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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2002
| | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD ________ TO ________.
COMMISSION FILE NUMBER 001-13797
HAWK CORPORATION
(Exact name of Registrant as specified in its charter)
DELAWARE 34-1608156
(State of incorporation) (I.R.S. Employer Identification No.)
200 PUBLIC SQUARE, SUITE 30-5000, CLEVELAND, OHIO 44114
(Address of principal executive offices) (Zip Code)
(216) 861-3553
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No | |.
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date. As of the date of this report,
the Registrant had the following number of shares of common stock outstanding:
Class A Common Stock, $0.01 par value: 8,557,990
Class B Common Stock, $0.01 par value: None (0)
1
PAGE
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited) 3
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 24
Item 3. Quantitative and Qualitative Disclosures about Market Risk 35
Item 4. Controls and Procedures 35
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 36
Item 5. Other Events 36
Item 6. Exhibits and Reports on Form 8-K 36
SIGNATURES 38
2
PART I. FINANCIAL INFORMATION
ITEM I. FINANCIAL STATEMENTS (UNAUDITED)
HAWK CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
SEPTEMBER 30, DECEMBER 31,
2002 2001
------------- -------------
Assets
Current assets:
Cash and cash equivalents $ 3,343 $ 3,084
Accounts receivable, less allowance of
$488 in 2002 and $455 in 2001 33,305 25,773
Inventories 31,241 29,152
Deferred income taxes 1,210 1,200
Other current assets 3,997 4,638
------------- -------------
Total current assets 73,096 63,847
Property, plant and equipment:
Land and improvements 1,608 1,608
Buildings and improvements 18,686 18,657
Machinery and equipment 98,863 96,688
Furniture and fixtures 7,923 7,168
Construction in progress 4,496 1,450
------------- -------------
131,576 125,571
Less accumulated depreciation and amortization 65,521 58,208
------------- -------------
Total property, plant and equipment 66,055 67,363
Other assets:
Goodwill 32,495 53,877
Other intangible assets 11,531 12,828
Shareholder notes 1,010 1,010
Other 6,317 5,180
------------- -------------
Total other assets 51,353 72,895
Total assets $ 190,504 $ 204,105
============= =============
3
HAWK CORPORATION
CONSOLIDATED BALANCE SHEETS - (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE DATA)
SEPTEMBER 30, DECEMBER 31,
2002 2001
------------- -------------
Liabilities and shareholders' equity
Current liabilities:
Accounts payable $ 15,349 $ 13,432
Accrued compensation 5,339 5,233
Other accrued expenses 8,099 6,832
Current portion of long-term debt 3,533 6,862
------------- -------------
Total current liabilities 32,320 32,359
Long-term liabilities:
Long-term debt 98,905 90,957
Deferred income taxes 6,735 10,978
Other 3,662 3,374
------------- -------------
Total long-term liabilities 109,302 105,309
Shareholders' equity:
Series D preferred stock, $.01 par value; an aggregate
liquidation value of $1,530, plus any unpaid
dividends with 9.8% cumulative dividend (1,530
shares authorized, issued and outstanding) 1 1
Series E preferred stock, $.01 par value; 100,000 shares
Authorized; none issued or outstanding
Class A common stock, $.01 par value; 75,000,000
shares authorized; 9,187,750 issued; and 8,557,240
and 8,552,920 outstanding in 2002 and 2001,
respectively 92 92
Class B common stock, $.01 par value; 10,000,000
shares authorized; none issued or outstanding
Additional paid-in capital 54,619 54,626
Retained earnings 1,672 19,623
Accumulated other comprehensive loss (2,830) (3,201)
Treasury stock, at cost, 630,510 and 634,830
shares in 2002 and 2001, respectively (4,672) (4,704)
------------- -------------
Total shareholders' equity 48,882 66,437
------------- -------------
Total liabilities and shareholders' equity $ 190,504 $ 204,105
============= =============
Note: The balance sheet at December 31, 2001 has been derived from the audited
financial statements at that date but does not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements. See notes to consolidated financial statements.
4
HAWK CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2002 2001 2002 2001
---------- ---------- ---------- ----------
Net sales $ 49,447 $ 42,208 $ 149,599 $ 143,408
Cost of sales 39,200 33,504 116,946 110,550
---------- ---------- ---------- ----------
Gross profit 10,247 8,704 32,653 32,858
Operating Expenses:
Selling, technical and administrative expenses 7,845 6,016 25,339 23,047
Restructuring costs 1,000
Amortization of intangibles 348 1,141 1,071 3,406
---------- ---------- ---------- ----------
Total operating expenses 8,193 7,157 26,410 27,453
---------- ---------- ---------- ----------
Income from operations 2,054 1,547 6,243 5,405
Interest expense (2,369) (2,352) (7,010) (7,186)
Interest income 16 55 92 158
Exchange offer costs (818) (818)
Other expense, net (341) (187) (636) (433)
---------- ---------- ---------- ----------
Loss before income taxes (1,458) (937) (2,129) (2,056)
Income tax (benefit) provision (1,181) 16 (1,492) (541)
---------- ---------- ---------- ----------
Net loss before cumulative effect of change in accounting
principle (277) (953) (637) (1,515)
Cumulative effect of change in accounting principle, net of
tax of $4,252 (17,200)
---------- ---------- ---------- ----------
Net loss $ (277) $ (953) $ (17,837) $ (1,515)
========== ========== ========== ==========
Loss per share:
Basic loss per share:
Basic loss before cumulative effect of change in
accounting principle $ (.04) $ (.12) $ (.09) $ (.19)
Cumulative effect of change in accounting principle (2.01)
---------- ---------- ---------- ----------
Net loss per basic share $ (.04) $ (.12) $ (2.10) $ (.19)
========== ========== ========== ==========
Diluted loss per share:
Diluted loss before cumulative effect of change in
accounting principle $ (.04) $ (.12) $ (.09) $ (.19)
Cumulative effect of change in accounting principle (2.01)
---------- ---------- ---------- ----------
Net loss per diluted share $ (.04) $ (.12) $ (2.10) $ (.19)
========== ========== ========== ==========
See notes to consolidated financial statements.
5
HAWK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(DOLLARS IN THOUSANDS)
NINE MONTHS ENDED
SEPTEMBER 30,
2002 2001
---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (17,837) $ (1,515)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Depreciation and amortization 9,480 11,928
Deferred income taxes (58)
Cumulative effect of change in accounting principle, net of tax 17,200
Loss on fixed assets 276
Changes in operating assets and liabilities:
Accounts receivable (6,922) (497)
Inventories (1,516) 2,773
Other assets (585) (532)
Accounts payable 1,612 1,905
Other 936 (2,732)
---------- ----------
Net cash provided by operating activities 2,644 11,272
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property, plant and equipment (6,722) (7,440)
---------- ----------
Net cash used in investing activities (6,722) (7,440)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from long-term debt 48,198 30,316
Payments on long-term debt (43,808) (34,344)
Payments of preferred stock dividends (113) (113)
---------- ----------
Net cash provided by (used in) financing activities 4,277 (4,141)
---------- ----------
Effect of exchange rate changes on cash 60 (280)
---------- ----------
Net increase (decrease) in cash and cash equivalents 259 (589)
Cash and cash equivalents at beginning of year 3,084 4,010
---------- ----------
Cash and cash equivalents at end of year $ 3,343 $ 3,421
========== ==========
See notes to consolidated financial statements.
6
HAWK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30, 2002
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been prepared
in accordance with accounting principles generally accepted in the United States
for interim financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements. In the opinion of management, all adjustments
(consisting of normal recurring accruals) considered necessary for a fair
presentation have been included. Operating results for the period ended
September 30, 2002 are not necessarily indicative of the results that may be
expected for the year ending December 31, 2002. For further information, refer
to the consolidated financial statements and footnotes thereto in the Form 10-K
for Hawk Corporation (Company) for the year ended December 31, 2001.
The Company, through its business segments, designs, engineers, manufactures and
markets specialized components used in a variety of aerospace, industrial and
commercial applications.
The consolidated financial statements include the accounts of the Company and
its wholly owned subsidiaries. Beginning February 28, 2002, the financial
statements also include the Company's 100% ownership interest in Net Shape
Technologies LLC (Net Shape). Prior to that date, the Company owned a majority
interest in Net Shape. All significant intercompany accounts and transactions
have been eliminated in the accompanying financial statements.
Certain amounts have been reclassified in 2001 to conform to 2002 presentation.
NOTE 2 - CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRICIPLE AND GOODWILL AND
INTANGIBLE ASSETS
In June 2001, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 141 "Business Combinations" (SFAS
No. 141) and No. 142 "Goodwill and Other Intangible Assets" (SFAS No. 142).
These statements eliminate the pooling of interest method of accounting for
business combinations subsequent to June 30, 2001 and eliminate the amortization
of goodwill for all fiscal years beginning after December 15, 2001. The Company
adopted SFAS No. 141 and SFAS No. 142 with respect to new goodwill as of July 1,
2001 and adopted SFAS No. 142 with respect to existing goodwill as of January 1,
2002, the first day of its 2002 fiscal year. The adoption of SFAS No. 141 has
not impacted the Company's financial condition or results of operations. In
accordance with SFAS No. 142, existing goodwill was amortized through fiscal
2001. Upon adoption of SFAS No. 142, the Company stopped amortizing existing
goodwill. The pro forma effect of applying SFAS No. 142 for the nine and three
months ended September 30, 2001 would have been to decrease amortization expense
by approximately $2,361 and $819, respectively and would result in basic and
diluted loss per share of $0.02 and $0.06, respectively.
Additionally, upon adoption of SFAS No. 142, the Company changed the accounting
for goodwill and other indefinite-lived intangible assets from an amortization
methodology to an impairment-only methodology. SFAS No. 142 provided for a six
month transitional period from the effective date of adoption, to June 30, 2002,
for the Company to perform an initial assessment of whether there was an
indication that the carrying value of the goodwill was impaired. The Company
performed the assessment by comparing the fair value of each of its reporting
units, as determined in accordance with SFAS No. 142, to its carrying value. The
rules under SFAS No. 142 require that any initial impairment be taken as a
charge to income as a cumulative effect of change in accounting principle
retroactive to January 1, 2002.
