FORM 10-K SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED JUNE 30, 2003 Commission File Number 1-5318 KENNAMETAL INC. (Exact name of registrant as specified in its charter) Pennsylvania 25-0900168 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) World Headquarters 1600 TECHNOLOGY WAY P. O. BOX 231 Latrobe, Pennsylvania 15650-0231 (Address of principal executive offices) Registrant's telephone number, including area code: 724-539-5000 Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registered Capital Stock, par value $1.25 per share New York Stock Exchange Preferred Stock Purchase Rights New York Stock Exchange Securities registered pursuant to Section 12(g) of the Act: None. Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] Indicate by check mark whether the registrant is an accelerated filer (as defined by Rule 126-2 of the Exchange Act). YES [X] NO [ ] As of December 31, 2002, the aggregate market value of the registrant's Capital Stock held by non-affiliates of the registrant, estimated solely for the purposes of this Form 10-K, was approximately $910,500,000. For purposes of the foregoing calculation only, all directors and executive officers of the registrant and each person who may be deemed to own beneficially more than 5% of the registrant's Capital Stock have been deemed affiliates. As of August 29, 2003, there were 35,915,232 shares of the Registrant's Capital Stock outstanding. Documents Incorporated by Reference Portions of the Proxy Statement for the 2003 Annual Meeting of Shareowners are incorporated by reference into Parts III and IV.
Table of Contents Item No. Page PART I 1. Business 3 2. Properties 10 3. Legal Proceedings 11 4. Submission of Matters to a Vote of Security Holders 11 Executive Officers of the Registrant 12 PART II 5. Market for the Registrant's Common Equity and Related Shareowner Matters 14 6. Selected Financial Data 15 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 18 7A. Quantitative and Qualitative Disclosures About Market Risk 32 8. Financial Statements and Supplementary Data 34 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 67 9A. Controls and Procedures 67 PART III 10. Directors and Executive Officers of the Registrant 68 11. Executive Compensation 68 12. Security Ownership of Certain Beneficial Owners and Management and Related Shareowner Matters 68 13. Certain Relationships and Related Transactions 68 14. Principal Accountant Fees and Services 68 PART IV 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 69 Signatures 72 FORWARD-LOOKING INFORMATION This Form 10-K contains "forward-looking" statements within the meaning of Section 21E of the Securities Exchange Act of 1934. You can identify these forward-looking statements by the fact they use words such as "should," "anticipate," "estimate," "approximate," "expect," "may," "will," "project," "intend," "plan," "believe" and other words of similar meaning and expression in connection with any discussion of future operating or financial performance. One can also identify forward-looking statements by the fact that they do not relate strictly to historical or current facts. These statements are likely to relate to, among other things, our goals, plans and projections regarding our financial position, results of operations, cash flows, market position and product development, which are based on current expectations that involve inherent risks and uncertainties, including factors that could delay, divert or change any of them in the next several years. Although it is not possible to predict or identify all factors, they may include the following: global economic conditions; future terrorist attacks; epidemics; risks associated with integrating and divesting businesses and achieving the expected savings and synergies; demands on management resources; risks associated with international markets such as currency exchange rates, and social and political environments; competition; labor relations; commodity prices; demand for and market acceptance of new and existing products; and risks associated with the implementation of restructuring plans and environmental remediation matters. We can give no assurance that any goal or plan set forth in forward-looking statements can be achieved and readers are cautioned not to place undue reliance on such statements, which speak only as of the date made. We undertake no obligation to release publicly any revisions to forward-looking statements as a result of future events or developments. 2
Part I ITEM 1 - BUSINESS OVERVIEW Kennametal Inc. was incorporated in Pennsylvania in 1943. We are a leading global manufacturer, marketer and distributor of a broad range of cutting tools, tooling systems, supplies and technical services, as well as wear-resistant parts. We believe that our reputation for manufacturing excellence and technological expertise and innovation in our principal products has helped us achieve a leading market presence in our primary markets. We believe we are the second largest global provider of metalcutting tools and tooling systems. End users of our products include metalworking manufacturers and suppliers in the aerospace, automotive, machine tool and farm machinery industries, as well as manufacturers and suppliers in the highway construction, coal mining, quarrying and oil and gas exploration industries. We specialize in developing and manufacturing metalworking tools and wear-resistant parts using a specialized type of powder metallurgy. Our metalworking tools are made of cemented tungsten carbides, ceramics, cermets, high-speed steel and other hard materials. We also manufacture and market a complete line of toolholders, toolholding systems and rotary cutting tools by machining and fabricating steel bars and other metal alloys. We are one of the largest suppliers of metalworking consumables and related products in the United States and Europe. We also manufacture tungsten carbide products used in engineered applications, mining and highway construction, and other similar applications, including circuit board drills, compacts and metallurgical powders. BUSINESS SEGMENT REVIEW We operate four global business units consisting of Metalworking Solutions & Services Group (MSSG), Advanced Materials Solutions Group (AMSG), J&L Industrial Supply (J&L) and Full Service Supply (FSS). Segment selection was based upon internal organizational structure, the manner in which we organize segments for making operating decisions and assessing performance, the availability of separate financial results, and materiality considerations. Sales and operating income by segment are presented in Management's Discussion and Analysis set forth in Item 7 in this annual report on Form 10-K and Note 18 "Segment Data" of our consolidated financial statements set forth in Item 8 in this annual report on Form 10-K. METALWORKING SOLUTIONS & SERVICES GROUP--MSSG In the MSSG segment, we provide consumable metalcutting tools and tooling systems to manufacturing companies in a wide range of industries throughout the world. Metalcutting operations include turning, boring, threading, grooving, milling and drilling. Our tooling systems consist of a steel toolholder and cutting tool such as an indexable insert or drill made from cemented tungsten carbides, high speed steel and other hard materials. We also provide solutions to our customers' metalcutting needs through engineering services aimed at improving their competitiveness. During a metalworking operation, the toolholder is positioned in a machine that provides the turning power. While the workpiece or toolholder is rapidly rotating, the cutting tool insert or drill contacts the workpiece and cuts or shapes the workpiece. The cutting tool insert or drill is consumed during use and must be replaced periodically. We serve a wide variety of industries that cut and shape metal parts including manufacturers of automobiles, trucks, aerospace components, farm equipment, oil and gas drilling and processing equipment, railroad, marine, power generation equipment, machinery, appliances, factory equipment and metal components, as well as job shops and maintenance operations. We deliver our products to customers through a direct field sales force, distribution, integrated supply programs, mail-order and e-business. With a global marketing organization and operations worldwide, we believe we are the second largest global provider of consumable metalcutting tools and supplies. ADVANCED MATERIALS SOLUTIONS GROUP--AMSG In the AMSG segment, the principal business is the production and sale of cemented tungsten carbide products used in mining, highway construction, engineered applications requiring wear and corrosion resistance, including circuit board drills, compacts and other similar applications. These products have technical commonality to our core metalworking products. We also sell metallurgical powders to manufacturers of cemented tungsten carbide products. We also provide application specific component design services and on-site application support services. Our mining and construction tools are fabricated from steel parts and tipped with cemented carbide. Mining tools, used primarily in the coal industry, include longwall shearer and continuous miner drums, blocks, conical bits, drills, pinning rods, augers and a wide range of mining tool accessories. Highway construction cutting 3
tools include carbide-tipped bits for ditching, trenching and road planing, grader blades for site preparation and routine roadbed control, and snowplow blades and shoes for winter road plowing. We produce these products for mine operators and suppliers, highway construction companies, municipal governments and manufacturers of mining equipment. We believe we are the worldwide market leader in mining and highway construction tooling. Our customers use engineered products in manufacturing or other operations where extremes of abrasion, corrosion or impact require combinations of hardness or other toughness afforded by cemented tungsten carbides or other hard materials. We sell these products through a direct field sales force and distribution. We believe we are the largest independent supplier of oil field compacts in the world. Compacts are the cutting edges of oil well drilling bits, which are commonly referred to as "rock bits." J&L INDUSTRIAL SUPPLY--J&L In this segment, we provide metalworking consumables and related products to small- and medium-sized manufacturers in the United States and the United Kingdom. J&L markets products and services through annual mail-order catalogs and monthly sales flyers, telemarketing, the Internet and field sales. J&L distributes a broad range of metalcutting tools, abrasives, drills, machine tool accessories, precision measuring tools, gages, hand tools and other supplies used in metalcutting operations. The majority of industrial supplies distributed by J&L are purchased from other manufacturers, although the product offering does include Kennametal-manufactured items. FULL SERVICE SUPPLY--FSS In the FSS segment, we provide metalworking consumables and related products to medium- and large-sized manufacturers in the United States and Canada. FSS offers integrated supply programs that provide inventory management systems, just-in-time availability and programs that focus on total cost savings. Through FSS programs, large commercially-oriented customers seeking a single source of metalcutting supplies engage us to carry out all aspects of complex metalworking supply processes, including needs assessment, cost analysis, procurement planning, supplier selection, "just-in-time" restocking of supplies and ongoing technical support. INTERNATIONAL OPERATIONS Our international operations are subject to the usual risks of doing business in those countries, including foreign currency exchange fluctuations and changes in social, political and economic environments. Our principal international operations in the MSSG and AMSG segments are conducted in Western Europe, Canada, the Asia Pacific region, China, South Africa and Mexico. In addition, we have manufacturing and/or distribution in Israel and South America, and sales agents and distributors in Eastern Europe and other areas of the world. Our Western European operations are integral to our U.S. operations, however, the diversification of our overall operations tends to minimize the impact of changes in demand on total sales and earnings in any one particular geographic area. Our international assets and sales are presented under Note 18 "Segment Data" of our consolidated financial statements set forth in Item 8 in this annual report on Form 10-K. Information pertaining to the effects of foreign exchange risk is contained under the caption "Quantitative and Qualitative Disclosure about Market Risk" in Management's Discussion and Analysis set forth in Item 7 in this annual report on Form 10-K. BUSINESS DEVELOPMENT On August 30, 2002, we purchased the Widia Group (Widia) in Europe and India from Milacron Inc. for EUR 188 million ($185.3 million) subject to a purchase price adjustment. On February 12, 2003, Milacron Inc. and Kennametal signed a settlement agreement with respect to the calculation of the post-closing purchase price adjustment for the Widia acquisition pursuant to which Milacron paid Kennametal EUR 18.8 million ($20.1 million) in cash. The net cash purchase price of $167.1 million includes the actual purchase price of $185.3 million less the settlement of $20.1 million plus $6.2 million of direct acquisition costs ($1.1 million paid in fiscal year 2002 and $5.1 million paid during the twelve months ended June 30, 2003) less $4.3 million of acquired cash. We financed the acquisition with funds borrowed under our three-year, multi-currency, revolving credit facility (2002 Credit Agreement) which we entered into on June 27, 2002 with a group of financial institutions. The acquisition of Widia improves our global competitiveness, strengthens our European position and represents a strong platform for increased penetration in Asia. Widia's operating results have been included in our consolidated results since the acquisition date of August 30, 2002. We continue to evaluate new opportunities that allow for the expansion of existing product lines into new market areas, either directly or indirectly through joint ventures, where appropriate. MARKETING AND DISTRIBUTION We sell our manufactured products through the following distinct sales channels: (i) a direct sales force; (ii) integrated supply and FSS programs; (iii) mail-order catalogs; (iv) a network of independent distributors and sales agents in the United States and certain international markets; and (v) the Internet. Service engineers and technicians directly assist customers with product design, selection and application. 4
We market our products under various trademarks and tradenames, such as Kennametal*, the letter K combined with other identifying letters and/or numbers*, Block Style K*, Kendex*, Kenloc*, KennaMAX*, JLK*, J&L*, Kennametal Hertel*, Hertel*, KM Micro*, Widia*, Heinlein*, Widma*, Ecogrind*, Top Notch*, Erickson*, Kyon*, KM*, Drill-Fix*, Fix-Perfect*, Disston*, Chicago Latrobe*, Greenfield*, RTW* and Cleveland*. We also sell products to customers who resell such products under the customers' names or private labels. RAW MATERIALS AND SUPPLIES Major metallurgical raw materials consist of ore concentrates, compounds and secondary materials containing tungsten, tantalum, titanium, niobium and cobalt. Although adequate supply of these raw materials currently exists, our major sources for raw materials are located abroad and prices fluctuate at times. For these reasons, we exercise great care in the selection, purchase and inventory availability of raw materials. We also purchase steel bars and forgings for making toolholders, high speed steel and other tool parts, rotary cutting tools and accessories. We obtain products purchased for use in manufacturing processes and for resale from thousands of suppliers located in the United States and abroad. RESEARCH AND DEVELOPMENT Our product development efforts focus on providing solutions to our customers' manufacturing problems and productivity requirements. Our Achieving a Competitive Edge (ACE) Program provides discipline and focus for the product development process by establishing "gateways," or sequential tests, during the development process to remove inefficiencies and accelerate improvements. ACE speeds and streamlines development into a series of actions and decision points, combining effort and resources to produce new and enhanced products, faster. ACE assures a strong link between customer needs and corporate strategy, and enables us to gain full benefit from our investment in new product development. Research and development expenses totaled $23.6 million, $18.3 million and $18.9 million in 2003, 2002 and 2001, respectively. Additionally, certain costs associated with improving manufacturing processes are included in cost of goods sold. We hold a number of patents, which, in the aggregate, are material to the operation of our businesses. SEASONALITY Our business is not materially affected by seasonal variations. However, to varying degrees, traditional summer vacation shutdowns of metalworking customers' plants and holiday shutdowns often affect our sales levels during the first and second quarters of our fiscal year. BACKLOG Our backlog of orders generally is not significant to our operations. We fill approximately 90 percent of all orders from stock, and the balance generally is filled within short lead times. COMPETITION We are one of the world's leading producers of cemented carbide products and high-speed steel tools, and maintain a strong competitive position, especially in North America and Europe. We actively compete in the sale of all our products, with approximately 40 companies engaged in the cemented tungsten carbide business in the United States and many more outside the United States. Several competitors are divisions of larger corporations. In addition, several hundred fabricators and toolmakers, many of whom operate out of relatively small shops, produce tools similar to ours and buy the cemented tungsten carbide components for such tools from cemented tungsten carbide producers, including us. Major competition exists from both U.S.-based and international-based concerns. In addition, we compete with thousands of industrial supply distributors. The principal elements of competition in our businesses are service, product innovation, quality, availability and price. We believe that our competitive strength rests on our customer service capabilities, including multiple distribution channels, our global presence, state-of-the-art manufacturing capabilities, ability to develop solutions to address customer needs through new and improved tools, and the consistent high quality of our products. Based upon our strengths, we are able to sell products based on the value added to the customer rather than strictly on competitive prices. REGULATION We are not currently party to any material legal proceedings, however, we are periodically subject to legal proceedings and claims that arise in the ordinary course of our business. While management currently believes the amount of ultimate liability, if any, with respect to these actions will not materially affect the financial position, results of operations, or liquidity of the Company, the ultimate outcome of any litigation is uncertain. Were an unfavorable outcome to occur, or if protracted litigation were to ensue, the impact could be material to the Company. * Trademark owned by Kennametal Inc. or a subsidiary of Kennametal Inc. 5
Compliance with government laws and regulations pertaining to the discharge of materials or pollutants into the environment or otherwise relating to the protection of the environment did not have a material effect on our capital expenditures or competitive position for the years covered by this report, nor is such compliance expected to have a material effect in the future. We are involved in various environmental cleanup and remediation activities at several of our manufacturing facilities. In addition, we are currently named as a potentially responsible party (PRP) at the Li Tungsten Superfund site in Glen Cove, New York. In December 1999, we recorded a remediation reserve of $3.0 million with respect to our involvement in these matters, which is recorded as a component of operating expense. This represents our best estimate of the undiscounted future obligation based on our evaluations and discussions with outside counsel and independent consultants, and the current facts and circumstances related to these matters. We recorded this liability because certain events occurred, including the identification of other PRPs, an assessment of potential remediation solutions and direction from the government for the remedial action plan, that clarified our level of involvement in these matters and our relationship to other PRPs. This led us to conclude that it was probable that a liability had been incurred. At June 30, 2003, we have an accrual of $2.8 million recorded relative to this environmental issue. In addition to the amount currently reserved, we may be subject to loss contingencies related to these matters estimated to be up to an additional $3.0 million. We believe that such undiscounted unreserved losses are reasonably possible but are not currently considered to be probable of occurrence. The reserved and unreserved liabilities for all environmental concerns could change substantially in the near term due to factors such as the nature and extent of contamination, changes in remedial requirements, technological changes, discovery of new information, the financial strength of other PRPs, the identification of new PRPs and the involvement of and direction taken by the government on these matters. Additionally, we also maintain reserves for other potential environmental issues associated with our domestic operations and a location operated by our German subsidiary. At June 30, 2003, the total of these accruals was $1.3 million and represents anticipated costs associated with the remediation of these issues. Cash payments of $0.1 million have been made against this reserve during the year. During the due diligence phase of the Widia acquisition, we identified certain environmental exposures with Widia manufacturing locations in Europe and India. The purchase price paid reflected our estimate of this exposure. As a result of the Widia acquisition, we have established an environmental reserve of $6.2 million, which is consistent with our expectations determined during the due diligence phase. This reserve will be used for environmental clean-up and remediation activities at several Widia manufacturing locations. This liability represents our best estimate of the future obligation based on our evaluations and discussions with independent consultants and the current facts and circumstances related to these matters. This liability has been recorded as part of the Widia acquisition and has not been reflected in our operating results. We maintain a Corporate Environmental, Health and Safety (EH&S) Department, as well as an EH&S Policy Committee, to ensure compliance with environmental regulations and to monitor and oversee remediation activities. In addition, we have established an EH&S administrator at all our global manufacturing facilities. Our financial management team periodically meets with members of the Corporate EH&S Department and the Corporate Legal Department to review and evaluate the status of environmental projects and contingencies. On a quarterly basis, we establish or adjust financial provisions and reserves for environmental contingencies in accordance with Statement of Financial Accounting Standards (SFAS) No. 5, "Accounting for Contingencies." PUBLIC OFFERINGS On June 19, 2002, we sold 3.5 million shares of capital stock at a price of $36 per share. Net of issuance costs, this offering yielded proceeds of $120.6 million. On the same date, we issued $300.0 million of 7.2% Senior Unsecured Notes due 2012 at 99.629% of face amount for net proceeds of $294.3 million after related financing costs. Proceeds of these offerings were utilized to repay senior bank indebtedness. EMPLOYEES We employed approximately 13,970 persons at June 30, 2003, of which approximately 6,900 were located in the United States and 7,070 in other parts of the world, principally Europe and Asia Pacific. At June 30, 2003, approximately 3,690 of the above employees were represented by labor unions. We consider our labor relations to be generally good. 6
AVAILABLE INFORMATION Our Internet address is www.kennametal.com. On our Investor Relations page on our Web site, we post the following filings as soon as reasonably practicable after they are electronically filed with or furnished to the Securities and Exchange Commission: our annual report on Form 10-K, our quarterly reports on Form 10-Q, our current reports on Form 8-K and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934. All such filings on our Investor Information Web page, which also includes Forms 3, 4 and 5 filed pursuant to Section 16(a) of the Securities Exchange Act of 1934, are available to be viewed on this page free of charge. Information contained on our Web site is not part of this annual report on Form 10-K or our other filings with the Securities and Exchange Commission. We assume no obligation to update or revise any forward-looking statements in this annual report on Form 10-K, whether as a result of new information, future events or otherwise. A copy of this annual report on Form 10-K is available without charge upon written request to: Investor Relations, Beth Riley, Kennametal Inc., 1600 Technology Way, P.O. Box 231, Latrobe, Pa. 15650-0231. CORPORATE DIRECTORY Our consolidated subsidiaries and affiliated companies as of June 30, 2003 are: Consolidated Subsidiaries of Kennametal Inc. Kennametal Australia Pty. Ltd. Kennametal Foreign Sales Corporation Kennametal Ltd. Kennametal (Canada) Ltd. Kennametal (Shanghai) Ltd. Kennametal (Thailand) Co., Ltd. Kennametal (Xuzhou) Company Ltd. Kennametal Hardpoint Inc. Kennametal Japan Ltd. Kennametal (Malaysia) Sdn. Bhd. Kennametal de Mexico, S.A. de C.V. Kennametal SP. Z.o.o Kennametal (Singapore) Pte. Ltd. Kennametal South Africa (Proprietary) Ltd. Kennametal Korea Ltd. Kennametal Holding Cayman Islands Limited Kennametal Co., Ltd. Kennametal Financing I Kennametal Financing II Corp. Kennametal Holdings Europe Inc. Adaptive Technologies Corp. Circle Machine Company Greenfield Industries, Inc. Consolidated Subsidiaries of Kennametal Financing II Kennametal PC Inc. Kennametal TC Inc. Kennametal Receivables Corporation Consolidated Subsidiaries of Kennametal Holdings Europe Inc. JLK Direct Distribution Inc. Kennametal W Holdings Inc. Consolidated Subsidiaries of Kennametal Widia Holdings Inc. Kennametal Europe Holding GmbH Kennametal Widia Beteiligungs GmbH Kennametal Widia Holdings GmbH Widia GmbH V & S Werkzeuge GmbH 7
Corporate Directory (continued) Consolidated Subsidiaries of Kennametal Hardpoint, Inc. Kennametal Hardpoint H.K. Ltd. Kennametal Hardpoint (Taiwan) Inc. Consolidated Subsidiary of Kennametal Hardpoint H.K. Ltd. Kennametal Hardpoint (Shanghai) Ltd. Consolidated Subsidiaries of Widia GmbH Meturit AG Widia Vetriebsgesellschaft mbH Consolidated Subsidiary of Meturit AG Widia (India) Limited Consolidated Subsidiaries of Kennametal Holdings Cayman Islands Limited Kennametal Argentina S.A. Kennametal do Brasil Ltda. Kennametal Chile Ltda. Consolidated Subsidiary of Metruit AG Widia India Ltd. Consolidated Subsidiaries of Kennametal Europe Holdings GmbH Cirbo Limited England Kennametal Hertel Europe Holding GmbH Consolidated Subsidiaries of JLK Direct Distribution Inc. J&L America, Inc. Full Service Supply Inc. Consolidated Subsidiary of Full Service Supply Inc. Full Service Supply Ltd. Consolidated Subsidiaries of Kennametal Hertel Europe Holding GmbH Kennametal Hertel AG Kemmer Hartmetallwerkzeuge GmbH Kennametal Hertel Hungaria Kft. Kemmer Hartmetallwerkeeuge GmbH Consolidated Subsidiaries of Kemmer Hartmetallwerkeeuge GmbH Kemmer Prazisian GmbH Kemmer Cirbo S.r.l. Italy Consolidated Subsidiaries of Kennametal Hertel AG Kennametal Hertel Belgium S.A. Kennametal UK Limited Kennametal France SAS Kennametal Beteiligungs GmbH Kennametal Europe GmbH Kennametal Deutschland GmbH Kennametal Hertel International GmbH Kennametal GmbH & Co. K.G. Kennametal Korea GmbH Rubig G.m.b.H. & Co. K.G. Kennametal Hertel S.p.A. Kennametal Nederland B.V. Nederland Hardmetal Fabrieken B.V. Kennametal Kecisi Takimlar Sanayi ve Ticaret A.S. Kennametal Hertel International GmbH Kennametal Hertel Iberica S.L. Kennametal Osterreich GmbH 8
Consolidated Subsidiaries of Kennametal Osterreich GmbH Kennametal Polska Sp. Z.o.o. Kennametal Kft. Consolidated Subsidiary of Kennametal UK Limited Widia UK Ltd. Consolidated Subsidiaries of Kennametal Hertel Nederland B.V. Widia Nederland B.B. Kennametal Engineered Products B.V. Consolidated Subsidiary of Kennametal Hertel France S.L. Widia France SAS Consolidated Subsidiary of Kennametal Iberica S.L. Kenci S.A. Consolidated Subsidiary of Kennametal Italia S.p.A. Kennametal Hertel Italia S.r.l. Consolidated Subsidiary of Kennametal Hertel Italia S.r.L. Widia Italia S.r.l. Consolidated Subsidiaries of J&L America, Inc. J&L Industrial Supply Ltd. J&L Industrial Supply UK (branch) Consolidated Subsidiaries of Greenfield Industries, Inc. Greenfield Industries Canada Incorporated Hanita Metal Works, Ltd. Cleveland Twist Drill de Mexico, S.A. de C.V. Carbidie Asia Pacific Pte. Ltd. Kemmer International, Inc. Rogers Tool Works, Inc. South Deerfield Industrial, Inc. Hanita Cutting Tools, Inc. Hanita Metal Works GmbH (Germany) Consolidated Subsidiaries of Rogers Tool Works Inc. TCM Europe, Inc. RTW Limited (England) Kennametal Hungary Finance Services kft. Kennametal Hungary Holdings Inc. Consolidated Subsidiary of Cleveland Twist Drill de Mexico, S.A. de C.V. Herramientas Cleveland, S.A. de C.V. Consolidated Subsidiary of Herramientas Cleveland, S.A. de C.V. Greenfield Tools de Mexico, S.A. de C.V. 9
ITEM 2 - PROPERTIES Our principal executive offices are located at 1600 Technology Way, P.O. Box 231, Latrobe, Pa., 15650.A summary of our principal owned and leased manufacturing facilities is as follows: Location Owned/Leased Principal Products -------- ------------ ------------------ United States: Bentonville, Arkansas Owned Carbide Round Tools Rogers, Arkansas Owned Carbide Products Monrovia, California Leased Boring Bars Placentia, California Leased Wear Parts Evans, Georgia Owned High Speed Steel Drills Elk Grove Village, Illinois Leased Fixed Limited Gages Rockford, Illinois Owned Indexable Tooling Framingham, Massachusetts Leased Fixed Limited Gages Greenfield, Massachusetts Owned High Speed Steel Taps South Deerfield, Massachusetts Leased High Speed Steel Drills and Saw Blades Traverse City, Michigan Owned Ceramic Wear Parts Troy, Michigan Leased Metalworking Toolholders Fallon, Nevada Owned Metallurgical Powders Asheboro, North Carolina Owned High Speed Steel End Mills Roanoke Rapids, North Carolina Owned Metalworking Inserts Orwell, Ohio Owned Metalworking Inserts Solon, Ohio Owned Metalworking Toolholders Bedford, Pennsylvania Owned Mining and Construction Tools and Wear Parts Irwin, Pennsylvania Owned Carbide Wear Parts Latrobe, Pennsylvania Owned Metallurgical Powders and Wear Parts Clemson, South Carolina Owned High Speed Steel Drills Johnson City, Tennessee Owned Metalworking Inserts Whitehouse, Tennessee Leased Fixed Limited Gages Lyndonville, Vermont Owned High Speed Steel Taps Chilhowie, Virginia Owned Mining and Construction Tools and Wear Parts New Market, Virginia Owned Metalworking Toolholders International: Victoria, Canada Owned Wear Parts Pudong, China Owned Metalworking Inserts and Circuit Boards Xuzhou, China Owned Mining Tools Bodmin, England Owned Circuit Board Drills and Routers Kingswinford, England Leased Metalworking Toolholders Sheffield, England Leased High Speed Steel Drills Bordeaux, France Leased Metalworking Cutting Tools Boutheon Cedex, France Owned Metalworking Inserts Altenburg, Germany Leased High Speed Steel Taps Ebermannstadt, Germany Owned Metalworking Inserts Essen, Germany Owned/Leased Metallurgical Powders and Wear Parts Koenigsee, Germany Leased Carbide and High Speed Steel Drills Lichtenau, Germany Owned/Leased Metalworking Toolholders Lorch, Germany Leased Circuit Board Drills Mistelgau, Germany Owned Metallurgical Powders, Metalworking Inserts and Wear Parts 10
Properties (continued) Location Owned/Leased Principal Products -------- ------------ ------------------ Nabburg, Germany Owned Metalworking Toolholders Vohenstrauss, Germany Owned Metalworking Carbide Drills Bangalore, India Owned Metalworking Inserts and Toolholders and Wear Parts Patancheru, India Owned Mining Tools and Wear Parts Shlomi, Israel Owned High Speed Steel Endmills Milan, Italy Owned Metalworking Cutting Tools Pachuca, Mexico Owned High Speed Steel Drills Arnhem, Netherlands Owned Wear Products Hardenberg, Netherlands Owned Wear Products Vitoria, Spain Leased Metalworking Carbide Drills We also have a network of warehouses and customer service centers located throughout North America, Western Europe, India, Asia, South America and Australia, a significant portion of which are leased. The majority of our research and development efforts are conducted in a corporate technology center located adjacent to the world headquarters in Latrobe, Pa., and in Rogers, Ark., Furth, Germany and Essen, Germany. We use all significant properties in the business of powder metallurgy, tools, tooling systems and industrial supply. Our production capacity is adequate for our present needs. We believe that our properties have been adequately maintained, generally are in good condition and are suitable for our business as presently conducted. ITEM 3 - LEGAL PROCEEDINGS Incorporated by reference is information set forth in Part I herein under the caption "Regulation." Other than noted therein, there are no material pending legal proceedings, other than litigation incidental to the ordinary course of business, to which Kennametal or any of our subsidiaries is a party or of which any of our property is the subject. ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS During the fourth quarter of 2003, there were no matters submitted to a vote of security holders through the solicitation of proxies or otherwise. 11
EXECUTIVE OFFICERS OF THE REGISTRANT Information regarding the officers of Kennametal Inc. is as follows (included herein pursuant to Item 401(b) of Regulation S-K): Name, Age and Position, Experience During Past Five Years(2) Markos I. Tambakeras, 52(1) Chairman, President and Chief Executive Officer Chairman of the Board effective July 1, 2002. President and Chief Executive Officer since July 1, 1999. Formerly employed by Honeywell Inc. as President of Industrial Controls Business from 1997 to 1999. R. Daniel Bagley, 43(1) Vice President, Corporate Strategy and MSSG Marketing Vice President since July 2002. Formerly, Business Development Director and Industrial Consultant for Deloitte & Touche Consulting Group from 1997-2002; Vice President, Global Sales & Sourcing for General Signal Corporation from 1993-1997; and Director, U.S. Marketing and Distribution for Robert Bosch Fluid Power Corporation from 1992-1993. James R. Breisinger, 53(1) Vice President, President, Advanced Materials Solutions Group Vice President, President, Advanced Materials Solutions Group since April 2003. Chief Operating Officer, Advanced Materials Solutions Group from August 2000 to April 2003. Chief Financial Officer from September 1998 to August 2000. Chief Operating Officer, Greenfield Industries, Inc. from March through September 1998. Corporate Controller from 1994 to 1998. Carlos M. Cardoso, 45(1) Vice President, President, Metalworking Solutions and Services Group Vice President, President, Metalworking Solutions and Services Group since April 2003. Formerly, President, Pump Division, Flowserve Corporation from August 2001 to March 2003; Vice President and General Manager, Engine Systems and Accessories, of Honeywell International, Inc. (formerly Allied Signal, Inc.) from March 1999 to August 2001; and Vice President and General Manager, Marketing Sales and Services, Aerospace Services, Allied Signal, Inc. from March 1998 to March 1999. M. Rizwan Chand, 39(1) Vice President, Human Resources and Corporate Relations Vice President, Human Resources and Corporate Relations since March 2003. Vice President and Chief Human Resources Officer from May 2000 to February 2003. Previously Vice President, Human Resources for Aetna International in 1999. Previously with Mary Kay Inc. as Senior Vice President, Global Human Resources from 1996 to 1999. Stanley B. Duzy, Jr., 56(1) Vice President, Chief Administrative Officer Vice President since November 1999. Formerly employed by Honeywell Inc. as Vice President of Industrial Controls Business from 1998 to 1999 and Vice President and Controller, Asia Pacific from 1992 to 1997. F. Nicholas Grasberger III, 39(1) Vice President, Chief Financial Officer Vice President and Chief Financial Officer since August 2000. Formerly, Corporate Treasurer, H.J. Heinz Company from 1997 to 2000. David W. Greenfield, 53(1) Vice President, Secretary and General Counsel Vice President, Secretary and General Counsel since October 2001. Formerly a member of Buchanan Ingersoll Professional Corporation (attorneys-at-law) July 2000 to September 2001. Special Counsel for ArvinMeritor (a provider of components for vehicles) from February 1999 to July 2000. Senior Vice President, General Counsel and Secretary for Meritor Automotive, Inc. (predecessor to ArvinMeritor) from May 1997 to February 1999. 12
Timothy A. Hibbard, 46(1) Corporate Controller and Chief Accounting Officer Corporate Controller and Chief Accounting Officer since February 2002. Director of Finance for the Advanced Materials Solutions Group from September 2000 to February 2002. Vice President and Controller of Greenfield Industries, Inc. from October 1998 to September 2000. Division Controller of Mining & Construction Division from April 1998 to October 1998. Brian E. Kelly, 40 Assistant Treasurer and Director of Tax Assistant Treasurer and Director of Tax since September 1998. Manager of Corporate Tax from 1996 to 1998. Lawrence J. Lanza, 54(1) Corporate Treasurer Elected Corporate Treasurer in July 2003. Formerly Assistant Treasurer and Director of Treasury Services from April 1999 to July 2003. Manager, Treasury Services from August 1998 to March 1999. Previously, Director, Global Capital Markets for CBS Corporation, formerly Westinghouse Electric Corporation, from 1994 to 1998. James E. Morrison, 52(1) Vice President, Mergers and Acquisitions Vice President, Mergers and Acquisitions, since July 2003. Vice President since 1994. Treasurer from 1987 to July 2003. Wayne D. Moser, 50 Vice President, General Manager, Industrial Products Europe Vice President since 1998. General Manager, Industrial Products Europe effective July 2003. Integration Director from May 2002 to June 2003. Formerly, General Manager, Mining & Construction from 1997 to 2002. Ralph G. Niederst, 52(1) Vice President, Chief Information Officer Vice President since May 2000. Formerly, Director of Management Information Technology at Harsco Corporation's Heckett Multiserv Division from 1995 to 2000. Kevin G. Nowe, 51 Assistant Secretary, Assistant General Counsel Assistant General Counsel since 1992 and Assistant Secretary since 1993. Ajita G. Rajendra, 51 Vice President, Director, Industrial Products Group Vice President since 1998. Director, Industrial Products Group since 1997. Vice President of the Electronic Products Group of Greenfield Industries, Inc. from 1996 to 1997. P. Mark Schiller, 55 Vice President, Director of Distribution Services Vice President since 1992. Director of Distribution Services since 1990. Michael P. Wessner, 42(1) Vice President, President, J&L Industrial Supply Vice President, President, J&L Industrial Supply since April 2003 and formerly Vice President, Chief Operating Officer from January 2001 to April 2003. Formerly Chief Executive Officer, Emco/ESS Holdings from 1999 to 2000 and Vice President, Midwest Region for Office Depot from 1995 to 1999. Notes (1) Executive officer of the Registrant. (2) Each officer has been elected by the Board of Directors to serve until removed or until a successor is elected and qualified, and has served continuously as an officer since first elected. 13
Part II ITEM 5 - MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREOWNER MATTERS Our common stock is traded on the New York Stock Exchange (symbol KMT). The number of shareowners of record as of August 29, 2003 was 3,145. Stock price ranges and dividends declared and paid were as follows: Quarter ended Sep. 30 Dec. 31 Mar. 31 Jun. 30 - ----------------------------------------------------------------------------------- FISCAL 2003 High $ 36.80 $ 36.15 $ 35.56 $ 35.50 Low 27.73 28.75 27.10 27.75 Dividends 0.17 0.17 0.17 0.17 - ----------------------------------------------------------------------------------- FISCAL 2002 High $ 39.79 $ 41.37 $ 42.70 $ 43.00 Low 28.43 30.12 35.15 34.65 Dividends 0.17 0.17 0.17 0.17 =================================================================================== 14
ITEM 6 - SELECTED FINANCIAL DATA (in thousands, except per share data) 2003 2002 2001 - ---------------------------------------------------------------------------------------------------------- OPERATING RESULTS Sales (1) $ 1,758,957 $ 1,583,742 $1,807,896 Cost of goods sold (1) 1,190,053 1,072,918 1,192,176 Operating expense (1) 464,861 389,396 425,641 Interest expense 36,166 32,627 50,381 Restructuring, asset impairment and other charges (2) 31,954 27,307 9,545 Income taxes 14,300 18,900 37,300 Accounting changes, net of tax (3) - 250,406 599 Net income (loss) 18,130 (211,908) 53,288 - ---------------------------------------------------------------------------------------------------------- FINANCIAL POSITION Net working capital $ 428,332 $ 375,284 $ 386,711 Inventories 392,255 345,076 373,221 Property, plant and equipment, net 493,373 435,116 472,874 Total assets 1,779,092 1,523,611 1,825,442 Long-term debt, including capital leases 514,842 387,887 582,585 Total debt, including capital leases and notes payable 525,687 411,367 607,115 Total shareowners' equity (4) 721,577 713,962 796,769 - ---------------------------------------------------------------------------------------------------------- PER SHARE DATA Basic earnings (loss) $ 0.52 $ (6.80) $ 1.74 Diluted earnings (loss) 0.51 (6.70) 1.73 Dividends 0.68 0.68 0.68 Book value (at June 30) 20.34 20.51 25.84 Market price (at June 30) 33.84 36.60 36.90 - ---------------------------------------------------------------------------------------------------------- OTHER DATA Capital expenditures $ 49,413 $ 44,040 $ 59,929 Number of employees (at June 30) 13,970 11,660 12,570 Average sales per employee (1) $ 131 $ 131 $ 139 Basic weighted average shares outstanding (000) (4) 35,202 31,169 30,560 Diluted weighted average shares outstanding (000) (4) 35,479 31,627 30,749 - ---------------------------------------------------------------------------------------------------------- KEY RATIOS Sales growth (1) 11.1% (12.4)% (3.1)% Gross profit margin (1) 32.3 32.3 34.1 Operating profit margin (1) 3.9 5.8 8.7 - ---------------------------------------------------------------------------------------------------------- 15
Selected Financial Data (continued) 2000 1999 - --------------------------------------------------------------------------------------- OPERATING RESULTS Sales $ 1,866,578 $ 1,914,961 Cost of goods sold 1,228,685 1,272,090 Operating expense 434,136 455,903 Interest expense 55,079 68,594 Restructuring, asset impairment and other special charges 18,526 13,937 Income taxes 43,700 32,900 Accounting changes, net of tax - - Net income (loss) 51,710 39,116 - --------------------------------------------------------------------------------------- FINANCIAL POSITION Net working capital $ 397,403 $ 373,582 Inventories 410,885 434,462 Property, plant and equipment, net 498,784 539,800 Total assets 1,941,121 2,000,480 Long-term debt, including capital leases 637,686 717,852 Total debt, including capital leases and notes payable 699,242 861,291 Total shareowners' equity 780,254 745,131 - --------------------------------------------------------------------------------------- PER SHARE DATA Basic earnings (loss) $ 1.71 $ 1.31 Diluted earnings (loss) 1.70 1.31 Dividends 0.68 0.68 Book value (at June 30) 25.56 24.78 Market price (at June 30) 21.44 31.00 - --------------------------------------------------------------------------------------- OTHER DATA Capital expenditures $ 50,663 $ 94,993 Number of employees (at June 30) 13,210 13,640 Average sales per employee $ 140 $ 137 Basic weighted average shares outstanding (000) 30,263 29,917 Diluted weighted average shares outstanding (000) 30,364 29,960 - --------------------------------------------------------------------------------------- KEY RATIOS Sales growth (2.5)% 13.5% Gross profit margin 34.2 33.6 Operating profit margin 8.5 7.7 - --------------------------------------------------------------------------------------- Notes (1) Amounts and percentages for 2000, 1999, 1998 and 1997 were adjusted to reclassify shipping and handling fees to net sales and shipping and handling costs to cost of goods sold as required by Emerging Issues Task Force 00-10, "Accounting for Shipping and Handling Fees and Costs." It was not practicable to restate periods prior to 1997. (2) In 2003, restructuring, asset impairment and other charges related to the 2003 Workforce Restructuring Program, Kennametal Integration Restructuring Program, Electronics impairment and the 2003 Facility Consolidation Program. In 2002, restructuring, asset impairment and other charges related primarily to the MSSG facility rationalizations and employee severance, J&L business improvement program, electronics facility rationalization and FSS business improvement program and other operational improvement programs. In 2001, restructuring, asset impairment and other charges related primarily to the J&L business improvement program, core business resize program and FSS business improvement program and other operational improvement programs. In 2000, restructuring, asset impairment and other charges are associated with strategic alternatives and operational improvement programs. In 1999, restructuring, asset impairment and other charges are associated with charges related to operational improvement programs. In 1996, restructuring, asset impairment and other charges were related to the relocation of the North America Metalworking Headquarters from Raleigh, N.C. to Latrobe, Pa., and to close a manufacturing facility. In 1994, restructuring, asset impairment and other charges included integration costs associated with the acquisition of Hertel AG in 1994. 16
