, inventory
and accounts receivable management, purchasing, pricing, sales and distribution,
and the preparation of daily operating control reports which provide concise and
timely information regarding key aspects of its business. These systems enable
the company to ship to customers on a same-day basis, respond quickly to order
changes and provide a high level of customer service. In addition, these systems
enable the company to achieve cost savings, deliver exceptional customer
service, manage its operations centrally and manage its FSS programs. Certain of
the company's systems operate over a wide-area network and represent real-time
systems that allow each distribution center to share information and monitor
daily progress relating to sales activity, credit approval, inventory levels,
stock balancing, vendor returns, order fulfillment and other performance
measures. The company also maintains buying and inventory management systems
that monitor substantially all its SKUs and produce requisitions to purchase
inventory from vendors for replenishment based on projected customer ordering
models. The company has invested significant resources in developing an
extensive customer and prospect database which includes detailed information,
including customer size, industry of operation, various demographic and
geographic characteristics and purchase histories of company products. The
company also provides EDI invoicing, funds transfer, ordering, shipping and
acknowledgment to large customers.
In order to handle the company's future growth and to prepare for the year 2000,
the company is in the process of implementing a new information system, HK
System's Enterprise Information System (Enterprise System). The Enterprise
System will interface with Kennametal's SAP system and will provide the existing
functionality of the company's current systems, as well as numerous
enhancements. In addition, the Enterprise System will enable all areas of the
company to function on one common system, including the direct-marketing
program, the FSS programs and all acquisitions. The Enterprise System will
provide the platform for future growth and the flexibility for future
enhancements.
EMPLOYEES
As of June 30, 1999, the company employed approximately 1,300 employees, none of
whom are represented by a labor union. The company considers its relationships
with employees to be good and has experienced no work stoppages.
CORPORATE SUBSIDIARIES
The following is a summary of the company's consolidated subsidiaries at June
30, 1999:
J&L Industrial Supply U.K., England (branch)
J&L Werkzeuge und Industriebedarf GmbH, Germany
Abrasive & Tool Specialties Company, United States
GRS Industrial Supply Co., United States
J&L America, Inc., United States
Production Tools Sales, Inc., United States
Strong Tool Co., United States
4
7
ITEM 2. PROPERTIES
PROPERTIES
The company's principal executive offices are located at 1600 Technology Way,
P.O. Box 231, Latrobe, Pennsylvania 15650. The company's headquarters and
distribution centers, all of which are leased, are as follows:
LOCATION DESCRIPTION LEASE EXPIRATION APPROXIMATE SQUARE FEET
- -------------------------------------------------------------------------------------------------------------------
Charlotte, N.C. Distribution Center & Showroom 06/30/07 46,000
Elk Grove Village, Ill. Distribution Center & Showroom 02/27/05 128,000
Carrollton, Texas Distribution Center & Showroom 07/31/01 44,000
Wednesbury, Distribution Center, Showroom & 06/24/13 93,000
West Midlands, U.K. European Headquarters
Livonia, Mich.(2) Distribution Center, Showroom &
North American Headquarters 12/31/99-02/28/01 196,000
Los Angeles, Calif.(1) Distribution Center & Showroom 06/30/07 7,000
Neunkirchen, Germany(1) Distribution Center 09/30/00 2,200
Kent, Wash. Distribution Center & Showroom 07/31/02 27,000
- -------------------------------------------------------------------------------------------------------------------
(1) Shared location with Kennametal. The approximate square feet noted herein
only represents the square footage of the office space leased by the
company at these locations. The warehouses at these locations are managed
by Kennametal. A portion of the operating costs of these warehouses is
billed to the company through warehousing agreements with Kennametal.
(2) The company maintains its North American Headquarters and Livonia
Distribution Center in five separate locations in Livonia, Mich.
In addition, the company maintains 24 other showrooms, all but one of which are
leased, in 14 states, ranging in size from 6,000 to 21,000 square feet. The
leases for these showrooms will expire at various periods between September 1999
and November 2003.
The company also leases 12 locations and owns one location in 6 states that have
been acquired through recent acquisitions. These acquired locations range in
size from 3,500 to 30,000 square feet, with the leases expiring at various
periods between January 2000 and June 2003.
ITEM 3. LEGAL PROCEEDINGS
There are no material pending legal proceedings, other than litigation
incidental to the ordinary course of business, to which the company or any of
its subsidiaries is a party or of which any of their property is the subject.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of fiscal 1999, there were no matters submitted to a
vote of security holders through the solicitation of proxies or otherwise.
5
8
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S CAPITAL STOCK AND RELATED SHAREOWNER MATTERS
The company's Class A Common Stock is traded on the New York Stock Exchange (the
NYSE) under the symbol "JLK". The following table sets forth the range of the
high and low sales price as reported by the NYSE:
QUARTER ENDED: SEPT. 30 DEC. 31 MAR. 31 JUNE 30
- ------------------------------------------------------------
FISCAL 1999:
High $22 3/8 $13 1/8 $13 1/2 $12 3/8
Low 10 1/2 9 1/4 7 7/8 8 3/8
- ------------------------------------------------------------
Fiscal 1998:
High $30 1/4 $32 15/16 $39 1/2 $39 3/8
Low 22 3/4 26 1/2 28 20
- ------------------------------------------------------------
As of September 8, 1999 the approximate number of holders of record of the Class
A Common Stock was 69 and Class B Common Stock was one.
The company has not declared cash dividends on either the Class A Common Stock
or the Class B Common Stock and does not have any plans to pay any cash
dividends on either issue in the foreseeable future. The company anticipates
that any earnings that might be available to pay dividends on either issue will
be retained to finance the business of the company.
USE OF PROCEEDS FROM REGISTERED SECURITIES
On July 2, 1997, the company consummated the initial public offering of
4,897,000 shares of its Class A Common Stock at a price of $20.00 per share (the
Offering). The net proceeds from the Offering, after deducting underwriting
discounts and estimated expenses, were $90.4 million and represented the sale of
approximately 20 percent of the company's outstanding common stock. The net
proceeds were used by the company to repay $20.0 million of short-term debt
related to a dividend paid to Kennametal and to repay $20.0 million to
Kennametal for acquisitions in fiscal 1997 and income taxes paid on behalf of
the company. The remaining net proceeds of $50.4 million were used to pay for
fiscal 1998 acquisitions.
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated income statement and balance sheet data for the
company presented below are derived from the company's Consolidated Financial
Statements. The selected financial information presented below should be read in
conjunction with, and is qualified by reference to, the more detailed
information in the Consolidated Financial Statements and notes thereto included
elsewhere in this document, Management's Discussion and Analysis of Financial
Condition and Results of Operations and other financial information set forth
herein.
6
9
FISCAL YEAR ENDED JUNE 30, 1999 1998 1997 1996 1995
- -------------------------------------------------------------------------------------------------------------------
(in thousands, except per share data)
INCOME STATEMENT DATA:
Net sales $531,642 $425,348 $316,189 $243,969 $188,202
Cost of goods sold 361,717 277,417 213,020 166,326 127,917
- -------------------------------------------------------------------------------------------------------------------
Gross profit 169,925 147,931 103,169 77,643 60,285
Operating expenses 135,393 106,623 70,976 52,761 40,658
- -------------------------------------------------------------------------------------------------------------------
Operating income 34,532 41,308 32,193 24,882 19,627
Interest expense (income) and other 881 (3,068) 368 -- --
- -------------------------------------------------------------------------------------------------------------------
Income before provision for income taxes 33,651 44,376 31,825 24,882 19,627
Provision for income taxes 13,291 17,300 12,518 9,819 7,799
- -------------------------------------------------------------------------------------------------------------------
Net income $ 20,360 $ 27,076 $ 19,307 $ 15,063 $ 11,828
===================================================================================================================
PER SHARE DATA:
Basic earnings per share $ 0.83 $ 1.08 -- --
===================================================================================================
Diluted earnings per share $ 0.83 $ 1.07 -- --
===================================================================================================
Weighted average shares outstanding 24,510 25,138 -- --
===================================================================================================
Diluted weighted average shares outstanding 24,513 25,277 -- --
===================================================================================================
Pro forma basic and diluted
earnings per share(1) -- -- $ 0.92 $ 0.72
===================================================================================================
Pro forma weighted and diluted
average shares outstanding(1) -- -- 20,897 20,897
===================================================================================================
JUNE 30, 1999 1998 1997 1996 1995
- -------------------------------------------------------------------------------------------------------------------
(in thousands)
BALANCE SHEET DATA:
Working capital $ 128,317 $ 109,314 $ 61,472 $ 73,263 $ 51,945
Total assets 274,989 275,586 165,488 121,045 98,893
Shareowners' equity 215,874 195,935 92,731 97,991 76,722
- -------------------------------------------------------------------------------------------------------------------
FISCAL YEAR ENDED JUNE 30, 1999 1998 1997 1996 1995
- -------------------------------------------------------------------------------------------------------------------
SELECTED OPERATING DATA:
Active direct marketing customers(2)(3) 123,000 112,000 96,000 77,000 64,000
Number of SKUs(3)(4) 130,000 110,000 100,000 80,000 70,000
Number of publications per year 62 48 26 19 16
Total number of publications mailed 9,100,000 6,400,000 4,100,000 3,700,000 2,900,000
Direct-mail costs(5) $9,982,000 $6,974,000 $6,301,000 $4,249,000 $2,613,000
Showroom and distribution facilities(3) 32 34 24 19 12
Acquisition locations(3)(6) 13 21 4 -- --
Full Service Supply programs:
Customers(2)(3) 150 115 60 42 29
Site locations(3) 231 194 120 86 69
- -------------------------------------------------------------------------------------------------------------------
(1) Gives effect to the issuance of 20,897,000 shares of Class B Common Stock
to Kennametal for the periods presented.
(2) Number of customers that have purchased products from the company within
the 12 months preceding the relevant period end.
(3) Represents data at period end.
(4) Represents the number of SKUs offered in the United States. The number of
SKUs offered in European markets range from 45,000 to 75,000 and 45,000 to
60,000 SKUs for 1999 and 1998, respectively.
(5) Direct-mail costs include direct production and mailing costs.
(6) Represents locations acquired through acquisitions that have not yet been
converted into a showroom or a distribution center, or closed.
7
10
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
The accompanying financial information of the company includes the operations of
J&L America, Inc. d/b/a J&L Industrial Supply (J&L), a previously wholly owned
subsidiary of Kennametal, and Full Service Supply (FSS), which previously had
been operated as a program of Kennametal. Prior to April 1, 1997, the company
had no separate legal status or existence. Kennametal incorporated the company
as a Pennsylvania corporation under the name JLK Direct Distribution Inc. in
April 1997.
In April 1997, the company's Board of Directors authorized management to file a
registration statement with the Securities and Exchange Commission with respect
to an initial public offering (IPO) of the company's Class A Common Stock. In
anticipation of the IPO, Kennametal contributed to the company the stock of J&L,
including the J&L United Kingdom operations, and the assets and liabilities of
FSS. Immediately prior to the effective date of the IPO, Kennametal exchanged
its currently outstanding investment for 20,897,000 shares of Class B Common
Stock.
On July 2, 1997, the company consummated the IPO of 4,897,000 shares of its
Class A Common Stock at a price of $20.00 per share. The net proceeds from the
IPO were $90.4 million and represented the sale of approximately 20 percent of
the company's outstanding common stock. The net proceeds were used by the
company to repay $20.0 million of short-term debt related to a dividend paid to
Kennametal and to repay $20.0 million to Kennametal for acquisitions in fiscal
1997 and income taxes paid on behalf of the company. The remaining net proceeds
of $50.4 million were used to pay for fiscal 1998 acquisitions.
In connection with the IPO, Kennametal surrendered to the company 640,000 shares
of Class B Common Stock equal to the number of additional shares of Class A
Common Stock purchased by the underwriters upon exercise of the underwriters'
over-allotment option. In addition, Kennametal sold 20,000 shares of Class B
Common Stock at $20.00 per share to one of the members of its and the company's
board of directors. The 20,000 shares of Class B Common Stock were subsequently
converted on a one-to-one basis to Class A Common Stock. Subsequent to the IPO,
4,917,000 shares of Class A Common Stock were outstanding, and Kennametal held
20,237,000 shares of Class B Common Stock. Kennametal's ownership increased to
approximately 83 percent due to treasury stock purchases made by the company
since the IPO. The company and Kennametal operate as separate companies.
RESULTS OF OPERATIONS
The following discussion should be read in connection with the consolidated
financial statements of JLK and the related footnotes.