7
The Company, with the assistance of independent valuation experts, completed its
initial assessment test and concluded that certain of its goodwill was impaired
at January 1, 2002, resulting in a charge of $21,452 ($17,200 after tax). The
fair value of goodwill was estimated using a combination of a discounted cash
flow valuation model, incorporating a discount rate commensurate with the risks
involved for each segment and a market approach of guideline companies and
similar transactions. The impairment resulted from the carrying value exceeding
the fair value of certain operating segments. This was due primarily to a
shortfall in sales from levels anticipated at the time of the respective
acquisitions and other costs associated with the Company's global expansion
initiatives. In accordance with SFAS No. 142, this charge has been recorded as a
cumulative effect of change in accounting principle, retroactive to January 1,
2002. The net loss after the cumulative effect of change in accounting principle
for the nine month period ended September 30, 2002 was $2.10 per diluted share.
SFAS No. 142 requires a review at least annually of the carrying value of
indefinite-lived assets and goodwill. In addition to the transitional impairment
test completed in the second quarter of 2002, another impairment test will be
completed in the fourth quarter 2002 and at least annually thereafter. There can
be no assurance that future goodwill impairments will not occur.
The components of goodwill and other intangible assets and the related
accumulated amortization are as follows:
SEPTEMBER 30, DECEMBER 31,
2002 2001
------------ ------------
ACCUMULATED ACCUMULATED
GROSS AMORTIZATION NET GROSS AMORTIZATION NET
---------- ------------ ---------- ---------- ------------ ----------
Goodwill, beginning of the period $ 67,808 $ 13,931 $ 53,877 $ 67,380 $ 10,751 $ 56,629
Additions 70 70 428 3,180 2,752
Deletions 21,452 21,452
---------- ------------ ---------- ---------- ------------ ----------
Goodwill, end of the period $ 46,426 $ 13,931 $ 32,495 $ 67,808 $ 13,931 $ 53,877
Other intangible assets subject to
amortization:
Product certifications 20,820 10,084 10,736 20,820 9,544 11,276
Deferred financing 4,693 4,055 638 4,693 3,593 1,100
Other intangible assets 2,719 2,562 157 3,013 2,561 452
---------- ------------ ---------- ---------- ------------ ----------
Other intangible assets subject to
amortization-subtotal 28,232 16,701 11,531 28,526 15,698 12,828
---------- ------------ ---------- ---------- ------------ ----------
Total $ 74,658 $ 30,632 $ 44,026 $ 96,334 $ 29,629 $ 66,705
========== ============ ========== ========== ============ ==========
8
Product certifications were acquired and valued based on the acquired company's
position as a certified supplier of friction materials to the major
manufacturers of commercial aircraft brakes.
A summary of the Company's net goodwill at September 30, 2002 and December 31,
2001 by reportable operating segment is as follows:
SEPTEMBER 30, DECEMBER 31,
2002 2001
------------- -------------
Friction products $ 11,100
Precision components $ 28,109 28,039
Performance automotive 4,386 8,392
Motor 6,346
------------- -------------
Total $ 32,495 $ 53,877
============= =============
The Company estimates its amortization expense for its definite-lived assets for
the next five years to be as follows: 2002-$1,442; 2003-$1,257; 2004-$789;
2005-$789; and 2006-$776.
NOTE 3 - COMPREHENSIVE LOSS
Comprehensive loss is as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2002 2001 2002 2001
---------- ---------- ---------- ----------
Net loss $ (277) $ (953) $ (17,837) $ (1,515)
Foreign currency translation (113) 123 (371) (292)
---------- ---------- ---------- ----------
Comprehensive loss $ (390) $ (830) $ (18,208) $ (1,807)
========== ========== ========== ==========
NOTE 4 - INVENTORIES
Inventories are stated at the lower of cost or market. Cost is determined by the
first-in, first-out (FIFO) method. The major components of inventories are as
follows:
SEPTEMBER 30, DECEMBER 31,
2002 2001
------------- -------------
Raw materials and work-in-process $ 22,906 $ 19,360
Finished products 11,258 12,542
Inventory reserves (2,923) (2,750)
------------- -------------
$ 31,241 $ 29,152
============= =============
9
NOTE 5 - LOSS PER SHARE
Basic and diluted loss per share are computed as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2002 2001 2002 2001
---------- ---------- ---------- ----------
Numerator:
Net loss before cumulative effect of change in accounting
principle $ (277) $ (953) $ (637) $ (1,515)
Preferred stock dividend (38) (38) (113) (113)
---------- ---------- ---------- ----------
Net loss before cumulative effect of change in accounting
principle available to common shareholders $ (315) $ (991) $ (750) $ (1,628)
========== ========== ========== ==========
Net loss $ (277) $ (953) $ (17,837) $ (1,515)
Preferred stock (38) (38) (113) (113)
---------- ---------- ---------- ----------
Net loss available to common shareholders $ (315) $ (991) $ (17,950) $ (1,628)
========== ========== ========== ==========
Denominator:
Denominator for basic loss per share-
Weighted average shares 8,557 8,553 8,556 8,552
Effect of dilutive securities:
Stock options -- -- -- --
---------- ---------- ---------- ----------
Denominator for diluted loss per share-
adjusted weighted-average shares and assumed conversions
8,557 8,553 8,556 8,552
Basic loss per share:
Basic loss before cumulative effect of change in accounting
principle $ (.04) $ (.12) $ (.09) $ (.19)
Cumulative effect of change in accounting principle (2.01)
---------- ---------- ---------- ----------
Net loss per basic share $ (.04) $ (.12) $ (2.10) $ (.19)
========== ========== ========== ==========
Diluted loss per share:
Diluted loss before cumulative effect of change in
accounting principle $ (.04) $ (.12) $ (.09) $ (.19)
Cumulative effect of change in accounting principle (2.01)
---------- ---------- ---------- ----------
Net loss per diluted share $ (.04) $ (.12) $ (2.10) $ (.19)
========== ========== ========== ==========
For the three and nine months ended September 30, 2002 and 2001 outstanding
stock options were not included in the computation of diluted earnings per share
since it would have resulted in an anti-dilutive effect.
10
NOTE 6 - BUSINESS SEGMENTS
The Company operates in four primary business segments: friction products,
precision components, performance automotive and motors. The Company's
reportable segments are strategic business units that offer different products
and services. They are managed separately based on fundamental differences in
their operations.
The friction products segment engineers, manufactures and markets specialized
components, used in a variety of aerospace, industrial and commercial
applications. The Company, through this segment, is a worldwide supplier of
friction components for brakes, clutches and transmissions.
The precision component segment engineers, manufactures and markets specialized
components, used primarily in industrial applications. The Company, through this
segment, targets three areas of the powder metal component marketplace: high
precision components that are used in fluid power applications, large powder
metal parts primarily used in construction, agricultural and truck applications,
and smaller high-volume parts.
The performance automotive segment engineers, manufactures and markets high
performance friction material for use in premium branded clutch and drive train
components. The Company, through this segment, targets leading teams in the
NASCAR, CART and IRL racing series, as well as drivers in the SCCA and ASA
racing circuits, high-performance street vehicles and other road race and oval
track competition cars. An operating unit formerly associated with the Company's
performance automotive segment was reclassified as of January 1, 2002 to the
Company's friction products segment as a result of changes in the internal
operating responsibility of that unit. All prior periods have been reclassified
to reflect this change.
The motor segment engineers, manufactures and markets die-cast aluminum rotors
for use in the fractional and subfractional electric motors. The Company,
through this segment, targets a wide variety of applications such as small
household appliances, business equipment, pumps and fans.
11
The information by segment is as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2002 2001 2002 2001
---------- ---------- ---------- ----------
Net sales to external customers:
Friction products $ 27,017 $ 24,060 $ 80,151 $ 81,238
Precision components 16,147 13,000 50,478 45,268
Performance automotive 2,846 2,825 10,067 10,215
Motor 3,437 2,323 8,903 6,687
---------- ---------- ---------- ----------
Consolidated $ 49,447 $ 42,208 $ 149,599 $ 143,408
========== ========== ========== ==========
Gross profit (loss):
Friction products $ 6,016 $ 5,882 $ 18,999 $ 20,966
Precision components 3,522 2,265 10,225 8,937
Performance automotive 752 761 3,317 3,081
Motor (43) (204) 112 (126)
---------- ---------- ---------- ----------
Consolidated $ 10,247 $ 8,704 $ 32,653 $ 32,858
========== ========== ========== ==========
Depreciation and amortization:
Friction products $ 2,002 $ 2,353 $ 5,895 $ 6,973
Precision components 940 1,214 2,807 3,636
Performance automotive 61 185 147 558
Motor 217 271 631 761
---------- ---------- ---------- ----------
Consolidated $ 3,220 $ 4,023 $ 9,480 $ 11,928
========== ========== ========== ==========
Operating income (loss):
Friction products $ 1,668 $ 2,726 $ 5,119 $ 7,010
Precision components 1,019 (132) 2,035 335
Performance automotive 134 41 1,069 514
Motor (767) (1,088) (1,980) (2,454)
---------- ---------- ---------- ----------
Consolidated $ 2,054 $ 1,547 $ 6,243 $ 5,405
========== ========== ========== ==========
Cumulative effect of change in
accounting principle, net of tax:
Friction products $ 8,373
Performance automotive 2,484
Motor 6,343
----------
Total $ 17,200
==========
12
NOTE 7 - RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In October 2001, the FASB issued SFAS No. 144 "Accounting for the Impairment or
Disposal of Long-Lived Assets" (SFAS No. 144). SFAS No. 144 supersedes SFAS No.
121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of" (SFAS No. 121), however it retains the fundamental
provisions of that statement related to the recognition and measurement of the
impairment of long-lived assets to be "held and used." In addition, SFAS No. 144
provides more guidance on estimating cash flows when performing a recoverability
test, requires that a long-lived asset (group) to be disposed of other than by
sale (e.g. abandoned) be classified as "held and used" until it is disposed of,
and establishes more restrictive criteria to classify an asset (group) as "held
for sale." SFAS No. 144 is effective for fiscal years beginning after December
15, 2001. The adoption of SFAS No. 144 did not have a material impact on the
Company's consolidated financial condition or results of operations.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Exit or Disposal
Activities." SFAS No. 146 addresses significant issues regarding the
recognition, measurement and reporting of costs that are associated with exit
and disposal activities, including restructuring activities that are currently
accounted for pursuant to the guidance that the Emerging Issues Task Force
(EITF) has set forth in Issue No. 94-3, "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs Incurred in a Restructuring)." The scope of SFAS No. 146 also
includes (1) costs related to terminating a contract that is not a capital lease
and (2) termination benefits that employees who are involuntarily terminated
receive under the terms of a one-time benefit arrangement that is not an ongoing
benefit arrangement or an individual deferred compensation contract. SFAS No.