1998 1997 1996 1995 1994 1993 - --------------------------------------------------------------------------------- $1,687,516 $1,160,452 $1,079,963 $ 983,873 $ 802,513 $ 598,496 1,057,089 713,182 625,473 560,867 472,533 352,773 419,182 317,315 328,377 293,868 263,300 200,912 59,536 10,393 11,296 12,793 13,811 9,549 - - 2,666 - 24,749 - 53,900 44,900 43,900 45,000 15,500 14,000 - - - - 15,003 - 71,197 72,032 69,732 68,294 (4,088) 20,094 - --------------------------------------------------------------------------------- $ 447,992 $ 175,877 $ 217,651 $ 184,072 $ 130,777 $ 120,877 436,472 210,111 204,934 200,680 158,179 115,230 525,927 300,386 267,107 260,342 243,098 192,305 2,091,520 851,243 799,491 781,609 697,532 448,263 840,932 40,445 56,059 78,700 90,178 87,891 967,667 174,464 131,151 149,730 147,295 110,628 735,460 459,608 438,949 391,885 322,836 255,141 - --------------------------------------------------------------------------------- $ 2.61 $ 2.71 $ 2.62 $ 2.58 $ (0.17) $ 0.93 2.58 2.69 2.60 2.56 (0.17) 0.92 0.68 0.66 0.60 0.60 0.58 0.58 24.66 17.61 16.44 14.75 12.25 11.64 41.75 43.00 34.00 34.50 24.63 16.75 - --------------------------------------------------------------------------------- $ 104,774 $ 73,779 $ 57,556 $ 43,371 $ 27,313 $ 23,099 14,380 7,550 7,260 7,030 6,600 4,850 $ 153 $ 159 $ 152 $ 146 $ 125 $ 122 27,263 26,575 26,635 26,486 24,304 21,712 27,567 26,786 26,825 26,640 24,449 21,753 - --------------------------------------------------------------------------------- 45.4% 7.5% 9.8% 22.6% 34.1% 0.7% 37.4 38.5 42.1 43.0 41.1 41.1 11.6 10.9 11.3 12.9 4.7 7.2 - --------------------------------------------------------------------------------- (3) Accounting changes in 2002 reflect the non-cash charge related to goodwill impairment recorded as a result of the adoption of SFAS No. 142. In 2001, this charge reflects the change in the method of accounting for derivative financial instruments (SFAS No. 133) and in 1994, the changes in the methods of accounting for postretirement health care and life insurance benefits (SFAS No. 106) and income taxes (SFAS No. 109) are reflected. (4) During 2002 and 1998, we issued 3.5 million and 3.45 million shares of capital stock for net proceeds of $120.6 million and $171.4 million, respectively. 17
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS The following discussion should be read in connection with the consolidated financial statements of Kennametal Inc. and the related footnotes. Unless otherwise specified, any reference to a "year" is to a fiscal year ended June 30. Additionally, when used in this annual report on Form 10-K, unless the context requires otherwise, the terms "we," "our" and "us" refer to Kennametal Inc. and its subsidiaries. BUSINESS OVERVIEW We are a leading global manufacturer, marketer and distributor of a broad range of cutting tools, tooling systems, supplies and technical services, as well as wear-resistant parts. We believe that our reputation for manufacturing excellence and technological expertise and innovation in our principal products has helped us achieve a leading market presence in our primary markets. We believe we are the second largest global provider of metalcutting tools and tooling systems. End users of our products include metalworking manufacturers and suppliers in the aerospace, automotive, machine tool and farm machinery industries, as well as manufacturers and suppliers in the highway construction, coal mining, quarrying and oil and gas exploration industries. SALES Sales of $1,759.0 million in 2003 increased 11.1 percent, versus $1,583.7 million last year. The increase in sales is attributed to the positive benefit of $163.9 million from the Widia acquisition and the favorable foreign currency effects of $68.9 million. Additionally, Metalworking South America, a component of MSSG, showed continued growth with a $8.3 million increase in revenue. For Industrial Products Group (IPG), which is a component of MSSG, revenue increased $10.6 million due to market share gains made in the high-speed steel business. This was offset by the sale of Strong Tool which comprised $25.9 million of 2002 revenue. After taking these factors into consideration, the significant components of the remaining change was attributed to a decline in sales in Metalworking North America, which is a component of MSSG, of $10.0 million; Metalworking Europe, which is a component of MSSG, of $5.5 million; Energy, which is a component of AMSG, of $8.5 million; J&L of $6.0 million and FSS of $32.6 million. The decline in sales in North America and Europe is due to overall weak market conditions that were experienced throughout 2003. The decline in FSS sales is due to the loss of sales associated with the discontinuance of certain customer relationships. Sales of $1,583.7 million in 2002 decreased 12.4 percent compared to sales of $1,807.9 million in 2001. The decline in sales is attributed to unfavorable foreign currency effects of $14.3 million and $10.7 million related to the decrease in revenue year-over-year due to the sale of Strong Tool. Lower sales in North America, due to overall weak market conditions, contributed to the remaining decline in sales. GROSS PROFIT MARGIN In 2003 our gross profit margin remained flat at 32.3 percent. The gross margin was negatively impacted by lower Widia margins which decreased margins by $5.5 million, a decrease in domestic pension income of $4.2 million, unfavorable product mix and pricing pressures. This was offset by a positive benefit from foreign exchange of $31.6 million, favorable raw material prices and lean manufacturing efficiencies. The 2003 gross margin includes charges associated with the Widia integration of $2.2 million. The 2002 gross margin includes inventory abandonment charges of $2.7 million associated with facility closures in 2002. The gross profit margin for 2002 was 32.3 percent, down from 34.1 percent in 2001. The decrease was due primarily to underutilized capacity and unfavorable manufacturing variances associated with the lower sales volume. Additionally, unfavorable product mix contributed to the lower margins. These unfavorable items were partially offset by efficiencies derived from our lean initiatives. Gross margins for 2002 and 2001 included $2.7 million and $3.6 million, respectively, of inventory abandonment charges primarily associated with facility closures in 2002 and the rationalization of certain product lines discontinued as part of a program to streamline and optimize the product offering of J&L in 2001. OPERATING EXPENSE Operating expense of $464.9 million in 2003 was $75.5 million or 19.4 percent higher than the operating expense level in 2002 of $389.4 million. The increase in operating expenses is associated with the Widia acquisition, $20.1 million of unfavorable foreign currency effects, a decrease in domestic pension income of $4.5 million and reinstatement of salary increases and the company match on 401(k) contributions. These amounts were offset, in part, by the Strong Tool divestiture which comprised $5.1 million of the 2002 operating expense. Operating expenses included charges of $5.5 million in 2003 related to the Widia integration. 18
In 2002, operating expense declined to $389.4 million from $425.6 million in 2001. Ongoing cost-cutting and lean initiatives, combined with several short-term savings actions, including the curtailment of salary increases and the company match on 401(k) contributions, mitigated the impact of reduced sales. Although overall operating expense declined, our spending on growth programs and research and development was sustained. RESTRUCTURING AND ASSET IMPAIRMENT CHARGES Impairment In June 2003, we completed an assessment of the carrying value of certain long-lived assets in the Electronics business, a component of AMSG. As a result of this assessment, we recorded a pre-tax charge of $16.1 million ($15.3 million after tax) as a component of restructuring and asset impairment charges. The charge is a result of price declines caused by persistent global over-capacity and low-cost Asian competition. The fixed asset impairment charge reduced the book value of the Electronics business' assets to $2.6 million. This remaining value was determined based on cash flow and estimated realizable value of the assets. 2003 Facility Consolidation Program In June 2003, we approved a facility consolidation program. This program is expected to have restructuring charges of approximately $2.5 million and is anticipated to generate in excess of $1.5 million in cash savings annually. The plan includes the closure of two regional operating centers and the Framingham manufacturing facility and a workforce reduction. In conjunction with the program, we recorded an asset write-down related to fixed assets that will be disposed of as a result of the restructuring program. All actions pertain to the MSSG segment. All costs associated with the restructuring program are expected to be incurred and paid by December 31, 2003, except certain lease costs which may extend to June 2004. Accrual at Asset Cash Accrual at (in thousands) June 30, 2002 Expense Write-down Expenditures June 30, 2003 - ------------------------------------------------------------------------------------------------------------ Employee severance $ - $ 1,188 $ - $ - $ 1,188 Facility rationalization - 460 (316) - 144 - ------------------------------------------------------------------------------------------------------------ Total $ - $ 1,648 $ (316) $ - $ 1,332 ============================================================================================================ 2003 Workforce Restructuring Program In October 2002, we announced a global salaried workforce reduction of approximately five percent. The reduction as announced was expected to cost between $9 million and $10 million. The expected cost was revised to $8.0 million as the plan was substantially completed as of June 30, 2003. As previously announced, the plan generated in excess of $10 million in cash savings during fiscal 2003. The program resulted in $2.8 million of charges for the MSSG segment, $2.6 million for AMSG, $1.3 million for J&L, $0.1 million for FSS and $1.2 million for Corporate. The components of the restructuring accrual at June 30, 2003 for this program are as follows: Accrual at Expense Cash Accrual at (in thousands) June 30, 2002 Expense Adjustment Expenditures June 30, 2003 - ------------------------------------------------------------------------------------------------------------ Employee severance $ - $ 8,345 $ (434) $ (6,076) $ 1,835 - ------------------------------------------------------------------------------------------------------------ Total $ - $ 8,345 $ (434) $ (6,076) $ 1,835 ============================================================================================================ The restructuring accrual at June 30, 2003 represents expected future cash payments for these obligations over the next six months. The expense adjustments represent revisions in the original cost estimates related to this plan. Widia Integration In addition to the 2003 Workforce Restructuring Program, we have implemented two Widia acquisition-related integration programs (Kennametal Integration Restructuring Program and the Widia Integration Plan) which together are expected to result in a global headcount reduction of between 650 and 700 positions. The integration plan is expected to result in annual cost savings of $30 million annually. We have substantially completed the integration plan and, as of June 30, have closed six sales offices, two manufacturing facilities and closed or consolidated four warehouses. As of June 30, 2003 we have terminated approximately 545 employees in Europe and India and expect the remaining workforce reduction to be within our original estimates. We expect the completion of all integration activities in the second quarter of 2004. Kennametal Integration Restructuring Program This program includes employee severance costs associated with existing Kennametal facilities. 19
The components of the restructuring accrual at June 30, 2003 for this program are as follows: Accrual at Cash Accrual at (in thousands) June 30, 2002 Expense Expenditures June 30, 2003 - ----------------------------------------------------------------------------------------------- Employee severance $ - $ 6,956 $ (3,316) $ 3,640 - ----------------------------------------------------------------------------------------------- Total $ - $ 6,956 $ (3,316) $ 3,640 =============================================================================================== Widia Integration Plan In connection with the acquisition, we have established a Widia integration plan to develop centers of excellence in functional areas and enable long-term growth and competitive advantages. Costs that are incurred under this plan will be accounted for under EITF 95-3, "Recognition of Liabilities in Connection with a Purchase Business Combination." As a result, these costs have been recorded as part of the Widia purchase price allocation. Accrual at Adjustment Cash Accrual at (in thousands) June 30, 2002 to Goodwill Expenditures June 30, 2003 - ------------------------------------------------------------------------------------------------- Facility rationalizations $ - $ 4,678 $ (3,321) $ 1,357 Employee severance - 19,783 (4,849) 14,934 Terminated contracts - 1,401 (938) 463 - ------------------------------------------------------------------------------------------------- Total $ - $ 25,862 $ (9,108) $ 16,754 ================================================================================================= Widia Restructuring In connection with our acquisition of Widia, we assumed $2.4 million of restructuring accruals related to restructuring programs initiated by Widia prior to the acquisition date. These programs, initiated in December 2001, relate to the severance of 156 European employees in both production and administration. The accrual balance at June 30, 2003 of $0.2 million represents a decrease of $2.2 million related to cash payments made during the period since acquisition. 2002 AMSG and MSSG Restructuring In November 2001, we announced a restructuring program whereby we recognized special charges of $18 million. This was done in response to continued steep declines in the end market demand in the Electronics and Industrial Products Group businesses. All initiatives under this program have been implemented and completed. These costs are related to the closing and consolidation of the AMSG electronics facility in Chicago, Ill., and MSSG Industrial Products Group's Pine Bluff, Ark. and Monticello, Ind. locations, the production of a particular line of products in Rogers, Ark. and several customer service centers. As a result, we recorded restructuring charges of $14.8 million during 2002 related to exit costs associated with these actions, including severance for substantially all 337 employees at the closed facilities. We also recorded a charge of $2.5 million related to severance for 84 individuals, primarily in the MSSG segment. The components of the charges and the accrual at June 30, 2003 for this program are as follows: Accrual at Expense Cash Accrual at (in thousands) June 30, 2002 Expense Adjustment Expenditures June 30, 2003 - ------------------------------------------------------------------------------------------------------------ Facility rationalizations $ 2,977 $ 15 $ (511) $ (2,180) $ 301 Employee severance 1,220 110 (2) (1,229) 99 - ------------------------------------------------------------------------------------------------------------ Total $ 4,197 $ 125 $ (513) $ (3,409) $ 400 ============================================================================================================ The restructuring accrual at June 30, 2003 represents future cash payments for these obligations, of which the majority are expected to occur over the next six months. The expense adjustments represent revisions in the original cost estimates related to this plan. 2002 and 2001 J&L and FSS Business Improvement Program In the J&L segment for 2001, we recorded a restructuring and asset impairment charge of $2.5 million for severance of 115 individuals, $1.8 million associated with the closure of 11 underperforming satellite locations, including certain German operations, and $0.7 million for the exiting of three warehouses. This includes a $0.4 million non-cash write-down of the book value of certain property, plant and equipment, net of salvage value, that we determined would no longer be utilized in ongoing operations. In the FSS segment for 2001, we recorded restructuring charges of $0.6 million for severance related to eight individuals. 20
In 2002, we continued our J&L and FSS business improvement programs initiated in 2001. In the J&L segment during 2002, we recorded restructuring and asset impairment charges of $5.3 million related to the write-down of a portion of the value of a business system, $2.5 million for severance for 81 individuals and $1.7 million related to the closure of 10 satellites and two call centers. In the FSS segment for 2002, we recorded restructuring charges of $0.7 million for severance related to 34 individuals. Total charges related to this plan were $19 million which are consistent with our original estimate of $15 to $20 million. During the third quarter of 2003, we completed the 2001 J&L and FSS Business Improvement Programs and have incurred cash payments of $1.2 million, $3.2 million and $4.4 million related to this program in 2003, 2002 and 2001, respectively. 2001 Core-Business Resize Program In 2001, we took actions to reduce our salaried workforce in response to the weakened U.S. manufacturing sector. As a result of implementing this core-business resize program, we recorded a restructuring charge in 2001 of $4.6 million related to severance for 209 individuals. All employee benefit initiatives under this program have been implemented and the program has been completed. Cash expenditures were $0.3 million, $1.9 million and $2.2 million in 2003, 2002 and 2001, respectively. AMORTIZATION OF INTANGIBLES The provision for amortization expense was $4.2 million in 2003 compared with $2.8 million in 2002. The increase in amortization expense of $1.4 million or 48.5 percent, is attributed to the Widia acquisition, which was completed on August 30, 2002. As a result of the acquisition, we have recorded $27.2 million of identifiable intangible assets of which $6.4 million has a definite life and therefore will be amortized over its remaining useful life. The provision for amortization expense was $2.8 million in 2002 compared with $24.1 million in 2001. The decrease was primarily the result of ceasing amortization of goodwill in 2002 under the provisions of SFAS 142, "Goodwill and Other Intangible Assets," which was adopted on July 1, 2001. INTEREST EXPENSE Interest expense was $36.2 million in 2003 compared with $32.6 million in 2002. This increase in interest expense is due to the greater average level of borrowings to fund the Widia acquisition. Total debt and capital leases has increased from $404.4 million in 2002 to $517.8 million in 2003. Our average domestic borrowing rate was 5.36 percent in 2003 compared to 4.91 percent in 2002. The increase in average borrowing rate is a result of the issuance of Senior Unsecured Notes and the related interest rate swaps. Interest expense for 2003 and 2002 included $0.5 million and $0.3 million, respectively, related to the write-down of the remaining deferred financing fees. The write-down of financing fees in 2003 was a result of our decision to reduce the size of our 2002 Credit Agreement from $650 million to $500 million. The write-down in 2002 related to deferred financing fees from the Bank Credit Agreement entered into in 1998 (Bank Credit Agreement) that was replaced in June 2002 with the 2002 Credit Agreement. Interest expense for 2002 was $32.6 million compared with $50.4 million in 2001. The decrease was due to debt reduction and lower average borrowing rates. Overall debt levels declined to $404.4 million at June 30, 2002 from $584.6 million in 2001. Our average domestic borrowing rate of 4.91 percent in 2002 was 202 basis points below 2001 due to Federal Reserve rate cuts and improved pricing under the Bank Credit Agreement. OTHER (INCOME) EXPENSE, NET In 2003, other income, net increased by $2.2 million to $2.5 million compared with $0.4 million in 2002. The prior year income of $0.4 million includes the negative impact of the loss on divestiture of Strong Tool of $3.5 million. Included in other income, net for 2003 were $1.9 million in fees associated with the account receivable securitization program, which decreased $0.6 million from the $2.5 million recorded in 2002. The decline in account receivable securitization fees is attributable to lower interest rates in the commercial paper market. Additionally, interest income has increased from $1.5 million in 2002 to $2.8 million in 2003. The benefits associated with the securitization program and increased interest income were offset by foreign exchange losses, which increased $2.8 million during the current year from income of $1.8 million in 2002 to expense of $1.0 million in 2003. In 2002, other income, net increased by $12.1 million to $0.4 million, compared to other expense, net of $11.7 million in 2001. These amounts include losses of $3.5 million associated with our divestiture of Strong Tool Company and $5.8 million associated with our divestiture of ATS Industrial Supply, Inc. (ATS) in 2002 and 2001, respectively. Account receivable securitization fees were reduced by $3.2 million during 2002 due to a significant decline in commercial paper rates which are the basis for determining the fees. Additionally, during 2002 foreign exchange gains increased by $4.0 million resulting from contracts entered to hedge against cross-border cash flows. 21
INCOME TAXES The effective tax rate for 2003 was 41.7 percent compared to an effective rate of 32.0 percent for 2002. The 2003 effective rate included an 11.7 percentage point negative impact related to the impairment charge for our Electronics business unit. Partially offsetting this was a 9.7 percentage point favorable impact related to the utilization of capital losses that were previously reserved. Also included in our effective rate is the net impact of our European tax planning initiatives offset by losses from our foreign subsidiaries for which no tax benefit has been provided. The effective tax rate in 2002 was 32.0 percent compared to the effective rate of 39.5 percent in 2001. The significant decrease in the effective tax rate was due to the effects of the elimination of non-deductible goodwill expense due to the adoption of SFAS 142, as well as European tax planning. CHANGES IN ACCOUNTING PRINCIPLES We adopted SFAS No. 142, effective July 1, 2001, which established new accounting and reporting requirements for goodwill and other intangible assets, including new measurement techniques for evaluating the recoverability of such assets. Under SFAS No. 142, all goodwill amortization ceased effective July 1, 2001. Material amounts of recorded goodwill attributable to each of our reporting units in 2002 were tested for impairment by comparing the fair value of each reporting unit with its carrying value. As a result of the adoption of this rule, we recorded a non-cash charge in 2002, net of tax, of $250.4 million, specific to the Electronics (AMSG segment--$82.1 million) and the IPG (MSSG segment--$168.3 million) businesses, which were acquired in 1998 as part of the acquisition of Greenfield Industries. The fair values of these reporting units were determined using a combination of discounted cash flow analysis and market multiples based upon historical and projected financial information. Under SFAS No. 142, the impairment adjustment recognized at adoption of this standard was reflected as a cumulative effect of a change in accounting principle, effective July 1, 2001. NET INCOME We reported net income of $18.1 million for 2003 compared with net loss of $211.9 million in 2002. Net income in the current year included a $15.3 million after-tax charge associated with the Electronics impairment. The net loss reported in 2002 was due largely to the goodwill impairment charges, which was $250.4 million. The increase in net income, in the current year, is due to a reduction in impairment charges from $250.4 million in 2002 to $15.3 million in 2003, offset by an increase in operating expense related to the Widia integration, a $3.5 million increase in interest expense and a 9.7 percentage point increase in the effective tax rate. Due largely to the goodwill impairment charge, we recorded a net loss in 2002 of $211.9 million, compared to net income of $53.3 million in 2001. Additionally, in 2002 earnings declined due to lower sales levels and margins, partially offset by lower operating and interest expense, and a decline in our effective tax rate. Outside of the goodwill impairment charge, other restructuring and asset impairment charges of $27.3 million in 2002 related primarily to the MSSG and AMSG restructuring initiated in 2002 and additional costs associated with restructuring actions made in the J&L business improvement program that was started in 2001. Included in net income for 2001 was $19.0 million of goodwill amortization, net of tax that was not included in 2002 due to the non-amortization provisions of SFAS No. 142. BUSINESS SEGMENT REVIEW Our operations are organized into four global business units consisting of MSSG, AMSG, J&L and FSS, and corporate functional shared services. The presentation of segment information reflects the manner in which we organize segments for making operating decisions and assessing performance. METALWORKING SOLUTIONS & SERVICES GROUP In the MSSG segment, we provide consumable metalcutting tools and tooling systems to manufacturing companies in a wide range of industries throughout the world. Metalcutting operations include turning, boring, threading, grooving, milling and drilling. Our tooling systems consist of a steel toolholder and a cutting tool such as an indexable insert or drill made from cemented tungsten carbides, high speed steel or other hard materials. Other cutting tools include end mills, reamers and taps. We provide solutions to our customers' metalcutting needs through engineering services aimed at improving their competitiveness. We also manufacture cutting tools, drill bits, saw blades and other tools for the consumer market which are marketed under private label and other proprietary brands. (in thousands) 2003 2002 2001 - -------------------------------------------------------------------------------- External sales $1,123,175 $ 897,157 $ 999,813 Intersegment sales 107,486 116,467 111,780 Operating income 90,627 97,323 130,558 - -------------------------------------------------------------------------------- 22
MSSG external sales increased by $226.0 million, or 25.2 percent, from 2002. The increase in MSSG external sales is primarily related to the acquisition of Widia which increased sales by $163.9 million and favorable foreign exchange effects of $57.3 million. The other significant components that affected the MSSG segment included North America, which had a decrease in external sales of $10.0 million, Europe, which had a $5.5 million decrease offset by a $8.3 million increase in South America and the Industrial Products Group which had a $10.6 million increase in sales. Operating income declined from $97.3 million in 2002 to $90.6 million in 2003, representing a decrease of $6.7 million or 6.9 percent. The decrease in operating income is directly related to the dilutive effect of the Widia margins which decreased margins by $5.5 million and unfavorable product mix and pricing pressures. We continue to expect Widia to be accretive to MSSG margins during 2004 as the synergy benefits from our Widia Integration Program are realized. Included in operating income is $9.1 million and $10.2 million of restructuring costs for 2003 and 2002, respectively. The 2003 restructuring expense pertains to the 2003 Workforce Restructuring Program and 2003 Facility Consolidation Program. The restructuring expense has declined due to the completion of the 2002 AMSG and MSSG Restructuring Program. This reduction was offset, in part, by $6.5 million of Widia integration costs. In 2002, external sales in the MSSG segment of $897.2 million declined 10 percent from $999.8 million in 2001. In the North America Metalworking Group, sales declined $45.5 million or 13 percent while Industrial Products Group sales declined $46.3 million or 19 percent. Due to depressed market conditions, sales of the North American operations contributed to nearly 90% of the overall segment decline. Additionally, unfavorable foreign exchange effects accounted for $11.6 million of the decrease in sales. In 2002, operating income declined $33.2 million to $97.3 million, including $10.2 million of charges related to MSSG restructuring. Additionally, the lower sales levels contributed significantly to the reduced operating profit, partially offset by operating expense reductions and lean initiatives. ADVANCED MATERIALS SOLUTIONS GROUP This segment's principal business is the production and sale of cemented tungsten carbide products used in mining, highway construction and engineered applications including circuit board drills, compacts and other similar applications. These products have technical commonality to our core metalworking products. We also sell metallurgical powders to manufacturers of cemented tungsten carbide products. In addition, we provide application specific component design services and on-site application support services. (in thousands) 2003 2002 2001 - -------------------------------------------------------------------------------- External sales $319,223 $307,668 $352,933 Intersegment sales 29,137 24,167 28,167 Operating income 17,348 26,781 43,270 - -------------------------------------------------------------------------------- AMSG external sales for 2003 increased by $11.6 million, or 3.8 percent, from $307.7 million in 2002 to $319.2 million in 2003. The increase in external sales is attributed to favorable foreign exchange effects of $9.5 million; an increase in Engineered Products Group which increased $5.4 million, and the Carmet acquisition which contributed $4.3 million to sales. This was offset, in part, by a $8.5 million decline in Energy Products. Operating income decreased from $26.8 million in 2002 to $17.3 million to 2003. Restructuring expense in 2003 was $4.4 million compared to the prior year of $8.0 million. Additionally, 2003 operating income includes integration costs associated with the Widia acquisition of $1.2 million, and the Electronics impairment charge of $16.1 million (pre-tax). Operating income benefited from manufacturing efficiencies, reduced restructuring costs, lower raw material costs and benefits derived from previously implemented restructuring programs. AMSG external sales declined $45.3 million or 12.8 percent from $352.9 million in 2001 to $307.7 million in 2002. Unfavorable foreign exchange effects accounted for $2.3 million of the decline. A continued weak demand in the Electronics business due to a depressed market accounted for 64 percent of the overall sales decline of this segment. Additionally, lower sales in Energy and the Engineered Products Group contributed 25 and 11 percent, respectively, to the overall sales decline due primarily to declining rig counts and lower levels of industrial activity. 23
Operating income declined by $16.5 million from $43.3 million in 2001 to $26.8 million in 2002. A portion of the decrease is attributed to restructuring charges which increased from $0.9 million in 2001 to $8.0 million in 2002. The remainder of the decline was due to lower gross profit due to under-utilization of capacity caused by the volume declines which was partially offset by operating expense reductions. J&L INDUSTRIAL SUPPLY In this segment, we provide metalworking consumables and related products to small- and medium-sized manufacturers in the United States and the United Kingdom. J&L markets products and services through annual mail-order catalogs and monthly sales flyers, telemarketing, the Internet and field sales. J&L distributes a broad range of metalcutting tools, abrasives, drills, machine tool accessories, precision measuring tools, gages, hand tools and other supplies used in metalcutting operations. (in thousands) 2003 2002 2001 - -------------------------------------------------------------------------------- External sales $ 196,170 $ 226,010 $ 296,264 Intersegment sales 1,989 2,083 3,823 Operating income (loss) 6,140 (681) 3,689 - -------------------------------------------------------------------------------- External sales in this segment have decreased by $29.8 million, or 13.2 percent, from $226.0 million in 2002 to $196.2 million in 2003. The decrease in sales is due to the sale of Strong Tool Company which comprised $25.9 million in sales in 2002 and due to slower sales in automotive and aerospace markets offset, in part, by favorable foreign exchange of $2.0 million. Operating income increased by $6.8 million from a loss of $0.7 million in 2002 to income of $6.1 million in 2003. The increase is due to restructuring expense declining from $10.1 million in 2002 to $1.2 million in 2003. In 2002, external sales in this segment declined $70.3 million or 24 percent from 2001, including eight percent due to the ATS and Strong Tool Company divestitures. The remainder of the decline is due to weak demand in the broad U.S. industrial market. The decline occurred primarily due to the reduction in sales despite reduced operating expense as a result of the initiatives related to the business improvement plan implemented in both 2002 and 2001. Operating income in 2002 and 2001 included $10.1 million and $8.0 million, respectively, associated with the business improvement program begun in 2001. Additionally, 2001 included $2.1 million related to the tender offer to acquire the minority shares of JLK. FULL SERVICE SUPPLY In the FSS segment, we provide metalworking consumables and related products to large- and medium-sized manufacturers in the United States and Canada. FSS offers integrated supply programs that provide inventory management systems, just-in-time availability and programs that focus on total cost savings. (in thousands) 2003 2002 2001 - -------------------------------------------------------------------------------- External sales $ 120,389 $ 152,907 $ 158,886 Intersegment sales 3,134 2,747 5,278 Operating income (56) 2,014 7,541 - -------------------------------------------------------------------------------- FSS external sales for 2003 declined by $32.5 million, or 21.3 percent, from $152.9 million in 2002 to $120.4 million in 2003. The decline in sales is due to the discontinuance of certain customer relationships. FSS had an operating loss for 2003 which is a $2.1 million decline from 2002. The operating loss is due to the inability of the reduced volume to cover fixed costs. We are addressing this issue through right-sizing efforts and through a continuous program to reduce operating expenses. New business and marketing programs have been developed to offset the lost sales. At the end of 2003 and during the first quarter of 2004, we have obtained new customers that have an annualized sales value in excess of the revenue associated with the customers lost during the current year. FSS external sales for 2002 declined four percent, or $6.0 million, compared to 2001 due primarily to the weakening in the North American industrial market. Operating income of $2.0 million in 2002, declined $5.5 million compared to 2001. The decline is due to lower sales levels coupled with slightly lower gross margins due to a higher percentage of sales in the automotive sector. 24
LIQUIDITY AND CAPITAL RESOURCES Our cash flow from operations is the primary source of financing for capital expenditures and internal growth. The most significant risks associated with our ability to generate sufficient cash flow from operations is the overall level of demand for our products. However, we believe we can adequately control costs and manage our working capital to meet our cash flow needs, despite changes in the economic cycle. In June 2002, we entered into a three-year, multi-currency, $650 million revolving bank credit facility with a group of financial institutions (2002 Credit Agreement). Following a review of anticipated borrowing requirements, in June 2003, we notified the administrative agent of our decision to permanently reduce the 2002 Credit Agreement from $650 million to $500 million resulting in lower facility fees for the remaining two years of the agreement. This resulted in a write-down of a portion of deferred financing fees of $0.5 million. The 2002 Credit Agreement replaced the previous Bank Credit Agreement, Euro Credit Agreement and the Yen Credit Facility. The 2002 Credit Agreement allows for borrowings in U.S. dollars, Euro, Canadian dollars, Pound Sterling or Japanese Yen. The 2002 Credit Agreement contains various covenants with which we must be in compliance, including three financial covenants: a maximum leverage ratio, a maximum fixed charge coverage ratio and a minimum consolidated net worth. As of June 30, 2003 and 2002, outstanding borrowings under this agreement were $181.2 and $81.5 million, respectively. As of June 30, 2003, $75.0 million of the borrowings were denominated in U.S. dollars, $92.2 million were denominated in Euro and $14.0 million were denominated in Yen. We had the ability to borrow under this agreement or otherwise have additional debt of up to $108.7 and $262.5 million as of June 30, 2003 and 2002, respectively, and be in compliance with the maximum leverage ratio financial covenant. The $262.5 million of available debt at the end of June 30, 2002 did not reflect the $165.2 million of net borrowings incurred to fund the Widia acquisition. The maximum leverage ratio financial covenant requires that we maintain at the end of each fiscal quarter a specified consolidated leverage ratio (as that term is defined in this agreement). At June 30, 2003 and 2002, we were in compliance with all debt covenants. Additionally, we generally obtain local financing through credit lines with commercial banks in the various countries in which we operate. At June 30, 2003, these borrowings amounted to $7.9 million for notes payable and $10.2 million for term debt and capital leases. We believe that cash flow from operations and the availability under our credit lines will be sufficient to meet our cash requirements over the next 12 months. Based upon our debt structure at June 30, 2003 and 2002, 69 and 54 percent, respectively, of our debt was exposed to floating rates of interest, which is consistent with our target range for floating versus fixed interest rate debt. We periodically review the target range and the strategies designed to maintain the mix of floating to fixed interest rate debt within that range. In the future, we may decide to adjust the target range or the strategies to achieve it. Following is a summary of our contractual obligations and other commercial commitments as of June 30, 2003 (in thousands): 2007 and Contractual Obligations 2004 2005 2006 thereafter Total - -------------------------------------------------------------------------------- CASH COMMITMENTS Long-term debt $ 311 $ 353 $181,556 $323,581 $505,801 Notes payable 7,938 - - - 7,938 Capital leases 2,596 2,174 3,322 3,856 11,948 Operating leases 18,305 14,867 10,357 40,379 83,908 - -------------------------------------------------------------------------------- Total $ 29,150 $ 17,394 $195,235 $367,816 $609,595 ================================================================================ Amount of Committed Expiration Per Period ------------------------------------------- Total Amount Less than Over Other Commercial Commitments Committed 1 Year 1-3 Years 4-5 Years 5 Years - --------------------------------------------------------------------------------------- Standby letters of credit $12,293 $10,293 $ 2,000 $ - $ - Guarantees 7,089 6,138 636 - 315 - --------------------------------------------------------------------------------------- Total commercial commitments $19,382 $16,431 $ 2,636 $ - $ 315 ======================================================================================= The standby letters of credit are related to insurance and other activities. 25
During 2003, we generated $181.5 million in cash from operations, compared to $162.4 million in 2002. The $181.5 million was driven by operating performance including $11.5 million, derived from accounts receivable, $38.2 million from inventory and $10.6 million from tax refunds. This was offset, in part, by a decrease in other accrued liabilities of $11.6 million. The increase in operating cash flow in 2003 is primarily related to cash generated from reductions in working capital. Net cash used for investing activities was $219.4 million in 2003, an increase of $176.1 million compared to $43.3 million used in 2002. The increase in cash used for investing activities is primarily due to the net cash paid for Widia of $166.1 million and purchase of subsidiary stock which increased $5.8 million. Additionally, capital expenditures increased by $5.4 million from $44.0 million to $49.4 million. We believe the level of capital spending in 2003 was sufficient to enhance productivity and make necessary improvements to remain competitive. Net cash flow provided by financing activities was $37.5 million in 2003, compared to cash flow used of $125.5 million in 2002. The increase of $163.0 million is due primarily to the incremental borrowings required to finance the Widia acquisition and $15.5 million received from the termination of the fair value interest rate swaps. This was partially offset by debt repayments, lower purchases of treasury stock and increased cash payments for dividends due to additional shares being issued in June 2002. During 2002, we generated $162.4 million in cash from operations, compared to $197.8 million in 2001. Lower income from operations and depreciation and amortization charges were partially offset by a net reduction in working capital. The continued reduction of working capital reflects our initiatives to generate strong cash flow. Both receivables and inventories were reduced when compared to the prior year as a result of the above initiatives and the lower sales levels experienced in 2002. Net cash used for investing activities was $43.3 million in 2002. Compared to the prior year, net cash used for investing activities declined by $59.2 million primarily due to a reduction in the repurchase of minority interests of $46.3 million from 2001 and decreased capital spending of $15.9 million in 2002. Net cash flow used for financing activities was $125.5 million in 2002, compared to $102.5 million in 2001. This increase of $23.1 million was due primarily to higher debt repayments including the repayment of the borrowings under the Bank Credit Agreement and the Euro Credit Agreement, partially offset by $120.6 million in proceeds from the June 2002 stock offering. On June 19, 2002, we issued $300.0 million of 7.2% Senior Unsecured Notes due 2012 (Senior Unsecured Notes). These notes were issued at 99.629% of the face amount and yielded $294.3 million of net proceeds after related financing costs. Additionally, on June 19, 2002, we issued 3.5 million shares of our capital stock at a price of $36 per share. Net of issuance costs, this offering yielded proceeds of $120.6 million. Proceeds from these offerings were utilized to repay senior bank indebtedness. During 2003, we did not purchase any shares of our outstanding capital stock. In 2002, we continued our program to repurchase, from time to time, up to a total of 1,600,000 shares of our outstanding capital stock for investment or other general corporate purposes under the repurchase program announced on January 31, 1997. We completed the program announced in 1997 and the Board of Directors authorized the repurchase of up to a total of 2,000,000 additional shares of our outstanding capital stock. During 2002, we purchased 375,000 shares of our capital stock at a total cost of $12.4 million bringing the total number of shares purchased under the authority of both programs to 1,755,900 shares. The repurchases were financed principally by cash from operations and short-term borrowings. Repurchases may be made from time to time in the open market, in negotiated or other permissible transactions. In December 2000, we entered into a EUR 212.0 million ($179.1 million at June 30, 2001 exchange rates) Euro-denominated revolving credit facility (Euro Credit Agreement) to partially hedge the foreign exchange exposure of our net investment in Euro-based subsidiaries and to diversify our interest rate exposure. Amounts borrowed under the Euro Credit Agreement were required to be used to repay indebtedness under the Bank Credit Agreement. To the extent the Bank Credit Agreement was fully repaid, these funds were available for working capital and general corporate purposes. On January 8, 2001, we borrowed EUR 212.0 million under this facility to meet our obligation under the outstanding Euro-denominated forward exchange contracts. The proceeds from the Euro-denominated forward exchange contracts of $191.1 million were used to repay amounts borrowed under the Bank Credit Agreement. Subsequently, the availability under the Bank Credit 26
Agreement was permanently reduced from $900.0 million to $700.0 million, resulting in a write-down of a portion of deferred financing fees of $0.3 million. This was recorded as a component of interest expense. The Bank Credit Agreement and the Euro Credit Agreement were cancelled in June 2002 when we repaid both facilities using proceeds raised from the public debt offering, the capital stock issuance and the 2002 Credit Agreement. OFF-BALANCE SHEET ARRANGEMENTS Since 1999 we have had an agreement with a financial institution whereby we securitize, on a continuous basis, an undivided interest in a specific pool of our domestic trade accounts receivable. We were permitted to securitize up to $100.0 million of accounts receivable under this agreement. In July 2003, we entered into a new securitization program (2003 Securitization Program) which also permitted us to securitize up to $100.0 million of accounts receivable. The 2003 Securitization Program was amended on September 11, 2003, permitting us to securitize up to $125.0 million of accounts receivable. The 2003 Securitization Program provides for a co-purchase arrangement whereby two financial institutions participate in the purchase of our accounts receivables. The actual amount of accounts receivable securitized each month is a function of the net change (new billings less collections) in the specific pool of domestic accounts receivable, the impact of detailed eligibility requirements in the agreement (e.g. the aging, terms of payment, quality criteria and customer concentration), and the application of various reserves which are typically in trade receivable securitization transactions. A decrease in the amount of eligible accounts receivable could result in our inability to continue to securitize all or a portion of our accounts receivable. It is not unusual, however, for the amount of our eligible accounts receivable to vary by up to $5.0 to $10.0 million per month. The financial institution charges us fees based on the level of accounts receivable securitized under this agreement and the commercial paper market rates plus the financial institution's cost to administer the program. The costs incurred under this program, $1.9 million, $2.5 million and $5.7 million in 2003, 2002 and 2001, respectively, are accounted for as a component of other expense, net and represent attractive funding costs compared to existing bank and public debt transactions. At June 30, 2003 and 2002, we securitized accounts receivable of $99.3 million and $95.9 million, respectively, under this program. The 2003 Securitization Program is required to be renewed periodically, and it is our intention to continuously obtain that renewal when required. The prior agreement expired on June 30, 2003 and was renewed to July 3, 2003, when the 2003 Securitization Program became effective. The 2003 Securitization Program is a three-year program, which contains certain provisions that require annual approval. Non-renewal or non-annual approval of this securitization program would result in our requirement to otherwise finance the amounts securitized. We anticipate that the risk of non-renewal or non-annual approval of this securitization program with the current providers or some other providers is very low. In the event of a decrease of our eligible accounts receivable or non-renewal or non-annual approval of our securitization program, we would have to utilize alternative sources of capital to fund that portion of our working capital needs. Capital expenditures for 2004 are estimated to be $70 million and will be used primarily to support new strategic initiatives, new products and to upgrade machinery and equipment, almost all of which are discretionary. FINANCIAL CONDITION At June 30, 2003, total assets were $1,779.1 million, an increase of 16.8 percent from June 30, 2002 due predominantly to the acquisition of Widia which increased total assets by $327.7 million on August 30, 2002. Net working capital was $428.3 million, an increase of 14.1 percent from $375.3 million for 2002, due to the Widia acquisition and the impact of foreign exchange translation. In 2003, accounts receivable increased $56.5 million to $235.6 million; inventories also increased $47.2 million to $392.3 million compared to 2002. The increase in accounts receivable and inventory are directly related to the Widia acquisition. Inventory turnover was 3.2 in 2003 compared to 3.0 in 2002. Account receivable turnover increased from 8.2 in 2002 to 8.5 in 2003. The increase in account receivable and inventory turnover is a result of our continued focus on improving working capital and our successful integration of Widia. Total debt (including capital lease obligations and notes payable) increased $114.3 million or 27.8 percent to $525.7 million in 2003. Higher debt was attributed primarily to the Widia acquisition which resulted in net borrowings of $165.2 million, the impact of changes in foreign exchange rates of approximately $40.0 million, fixed to floating rate swaps of $24.9 million and acquired debt from Widia of $4.6 million. This was offset by repayments of $123.7 million. The ratio of debt to equity was 42.1 percent at June 30, 2003 compared with 36.6 percent at June 30, 2002. The increase is related to additional borrowings to fund the Widia acquisition. Cash from operations and our debt capacity are expected to continue to be sufficient to fund capital expenditures, debt service obligations, share repurchases, dividend payments and operating requirements. 27
