ITEM 1. BUSINESS
Overview - -------- Kennametal Inc. was incorporated in Pennsylvania in 1943. Kennametal Inc. and subsidiaries ("Kennametal" or the "company") manufacture, purchase and distribute a broad range of tools, tooling systems, supplies and services for the metalworking, mining and highway construction industries. Kennametal specializes in developing and manufacturing metalcutting tools and wear- resistant parts using a specialized type of powder metallurgy. Kennametal's metalcutting tools are made of cemented carbides, ceramics, cermets and other hard materials. The company manufactures a complete line of toolholders and toolholding systems by machining and fabricating steel bars and other metal alloys. The company also distributes a broad range of industrial supplies used in the metalworking industry. Kennametal's mining and construction cutting tools are tipped with cemented carbide and are used for underground coal mining and highway construction, repair and maintenance.
On July 2, 1997, an initial public offering of approximately 20 percent of a newly formed subsidiary of the company, JLK Direct Distribution Inc. (JLK) was consummated. The new subsidiary was incorporated on April 28, 1997 and operates the metalworking industrial supply operations of the company. The company currently has approximately 80 percent ownership. (see Note 3 to the consolidated financial statements presented on page 31 of the 1997 Annual Report to Shareholders, and such information is incorporated herein by reference).
The matters discussed in this Form 10-K contain "forward-looking statements" as defined by Section 21E of the Securities Exchange Act of 1934. Actual results can differ from those in the forward-looking statements to the extent that the economic conditions in the United States, Europe and, to a lesser extent, Asia Pacific change from the company's expectations.
Business Segment and Markets - ---------------------------- The company operates predominantly as a tooling supplier specializing in powder metallurgy, which represents a single business segment. While many of the company's products are similar in composition, sales are classified into three markets: metalworking, industrial supply, and mining and construction. The company's sales by market are presented on page 21 of the 1997 Annual Report to Shareholders, and such information is incorporated herein by reference. Additional information about the company's operations by geographic area is presented on page 37 of the 1997 Annual Report to Shareholders, and such information is incorporated herein by reference.
Metalworking Markets - -------------------- Kennametal markets, manufactures and distributes a full line of products and services for the metalworking industry. The company provides metalcutting tools to manufacturing companies in a wide range of industries throughout the world.
A Kennametal tooling system usually consists of a steel toolholder and an indexable cutting tool called an insert. During a metalworking operation, the toolholder is positioned in a machine tool that provides the turning power. While the workpiece or toolholder is rapidly rotating, the cutting tool insert contacts the workpiece and cuts or shapes the workpiece. The cutting tool insert is consumed during use and must be replaced periodically. Metalcutting operations include turning, boring, threading, grooving, milling and drilling. The company also makes wear-resistant parts for use in abrasive environments and specialty applications.
Industrial Supply Market - ------------------------ Kennametal distributes a full line of industrial supplies to the metalworking industry. These products include cutting tools, abrasives, precision measuring devices, power tools and hand tools, machine tool accessories and, to a lesser extent, some maintenance, repair and operating supplies. The majority of industrial supplies distributed by the company are purchased from other manufacturers, although the industrial supply product offering does include Kennametal-manufactured items.
Mining and Construction Market - ------------------------------ Mining and construction cutting 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, bits, pinning rods, augers and a wide range of mining tool accessories. The company also supplies compacts for mining, quarrying, water well drilling and oil and gas exploration. Construction cutting 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.
The company also makes proprietary metallurgical powders for use as a basic material in many of its metalworking, mining and construction products. In addition, the company produces a variety of metallurgical powders and related materials for specialized markets. These products include intermediate carbide powders, hardfacing materials and matrix powders that are sold to manufacturers of cemented carbide products, oil and gas drilling equipment and diamond drill bits.
Issuance of Subsidiary Stock - ---------------------------- On July 2, 1997, an initial public offering ("IPO") of approximately 4.9 million shares of common stock at a price of $20 per share of a newly formed subsidiary of the company, JLK was consummated. JLK operates the industrial supply operations consisting of the company's wholly owned J&L America, Inc. ("J&L") subsidiary and its Full Service Supply programs. The net proceeds from the offering were approximately $90 million and represented approximately 20 percent of JLK's common stock. The net proceeds were used by JLK to repay $20 million of indebtedness related to a dividend to the company and $20 million related to intercompany obligations to the company. The company used these proceeds to repay short term debt. The company today owns approximately 80 percent of the outstanding common stock of JLK and intends to retain a majority of both the economic and voting interests of JLK.