146 will be effective for fiscal years beginning after December 31, 2002.
NOTE 8 - FINANCING ARRANGEMENTS
On October 18, 2002, the Company entered into a new senior secured credit
facility (new credit facility). The new credit facility has a maximum commitment
of $53,000, comprised of a $50,000 revolving credit component and a $3,000
capital expenditure loan facility. The new credit facility matures 120 days
prior to the maturity of the New Senior Notes (described below). The new credit
facility replaces the $35,000 term loan facility and $25,000 revolving credit
facility (old credit facility), of which $13,750 and $14,050 were outstanding as
of September 30, 2002, respectively. The old credit facility has been classified
as current and long term on the September 30, 2002 balance sheet, based on the
maturity terms of the new credit facility.
The revolving credit component of the new credit facility is subject to a
borrowing base formula. The borrowing base formula is comprised of the Company's
domestic accounts receivable, domestic inventory and the Company's domestic real
estate, machinery and equipment. The components of the borrowing base under the
new credit facility are as follows:
- 85% of eligible accounts receivable, plus;
- the lesser of (a) 65% of the cost of eligible inventory, excluding
work-in-process, plus 25% of the cost of eligible work-in-process
(eligible work-in-process is limited to $4.0 million), (b) 85% of
the appraised value of inventory, and (c) $15.0 million, plus;
- $13.0 million. The availability under the $13.0 million component of
the borrowing base will reduce on a 7 year straight-line
amortization basis beginning March 31, 2003. The remaining
unamortized principal balance of this component is due and payable
on the final maturity date of the new credit facility.
The capital expenditure loan facility may be used to finance 80% of the cost of
equipment purchased after October 18, 2002. At the end of each calendar year,
beginning December 31, 2003, the principal amount of all loans under the capital
expenditure facility borrowed during the applicable calendar year to begin to
amortize monthly over a seven year, straight-line basis. The remaining
unamortized principal balance under the capital expenditure loan facility is due
and payable on the final maturity date of the new credit facility. The new
credit facility is collateralized by a security interest in the accounts
receivable, inventory, equipment and real estate and other assets of the Company
and its domestic subsidiaries. The Company has also pledged the stock of all of
its domestic
13
subsidiaries and certain stock of its foreign subsidiaries as collateral.
Restrictive terms of the credit facility require that the Company maintain
specified financial ratios including leverage and fixed charge ratios, and
comply with other loan covenants. The interest rates on the new credit facility
range from 225 to 375 basis points over the London Interbank Offered Rates
("LIBOR"), or alternatively, 0 to 100 basis points over the prime rate. As of
October 18, 2002, the Company had approximately $9,600 available for future
borrowings, as determined under the new borrowing base formula.
Additionally, on October 18, 2002, the Company accepted for exchange $64,417,
or approximately 99% of its outstanding $65,000, 10 1/4% Senior Notes due
December 1, 2003 (Old Senior Notes), for 12% Senior Notes due December 1, 2006
(New Senior Notes). The New Senior Notes were issued on October 23, 2002. The
remaining principal of the Old Senior Notes in the amount of $583 remain
outstanding as of October 23, 2002 and will mature on December 1, 2003. In
addition, the holders of the Old Senior Notes that participated in the exchange
for New Senior Notes received a consent payment of $25.63 for each $1,000 of
Old Senior Notes held as of October 23, 2002. The consent payment, which
totaled $1,642, was issued in the form of New Senior Notes and is payable to
the holders at maturity of the New Senior Notes. The New Senior Notes are
general unsecured senior obligations of the Company and are fully and
unconditionally guaranteed, on a joint and several basis, by all domestic
wholly owned subsidiaries of the Company. The New Senior Notes accrue interest
in cash at a rate of 12 percent per annum on the principal amount commencing
October 23, 2002. Interest payments are due December 31 and June 30. In
addition, in the event that the Company's leverage ratio exceeds 4.0 to 1.0 for
the most recently ended four quarters beginning with the semi-annual period
ended December 31, 2002, the Company will be required to pay additional payment
in kind (PIK) interest at a rate ranging from .25% to 2.00% until the next
semi-annual test period. Any interest payment under this test will be made by
issuing additional New Senior Notes. The Company expects to pay additional
interest in the form of PIK notes for the test period ended December 31, 2002
of approximately .50% to .75%.
The Company has the option to redeem the New Senior Notes in whole or in part
during the twelve months beginning December 1, 2002 at 105.0% of the aggregate
principal amount thereof, beginning December 1, 2003 at 102.50% of the
aggregate principal amount thereof and beginning December 1, 2004 at 100% of the
aggregate principal amount thereof together with any interest accrued and unpaid
to the redemption date. Upon a change of control as defined in the New Senior
Note indenture, each holder of the notes will have the right to require the
Company to repurchase all or any part of such holder's notes at a purchase price
equal to 101% of the aggregate principal amount thereof, plus accrued and unpaid
interest to the date of purchase.
The New Senior Note indenture permits the Company and its subsidiaries to incur
additional indebtedness without limitation, provided that it continues to meet a
cash flow coverage ratio. As of October 23, 2002, the Company did not meet the
prescribed ratio. The failure to meet the ratio does not constitute a default
under the New Senior Note indenture. Rather, the New Senior Note indenture
continues to permit certain other types of indebtedness subject to certain
limitations. The Company's bank credit facility, which is secured by liens on
all of the assets and the assets of the subsidiaries, is permitted. The Company
does not believe that its operations will be materially impacted by the
limitation on indebtedness arising under the New Senior Note indenture.
The New Senior Note indenture prohibits the payment of cash dividends on the
Company's Class A Common Stock. The New Senior Note indenture also contains
other covenants limiting the Company's ability and its subsidiaries to, among
other things, make certain other restricted payments, make certain investments,
permit liens, incur dividend and other payment restrictions affecting
subsidiaries, enter into consolidation, merger, conveyance, lease or transfer
transactions, make asset sales, enter into transactions with affiliates or
engage in unrelated lines of business. These covenants are subject to certain
exceptions and qualifications. The New Senior Note indenture considers
non-compliance with the limitations events of default. In addition to
non-payment of interest and principal amounts, the New Senior Note indenture
also considers default with respect to other indebtedness in excess of $5,000 an
event of default. In the event of a default, the principal and interest could be
accelerated upon written notice by 25% or more of the holders of the notes.
14
NOTE 9 - SUPPLEMENTAL GUARANTOR INFORMATION
Each of the Company's Guarantor Subsidiaries has fully and unconditionally
guaranteed, on a joint and several basis, the obligation to pay principal,
premium, if any, and interest with respect to the Company's 10.25% Senior Notes
due December 1, 2003 (the Old Notes). As of October 23, 2002, the Old Notes are
no longer guaranteed by the Guarantor Subsidiaries, but each of the Guarantor
Subsidiaries has fully and unconditionally guaranteed, on a joint and several
basis, the obligation to pay principal, premium, if any, and interest with
respect to the Company's new 12% Senior Notes due December 1, 2006.
The following supplemental unaudited consolidating condensed financial
statements present (in thousands):
1. Consolidating condensed balance sheets as of September 30, 2002 and
December 31, 2001, consolidating condensed statements of operations
for the nine month periods ended September 30, 2002 and 2001 and
consolidating condensed statements of cash flows for the nine months
ended September 30, 2002 and 2001.
2. Hawk Corporation ("Parent") combined Guarantor Subsidiaries and
combined Non-Guarantor Subsidiaries (consisting of the Company's
non-U.S. subsidiaries) with their investments in subsidiaries
accounted for using the equity method.
3. Elimination entries necessary to consolidate the Parent and all of
its subsidiaries.
Management does not believe that separate financial statements of the Guarantor
Subsidiaries of the New Senior Notes are material to investors. Therefore,
separate financial statements and other disclosures concerning the Guarantor
Subsidiaries are not presented.