During 2003, our accrued pension obligation increased $71.4 million to $111.7 million. The significant increase in the pension obligation was due to approximately $40.0 million from the Widia acquisition and foreign exchange of $9.5 million. The remainder of the increase is due to a decrease in discount rates and expected returns on assets. Additionally during 2003, we recorded an additional minimum pension liability associated with our pension plans. This resulted in a charge to equity of $54.7 million, net of tax, which is reflected in accumulated other comprehensive loss. ACQUISITION AND DIVESTITURES On August 30, 2002, we purchased the Widia Group (Widia) in Europe and India from Milacron Inc. for EUR 188 million ($185.3 million) subject to a purchase price adjustment. On February 12, 2003, Milacron Inc. and Kennametal signed a settlement agreement with respect to the calculation of the post-closing purchase price adjustment for the Widia acquisition pursuant to which Milacron paid Kennametal EUR 18.8 million ($20.1 million) in cash. The net cash purchase price of $167.1 million includes the actual purchase price of $185.3 million less the settlement of $20.1 million plus $6.2 million of direct acquisition costs ($1.1 million paid in fiscal year 2002 and $5.1 million paid during the twelve months ended June 30, 2003) less $4.3 million of acquired cash. We financed the acquisition with funds borrowed under the 2002 Credit Agreement. The acquisition of Widia improves our global competitiveness, strengthens our European position and represents a strong platform for increased penetration in Asia. Widia's operating results have been included in our consolidated results since August 30, 2002. In accordance with SFAS No. 141, "Business Combinations," we accounted for the acquisition using the purchase method of accounting. Accordingly, the preliminary purchase price allocations have been made based upon an estimated fair value of net assets acquired resulting in the recognition of approximately $53.0 million of goodwill and $27.2 million of other intangibles. Of the $27.2 million of identifiable intangible assets approximately $6.4 million have a definite life and therefore will be amortized over its remaining useful life. In accordance with SFAS No. 142 the goodwill will not be amortized but will instead be subject to an annual impairment test. All goodwill and intangible assets resulting from the acquisition will be included in the MSSG segment. The preliminary purchase price allocations are subject to adjustment and may be modified within one year from the acquisition. Subsequent changes are not expected to have a material effect on our consolidated financial position. In April 2002, we sold Strong Tool Company, our industrial supply distributor based in Cleveland, Ohio, for $8.6 million comprised of cash proceeds of $4.0 million and a seller note for $4.6 million. This action resulted in a pretax loss of $3.5 million and is in line with our strategy to refocus the J&L segment on its core catalog business. Annualized sales of this business were approximately $34 million. In January 2002, we acquired Carmet Company for $5.1 million. Located in Duncan, S.C., this entity is a producer of tungsten carbide cutting tools and wear parts and is included in our AMSG segment. In April 2001, we sold ATS, our industrial supply distributor based in Salt Lake City, Utah, for $6.8 million comprised of cash proceeds of $1.0 million and a seller note for $5.8 million. This action resulted in a pretax loss of $5.8 million and is in line with our strategy to refocus the J&L segment on its core catalog business. Annualized sales of this business were approximately $17 million. In 2000, we engaged an investment bank to explore strategic alternatives regarding our 83 percent-owned subsidiary, JLK Direct Distribution Inc. (JLK), including a possible divestiture. At that time, we believed a divestiture might enhance growth prospects for both ourselves and JLK by allowing each company to focus on its core competencies. We completed a thorough and disciplined process of evaluating strategic alternatives and on May 2, 2000, decided to terminate consideration of a possible divestiture at that time. We incurred and expensed $0.8 million in costs associated with this evaluation in 2000. On July 20, 2000, we proposed to the Board of Directors of JLK to acquire the outstanding shares of JLK we did not already own. On September 11, 2000, we announced a definitive merger agreement with JLK to acquire all the outstanding minority shares. Pursuant to the agreement, JLK agreed to initiate a cash tender offer for all of its shares of Class A Common Stock at a price of $8.75 per share. The tender offer commenced on October 3, 2000 and expired on November 15, 2000 resulting in JLK reacquiring 4.3 million shares for $37.5 million. Following JLK's purchase of shares in the tender offer, we acquired the minority shares at the same price in a merger. We incurred transaction costs of $3.3 million, which were included in the total cost of the transaction. JLK incurred costs of $2.1 million associated with the transaction, which were expensed as incurred. The transaction was unanimously approved by the JLK Board of Directors, including a special committee comprised of independent directors of the JLK Board. We continue to evaluate new opportunities that allow for the expansion of existing product lines into new market areas, either directly or indirectly through joint ventures, where appropriate. 28
ENVIRONMENTAL MATTERS We are involved in various environmental cleanup and remediation activities at several of our manufacturing facilities. In addition, we are currently named as a potentially responsible party (PRP) at the Li Tungsten Superfund site in Glen Cove, New York. In December 1999, we recorded a remediation reserve of $3.0 million with respect to our involvement in these matters, which was recorded as a component of operating expense. This represents our best estimate of the undiscounted future obligation based on our evaluations and discussions with outside counsel and independent consultants, and the current facts and circumstances related to these matters. We recorded this liability because certain events occurred, including the identification of other PRPs, an assessment of potential remediation solutions and direction from the government for the remedial action plan, that clarified our level of involvement in these matters and our relationship to other PRPs. This led us to conclude that it was probable that a liability had been incurred. At June 30, 2003, we have an accrual of $2.8 million recorded relative to this environmental issue. In addition to the amount currently reserved, we may be subject to loss contingencies related to these matters estimated to be up to an additional $3.0 million. We believe that such undiscounted unreserved losses are reasonably possible but are not currently considered to be probable of occurrence. The reserved and unreserved liabilities for all environmental concerns could change substantially in the near term due to factors such as the nature and extent of contamination, changes in remedial requirements, technological changes, discovery of new information, the financial strength of other PRPs, the identification of new PRPs and the involvement of and direction taken by the government on these matters. Additionally, we also maintain reserves for other potential environmental issues associated with our domestic operations and a location operated by our German subsidiary. At June 30, 2003, the total of these accruals was $1.3 million and represents anticipated costs associated with the remediation of these issues. Cash payments of $0.1 million have been made against this reserve during the year. During the due diligence phase of the Widia acquisition, we identified certain environmental exposures with Widia manufacturing locations in Europe and India. The purchase price paid reflected our estimate of this exposure. As a result of the Widia acquisition, we have established an environmental reserve of $6.2 million which is consistent with our expectations determined during the due diligence process. This reserve will be used for environmental clean-up and remediation activities at several Widia manufacturing locations. This liability represents our best estimate of the future obligation based on our evaluations and discussions with independent consultants and the current facts and circumstances related to these matters. This liability has been recorded as part of the Widia acquisition and has not been reflected in our operating results. We maintain a Corporate Environmental, Health and Safety (EH&S) Department, as well as an EH&S Policy Committee, to ensure compliance with environmental regulations and to monitor and oversee remediation activities. In addition, we have established an EH&S administrator at each of our global manufacturing facilities. Our financial management team periodically meets with members of the Corporate EH&S Department and the Corporate Legal Department to review and evaluate the status of environmental projects and contingencies. On a quarterly basis, we establish or adjust financial provisions and reserves for environmental contingencies in accordance with SFAS No. 5, "Accounting for Contingencies." EFFECTS OF INFLATION Despite modest inflation in recent years, rising costs continue to affect our operations throughout the world. We strive to minimize the effects of inflation through cost containment, productivity improvements and price increases under highly competitive conditions. DISCUSSION OF CRITICAL ACCOUNTING POLICIES In preparing our financial statements in conformity with accounting principles generally accepted in the United States of America, we make judgments and estimates about the amounts reflected in our financial statements. As part of our financial reporting process, our management collaborates to determine the necessary information on which to base our judgments and develops estimates used to prepare the financial statements. We use historical experience and available information to make these judgments and estimates. However, different amounts could be reported using different assumptions and in light of different facts and circumstances. Therefore, actual amounts could differ from the estimates reflected in our financial statements. Our significant accounting policies are described in Note 2 of our consolidated financial statements. We believe that the following discussion addresses our critical accounting policies. Accounting for Contingencies We accrue for contingencies in accordance with SFAS No. 5, "Accounting for Contingencies," when it is probable that a liability or loss has been incurred and the amount can be reasonably estimated. Contingencies by their nature relate to uncertainties that require our exercise of judgment both in assessing whether or not a liability or loss has been incurred and estimating the amount of 29
probable loss. The significant contingencies affecting our financial statements include accounts and notes receivable collectibility, inventory valuation, environmental health and safety matters, pending litigation and the realization of deferred tax assets. Long-Lived Assets As required under SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," we evaluate the recoverability of property, plant and equipment and intangible assets other than goodwill that are amortized whenever events or changes in circumstances indicate the carrying amount of any such assets may not be fully recoverable. Changes in circumstances include technological advances, changes in our business model, capital structure, economic conditions or operating performance. Our evaluation is based upon, among other things, our assumptions about the estimated future undiscounted cash flows these assets are expected to generate. When the sum of the undiscounted cash flows is less than the carrying value, we will recognize an impairment loss. We continually apply our best judgment when performing these evaluations to determine the timing of the testing, the undiscounted cash flows used to assess recoverability and the fair value of the asset. In conjunction with the Widia acquisition, we reviewed the estimated lives currently being used for existing Kennametal assets, and have determined that the current useful lives should be extended to more appropriately match the life of the asset. Starting July 1, 2003, we have extended our useful lives of machinery and equipment from a maximum life of 10 years to 15 years. We expect this change to result in an annual benefit of approximately $17 million. Goodwill and Other Intangible Assets We evaluate the recoverability of the goodwill and other intangibles of each of our reporting units as required under SFAS No. 142 by comparing the fair value of each reporting unit with its carrying value. The fair values of our reporting units are determined using a combination of a discounted cash flow analysis and market multiples based upon historical and projected financial information. We apply our best judgment when assessing the reasonableness of the financial projections used to determine the fair value of each reporting unit. Pension and Other Postretirement and Postemployment Benefits We sponsor these types of benefit plans for a majority of our employees and retirees. We account for these plans as required under SFAS No. 87, "Employers' Accounting for Pensions," SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other than Pensions" and SFAS No. 112, "Employers' Accounting for Postemployment Benefits." Accounting for the cost of these plans requires the estimation of the cost of the benefits to be provided well into the future and attributing that cost over the expected work life of employees participating in these plans. This estimation requires our judgment about the discount rate used to determine these obligations, expected return on plan assets, rate of future compensation increases, rate of future health care costs, withdrawal and mortality rates and participant retirement age. Differences between our estimates and actual results may significantly affect the cost of our obligations under these plans. Due to the changes in assumptions and return on plan assets, we expect our pension and supplemental early executive retirement income to decrease from $1.0 million in 2003 to expense of $13.3 million in 2004. Restructuring Activities We accrue the cost of our restructuring activities in accordance with SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." We exercise our judgment in estimating the total costs of each of these activities. As we implement these activities, the actual costs may differ from the estimated costs due to changes in the facts and circumstances that were not foreseen at the time of our initial cost accrual. Allowance for Doubtful Accounts We record allowances for estimated losses resulting from the liability of our customers to make required payments. We assess the credit worthiness of our customers based on multiple sources of information and analyze such factors as our historical bad debt experiences, industry and geographic concentrations of credit risk, current economic trends and changes in customer payment terms. This assessment requires significant judgment. If the financial condition of our customers were to worsen, additional allowances may be required, resulting in future operating losses that are not included in the allowance for doubtful accounts at June 30, 2003. Income Taxes Realization of our deferred tax assets is primarily dependent on future taxable income, the timing and amount of which are uncertain in part due to the expected profitability of certain foreign subsidiaries. As of June 30, 2003, the deferred tax assets with valuation allowances are primarily attributable 30
to postretirement benefits, inventory reserves and net operating loss carryforwards. In the event that we were to determine that we would not be able to realize our deferred tax assets in the future, an increase in the valuation allowance would be required. NEW ACCOUNTING STANDARDS In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 143, "Accounting for Asset Retirement Obligations." SFAS No. 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. It applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and/or the normal operation of a long-lived asset. The adoption of this standard, effective July 1, 2002, had no material impact on the results of our operations or financial position. In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," which addresses financial accounting and reporting for the impairment of long-lived assets and for long-lived assets to be disposed of and supersedes SFAS No. 121. This statement retains the fundamental provisions of SFAS No. 121 for recognition and measurement of the impairment of long-lived assets to be held and used and measurement of long-lived assets to be disposed of by sale. The provisions of this statement are effective for fiscal years beginning after December 15, 2001, and interim periods within those fiscal years. The adoption of this standard effective July 1, 2002, did not have a material impact on our consolidated financial statements. In April 2002, SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections," was issued. This statement updates, clarifies and simplifies existing accounting pronouncements. While the technical corrections to existing pronouncements are not substantive in nature, in some instances they may change accounting practice. The provisions of this standard related to SFAS No. 13 are effective for transactions occurring after May 15, 2002. Prospectively, as a result of the adoption of SFAS No. 145, debt extinguishment costs previously classified as extraordinary items will be reclassified as interest expense. In July 2002, the FASB issued SFAS No. 146, "Accounting for Exit or Disposal Activities," which addresses significant issues regarding the recognition, measurement and reporting of costs that are associated with exit and disposal activities, including restructuring activities. SFAS No. 146 nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity," under which a liability for an exit cost was recognized at the date of an entity's commitment to an exit plan. SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized at fair value when the liability is incurred. The provisions of this statement have been applied to any exit or disposal activities entered into after January 1, 2003. In November 2002, the FASB issued FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others." FIN 45 clarifies the requirements of FASB Statement No. 5, "Accounting for Contingencies," relating to a guarantor's accounting for, and disclosure of, the issuance of certain types of guarantees. FIN 45 requires that upon issuance of a guarantee, the guarantor must recognize a liability for the fair value of the obligation it assumes under that guarantee; FIN 45 also requires enhanced disclosures in a company's interim and annual filings. FIN 45 is effective for guarantees issued or modified after December 31, 2002. The disclosure requirements were effective for financial statements of both interim and fiscal years ending after December 15, 2002. The adoption of this standard did not have a material impact on our consolidated financial statements. In January 2003, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation Transition and Disclosure," to provide alternative methods of transition for an entity that voluntarily changes to the fair value- based method of accounting for stock-based employee compensation. This statement also amends the disclosure provisions of that statement to require prominent disclosure about the effects on reported net income of an entity's accounting policy decisions with respect to stock-based employee compensation. Finally, the statement amends APB Opinion No. 28, "Interim Financial Reporting," to require disclosure about those effects in interim financial information. The amendments to APB Opinion No. 28 are effective for financial reports containing condensed financial statements for interim periods beginning after December 15, 2002. The disclosure provisions of this statement were adopted on January 1, 2003. 31
In January 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"), "Consolidation of Variable Interest Entities--an interpretation of ARB No. 51." FIN 46 clarifies the application of Accounting Research Bulletin No. 51, "Consolidated Financial Statements," to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective for the Company July 1, 2003 and will not have a material impact on the Company's results of operations or financial condition. In January 2003, the EITF released Issue No. 00-21 ("EITF 00-21"), "Revenue Arrangements with Multiple Deliverables," which addresses certain aspects of the accounting by a vendor for arrangement under which it will perform multiple revenue-generating activities. Specifically, EITF 00-21 addresses whether an arrangement contains more than one unit of accounting and the measurement and allocation to the separate units of accounting in the arrangement. EITF 00-21 is effective for revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The adoption of this standard did not have a material impact on our consolidated financial statements. In May 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." SFAS No. 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. The Company is currently analyzing the provisions of SFAS No. 149 to determine if there will be any impact of adoption, but does not believe that there will be any material impact on its consolidated financial statements. In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150 establishes standards for how companies classify and measure certain financial instruments with characteristics of both liabilities and equity. It requires companies to classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003. The standard will not impact our consolidated financial statements. ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK MARKET RISK We are exposed to certain market risks arising from transactions that are entered into in the normal course of business. As part of our formal documented risk management program, we use certain derivative financial instruments to manage these risks. We do not enter into derivative transactions for speculative purposes and therefore hold no derivative instruments for trading purposes. We use derivative financial instruments to dampen the effects of changes in foreign exchange rates on our consolidated results and to achieve our targeted mix of fixed and floating interest rates on outstanding debt. Our objective in managing foreign exchange exposures with derivative instruments is to reduce both earnings and cash flow volatility, allowing us to focus our attention on business operations. With respect to interest rate management, these derivative instruments allow us to achieve our targeted fixed-to-floating interest rate mix as a separate decision from funding arrangements in the bank and public debt markets. We measure hedge effectiveness by assessing the changes in the fair value or expected future cash flows of the hedged item. The ineffective portions are recorded in other income or expense in the current period. See Notes 2 and 13 to our consolidated financial statements for additional information. We are exposed to counterparty credit risk for nonperformance of derivative contracts and, in the event of nonperformance, to market risk for changes in interest and currency rates. We manage exposure to counterparty credit risk through credit standards, diversification of counterparties and procedures to monitor concentrations of credit risk. We do not anticipate nonperformance by any of the counterparties. The following provides additional information on our use of derivative instruments. Included below is a sensitivity analysis that is based upon a hypothetical 10 percent weakening or strengthening in the U.S. dollar compared to the June 30, 2003 foreign currency rates, the effective interest rates under our current borrowing arrangements and the market value of our available-for-sale securities. We compared the contractual derivative 32
and borrowing arrangements in effect at June 30, 2003 to the hypothetical foreign exchange or interest rates in the sensitivity analysis to determine the effect on interest expense, pretax income, fair value of the available-for-sale securities or the accumulated other comprehensive loss. Our analysis takes into consideration the different types of derivative instruments and the applicability of hedge accounting. CASH FLOW HEDGES Currency A portion of our operations consists of investments in foreign subsidiaries. Our exposure to market risk for changes in foreign exchange rates arises from these investments, inter-company loans utilized to finance these subsidiaries, trade receivables and payables, and firm commitments arising from international transactions. We manage our foreign exchange transaction risk to reduce the volatility of cash flows caused by currency fluctuations through natural offsets, where appropriate, and foreign exchange contracts. These contracts are designated as hedges of transactions that will settle in future periods, and otherwise would expose us to foreign currency risk. Our foreign exchange hedging program minimizes our exposure to foreign exchange rate movements. This exposure arises largely from anticipated cash flows from cross-border intercompany sales of products and services. This program utilizes purchased options, range forwards and forward contracts primarily to sell foreign currency. The notional amounts of the contracts translated into U.S. dollars at June 30, 2003 and 2002 rates are $123.4 million and $62.5 million, respectively. At June 30, 2003 and 2002, a hypothetical 10 percent strengthening or weakening of the U.S. dollar would not materially change pretax income related to these positions; however, accumulated other comprehensive loss would change by $4.6 million and $4.4 million, respectively. In addition, we may enter into forward contracts to hedge transaction exposures or significant cross-border intercompany loans by either purchasing or selling specified amounts of foreign currency at a specified date. At June 30, 2003 and 2002, we had several outstanding forward contracts to purchase and sell foreign currency, with notional amounts, translated into U.S. dollars at June 30, 2003 and 2002 rates, of $13.1 million and $135.2 million, respectively. A hypothetical 10 percent change in the applicable 2003 and 2002 year-end exchange rates would result in an increase or decrease in pretax income of $1.3 million and $5.5 million, respectively, related to these positions. Interest Rate Our exposure to market risk for changes in interest rates relates primarily to our long-term debt obligations. We seek to manage our interest rate risk in order to balance our exposure between fixed and floating rates while attempting to minimize our borrowing costs. To achieve these objectives, we primarily use interest rate swap agreements to manage exposure to interest rate changes related to these borrowings. At June 30, 2003 and 2002, we had interest rate swap agreements outstanding that effectively convert a notional amount of $50 million and $150.0 million, respectively, of debt from floating to fixed interest rates. At June 30, 2003, these agreements mature in June of 2008. FAIR VALUE HEDGES Interest Rate As discussed above, our exposure to market risk for changes in interest rates relates primarily to our long-term debt obligations. We seek to manage this risk through the use of interest rate swap agreements. At June 30, 2003, we had interest rate swap agreements outstanding that effectively convert a notional amount of $200 million of the Senior Unsecured Notes from fixed to floating interest rates. These agreements mature in June 2012 but provide for a one-time optional early termination for the bank counterparty in June 2008 at the then prevailing market value of the swap agreements. DEBT AND NOTES PAYABLE At June 30, 2003 and 2002, we had $525.7 million and $411.4 million, respectively, of debt and notes payable outstanding at effective interest rates of 6.9 percent and 7.9 percent, respectively, including the effect of interest rate swaps. A hypothetical change of 10 percent in interest rates from year-end 2003 and 2002 levels would increase or decrease interest expense by approximately $1.4 million and $2.2 million, respectively. In addition to outstanding debt, at June 30, 2003 and 2002 we had $7.9 million and $6.9 million, respectively, of outstanding notes payable. OTHER Our investment in Toshiba Tungaloy is classified as an available-for-sale security and, therefore, is carried at its quoted market value, adjusted for changes in currency exchange rates. At June 30, 2003 and 2002, the carrying and fair value of our investment was $11.4 million and $10.7 million, respectively. A hypothetical change of 10 percent in the quoted market value of this common stock at June 30, 2003 and 2002 would result in a $1.1 million increase or decrease in fair value for both periods. 33
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA SELECTED QUARTERLY FINANCIAL DATA (unaudited) Quarter Ended ------------------------------------------------ (in thousands, except per share data) Sep. 30 Dec. 31 Mar. 31 Jun. 30 - ------------------------------------------------------------------------------------------------------ FISCAL 2003 Sales $ 404,218 $ 431,731 $ 459,243 $ 463,765 Gross profit 130,969 137,483 151,661 148,791 Net income (loss) 10,829 2,470 9,699 (4,868) Basic earnings (loss) per share 0.31 0.07 0.28 (0.14) Diluted earnings (loss) per share 0.31 0.07 0.27 (0.14) - ----------------------------------------------------------------------------------------------------- FISCAL 2002 Sales $ 406,654 $ 380,338 $ 393,852 $ 402,898 Gross profit 129,839 116,465 127,647 136,873 Income (loss) before cumulative effect of change in accounting principle 12,444 (2,460) 13,144 15,370 Net (loss) income (237,962) (2,460) 13,144 15,370 Basic earnings (loss) per share before cumulative effect of change in accounting principle 0.40 (0.08) 0.42 0.49 Diluted earnings (loss) per share before cumulative effect of change in accounting principle 0.40 (0.08) 0.42 0.48 Basic (loss) earnings per share (7.68) (0.08) 0.42 0.49 Diluted (loss) earnings per share (7.57) (0.08) 0.42 0.48 - ----------------------------------------------------------------------------------------------------- Earnings per share amounts for each quarter are required to be computed independently and, therefore, may not equal the amount computed for the year. 34
Consolidated Statements of Income Year ended June 30 (in thousands, except per share data) 2003 2002 2001 - ------------------------------------------------------------------------------------------------------- OPERATIONS Sales (Note 2) $ 1,758,957 $ 1,583,742 $ 1,807,896 Cost of goods sold 1,190,053 1,072,918 1,192,176 - ------------------------------------------------------------------------------------------------------- Gross profit 568,904 510,824 615,720 Operating expense 464,861 389,396 425,641 Restructuring and asset impairment charges (Note 12) 31,954 27,307 9,545 Amortization of intangibles 4,164 2,804 24,134 - ------------------------------------------------------------------------------------------------------- Operating income 67,925 91,317 156,400 Interest expense 36,166 32,627 50,381 Other (income) expense, net (2,531) (361) 11,690 - ------------------------------------------------------------------------------------------------------- Income before provision for income taxes and minority interest 34,290 59,051 94,329 Provision for income taxes (Notes 2 and 9) 14,300 18,900 37,300 Minority interest 1,860 1,653 3,142 - ------------------------------------------------------------------------------------------------------- Income before cumulative effect of change in accounting principles 18,130 38,498 53,887 Cumulative effect of change in accounting principles, net of tax of $2,389 and $399, respectively - (250,406) (599) - ------------------------------------------------------------------------------------------------------- Net income (loss) $ 18,130 $ (211,908) $ 53,288 ======================================================================================================= PER SHARE DATA Basic earnings per share before cumulative effect of change in accounting principles $ 0.52 $ 1.24 $ 1.76 Cumulative effect of change in accounting principles - (8.04) (0.02) - ------------------------------------------------------------------------------------------------------- Basic earnings (loss) per share $ 0.52 $ (6.80) $ 1.74 ======================================================================================================= Diluted earnings per share before cumulative effect of change in accounting principles $ 0.51 $ 1.22 $ 1.75 Cumulative effect of change in accounting principles - (7.92) (0.02) - ------------------------------------------------------------------------------------------------------- Diluted earnings (loss) per share (Note 2) $ 0.51 $ (6.70) $ 1.73 ======================================================================================================= Dividends per share $ 0.68 $ 0.68 $ 0.68 ======================================================================================================= Basic weighted average shares outstanding (Note 2) 35,202 31,169 30,560 ======================================================================================================= Diluted weighted average shares outstanding 35,479 31,627 30,749 ======================================================================================================= The accompanying notes are an integral part of these consolidated financial statements. 35
Consolidated Balance Sheets As of June 30 (in thousands, except per share data) 2003 2002 - ------------------------------------------------------------------------------------------------ ASSETS Current assets: Cash and cash equivalents (Note 2) $ 15,093 $ 10,385 Marketable equity securities available-for-sale (Note 2) 11,365 10,728 Accounts receivable, less allowance for doubtful accounts of $23,405 and $12,671 (Notes 2 and 4) 235,648 179,101 Inventories (Notes 2 and 5) 392,255 345,076 Deferred income taxes (Notes 2 and 9) 79,564 71,375 Other current assets 30,754 20,719 - ------------------------------------------------------------------------------------------------ Total current assets 764,679 637,384 - ------------------------------------------------------------------------------------------------ Property, plant and equipment (Note 2): Land and buildings 261,345 227,539 Machinery and equipment 948,260 847,196 Less accumulated depreciation (716,232) (639,619) - ------------------------------------------------------------------------------------------------ Net property, plant and equipment 493,373 435,116 - ------------------------------------------------------------------------------------------------ Other assets: Investments in affiliated companies 16,788 11,681 Goodwill (Note 2) 434,431 359,055 Intangible assets, less accumulated amortization of $15,037 and $11,911 (Note 2) 39,501 8,937 Other 30,320 71,438 - ------------------------------------------------------------------------------------------------ Total other assets 521,040 451,111 - ------------------------------------------------------------------------------------------------ Total assets $ 1,779,092 $ 1,523,611 ================================================================================================ LIABILITIES Current liabilities: Current maturities of long-term debt and capital leases (Note 7) $ 2,907 $ 16,554 Notes payable to banks (Note 8) 7,938 6,926 Accounts payable 119,853 101,586 Accrued income taxes 22,511 4,066 Accrued vacation pay 31,459 28,190 Accrued payroll 32,592 22,696 Other current liabilities (Note 6) 119,087 82,082 - ------------------------------------------------------------------------------------------------ Total current liabilities 336,347 262,100 - ------------------------------------------------------------------------------------------------ Long-term debt and capital leases, less current maturities (Note 7) 514,842 387,887 Deferred income taxes (Note 9) 8,748 52,570 Postretirement benefits (Note 10) 44,030 42,604 Accrued pension benefits (Note 10) 111,690 40,307 Other liabilities 22,978 13,510 - ------------------------------------------------------------------------------------------------ Total liabilities 1,038,635 798,978 - ------------------------------------------------------------------------------------------------ Commitments and contingencies (Note 16) - - - ------------------------------------------------------------------------------------------------ Minority interest in consolidated subsidiaries 18,880 10,671 - ------------------------------------------------------------------------------------------------ SHAREOWNERS' EQUITY Preferred stock, no par value; 5,000 shares authorized; none issued - - Capital stock, $1.25 par value; 70,000 shares authorized; 37,649 and 37,383 shares issued 47,061 46,729 Additional paid-in capital 507,343 491,263 Retained earnings 301,263 307,631 Treasury stock, at cost; 2,176 and 2,573 shares held (67,268) (72,026) Unearned compensation (9,109) (4,856) Accumulated other comprehensive loss (Note 11) (57,713) (54,779) - ------------------------------------------------------------------------------------------------ Total shareowners' equity 721,577 713,962 - ------------------------------------------------------------------------------------------------ Total liabilities and shareowners' equity $ 1,779,092 $ 1,523,611 ================================================================================================ The accompanying notes are an integral part of these consolidated financial statements. 36
Consolidated Statements of Cash Flows Year ended June 30 (in thousands) 2003 2002 2001 - -------------------------------------------------------------------------------------------------- OPERATING ACTIVITIES Net income (loss) $ 18,130 $(211,908) $ 53,288 Adjustments for non-cash items: Depreciation 79,879 70,825 73,163 Amortization 4,164 2,804 24,134 Loss on divestitures - 3,522 5,781 Stock-based compensation expense 9,477 7,768 11,775 Restructuring and asset impairment charges 14,998 12,712 4,325 Cumulative effect of change in accounting principles, net of tax - 250,406 599 Other 10,981 505 9,792 Changes in certain assets and liabilities, excluding effects of acquisition and divestitures: Accounts receivable 8,064 33,603 9,620 Proceeds from accounts receivable securitization 3,416 2,200 5,200 Inventories 38,171 40,251 19,894 Accounts payable and accrued liabilities (12,070) (29,033) (827) Other 6,334 (21,207) (18,947) - -------------------------------------------------------------------------------------------------- Net cash flow from operating activities 181,544 162,448 197,797 - -------------------------------------------------------------------------------------------------- INVESTING ACTIVITIES Purchases of property, plant and equipment (49,413) (44,040) (59,929) Disposals of property, plant and equipment 1,875 10,905 4,227 Divestitures, net of cash - 3,309 729 Purchase of subsidiary stock (6,984) (1,161) (47,505) Acquisition of business assets, net of cash acquired (166,077) (5,385) - Investment in affiliates (3) (5,770) - Other 1,223 (1,129) (26) - -------------------------------------------------------------------------------------------------- Net cash flow used for investing activities (219,379) (43,271) (102,504) - -------------------------------------------------------------------------------------------------- FINANCING ACTIVITIES Net (decrease) increase in notes payable (17,324) (4,778) 4,038 Net (decrease) in revolving and other lines of credit (105,001) (84,151) (78,905) Term debt borrowings 1,653 549,950 1,216 Term debt repayments (4,706) (677,563) (2,941) Borrowings for Widia acquisition, net 165,240 - - Proceeds from interest rate swap termination 15,546 - - Net proceeds from issuance of capital stock - 120,584 - Dividend reinvestment, employee benefit and stock plans 7,606 15,981 12,613 Purchase of treasury stock - (12,417) (16,494) Cash dividends paid to shareowners (24,498) (21,426) (21,056) Financing fees - (10,448) - Other (1,060) (1,268) (949) - -------------------------------------------------------------------------------------------------- Net cash flow provided by (used) for financing activities 37,456 (125,536) (102,478) - -------------------------------------------------------------------------------------------------- Effect of exchange rate changes on cash and equivalents 5,087 3,804 (2,198) - -------------------------------------------------------------------------------------------------- CASH AND EQUIVALENTS Net increase (decrease) in cash and equivalents 4,708 (2,555) (9,383) Cash and equivalents, beginning of year 10,385 12,940 22,323 - -------------------------------------------------------------------------------------------------- Cash and equivalents, end of year $ 15,093 $ 10,385 $ 12,940 ================================================================================================== SUPPLEMENTAL DISCLOSURES Interest paid $ 33,434 $ 33,861 $ 51,480 Income taxes (refunded) paid (10,652) 31,949 36,608 Contribution of stock to employee defined contribution benefit plans 4,361 5,788 9,205 Change in fair value of interest rate swaps 8,386 934 - Notes received from sale of subsidiaries - 4,587 5,809 - -------------------------------------------------------------------------------------------------- The accompanying notes are an integral part of these consolidated financial statements. 37
Consolidated Statements of Shareholders' Equity Year ended June 30 (in thousands) 2003 2002 2001 - ------------------------------------------------------------------------------------------ CAPITAL STOCK Balance at beginning of year $ 46,729 $ 42,018 $ 41,500 Issuance of capital stock - 4,428 - Issuance of capital stock under employee benefit and stock plans 332 283 518 - ------------------------------------------------------------------------------------------ Balance at end of year 47,061 46,729 42,018 - ------------------------------------------------------------------------------------------ ADDITIONAL PAID-IN CAPITAL Balance at beginning of year 491,263 353,804 335,314 Issuance of capital stock - 116,156 - Dividend reinvestment 1,476 1,672 1,511 Issuance of capital stock under employee benefit and stock plans 14,604 19,631 16,979 - ------------------------------------------------------------------------------------------ Balance at end of year 507,343 491,263 353,804 - ------------------------------------------------------------------------------------------ RETAINED EARNINGS Balance at beginning of year 307,631 540,965 508,733 Net income (loss) 18,130 (211,908) 53,288 Cash dividends to shareowners (24,498) (21,426) (21,056) - ------------------------------------------------------------------------------------------ Balance at end of year 301,263 307,631 540,965 - ------------------------------------------------------------------------------------------ TREASURY STOCK Balance at beginning of year (72,026) (65,963) (55,236) Purchase of treasury stock, at cost - (12,417) (16,494) Dividend reinvestment 1,290 854 1,284 Issuance of capital stock under employee benefit and stock plans 3,468 5,500 4,483 - ------------------------------------------------------------------------------------------ Balance at end of year (67,268) (72,026) (65,963) - ------------------------------------------------------------------------------------------ UNEARNED COMPENSATION Balance at beginning of year (4,856) (2,165) (2,814) Issuance of capital stock under employee benefit and stock plans (9,136) (4,671) (1,921) Amortization of unearned compensation 4,883 1,980 2,570 - ------------------------------------------------------------------------------------------ Balance at end of year (9,109) (4,856) (2,165) - ------------------------------------------------------------------------------------------ ACCUMULATED OTHER COMPREHENSIVE (LOSS) INCOME Balance at beginning of year (54,779) (71,890) (47,243) Unrealized gain (loss) on marketable equity securities available-for-sale, net of tax 321 (1,774) (7,379) Cumulative effect of change in accounting principle, net of tax - - 1,571 Unrealized gain (loss) on derivatives designated and qualified as cash flow hedges, net of tax (4,879) (1,372) (2,044) Reclassification of unrealized gains or losses on expired derivatives, net of tax 5,157 (1,902) (2,049) Minimum pension liability adjustment, net of tax (54,696) (945) (2,670) Foreign currency translation adjustments 51,163 23,104 (12,076) - ------------------------------------------------------------------------------------------ Other comprehensive (loss) income (2,934) 17,111 (24,647) - ------------------------------------------------------------------------------------------ Balance at end of year (57,713) (54,779) (71,890) - ------------------------------------------------------------------------------------------ Total shareowners' equity, June 30 $ 721,577 $ 713,962 $ 796,769 ========================================================================================== COMPREHENSIVE INCOME (LOSS) Net income (loss) $ 18,130 $(211,908) $ 53,288 Other comprehensive (loss) income (2,934) 17,111 (24,647) - ------------------------------------------------------------------------------------------ Comprehensive income (loss) $ 15,196 $(194,797) $ 28,641 ========================================================================================== The accompanying notes are an integral part of these consolidated financial statements. 38