FISCAL YEAR ENDED JUNE 30, 1999 COMPARED TO FISCAL YEAR ENDED JUNE 30, 1998
NET SALES. Net sales for fiscal 1999 were $531.6 million, an increase of 25.0
percent from $425.3 million in fiscal 1998. The overall increase in sales was
predominately attributable to acquisitions, and to a lesser extent, growth from
new FSS programs and increased sales in Europe. This increase was offset by
lower mail-order sales due to the company's reduction of lower-margin business
from acquired companies, a reduction in FSS sales due to the General Electric
contract (GE Contract) disengagement and the divestiture of the Strong Tool Co.
steel mill business. Excluding acquisitions and the divestiture, net sales were
flat compared to last year.
J&L external sales for fiscal 1999 were $400.3 million, an increase of 35.4
percent from $295.6 million in fiscal 1998. This increase in sales was primarily
due to acquisitions, which generated $117.9 million in sales, and to a lesser
extent, increased sales in Europe. This increase was offset in part by lower
sales of certain acquired companies due to the reduction of lower-margin
business, the downturn in the oil and gas markets and the divestiture of the
Strong Tool Co. steel mill business. Excluding acquisitions and the divestiture,
J&L sales were flat compared to the prior year. At June 30, 1999, J&L operated a
total of 31 showrooms, including eight distribution centers, and 13 other
locations added through acquisitions. This compares to 33 showrooms, including
nine distribution centers, and 21 other locations added through acquisitions at
June 30, 1998.
FSS external sales for fiscal 1999 were $131.3 million, an increase of 1.2
percent from $129.7 million in fiscal 1998. Excluding the effect of the GE
Contract disengagement, sales increased approximately 20 percent.
8
11
This is due to the growth in new and existing FSS programs. At June 30, 1999,
FSS provided programs to 150 customers covering 231 different facilities. This
compares to 115 customers covering 194 different facilities at June 30, 1998.
GROSS PROFIT. Gross profit for fiscal 1999 was $169.9 million, an increase of
14.9 percent from $147.9 million in fiscal 1998. Gross margin for fiscal 1999
was 32.0 percent compared to 34.8 percent in fiscal 1998. The gross margin was
affected by lower-margin sales from acquisitions, growth in FSS programs and
weaker demand in the higher-margin mail-order business.
The gross profit margin at J&L decreased due to the addition of the lower-margin
sales from the acquisitions while the FSS gross profit margin was approximately
the same as the prior year.
OPERATING EXPENSES. Operating expenses for fiscal 1999 were $135.4 million, an
increase of 27.0 percent from $106.6 million in fiscal 1998. Operating expenses
as a percentage of net sales were 25.5 percent in fiscal 1999 compared to 25.1
percent in fiscal 1998. Operating expenses at J&L increased while operating
expenses at FSS remained relatively flat.
J&L operating expenses increased primarily as a result of increased costs from
acquisitions, including higher amortization of intangible assets, the opening of
new showrooms, the relocation of the United Kingdom office and distribution
center and higher direct mail costs. This was partially offset by cost-reduction
actions implemented in November 1998. These cost-reduction actions involved
selected work force reductions, facility consolidations and closings and other
measures. The GE Contract disengagement resulted in lower operating expenses at
FSS, which were offset by additional expenses related to new FSS programs for
customers covering more than 35 different facilities.
Included in the company's operating expenses were charges from Kennametal for
warehousing, administrative, financial and management information systems
services provided to the company. Charges from Kennametal were $9.5 million in
fiscal 1999, a decrease of 21.7 percent from $12.1 million in fiscal 1998.
Charges from Kennametal as a percentage of net sales were 1.8 percent in fiscal
1999 compared to 2.8 percent in fiscal 1998. The decline in total charges from
Kennametal resulted from the reduction in warehouse charges in fiscal 1999 due
to the company assuming the operation of several warehouses previously operated
by Kennametal, the closure of another commonly operated facility and the
assumption of more administrative functions by the company. Such charges are
expected to continue to decline slightly in coming years.
INTEREST EXPENSE (INCOME) AND OTHER. The company incurred net interest expense
from Kennametal of approximately $0.3 million and net interest income of $2.9
million during fiscal 1999 and 1998, respectively.
The decrease in interest income from fiscal 1998 is due to prior year's
investments made from the residual proceeds the company received from its IPO
and from increased costs due to prior year acquisitions.
INCOME TAXES AND NET INCOME. The effective tax rate was 39.5 percent in fiscal
1999 compared to 39.0 percent in fiscal 1998. Net income decreased 24.8 percent
to $20.4 million in fiscal 1999, as a result of lower-margin sales from acquired
companies, an unfavorable product mix, higher operating expenses and higher
interest expense.
FISCAL YEAR ENDED JUNE 30, 1998 COMPARED TO FISCAL YEAR ENDED JUNE 30, 1997
NET SALES. Net sales for fiscal 1998 were $425.3 million, an increase of 34.5
percent from $316.2 million in fiscal 1997. Net sales increased due to
acquisitions, new showrooms, a new distribution center in Germany, expansion of
the product offering, further penetration of existing customers and new
customers in the United Kingdom. Excluding acquisitions, sales increased 8.8
percent. Additionally, the increase in sales was realized despite a $31.8
million reduction in sales due to the GE contract disengagement.
J&L external sales for fiscal 1998 were $295.6 million, an increase of 68.4
percent from $175.5 million in fiscal 1997. Net sales increased primarily due to
the acquisition of six industrial supply companies during fiscal 1998, the
opening of four new showrooms, including one distribution center, and the
opening of a new distribution center in Germany. Sales also benefited from the
addition of more than 10,000 SKUs to the 1998 master catalog, which expanded the
product offering to 110,000 SKUs, and further penetration of existing customers.
The six acquired companies had annual
9
12
sales of approximately $137.0 million in their latest fiscal year and provided
21 additional locations, primarily in the Midwestern United States and Texas.
Net sales also rose to a lessor extent because of increased sales to new
customers in the United Kingdom. Excluding the acquisitions, J&L sales increased
22 percent.
At June 30, 1998, J&L operated 33 showrooms, including nine distribution
centers, and 21 other locations added through acquisitions. In the previous
year, J&L operated 24 showrooms, including seven distribution centers, and four
other locations added through acquisitions.
FSS external sales for fiscal 1998 were $129.7 million, a decrease of 7.8
percent from $140.7 million in fiscal 1997. Excluding the effect of the GE
Contract disengagement, sales increased approximately 25 percent. This is due to
the growth in new and existing FSS programs. At June 30, 1998, FSS provided
programs to 115 customers covering 194 different facilities. This compares to 60
customers covering 120 different facilities at June 30, 1997.
GROSS PROFIT. Gross profit for fiscal 1998 was $147.9 million, an increase of
43.4 percent from $103.2 million in fiscal 1997. Gross margin for fiscal 1998
was 34.8 percent compared to 32.6 percent in fiscal 1997. The gross margin
improved due to a more favorable sales mix as well as improved contract pricing
on new FSS programs and the positive impact of the GE Contract disengagement.
These benefits were partially offset by acquisition-related effects.
The gross profit margin at J&L decreased due to the addition of lower-margin
acquisition sales. The FSS gross profit margin increased due to improved
contract pricing on new programs and the positive impact of the GE Contract
disengagement.
OPERATING EXPENSES. Operating expenses for fiscal 1998 were $106.6 million, an
increase of 50.2 percent from $71.0 million in fiscal 1997. Operating expenses
as a percentage of net sales were 25.1 percent in fiscal 1998 compared to 22.4
percent in fiscal 1997. Operating expenses at J&L increased while operating
expenses at FSS remained relatively flat.
J&L operating expenses increased as a result of acquisitions, including higher
amortization of intangible assets, and from higher costs associated with the
opening of new showrooms and new distribution centers. New showroom and
distribution center opening costs also include additional product promotions,
increased direct mail costs and new customer marketing campaigns. Overall,
operating expenses at FSS remained flat. The GE Contract disengagement resulted
in lower operating expenses which were offset by additional expenses related to
new FSS programs for customers covering more than 70 different facilities.
Included in the company's operating expenses were charges from Kennametal for
warehousing, administrative, financial and management information systems
services provided to the company. Charges from Kennametal were $12.1 million in
fiscal 1998, an increase of 30.3 percent from $9.3 million in fiscal 1997.
Charges from Kennametal as a percentage of net sales were 2.8 percent in fiscal
1998 compared to 2.9 percent in fiscal 1997. The increase in total charges from
Kennametal resulted primarily from increased costs to support higher sales
volume.
INTEREST EXPENSE (INCOME) AND OTHER. The company earned interest income from
Kennametal of approximately $2.9 million during fiscal 1998 due to investments
made from the residual proceeds the company received from its IPO and from
excess cash.
INCOME TAXES AND NET INCOME. The effective tax rate was 39.0 percent in fiscal
1998 compared to 39.3 percent in fiscal 1997. Net income increased 40.2 percent
to $27.1 million in fiscal 1998, as a result of higher sales and an improved
gross margin, offset by higher operating expenses.
SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The following table sets forth summary quarterly financial information for
fiscal 1999 and 1998. In the opinion of management, such information has been
prepared on the same basis as the consolidated financial statements and reflects
all necessary adjustments (consisting of only normal recurring adjustments) for
a fair presentation of such unaudited quarterly results when read in conjunction
with the consolidated financial statements and notes hereto. The operating
results are not necessarily indicative of results for any future period as there
can be no assurance that any trends reflected in such results will continue in
the future.
10
13
QUARTER ENDED: Sept. 30 Dec. 31 Mar. 31 June 30
- ---------------------------------------------------------
(in thousands,
except per share data)
FISCAL 1999:
Net sales $131,762 $133,735 $138,306 $127,839
Gross profit 42,790 42,997 44,066 40,072
Net income 3,724 5,212 6,357 5,067
Basic earnings
per share 0.15 0.21 0.26 0.21
Diluted earnings
per share 0.15 0.21 0.26 0.21
- ---------------------------------------------------------
Fiscal 1998:
Net sales $ 95,420 $ 93,693 $109,945 $126,290
Gross profit 32,249 34,537 39,146 41,999
Net income 6,769 6,977 7,338 5,992
Basic earnings
per share 0.27 0.28 0.29 0.24
Diluted earnings
per share 0.26 0.28 0.29 0.24
- ---------------------------------------------------------
SEASONALITY
Seasonal variations do not have a major effect on the company's business.
However, to varying degrees, traditional summer vacations and holidays often
affect the company's sales levels during the first and second quarters of its
fiscal year.
LIQUIDITY AND CAPITAL RESOURCES
In fiscal 1999, the company's primary capital needs were to fund working capital
requirements necessitated by sales growth, the addition of new products and FSS
programs, and direct marketing programs in the United Kingdom and in Germany. In
fiscal 1998, the company used capital to fund acquisitions, as well as for the
capital needs discussed above. The company's primary sources of financing have
been cash from operations and the Intercompany Debt/Investment and Cash
Management Agreement with Kennametal, and in fiscal 1998, the net proceeds from
the IPO. The company anticipates that its cash flows from operations and its
Intercompany Debt/Investment and Cash Management Agreement with Kennametal will
be adequate to support its operations for the foreseeable future.
Net cash from operating activities was $10.0 million, $30.0 million and $22.6
million in fiscal 1999, 1998 and 1997, respectively. Compared to the prior year,
the decrease in cash from operations in fiscal 1999 resulted primarily from
lower net income and higher working capital requirements. This was offset by
proceeds from the sale of accounts receivable to Kennametal as a part of
Kennametal's accounts receivable securitization program. The increase in cash
from operations in fiscal 1998 resulted from higher net income and from lower
working capital requirements.
Net cash used for investing activities was $17.8 million, $70.6 million and $7.4
million in fiscal 1999, 1998 and 1997, respectively. The change in net cash used
for investing activities in fiscal 1999 resulted from an increase in a note
receivable from Kennametal as a result of the accounts receivable securitization
program, reduced acquisition activity, offset by decreased capital expenditures
related primarily to the new information systems and the relocation of two
distribution centers. This was further offset by the proceeds from the
divestiture of the Strong Tool Co. steel mill business unit.
In fiscal 1998, the company acquired six industrial supply companies for $57.3
million and made capital expenditures for $12.3 million. The increase in capital
expenditures from $2.3 million in fiscal 1997 resulted from the opening of the
distribution centers in Kent, Wash. and Germany, coupled with expenditures
related to the installation of state-of-the-art conveyor and order selection
systems in the newly relocated Elk Grove Village, Ill. and United Kingdom
distribution centers.
Similarly, the increase in net cash used for investing activities in fiscal 1997
resulted from the acquisition of two industrial supply companies. The remaining
cash used for investing activities in fiscal 1997 was for investments related
primarily to capital expenditures for improved information systems and office
and computer equipment to accommodate new product offerings and showroom and
distribution center openings.