15
SUPPLEMENTAL CONSOLIDATING CONDENSED
BALANCE SHEET (UNAUDITED)
SEPTEMBER 30, 2002
----------------------------------------------------------------------------
COMBINED COMBINED
GUARANTOR NON-GUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------------ ------------ ------------- ------------ ------------
ASSETS
Current assets:
Cash and cash equivalents $ 1,448 $ 125 $ 1,770 $ 3,343
Accounts receivable, net 24,400 8,905 33,305
Inventories, net 22,828 8,413 31,241
Deferred income taxes 1,111 99 1,210
Other current assets 1,998 1,083 916 3,997
------------ ------------ ------------ ------------ ------------
Total current assets 4,557 48,436 20,103 73,096
Investment in subsidiaries 793 (2,765) $ 1,972
Inter-company advances, net 160,113 20,813 (20,067) (160,859)
Property, plant and equipment, net 11 56,001 10,043 66,055
Intangible assets 72 43,954 44,026
Other 1,010 6,230 1,097 (1,010) 7,327
------------ ------------ ------------ ------------ ------------
TOTAL ASSETS $ 166,556 $ 172,669 $ 11,176 $ (159,897) $ 190,504
============ ============ ============ ============ ============
LIABILITIES AND SHAREHOLDERS'
EQUITY
Current liabilities:
Accounts payable $ 11,524 $ 3,825 $ 15,349
Accrued compensation $ 455 3,777 1,107 5,339
Other accrued expenses 3,386 3,553 1,160 8,099
Current portion of long-term debt 1,083 2,409 41 3,533
------------ ------------ ------------ ------------ ------------
Total current liabilities 4,924 21,263 6,133 32,320
Long-term liabilities:
Long-term debt 91,717 3,044 4,144 98,905
Deferred income taxes 6,642 93 6,735
Other 2,079 1,583 3,662
Inter-company advances, net 1,128 159,546 1,988 $ (162,662)
------------ ------------ ------------ ------------ ------------
Total long-term liabilities 99,487 164,669 7,808 (162,662) 109,302
------------ ------------ ------------ ------------ ------------
Total liabilities 104,411 185,932 13,941 (162,662) 141,622
Shareholders' equity (deficit) 62,145 (13,263) (2,765) 2,765 48,882
------------ ------------ ------------ ------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS'
EQUITY
$ 166,556 $ 172,669 $ 11,176 $ (159,897) $ 190,504
============ ============ ============ ============ ============
16
SUPPLEMENTAL CONSOLIDATING CONDENSED
BALANCE SHEET (UNAUDITED)
DECEMBER 31, 2001
----------------------------------------------------------------------------
Combined Combined
Guarantor Non-Guarantor
Parent Subsidiaries Subsidiaries Eliminations Consolidated
------------ ------------ ------------- ------------ ------------
ASSETS
Current assets:
Cash and cash equivalents $ 1,073 $ 247 $ 1,764 $ 3,084
Accounts receivable, net 160 18,828 6,785 25,773
Inventories, net 42 22,566 6,544 29,152
Deferred income taxes 1,111 89 1,200
Other current assets 2,976 1,143 519 4,638
------------ ------------ ------------ ------------ ------------
Total current assets 5,362 42,784 15,701 63,847
Investment in subsidiaries 794 (1,080) $ 286
Inter-company advances, net 153,455 9,447 (8,555) (154,347)
Property, plant and equipment 18 58,026 9,319 67,363
Intangible assets 199 66,506 66,705
Other 1,010 5,082 1,108 (1,010) 6,190
------------ ------------ ------------ ------------ ------------
TOTAL ASSETS $ 160,838 $ 180,765 $ 17,573 $ (155,071) $ 204,105
============ ============ ============ ============ ============
LIABILITIES AND SHAREHOLDERS'
EQUITY
Current liabilities:
Accounts payable $ 10,292 $ 3,140 $ 13,432
Accrued compensation $ (18) 4,440 811 5,233
Other accrued expenses 1,449 4,345 1,038 6,832
Current portion of long-term debt 5,000 1,669 193 6,862
------------ ------------ ------------ ------------ ------------
Total current liabilities 6,431 20,746 5,182 32,359
Long-term liabilities:
Long-term debt 82,450 4,765 3,742 90,957
Deferred income taxes 10,894 84 10,978
Other 2,154 1,220 3,374
Inter-company advances, net 1,350 144,786 8,425 $ (154,561)
------------ ------------ ------------ ------------ ------------
Total long-term liabilities 94,694 151,705 13,471 (154,561) 105,309
------------ ------------ ------------ ------------ ------------
Total liabilities 101,125 172,451 18,653 (154,561) 137,668
Shareholders' equity (deficit) 59,713 8,314 (1,080) (510) 66,437
------------ ------------ ------------ ------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS'
EQUITY $ 160,838 $ 180,765 $ 17,573 $ (155,071) $ 204,105
============ ============ ============ ============ ============
17
SUPPLEMENTAL CONSOLIDATING CONDENSED
STATEMENT OF OPERATIONS (UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30, 2002
---------------------------------------------------------------------------
COMBINED COMBINED
GUARANTOR NON-GUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------------ ------------ ------------- ------------ ------------
Net sales $ 127,133 $ 22,466 $ 149,599
Cost of sales 97,298 19,648 116,946
------------ ------------ ------------ ------------ ------------
Gross profit 29,835 2,818 32,653
Expenses:
Selling, technical and
administrative expenses $ (188) 22,016 3,511 25,339
Amortization of intangible assets 7 1,064 1,071
------------ ------------ ------------ ------------ ------------
Total expenses (181) 23,080 3,511 26,410
------------ ------------ ------------ ------------ ------------
Income (loss) from operations 181 6,755 (693) 6,243
Interest income (expense), net 2,736 (8,973) (681) (6,918)
Exchange offer costs (818) (818)
Loss from equity investees (20,366) (1,728) $ 22,094
Other (expense), net (342) (252) (42) (636)
------------ ------------ ------------ ------------ ------------
Loss before income taxes (18,609) (4,198) (1,416) 22,094 (2,129)
Income tax (benefit) provision (851) (953) 312 (1,492)
------------ ------------ ------------ ------------ ------------
Net loss before cumulative effect of
change in accounting principle (17,758) (3,245) (1,728) 22,094 (637)
Cumulative effect of change in
accounting principle, net of tax (79) (17,121) (17,200)
------------ ------------ ------------ ------------ ------------
NET LOSS $ (17,837) $ (20,366) $ (1,728) $ 22,094 $ (17,837)
============ ============ ============ ============ ============
18
SUPPLEMENTAL CONSOLIDATING CONDENSED
STATEMENT OF OPERATIONS (UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30, 2001
---------------------------------------------------------------------------
COMBINED COMBINED
GUARANTOR NON-GUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------------ ------------ ------------- ------------ ------------
Net sales $ 125,473 $ 17,935 $ 143,408
Cost of sales 93,998 16,552 110,550
------------ ------------ ------------ ------------ ------------
Gross profit 31,475 1,383 32,858
Expenses:
Selling, technical and
administrative expenses $ (306) 20,235 3,118 23,047
Restructuring costs 1,000 1,000
Amortization of intangible assets 15 3,391 3,406
------------ ------------ ------------ ------------ ------------
Total expenses (291) 24,626 3,118 27,453
------------ ------------ ------------ ------------ ------------
Income (loss) from operations 291 6,849 (1,735) 5,405
Interest income (expense), net 2,753 (9,122) (659) (7,028)
Loss from equity investees (3,809) (2,458) $ 6,267
Other (expense) income, net (544) 77 34 (433)
------------ ------------ ------------ ------------ ------------
(Loss) before income taxes (1,309) (4,654) (2,360) 6,267 (2,056)
Income tax provision (benefit) 206 (845) 98 (541)
------------ ------------ ------------ ------------ ------------
NET LOSS $ (1,515) $ (3,809) $ (2,458) $ 6,267 $ (1,515)
============ ============ ============ ============ ============
19
SUPPLEMENTAL CONSOLIDATING CONDENSED
STATEMENT OF OPERATIONS (UNAUDITED)
THREE MONTHS ENDED SEPTEMBER 30, 2002
---------------------------------------------------------------------------
COMBINED COMBINED
GUARANTOR NON-GUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------------ ------------ ------------- ------------ ------------
Net sales $ 41,707 $ 7,740 $ 49,447
Cost of sales 32,168 7,032 39,200
------------ ------------ ------------ ------------ ------------
Gross profit 9,539 708 10,247
Expenses:
Selling, technical and
administrative expenses $ (202) 6,804 1,243 7,845
Amortization of intangible assets 3 345 348
------------ ------------ ------------ ------------ ------------
Total expenses (199) 7,149 1,243 8,193
------------ ------------ ------------ ------------ ------------
Income (loss) from operations 199 2,390 (535) 2,054
Interest income (expense), net 913 (3,006) (260) (2,353)
Exchange offer costs (818) (818)
Loss from equity investees (1,328) (777) $ 2,105
Other expense, net (58) (258) (25) (341)
------------ ------------ ------------ ------------ ------------
Loss before income taxes (1,092) (1,651) (820) 2,105 (1,458)
Income tax (benefit) (815) (323) (43) (1,181)
------------ ------------ ------------ ------------ ------------
NET LOSS $ (277) $ (1,328) $ (777) $ 2,105 $ (277)
============ ============ ============ ============ ============
20
SUPPLEMENTAL CONSOLIDATING CONDENSED
STATEMENT OF OPERATIONS (UNAUDITED)
THREE MONTHS ENDED SEPTEMBER 30, 2001
---------------------------------------------------------------------------
COMBINED COMBINED
GUARANTOR NON-GUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------------ ------------ ------------- ------------ ------------
Net sales $ 37,128 $ 5,080 $ 42,208
Cost of sales 28,340 5,164 33,504
------------ ------------ ------------ ------------ ------------
Gross profit 8,788 (84) 8,704
Expenses:
Selling, technical and
administrative expenses $ (48) 5,158 906 6,016
Amortization of intangible assets 6 1,135 1,141
------------ ------------ ------------ ------------ ------------
Total expenses (42) 6,293 906 7,157
------------ ------------ ------------ ------------ ------------
Income (loss) from operations 42 2,495 (990) 1,547
Interest income (expense), net 917 (2,973) (241) (2,297)
Loss from equity investees (1,378) (1,152) $ 2,530
Other (expense) income, net (268) 117 (36) (187)
------------ ------------ ------------ ------------ ------------
Loss before income taxes (687) (1,513) (1,267) 2,530 (937)
Income tax provision (benefit) 266 (135) (115) 16
------------ ------------ ------------ ------------ ------------
NET LOSS $ (953) $ (1,378) $ (1,152) $ 2,530 $ (953)
============ ============ ============ ============ ============
21
SUPPLEMENTAL CONSOLIDATING CONDENSED
CASH FLOW STATEMENT (UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30, 2002
---------------------------------------------------------------------------
COMBINED COMBINED
GUARANTOR NON-GUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------------ ------------ ------------- ------------ ------------
Net cash (used in) provided by
operating activities $ (4,862) $ 6,886 $ 620 $ 2,644
Cash flows from investing activities:
Purchase of property, plant and
equipment (6,214) (508) (6,722)
------------ ------------ ------------ ------------ ------------
Net cash used in investing activities (6,214) (508) (6,722)
Cash flows from financing activities:
Proceeds from debt 47,865 333 48,198
Payments on debt (42,515) (1,127) (166) (43,808)
Payment of preferred stock dividend (113) (113)
------------ ------------ ------------ ------------ ------------
Net cash provided by (used in)
financing activities 5,237 (794) (166) 4,277
Effect of currency rate changes 60 60
Net increase (decrease) in cash and
cash equivalents 375 (122) 6 259
------------ ------------ ------------ ------------ ------------
Cash and cash equivalents
at beginning of period $ 1,073 $ 247 $ 1,764 $ 3,084
------------ ------------ ------------ ------------ ------------
Cash and cash equivalents
at end of period $ 1,448 $ 125 $ 1,770 $ 0 $ 3,343
============ ============ ============ ============ ============
22
SUPPLEMENTAL CONSOLIDATING CONDENSED
CASH FLOW STATEMENT (UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30, 2001
---------------------------------------------------------------------------
COMBINED COMBINED
GUARANTOR NON-GUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------------ ------------ ------------- ------------ ------------
Net cash provided by (used in)
operating activities $ 6,435 $ 6,770 $ (1,933) $ 11,272
Cash flows from investing activities:
Purchase of property, plant and
equipment (6,426) (1,014) (7,440)
------------ ------------ ------------ ------------ ------------
Net cash used in investIng activities (6,426) (1,014) (7,440)
Cash flows from financing activities:
Proceeds from long-term debt 26,075 848 3,393 30,316
Payments on long-term debt (32,095) (1,989) (260) (34,344)
Payments of preferred stock
dividends (113) (113)
------------ ------------ ------------ ------------ ------------
Net cash (used in) provided by
financing activities (6,133) (1,141) 3,133 (4,141)
Effect of exchange rate changes on
cash (280) (280)
Net increase (decrease) in cash and
cash equivalents 302 (797) (94) (589)
------------ ------------ ------------ ------------ ------------
Cash and cash equivalents,
at beginning of period 553 1,027 2,430 4,010
------------ ------------ ------------ ------------ ------------
CASH AND CASH EQUIVALENTS,
AT END OF PERIOD $ 855 $ 230 $ 2,336 $ 0 $ 3,421
============ ============ ============ ============ ============
23
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis should be read in conjunction with the
consolidated financial statements and notes thereto appearing elsewhere in this
report.