Notes to Consolidated Financial Statements NOTE 1 - NATURE OF OPERATIONS We are a leading global manufacturer, marketer and distributor of a broad range of cutting tools, tooling systems, supplies and technical services, as well as wear-resistant parts. We believe that our reputation for manufacturing excellence and technological expertise and innovation in our principal products has helped us achieve a leading market presence in our primary markets. We believe we are the second largest global provider of metalcutting tools and tooling systems. End users of our products include metalworking manufacturers and suppliers in the aerospace, automotive, machine tool and farm machinery industries, as well as manufacturers and suppliers in the highway construction, coal mining, quarrying and oil and gas exploration industries. Unless otherwise specified, any reference to a "year" is to a fiscal year ended June 30. When used in this annual report on Form 10-K, unless the context requires otherwise, the terms "we," "our" and "us" refer to Kennametal Inc. and its subsidiaries. NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The summary of our significant accounting policies is presented below to assist in evaluating our consolidated financial statements. PRINCIPLES OF CONSOLIDATION The consolidated financial statements include our accounts and those of majority-owned subsidiaries. All significant intercompany balances and transactions are eliminated. Investments in entities over which we have significant influence are accounted for on an equity basis. Widia's operating results have been included in our consolidated results since the acquisition date of August 30, 2002. USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS In preparing our financial statements in conformity with accounting principles generally accepted in the United States of America, we make judgments and estimates about the amounts reflected in our financial statements. As part of our financial reporting process, our management collaborates to determine the necessary information on which to base our judgments and develop estimates used to prepare the financial statements. We use historical experience and available information to make these judgments and estimates. However, different amounts could be reported using different assumptions and in light of different facts and circumstances. Therefore, actual amounts could differ from the estimates reflected in our financial statements. CASH AND CASH EQUIVALENTS Cash investments having original maturities of three months or less are considered cash equivalents. Cash equivalents principally consist of investments in money market funds. MARKETABLE EQUITY SECURITIES AVAILABLE-FOR-SALE Our investment in Toshiba Tungaloy Co., Ltd. (Toshiba) is accounted for as an available-for-sale security under SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities." This investment in Toshiba, a leading Japanese manufacturer of consumable metalcutting products, is reported at fair value, as determined through quoted market sources. The unrealized gain or loss on this investment is recorded as a component of accumulated other comprehensive loss, net of tax. The gross unrealized loss on this investment was $0.3 million and $0.8 million at June 30, 2003 and June 30, 2002, respectively. ACCOUNTS RECEIVABLE Sales to affiliated companies were $17.5 million and $13.3 million in 2003 and 2002. Accounts receivable includes $4.3 million and $3.3 million of receivables from affiliates at June 30, 2003 and 2002, respectively. We market our products to a diverse customer base throughout the world. Trade credit is extended based upon evaluations of each customer's ability to satisfy its obligations, which are updated periodically. We make judgments as to our ability to collect outstanding receivables and provide allowances for the portion of receivables when collection becomes doubtful. Accounts receivable reserves are determined based upon an aging of accounts and a review of specific accounts. INVENTORIES Inventories are stated at the lower of cost or market. We use the last-in, first-out (LIFO) method for determining the cost of a significant portion of our U.S. inventories. The cost of the remainder of inventories is determined under the first-in, first-out (FIFO) or average cost methods. When market conditions indicate an excess of carrying costs over market value, a lower-of-cost-or-market provision is recorded. Excess and obsolete inventory reserves are established based upon our evaluation of the quantity of inventory on hand relative to demand. The excess and obsolete inventory reserve at June 30, 2003 and 2002, was $70.9 million and $46.7 million, respectively. 39
PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment are carried at cost. Major improvements are capitalized, while maintenance and repairs are expensed as incurred. Retirements and disposals are removed from cost and accumulated depreciation accounts, with the gain or loss reflected in income. Interest related to the construction of major facilities is capitalized as part of the construction costs and is amortized over its estimated useful life. Depreciation for financial reporting purposes is computed using the straight-line method over the following estimated useful lives: Building and improvements 15-40 years Machinery and equipment 4-10 years Furniture and fixtures 5-10 years Computer hardware and software 3-5 years Leased property and equipment under capital leases are amortized using the straight-line method over the terms of the related leases. Under the provisions of SOP 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use," we capitalize costs associated with software developed or obtained for internal use when both the preliminary project stage is completed and we have authorized further funding for projects which we believe will be completed and used to perform the function intended. In conjunction with the Widia acquisition, we reviewed the estimated useful lives currently being used for existing Kennametal assets, and have determined that the current useful lives should be extended to more appropriately match the life of the asset. Starting July 1, 2003, we have extended our useful lives of machinery and equipment from a maximum life of 10 years to 15 years. LONG-LIVED ASSETS We periodically perform ongoing reviews of underperforming businesses and other long-lived assets, including amortizable intangible assets, for impairment pursuant to the provisions of SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." These reviews may include an analysis of the current operations and capacity utilization, in conjunction with the markets in which the businesses are operating. A comparison is performed of the undiscounted projected cash flows of the current operating forecasts to the net book value of the related assets. If it is determined that the full value of the assets may not be recoverable, an appropriate charge to adjust the carrying value of the long-lived assets to fair value may be required. As a result of continued price declines caused by persistent global over-capacity and low-cost Asian competition, we completed an assessment in June 2003 of the carrying value of certain long-lived assets in the Electronics business and recorded a pre-tax charge of $16.1 million as a component of restructuring and asset impairment charges. The fixed asset impairment charge reduced the book value of the Electronics business' assets to $2.6 million. This remaining value was determined based on cash flow and estimated realizable value of the assets. GOODWILL AND INTANGIBLE ASSETS Goodwill represents the excess of cost over the fair value of acquired companies. Prior to our adoption of SFAS No. 142, goodwill was amortized using the straight-line method. Under SFAS No. 142, all goodwill amortization ceased effective July 1, 2001. Goodwill and intangible assets with indefinite useful lives will be tested at least annually for impairment. On an ongoing basis (absent of any impairment indicators), we perform our impairment tests during the June quarter, in connection with our planning process. As a result of the Widia acquisition, we have recorded $27.2 million of identifiable intangible assets of which $6.4 million has a definite life and therefore will be amortized over its remaining life. 40
We adopted SFAS No. 142 effective July 1, 2001. Goodwill attributable to each of our reporting units was tested for impairment by comparing the fair value of each reporting unit with its carrying value. As a result of the adoption of this rule, we recorded a non-cash pre-tax charge of $252.8 million specific to the Electronics (AMSG segment--$82.1 million) and the Industrial Products Group (MSSG segment--$170.7 million) businesses, which were acquired in 1998 as part of Greenfield Industries. The fair values of these reporting units were determined using a combination of discounted cash flow analysis and market multiples based upon historical and projected financial information. The initial phase of the impairment tests were performed within six months of adoption of SFAS No. 142 or December 31, 2001, and are required at least annually thereafter. Under SFAS No. 142, the impairment adjustment recognized at adoption of this standard was reflected as a cumulative effect of a change in accounting principle, effective July 1, 2001. Impairment adjustments recognized after adoption, if any, are required to be recognized as a component of operating expense. The carrying amount of goodwill attributable to each segment at June 30, 2002 and 2003 is as follows: (in thousands) June 30, 2001 Impairment Disposals Translation June 30, 2002 - --------------------------------------------------------------------------------------------------- MSSG $ 315,463 $(170,682) $ - $ 2,376 $ 147,157 AMSG 249,345 (82,113) - 310 167,542 J&L Industrial Supply 45,748 - (6,099) - 39,649 Full Service Supply 4,707 - - - 4,707 - --------------------------------------------------------------------------------------------------- Total $ 615,263 $(252,795) $ (6,099) $ 2,686 $ 359,055 =================================================================================================== (in thousands) June 30, 2002 Acquisition Disposals Translation June 30, 2003 - --------------------------------------------------------------------------------------------------- MSSG $147,157 $ 58,624 $ - $ 16,528 $ 222,309 AMSG 167,542 197 - 27 167,766 J&L Industrial Supply 39,649 - - - 39,649 Full Service Supply 4,707 - - - 4,707 - --------------------------------------------------------------------------------------------------- Total $359,055 $ 58,821 $ - $ 16,555 $ 434,431 =================================================================================================== In connection with the adoption of SFAS No. 142, we also reassessed the useful lives and the classification of our identifiable intangible assets and determined that they continue to be appropriate. The components of our intangible assets are as follows: June 30, 2003 June 30, 2002 ---------------------------- ---------------------------- Estimated Gross Carrying Accumulated Gross Carrying Accumulated (in thousands) Useful Life Amount Amortization Amount Amortization - --------------------------------------------------------------------------------------------------------------------- Contract based 4-15 years $ 11,218 $ (10,230) $ 11,910 $ (9,488) Technology based and other 4-15 years 10,799 (4,807) 3,374 (2,423) Trademarks Indefinite 24,139 - - - Intangible pension asset and other Indefinite 8,382 - 5,564 - - --------------------------------------------------------------------------------------------------------------------- Total $ 54,538 $ (15,037) $ 20,848 $ (11,911) ===================================================================================================================== Amortization expense for intangible assets, other than goodwill, was $4.2 million, $2.8 million and $3.1 million for 2003, 2002 and 2001, respectively. Goodwill amortization was $19.0 million, net of tax, in 2001; no amortization was recorded in 2002 or 2003 due to the adoption of SFAS 142. 41
The effects of adopting SFAS No. 141 and 142 on net income and basic and diluted earnings per share for the years ended June 30, 2003, 2002 and 2001 are as follows: June 30 ------------------------------------- (in thousands, except per share amounts) 2003 2002 2001 - ---------------------------------------------------------------------------------- Reported net income (loss) $ 18,130 $ (211,908) $ 53,288 Goodwill impairment, net of tax - 250,406 - Goodwill amortization, net of tax - - 18,975 - ---------------------------------------------------------------------------------- Adjusted net income $ 18,130 $ 38,498 $ 72,263 ================================================================================== Basic earnings per share: Reported net income (loss) $ 0.52 $ (6.80) $ 1.74 Goodwill impairment - 8.04 - Goodwill amortization - 0.62 - ---------------------------------------------------------------------------------- Adjusted net income $ 0.52 $ 1.24 $ 2.36 ================================================================================== Diluted earnings per share: Reported net income (loss) $ 0.51 $ (6.70) $ 1.73 Goodwill impairment - 7.92 - Goodwill amortization - - 0.62 - ---------------------------------------------------------------------------------- Adjusted net income $ 0.51 $ 1.22 $ 2.35 ================================================================================== Deferred Financing Fees Fees incurred in connection with new borrowings are capitalized and amortized to interest expense over the life of the related obligation. Earnings Per Share Basic earnings per share is computed using the weighted average number of shares outstanding during the period, while diluted earnings per share is calculated to reflect the potential dilution that occurs related to issuance of capital stock under stock option grants and restricted stock awards. The difference between basic and diluted earnings per share relates solely to the effect of capital stock options and restricted stock awards. For purposes of determining the number of dilutive shares outstanding, weighted average shares outstanding for basic earnings per share calculations were increased due solely to the dilutive effect of unexercised capital stock options and restricted stock awards by 0.3 million, 0.5 million and 0.2 million shares in 2003, 2002 and 2001, respectively. Unexercised stock options to purchase our capital stock of 1.7 million, 1.2 million and 1.5 million shares at June 30, 2003, 2002 and 2001, respectively, are not included in the computation of diluted earnings per share because the option exercise price was greater than the average market price. Revenue Recognition Revenue from the sale of products is generally recognized when risk of loss, title and insurable risk have transferred to the customer, which in most cases coincides with shipment of the related products. We do not ship product unless we have documentation authorizing shipment to our customers. Historically, we have experienced very low levels of returned product and do not consider the effect of returned product to be material. Stock-Based Compensation Stock options generally are granted to eligible employees with a stock price equal to fair market value at the date of grant. Options are exercisable under specific conditions for up to 10 years from the date of grant. As permitted under the SFAS No. 123 we have elected to measure compensation expense related to stock options in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and related interpretations which uses the intrinsic value method. In addition to stock option grants, the 2002 plan permits the award of restricted stock to directors, officers and key employees. Expense associated with restricted stock grants is amortized over the vesting period. The expense for these awards is the same under the fair value method or intrinsic value method, and therefore is not included in the table below. If compensation expense was determined based on the estimated fair value of options granted in 2003, 2002 and 2001, consistent with the methodology in SFAS No. 123 and 148, our 2003, 2002 and 2001 net income and earnings per share would be reduced to the pro forma amounts indicated on the following page: 42
Fiscal Year Ended June 30, ---------------------------------- (in thousands, except per share data) 2003 2002 2001 - ---------------------------------------------------------------------------------------------------- Net income (loss), as reported $ 18,130 $(211,908) $ 53,288 Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects (5,591) (3,603) (2,486) Add: Total stock-based employee compensation expense determined under intrinsic value based method for all awards, net of related tax effects 158 - - - ---------------------------------------------------------------------------------------------------- Total stock-based compensation (5,433) (3,603) (2,486) - ---------------------------------------------------------------------------------------------------- Pro forma net income (loss) $ 12,697 $(215,511) $ 50,802 ==================================================================================================== Earnings (loss) per share: Basic-as reported $ 0.52 $ (6.80) $ 1.74 ==================================================================================================== Basic-pro forma $ 0.36 $ (6.91) $ 1.66 ==================================================================================================== Diluted-as reported $ 0.51 $ (6.70) $ 1.73 ==================================================================================================== Diluted-pro forma $ 0.36 $ (6.86) $ 1.65 ==================================================================================================== The fair values of the options granted were estimated on the date of their grant using the Black-Scholes option- pricing model based on the following weighted average assumptions: 2003 2002 2001 - ---------------------------------------------------------------------------- Risk-free interest rate 3.1% 4.6% 5.9% Expected life (years) 5 5 5 Expected volatility 34.2% 34.0% 33.2% Expected dividend yield 2.1% 1.8% 2.4% - --------------------------------------------------------------------------- Research and Development Costs Research and development costs of $23.6 million, $18.3 million and $18.9 million in 2003, 2002 and 2001, respectively, were expensed as incurred. Shipping and Handling Fees and Costs All fees billed to customers for shipping and handling are classified as a component of net sales. All costs associated with shipping and handling are classified as a component of cost of goods sold. Income Taxes Deferred income taxes are recognized based on the future income tax effects (using enacted tax laws and rates) of differences in the carrying amounts of assets and liabilities for financial reporting and tax purposes. A valuation allowance is recognized if it is "more likely than not" that some or all of a deferred tax asset will not be realized. The valuation allowance was $36.0 million and $6.6 million at June 30, 2003 and 2002, respectively. The increase is primarily attributable to net operating loss carryforwards acquired in the Widia acquisition. FINANCIAL INSTRUMENTS AND DERIVATIVES On July 1, 2000, we adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended. The adoption of SFAS No. 133 resulted in the recording of current assets of $1.6 million, long-term assets of $1.4 million, current liabilities of $1.3 million, long-term liabilities of $0.7 million, a decrease in accumulated other comprehensive loss of $1.6 million, net of tax, and a loss from the cumulative effect from the change in accounting principle of $0.6 million, net of tax. As part of our formal documented risk management program, we use certain derivative financial instruments. We do not enter into derivative transactions for speculative purposes and therefore hold no derivative instruments for trading purposes. We use derivative financial instruments to dampen the effects of changes in foreign exchange rates on our consolidated results and to achieve our targeted mix of fixed and floating interest rates on outstanding debt. We account for derivative instruments as a hedge of the related asset, liability, firm commitment or anticipated transaction when the derivative is specifically designated as a hedge of such items. Our objective in managing foreign exchange exposures with derivative instruments is to reduce both earnings and cash flow volatility, allowing us to focus our attention on business operations. With respect to interest rate management, these derivative instruments allow us to achieve our targeted fixed-to-floating interest rate mix as a separate decision from funding arrangements in the bank and public debt markets. We measure hedge effectiveness by assessing the changes in the fair value or expected future cash flows of the 43
hedged item. The ineffective portions are recorded in other income or expense in the current period. In addition, other forward contracts hedging significant cross-border intercompany loans are considered other derivatives and therefore, not eligible for hedge accounting under SFAS No. 133. These contracts are recorded at fair value in the balance sheet, with the offset to other (income) expense, net. CASH FLOW HEDGES Currencies Forward contracts, purchased options and range forward contracts (a transaction where both a put option is purchased and a call option is sold), designated as cash flow hedges, hedge anticipated cash flows from cross-border intercompany sales of product and services. Gains and losses realized on these contracts at maturity are recorded in accumulated other comprehensive loss, net of tax, and are recognized as a component of other (income) expense, net when the underlying sale of product or services are recognized into earnings. We recognized expense of $0.7 million and $0.1 million as a component of other income, net, in 2003 and 2002, respectively, related to hedge ineffectiveness. The time value component of the fair value of purchased options and range forwards is excluded from the assessment of hedge effectiveness. Assuming market rates remain constant with the rates at June 30, 2003, we expect to recognize into earnings in the next 12 months losses on outstanding derivatives of $2.9 million. Interest Rates Floating-to-fixed interest rate swap agreements, designated as cash flow hedges, hedge our exposure to interest rate changes on a portion of our floating rate debt. The interest rate swap converts a portion of our floating rate debt to fixed rate debt. We record the fair value of these contracts in the balance sheet, with the offset to accumulated other comprehensive loss, net of tax. During 2003, we entered into interest rate swap agreements to convert $53.5 million of our floating rate debt to fixed rate debt. As of June 30, 2003, we have recorded a loss of $1.0 million on these contracts which has been recorded in other comprehensive loss. The contracts require periodic settlement; the difference between the amounts to be received and paid under interest rate swap agreements is recognized in interest expense. Assuming market rates remain constant with rates at June 30, 2003, we expect to recognize into earnings in the next 12 months losses on outstanding derivatives of $0.2 million. FAIR VALUE HEDGES Interest Rates Fixed-to-floating interest rate swap agreements, designated as fair value hedges, hedge our exposure to fair value fluctuations on a portion of our fixed rate ten-year Senior Unsecured Notes due to changes in the overall interest rate environment. These interest rate swap agreements convert a portion of our fixed rate debt to floating rate debt. During 2002, we entered into interest rate swap agreements which mature in 2012, to convert $200 million of our fixed rate debt to floating rate debt. These contracts require periodic settlement; the difference between amounts to be received and paid under the interest rate swap agreements is recognized in interest expense. In April 2003, we terminated these contracts and received a cash payment of $15.5 million. This gain will be amortized as a component of interest expense over the life of the debt using the effective interest rate method. Upon termination of the contracts in April, we entered into a new interest rate swap agreement with a notional amount of $200 million and a maturity date of June 2012. As of June 30, 2003, we have recorded a gain of $8.4 million related to these contracts. We record the gain or loss of these contracts in the balance sheet, with the offset to the carrying value of the Senior Unsecured Notes. Any gain or loss resulting from changes in the fair value of these contracts offset the corresponding gains or losses from changes in the fair values of the Senior Unsecured Notes. As a result, changes in the fair value of these contracts had no net impact on current year earnings. Foreign Currency Translation Assets and liabilities of international operations are translated into U.S. dollars using year-end exchange rates, while revenues and expenses are translated at average exchange rates throughout the year. The resulting net translation adjustments are recorded as a component of accumulated other comprehensive loss. The local currency is the functional currency of most of our locations. NEW ACCOUNTING STANDARDS In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 143, "Accounting for Asset Retirement Obligations." SFAS No. 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. It applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and/or the normal operation of a long-lived asset. The adoption of this standard, effective July 1, 2002, had no material impact on the results of our operations or financial position. 44
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," which addresses financial accounting and reporting for the impairment of long-lived assets and for long-lived assets to be disposed of and supersedes SFAS No. 121. This statement retains the fundamental provisions of SFAS No. 121 for recognition and measurement of the impairment of long-lived assets to be held and used and measurement of long-lived assets to be disposed of by sale. The provisions of this statement are effective for fiscal years beginning after December 15, 2001, and interim periods within those fiscal years. The adoption of this standard effective July 1, 2002, did not have a material impact on our consolidated financial statements. In April 2002, SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections," was issued. This statement updates, clarifies and simplifies existing accounting pronouncements. While the technical corrections to existing pronouncements are not substantive in nature, in some instances they may change accounting practice. The provisions of this standard related to SFAS No. 13 are effective for transactions occurring after May 15, 2002. Prospectively, as a result of the adoption of SFAS No. 145, debt extinguishment costs previously classified as extraordinary items will be reclassified as interest expense. In July 2002, the FASB issued SFAS No. 146, "Accounting for Exit or Disposal Activities," which addresses significant issues regarding the recognition, measurement and reporting of costs that are associated with exit and disposal activities, including restructuring activities. SFAS No. 146 nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity," under which a liability for an exit cost was recognized at the date of an entity's commitment to an exit plan. SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized at fair value when the liability is incurred. The provisions of this statement have been applied to any exit or disposal activities entered into after January 1, 2003. In November 2002, the FASB issued FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others." FIN 45 clarifies the requirements of FASB Statement No. 5, "Accounting for Contingencies," relating to a guarantor's accounting for, and disclosure of, the issuance of certain types of guarantees. FIN 45 requires that upon issuance of a guarantee, the guarantor must recognize a liability for the fair value of the obligation it assumes under that guarantee. FIN 45 also requires enhanced disclosures in a company's interim and annual filings. FIN 45 is effective for guarantees issued or modified after December 31, 2002. The disclosure requirements were effective for financial statements of both interim and fiscal years ending after December 15, 2002. The adoption of this standard did not have a material impact on our consolidated financial statements. In January 2003, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation Transition and Disclosure," to provide alternative methods of transition for an entity that voluntarily changes to the fair value- based method of accounting for stock-based employee compensation. This statement also amends the disclosure provisions of that statement to require prominent disclosure about the effects on reported net income of an entity's accounting policy decisions with respect to stock-based employee compensation. Finally, the statement amends APB Opinion No. 28, "Interim Financial Reporting," to require disclosure about those effects in interim financial information. The amendments to APB Opinion No. 28 are effective for financial reports containing Condensed Financial Statements for interim periods beginning after December 15, 2002. The disclosure provisions of this statement were adopted on January 1, 2003. In January 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"), "Consolidation of Variable Interest Entities--an interpretation of ARB No. 51." FIN 46 clarifies the application of Accounting Research Bulletin No. 51, "Consolidated Financial Statements," to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective for the Company July 1, 2003 and is not expected to have a material impact on the Company's results of operations or financial condition. 45
In January 2003, the EITF released Issue No. 00-21 ("EITF 00-21"), "Revenue Arrangements with Multiple Deliverables," which addresses certain aspects of the accounting by a vendor for arrangement under which it will perform multiple revenue-generating activities. Specifically, EITF 00-21 addresses whether an arrangement contains more than one unit of accounting and the measurement and allocation to the separate units of accounting in the arrangement. EITF 00-21 is effective for revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The adoption of this standard did not have a material impact on our consolidated financial statements. In May 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." SFAS No. 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. The Company is currently analyzing the provisions of SFAS No. 149 to determine if there will be any impact of adoption, but does not believe that there will be any material impact on its consolidated financial statements. In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150 establishes standards for how companies classify and measure certain financial instruments with characteristics of both liabilities and equity. It requires companies to classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003. The standard will not impact the consolidated financial statements. RECLASSIFICATIONS Certain amounts in the prior years' consolidated financial statements have been reclassified to conform with the current-year presentation. NOTE 3 - ACQUISITIONS AND DIVESTITURES On August 30, 2002, we purchased the Widia Group (Widia) in Europe and India from Milacron Inc. for EUR 188 million ($185.3 million) subject to a purchase price adjustment. On February 12, 2003, Milacron Inc. and Kennametal signed a settlement agreement with respect to the calculation of the post-closing purchase price adjustment for the Widia acquisition pursuant to which Milacron paid Kennametal EUR 18.8 million ($20.1 million) in cash. The net cash purchase price of $167.1 million includes the actual purchase price of $185.3 million less the settlement of $20.1 million plus $6.2 million of direct acquisition costs ($1.1 million paid in fiscal year 2002 and $5.1 million paid during the twelve months ended June 30, 2003) less $4.3 million of acquired cash. We financed the acquisition with funds borrowed under the 2002 Credit Agreement. The acquisition of Widia improves our global competitiveness, strengthens our European position and represents a strong platform for increased penetration in Asia. Widia's operating results have been included in our consolidated results since August 30, 2002. The fair market value of the Widia tangible and intangible assets were determined by an independent appraiser. In accordance with SFAS No. 141, "Business Combinations," we accounted for the acquisition using the purchase method of accounting. Accordingly, the preliminary purchase price allocations have been made based upon an estimated fair value of net assets acquired resulting in the recognition of approximately $53.0 million of goodwill and $27.2 million of other intangibles. Of the $27.2 million of identifiable intangible assets approximately $6.4 million has a definite life and therefore will be amortized over its remaining useful life. In accordance with SFAS No. 142, "Goodwill and Other Intangible Assets," the goodwill will not be amortized but will instead be subject to an annual impairment test. All goodwill and intangible assets resulting from the acquisition will be included in the MSSG segment. The preliminary purchase price allocations are subject to adjustment and may be modified within one year from the acquisition. Subsequent changes are not expected to have a material effect on our consolidated financial position. 46
The following summarizes the estimated fair values at the date of acquisition: (in thousands) - ----------------------------------------------------------------------------------------- Cash $ 4.3 Accounts receivable, net 49.4 Inventory, net 65.4 Other current assets 24.8 Property, plant and equipment, net 83.7 Trademarks 20.8 Patented technology 6.4 Other assets 19.9 Goodwill 53.0 - ----------------------------------------------------------------------------------------- Total assets acquired $ 327.7 ========================================================================================= Accounts payable and accrued wages 22.5 Notes payable 18.1 Other current liabilities 48.0 Long-term liabilities 60.8 Minority interest 6.9 - ----------------------------------------------------------------------------------------- Total liabilities and minority interest 156.3 - ----------------------------------------------------------------------------------------- Net assets acquired $ 171.4 ========================================================================================= The unaudited pro forma consolidated financial data presented below gives effect to the Widia acquisition as if it had occurred as of the beginning of each period presented. The pro forma adjustments are based upon available information and certain assumptions that we believe are reasonable, including additional interest expense and amortization that resulted from the transaction, net of any applicable income tax effects. The unaudited pro forma consolidated financial data is not necessarily indicative of the operating results that would have occurred had the acquisition been consummated on the date indicated, nor are they indicative of future operating results. Except for actions actually taken as of and since the close of the transaction and for which any related impact would be included in the actual results through the period end, anticipated cost savings have not been reflected in this pro forma presentation. The unaudited pro forma consolidated financial data should be read in conjunction with the historical consolidated financial statements and accompanying notes. Twelve Months Ended June 30, 2003 2002 - ------------------------------------------------------------------------------------------------------ PRO FORMA CONSOLIDATED FINANCIAL DATA Net sales $ 1,794,351 $ 1,807,135 Income before cumulative effect of change in accounting principle 13,489 26,786 Net income (loss) 13,489 (223,620) Basic earnings per share before cumulative effect of change in accounting principle 0.38 0.86 Basic earnings (loss) per share 0.38 (7.17) Diluted earnings per share before cumulative effect of change in accounting principle 0.38 0.85 Diluted earnings (loss) per share 0.38 (7.07) - ------------------------------------------------------------------------------------------------------ Additionally, during the first quarter of the current year, we acquired the remaining nine percent minority interest of our subsidiary in Poland for total consideration of $0.2 million. This subsidiary is now wholly-owned by Kennametal. During 2003 we acquired an additional one percent ownership interest from minority shareowners of our subsidiary in Germany for total consideration of $4.5 million bringing our ownership to 99.3 percent. An additional payment of $2.3 million was made during the second quarter related to minority shareowners that sold their shares in the prior year. Total goodwill resulting from these transactions was $5.6 million. In January 2002, we acquired Carmet Company for $5.1 million. Located in Duncan, S.C., this entity is a producer of tungsten cutting tools and wear parts and is included in our AMSG segment. 47
On April 19, 2002, we sold Strong Tool Company, our industrial supply distributor based in Cleveland, Ohio, for $8.6 million comprised of cash proceeds of $4.0 million and a seller note for $4.6 million. This action resulted in a pretax loss of $3.5 million and is in line with our strategy to refocus the J&L segment on its core catalog business. Annualized sales of this business were approximately $34 million. In April 2001, we sold ATS Industrial Supply, Inc., our industrial supply distributor based in Salt Lake City, Utah, for $6.8 million comprised of cash proceeds of $1.0 million and a seller note for $5.8 million. This action resulted in a pretax loss of approximately $5.8 million and is in line with our strategy to refocus the J&L segment on its core catalog business. Annualized sales of this business were approximately $17 million. On July 20, 2000, we proposed to the Board of Directors of JLK to acquire the outstanding shares of JLK we did not already own. On September 11, 2000, we announced a definitive merger agreement with JLK to acquire all the outstanding minority shares. Pursuant to the agreement, JLK agreed to initiate a cash tender offer for all of its shares of Class A Common Stock at a price of $8.75 per share. The tender offer commenced on October 3, 2000 and expired on November 15, 2000 resulting in JLK reacquiring 4.3 million shares for $37.5 million. Following JLK's purchase of shares in the tender offer, we acquired these shares at the same price in a merger. We incurred transaction costs of $3.3 million, which were included in the total cost of the transaction. JLK incurred costs of $2.1 million associated with the transaction, which were expensed as incurred. The transaction was unanimously approved by the JLK Board of Directors, including its special committee comprised of independent directors of the JLK Board. NOTE 4 - ACCOUNTS RECEIVABLE SECURITIZATION PROGRAM Since 1999, we had an agreement with a financial institution whereby we securitize, on a continuous basis, an undivided interest in a specific pool of our domestic trade accounts receivable. This agreement expired on June 30, 2003, and was renewed to July 3, 2003. On July 3, 2003, we entered into a new three-year securitization program (2003 Securitization Program) which also permitted us to securitize up to $100.0 million of accounts receivable. The 2003 Securitization Program provides for a co-purchase arrangement whereby two financial institutions participate in the purchase of our accounts receivable. Pursuant to this agreement, we, and several of our domestic subsidiaries, sell our domestic accounts receivable to Kennametal Receivables Corporation, a wholly-owned, bankruptcy-remote subsidiary (KRC). A bankruptcy-remote subsidiary is a company that has been structured to make it highly unlikely that it would be drawn into a bankruptcy of Kennametal Inc., or any of our other subsidiaries. KRC was formed to purchase these accounts receivable and sell participating interests in such accounts receivable to the financial institutions which, in turn, purchases and receives ownership and security interests in those assets. As collections reduce the amount of accounts receivable included in the pool, we sell new accounts receivable to KRC which, in turn, securitizes these new accounts receivable with the financial institutions. We are permitted to securitize up to $100.0 million of accounts receivable under this agreement. The actual amount of accounts receivable securitized each month is a function of the net change (new billings less collections) in the specific pool of domestic accounts receivable, the impact of detailed eligibility requirements in the agreement (e.g. the aging, terms of payment, quality criteria and customer concentrations), and the application of various reserves which are typically in trade receivable securitization transactions. A decrease in the amount of eligible accounts receivable could result in our inability to continue to securitize all or a portion of our accounts receivable. It is not unusual, however, for the amount of our eligible accounts receivable to vary by up to $5.0 to $10.0 million per month. The financial institutions charge us fees based on the level of accounts receivable securitized under this agreement and the commercial paper market rates plus the financial institution's cost to administer the program. The costs incurred under this program, $1.9 million, $2.5 million and $5.7 million in 2003, 2002 and 2001, respectively, are accounted for as a component of other expense, net and represent attractive funding costs compared to existing bank and public debt transactions. At June 30, 2003 and 2002, we securitized accounts receivable of $99.3 million and $95.9 million, respectively, under this program. Our retained interests in accounts receivable available for securitization and recorded as a component of accounts receivable were $36.4 million and $37.1 million at June 30, 2003 and 2002, respectively. The 2003 Securitization Program is required to be renewed periodically, and it is our intention to continuously obtain that renewal when required. However, certain provisions of the 2003 Securitization Program will require annual approval. Non-renewal or non-annual approval of this agreement would result in our requirement to otherwise finance the amounts securitized. In the event of a decrease of our eligible accounts receivable or non-renewal or non-annual approval of our securitization program, we would have to utilize alternative sources of capital to fund that portion of our working capital needs. 48
NOTE 5 - INVENTORIES Inventories consisted of the following: (in thousands) 2003 2002 - ------------------------------------------------------------------------------------------- Finished goods $ 273,803 $ 260,783 Work in process and powder blends 109,295 91,871 Raw materials and supplies 36,514 34,452 - ------------------------------------------------------------------------------------------- Inventories at current cost 419,612 387,106 Less LIFO valuation (27,357) (42,030) - ------------------------------------------------------------------------------------------- Total inventories $ 392,255 $ 345,076 =========================================================================================== We used the LIFO method of valuing our inventories for approximately 40 and 49 percent of total inventories at June 30, 2003 and 2002, respectively. We use the LIFO method in order to more closely match current costs with current revenues, thereby reducing the effects of inflation on earnings. NOTE 6 - OTHER CURRENT LIABILITIES Other current liabilities consisted of the following: (in thousands) 2003 2002 - ------------------------------------------------------------------------------------------ Accrued employee benefits $ 28,898 $ 21,378 Payroll, state and local taxes 7,799 5,234 Accrued interest expense 1,687 1,355 Derivative financial instruments 3,539 6,944 Environmental reserve 6,310 3,723 Restructuring reserve 24,868 8,456 Other accrued expenses 45,986 34,992 - ------------------------------------------------------------------------------------------ Total other current liabilities $ 119,087 $ 82,082 ========================================================================================== NOTE 7 - LONG-TERM DEBT AND CAPITAL LEASES Long-term debt and capital lease obligations consisted of the following: (in thousands) 2003 2002 - ---------------------------------------------------------------------------------------------------------- 7.2% Senior Unsecured Notes due 2012 net of discount of $1.0 million and $1.1 million for 2003 and 2002, respectively. Also including interest rate swap adjustments in 2003 of $23.7 million and ($0.9 million) in 2002. $ 322,667 $ 297,958 - ---------------------------------------------------------------------------------------------------------- 2002 Credit Agreement: U.S. Dollar-denominated borrowings, 2.055% to 2.625% in 2003, due 2005 75,000 81,500 Euro-denominated borrowings, 3.165% to 3.44375% in 2003, due 2005 92,184 - Yen-denominated borrowings, 1.0875% in 2003, due 2005 14,036 - - ---------------------------------------------------------------------------------------------------------- Total 2002 Credit Agreement borrowings 181,220 81,500 Yen Credit Facility, 0.83% in 2002, due 2003 - 14,083 Lease of office facilities and equipment with terms expiring through 2008 at 3.25% to 4.73% 11,948 8,982 Other 1,914 1,918 - ---------------------------------------------------------------------------------------------------------- Total debt and capital leases 517,749 404,441 - ---------------------------------------------------------------------------------------------------------- Less current maturities: Long-term debt (311) (14,621) Capital leases (2,596) (1,933) - ---------------------------------------------------------------------------------------------------------- Total current maturities (2,907) (16,554) - ---------------------------------------------------------------------------------------------------------- Long-term debt and capital leases $ 514,842 $ 387,887 ========================================================================================================== 49