Net cash from (used for) financing activities was $5.5 million, $32.4 million
and $(3.0) million in fiscal 1999, 1998 and 1997, respectively. Fiscal 1999
financing activities reflected amounts borrowed under notes payable to banks
which were used to fund capital expenditures. The increase in net cash from
financing activities in fiscal 1998 was a result of the net proceeds received
from the issuance of common stock in connection with the company's IPO. This
amount was offset by repayments to Kennametal for amounts previously advanced to
the company, repayments of short-term debt and the purchase of treasury stock.
Net cash used for financing activities in fiscal 1997 was due to repayments to
Kennametal for amounts previously advanced to the company for working capital
needs and a dividend paid to Kennametal offset by short-term borrowings. The
short-term borrowings were made under the company's line of credit primarily to
fund the dividend paid to Kennametal.
11
14
On June 18, 1999, Kennametal entered into an agreement with a financial
institution whereby Kennametal securitizes, on a continuous basis, an undivided
interest in a pool of the company's domestic trade accounts receivable. Pursuant
to this agreement, the company sold $18.4 million of its domestic accounts
receivable to Kennametal in exchange for a note receivable from Kennametal
consistent with the Intercompany Debt/Investment and Cash Management Agreement.
The company will continue to sell receivables to Kennametal under this program
as collections reduce the accounts receivable previously sold. The company will
receive incremental interest income under the Intercompany Debt/Investment and
Cash Management Agreement, as well as servicing revenue from the transaction.
The costs incurred by the company under this program were $0.2 million as a
result of the discount on the sale of the accounts receivable and are accounted
for as a component of Interest Expense (Income) and Other.
There were no acquisitions during fiscal 1999. During fiscal 1998, JLK acquired
six companies that are engaged in the distribution of metalcutting tools and
industrial supplies. The acquired companies have combined annual sales of
approximately $137.0 million. The acquisitions were accounted for using the
purchase method of accounting. The consolidated financial statements include the
operating results from the date of acquisition. Of the proceeds from the
company's IPO, $50.4 million were used to fund these acquisitions.
In June 1998, the company initiated a stock repurchase program to repurchase,
from time-to-time, up to a total of 20 percent, or approximately 1.0 million
shares, of its outstanding Class A Common Stock. In 1999 and 1998, the company
repurchased 15,000 and 628,700 shares, respectively, of its Class A Common Stock
at a total cost of $0.3 million and $14.2 million, respectively. The repurchases
were made in the open market or in negotiated or other permissible transactions.
The repurchases of Class A Common Stock were financed principally by available
funds and short-term borrowings.
On July 2, 1997, the company consummated an IPO of 4,897,000 shares of its Class
A Common Stock at a price of $20.00 per share. The net proceeds from the IPO
were $90.4 million and represented the sale of approximately 20 percent of the
company's outstanding common stock. The net proceeds were used by the company to
repay $20.0 million of short-term debt related to the dividend paid to
Kennametal and $20.0 million to repay Kennametal for the recent acquisitions and
income taxes paid for on behalf of the company. Additional net proceeds of $50.4
million were used to make acquisitions in fiscal 1998. Pending such uses, the
net proceeds were loaned to Kennametal under an Intercompany Debt/Investment and
Cash Management Agreement at a fluctuating rate of interest equal to
Kennametal's short-term borrowing costs. Kennametal maintains unused lines of
credit to enable it to repay any portion or all of such loans on demand by the
company.
The company anticipates that its accounts receivable will continue to increase
due to increased sales levels and that inventory levels also will increase due
to the addition of new products and FSS programs. The company believes that cash
flows from operations will be sufficient to fund future growth and meet planned
capital expenditure needs. However, if the company was to make any material
acquisitions, the company may be required to utilize the Intercompany
Debt/Investment and Cash Management Agreement with Kennametal or obtain debt or
equity financing.
YEAR 2000
The company continues to address its exposure relative to year 2000 issues for
both information and non-information technology systems. A committee actively
monitors the status of the readiness program of the company and its
subsidiaries. Overall, the company believes that 85 percent of the tasks
identified to remediate the year 2000 exposure have been completed for both
information and non-information technology systems, with the remaining tasks
targeted for September 1999 completion.
The company completed an assessment regarding the impact of this issue on its
existing information systems and determined that while not all systems were year
2000 compliant, these non-compliant systems could be modified to become year
2000 compliant. Due to the fact that the company was operating on several
different information systems, the company decided to implement a new business
system, HK System's Enterprise Information System (Enterprise System), in order
to have all existing operations on one integrated system. The Enterprise System
also is year 2000 compliant. The company is implementing the Enterprise System
in two phases and, in August 1999, has completed all of the tasks identified to
remediate the year 2000 exposure in the initial phase.
The second phase is expected to be initiated in late 1999, and tested and
completed thereafter. Due to the timing of the completion of this phase, the
company is currently modifying the existing non-compliant
12
15
business systems to ensure these operations are supported by a year 2000
compliant information system. This modification process is 80 percent complete.
Remaining modifications, as well as testing of all modifications, are expected
to be completed by the end of September 1999. Management has determined that
sufficient internal resources are available and adequate time exists to
implement these procedures.
The company also has completed an assessment of the impact of this issue on its
non-information technology systems, including the company's personal computers,
embedded technology in equipment used in operations, and other non-information
technology items. Any non-compliant systems have been substantially remedied,
either through replacement of or modification to the existing systems. Testing
of these remedies is expected to be completed by the end of September 1999.
The company estimates the total year 2000 expenditures to be approximately $10.0
to $13.0 million, with the majority being spent on the implementation of the
company's new business system. Included in the total costs are expenditures to
rectify non-compliant personal computers, embedded technology in equipment used
in operations, and various non-information technology items, which are estimated
to be $0.2 million. These costs include both internal and external personnel
costs related to the assessment, remediation and implementation processes, as
well as the cost of purchasing certain hardware and software. There can be no
guarantee that these estimates will be achieved and actual results could differ
from those planned.
Cash flows from operating and financing activities have provided, and should
continue to provide, funding for these expenditures. Through June 1999, the
company has incurred approximately $8.0 million of the total costs, of which
approximately $7.1 million relate to software licenses, software modifications
and hardware. The balance of the expenditures will be incurred in fiscal 2000.
Management believes the most significant risk of the year 2000 issue could be an
interrupted supply of goods and services from the company's vendors. The company
has an ongoing effort to gain assurances and certifications of suppliers'
readiness programs. To date, the results of this effort indicate that the
company's suppliers should be able to provide the company with sufficient goods
and services in the year 2000. The company will continue to expand its efforts
to ensure that major third-party businesses and public and private providers of
infrastructure services, such as utilities, communications services and
transportation, will also be prepared for the year 2000, and address any
failures on their part to become year 2000 compliant.
The company is in the process of developing contingency plans and actions for
the year 2000 issues related to both internal and external systems. As part of
this planning, the company is evaluating the incremental cost of the contingency
alternative as compared to the perceived level of risk for year 2000 problems.
In some cases, management has determined that the perceived level of risk does
not justify the cost of the contingency alternative. Contingency plans involve
consideration of a number of possible actions, including, to the extent
necessary or justified, the selection of alternative service providers,
purchasing inventory from alternative certified vendors, the increase of safety
stock of major product lines and adjustments to staffing strategies. The company
will continue to develop and modify these contingency plans throughout 1999 as
management monitors and evaluates the progress of the internal and external year
2000 compliance activities.
There can be no guarantee that the efforts of the company or of third parties,
whose systems the company relies upon, will completely mitigate a year 2000
problem that could have a material adverse effect on the company's operations or
financial results. While such problems could affect important operations of the
company and its subsidiaries, either directly or indirectly, in a significant
manner, the company cannot at present estimate either the likelihood or the
potential cost of such failures. However, the company will continue to
aggressively pursue all the year 2000 remediation activities discussed herein.
EFFECTS OF INFLATION
Despite modest inflation in recent years, rising costs continue to affect the
company's business. However, the company does not believe that inflation has had
a material effect on its results of operations in recent years. The company
strives to minimize the effects of inflation through cost containment and price
increases under highly competitive conditions.
TERMINATION OF GE CONTRACT
During fiscal 1997, the company finalized its plan of disengagement from an FSS
program contract with General Electric Corporation (GE) for services provided
13
16
at certain metalworking manufacturing facilities within GE's Aircraft Engine
Group (GE Contract). The operating margin related to the GE Contract was lower
than the company's other FSS program contracts. In addition, many of the
products provided by the company to GE under the GE Contract fell outside of the
company's core focus on metalworking consumables and related products.
As such, after careful evaluation, the company concluded that it was not in its
best interest to accede to certain price concessions requested by GE. As a
result, GE served notice to the company that the GE Contract would not be
renewed for a significant portion of the manufacturing facilities served by the
company.
During fiscal 1998 and 1997, the company completed its disengagement from the GE
manufacturing sites that were discontinued. Sales to these GE sites totaled
$22.9 and $54.7 million in fiscal 1998 and 1997, respectively. In fiscal 1999,
the company has not had sales to GE for those manufacturing sites that were
discontinued. The company has redeployed its resources related to the GE
Contract to take advantage of requests by certain current FSS program customers
to ramp-up their existing programs at an increased rate as well as to offer Full
Service Supply programs to new customers.
NEW ACCOUNTING STANDARDS
The company adopted Statement of Financial Accounting Standards (SFAS) No. 130,
"Reporting Comprehensive Income," issued in June 1997. This statement
establishes standards for reporting comprehensive income and its components in a
full set of general-purpose financial statements. The adoption of this standard
did not have a financial impact on the company.
In June 1997, SFAS No. 131, "Disclosure about Segments of an Enterprise and
Related Information," was issued by the Financial Accounting Standards Board.
SFAS No. 131 introduced a new model for segment reporting called the management
approach. The management approach is based on the way the chief operating
decision-maker organizes segments within a company for making operating
decisions and assessing performance. Accordingly, the company reports two
segments consisting of J&L Industrial Supply and Full Service Supply. Segment
information for fiscal 1998 and 1997 has been restated to meet the requirements
of SFAS No. 131. This new standard did not have a financial impact on the
company. See Note 14 to the financial statements for the required disclosures.
In February 1998, SFAS No. 132, "Employers Disclosures about Pensions and Other
Postretirement Benefits," was issued. The implementation of SFAS No. 132 in
fiscal 1999 revised certain footnote disclosure requirements related to pension
and other retiree benefits. The new standard did not have a financial impact on
the company. See Note 9 to the financial statements for the required
disclosures.
In June 1998, SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities," was issued. The company must adopt the standard by the beginning of
the first quarter of fiscal year 2001. SFAS No. 133 establishes accounting and
reporting standards requiring all derivative instruments (including certain
derivative instruments imbedded in other contracts) be recorded in the balance
sheet as either an asset or liability measured at their fair value. SFAS No. 133
requires that changes in the derivative's fair value be recognized currently in
earnings unless specific hedge accounting criteria are met. Accounting for
qualifying hedges allows a derivative's gains and losses to offset related
results on the hedged item in the income statement, and requires that a company
must formally document, designate and assess the effectiveness of transactions
that receive hedge accounting. The company currently is evaluating the effects
of SFAS No. 133 and does not believe that the adoption will have a material
effect on the financial statements or results of operations of the company.
ITEM 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
See Note 10 to the financial statements for required disclosures.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
PAGE
Selected Quarterly Financial Data (Unaudited) .............. 10
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Public Accountants ................... 15
Consolidated Statements of Income .......................... 16
Consolidated Balance Sheets ................................ 17
Consolidated Statements of Cash Flows ...................... 18
Consolidated Statements of Shareowners' Equity ............. 19
Notes to Consolidated Financial Statements ................. 20
14
17
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
TO THE SHAREOWNERS OF JLK DIRECT DISTRIBUTION INC.
We have audited the accompanying consolidated balance sheets of JLK Direct
Distribution Inc. (a Pennsylvania corporation) as of June 30, 1999 and 1998, and
the related consolidated statements of income, shareowners' equity and cash
flows for each of the three years in the period ended June 30, 1999. 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 generally accepted auditing
standards. 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 consolidated financial statements referred to above present
fairly, in all material respects, the financial position of JLK Direct
Distribution Inc. as of June 30, 1999 and 1998, and the results of its
operations and its cash flows for each of the three years in the period ended
June 30, 1999, in conformity with generally accepted accounting principles.