GENERAL
Hawk operates in four primary reportable segments: friction products, precision
components, performance automotive and motors. The Company focuses on
manufacturing products requiring sophisticated engineering and production
techniques for applications in markets in which it has achieved a significant
market share.
The Company's friction products are made from proprietary formulations of
composite materials that primarily consist of cold-rolled steel, metal powders,
resins and synthetic and natural fibers. Friction products are the replacement
elements used in brakes, clutches and transmissions to absorb vehicular energy
and dissipate it through heat and normal mechanical wear. Friction products
engineered, manufactured and marketed by the Company include friction components
for use in brakes, transmissions and clutches in aerospace, agriculture,
construction, truck and specialty vehicle markets.
The Company's precision components are made from formulations of composite
powder metal alloys. The precision components segment targets three specific
areas of the powder metal marketplace:
- High precision components specializing in tight tolerance fluid
power components;
- Large powder metal components, primarily used in agriculture,
construction and truck applications; and
- Smaller, higher volume parts, utilizing efficient pressing and
sintering capabilities, primarily for appliance, automotive,
business equipment and lawn and garden markets.
In its performance automotive segment, the Company engineers, manufactures and
markets high performance premium branded clutch and drive train components for
the performance automotive markets. The Company, through this segment, targets
teams in the NASCAR and CART racing series, as well as drivers in the SCCA and
ASA racing circuits, high-performance street vehicles and other road race and
oval track competition cars.
Through its motor segment, the Company designs and manufactures die-cast
aluminum rotors for fractional and subfractional horsepower electric motors for
use in a wide variety of applications, including appliances, business equipment,
pumps and fans. The Company also designs and produces integral
horsepower custom motors and generators.
As of September 30, 2002, Hawk had approximately 1,600 employees and 16
manufacturing sites in five countries.
RECENT EVENTS
On October 18, 2002, the Company completed a major financial restructuring. The
purpose of financial restructuring was to extend the maturity of the majority of
the Company's existing debt to 2006 and to improve the Company's future
financial flexibility. The new transactions are described below:
New Senior Notes. On October 18, 2002, the Company accepted for exchange $64.4
million, or approximately 99 percent of its 10 1/4% Senior Notes due 2003 (the
Old Senior Notes) for $64.4 million of new 12% Senior Notes due 2006 (the New
Senior Notes). The New Senior Notes were issued on October 23, 2002. The
remaining principal of the Old Senior Notes of $0.6 million remains outstanding
and will mature on December 1, 2003. In addition, holders of the New Senior
Notes received a consent payment of $25.63 in principal amount of New Senior
Notes
24
for each $1,000.00 of Old Senior Notes exchanged. The consent payment, which
totaled $1.6 million, was issued in the form of New Senior Notes and is payable
to holders of the New Senior Notes at maturity.
The New Senior Notes are general unsecured senior obligations of the Company and
are fully and unconditionally guaranteed, on a joint and several basis, by all
domestic wholly owned subsidiaries of the Company. The New Senior Notes accrue
interest in cash at a rate of 12% per annum on the outstanding principal
amount, which interest will be payable semi-annually in arrears, commencing
December 31, 2002. The new notes will mature on December 1, 2006. In addition,
in the event that the Company's leverage ratio exceeds 4.0 to 1.0 for the most
recently ended four quarters beginning with the semi-annual period ending
December 31, 2002, the Company will be required to pay additional interest at a
rate ranging from .25% to 2.00% until the next semi-annual test period. Any
interest payment under this test will be made by issuing additional New Senior
Notes. The Company expects to pay additional interest in the form of payment
in kind (PIK) notes for the test period ended December 31, 2002 of approximately
..50% to .75% of the outstanding principal amount of the New Senior Notes.
The Company has the option to redeem the New Senior Notes in whole or in part
during the twelve months beginning December 1, 2002 at 105.0% of the aggregate
principal amount thereof, beginning December 1, 2003 at 102.50% of the aggregate
principal amount thereof and beginning December 1, 2004 at 100.0% of the
aggregate principal amount thereof, in each case together with any interest
accrued and unpaid to the redemption date. Upon a change of control as defined
in the New Senior Note indenture, each holder of the notes will have the right
to require the Company to repurchase all or any part of such holder's notes at a
purchase price equal to 101.0% of the aggregate principal amount thereof, plus
accrued and unpaid interest to the date of purchase.
The New Senior Note indenture permits the Company and its subsidiaries to incur
additional indebtedness without limitation, provided that it continues to meet a
cash flow coverage ratio. As of October 23, 2002, the Company did not meet the
prescribed ratio. The failure to meet the ratio does not constitute a default
under the New Senior Note indenture. Rather, the New Senior Note indenture
continues to permit certain other types of indebtedness subject to certain
limitations. Borrowings under the Company's senior secured credit facility are
permitted. The Company does not believe that its operations will be materially
impacted by the limitation on indebtedness arising under the New Senior Note
indenture.
The New Senior Note indenture prohibits the payment of cash dividends on the
Company's Class A Common Stock. The New Senior Note indenture also contains
other covenants limiting the ability of the Company and its subsidiaries to,
among other things, make certain other restricted payments, make certain
investments, permit liens, incur dividend and other payment restrictions
affecting subsidiaries, enter into consolidation, merger, conveyance, lease or
transfer transactions, make asset sales, enter into transactions with affiliates
or engage in unrelated lines of business. These covenants are subject to certain
exceptions and qualifications. The New Senior Note indenture considers
non-compliance with the limitations events of default. In addition to
non-payment of interest and principal, the New Senior Note indenture also
considers default with respect to other indebtedness in excess of $5.0 million
an event of default. In the event of a default under the New Senior Note
Indenture, the principal and interest due under the New Senior Notes could be
accelerated upon written notice by 25% or more of the holders of the New Senior
Notes.
In connection with the exchange offer, the holders of the Old Senior Notes also
amended the Old Senior Note indenture to eliminate the guarantees of the Old
Senior Notes by the Company's subsidiaries and to eliminate all of the
restrictive covenants and certain events of default.
New Bank Credit Facility. On October 18, 2002, the Company entered into a new
senior secured credit facility with a syndicate of banks led by J.P. Morgan
Business Credit Corp. The new credit facility has a maximum commitment of $53.0
million. The new facility matures 120 days prior to the maturity of the New
Senior Notes. The Company has used a portion of the proceeds of the new facility
to pay off its old credit facility in full and to pay certain fees and expenses
associated with the new senior credit facility and the exchange offer, and may
use the remaining proceeds to provide for future working capital needs and for
general corporate purposes.
25
The new credit facility is comprised of a $50.0 million revolving line of credit
component and a $3.0 million capital expenditure loan facility. The revolving
credit component of the new credit facility is subject to a borrowing base
formula. The borrowing base is comprised of the Company's domestic accounts
receivable, domestic inventory and domestic real estate, machinery and
equipment. The components of the borrowing base under the new credit facility
are as follows:
- 85% of eligible accounts receivable, plus;
- the lesser of (a) 65% of the cost of eligible inventory, excluding
work-in-process, plus 25% of the cost of eligible work-in-process
(eligible work-in-process is limited to $4.0 million), (b) 85% of
the appraised value of inventory, and (c) $15.0 million, plus;
- $13.0 million. The availability under the $13.0 million component of
the borrowing base will reduce on a 7 year straight-line
amortization basis beginning March 31, 2003. The remaining
unamortized principal balance of this component is due and payable
on the final maturity date of the new credit facility.
The capital expenditure loan facility may be used to finance 80 percent of the
cost of equipment purchased after October 18, 2002. At the end of each calendar
year, beginning with the year ending December 31, 2003, the principal amount of
all loans under the capital expenditure facility borrowed during the applicable
calendar year will begin to amortize on a seven year, straight-line basis. The
remaining unamortized principal balance under the capital expenditure loan
facility is due and payable on the final maturity date of the new credit
facility.
The new credit facility is collateralized by a security interest in the accounts
receivable, inventory, equipment and real estate and other assets of the Company
and its domestic subsidiaries, and the Company has pledged the stock of all of
its domestic subsidiaries and certain stock of its foreign subsidiaries as
collateral. Restrictive terms of the credit facility require that the Company
maintain specified financial ratios including leverage and fixed charge ratios,
require the Company to achieve a minimum EBITDA for the year ending December 31,
2002, and comply with other loan covenants. The interest rates on the new credit
facility range from 225 to 375 basis points over the London Interbank Offered
Rates ("LIBOR"), or alternatively, 0 to 100 basis points over the prime rate. As
of October 18, 2002, the Company had approximately $9.6 million available for
future borrowings, as determined by the borrowing base under its new credit
facility after the payoff all outstanding loans under its old credit facility.
SIGNIFICANT ACCOUNTING POLICIES
The Company's discussion and analysis of its financial condition and results of
operations are based upon the Company's consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States. The preparation of these financial statements requires the
Company to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenues and expenses, and related disclosure of contingent
assets and liabilities. On an on-going basis, the Company evaluates its
estimates, including those related to bad debts, inventories, intangible assets,
income taxes, financing operations, pensions and contingencies and litigation.