Senior Unsecured Notes On June 19, 2002, we issued $300 million of 7.2% Senior Unsecured Notes due 2012 (Senior Unsecured Notes). These notes were issued at 99.629% of the face amount and yielded $294.3 million of net proceeds after related financing fees. The proceeds of this debt issuance were utilized to repay senior bank indebtedness. Interest is payable semi-annually on June 15th and December 15th of each year commencing December 15, 2002. The Senior Unsecured Notes contain covenants that restrict our ability to create liens, enter into sale-leaseback transactions or certain consolidations or mergers, or sell all or substantially all of our assets. As discussed under "Financial Instruments and Derivatives," in April 2003, we terminated interest rate swap agreements that converted the interest rate on $200 million of the Senior Unsecured Notes from fixed to floating interest rates. This transaction resulted in cash proceeds of $15.5 million which is included in the Senior Unsecured Note balance of $322.7 million at June 30, 2003. This gain will be amortized as a component of interest expense over the life of the debt using the effective interest rate method. During 2003, we entered into a new interest rate swap agreement with a notional amount of $200 million, and a maturity date of June 2012. As of June 30, 2003, we recorded a gain of $8.4 million related to these contracts. We record the gain or loss on these contracts in the balance sheet, with the offset to the carrying value of the Senior Unsecured Notes. 2002 Credit Agreement We also entered into a three-year, multi-currency, revolving credit facility with a group of financial institutions (2002 Credit Agreement). The 2002 Credit Agreement originally permitted revolving credit loans of up to $650 million for working capital, capital expenditures and general corporate purposes and replaced the previous Bank Credit Agreement, the Euro Credit Agreement and the Yen Credit Facility discussed below. The 2002 Credit Agreement allows for borrowings in U.S. dollars, Euro, Canadian dollars, Pound Sterling and Japanese Yen. In June 2003, we provided written notice to the administrative agent indicating our decision to reduce the 2002 Credit Agreement from $650 million to $500 million. This resulted in a write-down of a portion of deferred financing fees of $0.5 million. Interest payable under the 2002 Credit Agreement is based upon the type of borrowing under the facility and may be (1) the greater of the prime rate and the federal funds effective rate plus 0.50%, (2) Euro-currency rates plus an applicable margin or (3) a quoted fixed rate offered by one or more lenders at the time of borrowing. The 2002 Credit Agreement contains various covenants with which we must be in compliance including three financial covenants: a maximum leverage ratio, a maximum fixed charge coverage ratio and a minimum consolidated net worth. As of June 30, 2003, outstanding borrowings under this agreement were $181.2 million and we had the ability to borrow under this agreement or otherwise have additional debt of up to $108.7 million and be in compliance with the maximum leverage ratio financial covenant. The maximum leverage ratio financial covenant requires that we maintain at the end of each fiscal quarter a specified consolidated leverage ratio (as that term is defined in this agreement). Previous Debt Agreements In 1998, we entered into a $1.4 billion Bank Credit Agreement. Subject to certain conditions, the Bank Credit Agreement permitted term loans of up to $500 million and revolving credit loans of up to $900 million for working capital, capital expenditures and general corporate purposes. The Yen Credit Facility was entered into on January 28, 1999 and allowed for Japanese Yen-denominated borrowings up to JPY 1.68 billion. The facility matured on July 27, 2002 and was not renewed. The proceeds from the 2002 Credit Agreement were used to pay the outstanding balance. On December 20, 2000, we entered into a EUR 212 million Euro-denominated revolving credit facility (Euro Credit Agreement) to partially hedge the foreign exchange exposure of our net investment in Euro-based subsidiaries and to diversify our interest rate exposure. Amounts borrowed under the Euro Credit Agreement were required to be used to repay indebtedness under the Bank Credit Agreement and, to the extent the Bank Credit Agreement was repaid, for working capital and general corporate purposes. On January 8, 2001, we borrowed EUR 212 million under this facility to meet our obligation under then outstanding Euro-denominated forward foreign exchange contracts. The proceeds from the Euro-denominated forward foreign exchange contracts of $191.1 million were used to repay amounts borrowed under the Bank Credit Agreement. Subsequently, the availability under the Bank Credit Agreement was permanently reduced from $900 million to $700 million, resulting in a write-down of a portion of deferred financing fees of $0.3 million. This charge was recorded as a component of interest expense. 50
The Bank Credit Agreement and the Euro Credit Agreement were cancelled in June 2002 when we repaid both facilities using proceeds raised from the public debt offering, the capital stock issuance and the 2002 Credit Agreement. Future principal maturities of long-term debt are $0.3 million, $0.4 million, $181.6 million, $0.2 million and $0.1 million, respectively, in 2004 through 2008. Future minimum lease payments under capital leases for the next five years and thereafter in total are as follows: (in thousands) - ------------------------------------------------------------------------------------------ 2004 $ 3,263 2005 2,627 2006 3,749 2007 1,325 2008 1,459 After 2008 1,671 - ------------------------------------------------------------------------------------------ Total future minimum lease payments 14,094 Less amount representing interest (2,146) ========================================================================================== Amount recognized as capital lease obligation $ 11,948 ========================================================================================== Our secured debt at June 30, 2003 are industrial revenue bond obligations of $1.3 million and the capitalized lease obligations of $11.9 million. These obligations are secured by the underlying assets. NOTE 8 - NOTES PAYABLE AND LINES OF CREDIT Notes payable to banks of $7.9 million and $6.9 million at June 30, 2003 and 2002, respectively, represent short-term borrowings under international credit lines with commercial banks. These credit lines, translated into U.S. dollars at June 30, 2003 exchange rates, totaled $125.9 million at June 30, 2003, of which $117.8 million was unused. The weighted average interest rate for notes payable and lines of credit was 5.84 percent and 2.78 percent at June 30, 2003 and 2002, respectively. The increase in the weighted average interest rate is associated with notes payable that were acquired during the Widia acquisition. These notes carried a significantly higher interest rate than Kennametal's historical rates. NOTE 9 - INCOME TAXES Income before income taxes and the provision for income taxes consisted of the following: (in thousands) 2003 2002 2001 (1) - ----------------------------------------------------------------------------------------------------------- Income before provision for income taxes: United States $ 15,954 $ 11,564 $ 35,108 International 18,336 47,487 59,221 - ----------------------------------------------------------------------------------------------------------- Total income before provision for income taxes and minority interest $ 34,290 $ 59,051 $ 94,329 =========================================================================================================== Current income taxes: Federal $ (5,362) $ (17,303) $ 26,435 State 55 1,070 5,034 International 12,258 19,255 15,234 - ----------------------------------------------------------------------------------------------------------- Total current income taxes 6,951 3,022 46,703 Deferred income taxes 7,349 15,878 (9,403) - ----------------------------------------------------------------------------------------------------------- Provision for income taxes $ 14,300 $ 18,900 $ 37,300 =========================================================================================================== Effective tax rate 41.7% 32.0% 39.5% =========================================================================================================== (1) Taxes of $16.8 million in the 2001 annual report were previously classified as current and have been reclassified to deferred taxes. 51
The reconciliation of income taxes computed using the statutory U.S. income tax rate and the provision for income taxes was as follows: (in thousands) 2003 2002 2001 - ------------------------------------------------------------------------------------ Income taxes at U.S. statutory rate $ 12,002 $ 20,668 $ 33,015 State income taxes, net of federal tax benefits 915 2,656 2,696 Nondeductible goodwill - - 5,557 Combined tax effects of international income (7,465) (5,773) (4,899) International losses with no related tax benefits 8,003 990 1,135 Capital loss utilization (3,344) - - Electronics impairment charge 4,765 - - Other (576) 359 (204) - ------------------------------------------------------------------------------------ Provision for income taxes $ 14,300 $ 18,900 $ 37,300 ==================================================================================== Deferred tax assets and liabilities consisted of the following: (in thousands) 2003 2002 - --------------------------------------------------------------------------- Deferred tax assets: Net operating loss carryforwards $ 42,643 $ 9,602 Inventory valuation and reserves 24,025 23,630 Pension benefits 12,218 - Other postretirement benefits 19,318 18,721 Accrued employee benefits 16,663 17,962 Hedging activities 20,031 3,315 FTC carryforward 3,314 3,525 Other 21,659 20,602 - --------------------------------------------------------------------------- Total 159,871 97,357 Valuation allowance (35,998) (6,600) - --------------------------------------------------------------------------- Total deferred tax assets $ 123,873 $ 90,757 =========================================================================== Deferred tax liabilities: Tax depreciation in excess of book $ 44,091 $ 47,321 Pension benefits - 16,827 Other 8,966 7,804 - --------------------------------------------------------------------------- Total deferred tax liabilities $ 53,057 $ 71,952 =========================================================================== Deferred income taxes were not provided on cumulative undistributed earnings of international subsidiaries and affiliates. At June 30, 2003, unremitted earnings of non-U.S. subsidiaries were determined to be permanently reinvested. It is not practical to estimate the income tax effect that might be incurred if earnings were remitted to the United States. Included in deferred tax assets at June 30, 2003 are unrealized tax benefits totaling $42.6 million related to net operating loss carryforwards. Of that amount, $3.7 million expire through June 2008, $1.0 expire through June 2013, another $1.0 million expire through June 2018 and the remaining $36.9 million do not expire. The realization of these tax benefits is contingent on future taxable income in certain international operations. A valuation allowance of $30.4 million has been placed against certain losses resulting in a net deferred asset related to net operating loss carryforwards of $12.2 million. Of this amount, $10.0 million relates to net operating loss carryforwards in Germany, $0.7 million are associated with Brazil, and $1.5 million related to Spain, Belgium and South Africa. A valuation allowance of $5.5 million has been placed on other deferred tax assets in the United Kingdom. 52
NOTE 10 - PENSION AND OTHER POSTRETIREMENT AND POSTEMPLOYMENT BENEFITS We sponsor several pension plans that cover substantially all employees. Pension benefits under defined benefit pension plans are based on years of service and, for certain plans, on average compensation immediately preceding retirement. We fund pension costs in accordance with the funding requirements of the Employee Retirement Income Security Act of 1974 (ERISA), as amended, for U.S. plans and in accordance with local regulations or customs for non-U.S. plans. Additionally, we maintain a supplemental early executive retirement plan for various executives. The liability associated with this plan is also included in the pension disclosure below. We presently provide varying levels of postretirement health care and life insurance benefits to most U.S. employees. Postretirement health care benefits are available to employees and their spouses retiring on or after age 55 with 10 or more years of service after age 40. Beginning with retirements on or after January 1, 1998, our portion of the costs of postretirement health care benefits are capped at 1996 levels. The funded status of our pension plans and amounts recognized in the consolidated balance sheets were as follows: (in thousands) 2003 2002 - ---------------------------------------------------------------------------------- Change in benefit obligation: Benefit obligation, beginning of year $ 417,070 $ 387,977 Service cost 13,098 11,195 Interest cost 30,103 27,328 Participant contributions 729 642 Actuarial (gains) losses 65,389 3,705 Benefits paid (19,288) (20,450) Effect of curtailment and other - 63 Effect of acquired businesses 40,475 516 Foreign currency translation adjustments 14,992 5,950 Plan amendments - 144 - ---------------------------------------------------------------------------------- Benefit obligation, end of year $ 562,568 $ 417,070 ================================================================================== Change in plan assets: Fair value of plan assets, beginning of year $ 403,388 $ 443,217 Actual return on plan assets 5,591 (25,245) Company contributions 5,021 1,947 Participant contributions 729 642 Benefits paid (19,288) (19,489) Other (435) 21 Effect of acquired businesses 6,625 - Foreign currency translation adjustments 3,799 2,295 - ---------------------------------------------------------------------------------- Fair value of plan assets, end of year $ 405,430 $ 403,388 ================================================================================== Funded status of plans $(157,138) $ (13,682) Unrecognized transition obligation 2,483 963 Unrecognized prior service cost 5,283 6,009 Unrecognized actuarial losses 134,058 27,190 ================================================================================== Net accrued (liability) benefit $ (15,314) $ 20,480 ================================================================================== Amounts recognized in the balance sheet consist of: Prepaid benefit $ 1,589 $ 48,666 Intangible assets 8,382 4,926 Accumulated other comprehensive income 86,405 7,195 Accrued benefit obligation (111,690) (40,307) - ---------------------------------------------------------------------------------- Net accrued (liability) benefit $ (15,314) $ 20,480 ================================================================================== 53
Prepaid pension benefits are included in other long-term assets. Accrued pension benefit obligations are included in other long-term liabilities. U.S. defined benefit pension plan assets consist principally of common stocks, corporate bonds and U.S. government securities. International defined benefit pension plan assets consist principally of common stocks, corporate bonds and government securities. To the best of our knowledge and belief, the asset portfolios of our defined benefit plans do not contain our capital stock. We do not issue insurance contracts to cover future annual benefits of defined benefit plan participants. Transactions between us and our defined benefit plans include the reimbursement of plan expenditures incurred by us on behalf of the plans. To the best of our knowledge and belief, the reimbursement of cost is permissible under current ERISA or local government law. Included in the above information are pension plans with accumulated benefit obligations exceeding the fair value of plan assets as follows: (in thousands) 2003 2002 - ---------------------------------------------------------- Projected benefit obligation $551,382 $ 74,753 Accumulated benefit obligation 504,590 68,758 Fair value of plan assets 393,739 28,709 - ---------------------------------------------------------- The components of net pension (benefit) cost include the following: (in thousands) 2003 2002 2001 - ------------------------------------------------------------------------ Service cost $ 13,098 $ 11,195 $ 11,317 Interest cost 30,103 27,328 26,368 Expected return on plan assets (43,166) (45,367) (43,526) Amortization of transition obligation (1,355) (1,998) (2,052) Amortization of prior service cost 772 757 428 Recognition of actuarial gains (495) (2,317) (2,836) - ------------------------------------------------------------------------ Net benefit $ (1,043) $(10,402) $(10,301) ======================================================================== The significant actuarial assumptions used to determine the present value of net pension obligations were as follows: (in thousands) 2003 2002 2001 - ------------------------------------------------------------------------------------- Discount rate: U.S. plans 6.0% 7.3% 7.5% International plans 5.0-6.3% 6.0-6.8% 5.5-6.8% Rates of future salary increases: U.S. plans 4.5% 4.5% 4.5% International plans 3.0-4.0% 3.3-4.0% 3.0-4.3% Rates of return on plan assets: U.S. plans 8.5% 9.5% 10.0% International plans 6.5-7.3% 6.5-7.3% 6.5-8.0% - ------------------------------------------------------------------------------------- 54
The funded status of our other postretirement benefit plan and amounts recognized in the consolidated balance sheets were as follows: (in thousands) 2003 2002 - ---------------------------------------------------------------------------- Change in benefit obligation: Benefit obligation, beginning of year $ 42,120 $ 41,122 Service cost 1,259 1,291 Interest cost 2,930 2,950 Actuarial losses 2,359 165 Benefits paid (3,403) (3,408) - ---------------------------------------------------------------------------- Benefit obligation, end of year $ 45,265 $ 42,120 - ---------------------------------------------------------------------------- Funded status of plans $(45,265) $(42,120) Unrecognized prior service cost 672 1,078 Unrecognized actuarial gains (2,053) (4,279) - ---------------------------------------------------------------------------- Net accrued obligation $(46,646) $(45,321) ============================================================================ The components of other postretirement cost include the following: (in thousands) 2003 2002 2001 - ---------------------------------------------------------------------------- Service cost $ 1,259 $ 1,291 $ 1,130 Interest cost 2,930 2,950 2,744 Amortization of prior service cost 406 406 406 Recognition of actuarial gains (108) (247) (753) - ---------------------------------------------------------------------------- Net cost $ 4,487 $ 4,400 $ 3,527 ============================================================================ The discount rate used to determine the present value of the other postretirement benefit obligation was 6.0%, 7.3% and 7.5% in 2003, 2002 and 2001, respectively. The annual assumed rate of increase in the per capita cost of covered benefits (the health care cost trend rate) for health care plans was 9% in 2003 and was assumed to decrease gradually to 5.0% in 2007 and remain at that level thereafter. Assumed health care cost trend rates have a significant effect on the cost components and obligation for the health care plans. A change of one percentage point in the assumed health care cost trend rates would have the following effects on the total service and interest cost components of other postretirement cost and the other postretirement benefit obligation at June 30, 2003: (in thousands) 1% Increase 1% Decrease - ----------------------------------------------------------------------------------------------------- Effect on total of service and interest cost components $ 200 $ (170) Effect on other postretirement benefit obligation 2,140 (1,850) - ----------------------------------------------------------------------------------------------------- We also sponsor several defined contribution pension plans. Pension costs for defined contribution plans were $12.4 million, $9.1 million and $12.1 million in 2003, 2002 and 2001, respectively. Effective October 1, 1999, company contributions to U.S. defined contribution pension plans are made primarily in our capital stock, resulting in the issuance of 146,350, 155,097 and 331,960 shares during 2003, 2002 and 2001, respectively, with a market value of $4.4 million, $5.8 million and $9.2 million, respectively. We temporarily suspended all company contributions to certain defined contribution plans from January 1, 2002 through January 1, 2003. We provide for postemployment benefits pursuant to SFAS No. 112, "Employers' Accounting for Postemployment Benefits." We accrue the cost of separation and other benefits provided to former or inactive employees after employment but before retirement. Postemployment benefit costs were not significant in 2003, 2002 and 2001. 55
NOTE 11 - ACCUMULATED OTHER COMPREHENSIVE LOSS The components of accumulated other comprehensive income (loss) consist of the following: Twelve Months Ended June 30 (in thousands), 2003 2002 - ------------------------------------------------------------------------------------------------------ Income before cumulative effect of change in accounting principle $ 18,130 $ 38,498 Cumulative effect of change in accounting principle, net of tax - (250,406) Unrealized (loss) gain on derivatives designated and qualified as cash flow hedges, net of tax (4,879) (1,372) Reclassification of unrealized gain (loss) on matured derivatives, net of tax 5,157 (1,902) Unrealized gain (loss) on marketable equity securities available-for-sale, net of tax 321 (1,774) Minimum pension liability adjustment, net of tax (54,696) 945 Foreign currency translation adjustments 51,163 23,104 - ------------------------------------------------------------------------------------------------------ Comprehensive income (loss) $ 15,196 $(194,797) ====================================================================================================== As of June 30, 2003 (in thousands) Pre-tax Tax After-tax - ----------------------------------------------------------------------------------------------------- Unrealized loss on marketable equity securities available-for-sale $ (273) $ 104 $ (169) Unrealized loss on derivatives designated and qualified as cash flow hedges (8,900) 3,382 (5,518) Minimum pension liability adjustment (86,405) 27,244 (59,161) Foreign currency translation adjustments (25,819) 32,954 7,135 - ----------------------------------------------------------------------------------------------------- Total accumulated other comprehensive (loss) $(121,397) $ 63,684 $ (57,713) ===================================================================================================== As of June 30, 2002 (in thousands) Pre-tax Tax After-tax - ----------------------------------------------------------------------------------------------------- Unrealized loss on marketable equity securities available-for-sale $ (791) $ 301 $ (490) Unrealized loss on derivatives designated and qualified as cash flow hedges (9,339) 3,543 (5,796) Minimum pension liability adjustment (7,195) 2,730 (4,465) Foreign currency translation adjustments (47,520) 3,492 (44,028) - ----------------------------------------------------------------------------------------------------- Total accumulated other comprehensive (loss) $(64,845) $ 10,066 $(54,779) ==================================================================================================== NOTE 12 - RESTRUCTURING AND ASSET IMPAIRMENT CHARGES In accordance with SFAS No. 144, in June 2003, we completed an assessment of the carrying value of certain long-lived assets in the Electronics business. As a result of this assessment, we recorded a pre-tax charge of $16.1 million ($15.3 million after-tax) as a component of restructuring and asset impairment charges. The charge is a result of price declines caused by persistent global over-capacity and low-cost Asia competition. The fixed asset impairment charge reduced the book value of the Electronics business' assets to $2.6 million. 2003 Facility Consolidation Program In June 2003, we approved a facility consolidation program. This program is expected to have restructuring charges of approximately $2.5 million. The plan includes the closure of two regional operating centers and the Framingham manufacturing facility and a workforce reduction. In conjunction with the program we recorded an asset write-down related to fixed assets that will be disposed of as a result of the restructuring program. All actions pertain to the MSSG segment. All costs associated with the restructuring program are expected to be incurred and paid by December 31, 2003, except certain lease costs which may extend to 2004. Accrual at Asset Cash Accrual at (in thousands) June 30, 2002 Expense Write-down Expenditures June 30, 2003 - -------------------------------------------------------------------------------------------------------------- Employee severance $ - $ 1,188 $ - $ - $ 1,188 Facility rationalization - 460 (316) - 144 - -------------------------------------------------------------------------------------------------------------- Total $ - $ 1,648 $(316) $ - $ 1,332 ============================================================================================================== 56
2003 Workforce Restructuring Program In October 2002, we announced a global salaried workforce reduction of approximately five percent. The reduction as announced was expected to cost between $9 million and $10 million. The expected cost was revised to $8.0 million as the plan was subsequently completed as of June 30, 2003. The program resulted in $2.8 million of charges for the MSSG segment, $2.6 million for AMSG, $1.3 million for J&L, $0.1 million for FSS and $1.2 million for Corporate. The components of the restructuring accrual at June 30, 2003 for this program are as follows: Accrual at Expense Cash Accrual at (in thousands) June 30, 2002 Expense Adjustment Expenditures June 30, 2003 - ------------------------------------------------------------------------------------------------------------- Employee severance $ - $ 8,345 $ (434) $ (6,076) $ 1,835 - ------------------------------------------------------------------------------------------------------------- Total $ - $ 8,345 $ (434) $ (6,076) $ 1,835 ============================================================================================================= The restructuring accrual at June 30, 2003 represents expected future cash payments for these obligations over the next six months. The expense adjustments represent revision in original cost estimates related to this plan. Widia Integration In addition to the 2003 Workforce Restructuring Program, we have implemented two Widia acquisition-related integration programs (Kennametal Integration Restructuring Program and the Widia Integration Plan) which together are expected to result in a global headcount reduction of between 650 and 700 positions. We have substantially completed the integration plan and, as of June 30, we have closed six sales offices, two manufacturing facilities and closed or consolidated four warehouses. As of June 30, 2003, we have terminated approximately 545 employees in Europe and India and expect the remaining workforce reduction to be within our original estimates. We expect the completion of all integration activities in the second quarter of 2004. Kennametal Integration Restructuring Program This program includes employee severance costs associated with existing Kennametal facilities. The components of the restructuring accrual at June 30, 2003 for this program are as follows: Accrual at Cash Accrual at (in thousands) June 30, 2002 Expense Expenditures June 30, 2003 - ------------------------------------------------------------------------------------------------------------- Employee severance $ - $ 6,956 $ (3,316) $ 3,640 - ------------------------------------------------------------------------------------------------------------- Total $ - $ 6,956 $ (3,316) $ 3,640 ============================================================================================================= Widia Integration Plan In connection with the acquisition, we have established a Widia integration plan to develop centers of excellence in functional areas and enable long-term growth and competitive advantages. Costs that are incurred under this plan will be accounted for under EITF 95-3, "Recognition of Liabilities in Connection with a Purchase Business Combination." As a result, these costs have been recorded as part of the Widia purchase price allocation. Accrual at Adjustment Cash Accrual at (in thousands) June 30, 2002 to Goodwill Expenditures June 30, 2003 - --------------------------------------------------------------------------------------------------------------- Facility rationalizations $ - $ 4,678 $ (3,321) $ 1,357 Employee severance - 19,783 (4,849) 14,934 Terminated contracts - 1,401 (938) 463 - --------------------------------------------------------------------------------------------------------------- Total $ - $ 25,862 $ (9,108) $ 16,754 =============================================================================================================== Widia Restructuring In connection with our acquisition of Widia, we assumed $2.4 million of restructuring accruals related to restructuring programs initiated by Widia prior to the acquisition date. These programs, initiated in December 2001, relate to the severance of 156 European employees in both production and administration. The accrual balance at June 30, 2003 of $0.2 million represents a decrease of $2.2 million related to cash payments made during the period since acquisition. 57
2002 AMSG and MSSG Restructuring In November 2001, we announced a restructuring program whereby we recognized special charges of $18 million. This was done in response to continued steep declines in the end market demand in the Electronics and Industrial Products Group businesses. All initiatives under this program have been implemented and completed. These costs are related to the closing and consolidation of the AMSG electronics facility in Chicago, IL., and MSSG Industrial Products Group's Pine Bluff, Ark. and Monticello, Ind. locations, the production of a particular line of products in Rogers, Ark. and several customer service centers. As a result, we recorded restructuring charges of $14.8 million during 2002 related to exit costs associated with these actions, including severance for substantially all 337 employees at the closed facilities. We also recorded a charge of $2.5 million related to severance for 84 individuals, primarily in the MSSG segment. The components of the charges and the accrual at June 30, 2002 for this program are as follows: Accrual at Expense Cash Accrual at (in thousands) June 30, 2002 Expense Adjustment Expenditures June 30, 2003 - ---------------------------------------------------------------------------------------------------------------------- Facility rationalizations $ 2,977 $ 15 $ (511) $ (2,180) $ 301 Employee severance 1,220 110 (2) (1,229) 99 - ---------------------------------------------------------------------------------------------------------------------- Total $ 4,197 $ 125 $ (513) $ (3,409) $ 400 ====================================================================================================================== The restructuring accrual at June 30, 2002 represents future cash payments for these obligations, of which the majority are expected to occur over the next six months. The expense adjustments represent revisions in original cost estimates related to this plan. 2002 and 2001 J&L and FSS Business Improvement Programs In the J&L segment for 2001, we recorded a restructuring and asset impairment charge of $2.5 million for severance of 115 individuals, $1.8 million associated with the closure of 11 underperforming satellite locations, including certain German operations, and $0.7 million for the exiting of three warehouses. This includes a $0.4 million non-cash write-down of the book value of certain property, plant and equipment, net of salvage value, that we determined would no longer be utilized in ongoing operations. In the FSS segment for 2001, we recorded restructuring charges of $0.6 million for severance related to eight individuals. In 2002, we continued our J&L and FSS business improvement programs initiated in 2001. In the J&L segment during 2002, we recorded restructuring and asset impairment charges of $5.3 million related to the write-down of a portion of the value of a business system, $2.5 million for severance for 81 individuals and $1.7 million related to the closure of 10 satellites and two call centers. In the FSS segment for 2002, we recorded restructuring charges of $0.7 million for severance related to 34 individuals. Total special charges related to this plan were $19 million which are consistent with our original estimates of $15 to $20 million. During the third quarter of 2003, we completed the 2001 J&L and FSS Business Improvement Programs and have incurred cash payments of $1.2 million, $3.2 million and $4.4 million related to this program in 2003, 2002 and 2001, respectively. 2001 Core-Business Resize Program In 2001, we took actions to reduce our salaried workforce in response to the weakened U.S. manufacturing sector. As a result of implementing this core-business resize program, we recorded a restructuring charge in 2001 of $4.6 million related to severance for 209 individuals. All employee benefit initiatives under these programs have been implemented and the program has been completed. Cash expenditures were $0.3 million, $1.9 million and $2.2 million in 2003, 2002 and 2001, respectively. NOTE 13 - FINANCIAL INSTRUMENTS The methods used to estimate the fair value of our financial instruments are as follows: Cash and Equivalents, Current Maturities of Long-Term Debt and Notes Payable to Banks The carrying amounts approximate their fair value because of the short maturity of the instruments. Marketable Equity Securities The fair value is estimated based on the quoted market price of this security, as adjusted for the currency exchange rate at June 30. 58
Long-Term Debt Fixed rate debt has a fair market value of $334 million and $298 million in 2003 and 2002, respectively. Fair value was determined using discounted cash flow analysis and our incremental borrowing rates for similar types of arrangements. Foreign Exchange Contracts The notional amount of outstanding foreign exchange contracts, translated at current exchange rates, was $136.5 million and $197.7 million at June 30, 2003 and 2002, respectively. We would have received $2.5 million at June 30, 2002, and would have paid $3.1 million at June 30, 2003, to settle these contracts, representing the fair value of these agreements. Under SFAS No. 133, the carrying value equals the fair value for these contracts at June 30, 2003 and 2002. Fair value was estimated based on quoted market prices of comparable instruments. Interest Rate Swap Agreements At June 30, 2003 and 2002, we had interest rate swap agreements outstanding that effectively convert a notional amount of $53.6 million and $150.0 million, respectively, of debt from floating to fixed interest rates. At June 30, 2003 and 2002, we would have paid $1.6 million and $5.5 million, respectively, to settle these interest rate swap agreements, which represents the fair value of these agreements. During 2002, we entered into interest rate swap agreements which mature in 2012, to convert $200 million of our fixed rate debt to floating rate debt. These contracts require periodic settlement; the difference between amounts to be received and paid under the interest rate swap agreements is recognized in interest expense. In April 2003, we terminated these contracts and received a cash payment of $15.5 million. This gain will be amortized as a component of interest expense over the life of the debt using the effective interest rate method. Upon termination of the contracts in April, we entered into a new interest rate swap agreement with a notional amount of $200 million and a maturity date of June 2012. As of June 30, 2003, we have recorded a gain of $8.4 million related to these contracts. We record the gain or loss of these contracts in the balance sheet, with the offset to the carrying value of the Senior Unsecured Notes. Any gain or loss resulting from changes in the fair value of these contracts offset the corresponding gains or losses from changes in the fair values of the Senior Unsecured Notes. As a result, changes in the fair value of these contracts had no net impact on current year earnings. Under SFAS No. 133, the carrying value equals the fair value for these contracts at June 30, 2003 and 2002. Fair value was estimated based on the mark-to-market value of the contracts which closely approximates the amount that we would receive or pay to terminate the agreements at year end. Concentrations of Credit Risk Financial instruments that potentially subject us to concentrations of credit risk consist primarily of temporary cash investments and trade receivables. By policy, we make temporary cash investments with high credit quality financial institutions. With respect to trade receivables, concentrations of credit risk are significantly reduced because we serve numerous customers in many industries and geographic areas. We are exposed to counterparty credit risk for nonperformance of derivatives and, in the unlikely event of nonperformance, to market risk for changes in interest and currency rates. We manage exposure to counterparty credit risk through credit standards, diversification of counterparties and procedures to monitor concentrations of credit risk. We do not anticipate nonperformance by any of the counterparties. As of June 30, 2003 and 2002, we had no significant concentrations of credit risk. NOTE 14 - STOCK OPTIONS, AWARDS AND PURCHASE PLAN Stock options generally are granted to eligible employees at fair market value at the date of grant. Options are exercisable under specified conditions for up to 10 years from the date of grant. During 2002, Kennametal established the Kennametal Inc. Stock and Incentive Plan of 2002 ("the 2002 Plan") pursuant to which eligible individuals may be granted awards. The 2002 Plan eliminated grants or awards under any prior stock option plan. Prior to the approval of the 2002 Plan, Kennametal had four plans under which options were granted: the 1992 Plan, the 1996 Plan and two 1999 Plans. Under provisions of the 2002 Plan, participants may deliver our stock, owned by the holder for at least six months, in payment of the option price and receive credit for the fair market value of the shares on the date of delivery. The fair value of shares delivered in each of 2002 and 2001 was $0.2 million. Shares delivered in 2003 were not significant. 59
Stock option activity for 2003, 2002 and 2001 is set forth below: 2003 2002 2001 -------------------------- -------------------------- -------------------------- Weighted Weighted Weighted Average Average Average Number of Options Options Exercise Price Options Exercise Price Options Exercise Price - -------------------------------------------------------------------------------------------------------------------- Options outstanding, beginning of year 3,307,854 $ 32.08 2,913,436 $ 32.08 2,856,298 $ 33.05 Granted 1,029,975 30.57 964,025 38.67 726,850 25.51 Exercised (63,672) 26.49 (382,542) 28.54 (263,719) 22.48 Lapsed and forfeited (248,740) 35.98 (187,065) 45.24 (405,993) 34.40 - -------------------------------------------------------------------------------------------------------------------- Options outstanding, end of year 4,025,417 $ 32.91 3,307,854 $ 33.75 2,913,436 $ 32.08 - -------------------------------------------------------------------------------------------------------------------- Options exercisable, end of year 2,276,984 $ 33.20 1,882,539 $ 33.37 1,959,311 $ 34.99 - -------------------------------------------------------------------------------------------------------------------- Weighted average fair value of options granted during the year $ 8.77 $ 12.24 $ 7.95 ==================================================================================================================== Stock options outstanding at June 30, 2003: Options Outstanding Options Exercisable ----------------------------------------- -------------------------- Weighted Remaining Weighted Weighted Contractual Average Average Range of Exercise Prices Options Life (years) Exercise Price Options Exercise Price - -------------------------------------------------------------------------------------------------------------- $ 20.63- $ 24.47 717,540 6.53 $23.74 553,064 $23.56 24.75- 28.13 490,727 6.35 26.28 459,814 26.31 28.16- 29.64 133,000 9.29 29.50 20,501 29.16 29.81 700,275 9.06 29.81 0 0 29.82- 36.15 490,614 6.43 32.58 302,033 31.64 36.28- 38.30 296,200 3.34 37.16 273,405 37.17 38.44 590,352 8.08 38.44 202,180 38.44 38.51- 48.56 479,709 6.22 44.94 338,987 46.75 49.25- 53.97 127,000 4.51 51.44 127,000 51.44 - -------------------------------------------------------------------------------------------------------------- 4,025,417 6.92 $32.91 2,276,984 $33.20 ============================================================================================================== In addition to stock option grants, the 2002 Plan permits the award of restricted stock to directors, officers and key employees. During 2003, 2002 and 2001, we granted restricted stock awards of 286,075, 124,298 and 75,790 shares, respectively, which vest over periods of one to six years from the grant date. For some grants, vesting may accelerate due to achieving certain performance goals. Restricted stock awards are considered unearned compensation until vesting occurs due to the passage of time or achievement of certain performance goals. As of June 30, 2003, 2002 and 2001, unearned compensation related to restricted stock was $9.1 million, $4.7 million and $1.9 million, respectively. Unearned compensation is amortized to expense over the vesting period. Compensation expense related to these awards was $4.9 million, $2.0 million and $2.6 million in 2003, 2002 and 2001, respectively. On October 24, 2000, our shareowners approved the Employee Stock Purchase Plan (ESPP), which provides for the purchase by employees of up to 1.5 million shares of capital stock through payroll deductions. Employees who choose to participate in the ESPP receive an option to purchase capital stock at a discount equal to the lower of 85 percent of the fair market value of the capital stock on the first or last day of a purchase period. The ESPP was launched on February 1, 2001 and employees purchased 31,580 and 24,944 shares under the ESPP during 2003 and 2002, respectively. 60
NOTE 15 - ENVIRONMENTAL MATTERS We are involved in various environmental cleanup and remediation activities at several of our manufacturing facilities. In addition, we are currently named as a potentially responsible party (PRP) at the Li Tungsten Superfund site in Glen Cove, New York. In December 1999, we recorded a remediation reserve of $3.0 million with respect to our involvement in these matters, which is recorded as a component of operating expense. This represents our best estimate of the undiscounted future obligation based on our evaluations and discussions with outside counsel and independent consultants, and the current facts and circumstances related to these matters. We recorded this liability because certain events occurred, including the identification of other PRPs, an assessment of potential remediation solutions and direction from the government for the remedial action plan, that clarified our level of involvement in these matters and our relationship to other PRPs. This led us to conclude that it was probable that a liability had been incurred. At June 30, 2003, we have an accrual of $2.8 million recorded relative to this environmental issue. In addition to the amount currently reserved, we may be subject to loss contingencies related to these matters estimated to be up to an additional $3.0 million. We believe that such undiscounted unreserved losses are reasonably possible but are not currently considered to be probable of occurrence. The reserved and unreserved liabilities for all environmental concerns could change substantially in the near term due to factors such as the nature and extent of contamination, changes in remedial requirements, technological changes, discovery of new information, the financial strength of other PRPs, the identification of new PRPs and the involvement of and direction taken by the government on these matters. Additionally, we also maintain reserves for other potential environmental issues associated with our domestic operations and a location operated by our German subsidiary. At June 30, 2003, the total of these accruals was $1.3 million and represents anticipated costs associated with the remediation of these issues. Cash payments of $0.1 million have been made against this reserve during the year. As a result of the Widia acquisition, we have established an environmental reserve of $6.2 million. This reserve will be used for environmental clean-up and remediation activities at several Widia manufacturing locations. This liability represents our best estimate of the future obligation based on our evaluations and discussions with independent consultants and the current facts and circumstances related to these matters. This liability has been recorded as part of the Widia acquisition and has not been reflected in our operating results. We maintain a Corporate Environmental, Health and Safety (EH&S) Department, as well as an EH&S Policy Committee, to ensure compliance with environmental regulations and to monitor and oversee remediation activities. In addition, we have established an EH&S administrator at each of our global manufacturing facilities. Our financial management team periodically meets with members of the Corporate EH&S Department and the Corporate Legal Department to review and evaluate the status of environmental projects and contingencies. On a quarterly basis, we establish or adjust financial provisions and reserves for environmental contingencies in accordance with SFAS No. 5, "Accounting for Contingencies." NOTE 16 - COMMITMENTS AND CONTINGENCIES Legal Matters Various lawsuits arising during the normal course of business are pending against us. In our opinion, the ultimate liability, if any, resulting from these matters will have no significant effect on our consolidated financial positions or results of operations. Lease Commitments We lease a wide variety of facilities and equipment under operating leases, primarily for warehouses, production and office facilities and equipment. Lease expense under these rentals amounted to $26.7 million, $23.5 million and $24.2 million in 2003, 2002 and 2001, respectively. Future minimum lease payments for non-cancelable operating leases are $18.3 million, $14.9 million, $10.4 million, $8.9 million and $7.1 million for the years 2004 through 2008 and $24.3 million thereafter. Purchase Commitments We have purchase commitments for materials, supplies, and machinery and equipment as part of the ordinary conduct of business. A few of these commitments extend beyond one year and are based on minimum purchase requirements. In the aggregate, we believe these commitments are not at prices in excess of current market. 61