Acquisition - ----------- In August 1993, the company acquired an 81 percent interest in Hertel AG ("Hertel") for $43 million in cash and $55 million of assumed debt. Hertel, based in Fuerth, Germany, is a manufacturer and marketer of cemented carbide tools and tooling systems which are similar to the metalcutting tools and tooling systems produced by the company. The acquisition of Hertel has not materially changed the product lines offered by the company. While the company's primary market is the United States, Hertel's primary market is Germany and western Europe. The acquisition of Hertel significantly increased the company's market share in these markets.
Since January 1, 1994, the company purchased additional shares of Hertel for $21 million, thereby increasing the company's ownership interest to 95 percent at June 30, 1997.
International Operations - ------------------------ The company's principal international operations are conducted in Western Europe and Canada. In addition, the company has joint ventures in China, India, Italy, Poland and Russia, manufacturing and sales subsidiaries in Asia Pacific and sales agents and distributors in eastern Europe and other areas of the world.
The company's international operations are subject to the usual risks of doing business in those countries, including currency fluctuations and changes in social, political and economic environments. In management's opinion, the company's business is not materially dependent upon any one international location involving significant risk.
The company's international sales are presented on page 21 of the 1997 Annual Report to Shareholders, and such information is incorporated herein by reference. Information pertaining to the effects of foreign currency fluctuations is contained under the caption "Foreign Currency Translation" in the notes to the consolidated financial statements on page 30 of the 1997 Annual Report to Shareholders, and such information is incorporated herein by reference.
Marketing and Distribution - -------------------------- The company's products are sold through three distinct channels: a direct sales force, Full Service Supply programs, and retail showrooms and mail-order catalogs. The company's manufactured products are sold to end users primarily through a direct sales force. Service engineers and technicians directly assist customers with product design, selection and application. In addition, Kennametal-manufactured products, together with a broad range of purchased products, are sold through Full Service Supply programs and retail showrooms and mail-order catalogs. The company also uses independent distributors and sales agents in the United States and certain international markets.
The company's products are marketed under various trademarks and tradenames, such as Kennametal*, Hertel*, the letter K combined with other identifying letters and/or numbers*, Block Style K*, Kendex*, Kenloc*, Top Notch*, Erickson*, Kyon*, KM*, Drill-Fix* and Fix-Perfect*. Purchased products are sold under the manufacturer's name or a private label.
Competition - ----------- Kennametal is one of the world's leading producers of cemented carbide tools and maintains a strong competitive position, especially in North America and Europe. There is active competition in the sale of all products made by the company, with approximately 30 companies engaged in the cemented 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 those made by the company and buy the cemented carbide components for such tools from cemented carbide producers, including the company. Major competition exists from both U.S.- based and international-based concerns. In addition, the company competes with thousands of industrial supply distributors.
The principal methods of competition in the company's business are service, product innovation, quality, availability and price. The company believes that its competitive strength rests on its customer service capabilities, including its multiple distribution channels, its global presence, its state- of-the-art manufacturing capabilities, its ability to develop new and improved tools responsive to the needs of its customers, and the consistent high quality of its products. These factors frequently permit the company to sell such products based on the value added for the customer rather than strictly on competitive prices.
Seasonality - ----------- Seasonal variations do not have a major effect on the company's business. However, to varying degrees, traditional summer vacation shutdowns of metalworking customers' plants and holiday shutdowns often affect the company's sales levels during the first and second quarters of its fiscal year.
Backlog - ------- The company's backlog of orders generally is not significant to its operations. Approximately 80 percent of all orders are filled from stock, and the balance generally is filled within short lead times.
Research and Development - ------------------------ The company is involved in research and development of new products and processes. Research and development expenses totaled $24.1 million, $20.6 million and $18.7 million in 1997, 1996 and 1995, respectively. Additionally, certain costs associated with improving manufacturing processes are included in cost of goods sold. The company holds a number of patents and licenses which, in the aggregate, are not material to the operation of the business.
The company has brought a number of new products to market during the past few years. These include metalcutting inserts that incorporate innovative tool geometries or compositions for improved chip control and productivity. These new compositions include KC994M* multi-coated metalcutting inserts for milling applications, KC9010* and KC9025* multi-coated metalcutting inserts for turning applications, Kyon 3500* ceramic metalcutting inserts for machining cast irons, and KCD25* diamond-coated metalcutting inserts for machining aluminum alloys and other nonferrous materials.
Raw Materials and Supplies - -------------------------- Major metallurgical raw materials consist of ore concentrates, compounds and secondary materials containing tungsten, tantalum, titanium, niobium and cobalt. Although these raw materials are in relatively adequate supply, major sources are located abroad and prices at times have been volatile. For these reasons, the company exercises great care in the selection, purchase and inventory availability of these materials. The company also purchases substantial quantities of steel bars and forgings for making toolholders and other tool parts and accessories. Products purchased for resale are obtained from thousands of suppliers located in the United States and abroad.