The Company bases its estimates on historical experience and on various other
assumptions that are believed to be reasonable under the circumstances, the
results of which form the basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other sources.
Actual results may differ from these estimates under different assumptions or
conditions. Hawk's significant accounting policies include the following:
Revenue Recognition and Credit Risk. The Company's revenue recognition policy is
to recognize revenues when products are shipped and title has transferred. The
Company maintains an allowance for trade accounts receivable for which
collection on specific customer accounts is doubtful. In determining
collectibility, management reviews available customer financial statement
information, credit rating reports as well as other external documents and
public filings. When it is deemed probable that a specific customer account is
uncollectible, that balance is included in the reserve calculation set by the
Company. Actual results could differ from these estimates.
26
Foreign Currency Translation and Transactions. Assets and liabilities of the
Company's foreign operations are translated using period-end exchange rates and
revenues and expenses are translated using average exchange rates as determined
throughout the period. Gains or losses resulting from translation are included
in a separate component of shareholder's equity. Gains or losses resulting from
foreign currency transactions are translated to local currency at the rates of
exchange prevailing at the dates of the transactions. Accounts receivable or
payable in foreign currencies, other than the subsidiary's local currency, are
translated at the rates of exchange prevailing at the balance sheet date. The
effect of the transaction's gain or loss in included in other expense, net in
the Company's statement of operations.
THIRD QUARTER 2002 COMPARED TO THIRD QUARTER 2001
Net Sales. Consolidated net sales for the third quarter of 2002 were $49.4
million, an increase of $7.2 million, or 17 percent, from the comparable period
in 2001. The increase in net sales was primarily the result of improved
conditions in most of the Company's markets, increased sales and production
levels at its Mexican and Chinese facilities, and new product introductions
leading to market share gains in the Company's friction products and precision
component segments.
- Friction Segment. Net sales in the friction segment during the third
quarter of 2002 were $27.0 million, an increase of 12 percent
compared to net sales of $24.1 million in the third quarter of 2001.
Most of the major markets served by this segment, including truck,
construction, agriculture and automotive, experienced improving
operating conditions in the United States and Europe during the
quarter when compared to the third quarter of 2001. However, net
sales to the aerospace market declined 3 percent during the third
quarter of 2002 compared to the same period in 2001, primarily as a
result of the continuing softness in worldwide air travel. Net sales
to the aerospace market in the third quarter of 2002 were up 20
percent when compared to the second quarter of 2002. This quarter to
quarter improvement in the aerospace market was driven by increased
sales to military applications and newer model aircraft. The Company
continues to expect that most of the markets it serves will continue
to experience gradual economic improvement during the remainder of
2002. However, volumes in the aerospace market for all of 2002 are
expected to decline by approximately 20 percent compared to 2001,
as a result of the continued decline in air travel. The Company
experienced strong sales activity at its foreign operations during
the quarter. The Company's Italian operation's net sales increased
47 percent in the third quarter of 2002 compared to the third
quarter of 2001, as a result of increased sales in the agriculture
and construction markets. The Company also benefited from the
continuing ramp up of sales activity at its Chinese operation. Net
sales from the Company's Chinese operation were up 250 percent when
compared to the same year-ago period. The Company expects the sales
increases at these locations to continue, although not necessarily
at the same rate, as it takes advantage of new sales opportunities
and new product introductions.
- Precision Component Segment. Net sales in the precision components
segment for the third quarter of 2002 were $16.2 million, an
increase of $3.2 million, or 25 percent, compared to the third
quarter of 2001. The increase in net sales was primarily
attributable to increased sales to customers in the lawn and garden,
truck, appliance, power tool and fluid power markets, as the general
industrial segments of the domestic economy continued to show
improvement during the quarter. The Company expects the markets
served by this segment to show gradual improvement during the
remainder of 2002.
- Performance Automotive. Net sales in the Company's performance
automotive segment were flat during the third quarter of 2002 at
$2.8 million compared to the third quarter of 2001. Net sales
increased at the Company's Tex Racing subsidiary by 10 percent
during the third quarter of 2002 compared to the third quarter of
2001 primarily as a result of new drive train product introductions.
This increase was offset by softness in the Company's high
performance clutch business during the quarter.
27
- Motor Segment. Net sales in the Company's motor segment during the
third quarter of 2002 were $3.4 million, an increase of $1.1
million, or 48 percent, from the same period in 2001. The sales
growth in the motor segment came primarily from new outsourcing
business and new product introductions at the Company's
manufacturing facilities in the United States and Monterrey, Mexico.
This Company expects that the segment's new business volumes will
continue to grow, although not necessarily at the same growth rate
as the third quarter of 2002.
Gross Profit. Gross profit increased $1.5 million to $10.2 million during the
third quarter of 2002, a 17 percent increase compared to gross profit of $8.7
million in the comparable period of 2001. The gross profit margin was flat at 21
percent of net sales in the third quarter of 2002 compared to 2001. However,
during the third quarter of 2001, the Company benefited from a substantial
reduction to employee benefit and incentive compensation costs as a result of
cost reduction initiatives implemented by the Company. Eliminating this 2001
reduction, the Company experienced margin improvement in all of its segments,
primarily as a result of higher sales volumes and cost containment programs
partially offset by changes in product mix as well as continued production
ramp-up costs incurred during the quarter at the Company's Chinese and Mexican
facilities.
- Friction Segment. The Company's friction segment reported gross
profit of $6.0 million, or 22 percent, of its net sales in the third
quarter of 2002 compared to $5.9 million or 24 percent of its net
sales in the third quarter of 2001. The decrease in the segment's
gross profit margin during the quarter was primarily the result of
the change in product mix, including lower product margin sales to
the aerospace market during the quarter, partially offset by volume
increases. Additionally, during the third quarter of 2001, the
segment benefited from a reduction to employee benefit and incentive
compensation costs. There was no corresponding reduction in the
third quarter of 2002.
- Precision Components Segment. Gross profit in the precision
components segment during the third quarter of 2002 was $3.5 million
or 22 percent of net sales in third quarter of 2002 compared to $2.3
million, or 18 percent, of net sales in 2001. The increase in margin
was primarily the result of sales volume increases in the segment
and the ability of the Company to leverage the fixed manufacturing
costs associated with this segment to the volume increase.
Additionally, during the third quarter of 2001, the segment
benefited from a reduction to employee benefit and incentive
compensation costs. There was no corresponding reduction in the
third quarter of 2002.
- Performance Automotive Segment. The Company's performance automotive
segment reported gross profit of $0.8 million, or 29 percent, of its
sales in the third quarter of 2002 and 2001. The gross profit margin
was maintained during the quarter primarily as a result of new drive
train product introductions at the Company's Tex Racing subsidiary.
Additionally, during the third quarter of 2001, the segment
benefited from a reduction to employee benefit and incentive
compensation costs. There was no corresponding reduction in the
third quarter of 2002.
- Motor Segment. The Company's motor segment reported a break even
gross margin during the third quarter of 2002 compared to gross
margin loss of $0.2 million for the third quarter of 2001. The
break-even gross margin was primarily the result of the Company's
continued support of its rotor manufacturing facility in Mexico. The
Company experienced higher than expected material and labor costs
during the third quarter of 2002 as production and sales levels
continued to increase as a result of new product introductions at
both its U.S. and Mexican facilities.
Selling, Technical and Administrative Expenses. ST&A expenses increased $1.8
million, or 30 percent, to $7.8 million in the third quarter of 2002 from $6.0
million in the comparable period of 2001. The increase in ST&A expenses is
primarily attributable to the reduction to employee benefit and incentive
compensation costs during the third quarter of 2001. There was no corresponding
reduction in the third quarter of 2002.
28
Amortization of Intangibles. Results for the third quarter of 2002 were
favorably impacted by the adoption of SFAS No. 142 on January 1, 2002, which
eliminated the amortization of goodwill and indefinite life intangible assets.
This accounting change increased pretax income for the third quarter of 2002 by
$0.8 million compared to the prior year period.
Income from Operations. Income from operations increased to $2.1 million in the
third quarter of 2002, or 40 percent, from $1.5 million in comparable period of
2001. The increase in operating income was primarily the result of the sales
volume increases and the reduction of goodwill amortization expense as a result
of the implementation of SFAS No. 142. This improvement was partially offset by
unfavorable product mix and higher than expected costs incurred during the sales
ramp-up at the Company's Mexican facility. Additionally, the Company recorded a
reduction to employee benefit and incentive compensation costs of $1.7 million
in the third quarter of 2001. Income from operations as a percentage of net
sales was flat at 4 percent in both 2002 and 2001. As a result of continuing
product mix issues and the higher than expected material and labor costs in
Mexico, the Company expects to see continued pressure on income from operations
in the fourth quarter of 2002 despite the expected sales volume increases.
As a result of the items discussed above, results from operations at the
Company's segments were as follows:
- The friction segment's income from operations decreased $1.0
million, or 37 percent, to $1.7 million in the third quarter of 2002
from $2.7 million in the comparable period in 2001.
- Income from operations in the precision components segment was $1.0
million in the third quarter of 2002, an increase of $1.1 million
compared to a loss of $0.1 million in the comparable period in 2001.
- Income from operations at the performance automotive segment was
$0.1 million in the third quarter of 2002 compared to break even
results in the comparable period of 2001.
- The loss from operations in the motor segment decreased $0.3
million, or 27 percent, to $0.8 million in the third quarter of 2002
from a loss of $1.1 million in the comparable period in 2001.
Interest Expense. Interest expense was flat at $2.4 million in the third quarter
of 2002 and 2001. The Company benefited from lower borrowing costs during the
quarter. However, this benefit was offset by increased borrowing levels incurred
by the Company during the quarter.
Exchange Offer Costs. During the third quarter of 2002, the Company incurred
third-party fees and expenses of $0.8 million related to its recently completed
offer to exchange new 12% Senior Notes due 2006 for its outstanding 10 1/4%
Senior Notes due 2003. The Company expects to incur an additional $1.1 million
in exchange offer costs in the fourth quarter of 2002.
Other Expense, Net. Other expense was $0.3 million in the third quarter of
2002. The expense in the third quarter of 2002 consisted primarily of expense
relating to a write-off of a licensing agreement at the Company's metal
injection molding subsidiary partially offset by foreign currency transaction
income due to the strength of the Euro during the quarter.