Other Contractual Obligations We do not have material financial guarantees or other contractual commitments that are reasonably likely to adversely affect our liquidity. Related Party Transactions We do not have any related party transactions that affect our operations, results of operations, cash flow or financial condition. NOTE 17 - RIGHTS PLAN On July 24, 2000, our Board of Directors adopted a new shareowner rights plan to replace our previous plan, which had been in effect since 1990. The new plan became effective upon the expiration of the previous plan on November 2, 2000 and provided for the distribution to shareowners of one stock purchase right for each share of capital stock held as of September 5, 2000. Each right entitles a shareowner to buy 1/100th of a share of a new series of preferred stock at a price of $120 (subject to adjustment). The rights are exercisable only if a person or group of persons acquires or intends to make a tender offer for 20 percent or more of our capital stock. If any person acquires 20 percent of the capital stock, each right will entitle the other shareowners to receive that number of shares of capital stock having a market value of two times the exercise price. If we are acquired in a merger or other business combination, each right will entitle the shareowners to purchase at the exercise price that number of shares of the acquiring company having a market value of two times the exercise price. The rights will expire on November 2, 2010 and are subject to redemption at $0.01 per right. NOTE 18 - SEGMENT DATA We operate four global business units consisting of Metalworking Solutions & Services Group (MSSG), Advanced Materials Solutions Group (AMSG), J&L Industrial Supply (J&L) and Full Service Supply (FSS), and corporate functional shared services. The presentation of segment information reflects the manner in which we organize segments for making operating decisions and assessing performance. Intersegment sales are accounted for at arm's-length prices, reflecting prevailing market conditions within the various geographic areas. Such sales and associated costs are eliminated in our consolidated financial statements. Sales to a single customer did not aggregate 10 percent or more of total sales in 2003, 2002 or 2001. Export sales from U.S. operations to unaffiliated customers were $64.6 million, $65.1 million and $78.7 million in 2003, 2002 and 2001, respectively. METALWORKING SOLUTIONS & SERVICES GROUP In the MSSG segment, we provide consumable metalcutting tools and tooling systems to manufacturing companies in a wide range of industries throughout the world. Metalcutting operations include turning, boring, threading, grooving, milling and drilling. Our tooling systems consist of a steel toolholder and a cutting tool such as an indexable insert or drill made from cemented tungsten carbides, high-speed steel and other hard materials. We also provide solutions to our customers' metalcutting needs through engineering services aimed at improving their competitiveness. ADVANCED MATERIALS SOLUTIONS GROUP In the AMSG segment, the principal business is the production and sale of cemented tungsten carbide products used in mining, highway construction, engineered applications, including circuit board drills, compacts and other similar applications. These products have technical commonality to our core metalworking products. We also sell metallurgical powders to manufacturers of cemented tungsten carbide products. J&L INDUSTRIAL SUPPLY In this segment, we provide metalworking consumables and related products to small- and medium-sized manufacturers in the United States and the United Kingdom. J&L markets products and services through annual mail-order catalogs and monthly sale flyers, telemarketing, the Internet and field sales. FULL SERVICE SUPPLY In the FSS segment, we provide metalworking consumables and related products to large- and medium-sized manufacturers in the United States and Canada. FSS offers integrated supply programs that provide inventory management systems, just-in-time availability and programs that focus on total cost savings. 62
Segment data is summarized as follows: (in thousands) 2003 2002 2001 - -------------------------------------------------------------------------------------------- External sales: MSSG $ 1,123,175 $ 897,157 $ 999,813 AMSG 319,223 307,668 352,933 J&L 196,170 226,010 296,264 FSS 120,389 152,907 158,886 - -------------------------------------------------------------------------------------------- Total external sales $ 1,758,957 $ 1,583,742 $ 1,807,896 ============================================================================================ Intersegment sales: MSSG $ 107,486 $ 116,467 $ 111,780 AMSG 29,137 24,167 28,167 J&L 1,989 2,083 3,823 FSS 3,134 2,747 5,278 - -------------------------------------------------------------------------------------------- Total intersegment sales $ 141,746 $ 145,464 $ 149,048 ============================================================================================ Total sales: MSSG $ 1,230,661 $ 1,013,624 $ 1,111,593 AMSG 348,360 331,835 381,100 J&L 198,159 228,093 300,087 FSS 123,523 155,654 164,164 - -------------------------------------------------------------------------------------------- Total sales $ 1,900,703 $ 1,729,206 $ 1,956,944 ============================================================================================ Operating income (loss): MSSG $ 90,627 $ 97,323 $ 130,558 AMSG 17,348 26,781 43,270 J&L 6,140 (681) 3,689 FSS (56) 2,014 7,541 Corporate (46,134) (34,120) (28,658) - -------------------------------------------------------------------------------------------- Total operating income 67,925 91,317 156,400 Interest expense 36,166 32,627 50,381 Other (income) expense, net (2,531) (361) 11,690 - -------------------------------------------------------------------------------------------- Income before income taxes and minority interest $ 34,290 $ 59,051 $ 94,329 ============================================================================================ Depreciation and amortization: MSSG $ 57,674 $ 51,897 $ 62,374 AMSG 12,325 12,065 21,024 J&L 2,654 2,398 8,400 FSS 1,658 1,852 804 Corporate 9,732 5,417 4,695 - -------------------------------------------------------------------------------------------- Total depreciation and amortization $ 84,043 $ 73,629 $ 97,297 ============================================================================================ Equity income (loss): MSSG $ 849 $ 629 $ 470 AMSG (447) (16) (15) - -------------------------------------------------------------------------------------------- Total equity income $ 402 $ 613 $ 455 ============================================================================================ Total assets: MSSG $ 1,061,505 $ 738,654 $ 937,863 AMSG 365,215 361,122 429,981 J&L 174,148 178,728 224,939 FSS 41,330 56,078 63,056 Corporate 136,894 189,029 169,603 - -------------------------------------------------------------------------------------------- Total assets $ 1,779,092 $ 1,523,611 $ 1,825,442 ============================================================================================ 63
Segment data (continued): (in thousands) 2003 2002 2001 - ------------------------------------------------------------------------------------------------- Capital expenditures: MSSG $ 33,992 $ 26,257 $ 32,913 AMSG 5,921 8,168 7,947 J&L 2,281 2,537 2,679 FSS 281 437 439 Corporate 6,938 6,641 15,951 - ------------------------------------------------------------------------------------------------- Total capital expenditures $ 49,413 $ 44,040 $ 59,929 ================================================================================================= Investments in affiliated companies: MSSG $ 13,911 $ 8,354 $ 3,688 AMSG 2,877 3,327 187 - ------------------------------------------------------------------------------------------------- Total investments in affiliated companies $ 16,788 $ 11,681 $ 3,875 ================================================================================================= Geographic information for sales, based on country of origin, and assets is follows: (in thousands) 2003 2002 2001 - ------------------------------------------------------------------------------------------------- External sales: United States $ 1,011,222 $ 1,085,297 $ 1,267,506 Germany 281,378 171,199 192,283 United Kingdom 92,635 79,906 86,670 Canada 55,516 51,814 61,335 Other 318,206 195,526 200,102 - ------------------------------------------------------------------------------------------------- Total external sales $ 1,758,957 $ 1,583,742 $ 1,807,896 ================================================================================================= Total assets: United States $ 946,151 $ 1,087,716 $ 1,368,055 Germany 441,289 162,900 166,259 United Kingdom 77,803 91,548 93,432 Canada 23,740 20,776 33,982 Other 290,109 160,671 163,714 - ------------------------------------------------------------------------------------------------- Total assets $ 1,779,092 $ 1,523,611 $ 1,825,442 ================================================================================================= 64
REPORT OF INDEPENDENT AUDITORS TO THE SHAREOWNERS OF KENNAMETAL INC. In our opinion, the accompanying consolidated balance sheet and the related consolidated statements of income, shareowners' equity and cash flows present fairly, in all material respects, the financial position of Kennametal Inc. and its subsidiaries at June 30, 2003 and 2002, and the results of their operations and their cash flows for the years ended June 30, 2003 and 2002 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of Kennametal Inc.'s management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. The financial statements of Kennametal Inc. as of June 30, 2001 were audited by other independent accountants who have ceased operations. Those independent accountants expressed an unqualified opinion on those financial statements, before the revision described in Note 2, in their report dated July 20, 2001. As discussed in Note 2 to the financial statements, Kennametal Inc. changed its method of accounting for goodwill and other intangible assets in conformity with Statement of Financial Accounting Standard No. 142, "Goodwill and Other Intangible Assets" which was adopted July 1, 2001. As discussed above, the financial statements of Kennametal Inc. as of June 30, 2001 and the year then ended were audited by other independent accountants who have ceased operations. As described in Note 2, these financial statements have been revised to include the transitional disclosures required by Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets," which was adopted by Kennametal Inc. as of July 1, 2001. We audited the transitional disclosures described in Note 2. In our opinion, the transitional disclosures for 2001 in Note 2 are appropriate. However, we were not engaged to audit, review or apply any procedures to the 2001 financial statements of Kennametal Inc. other than with respect to such disclosures and, accordingly, we do not express an opinion or any other form of assurance on the 2001 financial statements taken as a whole. (PRICEWATERHOUSECOOPERS LLP) PricewaterhouseCoopers LLP Pittsburgh, Pennsylvania August 1, 2003 65
The following report is a copy of a previously issued report by Arthur Andersen LLP and it has not been reissued by Arthur Andersen LLP. Arthur Andersen LLP has not consented to its inclusion; therefore, an investor's ability to recover any potential damage may be limited. TO THE SHAREOWNERS OF KENNAMETAL INC. We have audited the accompanying consolidated balance sheets of Kennametal Inc. (a Pennsylvania corporation) and subsidiaries as of June 30, 2001 and 2000*, and the related consolidated statements of income, shareowners' equity and cash flows for each of the three* years in the period ended June 30, 2001. These financial statements are the responsibility of the company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Kennametal Inc. and subsidiaries as of June 30, 2001 and 2000*, and the results of their operations and their cash flows for each of the three* years in the period ended June 30, 2001, in conformity with accounting principles generally accepted in the United States. (ARTHUR ANDERSEN LLP) Arthur Andersen LLP Pittsburgh, Pennsylvania July 20, 2001 * The 1999 and 2000 consolidated financial statements are not required to be presented in the 2003 annual report on Form 10-K. 66
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Effective May 14, 2002, the Board of Directors, upon the recommendation of the Audit Committee, approved the engagement of PricewaterhouseCoopers LLP as its independent accountants for the fiscal year ending June 30, 2002 and dismissed the firm of Arthur Andersen LLP. The reports of Arthur Andersen LLP on our consolidated financial statements for the 2000 fiscal year did not contain an adverse opinion or disclaimer of opinion, nor were such reports qualified or modified as to uncertainty, audit scope or accounting principle. Through May 14, 2002 and for the 2001 audit, there were no disagreements between us and Arthur Andersen LLP on any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedure which, if not resolved to Arthur Andersen LLP's satisfaction, would have caused the firm to make reference to the subject matter thereof in connection with their report on our consolidated financial statements and there were no reportable events as described in Item 304(a)(1)(v) of Regulation S-K. During the years ended June 30, 2001 and through May 14, 2002, we did not consult with PricewaterhouseCoopers LLP with respect to the application of accounting principles to a specified transaction, either completed or proposed, or the type of audit opinion that might be rendered on our consolidated financial statements, or any other matters or reportable events as set forth in Items 304(a)(2)(i) and (ii) of Regulation S-K. ITEM 9A - CONTROLS AND PROCEDURES As of the end of the period covered by this annual report on Form 10-K, the Company's management evaluated, with the participation of the Company's Chief Executive Officer and Chief Financial Officer, the effectiveness of the Company's disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)). The Company's disclosure controls were designed to provide a reasonable assurance that information required to be disclosed in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. It should be noted that the design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote. However, the controls have been designed to provide reasonable assurance of achieving the controls' stated goals. Based on that evaluation, the Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective at the reasonable assurance level. There were no changes in the Company's internal control over financial reporting that occurred during the Company's most recent fiscal quarter that have materially affected or are reasonably likely to materially affect the Company's internal control over financial reporting. 67
Part III ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Incorporated herein by reference is the information set forth in Part I under the caption "Executive Officers of the Registrant" and the information under the captions "Election of Directors" and "Compliance with Section 16(a) of the Exchange Act" in our definitive proxy statement to be filed with the Securities and Exchange Commission within 120 days after June 30, 2003 ("2003 Proxy Statement"). Incorporated herein by reference is the information set forth under the caption "Ethics and Corporate Governance--Code of Business Ethics and Conduct" in the 2003 Proxy Statement. The Company has a separately-designated standing audit committee established in accordance with Section 3(a)(58)(A) of the Securities Exchange Act of 1934. The members of the Audit Committee of the Company's Board of Directors include: Kathleen J. Hempel, Ronald M. DeFeo, A. Peter Held, Aloysius T. McLaughlin, Jr. and Lawrence W. Stranghoener. ITEM 11 - EXECUTIVE COMPENSATION Incorporated herein by reference is the information set forth under the caption "Compensation of Executive Officers" and certain information regarding directors' fees under the caption "Board of Directors and Board Committees" in the 2003 Proxy Statement. ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREOWNER MATTERS Incorporated herein by reference is the information set forth under the caption "Ownership of Capital Stock by Directors, Nominees and Executive Officers" with respect to the directors' and officers' shareholdings, under the caption "Principal Holders of Voting Securities" with respect to other beneficial owners in the 2003 Proxy Statement and under the caption "Equity Compensation Plan Information" with respect to disclosure regarding the number of outstanding options, warrants and rights granted under equity compensation plans and the number of shares remaining for issuance under such plans. ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Incorporated herein by reference is certain information set forth in the notes to the tables under the captions "Election of Directors" and "Compensation of Executive Officers" in the 2003 Proxy Statement. ITEM 14 - PRINCIPAL ACCOUNTANT FEES AND SERVICES Incorporated herein by reference is the information with respect to principal accountant fees and services set forth under the caption "Independent Auditors" in the 2003 Proxy Statement. 68
Part IV ITEM 15 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) Documents filed as part of this Form 10-K report. 1. Financial Statements 2. Financial Statement Schedule The financial statement schedule required by Part II, Item 8 of this document is filed as part of this report. All of the other schedules are omitted as the required information is inapplicable or the information is presented in our consolidated financial statements or related notes. Separate financial statements of Kennametal are omitted because Kennametal is primarily an operating company, and all significant subsidiaries included in our consolidated financial statements are wholly owned, with the exception of Kennametal Hertel AG, in which Kennametal has over a 99 percent ownership interest. FINANCIAL STATEMENT SCHEDULE: Page Reports of Independent Auditors 73 Schedule II--Valuation and Qualifying Accounts and Reserves for the Three Years Ended June 30, 2003 74 3. Exhibits (2) Plan of Acquisition, Reorganization, Arrangement, Liquidation, or Succession (2.1) Stock Purchase Agreement dated Exhibit 2.1 of the May 6, 2002 Form May 3, 2002 among Milacron Inc., 8-K is incorporated herein by reference. Milacron B.V. and Kennametal Inc. (3) Articles of Incorporation and Bylaws (3.1) Bylaws of Kennametal Inc. as Exhibit 3.1 of December 31, 2001 amended through January 29, Form 10-Q is incorporated herein by 2002 reference. (3.2) Amended and Restated Articles Exhibit 3.1 of the September 30, 1994 of Incorporation as Amended Form 10-Q (SEC file no. reference 1-5318; docket entry date--November 14, 1994) is incorporated herein by reference. (4) Instruments Defining the Rights of Security Holders, Including Indentures (4.1) Rights Agreement effective Exhibit 1 of the Form 8-A dated October 10, as of November 2, 2002 2000 is incorporated herein by reference. (10) Material Contracts (10.1)* Prime Bonus Plan The discussion regarding the Prime Bonus Plan under the caption "Report of the Compensation Committee of the Board of Directors" contained in the 2003 Proxy Statement is incorporated herein by reference. (10.2)* Stock Option and Exhibit 10.1 of the December 31, 1988 Incentive Plan of 1988 Form 10-Q (SEC file no. reference 1-5318; docket entry date--February 9, 1989) is incorporated herein by reference. 69
Item 15 (continued) (10.3)* Deferred Fee Plan Exhibit 10.4 of the June 30, 1988 for Outside Directors Form 10-K (SEC file no. reference 1-5318; docket entry date--September 23, 1988) is incorporated herein by reference. (10.4)* Executive Deferred Exhibit 10.5 of the June 30, 1988 Compensation Trust Agreement Form 10-K (SEC file no. reference 1-5318; docket entry date--September 23, 1988) is incorporated herein by reference. (10.5)* Directors Stock Incentive Filed herewith. Plan, as amended (10.6)* Performance Bonus Stock Exhibit 10.6 of the June 30, 1999 Form 10-K Plan of 1995, as amended is incorporated herein by reference. (10.7)* Stock Option and Incentive Exhibit 10.14 of the September 30, 1996 Form Plan of 1996 10-Q is incorporated herein by reference. (10.8)* Stock Option and Incentive Plan Exhibit 10.8 of the December 31, 1996 Form of 1992, as amended 10-Q is incorporated herein by reference. (10.9)* Form of Employment Agreement Exhibit 10.9 of the June 30, 2000 Form with Named Executive Officers 10-K is incorporated herein by reference. (other than Mr. Tambakeras) (10.10)* Supplemental Executive Exhibit 10.10 of the June 30, 1999 Form Retirement Plan, as amended 10-K is incorporated herein by reference. (10.11)* Executive Employment Exhibit 10.11 of the June 30, 2002 Form Agreement dated May 1, 2002 10-K is incorporated herein by reference. between Kennametal Inc. and Markos I. Tambakeras (10.12)* Kennametal Inc. 1999 Stock Plan Exhibit 10.5 of the June 11, 1999 Form 8-K is incorporated herein by reference. (10.13)* Kennametal Inc. Stock Option and Exhibit A of the 1999 Proxy Statement Incentive Plan of 1999 is incorporated herein by reference. (10.14) Credit Agreement dated as of Exhibit 10.1 of the September 11, 2002 June 27, 2002 among Kennametal Form 8-K is incorporated herein by reference. Inc., and the several lenders from time to time parties thereto, Bank of Tokyo-Mitsubishi Trust Company; Bank One, N.A.; Fleet National Bank; and PNC Bank, N.A. as the Co-Syndication Agents, and JP Morgan Chase Bank, as the Administrative Agent (10.15)* Executive Employment Agreement Filed herewith. dated April 29, 2003 between Kennametal Inc. and Carlos M. Cardoso (10.16)* Amended and Restated Kennametal Filed herewith. Inc. Stock and Incentive Plan of 2002 70
(10.17)* Post Employment Compensation The discussion regarding Mr. Mahanes' Arrangement between Kennametal arrangement under the caption Inc. and H. Patrick Mahanes Jr. "Employment Agreements and Termination of Employment and Change in Control Arrangements" in the 2003 Proxy Statement is incorporated herein by reference. (21) Subsidiaries of the Registrant Filed herewith. (23) Consent of Independent Auditors Filed herewith. (31) Certifications (31.1) Certification executed by Markos I. Filed herewith. Tambakeras, Chief Executive Officer of Kennametal Inc. (31.2) Certification executed by F. Nicholas Filed herewith. Grasberger III, Chief Financial Officer of Kennametal Inc. (32) Section 1350 Certifications (32.1) Certification Pursuant to 18 U.S.C. Filed herewith. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, executed by Markos I. Tambakeras, Chief Executive Officer of Kennametal Inc., and F. Nicholas Grasberger III, Chief Financial Officer of Kennametal Inc. * Denotes management contract or compensatory plan or arrangement. (b) Reports on Form 8-K and 8-K/A. The following was furnished and not deemed to be filed during the quarter ended June 30, 2003: Form 8-K dated April 30, 2003, reported under Item 9. Regulation FD Disclosure reporting the press release announcing third quarter 2003 financial results. The following were furnished and not deemed to be filed subsequent to the quarter ended June 30, 2003: Form 8-K dated July 30, 2003, reported under Item 12. Results of Operations and Financial Condition regarding the fourth quarter and fiscal year ended June 30, 2003 financial results. Form 8-K/A dated July 30, 2003, reported under Item 12. Results of Operations and Financial Condition regarding the fourth quarter and fiscal year ended June 30, 2003 financial results. 71
SIGNATURES Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. KENNAMETAL INC. By: /s/ TIMOTHY A. HIBBARD Timothy A. Hibbard Corporate Controller and Chief Accounting Officer Date: September 18, 2003 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. SIGNATURE TITLE DATE /s/ MARKOS I. TAMBAKERAS Chairman, President and September 18, 2003 Markos I. Tambakeras Chief Executive Officer /s/ F. NICHOLAS GRASBERGER III Vice President and September 18, 2003 F. Nicholas Grasberger III Chief Financial Officer /s/ RICHARD C. ALBERDING Director September 18, 2003 Richard C. Alberding /s/ PETER B. BARTLETT Director September 18, 2003 Peter B. Bartlett /s/ RONALD M. DEFEO Director September 18, 2003 Ronald M. DeFeo /s/ A. PETER HELD Director September 18, 2003 A. Peter Held /s/ KATHLEEN J. HEMPEL Director September 18, 2003 Kathleen J. Hempel /s/ ALOYSIUS T. MCLAUGHLIN, JR. Director September 18, 2003 Aloysius T. McLaughlin, Jr. /s/ WILLIAM R. NEWLIN Director September 18, 2003 William R. Newlin /s/ LAWRENCE W. STRANGHOENER Director September 18, 2003 Lawrence W. Stranghoener /s/ LARRY D. YOST Director September 18, 2003 Larry D. Yost 72
REPORT OF INDEPENDENT AUDITORS ON FINANCIAL STATEMENT SCHEDULE TO THE SHAREOWNERS OF KENNAMETAL INC. Our audits of the consolidated financial statements referred to in our report dated August 1, 2003 appearing in this annual report on Form 10-K also included an audit of the financial statement schedule listed in Item 15(a)(2) of this Form 10-K. In our opinion, this financial statement schedule for the years ended June 30, 2003 and 2002 presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. The financial statement schedule of Kennametal Inc. for the year ended June 30, 2001 was audited by other independent accountants who have ceased operations. Those independent accountants expressed an unqualified opinion on that financial statement schedule in their report dated July 20, 2001. /s/ PricewaterhouseCoopers LLP PricewaterhouseCoopers LLP Pittsburgh, Pennsylvania August 1, 2003 The following report is a copy of a previously issued report by Arthur Andersen LLP and it has not been reissued by Arthur Andersen LLP. Arthur Andersen LLP has not consented to its inclusion; therefore an investor's abilities to recover any potential damage may be limited. REPORT ON PREVIOUS INDEPENDENT PUBLIC ACCOUNTANTS ON FINANCIAL STATEMENTS SCHEDULE TO THE SHAREOWNERS OF KENNAMETAL INC. We have audited in accordance with auditing standards generally accepted in the United States, the consolidated financial statements included in Kennametal Inc.'s annual report to shareowners incorporated by reference in this Form 10-K, and have issued our report thereon dated July 20, 2001. Our audits were made for the purpose of forming an opinion on those statements taken as a whole. The schedule listed in the index in Item 14*(a) 2 of this Form 10-K is the responsibility of the Company's management and is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. The schedule has been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole. /s/ Arthur Andersen LLP Arthur Andersen LLP Pittsburgh, Pennsylvania July 20, 2001 * The schedule is listed in the index in Item 15(a)2 of the 2003 annual report on Form 10-K. 73
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES Additions ------------------------------------ Balance at Charged to Deductions (in thousands) Beginning Costs and Other from Balance at For the Three Years Ended June 30, of Year Expenses Recoveries Adjustments Reserves End of Year - ------------------------------------------------------------------------------------------------------------------------ 2003 Allowance for doubtful accounts $ 12,671 $ 6,204 $ 307 $ 11,652(a) $ 7,429(b) $ 23,405 - ------------------------------------------------------------------------------------------------------------------------ 2002 Allowance for doubtful accounts $ 7,999 $ 7,137 $ 640 $ 315(a) $ 3,420(b) $ 12,671 - ------------------------------------------------------------------------------------------------------------------------ 2001 Allowance for doubtful accounts $ 12,214 $ 2,576 $ 324 $ (918)(a) $ 6,197(b) $ 7,999 ======================================================================================================================== (a) Represents foreign currency translation adjustment and reserves acquired through business combinations. (b) Represents uncollected accounts charged against the allowance. 74
Exhibit 10.5 KENNAMETAL INC. AMENDED AND RESTATED DIRECTORS STOCK INCENTIVE PLAN (AS AMENDED THROUGH JULY 29, 2003) ARTICLE I GENERAL PROVISIONS SECTION 1.1. ESTABLISHMENT AND PURPOSE. There is hereby established the Kennametal Inc. Directors Stock Incentive Plan (the "Plan") pursuant to which each director of Kennametal Inc. (the "Company") or of a Qualifying Subsidiary (as hereinafter defined) who is not an employee of the Company or any of its subsidiaries (a "Non-Employee Director") shall be eligible: (a) to elect to receive shares of the Company's capital stock, par value $1.25 per share (the "Capital Stock"), in lieu of cash compensation; and (b) through an election to defer receipt of any compensation to be earned by such Non-Employee Director made under the Kennametal Inc. Deferred Fee Plan for Outside Directors or the deferred compensation plan of such Qualifying Subsidiary (the "Deferred Compensation Plan"), to have Kennametal Stock Credits (as hereinafter defined) credited to an account established for such Non-Employee Director by the Company. The purpose of the Plan is to assist the Company in attracting, retaining and motivating highly qualified Non-Employee Directors and to promote identification of, and align Non-Employee Directors' interests more closely with, the interests of the stockholders of the Company. SECTION 1.2. DEFINITIONS. In addition to the terms previously or hereafter defined herein, the following terms when used herein shall have the meanings set forth below: "Board" shall mean the Board of Directors of the Company. "Committee" shall mean the committee of the Board appointed by the Board to administer the Plan. Unless otherwise determined by the Board, the Committee shall be the Committee on Executive Compensation of the Board. "Company Stock Credit" shall mean a credit that is equivalent to one share of Capital Stock. "Compensation" shall mean all remuneration paid to a Non-Employee Director for service as such that is not deferred pursuant to the Deferred Compensation Plan. "Deferred Compensation" shall mean all remuneration paid to a Non-Employee Director for service as such that is deferred pursuant to the Deferred Compensation Plan. "Fair Market Value" shall mean with respect to Capital Stock, as of any date, the mean of the highest and lowest sales prices for the Capital Stock as reported in the New York Stock
Exchange--Composite Transactions reporting system for the date in question or, if no sales were effected on such date, on the next preceding date on which sales were effected "Plan Year" shall mean the twelve-month period beginning January 1 and ending December 31 in any particular year. "Qualifying Subsidiary" shall mean any direct or indirect subsidiary of the Company which has been designated as being eligible to participate in the Plan by the Committee. "Stock Credit" shall mean a Company Stock Credit. SECTION 1.3. ADMINISTRATION. The Plan shall be administered by the Committee. The Committee shall serve at the pleasure of the Board of Directors. A majority of the Committee shall constitute a quorum, and the acts of a majority of the members of the Committee present at any meeting at which a quorum is present, or acts approved in writing by a majority of the members of the Committee, shall be deemed the acts of the Committee. The Committee is authorized to interpret and construe the Plan, to make all determinations and take all other actions necessary or advisable for the administration of the Plan, and to delegate to employees of the Company or any subsidiary the authority to perform administrative functions under the Plan; provided, however, that the Committee shall have no authority to determine the persons entitled to receive Capital Stock or Stock Credits under the Plan nor the timing, amount or price of Capital Stock or Stock Credits issued under the Plan. SECTION 1.4. ELIGIBILITY. An individual who is a Non-Employee Director shall be eligible to participate in the Plan. SECTION 1.5. CAPITAL STOCK SUBJECT TO THE PLAN. The maximum number of shares of Capital Stock that may be issued pursuant to the Plan is 200,000. Capital Stock to be issued under the Plan may be either authorized and unissued shares of Capital Stock or shares of Capital Stock held in treasury by the Company. ARTICLE II ELECTIONS AND DISTRIBUTIONS SECTION 2.1. ELECTIONS TO RECEIVE CAPITAL STOCK FROM COMPENSATION. Any Non-Employee Director may elect to receive Capital Stock under this Plan in lieu of all or a portion of the Compensation otherwise payable to such Non-Employee Director in any Plan Year beginning with the Plan Year commencing January 1, 1993 (a "Stock Acquisition Election"). If a Non-Employee Director makes a Stock Acquisition Election, the Non-Employee Director shall receive, on the date that the Compensation otherwise would have been paid, the number of shares of Capital Stock that could have been purchased on that date based on the amount of Compensation subject to the Stock Acquisition Election and the Fair Market Value of the Capital Stock on that date, rounded up to the nearest whole share. In the absence of a Stock Acquisition Election, all Compensation shall be paid to the Non-Employee Director in cash in accordance with the Company's policies and procedures. Certificates for Capital Stock acquired by the Non- -2-
Employee Director pursuant to a Stock Acquisition Election shall be issued quarterly following the period during which such Capital Stock is acquired, as provided above. SECTION 2.2. ELECTIONS TO RECEIVE COMPANY STOCK CREDITS FROM DEFERRED COMPENSATION. Any Non-Employee Director may elect to receive Company Stock Credits under this Plan in any Plan Year with respect to all or a portion of the Deferred Compensation credited to the Non-Employee Director in that Plan Year, beginning with the Plan Year commencing January 1, 1993 (a "Company Stock Credit Election"). If a Non-Employee Director makes a Company Stock Credit Election, an account established for the Non-Employee Director and maintained by the Company shall be credited with that number of Company Stock Credits equal to the number of shares of Capital Stock (including fractions of a share to four decimal places) that could have been purchased with the amount of Deferred Compensation subject to a Company Stock Credit Election based on the Fair Market Value of the Capital Stock on the day that the Deferred Compensation is credited under the Deferred Compensation Plan. A Company Stock Credit Election shall be valid in any period only if the Non-Employee Director has elected to participate in the Deferred Compensation Plan for such period. SECTION 2.3. TERMS AND CONDITIONS OF ELECTIONS. A Stock Acquisition Election or a Company Stock Credit Election (an "Election") shall be subject to the following terms and conditions: (a) An Election shall be in writing and shall be irrevocable; and (b) An Election may be made on or before December 31, 1992, to take effect on January 1, 1993; thereafter, an Election shall be effective for any Plan Year only if made on or prior to the June 30 immediately preceding the commencement of such Plan Year, provided, however, that if a new Director's term begins after June 30 of a particular Plan Year, an Election may be made prior to the time that the Director is entitled to payment of compensation for such period and shall be effective when made; and (c) An Election shall remain in effect for all future Plan Years unless terminated or changed pursuant to an Election made on or prior to June 30 to take effect for the next Plan Year. SECTION 2.4. ADJUSTMENT OF STOCK CREDIT ACCOUNTS. (a) Cash Dividends--As of the date that any cash dividend is paid to stockholders of the Company, the applicable Stock Credit account of the Non-Employee Director shall be credited with additional Stock Credits equal to the number of shares of stock underlying such Stock Credit (including fractions of a share to four decimal places) that could have been purchased on that date with the dividends paid on the underlying shares based on the Fair Market Value of the Capital Stock on that date. (b) Stock Dividends--In the event that a stock dividend shall be paid upon the stock underlying the Stock Credit Account, the number of Stock Credits in the Non-Employee Director's applicable Stock Credit account shall be adjusted by adding thereto -3-
additional Stock Credits equal to the number of shares of the underlying stock which would have been distributable on such stock represented by Stock Credits if such shares had been outstanding on the date fixed for determining the stockholders entitled to receive such stock dividend. (c) Other Adjustments--In the event that the outstanding shares of Capital Stock shall be changed into or exchanged for a different number or kind of shares of stock or other securities whether through reorganization, recapitalization, stock split-up, combination of shares, merger or consolidation, then there shall be substituted, for the shares of stock underlying the Stock Credits, the number and kind of shares of stock or other securities which would have been substituted therefor if the underlying shares had been outstanding on the date fixed for determining the stockholders entitled to receive such changed or substituted stock or other securities. In the event there shall be any change, other than specified in this Section 2.4, in the number or kind of outstanding shares of stock underlying the Stock Credits or of any stock or other securities into which such underlying capital stock shall be changed or for which it shall have been exchanged, then, if the Board of Directors shall determine, in its discretion, that such change equitably requires an adjustment in the number of Stock Credits, such adjustment shall be made by the Board of Directors and shall be effective and binding for all purposes of the Plan and on each outstanding Stock Credit account. SECTION 2.5. CHANGE IN CONTROL. In the event of any threatened or actual change in control of the Company, issued and outstanding shares of Capital Stock shall be substituted for the Company Stock Credits in each Non-Employee Director's Stock Credit account, and such Capital Stock shall be transferred and delivered to such Non-Employee Director. SECTION 2.6. DISTRIBUTION OF COMPANY STOCK CREDITS. Unless a Non-Employee Director has selected a different payment option as set forth below, as soon as practicable following the date that such Non-Employee Director ceases (other than by reason of such Non-Employee Director's death) to be a Non-Employee Director (hereinafter, "retirement"), the Company shall issue to such Non-Employee Director that number of shares of Capital Stock equal to the whole number of Company Stock Credits in such Non-Employee Director's Company Stock Credit account and cash equal to the fractional Company Stock Credits in such account multiplied by the Fair Market Value of the Capital Stock as of the date of retirement. A Non-Employee Director may elect to receive the Capital Stock represented by the Company Stock Credits in such Non-Employee Director's Company Stock Credit account in monthly or annual installments beginning after retirement from the Board by written notification to the Company of such elected payment option and may modify any such election by a subsequent written notification to the Company; provided, however, that the Company shall be required to effect any such written notification only if submitted to the Company no fewer than twelve months prior to such Non-Employee Director's retirement from the Board. Notwithstanding the foregoing, the Committee, in its sole discretion, shall have the right to pay a Non-Employee Director a cash amount equal to the value of the Company Stock Credits, in lieu of distributing Capital Stock. -4-
SECTION 2.7. DISTRIBUTIONS ON DEATH. In the event of the death of a Non-Employee Director, whether before or after cessation of service as a Non-Employee Director, the Stock Credit account to which he or she was entitled shall be converted to cash and distributed in a lump sum to such person or persons or the survivors thereof, including corporations, unincorporated associates or trusts, as the Non-Employee Director may have designated. All such designations shall be made in writing, signed by the Non-Employee Director and delivered to the Company. A Non-Employee Director may from time to time revoke or change any such designation by written notice to the Company. If there is no unrevoked designation on file with the Company at the time of the Non-Employee Director's death, or if the person or persons designated therein shall have all predeceased the Non-Employee Director or otherwise ceased to exist, such distributions shall be made to the Non-Employee Director's estate. Any distribution under this Section 2.7 shall be made as soon as practicable following notification to the Company of the Non-Employee Director's death. In any case in which the Non-Employee Director's Stock Credit account is to be converted to cash pursuant to this Section 2.7, such cash amount shall be determined by multiplying the number of whole and fractional shares of Capital Stock to which the Non-Employee Director's Stock Credit account is equivalent by the Fair Market Value of the shares underlying such account on the date of death. SECTION 2.8. CONVERSION OF DEFERRED COMPENSATION TO STOCK CREDITS. The Committee may, in its discretion, permit a Non-Employee Director to convert Deferred Compensation already credited to such Non-Employee Director's cash account to Stock Credits (a "Conversion Election"). Any such election and the related conversion shall occur only during specified periods designated by the Committee and shall become effective on the date such election is delivered to the Company. If a Non-Employee Director makes a Conversion Election, such Non-Employee Director's Stock Credit account will be credited with that number of Stock Credits equal to the number of shares of Capital Stock underlying the Stock Credit Account (including fractions of a share to four decimal places) that could have been purchased with the amount of Deferred Compensation subject to the Conversion Election based on the Fair Market Value of the underlying stock on the day that the Conversion Election is made. ARTICLE III MISCELLANEOUS PROVISIONS SECTION 3.1. AMENDMENT AND DISCONTINUANCE. The Board of Directors may alter, amend, suspend or discontinue the Plan, provided that no such action shall deprive any person without such person's consent of any rights theretofore granted pursuant hereto. The Board of Directors may, in its discretion, submit any proposed amendment to the Plan to the stockholders of the Company for approval and shall submit proposed amendments to the Plan to the stockholders of the Company for approval if such approval is required in order for the Plan to comply with Rule 16b-3 of the Exchange Act (or any successor rule). SECTION 3.2. COMPLIANCE WITH GOVERNMENTAL REGULATIONS. Notwithstanding any provision of the Plan or the terms of any agreement entered into pursuant to the Plan, the Company shall not be required to issue any shares hereunder prior to registration of the shares subject to the Plan under the Securities Act of 1933 or the Exchange Act, if such registration -5-
shall be necessary, or before compliance by the Company or any participant with any other provisions of either of those acts or of regulations or rulings of the Securities and Exchange Commission thereunder, or before compliance with other federal and state laws and regulations and rulings thereunder, including the rules of the New York Stock Exchange, Inc. The Company shall use its best efforts to effect such registrations and to comply with such laws, regulations and rulings forthwith upon advice by its counsel that any such registration or compliance is necessary. SECTION 3.3. COMPLIANCE WITH SECTION 16. With respect to persons subject to Section 16 of the Exchange Act in relation to the Company, transactions under this Plan are intended to comply with all applicable conditions of Rule 16b-3 (or its successor rule). To the extent that any provision of the Plan or any action by the Board of Directors or the Committee fails to so comply, it shall be deemed null and void to the extent permitted by law and to the extent deemed advisable by the Committee. SECTION 3.4. NON-ALIENATION OF BENEFITS. No right or interest of a Non-Employee Director in a Stock Credit account under the Plan may be sold, assigned, transferred, pledged, encumbered or otherwise disposed of except as expressly provided in the Plan; and no interest or benefit of any Non-Employee Director under the Plan shall be subject to the claims of creditors of the Non-Employee Director. SECTION 3.5. WITHHOLDING TAXES. To the extent required by applicable law or regulation, each Non-Employee Director must arrange with the Company for the payment of any federal, state or local income or other tax applicable to the receipt of Capital Stock or Stock Credits under the Plan before the Company shall be required to deliver to the Non-Employee Director cash or a certificate for Capital Stock free and clear of all restrictions under the Plan, as the case may be. SECTION 3.6. FUNDING. Except as provided in Section 2.5 hereof, no obligation of the Company under the Plan shall be secured by any specific assets of the Company, nor shall any assets of the Company be designated as attributable or allocated to the satisfaction of any such obligation. To the extent that any person acquires a right to receive payments from the Company under the Plan, such right shall be no greater than the right of any unsecured creditor of the Company. SECTION 3.7. GOVERNING LAW. The Plan shall be governed by and construed and interpreted in accordance with the internal laws of the Commonwealth of Pennsylvania. SECTION 3.8. EFFECTIVE DATE OF PLAN. The Plan became effective upon approval and adoption of the Plan by the holders of a majority of the outstanding shares of Capital Stock of the Company at the 1992 annual meeting of shareholders. -6-
EXHIBIT 10.15 OFFICER'S EMPLOYMENT AGREEMENT THIS AGREEMENT, is made and entered into this 29th day of April, 2003, by and between KENNAMETAL INC., a corporation organized under the laws of the Commonwealth of Pennsylvania, for and on behalf of itself and on behalf of its subsidiary companies (hereinafter referred to as "Kennametal"), and Carlos M. Cardoso, an individual (hereinafter referred to as "Employee"). WITNESSETH: WHEREAS, Employee acknowledges that by reason of employment by Kennametal, it is anticipated that Employee will work with, add to, create, have access to and be entrusted with trade secrets and confidential information belonging to Kennametal which are of a technical nature or business nature or pertain to future developments, the disclosure of which trade secrets or confidential information would be highly detrimental to the interests of Kennametal; WHEREAS, in order to have the benefit of Employee's assistance, Kennametal is desirous of employing or continuing the employment of Employee; WHEREAS, Kennametal offered, and Employee accepted, certain terms of employment to which the parties mutually agreed, as set forth in the letter agreement, dated as of March 8, 2003 (the "Letter Agreement"), attached hereto as Exhibit A; WHEREAS, on the date hereof, the Board of Directors of Kennametal elected Employee a Vice President of Kennametal; NOW, THEREFORE, Kennametal and Employee, each intending to be legally bound hereby, do mutually covenant and agree as follows: 1. (a) Subject to the terms and conditions set forth herein, Kennametal hereby agrees to employ Employee as of the date hereof, and Employee hereby accepts such employment and agrees to devote his full time and attention to the business and affairs of Kennametal, in such capacity or capacities and to perform to the best of his ability such services as shall be determined from time to time by the Chief Executive Officer and the Board of Directors of Kennametal until the termination of his employment hereunder. (b) Subject to the terms of the Letter Agreement, Employee's base salary, the size of bonus awards, if any, granted to him and other emoluments for his services, if any, shall be determined by the Board of Directors or its Committee on Executive Compensation, as appropriate, from time to time in their sole discretion.