- ------------------------------------------------------------- * Trademark owned by Kennametal Inc. or Kennametal Hertel AG
Employees - --------- The company employed approximately 7,500 persons at June 30, 1997, of which 4,700 were located in the United States and 2,800 in other parts of the world, principally Europe and Asia Pacific. Approximately 1,100 employees were represented by labor unions, of which 170 were hourly-rated employees located at plants in the Latrobe, Pennsylvania area. The remaining 930 employees represented by labor unions were employed at seven plants located outside of the United States. The company considers its labor relations to be generally good.
Regulation - ---------- 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 the company's capital expenditures, earnings or competitive position for the year covered by this report, nor is such compliance expected to have a material effect in the future.
The company has been involved in various environmental cleanup and remediation activities at several of its manufacturing facilities. In addition, the company has been named as a potentially responsible party at four Superfund sites in the United States. However, it is management's opinion, based on its evaluations and discussions with outside counsel and independent consultants, that the ultimate resolution of these environmental matters will not have a material adverse effect on the results of operations, financial position or cash flows of the company.
The company maintains 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, the company has established an EH&S administrator at each of its domestic manufacturing facilities. The company's 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 and annual basis, management establishes or adjusts financial provisions and reserves for environmental contingencies in accordance with Statement of Financial Accounting Standards No. 5, "Accounting for Contingencies."
Corporate Directory - ------------------- The following is a summary of the company's consolidated subsidiaries and affiliated companies as of June 30, 1997:
CONSOLIDATED SUBSIDIARIES (% OWNERSHIP) Kennametal Australia Pty. Ltd., Australia Kennametal Foreign Sales Corporation, Barbados Kennametal Ltd., Canada Kennametal (China) Limited, China Kennametal (Shanghai) Ltd., China Shanxi-Kennametal Mining Cutting Systems Manufacturing Company Limited, China (70%) Xuzhou-Kennametal Mining Cutting Systems Manufacturing Company Limited, China (70%) Kennametal Hertel Limited, England Kennametal Hertel AG, Germany (95%) Kennametal Hardpoint H.K. Ltd., Hong Kong (90%) Kobe Kennametal K.K., Japan (51%) Kennametal Hertel (Malaysia) Sdn. Bhd., Malaysia Kennametal de Mexico, S.A. de C.V., Mexico Kennametal/Becker-Warkop Ltd., Poland (84%) Kennametal Hertel (Singapore) Pte. Ltd., Singapore Kennametal South Africa (Proprietary) Limited, South Africa Kennametal Hardpoint (Taiwan) Inc., Taiwan (90%) Kennametal Hertel Co., Ltd., Thailand (48%) Adaptive Technologies Corp., United States Kennametal Hardpoint Inc., United States (90%) Circle Machine Company, United States JLK Direct Distribution Inc., United States
CONSOLIDATED SUBSIDIARIES OF KENNAMETAL HERTEL AG Kennametal Hertel Belgium S.A., Belgium Kennametal Hertel France S.A., France Materiels de Precision et de Production S.A., France Kennametal Hertel G.m.b.H., Germany Kennametal Hertel Nederland B.V., Netherlands Nederlandse Hardmetaal Fabrieken B.V., Netherlands Kennametal GTS G.m.b.H. Korea, South Korea (branch)
CONSOLIDATED SUBSIDIARIES OF JLK DIRECT DISTRIBUTION INC. J&L America, Inc., United States
CONSOLIDATED SUBSIDIARIES OF J&L AMERICA, INC. J&L Industrial Supply UK, England (branch) Mill & Abrasive Supply, Inc., United States Strelinger Company, United States
AFFILIATED COMPANIES (% OWNERSHIP) Kennametal Hertel G. Beisteiner G.m.b.H., Austria (26%) Birla Kennametal Ltd., India (40%) Drillco Hertel Ltd., India (50%) Kennametal Ca.Me.S., S.p.A., Italy (51%) Kennametal Hertel S.p.A., Italy (40%) Wilke Carbide B.V., Netherlands (50%) PIGMA-Kennametal Joint Venture, Russia (49%) Kenci, S.A., Spain (20%)
ITEM 2.
ITEM 2. PROPERTIES
Presented below is a summary of principal manufacturing facilities used by the company and its majority-owned subsidiaries.