/s/ ARTHUR ANDERSEN LLP
- -----------------------
Arthur Andersen LLP
Pittsburgh, Pennsylvania
July 20, 1999
15
18
CONSOLIDATED STATEMENTS OF INCOME
FISCAL YEAR ENDED JUNE 30, 1999 1998 1997
- ----------------------------------------------------------------------------------------------------------------
(in thousands, except per share data)
Net sales $531,642 $425,348 $316,189
Cost of goods sold 361,717 277,417 213,020
- ----------------------------------------------------------------------------------------------------------------
Gross profit 169,925 147,931 103,169
Operating expenses 135,393 106,623 70,976
- ----------------------------------------------------------------------------------------------------------------
Operating income 34,532 41,308 32,193
Interest expense (income) and other 881 (3,068) 368
- ----------------------------------------------------------------------------------------------------------------
Income before provision for income taxes 33,651 44,376 31,825
Provision for income taxes 13,291 17,300 12,518
- ----------------------------------------------------------------------------------------------------------------
Net income $ 20,360 $ 27,076 $ 19,307
================================================================================================================
Basic earnings per share $ 0.83 $ 1.08 --
================================================================================================================
Diluted earnings per share $ 0.83 $ 1.07 --
================================================================================================================
Weighted average shares outstanding 24,510 25,138 --
================================================================================================================
Diluted weighted average shares outstanding 24,513 25,277 --
================================================================================================================
Pro forma basic and diluted net income per share -- -- $ 0.92
================================================================================================================
Pro forma weighted and diluted average
shares outstanding -- -- 20,897
================================================================================================================
The accompanying notes are an integral part of these statements.
16
19
CONSOLIDATED BALANCE SHEETS
JUNE 30, 1999 1998
- -----------------------------------------------------------------------------------------------------------------
(in thousands)
ASSETS:
Current assets:
Cash and equivalents $ 2,807 $ 4,715
Notes receivable from Kennametal 11,611 1,169
Accounts receivable, less allowance for doubtful
accounts of $981 and $827, respectively 53,680 71,426
Inventories 101,770 97,299
Deferred income taxes 6,818 5,853
Other current assets 52 --
- -----------------------------------------------------------------------------------------------------------------
Total current assets 176,738 180,462
- -----------------------------------------------------------------------------------------------------------------
Property, plant and equipment:
Land and buildings 6,318 5,152
Machinery and equipment 27,419 21,379
Less accumulated depreciation (8,400) (6,014)
- -----------------------------------------------------------------------------------------------------------------
Net property, plant and equipment 25,337 20,517
- -----------------------------------------------------------------------------------------------------------------
Other assets:
Intangible assets, net 64,383 71,090
Deferred tax assets 7,377 1,658
Other 1,154 1,859
- -----------------------------------------------------------------------------------------------------------------
Total other assets 72,914 74,607
- -----------------------------------------------------------------------------------------------------------------
Total assets $274,989 $275,586
=================================================================================================================
LIABILITIES:
Current liabilities:
Notes payable to banks $ 7,737 $ 1,915
Accounts payable 21,025 36,393
Due to Kennametal and affiliates 4,609 15,144
Income taxes payable 4,903 8,252
Accrued payroll and vacation pay 3,220 3,567
Other 6,927 5,877
- -----------------------------------------------------------------------------------------------------------------
Total current liabilities 48,421 71,148
- -----------------------------------------------------------------------------------------------------------------
Deferred income taxes 5,519 144
Other liabilities 5,175 8,359
- -----------------------------------------------------------------------------------------------------------------
Total liabilities 59,115 79,651
- -----------------------------------------------------------------------------------------------------------------
SHAREOWNERS' EQUITY:
Preferred Stock, $.01 par value; 25,000 shares authorized; none issued -- --
Class A Common Stock, $.01 par value; 75,000 shares authorized;
4,917 issued, 4,273 and 4,288 outstanding 49 49
Class B Common Stock, $.01 par value; 50,000 shares authorized;
20,237 issued and outstanding 202 202
Additional paid-in capital 182,822 182,822
Retained earnings 47,436 27,076
Treasury stock, at cost, 644 and 629 shares of Class A Common Stock held (14,529) (14,197)
Accumulated other comprehensive loss (106) (17)
- -----------------------------------------------------------------------------------------------------------------
Total shareowners' equity 215,874 195,935
- -----------------------------------------------------------------------------------------------------------------
Total liabilities and shareowners' equity $274,989 $275,586
=================================================================================================================
The accompanying notes are an integral part of these statements.
17
20
CONSOLIDATED STATEMENTS OF CASH FLOWS
FISCAL YEAR ENDED JUNE 30, 1999 1998 1997
- -------------------------------------------------------------------------------------------------------------------
(in thousands)
OPERATING ACTIVITIES:
Net income $ 20,360 $ 27,076 $ 19,307
Adjustments for noncash items:
Depreciation and amortization 8,749 5,185 1,768
Loss on sale of assets 177 112 --
Noncash transactions with Kennametal -- -- 6,266
Changes in certain assets and liabilities, net of
effects from acquisitions and divestiture:
Accounts receivable (811) (7,799) (4,074)
Proceeds from sale of accounts receivable 18,266 -- --
Inventory (6,208) (10,609) (4,390)
Accounts payable and accrued liabilities (28,115) 16,971 1,377
Other (2,465) (951) 2,383
- -------------------------------------------------------------------------------------------------------------------
Net cash flow from operating activities 9,953 29,985 22,637
- -------------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES:
Purchases of property, plant and equipment (9,681) (12,286) (2,287)
Notes receivable from Kennametal (10,442) (1,169) --
Acquisitions, net of cash -- (57,341) (5,106)
Divestiture 1,617 -- --
Other 709 179 --
- -------------------------------------------------------------------------------------------------------------------
Net cash flow used for investing activities (17,797) (70,617) (7,393)
- -------------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES:
Net proceeds from initial public offering of
Class A Common Stock -- 90,430 --
Borrowings under (repayments of) notes payable to banks 5,822 (28,064) 27,987
Repayments of notes payable to Kennametal -- (15,805) --
Cash dividend paid to Kennametal -- -- (20,000)
Purchase of treasury stock (332) (14,197) --
Net cash payments to Kennametal -- -- (10,968)
- -------------------------------------------------------------------------------------------------------------------
Net cash flow from (used for) financing activities 5,490 32,364 (2,981)
- -------------------------------------------------------------------------------------------------------------------
Exchange rate effect on cash 446 (105) 135
- -------------------------------------------------------------------------------------------------------------------
CASH AND EQUIVALENTS:
Net (decrease) increase in cash and equivalents (1,908) (8,373) 12,398
Cash and equivalents, beginning 4,715 13,088 690
- -------------------------------------------------------------------------------------------------------------------
Cash and equivalents, ending $ 2,807 $ 4,715 $ 13,088
===================================================================================================================
SUPPLEMENTAL DISCLOSURE:
Income taxes paid $ 17,491 $ 15,831 $ 12,518
Interest paid 471 49 368
- -------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these statements.
18
21
CONSOLIDATED STATEMENTS OF SHAREOWNERS' EQUITY
FISCAL YEAR ENDED JUNE 30, 1999 1998 1997
- -----------------------------------------------------------------------------------------------------------------------
(in thousands)
CLASS A COMMON STOCK:
Balance at beginning of year $ 49 $ -- $ --
Initial public offering of 4,897 shares of Class A
Common Stock, including surrender of 640 shares
of Class B Common Stock by Kennametal -- 48 --
Sale and exchange of 20 shares of Class B Common
Stock for Class A Common Stock by Kennametal -- 1 --
- -----------------------------------------------------------------------------------------------------------------------
Balance at end of year 49 49 --
- -----------------------------------------------------------------------------------------------------------------------
CLASS B COMMON STOCK:
Balance at beginning of year 202 -- --
Exchange of investment by and advances from Kennametal
for 20,897 shares of Class B Common Stock -- 209 --
Surrender of 640 shares of Class B Common Stock by Kennametal -- (6) --
Sale and exchange of 20 shares of Class B Common Stock
for Class A Common Stock by Kennametal -- (1) --
- -----------------------------------------------------------------------------------------------------------------------
Balance at end of year 202 202 --
- -----------------------------------------------------------------------------------------------------------------------
ADDITIONAL PAID-IN CAPITAL:
Balance at beginning of year 182,822 -- --
Initial public offering of 4,897 shares of Class A
Common Stock, including surrender of 640 shares
of Class B Common Stock by Kennametal -- 90,388 --
Exchange of investment by and advances from Kennametal
for 20,897 shares of Class B Common Stock -- 92,434 --
- -----------------------------------------------------------------------------------------------------------------------
Balance at end of year 182,822 182,822 --
- -----------------------------------------------------------------------------------------------------------------------
RETAINED EARNINGS:
Balance at beginning of year 27,076 -- --
Net income 20,360 27,076 --
- -----------------------------------------------------------------------------------------------------------------------
Balance at end of year 47,436 27,076 --
- -----------------------------------------------------------------------------------------------------------------------
TREASURY STOCK:
Balance at beginning of year (14,197) -- --
Purchase of treasury stock, 15 and 629 shares of Class A
Common Stock in 1999 and 1998 (332) (14,197) --
- -----------------------------------------------------------------------------------------------------------------------
Balance at end of year (14,529) (14,197) --
- -----------------------------------------------------------------------------------------------------------------------
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS):
Balance at beginning of year (17) 88 (47)
Foreign currency translation adjustments (89) (105) 135
- -----------------------------------------------------------------------------------------------------------------------
Balance at end of year (106) (17) 88
- -----------------------------------------------------------------------------------------------------------------------
INVESTMENTS BY AND ADVANCES FROM KENNAMETAL:
Balance at beginning of year -- 92,643 98,038
Net income -- -- 19,307
Dividend -- -- (20,000)
Net cash payments to Kennametal -- -- (10,968)
Other noncash transactions -- -- 6,266
Exchange of investment by and advances from Kennametal
for 20,897 shares of Class B Common Stock -- (92,643) --
- -----------------------------------------------------------------------------------------------------------------------
Balance at end of year -- -- 92,643
- -----------------------------------------------------------------------------------------------------------------------
Total shareowners' equity, June 30 $ 215,874 $ 195,935 $ 92,731
=======================================================================================================================
COMPREHENSIVE INCOME:
Net income $ 20,360 $ 27,076 $ 19,307
Foreign currency translation adjustments (89) (105) 135
- -----------------------------------------------------------------------------------------------------------------------
Comprehensive income $ 20,271 $ 26,971 $ 19,442
=======================================================================================================================
The accompanying notes are an integral part of these statements.
19
22
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1: FORMATION AND NATURE OF BUSINESS
The accompanying consolidated financial statements of JLK Direct Distribution
Inc. (the company) include the operations of J&L America, Inc. d/b/a J&L
Industrial Supply (J&L), a previously wholly owned subsidiary of Kennametal Inc.
(Kennametal), and Full Service Supply (FSS), which previously had been operated
as a program of Kennametal. Prior to April 1, 1997, the company had no separate
legal status or existence. Kennametal incorporated the company as a Pennsylvania
corporation under the name "JLK Direct Distribution Inc." in April 1997.
In April 1997, the company's Board of Directors authorized management to file a
registration statement with the Securities and Exchange Commission with respect
to an initial public offering (IPO) of the company's Class A Common Stock. In
anticipation of the IPO, Kennametal contributed to the company the stock of J&L,
including the J&L United Kingdom operations, and the assets and liabilities of
Full Service Supply. Immediately prior to the effective date of the IPO,
Kennametal exchanged its currently outstanding investment for 20,897,000 shares
of Class B Common Stock.
On July 2, 1997, the company consummated an IPO of 4,897,000 shares of its Class
A Common Stock at a price of $20.00 per share. The net proceeds from
the IPO were $90.4 million and represented the sale of approximately 20 percent
of the company's outstanding common stock. The net proceeds were used by the
company to repay $20.0 million of short-term debt related to a dividend paid to
Kennametal and to repay $20.0 million to Kennametal for acquisitions in fiscal
1997 and income taxes paid on behalf of the company. The remaining net proceeds
of $50.4 million were used to pay for fiscal 1998 acquisitions.
In connection with the IPO, Kennametal surrendered to the company 640,000 shares
of Class B Common Stock equal to the number of additional shares of Class A
Common Stock purchased by the underwriters upon exercise of the underwriters'
over-allotment option. In addition, Kennametal sold 20,000 shares of Class B
Common Stock at $20.00 per share to one of the members of its and the company's
board of directors. The 20,000 shares of Class B Common Stock were subsequently
converted on a one-to-one basis to Class A Common Stock. Subsequent to the IPO,
4,917,000 shares of Class A Common Stock were outstanding, and Kennametal held
20,237,000 shares of Class B Common Stock. Kennametal's ownership increased to
approximately 83 percent due to treasury stock purchases made by the company
since the IPO.
NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The summary of significant accounting policies is presented below to assist in
evaluating the company's financial statements.
BASIS OF PRESENTATION. The accompanying consolidated financial statements
include the accounts of the company and its subsidiaries. All significant
intercompany balances and transactions have been eliminated.
For periods prior to fiscal 1998, the accompanying consolidated financial
statements consist of the financial statements of the company as described in
Note 1. These statements are presented as if the company had existed as a
corporation separate from Kennametal and include the historical assets,
liabilities, sales and expenses directly related to the company's operations
that were either specifically identifiable or allocable. Shareowners' equity
(which represents Kennametal's 100 percent interest prior to the IPO) comprises
both investments by and non-interest bearing advances from Kennametal. In
connection with the IPO which was consummated on July 2, 1997, such amounts were
included as part of the company's permanent equity capitalization. All operating
expenses related to the company have been appropriately reflected in the
company's consolidated financial statements. All material transactions between
entities included in the consolidated financial statements have been eliminated.
For all periods presented, certain operating expenses reflected in the
consolidated financial statements include charges for certain services provided
by Kennametal. These charges are based on personnel, business volume or other
appropriate bases and generally include expenses related to information
management and other administrative services. These charges are estimates based
on Kennametal
20
23
management's best estimate of actual expenses. It is management's opinion that
the expenses charged to the company are reasonable and are representative of the
expenses the company would have incurred on a stand-alone basis. The
accompanying financial statements do not include Kennametal's general corporate
debt or an allocation of interest expense.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS. The preparation of
financial statements in conformity with generally accepted accounting principles
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements, and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
CASH EQUIVALENTS. Temporary cash investments having original maturities of three
months or less are considered cash equivalents. Cash equivalents consist
principally of investments in money market funds and certificates of deposit.
For periods prior to fiscal 1998, cash equivalents include the company's
position in Kennametal's centralized cash management system (see Note 12).
NOTES RECEIVABLE FROM KENNAMETAL. For fiscal 1999 and 1998, notes receivable
from Kennametal reflect the company's position in Kennametal's centralized cash
management system (see Note 12).
INVENTORIES. Inventories are carried at the lower of cost using the first-in,
first-out (FIFO) method or market.
PROPERTY, PLANT AND EQUIPMENT. Property, plant and equipment are carried at
cost. Major improvements are capitalized, while maintenance and repairs are
generally expensed as incurred. Retirements and disposals are removed from cost
and accumulated depreciation accounts, with the gain or loss reflected in net
income. Depreciation for financial reporting purposes is computed using the
straight-line method over the estimated useful lives of the assets ranging from
three to 40 years.
ADVERTISING AND CATALOG COSTS. Advertising costs are expensed as incurred. The
costs of producing and distributing the company's catalog are initially deferred
and included in other assets in the company's balance sheet. These catalog costs
are generally amortized to expense in the year incurred.
INTANGIBLE ASSETS. Goodwill includes an allocation from Kennametal for the
excess of costs over the fair value of net assets acquired related to the
historical acquisition costs of the company and includes the excess of cost over
net assets of acquired companies. Goodwill is being amortized on a straight-line
basis over periods ranging from 20 to 40 years. The company assesses the
recoverability of goodwill by determining whether the amortization of the
goodwill balance over its remaining life can be recovered through undiscounted
future operating cash flows of the acquired operation. Other intangible assets
arising from acquisitions consist of employee retention and non-compete
agreements and are being amortized over the life of the agreements which range
from three to five years.
COMMON STOCK. The holders of Class A Common Stock and Class B Common Stock
generally have identical rights, except that holders of Class A Common Stock are
entitled to one vote per share, while holders of Class B Common Stock are
entitled to ten votes per share on all matters to be voted on by the company's
shareowners.
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 common stock under stock option grants. The difference between basic
and diluted earnings per share relates solely to the effect of common stock
options.
For purposes of determining the number of dilutive shares outstanding, weighted
average shares outstanding for basic earnings per share calculations were
increased by 2,622 and 139,283 in 1999 and 1998, respectively, due to the
dilutive effect of unexercised stock options.
For periods prior to 1998, pro forma basic and diluted earnings per share were
computed using the pro forma weighted and diluted average number of shares
outstanding during the period. Pro forma weighted and diluted average common
shares outstanding are presented on a basis that gives pro forma effect to the
issuance of the Class B Common Stock.
21
24
REVENUE RECOGNITION. The company recognizes revenue from product sales upon
transfer of title to the customer.
PRE-OPENING COSTS. Pre-opening costs related to showrooms, distribution centers
and new integrated supply contracts are expensed as incurred.
INCOME TAXES. The provision for federal and state income taxes has been
calculated as if the company were a stand-alone corporation filing separate tax
returns. 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.
FOREIGN CURRENCY TRANSLATION. Assets and liabilities of the company's
international operations are translated into U.S. dollars using year-end
exchange rates, while sales 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.
NEW ACCOUNTING STANDARDS. The company adopted Statement of Financial Accounting
Standards (SFAS) No. 130, "Reporting Comprehensive Income," issued in June 1997.
This statement establishes standards for reporting comprehensive income and its
components in a full set of general-purpose financial statements. The adoption
of this standard did not have a financial impact on the company.
In June 1997, SFAS No. 131, "Disclosure about Segments of an Enterprise and
Related Information," was issued by the Financial Accounting Standards Board.
SFAS No. 131 introduced a new model for segment reporting called the management
approach. The management approach is based on the way the chief operating
decision-maker organizes segments within a company for making operating
decisions and assessing performance. Accordingly, the company reports two
segments consisting of J&L Industrial Supply and Full Service Supply. Segment
information for fiscal 1998 and 1997 has been restated to meet the requirements
of SFAS No. 131. This new standard did not have a financial impact on the
company.
In February 1998, SFAS No. 132, "Employers Disclosures about Pensions and Other
Postretirement Benefits," was issued. The implementation of SFAS No. 132 in
fiscal 1999 revised certain footnote disclosure requirements related to pension
and other retiree benefits. The new standard did not have a financial impact on
the company.
In June 1998, SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities," was issued. The company must adopt the standard by the beginning of
the first quarter of fiscal year 2001. SFAS No. 133 establishes accounting and
reporting standards requiring all derivative instruments (including certain
derivative instruments imbedded in other contracts) be recorded in the balance
sheet as either an asset or liability measured at their fair value. SFAS No. 133
requires that changes in the derivative's fair value be recognized currently in
earnings unless specific hedge accounting criteria are met. Accounting for
qualifying hedges allows a derivative's gains and losses to offset related
results on the hedged item in the income statement, and requires that a company
must formally document, designate and assess the effectiveness of transactions
that receive hedge accounting. The company is currently evaluating the effects
of SFAS No. 133 and does not believe that the adoption will have a material
effect on the financial statements or results of operations of the company.
RECLASSIFICATIONS. Certain amounts in the prior years' consolidated financial
statements have been reclassified to conform with the current year presentation.
NOTE 3: ACQUISITIONS
During fiscal 1998 and 1997, the company acquired the following distributors of
metalcutting tools and industrial supplies:
ACQUISITION
DATE ACQUIRED ACQUISITION HEADQUARTERS
- ------------------------------------------------------------------------
Fiscal 1998:
October 1997 Car-Max Tool & Cutter, Inc. Rockford, Ill.
December 1997 GRS Industrial Supply Co. Grand Rapids, Mich.
January 1998 Production Tools Sales, Inc. Dallas, Texas
March 1998 Dalworth Tool & Supply, Inc. Arlington, Texas
March 1998 ATS Industrial Supply Co. Salt Lake City, Utah
May 1998 Strong Tool Co. Cleveland, Ohio
- ------------------------------------------------------------------------
Fiscal 1997:
April 1997 Strelinger Company Troy, Mich.
May 1997 Mill & Abrasive Supply, Inc. Roseville, Mich.
- ------------------------------------------------------------------------
22
25
There were no acquisitions during fiscal 1999. All acquisitions were accounted
for under the purchase method of accounting. The excess of the purchase price
over the fair values of the net assets acquired for the acquisitions was
approximately $39.9 million and $3.6 million for fiscal 1998 and 1997,
respectively, which has been recorded as goodwill. The net purchase price of the
acquisitions was allocated as follows:
1998 1997
(in thousands) ACQUISITIONS ACQUISITIONS
- --------------------------------------------------------
Current assets $ 38,360 $ 12,660
Property, plant & equipment 3,431 1,687
Other long-term assets 590 250
Goodwill 39,850 3,629
Current liabilities (24,890) (13,120)
- --------------------------------------------------------
Purchase price, net of cash $ 57,341 $ 5,106
========================================================
The results of operations of the acquired businesses have been included in the
consolidated financial statements from the date of acquisition. Estimated
annualized sales for these acquisitions are $137.0 million and $36.0 million for
the companies acquired during fiscal 1998 and 1997, respectively. On a pro forma
basis, as if the acquisitions had taken place at the beginning of fiscal 1998
and 1997, consolidated net sales would have been $531.5 million and $479.2
million, respectively. The pro forma impact on net income and diluted earnings
per share would not be materially different from the amounts reported in fiscal
1998 and 1997.
In connection with the acquisitions, the company also entered into employee
retention and non-compete agreements which amounted to approximately $6.6
million and $4.1 million for the acquisitions consummated in 1998 and 1997,
respectively, which have been accounted for as noncash transactions. The
liability for these agreements at June 30, 1999 and 1998 recorded in other
current liabilities was $2.5 million and $2.8 million, respectively, and in
other liabilities was $2.9 million and $6.5 million, respectively.
NOTE 4: ACCOUNTS RECEIVABLE SECURITIZATION PROGRAM
On June 18, 1999, Kennametal entered into an agreement with a financial
institution whereby Kennametal securitizes, on a continuous basis, an undivided
interest in a pool of the company's domestic trade accounts receivable. Pursuant
to this agreement, the company sold $18.4 million of its domestic accounts
receivable to Kennametal, in exchange for a note receivable from Kennametal
consistent with the Intercompany Debt/Investment and Cash Management Agreement.
The costs incurred by the company under this program were $0.2 million as a
result of the discount on the sale of the receivables and are accounted for as a
component of Interest Expense (Income) and Other.
NOTE 5: INTANGIBLE ASSETS
Intangible assets consisted of the following:
(in thousands) 1999 1998
- --------------------------------------------------------
Goodwill $ 68,772 $ 68,766
Other intangible assets 9,203 10,555
- --------------------------------------------------------
77,975 79,321
Accumulated amortization (13,592) (8,231)
- --------------------------------------------------------
Intangible assets--net $ 64,383 $ 71,090
========================================================
NOTE 6: NOTES PAYABLE AND LINES OF CREDIT
Notes payable to banks represent short-term borrowings under credit lines
obtained with United States and international commercial banks. These credit
lines totaled approximately $28.9 million at June 30, 1999, of which $17.0
million was unused. The weighted average interest rate for borrowings was 6.0
percent and 8.25 percent at June 30, 1999 and 1998, respectively.
On April 3, 1998, the company entered into an agreement whereby the company,
through J&L, is a co-guarantor with Kennametal on a GBP 13.5 million
($21.6 million equivalent) line of credit with a bank. This line of credit
supports Kennametal's and JLK's operations in the United Kingdom. Interest
payable under the line of credit is based on one of the following rates,
depending upon the manner in which the credit facility is used: the Bank's base
rate, as defined in the credit facility, plus 1%, for overdrafts; or LIBOR plus
0.9%, for short-term borrowings. The effective rate was 6.0 and 8.5 percent at
June 30, 1999 and 1998, respectively. In fiscal 1999, this line of credit was
renewed which resulted in an extension of the maturity to June 30, 2000. At June
30, 1999 and 1998, total outstanding borrowings under this facility were $11.9
million, of which $7.7 million and $1.8 million, respectively, was borrowed
directly by JLK, and is included in Notes Payable to Banks.
On January 8, 1998, the company, through J&L, obtained a DM 10.0 million ($5.3
million equivalent) line of credit with a bank to support its German operations.
This line of credit is guaranteed by Kennametal, is due 30 days subsequent to
any termination of this guarantee by Kennametal, and bears interest at 3.5
percent. At June 30, 1999 and 1998, no amounts were outstanding under this
credit facility.
23
26
The company, through J&L, has available a credit facility with a bank
aggregating $2.0 million, with interest payable at the prevailing prime interest
rate. The credit facility may be terminated at the option of the bank or the
company. At June 30, 1999 and 1998, no amounts were outstanding under the credit
facility.