(c) Attached hereto as Exhibits B, C and D are the Incentive Stock Option Grant, the Nonstatutory Stock Option Grant and the Restricted Stock Award agreements, respectively, granted by the Company to Employee in accordance with the terms of the Letter Agreement. (d) As set forth in the Letter Agreement, Employee will forfeit the Nonstatutory Stock Options, the Restricted Stock Award, and eligibility for target bonuses and any guaranteed or sign-on bonuses paid if Employee shall voluntarily terminate his employment with Kennametal within twelve (12) months of the commencement of Employee's employment. In the event that Employee has received any such bonuses or has sold any stock pursuant to the options or award prior to a voluntary termination within twelve (12) months of the commencement of Employee's employment, Employee shall immediately reimburse Kennametal for such bonuses or gain from such stock sales as the case may be. 2. In addition to the compensation set forth or contemplated elsewhere herein, Employee, subject to the terms and conditions of this Agreement, shall be entitled to participate in all group insurance programs, retirement income (pension) plans, thrift plans and vacation and holiday programs normally provided for other executives of Kennametal. Nothing herein contained shall be deemed to limit or prevent Employee, during his employment hereunder, from being reimbursed by Kennametal for out-of-pocket expenditures incurred for travel, lodging, meals, entertainment expenses or any other expenses in accordance with the policies of Kennametal applicable to the executives of Kennametal. 3. Employee's employment may be terminated with or without any reason for termination by either party hereto at any time by giving the other party prior written notice thereof, provided, however, that any termination on the part of Kennametal shall occur only if specifically authorized by its Board of Directors; provided, further, that termination by Kennametal for Cause (as hereinafter defined) shall be made by written notice which states that it is a termination for Cause; and provided, further, that termination by Employee, other than termination for Good Reason (as hereafter defined) following a Change-in-Control (as hereafter defined), shall be on not less than 30 days prior written notice to Kennametal. 4. (a) In the event that Employee's employment is terminated by Kennametal prior to a Change-in-Control (as hereinafter defined) and other than for Cause, Employee will receive as severance pay, in addition to all amounts due him at the Date of Termination (as hereinafter defined), an amount, payable promptly after the Date of Termination, equal to three months' base salary at the annual rate in effect on the Date of termination. (b) In the event that Employee's employment is terminated by Employee following a Change-in-Control (as hereafter defined) without good reason (as such term in defined in paragraph 4(h)) or prior to a Change-in-Control (as hereinafter defined), Employee will not be entitled to receive any severance pay in addition to the amounts, if any, due him at the Date of Termination (as hereinafter defined).
(c) In the event at or after a Change-in-Control and prior to the third anniversary of the date of the Change-in-Control that Employee's employment is terminated by Employee for Good Reason or by Kennametal other than for Cause or Disability pursuant to paragraph 5, Employee will receive as severance pay (in addition to all other amounts due him at the Date of Termination) an amount equal to the product of: (i) the lesser of (x) two and eight tenths (2.8), (y) a number equal to the number of calendar months remaining from the Date of Termination to the Employee's Retirement Date (as such term is hereafter defined) divided by twelve (12), or (z) a number equal to the product obtained by multiplying thirty-six (36) less the number of completed months after the date of the Change in-Control during which the Employee was employed and did not have Good Reason for termination times one- twelfth (1/12); times (ii) the sum of (x) Employee's base salary at the annual rate in effect on the Date of Termination (or, at Employee's election, at the annual rate in effect on the first day of the calendar month immediately prior to the Change-in-Control), plus (y) the average of any bonuses which Employee was entitled to or paid during the three most recent fiscal years ending prior to the Date of Termination. Such severance pay shall be paid by delivery of a cashier's or certified check to the Employee at Kennametal's executive offices on a date which is no later than five business days following the Date of Termination. In addition to the severance payments provided for in this paragraph 4(c), Employee also will receive the same or equivalent medical, dental, disability and group insurance benefits as were provided to the Employee at the Date of Termination, which benefits shall be provided to Employee for a three year period commencing on the Date of Termination. The Employee shall also be deemed and shall be credited for computing benefits, for vesting and for all other purposes under any pension or retirement income plan of Kennametal and under the Supplemental Executive Retirement Plan to have continuously remained in the employment of Kennametal for the three year period (or, if clause (i)(y) or
clause(i)(z) above of this paragraph 4(c) is applicable to determine the severance payments to be made, the lesser period measured in years equal to clause (i)(y) or clause (i)(z) above, whichever is applicable) following the Date of Termination at an annual compensation equal to the sum of the base salary and bonus which were used to compute the payment due the Employee under the first paragraph of this paragraph 4(c). (d) If for any reason, whether by law or provisions of Kennametal's employee medical, dental or group insurance, pension or retirement plan or other benefit plans, any benefits which the Employee would be entitled to under the foregoing subparagraph (c) of this paragraph 4 cannot be paid pursuant to such employee benefit plans, then Kennametal hereby contractually agrees to pay to the Employee the difference between the benefits which the Employee would have received in accordance with the foregoing subparagraphs of this paragraph 4 if the relevant employee medical, dental or group insurance or pension or retirement plan or other benefit plan could have paid such benefit and the amount of benefits, if any, actual paid by such employee medical, dental or group insurance or pension or retirement plan or other benefit plan. Kennametal shall not be required to fund its obligation to pay the foregoing difference. (e) In the event of a termination of employment under the circumstances above described in paragraph 4(c), Employee shall have no duty to seek any other employment after termination of Employee's employment with Kennametal and Kennametal hereby waives and agrees not to raise or use any defense based on the position that Employee had a duty to mitigate or reduce the amounts due him hereunder by seeking other employment whether suitable or unsuitable and should Employee obtain other employment, then the only effect of such on the obligations of Kennametal hereunder shall be that Kennametal shall be entitled to credit against any payments which would otherwise be made for medical, dental or group insurance or similar benefits (excluding, however, any credit against Kennametal payments relating to pension or retirement benefits or the Supplemental Executive Retirement Plan) pursuant to the benefit provisions set forth in the second paragraph of paragraph 4(c) hereof, any comparable payments to which Employee is entitled under the employee benefit plans maintained by Employee's other employer or employers in connection with services to such employer or employers after termination of his employment with Kennametal. (f) The term "Change in Control" shall mean a change in control of a nature that would be required to be reported in response to Item 6(e) of Schedule 14A promulgated under the Securities Exchange Act of 1934 as in effect on the date hereof ("1934 Act"), or if Item 6(e) is no longer in effect, any regulations issued by the Securities and Exchange Commission pursuant to the 1934 Act which serve similar purposes; provided that, without limitation, such a change in control shall be deemed to have occurred if (A) Kennametal shall be merged or consolidated with any corporation or other entity other than a merger or consolidation with a corporation or other entity all of whose equity interests are owned by Kennametal immediately prior to the merger or consolidation, or
(B) Kennametal shall sell all or substantially all of its operating properties and assets to another person, group of associated persons or corporation, or (C) any "person" (as such term is used in Sections 13(d) and 14(d) of the 1934 Act), is or becomes a beneficial owner, directly or indirectly, of securities of Kennametal representing 25% or more of the combined voting power of Kennametal's then outstanding securities coupled with or followed by the existence of a majority of the board of directors of Kennametal consisting of persons other than persons who either were directors of Kennametal immediately prior to or were nominated by those persons who were directors of Kennametal immediately prior to such person becoming a beneficial owner, directly or indirectly, of securities of Kennametal representing 25% or more of the combined voting power of Kennametal's then outstanding securities. (g) For purposes of this Agreement "Date of Termination" shall mean: (i) if Employee's employment is terminated due to his death or retirement, the date of death or retirement, respectively; or (ii) if Employee's employment is terminated for any other reason, the date on which the termination becomes effective as stated in the written notice of termination given to or by the Employee. (h) The term "Good Reason" for termination by the Employee shall mean the occurrence of any of the following at or after a Change-in-Control: (i) without the Employee's express written consent, the assignment to the Employee of any duties materially and substantially inconsistent with his positions, duties, responsibilities and status with Kennametal immediately prior to a Change-in-Control, or a material change in his reporting responsibilities, titles or offices as in effect immediately prior to a Change-in-Control, or any removal of the Employee from or any failure to re-elect the Employee to any of such positions, except in connection with the termination of the Employee's employment due to Cause (as hereinafter defined) or as a result of the Employee's death; (ii) a reduction by Kennametal in the Employee's base salary as in effect immediately prior to any Change-in-Control; (iii) a failure by Kennametal to continue to provide incentive compensation, under the rules by which incentives are provided, comparable to that provided by Kennametal immediately prior to any Change-in-Control; (iv) the failure by Kennametal to continue in effect any benefit or compensation plan, stock option plan, pension plan, life insurance plan,
health and accident plan or disability plan in which Employee is participating immediately prior to a Change-in-Control (provided, however, that there shall not be deemed to be any such failure if Kennametal substitutes for the discontinued plan, a plan providing Employee with substantially similar benefits) or the taking of any action by Kennametal which would adversely affect Employee's participation in or materially reduce Employee's benefits under any of such plans or deprive Employee of any material fringe benefit enjoyed by Employee immediately prior to a Change-in-Control; (v) the failure of Kennametal to obtain the assumption of this Agreement by any successor as contemplated in paragraph 11 hereof; (vi) the relocation of the Executive to a facility or a location more than 50 miles from the Executives then present location, without the Executives prior written consent; or (vii) any purported termination of the employment of Employee by Kennametal which is not for Cause as provided in paragraph 5. 5. In the event that Employee (a) shall be guilty of malfeasance, willful misconduct or gross negligence in the performance of the services contemplated by this Agreement, or (b) shall not make his services available to Kennametal on a full time basis in accordance with paragraph 1(a) hereof for any reason (including Disability) other than arising from Employee's incapacity due to physical or mental illness or injury which does not constitute Disability and other than by reason of the fact Employee's employment has been terminated under the circumstances described in paragraph 4(a), or (c) shall breach the provisions of paragraph 8 hereof (the matters described in subparagraphs (a), (b) and (c) are collectively referred to as "Cause"), Kennametal shall have the right, exercised by resolution adopted by a majority of its Board of Directors, to terminate Employee's employment for Cause by giving prior written notice to Employee of its election so to do. In that event, Employee's employment shall be deemed terminated for Cause, Employee shall not be entitled to the benefits set forth in paragraph 4 which shall not be paid or payable and Kennametal only shall have the obligation to pay Employee the unpaid portion of Employee's base salary for the period from the last period from which Employee was paid to the Date of Termination; provided, however, that if Employee's employment is terminated as a result of the Disability of Employee, the benefits set forth in paragraph 4 shall not be paid or payable but Employee shall be entitled to receive the annual supplement under the Supplemental Executive Retirement Plan and Employee's employment by Kennametal shall not be deemed terminated for purposes of the Long-Term Disability Plan, Retirement Income Plan for US Salaried Employees or any other benefit plan which so provides. For purposes of this Agreement "Disability" shall mean such incapacity due to physical or mental illness or injury which results in the Employee's being absent from his principal office at Kennametal's offices for the entire portion of 180 consecutive business days. Prior to a Change-in-Control, a decision by the Board of Directors of Kennametal that "Cause" exists shall be in the discretion of the Board of Directors and shall be final and binding upon the
Employee and his rights hereunder. After a Change-in-Control, "Cause" shall not be deemed to include opposition by Employee to such a Change-in-Control or any matter incidental thereto and any determination by the Board of Directors that "Cause" existed shall not be final or binding upon the Employee or his rights hereunder or entitled to any deference in any court or other tribunal. 6. Employee understands and agrees that, except to the extent Employee is entitled to the benefits provided in paragraph 4(c) hereof, in the event Employee resigns or his employment is terminated for any reason other than death or Disability prior to his "Retirement Date" (as hereinafter defined), he will forfeit any interest he may have in any Kennametal retirement income plan (except to the extent vested by actual service to date of separation as per the plan provisions), and all other benefits dependent upon continuing service. The term "Retirement Date" shall mean the first day of the month following the day on which Employee attains his sixty-fifth birthday, or at Employee's request, any other day that Kennametal's Board of Directors may approve in writing. 7. Nothing herein contained shall affect the right of Employee to participate in and receive benefits under and in accordance with the then current provisions of any retirement income, profit-sharing, additional year-end or periodic remuneration or bonus, incentive compensation, insurance or any other employee welfare plan or program of Kennametal and all payments hereunder shall be in addition to any benefits received thereunder (including long term disability payments). 8. During the period of employment of Employee by Kennametal and for three years thereafter, (provided, however, that this paragraph 8 shall not apply to the Employee following a termination of Employee's employment (x) if a Change-in-Control, shall have occurred prior to the Date of Termination or (y) if Employee's employment is terminated by Kennametal other than for Cause), he will not, in any geographic area in which Kennametal is offering its services and products, without the prior written consent of Kennametal: (a) directly or indirectly engage in, or (b) assist or have an active interest in (whether as proprietor, partner, investor, shareholder, officer, director or any type of principal whatsoever), or (c) enter the employ of, or act as agent for, or advisor or consultant to, any person, firm, partnership, association, corporation or business organization, entity or enterprise which is or is about to become directly or indirectly engaged in, any business which is competitive with any business of Kennametal or any subsidiary or affiliate thereof in which Employee is or was engaged; provided, however, that the foregoing provisions of this paragraph 8 are not intended to prohibit and shall not prohibit Employee from purchasing, for investment, not in excess of I% of any class of stock or other corporate security of any company which is registered pursuant to Section 12 of the Securities Exchange Act of 1934.
Employee acknowledges that the breach by him of the provisions of this paragraph 8 would cause irreparable injury to Kennametal, acknowledges and agrees that remedies at law for any such breach will be inadequate and consents and agrees that Kennametal shall be entitled, without the necessity of proof of actual damage, to injunctive relief in any proceedings which may be brought to enforce the provisions of this paragraph 8. Employee acknowledges and warrants that he will be fully able to earn an adequate livelihood for himself and his dependents if this paragraph 8 should be specifically enforced against him and that such enforcement will not impair his ability to obtain employment commensurate with his abilities and fully acceptable to him. If the scope of any restriction contained in this paragraph 8 is too broad to permit enforcement of such restriction to its full extent, then such restriction shall be enforced to the maximum extent permitted by law and Employee and Kennametal hereby consent and agree that such scope may be judicially modified in any proceeding brought to enforce such restriction. 9. (a) Employee acknowledges and agrees that in the course of his employment by Kennametal, Employee may work with, add to, create or acquire trade secrets and confidential information ("Confidential Information") which could include, in whole or in part, information: (i) of a technical nature such as, but not limited to, Kennametal's manuals, methods, know-how, formulae, shapes, designs, compositions, processes, applications, ideas, improvements, discoveries, inventions, research and development projects, equipment, apparatus, appliances, computer programs, software, systems documentation, special hardware, software development and similar items; or (ii) of a business nature such as, but not limited to, information about business plans, sources of supply, cost, purchasing, profits, markets, sales, sales volume, sales methods, sales proposals, identity of customers and prospective customers, identity of customers' key purchasing personnel, amount or kind of customers' purchases and other information about customers; or (iii) pertaining to future developments such as, but not limited to, research and development or future marketing or merchandising. Employee further acknowledges and agrees that (i) all Confidential Information is the property of Kennametal; (ii) the unauthorized use, misappropriation or disclosure of any Confidential Information would constitute a breach of trust and could cause irreparable injury to Kennametal; and (iii) it is essential to the protection of Kennametal's goodwill and to the maintenance of its competitive position that all Confidential Information be kept secret and that Employee not disclose any Confidential Information to others or use any Confidential Information to the detriment of Kennametal.
Employee agrees to hold and safeguard all Confidential Information in trust for Kennametal, its successors and assigns and Employee shall not (except as required in the performance of Employee's duties), use or disclose or make available to anyone for use outside Kennametal's organization at any time, either during employment with Kennametal or subsequent thereto, any of the Confidential Information, whether or not developed by Employee, without the prior written consent of Kennametal. (b) Employee agrees that: (i) he will promptly and fully disclose to Kennametal or such officer or other agent as may be designated by Kennametal any and all inventions made or conceived by Employee (whether made solely by Employee or jointly with others) during employment with Kennametal (1) which are along the line of the business, work or investigations of Kennametal, or (2) which result from or are suggested by any work which Employee may do for or on behalf of Kennametal; and (ii) he will assist Kennametal and its nominees during and subsequent to such employment in every proper way (entirely at its or their expense) to obtain for its or their own benefit patents for such inventions in any and all countries; the said inventions, without further consideration other than such salary as from time to time may be paid to him by Kennametal as compensation for his services in any capacity, shall be and remain the sole and exclusive property of Kennametal or its nominee whether patented or not; and (iii) he will keep and maintain adequate and current written records of all such inventions, in the form of but not necessarily limited to notes, sketches, drawings, or reports relating thereto, which records shall be and remain the property of and available to Kennametal at all times. (c) Employee agrees that, promptly upon termination of his employment, he will disclose to Kennametal, or to such officer or other agent as may be designated by Kennametal, all inventions which have been partly or wholly conceived, invented or developed by him for which applications for patents have not been made and shall thereafter execute all such instruments of the character hereinbefore referred to, and will take such steps as may be necessary to secure and assign to Kennametal the exclusive rights in and to such inventions and any patents that may be issued thereon any expense therefor to be borne by Kennametal. (d) Employee agrees that he will not at any time aid in attacking the patentability, scope, or validity of any invention to which the provisions of subparagraphs (b) and (c), above, apply.
10. In the event that (a) Employee institutes any legal action to enforce his rights under, or to recover damages for breach of this Agreement, or (b) Kennametal institutes any action to avoid making any payments due to Employee under this Agreement, Employee, if he is the prevailing party, shall be entitled to recover from Kennametal any actual expenses for attorney's fees and other disbursements incurred by him in relation thereto. 11. The terms and provision of this Agreement shall be binding upon, and shall inure to the benefit of, Employee and Kennametal, it subsidiaries and affiliates and their respective successors and assigns. 12. This Agreement and the Letter Agreement constitute the entire agreement between the parties hereto and supersede all prior agreements and understandings, whether oral or written, among the parties with respect to the subject matter hereof. This Agreement may not be amended orally, but only by an instrument in writing signed by each of the parties to this Agreement. 13. The invalidity or unenforceability of any provision of this Agreement shall not affect the other provisions hereof, and this Agreement shall be construed in all respects as if such invalid or unenforceable provision were omitted. 14. Any pronoun and any variation thereof used in this Agreement shall be deemed to refer to the masculine, feminine, neuter, singular or plural, as the identity of the parties hereto may require. 15. Kennametal shall be entitled as a condition to paying any severance pay or providing any benefits hereunder upon a termination of the Employee's employment to require the Employee to deliver on or before the making of any severance payment or providing of any benefit a release in the form of Exhibit E attached hereto. 16. Notwithstanding any other provision of this Agreement, in the event that any payment or benefit received, or to be received, by Employee in connection with a change in control of the Corporation, or the termination of the Employees' employment (whether pursuant to the terms of this Agreement or any other plan, arrangement or agreement with the Corporation, any person whose actions result in a change in control or any person affiliated with the Corporation or such person) (collectively, the "Total Payments") would not be deductible, in whole or in part, as a result of section 28OG of the Internal Revenue Code of 1986 (the "Code") by the Corporation, an affiliate or other person making such payment or providing such benefit, the payments due under this Agreement (the "Contract Payments") shall be reduced until no portion of the Total Payments is not deductible, or the Contract Payments are reduced to zero. In the event that the Corporation determines that the Total Payments would not be deductible, in whole or part, as a result of section 28OG of the Code, the Corporation shall immediately notify Employee of this determination and the amount which would not be so deductible as well as a computation of Total Payments. Employee shall have five (5) business days after receipt of the foregoing notice and computation to waive in writing all or any portion of any of the Total Payments and any portion of the Total Payments the receipt or enjoyment of which Employee shall have effectively
waived in writing shall not be taken into account. If the Corporation had already withheld any Contract Payments prior to receipt of such waiver, the Corporation upon receipt of such waiver shall immediately pay to Employee any withheld Contract Payments which would have been paid had the Corporation had the Employee's written waiver prior to the date the Corporation withheld any such payments. For purposes of this limitation: (a) no portion of the Total Payments shall be taken into account which in the opinion of tax counsel selected by the Corporation's independent auditors and acceptable to Employee does not constitute a "parachute payment" within the meaning of section 28OG(b)(2) of the Code, (b) the Contract Payments shall be reduced only to the extent necessary so that the Total Payments (other than those Contract Payments which are waived in writing by the Employee or referred to in clause (a)) in their entirety constitute reasonable compensation for services actually rendered within the meaning of section 28OG(b)(4) of the Code or are otherwise not subject to disallowance as deductions, in the opinion of the tax counsel referred to in clause (a); and (c) the value of any non-cash benefit or any deferred payment or benefit included in the Total Payments shall be determined by the Corporation's independent auditors in accordance with the principles of section 28OG(d)(3) and (4) of the Code. 17. This Agreement and the Letter Agreement, and any dispute hereunder or thereunder, shall be governed, interpreted, construed and applied in accordance with the laws of the Commonwealth of Pennsylvania, without regard to the conflicts of laws provisions. WITNESS the due execution hereto the day and year first above written. ATTEST: KENNAMETAL INC. /s/ Susan Melbourne /s/ David W. Greenfield Susan Melbourne By: David W. Greenfield Vice President, Secretary and General Counsel WITNESS: EMPLOYEE: /s/ Jacqueline L. Zitt /s/ Carlos M. Cardoso Jacqueline L. Zitt Carlos M. Cardoso President, Metalworking Solutions and Services Group
EXHIBIT 10.16 KENNAMETAL INC. STOCK AND INCENTIVE PLAN OF 2002 (AS AMENDED ON JULY 29, 2003) SECTION 1. ESTABLISHMENT. There is hereby established the Kennametal Inc. Stock and Incentive Plan of 2002 (hereinafter called the "Plan") pursuant to which Eligible Individuals who are or will be mainly responsible for its continued growth and development and future financial success may be granted Awards in order to secure to the Company the advantage of the incentive and sense of proprietorship inherent in stock ownership by such persons, to further align such person's interests with those of the shareowners, to reward such persons for services previously performed and/or as an added inducement to continue to provide service to the Company. SECTION 2. CERTAIN DEFINITIONS. As used herein or, unless otherwise specified, in any document with respect to an Award, the following definitions shall apply: (a) "Affiliate" of a person means a person controlling, controlled by, or under common control with such person where control means the power to direct the policies and practices of such person. (b) "Award" means any Incentive Bonus Award, Option, Performance Share Award, Performance Unit Award, Restricted Stock Award, Restricted Unit Award, SAR, Share Award or Stock Unit Award granted under the Plan. (c) "Board" means the Board of Directors of the Company. (d) "Business Combination" shall mean a merger or consolidation of the Company with another corporation or entity, other than a corporation or entity which is an Affiliate. (e) "Capital Stock" means the Capital Stock, par value $1.25 per share, of the Company as adjusted pursuant to Section 10 of this Plan. (f) "Change in Control" shall mean a change in control of the Company of a nature that would be required to be reported in response to Item 6(e) of Schedule 14A promulgated under the Exchange Act as in effect on the date thereof or, if Item 6(e) is no longer in effect, any regulations issued which serve similar purposes; provided that, without limitation, such a Change in Control shall be deemed to have occurred if: (i) a Business Combination shall have occurred, or (ii) the Company shall sell all or substantially all of its operating properties and assets to another person, group of associated persons or corporation, excluding any Affiliate of the Company, if any, or (iii) any "person" (as such term is used in Sections 13(d) and 14(d) of the Exchange Act) is or becomes a beneficial owner, directly or indirectly, of securities of the Company representing 25% or more of the combined voting power of the Company's then
outstanding securities coupled with or followed by the election as directors of the Company of persons who were not directors at the time of such acquisition if such person shall elect a majority of the Board. (g) "Code" means the Internal Revenue Code of 1986, as amended. (h) "Committee" means a committee of the Board. (i) "Company" means Kennametal Inc., a Pennsylvania corporation. (j) "Consultant" means any person, including an advisor, who is engaged by the Company or any Parent or Subsidiary of the Company to render services and is compensated for such services. (k) "Continuous Status as an Employee" means the absence of any interruption or termination of the employment relationship by the Employee with the Company or any Parent or Subsidiary of the Company. Continuous Status as an Employee shall not be considered interrupted in the case of: (i) sick leave; (ii) military leave; (iii) any other leave of absence approved by the Plan Administrator; or (iv) transfers between locations of the Company or between the Company, its Parents, its Subsidiaries or its successor. (l) "Disability" means disability as determined by the Company's disability policy as in effect from time to time or as determined by the Plan Administrator consistent therewith. (m) "Eligible Individual" means any Employee or Consultant. (n) "Employee" means any person, including officers and directors, employed by the Company or any Parent or Subsidiary of the Company or any prospective employee who shall have received an offer of employment from the Company or any Parent or Subsidiary of the Company. The payment of a director's fee by the Company shall not be sufficient to constitute "employment" by the Company. (o) "Exchange Act" means the Securities Exchange Act of 1934, as amended. (p) "Fair Market Value" means, as of any date, the value of the Capital Stock determined as follows: (i) If the Capital Stock is listed on any established stock exchange, system or market, its Fair Market Value shall be the mean between the highest and lowest sales prices for the Capital Stock as quoted on such exchange, system or market for the last trading day prior to the time of determination as reported in the Wall Street Journal or such other source as the Plan Administrator deems reliable and; (ii) In the absence of an established market for the Capital Stock, the Fair Market Value thereof shall be determined in good faith by the Plan Administrator. (q) "Grantee" means an Eligible Individual who has been granted an Award. -2-
(r) "Incentive Bonus Award" means the opportunity to earn a future cash payment tied to the level of achievement with respect to one or more Qualifying Performance Criteria for a performance period as established by the Plan Administrator. (s) "Incentive Stock Option" means an Option intended to qualify as an incentive stock option within the meaning of Section 422 of the Code. (t) "Non-Employee Director" means a member of the Board who is not an employee of the Company or any Parent or Subsidiary of the Company. (u) "Nonstatutory Stock Option" means an Option not intended to qualify as an Incentive Stock Option. (v) "Option" means a right to purchase Shares granted pursuant to the Plan. (w) "Optionee" means a Participant who holds an Option or SAR. (x) "Original Option Period" means the initial period or periods for which an Option or SAR may be exercised as determined by the Plan Administrator at the time of the Award or, if no such determination is made, a period of 10 years from the date of grant of the Award. (y) "Parent" means a "parent corporation," whether now or hereafter existing, as defined in Section 424(e) of the Code. (z) "Participant" means any person who has an Award under the Plan including any person (including any estate) to whom an Award has been assigned or transferred in accordance with the Plan. (aa) "Performance Share Award" means a grant of a right to receive Shares or Stock Units contingent on the achievement of performance or other objectives during a specified period. (bb) "Performance Unit Award" means a grant of a right to receive a designated dollar value amount of Shares or Stock Units contingent on the achievement of performance or other objectives during a specified period. (cc) "Plan" means this Stock and Incentive Plan of 2002. (dd) "Plan Administrator" means the Board and/or any Committee appointed by the Board to administer the Plan; provided, however, that the Board, in its sole discretion, may, notwithstanding the appointment of any Committee to administer the Plan, exercise any authority under this Plan. (ee) "Prior Stock Plans" means the Kennametal Inc. Stock Option and Incentive Plan of 1988, the Kennametal Inc. Stock Option and Incentive Plan of 1992, the Kennametal Inc. Stock Option and Incentive Plan of 1996, the Kennametal Inc. 1999 Stock Plan, and the Kennametal Inc. Stock Option and Incentive Plan of 1999. -3-
(ff) "Qualifying Performance Criteria" means any one or more of the following performance criteria, either individually, alternatively or in any combination, applied to either the Company as a whole or to a business unit or Subsidiary, either individually, alternatively or in any combination, and measured over a period of time including any portion of a year, annually or cumulatively over a period of years, on an absolute basis or relative to a pre-established target, to previous years' results or to a designated comparison group, in each case as specified in the Award: (a) cash flow, (b) earnings (including earnings before interest, taxes, depreciation, and amortization or some variation thereof), (c) stock price, (d) return on equity, (e) total stockholder return, (f) return on capital, (g) return on assets or net assets, (h) revenue, (i) income or net income, (j) operating income or net operating income, (k) operating profit or net operating profit, (l) operating margin or profit margin, (m) return on operating revenue, and (n) market share. To the extent consistent with Section 162(m) of the Code, the Plan Administrator shall appropriately adjust any evaluation of performance under a Qualifying Performance Criteria to exclude any of the following events that occurs during a performance period: (i) asset write-downs, (ii) litigation or claim judgments or settlements, (iii) the effect of changes in tax law, accounting principles or other such laws or provisions affecting reported results, (iv) accruals for reorganization and restructuring programs and (v) any extraordinary non-recurring items as described in management's discussion and analysis of financial condition and results of operations or the financial statements and notes thereto appearing in the Company's annual report to shareowners for the applicable year. (gg) "Restricted Stock Award" means a grant of Shares subject to a risk of forfeiture or other restrictions that will lapse upon the achievement of one or more goals relating to completion of service by the Grantee, or achievement of performance or other objectives, as determined by the Plan Administrator. (hh) "Restricted Unit Award" means a grant of Stock Units subject to a risk of forfeiture or other restrictions that will lapse upon the achievement of one or more goals relating to completion of service by the Participant, or achievement of performance or other objectives, as determined by the Plan Administrator. (ii) "Retirement" means, in the case of an Employee, the termination of employment with the Company or any Subsidiary or Parent of the Company at a time when the Employee is eligible to receive immediately payable retirement benefits under a then existing retirement plan and, in the case of a Non-Employee Director, means retirement from service on the Board. (jj) "SAR" means a stock appreciation right, which is the right to receive a payment in cash, Shares or Stock Units equal to the amount of appreciation, if any, in the Fair Market Value of a Share from the date of the grant of the right to the date of its payment. (kk) "Share" means a share of Capital Stock. (ll) "Share Award" means a grant of Shares without a risk of forfeiture and without other restrictions. (mm) "Stock Unit" means the right to receive a Share at a future point in time. -4-
(nn) "Stock Unit Award" means the grant of a Stock Unit without a risk of forfeiture and without other restrictions. (oo) "Subsidiary" means a "subsidiary corporation," whether now or hereafter existing, as defined in Section 424(f) of the Code. SECTION 3. ADMINISTRATION. (a) The Plan shall be administered by the Plan Administrator. (b) Subject to the provisions of this Plan and, in the case of a Committee, the specific duties delegated to or limitations imposed upon such Committee by the Board, the Plan Administrator shall have the authority, in its discretion: (i) to establish, amend and rescind rules and regulations relating to the Plan; (ii) to select the Eligible Individuals to whom Awards may from time to time be granted hereunder; (iii) to determine the amount and type of Awards, including any combination thereof, to be granted to any Eligible Individual; (iv) subject to Section 3(c) hereof, to grant Awards to Eligible Individuals and, in connection therewith, to determine the terms and conditions, not inconsistent with the terms of this Plan, of any such Award including, but not limited to, the number of Shares or Stock Units that may be issued or amount of cash that may be paid pursuant to the Award, the exercise or purchase price of any Share or Stock Unit, the circumstances under which Awards or any cash, Shares or Stock Units relating thereto are issued, retained, become exercisable or vested, are no longer subject to forfeiture or are terminated, forfeited or expire, based in each case on such factors as the Plan Administrator shall determine, in its sole discretion; (v) to determine the Fair Market Value of the Capital Stock, in accordance with this Plan; (vi) to establish, verify the extent of satisfaction of, or adjust any performance goals or other conditions applicable to the grant, issuance, exercisability, vesting and/or ability to retain any Award; (vii) to approve forms of agreement for use under the Plan; (viii) to determine whether and under what circumstances an Award may be settled in cash instead of Shares or Stock Units; (ix) to determine whether, to what extent and under what circumstances Shares and other amounts payable with respect to an Award under this Plan shall be deferred either automatically or at the election of the participant (including providing for -5-