Location Owned/Leased Principal Products -------- ------------ ------------------
UNITED STATES: Monrovia, California Leased Boring Bars Troy, Michigan Leased Metalworking Toolholders Fallon, Nevada Owned Metallurgical Powders Henderson, North Carolina Owned Metallurgical Powders 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 Latrobe, Pennsylvania Owned Metallurgical Powders and Wear Parts Johnson City, Tennessee Owned Metalworking Inserts New Market, Virginia Owned Metalworking Toolholders
INTERNATIONAL (a): Victoria, Canada Owned Wear Parts Shanxi, China Owned Mining Tools Xuzhou, China Owned Mining Tools Blaydon, England Leased Mining Tools Kingswinford, England Leased Metalworking Toolholders Bordeaux, France Leased Metalworking Cutting Tools Ebermannstadt, Germany Owned Metalworking Inserts Mistelgau, Germany Owned Metallurgical Powders, Metalworking Inserts and Wear Parts Nabburg, Germany Owned Metalworking Toolholders Vohenstrauss, Germany Leased Metalworking Carbide Drills Arnhem, Netherlands Owned Wear Products
(a) In January 1996, the company began construction of a $20-million facility in Shanghai, China, to manufacture cemented carbide metalcutting tools. Operations are planned to begin in 1998.
The company also has a network of warehouses and customer service centers located throughout North America, Western Europe, Asia and Australia, a significant portion of which are leased. The majority of the company's research and development efforts are conducted in a corporate technology center located adjacent to world headquarters in Latrobe, Pennsylvania and in Fuerth, Germany.
All significant properties are used in the company's dominant business of powder metallurgy, tools, tooling systems and supplies. The company's production capacity is adequate for its present needs. The company believes that its properties have been adequately maintained, are generally in good condition and are suitable for the company's business as presently conducted.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
(a) In connection with a Domination Contract with Kennametal Hertel AG, under German law, the company is required to offer to minority shareholders to purchase their shares for a reasonable compensation and to guarantee dividends while the Domination Contract is in effect (having an indefinite term which may be terminated by giving six months notice to the end of each fiscal year of Kennametal Hertel AG) and to pay Kennametal Hertel AG any net cumulative losses it sustains during the term of the contract and has liability to Kennametal Hertel AG creditors as if Kennametal Hertel AG merged with the company. Several minority shareholders are contesting the reasonableness of the purchase price for minority shares and the minimum dividend on minority shares offered by the company in connection with the Domination Contract through litigation in Germany. It is management's opinion that the company and Kennametal Hertel AG have viable defenses to the contest of the reasonableness of the minority share purchase price and minimum dividend and, in any event, that the ultimate outcome of this matter will not have a material adverse effect on the results of operations, cash flows or financial position of the company.
(b) There are no other material pending legal proceedings, other than litigation incidental to the ordinary course of business, to which the company or any of its subsidiaries is a party or of which any of their property is the subject.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of fiscal year 1997, there were no matters submitted to a vote of security holders through the solicitation of proxies or otherwise.
PART II
The information required under Items 5 through 8 is included in the 1997 Annual Report to Shareholders and such information is incorporated herein by reference as indicated by the following table.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Incorporated herein by reference is the information set forth in Part I under the caption "Officers of the Registrant" and the information set forth under the caption "Election of Directors" in the company's definitive proxy statement to be filed with the Securities and Exchange Commission within 120 days after June 30, 1997 ("1997 Proxy Statement").
ITEM 11.
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 1997 Proxy Statement.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
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 and under the caption "Principal Holders of Voting Securities" with respect to other beneficial owners in the 1997 Proxy Statement.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated herein by reference is certain information set forth in the notes to the table under the caption "Election of Directors" and the information set forth in the section entitled "Certain Relationships and Related Transactions" in the 1997 Proxy Statement.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Documents filed as part of this Form 10-K report.
1. Financial Statements
The consolidated balance sheets as of June 30, 1997 and 1996, the consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended June 30, 1997, and the notes to consolidated financial statements, together with the report hereon of Arthur Andersen LLP dated July 21, 1997, presented in the company's 1997 Annual Report to Shareholders, are incorporated herein by reference.
2. Financial Statement Schedules
The financial statement schedule shown below should be read in conjunction with the financial statements contained in the 1997 Annual Report to Shareholders. Other schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto.
Separate financial statements of the company are omitted because the company is primarily an operating company, and all significant subsidiaries included in the consolidated financial statements are wholly owned, with the exception of Kennametal Hertel AG, in which the company has a 95 percent interest.
Financial Statement Schedule: ----------------------------- Report of Independent Public Accountants
Schedule II - Valuation and Qualifying Accounts for the Three Years Ended June 30, 1997
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the quarter ended June 30, 1997.
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/ RICHARD J. ORWIG ------------------------------- Richard J. Orwig Vice President, Chief Financial and Administrative Officer
Date: September 18, 1997
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE
To the Board of Directors and Shareholders of Kennametal Inc.
We have audited, in accordance with generally accepted auditing standards, the financial statements included in Kennametal Inc.'s annual report to shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated July 21, 1997. Our audit was 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 a part of the basic financial statements. The schedule has been subjected to the auditing procedures applied in the audit 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 21, 1997
(a)