NOTE 7: LEASES
The majority of the operations of the company are conducted on leased premises,
some of which are leased from related parties. The leases (most of which provide
for the payment of real estate taxes, insurance and other operating costs) are
for varying periods, the longest extending to the year 2013. At June 30, 1999,
approximate minimum annual rentals on such leases are as follows:
TOTAL (INCLUDING
RELATED PARTY RELATED PARTY
(in thousands) COMMITMENTS) COMMITMENTS
- -------------------------------------------------------
2000 $5,325 $1,164
2001 3,614 609
2002 2,552 113
2003 2,060 113
2004 1,656 113
2005 and thereafter 6,019 318
- -------------------------------------------------------
Total rental expense (exclusive of real estate taxes, insurance and other
operating costs) for all operating leases for the fiscal years ended 1999, 1998
and 1997 was approximately $6.0 million, $5.6 million and $2.8 million,
respectively, including approximately $1.4 million, $1.8 million and $1.2
million, respectively, paid to related parties. In the opinion of the company's
management, these leases with related parties are on terms that approximate fair
market value.
NOTE 8: INCOME TAXES
Income (loss) before income taxes and the provision for income taxes consisted
of the following:
(in thousands) 1999 1998 1997
- -----------------------------------------------------------------------
Income (loss) before
provision for
income taxes:
United States $ 36,491 $ 45,786 $ 32,716
International (2,840) (1,410) (891)
- -----------------------------------------------------------------------
Total income before
provision for
income taxes $ 33,651 $ 44,376 $ 31,825
=======================================================================
Current income taxes:
Federal $ 13,100 $ 17,600 $ 11,410
State 1,500 2,100 1,709
- -----------------------------------------------------------------------
Total 14,600 19,700 13,119
=======================================================================
Deferred income taxes (1,309) (2,400) (601)
- -----------------------------------------------------------------------
Provision for
income taxes $ 13,291 $ 17,300 $ 12,518
=======================================================================
Effective tax rate 39.5% 39.0% 39.3%
=======================================================================
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) 1999 1998 1997
- -----------------------------------------------------------------------
Income taxes at U.S.
statutory rate $ 11,777 $ 15,532 $11,139
State income taxes,
net of federal
tax benefits 901 1,445 1,064
Nondeductible goodwill 509 409 237
Foreign earnings rate
differential (100) (240) --
Other 204 154 78
- -----------------------------------------------------------------------
Provision for
income taxes $ 13,291 $ 17,300 $12,518
=======================================================================
Deferred tax assets and liabilities consisted of the following:
(in thousands) 1999 1998
- ------------------------------------------------------------------
Deferred tax assets (liabilities):
Inventory valuation and reserves $ 4,078 $ 4,384
Net operating loss carryforwards 1,572 862
Accrued vacation and workers
compensation 853 985
Deductible goodwill 585 340
Pension benefits 455 453
Postretirement benefits 347 255
Bad debts 335 299
Other 1,195 147
Property, plant and equipment (744) (358)
- ------------------------------------------------------------------
Net deferred tax asset $ 8,676 $ 7,367
==================================================================
Included in deferred tax assets at June 30, 1999 are unrealized tax benefits
totaling $1.6 million related to net operating loss carryforwards in Germany,
which can be carried forward indefinitely.
NOTE 9: PENSION AND OTHER POSTRETIREMENT BENEFITS
For pension benefits, the company participates in Kennametal's Retirement Income
Plan (the Plan) which covers substantially all of the company's employees. The
benefits provided by the Plan are measured by length of service, compensation
and other factors and are funded by a trust established under the Plan. The
Kennametal Plan is currently overfunded and complies with the funding
requirements of ERISA. Plan assets consist principally of common stocks,
corporate bonds and U.S. government securities. It is not practicable to
determine the funded status of the portion of the Plan that relates to the
company. On an overall basis, the funded assets of the Plan were in excess of
the projected benefit obligation as of June 30, 1999 and 1998.
24
27
For postretirement benefits, the company participates in Kennametal's sponsored
plan whereby Kennametal provides varying levels of postretirement health care
and life insurance benefits for retired employees. Substantially all employees
may become eligible for these benefits if they reach normal retirement age while
working for the company. These benefits are currently unfunded.
The components of net pension and postretirement cost for the company's portion
of the Plan were as follows:
OTHER POST-
PENSION BENEFITS RETIREMENT BENEFITS
- -------------------------------------------------------------------------
(in thousands) 1999 1998 1997 1999 1998 1997
- -------------------------------------------------------------------------
Service cost $ 689 $ 623 $ 601 $114 $ 55 $ 74
Interest cost 261 240 332 44 26 28
Return on
plan assets (609) (901) (1,110) -- -- --
Net amortization
and deferral (191) 252 471 12 (3) 1
- -------------------------------------------------------------------------
Net costs $ 150 $ 214 $ 294 $170 $ 78 $103
=========================================================================
The company also participates in Kennametal's 401(k) Thrift Plan for employees.
The charge to operations incurred by the company for contributions totaled $1.0
million, $0.7 million and $0.5 million in fiscal 1999, 1998 and 1997,
respectively.
NOTE 10: FINANCIAL INSTRUMENTS
FAIR VALUE. The company had $2.8 million and $4.7 million in cash and
equivalents at June 30, 1999 and 1998, respectively, which approximates fair
value because of the short maturity of these investments.
The estimated fair value of notes payable to banks approximated $7.7 million and
$1.9 million at June 30, 1999 and 1998, respectively. Fair value was determined
using discounted cash flow analysis and the company's incremental borrowing
rates for similar types of arrangements.
CONCENTRATIONS OF CREDIT RISK. Financial instruments that potentially subject
the company to concentrations of credit risk consist primarily of temporary cash
investments and trade accounts receivable. With respect to trade accounts
receivable, concentrations of credit risk are somewhat reduced because the
company serves numerous customers in many industries and geographic areas. As of
June 30, 1999 and 1998, receivables with the company's five largest accounts
represented 26 percent and 20 percent, respectively, of total accounts
receivable (see Note 11).
NOTE 11: SIGNIFICANT CUSTOMERS
In both fiscal 1999 and 1998, no customers accounted for more than 10 percent of
the company's total sales. During 1997, sales to one customer amounted to 17
percent of total sales.
During fiscal 1997, the company finalized its plan of disengagement from an FSS
program contract with General Electric Corporation (GE) for services provided at
certain metalworking manufacturing facilities within GE's Aircraft Engine Group
(the GE Contract). The operating margin related to the GE Contract was lower
than the company's other FSS program contracts. In addition, many of the
products provided by the company to GE under the GE Contract fell outside of the
company's core focus on metalworking consumables and related products.
As such, after careful evaluation, the company concluded that it was not in its
best interest to accede to certain price concessions requested by GE. As a
result, GE served notice to the company that the GE Contract would not be
renewed for a significant portion of the manufacturing facilities served by the
company.
During fiscal 1998 and 1997, the company completed its disengagement from the GE
manufacturing sites that were discontinued. Sales to these GE sites totaled
$22.9 million and $54.7 million in fiscal 1998 and 1997, respectively. In fiscal
1999, the company has not had any sales to GE for those manufacturing sites that
were discontinued. The company has redeployed its resources related to the GE
Contract to take advantage of requests by certain current FSS program customers
to ramp-up their existing programs at an increased rate as well as to offer FSS
programs to new customers.
25
28
NOTE 12: RELATED PARTY TRANSACTIONS
The company engages in business transactions with Kennametal and its
subsidiaries. Products purchased for resale from Kennametal and its subsidiaries
and sales to these entities were as follows:
(in thousands) 1999 1998 1997
- -------------------------------------------------------
Purchases from
Kennametal and
subsidiaries $38,625 $40,700 $30,918
Sales to Kennametal
and subsidiaries 13,130 10,583 12,361
=======================================================
The company and Kennametal have entered into a number of agreements, which
became effective upon completion of the IPO, for the purpose of defining certain
relationships between the two companies. As a result of Kennametal's ownership
interest in the company, the terms of such agreements were not, and the terms of
any future amendments to those agreements may not be, the result of arm's-length
negotiations. Management believes that the fees charged by Kennametal are
reasonable and such fees are representative of the expenses that the company
would incur on a stand-alone basis. The agreements primarily have initial terms
of ten years. Costs charged to the company by Kennametal under these agreements
were as follows:
(in thousands) 1999 1998
- ---------------------------------------------------------
Administrative services agreement $5,555 $ 6,308
Warehousing agreement 3,705 5,352
Shared facilities agreement 109 329
Lease agreement 106 106
- ---------------------------------------------------------
Total costs charged by Kennametal $9,475 $12,095
=========================================================
Descriptions of these agreements, and the material terms of which, are set forth
below.
ADMINISTRATIVE SERVICES AGREEMENT. The company and Kennametal entered into an
intercompany administrative services agreement with respect to services to be
provided by Kennametal to the company. The administrative services agreement
provides that such services will be provided in exchange for fees which,
generally, (i) in the case of services purchased by Kennametal from third
parties for the company, are based upon the incremental cost charged by such
third parties to Kennametal for such services provided to the company and (ii)
in the case of services directly provided by Kennametal, are based on the
estimated costs, including a reasonable allocation of direct and indirect
overhead costs, incurred by Kennametal for the services it provides directly to
the company. The services initially provided by Kennametal to the company
include, among other things, certain treasury, general accounting and
administrative services including, tax, risk management, human resources, legal,
internal audit, marketing, executive time and space, and information system
services. The administrative services agreement also provides that Kennametal
will arrange and administer all existing insurance arrangements and may continue
coverage of the company under Kennametal's insurance policies and will allow
eligible employees of the company to participate in all of Kennametal's benefit
plans.
WAREHOUSING AGREEMENTS. The company and Kennametal entered into separate
warehousing agreements with respect to (i) Kennametal distribution centers and
warehouses that store products for the company and (ii) company distribution
centers and warehouses that store products for Kennametal. The terms of each
warehousing agreement provide for the warehouser to store the warehousee's
products in the warehouses, segregated and separate from the warehouser's
products and upon request by the warehousee to ship its products from these
warehouses to the warehousee's customers. The warehousee pays to the warehouser
a charge for each of the products picked, packed and shipped based upon an
allocation of costs (including overhead) incurred by the warehouser at these
warehouses.
SHARED FACILITIES AGREEMENT. The company and Kennametal entered into shared
facilities agreements pursuant to which each company subleases to the other
company the facilities which are leased by either of the companies and shared
with the other company. The shared facilities agreements provide that the
relevant sublessor leases space to the sublessee at a rental rate equal to a pro
rata share (based on square feet occupied) of all costs and expenses
(principally fixed rent) under the relevant lease. The company's management
believes that the rental rates payable by the company are commensurate with
market rates.
LEASE AGREEMENT. The company and Kennametal entered into a lease agreement
pursuant to which Kennametal subleases to the company space within buildings
located on Kennametal's premises.
26
29
PRODUCT SUPPLY AGREEMENT. The company and Kennametal entered into a product
supply agreement pursuant to which Kennametal supplies and the company purchases
from Kennametal all of the company's requirements for metalworking consumables
and related products direct-marketed by the company, and Kennametal further
agreed to supply all metalworking consumables and related products requested
pursuant to FSS programs, except as otherwise agreed from time to time between
the company and Kennametal. The company is entitled to purchase products for its
direct-marketing business at prices discounted from Kennametal's published price
for each such product depending upon the volume of each such product purchased
by the company.
TAX-SHARING AGREEMENT. Pursuant to the tax-sharing agreement, the company makes
payments to Kennametal determined as though the company were to file separate
federal, state and local income tax returns.
TRADEMARK LICENSE AGREEMENT. The company and Kennametal entered into a trademark
license agreement which provides, among other things, for the grant to the
company by Kennametal of a non-exclusive license to use the trademarks service
marks, trade names and other intellectual property of Kennametal in connection
with the company's business. The company has also granted to Kennametal a
non-exclusive license to use the company's trademarks service marks and trade
names on terms similar to those granted by Kennametal to the company.
INDEMNIFICATION AGREEMENT. Under the indemnification agreement, subject to
limited exceptions, the company is required to indemnify Kennametal and its
directors, officers, employees, agents and representatives for liabilities under
federal or state securities laws as a result of the Offering, including
liabilities arising out of or based upon alleged misrepresentations in or
omissions from the Registration Statement. The indemnification agreement also
provides that each party thereto (the Indemnifying Party) will indemnify the
other party thereto and its directors, officers, employees, agents and
representatives (the Indemnified Party) for liabilities that may be incurred by
the Indemnified Party relating to, resulting from or arising out of: (i) the
businesses and operations conducted or formerly conducted, or assets owned or
formerly owned, by the Indemnifying Party and its subsidiaries (except, in the
case where Kennametal is the Indemnifying Party, such businesses, operations and
assets of the company and its subsidiaries); or (ii) the failure by the
Indemnifying Party to comply with any other agreements executed in connection
with the Offering, except to the extent caused by the Indemnified Party. The
indemnification agreement also provides that the company will indemnify
Kennametal for any liabilities incurred under guarantees of leases.