and determining the amount, if any, of any deemed earnings on any deferred amount during any deferral period); (x) to determine whether and to what extent an adjustment is required under Section 10 of this Plan; (xi) to interpret and construe this Plan, any rules and regulations under this Plan and the terms and conditions of any Award granted hereunder, and to make exceptions to any such provisions in good faith and for the benefit of the Company; and (xii) to make all other determinations deemed necessary or advisable for the administration of this Plan. (c) Notwithstanding anything contained in this Plan, the Plan Administrator may not: (i) grant any Option or SAR in substitution for an outstanding Option or SAR except as provided in Section 10(b); (ii) reduce the exercise price of an outstanding Option or SAR, whether through amendment, cancellation or replacement of such Option or SAR, unless such reduction is approved by the shareowners of the Company; (iii) grant a Restricted Stock Award or Restricted Unit Award with a risk of forfeiture or restriction that lapses earlier than at the rate of one-third of the Shares subject to the Award on each of the first, second and third anniversary of the date of grant; provided, however, that the Plan Administer may grant a Restricted Stock Award or Restricted Unit Award with a risk of forfeiture or restriction that lapses upon the later to occur of (x) the date of achievement of one or more performance criteria and (y) the one year anniversary of the date of grant of the Award; (iv) grant a Performance Share Award or Performance Unit Award that vests earlier than the later to occur of (x) the date of achievement of one or more performance criteria and (y) the one year anniversary of the date of the Award; (v) lapse or waive restrictions applicable to any Restricted Stock Award, Restricted Unit Award, Performance Share Award, or Performance Unit Award; or (vi) grant any Share Award or Stock Unit Award to any officer or director of the Company except in lieu of salary or cash bonus. (d) The limitations of Section 3(c) shall not apply to Awards for up to ten percent of the Shares under the Plan granted by a Committee composed entirely of "independent directors" (under all definitions of independence then applicable to the Company). -6-
(e) Except as specifically provided in this Plan, no action of the Plan Administrator shall deprive any person without such person's consent of any rights theretofore granted pursuant hereto. (f) All decisions, determinations and interpretations of the Plan Administrator shall be final and binding on all Participants. SECTION 4. SHARES SUBJECT TO THE PLAN. (a) The aggregate number of Shares which may be issued pursuant to the Plan shall be 1,750,000 plus Shares added to the Plan from the Prior Stock Plans pursuant to Sections 4(d) and 4(e) hereof. (b) Upon shareowner approval of this Plan, no further grants or awards of any kind shall be made by the Company under its Prior Stock Plans. (c) The number of Shares which may be issued under the Plan and covered by outstanding Awards is subject to adjustment as provided in Section 10. (d) To the extent that Options granted under the Plan or under the Prior Stock Plans shall expire or terminate without being exercised or Shares awarded under the Plan or under the Prior Stock Plans shall be forfeited, such Shares shall remain available or be added to and shall increase the number of Shares available for purposes of the Plan. (e) Shares delivered in payment of the purchase price in connection with the exercise of Options or Shares delivered or withheld to pay tax withholding obligations or otherwise under the Plan or under the Prior Stock Plans shall be added to and shall increase the number of Shares available for purposes of the Plan. (f) The aggregate number of Shares that may be issued pursuant to Incentive Stock Options shall be limited to 1,750,000. Notwithstanding anything to the contrary in this Plan, the foregoing limitation shall be subject to adjustment under Section 10, but only to the extent that such adjustment will not affect the status of any Award intended to qualify as an Incentive Stock Option. The foregoing limitation shall not apply to the extent that it is no longer required in order for Options to qualify as Incentive Stock Options. (g) The aggregate number of Shares issuable under all Awards granted under this Plan during any fiscal year to any one Eligible Individual shall not exceed 500,000. Notwithstanding anything to the contrary in this Plan, the foregoing limitation shall be subject to adjustment under Section 10, but only to the extent that such adjustment will not affect the status of any Award intended to qualify as "performance-based compensation" under Section 162(m) of the Code. The foregoing limitation shall not apply to the extent that it is no longer required in order for compensation in connection with grants under this Plan to be treated as "performance-based compensation" under Section 162(m) of the Code. (h) Capital Stock to be issued under the Plan may be either authorized and unissued Shares or Shares held in treasury by the Company. -7-
SECTION 5. TERMS OF OPTIONS AND SARs. Each Option and SAR granted under the Plan shall be evidenced by a written document (including an electronic version thereof) and shall be subject to the following terms and conditions: (a) Subject to adjustment as provided in Section 10 of this Plan, the price at which a Share covered by an Option may be purchased shall not be less than the Fair Market Value thereof at the time the Option is granted. If required by the Code, if an Optionee owns (or is deemed to own under applicable provisions of the Code and rules and regulations promulgated thereunder) more than ten percent (10%) of the combined voting power of all classes of the stock of the Company (or any Parent or Subsidiary of the Company) and an Option granted to such Optionee is intended to qualify as an Incentive Stock Option, the price at which a Share covered by an Option may be purchased shall be not less than 110% of the Fair Market Value thereof at the time the Option is granted. (b) The aggregate Fair Market Value of Shares with respect to which Incentive Stock Options are first exercisable by the Optionee in any calendar year (under all plans of the Company and its Subsidiaries and Parent) shall not exceed the limitations, if any, imposed by the Code. (c) If any Option designated as an Incentive Stock Option, either alone or in conjunction with any other Option or Options, exceeds the foregoing limitation, or does not otherwise qualify for treatment as an Incentive Stock Option, all or the portion of such Option in excess of such limitation shall automatically be reclassified (in whole Share increments and without fractional Share portions) as a Nonstatutory Stock Option, with later granted Options being so reclassified first. (d) Except as otherwise provided by the Plan Administrator, during the lifetime of the Optionee the Option or SAR may be exercised only by the Optionee and the Option or SAR shall not be transferable by the Optionee other than by will or by the laws of descent and distribution or pursuant to a domestic relations order. After the death of the Optionee, the Option or SAR may be transferred to the Company upon such terms and conditions, if any, as the Plan Administrator and the personal representative or other person entitled to the Option may agree within the period specified in this Section 5. (e) An Option or SAR may be exercised in whole at any time, or in part from time to time, within the Original Option Period; provided, however, that, unless otherwise provided by the Plan Administrator: (i) If the Optionee is an Employee who shall cease to be employed by the Company or any Subsidiary or Parent of the Company by reason of death, Disability or Retirement, the Option or SAR may be exercised only within three years after termination of employment and within the Original Option Period; (ii) If the Optionee is an Employee who shall cease to be employed by the Company or any Subsidiary or Parent of the Company by reason of termination of the Optionee for cause, the Option or SAR shall forthwith terminate and the Optionee shall -8-
not be permitted to exercise the Option or SAR following the Optionee's termination of employment; (iii) If the Optionee is an Employee who shall cease to be employed by the Company or any Subsidiary or Parent of the Company by reason of the Optionee's voluntary termination or a termination of the Optionee other than for cause, the Option or SAR may be exercised only within the three months after the termination of employment and within the Original Option Period; (iv) If the Optionee is a Non-Employee Director who shall cease to serve on the Board, the Option or SAR may be exercised only within three months after the cessation of Board service and within the Original Option Period or, if such cessation was due to death, Disability or Retirement, within three years after cessation of Board service and within the Original Option Period, unless such cessation of service as a Non-Employee Director was the result of removal for cause, in which case the Option or SAR shall forthwith terminate; (v) Notwithstanding anything to the contrary contained in this Plan, each Option or SAR held by an Employee who is terminated by the Company or any Subsidiary or Parent of the Company for any reason during the two-year period following a Change in Control or a Non-Employee Director who is removed from the Board for any reason during the two-year period following a Change in Control shall immediately vest and may be exercised at any time within the three-month period after the termination of employment or cessation of Board service regardless of the Original Option Period; (vi) If the Optionee shall die, the Option or SAR may be exercised by the Optionee's personal representative or persons entitled thereto under the Optionee's will or the laws of descent and distribution; (vii) Except as provided in Sections 5(e)(v), (ix) and (x), the Option or SAR may not be exercised for more Shares (subject to adjustment as provided in Section 10) after the termination of the Optionee's employment, cessation of service as a Non-Employee Director or the Optionee's death (as the case may be) than the Optionee was entitled to purchase thereunder at the time of such Optionee's termination of employment, cessation of service as a Non-Employee Director or the Optionee's death; (viii) To the extent provided by the Code, if an Optionee owns (or is deemed to own under applicable provisions of the Code and rules and regulations promulgated thereunder) more than 10% of the combined voting power of all classes of stock of the Company (or any Parent or Subsidiary of the Company) at the time an Option is granted to such Optionee and such Option is intended to qualify as an Incentive Stock Option, the Option, if not exercised within five years from the date of grant or any other period proscribed by the Code, will cease to be an Incentive Stock Option; (ix) If the Optionee is an Employee who shall cease to be employed by the Company or any Subsidiary or Parent of the Company or is a Non-Employee Director who shall cease to serve on the Board by reason of death or Disability, as the case may be, -9-
all Options and SARs held by the Optionee shall automatically vest and become exercisable in full as of the date that the Optionee's employment with the Company or any Subsidiary or Parent of the Company or service on the Board ceased; and (x) In the event that an Optionee ceases to be employed by the Company or any Subsidiary or Parent of the Company or to serve on the Board, as the case may be, as a result of such Optionee's Retirement, all Options and SARs held by the Optionee which are not vested on the date of Retirement shall continue to vest and become exercisable in accordance with their original vesting schedule during the two-year period following such Optionee's Retirement. Any Options or SARs which remain unvested on the second anniversary of such Optionee's Retirement shall forthwith terminate on such date. In the event of the death or Disability of such Optionee during the two-year period following Retirement, all Options or SARs held by the Optionee shall automatically vest and become exercisable in full. (f) Except as otherwise provided by the Plan Administrator, the purchase price of each Share purchased pursuant to an Option shall be paid in full at the time of each exercise (the "Payment Date") of the Option (i) in cash; (ii) by delivering to the Company a notice of exercise with an irrevocable direction to a registered broker-dealer under the Securities Exchange Act of 1934, as amended, to sell a sufficient portion of the Shares and deliver the sale proceeds directly to the Company to pay the exercise price; (iii) through the delivery to the Company (by attestation of Share ownership or as otherwise provided by the Plan Administrator) of previously-owned Shares having an aggregate fair market value equal to the price of the Shares being purchased pursuant to the Option; provided, however, that Shares delivered in payment of the Option price must have been purchased in the open market or held by the Participant for at least six (6) months in order to be utilized to pay the purchase price of the Option or must meet such other conditions as established by the Plan Administrator; or (iv) through any combination of the payment procedures set forth in subsections (i)-(iii) of this Section 5(f). (g) Exercise of an Option or SAR in any manner shall result in a decrease in the number of Shares which thereafter may be available under the Option or SAR by the number of Shares as to which the Option or SAR is exercised. In addition, in the event of an Option granted in tandem with an SAR, the exercise of the Option in any manner shall result in a decrease in the number of Shares which thereafter may be available under the SAR by the number of Shares as to which the Option is exercised, and the exercise of the SAR in any manner shall result in a decrease in the number of Shares which thereafter may be available under the Option by the number of Shares as to which the SAR is exercised. (h) The Plan Administrator, in its discretion, may authorize the issuance of "stock retention Options" under this Plan which provide, upon the exercise of an Option granted under this Plan or under any other stock plan (a "prior Option") and payment of the purchase price using previously-owned Shares, for the automatic issuance of a new Option under this Plan for up to the number of Shares equal to the number of previously-owned Shares delivered in payment of the exercise price of the prior Option, with an exercise price equal to the current Fair Market Value and for a term equal to the term of the prior Option. -10-
(i) The Plan Administrator may include such other terms and conditions of Options or SARs not inconsistent with the foregoing as the Plan Administrator shall approve. Without limiting the generality of the foregoing sentence, the Plan Administrator shall be authorized to determine that Options or SARs shall be exercisable in one or more installments during the term of the Option or SAR as determined by the Plan Administrator. SECTION 6. PERFORMANCE SHARE AWARDS, PERFORMANCE UNIT AWARDS, RESTRICTED STOCK AWARDS, RESTRICTED UNIT AWARDS, SHARE AWARDS AND STOCK UNIT AWARDS. (a) Subject to the terms of this Plan, including Section 3(c) hereof, Performance Share Awards, Performance Unit Awards, Restricted Stock Awards, Restricted Unit Awards, Share Awards or Stock Unit Awards may be issued by the Plan Administrator to Eligible Individuals, either alone, in addition to, or in tandem with other Awards granted under the Plan and/or cash awards made outside of this Plan. Such Awards shall be evidenced by a written document (including an electronic version thereof) containing any provisions regarding (i) the number of Shares or Stock Units subject to such Award or a formula for determining such, (ii) the purchase price of the Shares or Stock Units, if any, and the means of payment for the Shares or Stock Units, (iii) the performance criteria, if any, and level of achievement versus these criteria that shall determine the number of Shares or Stock Units granted, issued, retainable and/or vested, (iv) such terms and conditions on the grant, issuance, vesting and/or forfeiture of the Shares or Stock Units as may be determined from time to time by the Plan Administrator, including continued employment or service, (v) restrictions on the transferability of the Shares or Stock Units and (vi) such further terms and conditions in each case not inconsistent with this Plan as may be determined from time to time by the Plan Administrator. (b) The grant, issuance, retention and/or vesting of Shares or Stock Units pursuant to any Performance Share Award, Performance Unit Award, Restricted Stock Award or Restricted Unit Award shall occur at such time and in such installments as determined by the Plan Administrator or under criteria established by the Plan Administrator and consistent with this Plan, including Section 3(c) hereof. The Plan Administrator shall have the right to make the timing of the grant and/or the issuance, ability to retain and/or vesting of Shares or Stock Units subject to continued employment, passage of time and/or such performance criteria as deemed appropriate by the Plan Administrator and consistent with this Plan, including Section 3(c) hereof. Notwithstanding anything to the contrary herein, the performance criteria for any Award that is intended to satisfy the requirements for "performance-based compensation" under Section 162(m) of the Code shall be a measure based on one or more Qualifying Performance Criteria selected by the Plan Administrator and specified at the time the Award is granted. (c) Notwithstanding the foregoing, no single Share Award or Stock Unit Award to any one Grantee in any fiscal year shall be for more than 200 Shares. (d) With respect to any Performance Share Award, Performance Unit Award, Restricted Stock Award or Restricted Unit Award: (i) If, prior to a Change in Control, the designated goals have not been achieved within the designated period or the Grantee ceases to be employed by the Company or ceases to serve on the Board for any reason other than death, Disability or -11-
Retirement prior to the lapse of any restrictions or vesting of the Award, the Grantee shall forfeit such Award; (ii) In the event that a Grantee ceases to be an Employee or to serve on the Board as a result of such Grantee's death, Disability or Retirement, all outstanding Awards held by such Grantee shall automatically vest and all restrictions shall lapse as of the date of such Grantee's death, Disability or Retirement; (iii) Notwithstanding anything to the contrary contained in this Plan, each Award held by an Employee who is terminated by the Company or any Subsidiary or Parent of the Company for any reason during the two-year period following a Change in Control or a Non-Employee Director who is removed from the Board for any reason during the two-year period following a Change in Control shall automatically vest and all restrictions shall lapse as of the date of such Grantee's termination of employment or cessation of Board service; and (iv) During the lifetime of the Grantee, the Award shall not be transferable otherwise than by will or by the laws of descent and distribution or pursuant to a domestic relations order. (e) Except as otherwise provided by the Plan Administrator, a Grantee who has received a Restricted Stock Award shall have all rights of a shareowner in such Shares including, but not limited to, the right to vote and receive dividends with respect thereto from and after the date of grant of such Award; provided, however, that Shares awarded pursuant to the Plan which have not vested or which contain restrictions or conditions may not be sold or otherwise transferred by the Grantee and stock certificates representing such Shares may bear a restrictive legend to that effect. SECTION 7. INCENTIVE BONUS AWARDS. (a) Each Incentive Bonus Award will confer upon the Employee the opportunity to earn a future payment tied to the level of achievement with respect to one or more performance criteria established for a performance period established by the Plan Administrator. (b) Each Incentive Bonus Award shall be evidenced by a document containing provisions regarding (a) the target and maximum amount payable to the Employee, (b) the performance criteria and level of achievement versus these criteria that shall determine the amount of such payment, (c) the term of the performance period as to which performance shall be measured for determining the amount of any payment, (d) the timing of any payment earned by virtue of performance, (e) restrictions on the alienation or transfer of the bonus prior to actual payment, (f) forfeiture provisions and (g) such further terms and conditions, in each case not inconsistent with this Plan as may be determined from time to time by the Plan Administrator. The maximum amount payable as a bonus may be a multiple of the target amount payable, but the maximum amount payable pursuant to that portion of an Incentive Bonus Award granted under this Plan for any fiscal year to any Employee that is intended to satisfy the requirements for "performance-based compensation" under Section 162(m) of the Code shall not exceed $2,000,000. -12-
(c) The Plan Administrator shall establish the performance criteria and level of achievement versus these criteria that shall determine the target and maximum amount payable under an Incentive Bonus Award, which criteria may be based on financial performance and/or personal performance evaluations. The Plan Administrator may specify the percentage of the target incentive bonus that is intended to satisfy the requirements for "performance-based compensation" under Section 162(m) of the Code. Notwithstanding anything to the contrary herein, the performance criteria for any portion of an Incentive Bonus Award that is intended by the Plan Administrator to satisfy the requirements for "performance-based compensation" under Section 162(m) of the Code shall be a measure based on one or more Qualifying Performance Criteria selected by the Plan Administrator and specified at the time the Incentive Bonus Award is granted. The Plan Administrator shall certify the extent to which any Qualifying Performance Criteria has been satisfied, and the amount payable as a result thereof, prior to payment of any incentive bonus that is intended to satisfy the requirements for "performance-based compensation" under Section 162(m) of the Code. (d) The Plan Administrator shall determine the timing of payment of any incentive bonus. The Plan Administrator may provide for or, subject to such terms and conditions as the Plan Administrator may specify, may permit an election for the payment of any incentive bonus to be deferred to a specified date or event. An Incentive Bonus Award may be payable in Shares, Stock Units or in cash or other property, including any Award permitted under this Plan. (e) Notwithstanding satisfaction of any performance goals, the amount paid under an Incentive Bonus Award on account of either financial performance or personal performance evaluations may be reduced by the Plan Administrator on the basis of such further considerations as the Plan Administrator shall determine. SECTION 8. NON-EMPLOYEE DIRECTOR AWARDS. Notwithstanding anything to the contrary contained in this Plan, each Non-Employee Director shall only be entitled to receive the following Awards under this Plan, which Awards will be made on the day following the first regular Board meeting of each fiscal year beginning in fiscal year 2004: (a) Each Non-Employee Director shall receive a Nonstatutory Stock Option to purchase up to 5,000 shares, as determined by the Board, at Fair Market Value, such Option to Vest as to exercisability in 3 equal, annual installments and to have a term of ten (10) years. (b) Each Non-Employee Director shall receive a Restricted Stock Award for Shares with a Fair Market Value of up to $10,000, as determined by the Board, rounded to the nearest whole Share. Such Awards shall vest and the restrictions on transfer shall lapse as to one-third of the Shares subject to the Award on each anniversary of the date of grant provided that the Non-Employee Director continues to serve on the Board. (c) Each new Non-Employee Director shall receive, as of the first date of service on the Board, a Nonstatutory Stock Option to purchase twice the number of Shares provided in the Nonstatutory Stock Option most recently granted to the Non-Employee Directors -13-
(other than the lead director) and a Restricted Stock Award based on the number of Shares provided in the Restricted Stock Award most recently granted to the Non-Employee Directors (other than the lead director) but pro rated for the amount of the fiscal year remaining as of the first date of service. SECTION 9. TAX WITHHOLDING. (a) Whenever Shares are to be issued under the Plan, the Company shall have the right to require the Grantee to remit to the Company an amount sufficient to satisfy federal, state and local tax withholding requirements prior to the delivery of any certificate for such Shares; provided, however, that in the case of a Grantee who receives an Award of Shares under the Plan which is not fully vested, the Grantee shall remit such amount on the first business day following the Tax Date. The "Tax Date" for purposes of this Section 9 shall be the date on which the amount of tax to be withheld is determined. If an Optionee makes a disposition of Shares acquired upon the exercise of an Incentive Stock Option within the applicable disqualifying period, the Optionee shall promptly notify the Company and the Company shall have the right to require the Optionee to pay to the Company an amount sufficient to satisfy federal, state and local tax withholding requirements. (b) A Participant who is obligated to pay the Company an amount required to be withheld under applicable tax withholding requirements may pay such amount (i) in cash; (ii) in the discretion of the Plan Administrator, through the withholding by the Company of Shares otherwise deliverable to the Participant or through the delivery by the Participant to the Company of previously-owned Shares in each case having an aggregate Fair Market Value on the Tax Date equal to the tax obligation; or (iii) in the discretion of the Plan Administrator, through a combination of the foregoing. SECTION 10. ADJUSTMENT OF NUMBER AND PRICE OF SHARES. (a) In the event of a corporate transaction involving the Company (including, without limitation, any stock dividend, stock split, reverse stock split, extraordinary cash dividend, recapitalization, reorganization, merger, consolidation, split-up, spin-off, combination or exchange of shares), the Plan Administrator may adjust Awards to preserve the benefits or potential benefits of the Awards. Action by the Plan Administrator may include: (i) adjustment of the number and kind of securities which may be delivered under the Plan; (ii) adjustment of the number and kind of securities subject to outstanding Awards; (iii) adjustment of the exercise price of outstanding Options and SARs; (iv) adjustment of the share limitations contained in this Plan; and (v) any other adjustments that the Plan Administrator determines to be equitable. Any such adjustment shall be effective and binding for all purposes of the Plan and on each outstanding Award. (b) Without limiting the foregoing, in the event that, by reason of a corporate merger, consolidation, acquisition of property or stock, separation, reorganization or liquidation, the Board shall authorize the issuance or assumption of an Option in a transaction to which Section 424(a) of the Code applies, then, notwithstanding any other provision of the Plan, the Plan Administrator may grant an Option upon such terms and conditions as it may deem appropriate for the purpose of assumption of the old Option, or substitution of a new Option for -14-
the old Option, in conformity with the provisions of Code Section 424(a) and the rules and regulations thereunder, as they may be amended from time to time. (c) No adjustment or substitution provided for in this Section 10 shall require the Company to issue or to sell a fractional share and the total adjustment or substitution with respect to each Award agreement shall be limited accordingly. (d) Without limiting the foregoing, and notwithstanding anything to the contrary contained in the Plan or any document with respect to any Award, in the event of a Business Combination under the terms of which the holders of Capital Stock of the Company will receive upon consummation thereof cash for each share of Capital Stock of the Company surrendered pursuant to such Business Combination (the "Cash Purchase Price"), the Plan Administrator may provide that all outstanding Awards representing the right to purchase or receive Shares shall terminate upon consummation of the Business Combination and each such Award, including each Option and SAR, shall receive, in exchange therefor, a cash payment equal to the amount (if any) by which (i) the Cash Purchase Price multiplied by the number of Shares subject to such Award held by such Grantee exceeds (ii) the aggregate purchase or exercise price, if any, thereof. SECTION 11. CHANGE IN CONTROL. Unless the Board shall determine by resolution prior to a Change in Control, in the event of a Change in Control, the following provisions shall apply to Awards previously granted under the Plan, notwithstanding any provision herein or in any agreement to the contrary: (a) All Options which provide for exercise in one or more installments shall become immediately exercisable in full immediately prior to the Change in Control; and (b) All Awards which have not previously vested shall become vested and all restrictions on Awards shall lapse immediately prior to the Change in Control. SECTION 12. TERMINATION OF EMPLOYMENT AND FORFEITURE. Notwithstanding any other provision of the Plan (other than provisions regarding Change in Control, which shall apply in all events), a Participant shall have no right to exercise any Option or vest in any Shares awarded under the Plan if following the Participant's termination of employment with the Company or any Subsidiary or Parent of the Company and within a period of two years thereafter, the Participant engages in any business or enters into any employment which the Board in its sole discretion determines to be either directly or indirectly competitive with the business of the Company or substantially injurious to the Company's financial interest (the occurrence of an event described above shall be referred to herein as "Injurious Conduct"). Furthermore, notwithstanding any other provision of the Plan to the contrary, in the event that a Participant receives or is entitled to the delivery or vesting of cash or Shares pursuant to an Award made during the 12-month period prior to the Participant's termination of employment with the Company or any Subsidiary or Parent of the Company or during the 24-month period following the Participant's termination of such employment, then the Board, in its sole discretion, may require the Participant to return or forfeit to the Company the cash or Capital Stock received with respect to such Award (or its economic value as of (i) the date of the exercise of the Option -15-
or (ii) the date of grant or payment with respect to any other Award, as the case may be) in the event that the participant engages in Injurious Conduct. SECTION 13. AMENDMENT AND DISCONTINUANCE. The Board may alter, amend, suspend or discontinue the Plan, provided that no such action shall deprive any person without such person's consent of any rights theretofore granted pursuant hereto and, provided further, that the Board may not materially amend this Plan without shareowner approval. SECTION 14. COMPLIANCE WITH GOVERNMENTAL REGULATIONS. Notwithstanding any provision of the Plan or the terms of any agreement entered into pursuant to the Plan, the Company shall not be required to issue any securities hereunder prior to registration of the Shares subject to the Plan under the Securities Act of 1933, as amended, or the Exchange Act, if such registration shall be necessary, or before compliance by the Company or any Participant with any other provisions of either of those acts or of regulations or rulings of the Securities and Exchange Commission thereunder, or before compliance with other federal and state laws and regulations and rulings thereunder, including the rules of the New York Stock Exchange, Inc. and any other exchange or market on which the Shares are listed or quoted. The Company shall use its reasonable best efforts to effect such registrations and to comply with such laws, regulations and rulings forthwith upon advice by its counsel that any such registration or compliance is necessary. SECTION 15. COMPLIANCE WITH SECTION 16. With respect to persons subject to Section 16 of the Exchange Act, transactions under this Plan are intended to comply with all applicable conditions of Rule 16b-3 (or its successor rule). To the extent that any grant of an Award fails to so comply, it shall be deemed null and void to the extent permitted by law and to the extent deemed advisable by the Plan Administrator. SECTION 16. PARTICIPATION BY FOREIGN NATIONALS. The Plan Administrator may, in order to fulfill the purposes of the Plan and without amending the Plan, modify grants to foreign nationals or United States citizens employed abroad in order to recognize differences in local law, tax policy or custom. SECTION 17. NO RIGHT TO EMPLOYMENT. The Plan shall not confer upon any Participant any right with respect to continuation of any employment or consulting relationship with the Company or membership on the Board, nor shall it interfere in any way with the right to terminate such Participant's employment or consulting relationship at any time, with or without cause. SECTION 18. GOVERNING LAW. The validity, constrictions and effect of this Plan, agreements entered into pursuant to the Plan, and of any rules, regulations, determinations or decisions made by the Plan Administrator relating to the Plan or such agreements, and the rights of any and all persons having or claiming to have any interest therein or thereunder, shall be determined exclusively in accordance with applicable federal laws and the laws of the Commonwealth of Pennsylvania, without regard to its conflict of laws principles. SECTION 19. EFFECTIVE DATE OF PLAN/DURATION. The Plan shall become effective upon approval of the Plan by the affirmative vote of holders of a majority of the outstanding Shares -16-
present and voting at a meeting of shareowners; provided that at least a majority of the outstanding Shares votes for, against or abstains on the matter and at least a majority of these Shares votes in favor of the Plan. No Award may be granted under the Plan after July 23, 2012. Awards granted on or prior to July 23, 2012 shall remain outstanding in accordance with this Plan and their respective terms. -17-
. . . Exhibit 21 CORPORATE DIRECTORY Our consolidated subsidiaries and affiliated companies as of June 30, 2003 are: Consolidated Subsidiaries of Kennametal Inc. Kennametal Australia Pty. Ltd. Australia Kennametal Foreign Sales Corporation Barbados Kennametal Ltd. Canada Kennametal (Canada) Ltd. Canada Kennametal (Shanghai) Ltd. China Kennametal (Thailand) Co., Ltd. Thailand Kennametal (Xuzhou) Company Ltd. China Kennametal Hardpoint Inc. Delaware, US Kennametal Japan Ltd. Japan Kennametal (Malaysia) Sdn. Bhd. Malaysia Kennametal de Mexico, S.A. de C.V. Mexico Kennametal SP. Z.o.o Poland Kennametal (Singapore) Pte. Ltd. Singapore Kennametal South Africa (Proprietary) Ltd. South Africa Kennametal Korea Ltd. Korea Kennametal Holding Cayman Islands Limited Cayman Islands Kennametal Financing I Delaware, US Kennametal Financing II Corp. California, US Kennametal Holdings Europe Inc. Delaware, US Adaptive Technologies Corp. Michigan, US Circle Machine Company California, US Greenfield Industries, Inc. Delaware, US Consolidated Subsidiaries of Kennametal Financing II Corp. Kennametal PC Inc. California, US Kennametal TC Inc. California, US Kennametal Receivables Corporation Delaware, US Consolidated Subsidiaries of Kennametal Holdings Europe Inc. JLK Direct Distribution Inc. Pennsylvania, US Kennametal Widia Holdings Inc. Delaware, US Consolidated Subsidiaries of Kennametal Widia Holdings Inc. Kennametal Europe Holdings GmbH Germany Kennametal Widia Beteiligungs GmbH Germany Kennametal Widia Holdings GmbH Germany Widia GmbH Germany V & S Werkzeuge GmbH Germany Consolidated Subsidiaries of Kennametal Hardpoint Inc. Kennametal Hardpoint H.K. Ltd. Hong Kong Kennametal Hardpoint (Taiwan) Inc. Taiwan Consolidated Subsidiaries of Widia GmbH Meturit AG Switzerland Consolidated Subsidiary of Meturit AG Widia (India) Limited India
Consolidated Subsidiaries of Kennametal Holdings Cayman Islands Limited Kennametal Argentina S.A. Argentina Kennametal do Brasil Ltda. Brazil Kennametal Chile Ltda. Chile Consolidated Subsidiaries of Kennametal Europe Holdings GmbH Cirbo Limited England England Kennametal Hertel Europe Holding GmbH Germany Consolidated Subsidiaries of JLK Direct Distribution Inc. J&L America, Inc. Michigan, US Full Service Supply Inc. Pennsylvania, US Consolidated Subsidiary of Full Service Supply Inc. Full Service Supply Ltd. Canada Consolidated Subsidiaries of Kennametal Hertel Europe Holding GmbH Kennametal Hertel AG Germany Kemmer Hartmetallwerkzeuge GmbH Germany Kennametal Hungaria Kft. Hungary Consolidated Subsidiaries of Kemmer Hartmetallwerkeeuge GmbH Kemmer Prazisian GmbH Germany Kemmer Cirbo S.r.l. Italy Italy Consolidated Subsidiaries of Kennametal Hertel AG Kennametal Belgium S.A. Belgium Kennametal UK Limited England Kennametal France S.A.S. France Kennametal Beteiligungs GmbH Germany Kennametal Europe GmbH Germany Kennametal Deutschland GmbH Germany Kennametal Hertel International GmbH Germany Kennametal GmbH & Co. K.G. Germany Kennametal Hertel Korea GmbH Germany Rubig G.m.b.H. & Co. K.G. Germany Kennametal Italia S.p.A. Italy Kennametal Nederland B.V. Netherlands Nederland Hardmetal Fabrieken B.V. Netherlands Kennametal Kecisi Takimlar Sanayi ve Ticaret A.S. Turkey Kennametal Hertel International GmbH Germany Kennametal Hertel Iberica S.L. Spain Kennametal Osterreich GmbH Austria Consolidated Subsidiaries of Kennametal Osterreich GmbH Kennametal Polska Sp. Z.o.o. Poland Kennametal Kft. Hungary Consolidated Subsidiary of Kennametal UK Limited Widia UK Ltd. England Consolidated Subsidiaries of Kennametal Nederland B.V. Widia Nederland B.B. Netherlands Kennametal Engineered Products B.V. Netherlands
Consolidated Subsidiary of Kennametal Hertel Iberica S.L. Kenci S.A. Spain Consolidated Subsidiary of Kennametal Italia S.p.A. Kennametal Hertel Italia S.r.l. Italy Consolidated Subsidiary of Kennametal Hertel Italia S.r.L. Widia Italia S.r.l. Italy Consolidated Subsidiaries of J&L America, Inc. J&L Industrial Supply Ltd. Canada J&L Industrial Supply UK (branch) England Consolidated Subsidiaries of Greenfield Industries, Inc. Greenfield Industries Canada Incorporated Canada Hanita Metal Works, Ltd. Israel Cleveland Twist Drill de Mexico, S.A. de C.V. Mexico Carbidie Asia Pacific Pte. Ltd. Singapore Kemmer International, Inc. Delaware, US Rogers Tool Works Inc. Delaware, US South Deerfield Industrial, Inc. Massachusetts, US Hanita Cutting Tools, Inc. New Jersey, US Hanita Metal Works GmbH (Germany) Germany Consolidated Subsidiaries of Rogers Tool Works Inc. TCM Europe, Inc. Delaware, US RTW Limited (England) England Kennametal Hungary Finance Services kft. Hungary Kennametal Hungary Holdings Inc. Delaware, US Consolidated Subsidiary of Cleveland Twist Drill de Mexico, S.A. de C.V. Herramientas Cleveland, S.A. de C.V. Mexico Consolidated Subsidiary of Herramientas Cleveland, S.A. de C.V. Greenfield Tools de Mexico, S.A. de C.V. Mexico
Exhibit 23 CONSENT OF INDEPENDENT AUDITORS We hereby consent to the incorporation by reference in the Registration Statement on Form S-8 (No. 33-25331, No. 33-55768, No. 33-55766, No. 33-65023, No. 333-18423, No. 333-18429, No. 333-18437, No. 333-77411, No. 333-88049, No. 333-30454, No. 333-30448, No. 333-53562, No. 333-100867), and Form S-3 (No. 33-61854, No. 333-40809) of Kennametal Inc., of our reports dated August 1, 2003, relating to the financial statements and financial statement schedule, which appear in this Form 10-K. /s/ PricewaterhouseCoopers LLP PricewaterhouseCoopers LLP Pittsburgh, Pennsylvania September 18, 2003
Exhibit 31.1 I, Markos I. Tambakeras, certify that: 1. I have reviewed this annual report on Form 10-K of Kennametal Inc.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) [omitted in accordance with SEC Release No. 33-8238/34-47986] c) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. /s/ Markos I. Tambakeras Markos I. Tambakeras Chairman, President and Chief Executive Officer September 18, 2003
Exhibit 31.2 I, F. Nicholas Grasberger III, certify that: 1. have reviewed this annual report on Form 10-K of Kennametal Inc.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) [omitted in accordance with SEC Release No. 33-8238/34-47986] c) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. /s/ F. Nicholas Grasberger III F. Nicholas Grasberger III Vice President and Chief Financial Officer September 18, 2003
Exhibit 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Kennametal Inc. (the "Corporation") on Form 10-K for the period ended June 30, 2003, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), each of the undersigned officers of the Corporation certifies, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to his knowledge: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Corporation. /s/ Markos I. Tambakeras Markos I. Tambakeras Chairman, President and Chief Executive Officer Kennametal Inc. September 18, 2003 /s/ F. Nicholas Grasberger III F. Nicholas Grasberger III Vice President and Chief Financial Officer Kennametal Inc. September 18, 2003 * This certification is made solely for purposes of 18 U.S.C. Section 1350, subject to the knowledge standard contained therein, and not for any other purpose.