Income Taxes. The Company's recorded an income tax benefit in the third quarter
of 2002 of $1.2 million compared to a provision of $0.1 million in the
comparable quarter of 2001. The tax benefit was the result of the losses
incurred by the Company. Included in the third quarter of 2002 benefit, is an
income tax benefit of $0.6 million as a result of the resolution of a previously
provided for tax contingency.
Net Loss. As a result of the factors noted above, the Company reported a net
loss of $0.3 million in the third quarter of 2002, compared to a net loss of
$1.0 million in the comparable quarter of 2001.
29
FIRST NINE MONTHS OF 2002 COMPARED TO FIRST NINE MONTHS OF 2001
Net Sales. Consolidated net sales for the first nine months of 2002 were $149.6
million, an increase of $6.2 million, or 4 percent, from the comparable period
in 2001. The increase in net sales was primarily the result of improved
conditions in the truck, construction, agriculture, lawn and garden and
automotive markets as well increased sales from the Company's Mexican and
Chinese facilities. Additionally, the Company benefited from the new product
introductions during the period. Partially offsetting this improvement was the
continuing weakness in the aerospace market during the nine month period ended
September 30, 2002.
- Friction Segment. Net sales in the friction segment during the first
nine months of 2002 were $80.2 million, a decrease of $1.0 million,
or 1 percent, compared to the first nine months of 2001. While the
major markets served by this segment experienced improving operating
conditions during the first nine months of 2002 when compared to the
comparable period 2001, they were not able to overcome the declines
experienced by the Company's aerospace segment for the same period.
Net sales to the aerospace market declined 22 percent during the
first nine months of 2002 compared to the same period in 2001,
primarily as a result of the continuing softness in worldwide air
travel. The Company experienced increases in net sales to the truck,
construction, agriculture and automotive markets as a result of
generally improving operating conditions in the United States and
Europe. Net sales at the Company's Italian facility were up 16
percent during the first nine months of 2002 as a result of the
strength of the agriculture and construction markets in the European
markets. Additionally, net sales from the Company's Chinese facility
were up by 220 percent during the first nine months of 2002 as the
Company continued its sales and production ramp-up.
- Precision Component Segment. Net sales in the precision components
segment for the first nine months of 2002 were $50.4 million, an
increase of $5.1 million, or 11 percent, compared to the first nine
months of 2001. The increase in net sales was primarily attributable
to increased sales to customers in the lawn and garden, truck and
fluid power markets, as the general industrial segments of the
domestic economy continued to show improvement during the period.
Additionally, this segment benefited from new product introductions
during the period.
- Performance Automotive. Net sales in the Company's performance
automotive segment during the first nine months of 2002 were $10.1
million, a decrease of 1 percent compared to net sales of $10.2
million in the first nine months of 2001. The decrease in net sales
was primarily attributable to declines in clutch sales during the
period partially offset by new drivetrain product introductions at
the Company's Tex Racing subsidiary.
- Motor Segment. Net sales in the Company's motor segment during the
first nine months of 2002 were $8.9 million, an increase of $2.2
million, or 33 percent, from the same period in 2001. The sales
growth during the period came from new business at the Company's
facilities in the U.S. and Monterrey, Mexico. Additionally, the
Company continued to benefit from new product introductions to its
existing customer base during the period.
Gross Profit. Gross profit declined $0.2 million to $32.7 million during the
first nine months of 2002, a 1 percent decrease compared to gross profit of
$32.9 million in the comparable period of 2001. The gross profit margin
decreased to 22 percent of net sales in the first nine months of 2002 from 23
percent of net sales in the comparable period in 2001. The decline in the gross
margin was primarily the result of product mix issues, especially in the
aerospace market in addition to a reduction to employee benefit and incentive
compensation costs taken in the third quarter of 2001 as a result of cost
reduction initiatives implemented by the Company. There was no corresponding
reduction in the nine month period ended September 30, 2002. The decline in the
gross profit was partially offset by the sales volume increases experienced
during the period.
30
- Friction Segment. The Company's friction segment reported gross
profit of $19.0 million, or 24 percent of net sales, in the first
nine months of 2002 compared to $21.0 million or 26 percent of net
sales in the comparable period of 2001. The decline in the segment's
gross profit margin was primarily the result of the decline in
aerospace sales during period partially offset by increases in sales
to the other markets served by the segment. Additionally, during the
nine month period ended September 30, 2001, the segment benefited
from a reduction to employee benefit and incentive compensation
costs. There was no corresponding reduction in the nine month period
ended September 30, 2002.
- Precision Components Segment. Gross profit in the precision
components segment during the first nine months of 2002 was $10.2
million or 20 percent of net sales, compared to $8.9 million also 20
percent of net sales in 2001. This segment's margins were affected
primarily due to volume increases during the period and the ability
of the segment to leverage its fixed manufacturing costs as a result
of the volume increase. Additionally, during the nine month period
ended September 30, 2001, the segment benefited from a reduction to
employee benefit and incentive compensation costs. There was no
corresponding reduction in the nine month period ended September 30,
2002.
- Performance Automotive Segment. The Company's performance automotive
segment reported gross profit of $3.3 million or 33 percent of net
sales in the first nine months of 2002 compared to $3.1 million or
30 percent of net sales in 2001. The increase in gross profit margin
was primarily the result of new drivetrain product introductions at
the Company's Tex Racing subsidiary as well as manufacturing
efficiencies achieved by the segment during the period.
Additionally, during the nine month period ended September 30, 2001,
the segment benefited from a reduction to employee benefit and
incentive compensation costs. There was no corresponding reduction
in the nine month period ended September 30, 2002.
- Motor Segment. The Company's motor segment reported gross profit of
$0.1 million or 1 percent of net sales, in the first nine months of
2002 compared to a margin loss of $0.1 million in 2001. The increase
in gross margin was primarily the result sales volume increases
during the periods at both the U.S. and Mexican facilities.
Partially offsetting the sales improvement was higher than expected
material and labor costs during the nine month period of 2002.
Selling, Technical and Administrative Expenses. ST&A expenses increased $2.3
million, or 10 percent, to $25.3 million in the first nine months of 2002 from
$23.0 million in the comparable period of 2001. The increase in ST&A expenses is
primarily attributable to a reduction in employee benefit and incentive
compensation costs during the nine month period ended September 30, 2001.
Additionally, the Company incurred increased personnel costs during the nine
month period ended September 30, 2002 associated with its long-term sales and
growth initiatives.
Amortization of Intangibles. Results for the nine month period ended September
30, 2002 were favorably impacted by the adoption of SFAS No. 142 on January 1,
2002, which eliminated the amortization of goodwill and indefinite life
intangible assets. This accounting change increased pretax income for the nine
month period of 2002 by $2.3 million compared to the prior year period.
Income from Operations. Income from operations increased to $6.2 million, or 15
percent, in the first nine months of 2002 from $5.4 million in 2001. The
increase was primarily the result of the reduction of goodwill amortization
expense as a result of the implementation of SFAS No. 142 offset by changes in
product mix. During the nine months ended September 30, 2002, the Company took a
reduction to employee benefit and incentive compensation costs of $1.7 million.
Additionally, the Company incurred a restructuring charge of $1.0 million during
the 2001 reporting period as part of a corporate-wide cost reduction initiative
announced in June 2001. Income from operations as a percentage of net sales was
flat at 4 percent in 2002 and 2001.
As a result of the items discussed above, results from operations at the
Company's segments were as follows:
31
- The friction segment's income from operations decreased $1.9
million, or 27 percent, to $5.1 million in the first nine months of
2002 from $7.0 million in the comparable period in 2001.
- Income from operations in the precision components segment was $2.0
million in the first nine months of 2002, an increase of $1.7
million, or 567 percent, compared to $0.3 million in the comparable
period in 2001.
- Income from operations at the performance automotive segment was
$1.1 million in the first nine months of 2002, an increase of 120
percent, compared to $0.5 million in the comparable period of 2001.
- The loss from operations in the motor segment decreased to $2.0
million in the first nine months of 2002 from $2.5 million in the
comparable period in 2001.
Interest Expense. Interest expense decreased $0.2 million, or 3 percent, to $7.0
million in the first nine months of 2002 from $7.2 million in the comparable
period of 2001. The decrease is primarily attributable to lower borrowing costs
partially offset by increased borrowing levels incurred by the Company during
the period.
Exchange Offer Costs. During the nine month period ended September 30, 2002, the
Company incurred third-party fees and expenses of $0.8 million related to its
recently completed offer to exchange new 12% Senior Notes due 2006 for its
outstanding 10 1/4% Senior Notes due 2003. The Company expects to incur an
additional $1.1 million in exchange offer costs in the fourth quarter of 2002.
Other Expense, Net. Other expense was $0.6 million in the first nine months of
2002 compared to $0.4 million for the comparable period of 2002. The increase
was primarily the result of expense relating to a write-off of a licensing
agreement at the Company's metal injection molding subsidiary offset by foreign
currency transaction income due to the strength of the Euro during the period.
Income Taxes. The Company's recorded a benefit for income taxes during the first
nine months of 2002 of $1.5 million compared to a benefit of $0.5 million in the
comparable period of 2001. Included in the nine month benefit for the period
ended September 30, 2002, is an income tax benefit of $0.6 million as a result
of the resolution of a previously provided for tax contingency.
Cumulative Effect of Change in Accounting Principle. In accordance with the
requirements of SFAS No. 142, the Company recorded a charge for the cumulative
effect of change in accounting principle of $17.2 million in the nine months
ended September 30, 2002. (See "Notes to Consolidated Financial Statements" for
additional information on this charge.) This charge represents the write-off of
$21.5 million of goodwill ($17.2 million, net of income taxes).
Net Loss. As a result of the factors noted above, the Company reported a net
loss of $17.8 million in the first nine months of 2002, compared to a net loss
of $1.5 million in 2001.
LIQUIDITY AND CAPITAL RESOURCES
The primary financing requirements of the Company are (1) for capital
expenditures for maintenance, replacement and acquisitions of equipment,
expansion of capacity, productivity improvements and product development, (2)
for funding the Company's day-to-day working capital requirements and (3) to pay
interest on, and to repay principal of, indebtedness. The Company's primary
source of funds for conducting its business activities and servicing its
indebtedness has been cash generated from operations and borrowings under its
bank credit facility.