NON-COMPETITION AND CORPORATE OPPORTUNITIES ALLOCATION AGREEMENT. Pursuant to a
non-competition and corporate opportunities allocation agreement (the Corporate
Opportunities Agreement) entered into between Kennametal and the company: (i)
Kennametal agrees for as long as the other intercompany agreements remain in
effect (whose term is ten years) (A) not to compete with the company in the
business of direct marketing of a broad range of metalworking consumables and
related products through catalogs, monthly promotional flyers, additional
mailings and advertisements, telemarketing efforts, direct-sales efforts and
showrooms targeted at small- and medium-sized metalworking shops, nor in the
supply of consumable tooling and related metalworking products at designated
manufacturing plants of large industrial customers through integrated supply
programs (the Base Business), except where the company has been offered by
Kennametal or its affiliates or a third party, the right to acquire a business
which falls under the Base Business at fair market value, and the company's
Board of Directors has determined, for whatever reason, that the company shall
not acquire such business, and (B) not to sell, offer to sell, distribute or
otherwise make available Kennametal manufactured and branded products to anyone
who intends to direct market such products and therefore competes with the
company's direct-marketing program except, with respect to those contracts,
arrangements or relationships in existence on the date of the Corporate
Opportunities Agreement or with the prior written consent of the company; and
(ii) the company has agreed for as long as the other intercompany agreements
remain in effect not to sell, offer to sell, distribute or otherwise make
available any products which compete directly or indirectly with Kennametal
without the prior written consent of Kennametal, except in connection with the
provision of integrated industrial supply programs as may be required
specifically by customers thereof.
27
30
INTERCOMPANY DEBT/INVESTMENT AND CASH MANAGEMENT AGREEMENT. The company and
Kennametal entered into an Intercompany Debt/Investment and Cash Management
Agreement (the Cash Management Agreement) under which the company will continue
to participate in Kennametal's centralized cash management system. The Cash
Management Agreement provides for a daily transfer from the company's cash
accounts to Kennametal's centralized cash accounts and daily funding of the
disbursements of the company from such Kennametal cash account. The company
receives interest on net cash flows to Kennametal's centralized cash accounts
and is charged interest on net borrowings from the Kennametal centralized cash
accounts at a rate equal to the interest rate available to Kennametal from
outside sources for short-term borrowings or investments, depending upon the
overall position of the centralized cash accounts. The company pays for this
service pursuant to the Administrative Services Agreement and reimburses
Kennametal for an allocable portion of Kennametal's facility and/or commitment
fees under its credit lines. Total net interest expense under the Agreement
amounted to $0.3 million in fiscal 1999, while interest income amounted to $2.9
million in fiscal 1998.
CORPORATE AGREEMENT. The company and Kennametal entered into a corporate
agreement under which the company grants to Kennametal a continuing option,
transferable, in whole or in part, to any of its affiliates, to purchase, under
certain circumstances, additional shares of Class B Common Stock or Class A
Common Stock (the Stock Option). The Stock Option may be exercised by Kennametal
simultaneously with the issuance of any equity security of the company or
immediately prior to a Tax-Free Spin-Off to the extent necessary to maintain its
then-existing percentage of the total voting power and economic value of the
company at 80 percent of all outstanding Common Stock or, in connection with a
Tax-Free Spin-Off, in order to acquire stock ownership necessary to effect a
Tax-Free Spin-Off. The purchase price of the shares of Common Stock purchased
upon any exercise of the Stock Option, subject to certain exceptions, will be
based on the market price of the Class A Common Stock.
For the fiscal year ending June 30, 1997, the company received from Kennametal
certain warehouse, management information systems, financial and administrative
services. All amounts incurred by Kennametal on behalf of the company are
reflected in operating expenses in the accompanying statements of income
totaling $9.3 million in fiscal 1997.
Kennametal will continue to provide services to the company in the future in
accordance with the terms of the intercompany agreements. The amounts charged
pursuant to these intercompany agreements reflect the actual costs of providing
these services. The company periodically remits cash to Kennametal in payment of
such operating expense allocations.
NOTE 13: STOCK OPTION AND INCENTIVE PLAN
Effective June 27, 1997, the company adopted a stock option and incentive plan
(the Plan) under which directors, officers and employees of the company or
Kennametal may be granted options to purchase shares of Class A Common Stock.
The Plan authorizes the issuance of up to 2,000,000 shares of Class A Common
Stock. Options are granted at fair market value at the date of grant and are
exercisable under specified conditions for up to 10 years from the date of
grant. Under provisions of the Plan, participants may deliver to the company
stock in payment of the option price and receive credit for the fair market
value of the shares of Class A Common Stock delivered on the date of delivery.
Under the Plan, shares may also be awarded to eligible employees without
payment. The Plan specifies that such shares are to be awarded in the name of
the employee, who will then have all the rights of a shareowner, subject to
certain restrictions or forfeitures.
The company adopted the disclosure requirements of SFAS No. 123, "Accounting for
Stock-Based Compensation," effective with the 1997 consolidated financial
statements but elected to continue to measure compensation expense in accordance
with Accounting Principles Board No. 25, "Accounting for Stock Issued to
Employees." Accordingly, no compensation expense for stock options has been
recognized in the accompanying consolidated financial statements.
28
31
If compensation cost had been determined based on the value of options granted,
consistent with the methodology in SFAS No. 123, net income and earnings per
share would have been reduced to the pro forma amounts indicated below:
(in thousands,
except per share amounts) 1999 1998 1997
- -------------------------------------------------------
Net income:
As reported $20,360 $27,076 $19,307
Pro forma 20,268 26,890 17,271
Basic earnings
per share:
As reported $ 0.83 $ 1.08 --
Pro forma 0.83 1.07 --
Diluted earnings
per share:
As reported $ 0.83 $ 1.07 --
Pro forma 0.83 1.06 --
Pro forma basic and
diluted net income
per share:
As reported -- -- $ 0.92
Pro forma -- -- 0.82
- ------------------------------------------------------
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:
1999 1998 1997
- ---------------------------------------------------------
Risk-free interest rate 4.37% 5.85% 6.49%
Expected life (years) 5 5 5
Expected volatility 40.00% 35.00% 30.00%
Expected dividend yield -- -- --
- ---------------------------------------------------------
A summary of stock option activity for 1999, 1998 and 1997 is set forth below:
1999 1998 1997
------------------------ ------------------------ ------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
OPTIONS EXERCISE PRICE OPTIONS EXERCISE PRICE OPTIONS EXERCISE PRICE
- -------------------------------------------------------------------------------------------------------------------------
Options outstanding, beginning
of year 553,500 $20.90 513,500 $20.00 -- --
Granted 144,000 11.17 40,000 32.42 513,500 $20.00
Exercised -- -- -- -- -- --
Lapsed and forfeited (154,000) 21.96 -- -- -- --
- -------------------------------------------------------------------------------------------------------------------------
Options outstanding, end of year 543,500 $18.02 553,500 $20.90 513,500 $20.00
=========================================================================================================================
Options exercisable, end of year 439,500 $19.56 513,500 $20.00 -- --
=========================================================================================================================
Weighted average fair value of
options granted during the year $ 4.65 $13.19 $ 6.50
=========================================================================================================================
Stock options outstanding at June 30, 1999:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
- -------------------------------------------------------------------- --------------------------
WEIGHTED AVERAGE
REMAINING
RANGE OF CONTRACTUAL WEIGHTED AVERAGE WEIGHTED AVERAGE
EXERCISE PRICES OPTIONS LIFE (YEARS) EXERCISE PRICE OPTIONS EXERCISE PRICE
- -----------------------------------------------------------------------------------------------------------
$ 9.78 30,000 9.82 $ 9.78 30,000 $ 9.78
11.53 104,000 9.33 11.53 -- --
20.00 393,500 7.99 20.00 393,500 20.00
26.94 16,000 8.07 26.94 16,000 26.94
- -----------------------------------------------------------------------------------------------------------
543,500 8.35 $18.02 439,500 $19.56
===========================================================================================================
29
32
NOTE 14: SEGMENT DATA
The company reports two segments consisting of J&L Industrial Supply (J&L) and
Full Service Supply (FSS). Segment selection was based upon internal
organization structure, the way in which management organizes segments for
making operating decisions and assessing performance, the availability of
separate financial results and materiality considerations.
Intersegment sales are accounted for at cost plus a percentage to cover expenses
to distribute the product. Corporate level expenses and certain capital
expenditures and the related depreciation expense are not allocated to the two
segments and are included entirely in the J&L segment.
In the J&L segment, the company provides metalworking consumables and related
products to small-, medium-, and large-sized manufacturers in the United States,
the United Kingdom and Germany. J&L markets products and services through annual
mail-order catalogs and monthly sale flyers, telemarketing, retail stores, the
Internet and field sales.
In the FSS segment, the company provides metalworking consumables and related
products to medium- and large-sized manufacturers in the United States. 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) 1999 1998 1997
- ---------------------------------------------------------------------------
External sales:
J&L $400,340 $ 295,618 $175,530
FSS 131,302 129,730 140,659
- ---------------------------------------------------------------------------
Total external sales $531,642 $ 425,348 $316,189
===========================================================================
Intersegment sales:
J&L $ 2,435 $ 1,505 $ 534
FSS -- -- --
- ---------------------------------------------------------------------------
Total intersegment sales $ 2,435 $ 1,505 $ 534
===========================================================================
Total sales:
J&L $402,775 $ 297,123 $176,064
FSS 131,302 129,730 140,659
- ---------------------------------------------------------------------------
Total sales $534,077 $ 426,853 $316,723
===========================================================================
Operating income:
J&L $ 21,762 $ 27,854 $ 21,935
FSS 12,770 13,454 10,258
- ---------------------------------------------------------------------------
Total operating income $ 34,532 $ 41,308 $ 32,193
===========================================================================
Interest expense (income)
and other 881 (3,068) 368
- ---------------------------------------------------------------------------
Income before provision
for income taxes $ 33,651 $ 44,376 $ 31,825
===========================================================================
Depreciation and
amortization:
J&L $ 8,458 $ 4,969 $ 1,481
FSS 291 216 287
- ---------------------------------------------------------------------------
Total depreciation
and amortization $ 8,749 $ 5,185 $ 1,768
===========================================================================
Total assets:
J&L $205,803 $ 212,457 $121,425
FSS 69,186 63,129 44,063
- ---------------------------------------------------------------------------
Total assets $274,989 $ 275,586 $165,488
===========================================================================
Capital expenditures:
J&L $ 9,441 $ 12,222 $ 2,261
FSS 240 64 26
- ---------------------------------------------------------------------------
Total capital
expenditures $ 9,681 $ 12,286 $ 2,287
===========================================================================
Sales outside of the United States were approximately $21.8 million, $17.1
million and $10.0 million during fiscal 1999, 1998 and 1997, respectively. Total
assets outside of the United States were approximately $18.2 million, $14.1
million and $6.6 million at June 30, 1999, 1998 and 1997, respectively. These
sales were principally to customers in the United Kingdom and Germany and the
assets were located in the United Kingdom and Germany.
ITEM 9. CHANGES IN AND DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
30
33
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Incorporated herein by reference is the information set forth under the captions
"Election of Directors" and "Executive Officers of the Registrant" in the
company's definitive proxy statement to be filed with the Securities and
Exchange Commission within 120 days after June 30, 1999 (1999 Proxy Statement).
ITEM 11. EXECUTIVE COMPENSATION
Incorporated herein by reference is the information set forth under the caption
"Compensation of Executive Officers" and certain information regarding
directors' fees under the caption "Board of Directors and Board Committees" in
the 1999 Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated herein by reference is the information set forth under the caption
"Ownership of Common Stock by Directors, Nominees and Executive Officers" with
respect to the directors' and officers' shareholdings and under the caption
"Principal Holders of Voting Securities" with respect to other beneficial owners
in the 1999 Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated herein by reference is certain information set forth in the notes
to the table under the caption "Election of Directors" and the information set
forth in the section entitled "Certain Relationships and Related Transactions"
in the 1999 Proxy Statement.
31
34
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Documents filed as part of this Form 10-K report.
1. Financial Statements
Financial statements filed as a part of this report are listed on
the "Index to Financial Statements" herein.
2. Financial Statement Schedules
The financial statement schedule shown below should be read in
conjunction with the financial statements contained in this
Form 10-K. Other schedules are omitted because they are not applicable
or the required information is shown in the financial statements or
notes thereto.
Report of Independent Public Accountants
Schedule II--Valuation and Qualifying Accounts for the Three Years
Ended June 30, 1999
3. Exhibits
(3) ARTICLES OF INCORPORATION AND BY-LAWS
(3.1) Amended and Restated Articles of Incorporation
(incorporated herein by reference to Exhibit 3.a of Amendment No. 1 to
the company's Registration Statement on Form S-1 (No. 333-25989) filed
with the Commission on June 4, 1997).
(3.2) By-laws (incorporated by reference to Exhibit 3.b of
Amendment No. 1 to the company's Registration Statement on Form S-1
(No. 333-25989) filed with the Commission on June 4, 1997).
(10) MATERIAL CONTRACTS
(10.1) Administrative Services Agreement (incorporated by
reference to Exhibit 10.a of Amendment No. 1 to the company's
Registration Statement on Form S-1 (No. 333-25989) filed with the
Commission on June 4, 1997).
(10.2) Corporate Agreement (incorporated by reference to Exhibit
10.b of Amendment No. 1 to the company's Registration Statement on
Form S-1 (No. 333-25989) filed with the Commission on June 4, 1997).
(10.3) Indemnification Agreement (incorporated by reference to
Exhibit 10.c of Amendment No. 1 to the company's Registration
Statement on Form S-1 (No. 333-25989) filed with the Commission on
June 4, 1997).
(10.4) Intercompany Debt/Investment and Cash Management Agreement
(incorporated by reference to Exhibit 10.d of Amendment No. 1 to the
company's Registration Statement on Form S-1 (No. 333-25989) filed
with the Commission on June 4, 1997).
(10.5) Non-Competition and Corporate Opportunities Allocation
Agreement (incorporated by reference to Exhibit 10.e of Amendment No.
1 to the company's Registration Statement on Form S-1 (No. 333-25989)
filed with the Commission on June 4, 1997).
(10.6) Shared Facilities Agreements (incorporated by reference to
Exhibit 10.f of Amendment No. 1 to the company's Registration
Statement on Form S-1 (No. 333-25989) filed with the Commission on
June 4, 1997).
(10.7) Tax Sharing Agreement (incorporated by reference to
Exhibit 10.g of Amendment No. 1 to the company's Registration
Statement on Form S-1 (No. 333-25989) filed with the Commission on
June 4, 1997).
(10.8) Trademark License Agreement (incorporated by reference to
Exhibit 10.h of Amendment No. 1 to the company's Registration
Statement on Form S-1 (No. 333-25989) filed with the Commission on
June 4, 1997).
(10.9) Warehousing Agreements (incorporated by reference to
Exhibit 10.i of Amendment No. 1 to the company's Registration
Statement on Form S-1 (No. 333-25989) filed with the Commission on
June 4, 1997).
(10.10) Lease Agreement (incorporated by reference to Exhibit
10.j of Amendment No. 1 to the company's Registration Statement on
Form S-1 (No. 333-25989) filed with the Commission on June 4, 1997).
32
35
(10.11) Product Supply Agreement (incorporated by reference to
Exhibit 10.k of Amendment No. 1 to the company's Registration
Statement on Form S-1 (No. 333-25989) filed with the Commission on
June 4, 1997).
(10.12) 1997 JLK Direct Distribution Inc. Stock Option and
Incentive Plan (incorporated by reference to Exhibit 10.l of the
company's December 31, 1997 Form 10-Q).
(10.13) Kennametal Inc. Supplemental Executive Retirement Plan
(incorporated by reference to Exhibit 10.m of Amendment No. 1 to the
company's Registration Statement on Form S-1 (No. 333-25989) filed
with the Commission on June 4, 1997).
(10.14) Kennametal Inc. Employment Agreement with Michael W.
Ruprich (incorporated by reference to Exhibit 10.n of Amendment No. 1
to the company's Registration Statement on Form S-1 (No. 333-25989)
filed with the Commission on June 4, 1997).
(10.15) JLK Direct Distribution Inc. Management Bonus Plan
(incorporated by reference to Exhibit 10.s of Amendment No. 2 to the
company's Registration Statement on Form S-1 (No. 333-25989) filed
with the Commission on June 24, 1997).
(10.16) JLK Direct Distribution Inc. Employment Agreement with
Michael W. Ruprich (incorporated by reference to Exhibit 10.16 of the
company's June 30, 1998 Form 10-K).
(10.17) Severance Agreement with former Executive Officer dated
February 25, 1999 (incorporated by reference to Exhibit 10.1 of the
company's March 31, 1999 Form 10-Q).
(21) SUBSIDIARIES OF THE REGISTRANT
Filed herewith.
(27) FINANCIAL DATA SCHEDULE
Filed herewith.
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the quarter ended June 30,
1999.
33
36
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange
Act of 1934, the company has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
JLK DIRECT DISTRIBUTION INC.
By /s/ DIANA L. SCOTT
------------------
Diana L. Scott
Vice President, Chief Financial Officer and Treasurer
Date: September 23, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
- -------------------------------------------------------------------------------------------------------------
/s/ WILLIAM R. NEWLIN Chairman of the Board September 23, 1999
- ---------------------
William R. Newlin
/s/ RICHARD J. ORWIG President, Chief Executive September 23, 1999
- -------------------- Officer and Director
Richard J. Orwig
/s/ DIANA L. SCOTT Vice President, Chief Financial September 23, 1999
- ------------------ Officer and Treasurer
Diana L. Scott
/s/ RICHARD C. ALBERDING Director September 23, 1999
- ------------------------
Richard C. Alberding
/s/ JEFFERY M. BOETTICHER Director September 23, 1999
- -------------------------
Jeffery M. Boetticher
/s/ IRWIN L. ELSON Director September 23, 1999
- ------------------
Irwin L. Elson
/s/ H. PATRICK MAHANES, JR. Director September 23, 1999
- ---------------------------
H. Patrick Mahanes, Jr.
/s/ ALOYSIUS T. MCLAUGHLIN, JR. Director September 23, 1999
- -------------------------------
Aloysius T. McLaughlin, Jr.
/s/ MARKOS I. TAMBAKERAS Director September 23, 1999
- ------------------------
Markos I. Tambakeras
34
37
REPORT OF INDEPENDENT
PUBLIC ACCOUNTANTS ON
SUPPLEMENTAL SCHEDULE
We have audited in accordance with generally accepted auditing standards, the
consolidated financial statements of JLK Direct Distribution Inc., included in
this Form 10-K, and have issued our report thereon dated July 20, 1999. Our
audits were made for the purpose of forming an opinion on the basic financial
statements taken as a whole. This schedule listed in Item 14-a2 of this Form
10-K is the responsibility of the company's management and is presented for
purposes of complying with the Securities and Exchange Commission's rules and
regulations and is not part of the basic financial statements. This schedule has
been subjected to the auditing procedures applied in the audits of the basic
financial statements and, in our opinion, fairly states in all material respects
the financial data required to be set forth therein in relation to the basic
financial statements taken as a whole.
/s/ ARTHUR ANDERSEN LLP
- -----------------------
Arthur Andersen LLP
Pittsburgh, Pennsylvania
July 20, 1999
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
FOR THE THREE YEARS ENDED JUNE 30, 1999
BALANCE AT CHARGED TO DEDUCTIONS
BEGINNING COSTS AND OTHER FROM BALANCE AT
DESCRIPTION OF YEAR EXPENSES RECOVERIES ADJUSTMENTS(a) RESERVES(b) END OF YEAR
- ---------------------------------------------------------------------------------------------------------------------
1999
Allowance for doubtful accounts $827,416 $856,894 $68,328 $ 5,709 $(777,509) $980,838
- ---------------------------------------------------------------------------------------------------------------------
1998
Allowance for doubtful accounts $285,950 $515,002 $26,176 $499,538 $(499,250) $827,416
- ---------------------------------------------------------------------------------------------------------------------
1997
Allowance for doubtful accounts $218,487 $407,091 -- -- $(339,628) $285,950
- ---------------------------------------------------------------------------------------------------------------------
(a) Represents foreign currency translation adjustment and reserves acquired
through business combinations in fiscal 1998.
(b) Represents uncollected accounts charged against the allowance.
35
38
EXHIBIT INDEX
Exhibit
No. Reference
--- ---------
3.1 Amended and Restated Articles of Incorporated herein by reference to Exhibit 3.a of
Incorporation Amendment No. 1 to the company's Registration
Statement on Form S-1 (No. 333-25989) filed with the
Commission on June 4, 1997.
3.2 By-laws Incorporated herein by reference to Exhibit 3.b of
Amendment No. 1 to the company's Registration
Statement on Form S-1 (No. 333-25989) filed with the
Commission on June 4, 1997.
10.1 Administrative Services Agreement Incorporated herein by reference to Exhibit 10.a of
Amendment No. 1 to the company's Registration
Statement on Form S-1 (No. 333-25989) filed with the
Commission on June 4, 1997.
10.2 Corporate Agreement Incorporated herein by reference to Exhibit 10.b of
Amendment No. 1 to the company's Registration
Statement on Form S-1 (No. 333-25989) filed with the
Commission on June 4, 1997.
10.3 Indemnification Agreement Incorporated herein by reference to Exhibit 10.c of
Amendment No. 1 to the company's Registration
Statement on Form S-1 (No. 333-25989) filed with the
Commission on June 4, 1997.
10.4 Intercompany Debt/Investment and Incorporated herein by reference to Exhibit 10.d of
Cash Management Agreement Amendment No. 1 to the company's Registration
Statement on Form S-1 (No. 333-25989) filed with the
Commission on June 4, 1997.
10.5 Non-Competition and Corporate Incorporated herein by reference to Exhibit 10.e of
Opportunities Allocation Agreement Amendment No. 1 to the company's Registration
Statement on Form S-1 (No. 333-25989) filed with the
Commission on June 4, 1997.
39
Exhibit
No. Reference
--- ---------
10.6 Shared Facilities Agreements Incorporated herein by reference to Exhibit 10.f of
Amendment No. 1 to the company's Registration
Statement on Form S-1 (No. 333-25989) filed with the
Commission on June 4, 1997.
10.7 Tax Sharing Agreement Incorporated herein by reference to Exhibit 10.g of
Amendment No. 1 to the company's Registration
Statement on Form S-1 (No. 333-25989) filed with the
Commission on June 4, 1997.
10.8 Trademark License Agreement Incorporated herein by reference to Exhibit 10.h of
Amendment No. 1 to the company's Registration
Statement on Form S-1 (No. 333-25989) filed with the
Commission on June 4, 1997.
10.9 Warehousing Agreements Incorporated herein by reference to Exhibit 10.i of
Amendment No. 1 to the company's Registration
Statement on Form S-1 (No. 333-25989) filed with the
Commission on June 4, 1997.
10.10 Lease Agreement Incorporated herein by reference to Exhibit 10.j of
Amendment No. 1 to the company's Registration
Statement on Form S-1 (No. 333-25989) filed with the
Commission on June 4, 1997.
10.11 Product Supply Agreement Incorporated herein by reference to Exhibit 10.k of
Amendment No. 1 to the company's Registration
Statement on Form S-1 (No. 333-25989) filed with the
Commission on June 4, 1997.
10.12 1997 JLK Direct Distribution Inc. Incorporated herein by reference to Exhibit 10.1 of
Stock Option and Incentive Plan the company's December 31, 1997 Form 10-Q.
10.13 Kennametal Inc. Supplemental Incorporated herein by reference to Exhibit 10.m of
Executive Retirement Plan Amendment No. 1 to the company's Registration
Statement on Form S-1 (No. 333-25989) filed with the
Commission on June 4, 1997.
40
Exhibit
No. Reference
--- ---------
10.14 Kennametal Inc. Employment Incorporated herein by reference to Exhibit 10.n of
Agreement with Michael Ruprich Amendment No. 1 to the company's Registration
Statement on Form S-1 (No. 333-25989) filed with the
Commission on June 4, 1997.
10.15 JLK Direct Distribution Inc. Incorporated herein by reference to Exhibit 10.s of
Management Bonus Plan Amendment No. 2 to the company's Registration
Statement on Form S-1 (No. 333-25989) filed with the
Commission on June 24, 1997.
10.16 JLK Direct Distribution Inc. Incorporated herein by reference to Exhibit 10.16 of
Employment Agreement with the company's June 30, 1998 Form 10-K.
Michael W. Ruprich
10.17 Severance Agreement with former Incorporated herein by reference to Exhibit 10.1 of
Executive Officer dated February the company's March 31, 1999 Form 10-Q.
25, 1999
21 Subsidiaries of the Registrant Filed herewith.
27 Financial Data Schedule Filed herewith.