At September 30, 2002, the Company had available a bank credit facility used for
general corporate purposes. The facility was comprised of a $25.0 million
revolving credit component and a $13.8 million amortizing term loan subject
32
to a borrowing base formula. The term loan had quarterly maturities of $1.25
million and the facility had a maturity date of March 31, 2003. As of September
30, 2002, the Company had $17.8 million outstanding under the revolving credit
component of the facility. The credit facility was collateralized by a security
interest in the accounts receivable, inventory, equipment and real estate and
other assets of the Company and its subsidiaries, and the Company had pledged
the stock of all of its domestic subsidiaries and certain stock of its foreign
subsidiaries as collateral. Restrictive terms of the credit facility required
that the Company maintain specified financial ratios including leverage,
interest coverage and fixed charge ratios, and comply with other loan covenants.
The Company was in compliance with the financial covenants as of September 30,
2002. Additionally, the Company had approximately $5.3 million available for
future borrowings, as determined by the borrowing base under that credit
facility.
On October 23, 2002 the Company completed the exchange of $64.4 million, or
approximately 99 percent, in principal amount of its Old Senior Notes for New
Senior Notes. Concurrently, the Company entered into a new bank credit facility.
A portion of the proceeds from the new credit facility was used to pay off the
Company's existing credit facility. See "Recent Events" for additional
information about the new credit facility and the amounts currently available
for future borrowings under that facility.
The Company's Old Senior Notes bear interest at 10.25% per annum and mature
December 1, 2003. The Old Senior Notes are general unsecured senior obligations
of the Company and, prior to the exchange offer, were fully and unconditionally
guaranteed, on a joint and several basis, by all domestic wholly owned
subsidiaries of the Company. In connection with the exchange offer, all of the
subsidiary guarantees of the Old Senior Notes were eliminated. The New Senior
Notes, which bear interest at 12% per annum and mature December 1, 2006, were
issued on October 23, 2002 are also general unsecured senior obligations of the
Company, and are fully and unconditionally guaranteed, on a joint and several
basis, by all domestic wholly owned subsidiaries of the Company. See "Recent
Events" for additional information about the exchange offer and the terms of the
New Senior Notes.
Net cash provided by operating activities was $2.6 million for the nine month
period ended September 30, 2002. Net cash provided by operating activities was
$11.3 million for the comparable nine month period of 2001. The decline in cash
from operations was caused primarily by the net loss for the period and an
increase in working capital assets during the quarter. The increase in working
capital was caused primarily by the increase in accounts receivables due to
increased net sales during the period as well as extended payment terms by
customers during the nine month period compared to the comparable period of
2001.
Net cash used in investing activities was $6.7 million and $7.4 million for the
nine month period ended September 30, 2002 and 2001, respectively, for the
purchase of property, plant and equipment.
Net cash provided by financing activities was $4.3 million for the nine month
period ended September 30, 2002 as a result of increased borrowings by the
Company. The increase in borrowings during the nine month period ended September
30, 2002 was used primarily to support the increase in the Company's working
capital assets, the purchases of property plant and equipment and the fees and
expenses paid in connection with the Company's recently completed financing
transactions. Net cash used in financing activities was $4.1 million for the
nine month period ended September 30, 2001.
The Company believes that cash flow from operating activities and borrowings
under the its bank credit facility will be sufficient to satisfy its working
capital, capital expenditures and debt requirements and to finance continued
internal growth for the next twelve months
33
ACCOUNTING CHANGES
Refer to Note 7 "Recently Issued Accounting Pronouncements" of the Notes to
Consolidated Financial Statements for a discussion of recent accounting
pronouncements.
FORWARD LOOKING STATEMENTS
Statements that are not historical facts, including statements about the
Company's confidence in its prospects and strategies and its expectations about
growth of existing markets and its ability to expand into new markets, to
identify and acquire complementary businesses and to attract new sources of
financing, are forward-looking statements that involve risks and uncertainties.
In addition to statements which are forward-looking by reason of context, the
words "believe," "expect," "anticipate," "intend," "designed," "goal,"
"objective," "optimistic," "will" and other similar expressions identify
forward-looking statements. In light of the risks and uncertainties inherent in
all future projections, the inclusion of the forward-looking statements should
not be regarded as a representation by the Company or any other person that the
objectives or plans of the Company will be achieved. Many factors could cause
the Company's actual results to differ materially and adversely from those in
the forward-looking statements, including the following:
- the ability of the Company to continue to meet the terms of its
senior notes and bank facility which contain a number of significant
financial covenants and other restrictions;
- the effect of the Company's debt service requirements on funds
available for operations and future business opportunities and the
Company's vulnerability to adverse general economic and industry
conditions and competition;
- the continuing impact of the decline in the aerospace market on the
Company's gross margins;
- the ability of the Company to utilize all of its manufacturing
capacity in light of softness in the commercial and industrial
end-markets served by the Company;
- continuing start-up costs at the Company's facilities in Mexico and
China, as well the ability of the Company to generate a profit at
the start-up operations at the Company's Hawk MIM subsidiary;
- the effect of any additional impairment of goodwill as a result of
future testing of the carrying value of indefinite-lived assets and
goodwill;
- the effect of competition by manufacturers using new or different
technologies;
- the effect on the Company's international operations of unexpected
changes in regulatory requirements, export restrictions, currency
controls, tariffs and other trade barriers, difficulties in staffing
and managing foreign operations, political and economic instability,
fluctuations in currency exchange rates, difficulty in accounts
receivable collection and potentially adverse tax consequences;
- the ability of the Company to negotiate new agreements, as they
expire, with its unions representing certain of its employees, on
terms favorable to the Company or without experiencing work
stoppages;
- the effect of any interruption in the Company's supply of raw
materials or a substantial increase in the price of any of the raw
materials;
- the continuity of business relationships with major customers; and
- the ability of the Company's aircraft brake products to meet
stringent Federal Aviation Administration criteria and testing
requirements.
These risks and others that are detailed in this Form 10-Q and other filings by
the Company with the Securities and Exchange Commission must be considered by
any investor or potential investor in the Company.
34
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Market Risk Disclosures. The following discussion about the Company's market
risk disclosures involves forward-looking statements. Actual results could
differ materially from those projected in the forward-looking statements. The
Company is exposed to market risk related to changes in interest rates and
foreign currency exchange rates. The Company does not use derivative financial
instruments for speculative or trading purposes.
Interest Rate Sensitivity. At September 30, 2002, approximately 31 percent, or
$31.6 million, of the Company's debt obligations bear interest at a variable
rate. If interest rates were to increase 100 basis points (1.0%) from September
30, 2002 rates, and assuming no changes in debt from September 30, 2002 levels,
the additional annual interest expense to the Company would be approximately
$0.2 million. To mitigate the risk associated with interest rate fluctuations,
in January 2001, the Company entered into an interest rate swap essentially
converting $10.0 million notional amount of its variable rate debt to a fixed
base rate of 5.34 percent. The notional amount was used to calculate the
contractual cash flow to be exchanged and does not represent exposure to credit
loss. This financial instrument did not meet the hedge accounting criteria of
SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities". The
carrying value and the fair value of the interest rate swap at September 30,
2002 was $0.4 million (liability). The change in the fair value was reflected in
the Consolidated Statement of Operations in other expense, net. On October 18,
2002, in conjunction with the Company entering into a new bank credit facility,
the Company terminated its interest rate swap. The payment made by the Company
to terminate the interest rate swap was $0.4 million. The Company's primary
interest rate risk exposure results from floating rate debt. The Company does
not engage in activities using complex or highly leveraged instruments.
Foreign Currency Exchange Risk. The majority of the Company's receipts and
expenditures are contracted in U.S. dollars, and the Company does not consider
the market risk exposure relating to currency exchange to be material at this
time. The Company currently does not hedge its foreign currency exposure and,
therefore, has not entered into any forward foreign exchange contracts to hedge
foreign currency transactions. The Company has operations outside the United
States with foreign-currency denominated assets and liabilities, primarily
denominated in Italian lira, Canadian dollars, Mexican pesos and Chinese
renminbi. Because the Company has foreign-currency denominated assets and
liabilities, financial exposure may result, primarily from the timing of
transactions and the movement of exchange rates. The unhedged foreign currency
balance sheet exposures as of September 30, 2002 are not expected to result in a
significant impact on earnings or cash flows.
ITEM 4. CONTROLS AND PROCEDURES.
Within the 90 days prior to the filing date of this report, the Company
evaluated the effectiveness of the design and operation of its disclosure
controls and procedures. The evaluation was carried out under the supervision of
and with the participation of the Company's management, including the Company's
Chief Executive Officer, Vice President - Finance and Vice President -
Controller. Based on this evaluation, the Chief Executive Officer, Vice
President - Finance and Vice President - Controller concluded that the Company's
disclosure controls and procedures are effective in timely alerting them to
material information relating to the Company, including its consolidated
subsidiaries, required to be included in reports the Company files with or
submits to the Securities and Exchange Commission under the Securities Exchange
Act of 1934. There have been no significant changes in the Company's internal
controls or in other factors that could significantly affect the Company's
internal controls subsequent to the date of the evaluation.
35
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is involved in various lawsuits arising in the ordinary course of
business. In the Company's opinion, the outcome of these matters is not
anticipated to have a material adverse effect on the Company's financial
condition, liquidity or results of operations.
ITEM 5. OTHER EVENTS
On October 22, 2002, Hawk Corporation announced that its Board of Directors
appointed Andrew T. Berlin to fill the vacancy on its Board. Berlin's
appointment returns Hawk's board to eight directors. Mr. Berlin is no relation
to Hawk Corporation's President and Chief Operating Officer, Jeffrey H. Berlin.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
10.1* Credit Agreement, dated as of October 18, 2002, among the
Company, and certain of its domestic subsidiaries from time to time
party thereto, as Borrowers and Guarantors, the Lending Institutions
party thereto, as Lenders, J.P. Morgan Business Credit Corp., as
Advisor, JPMorgan Chase Bank, as Administrative Agent and Collateral
Agent, Issuing Bank and Arranger, PNC Bank, National Association as
a Documentation Agent and Fleet Capital Corp. as a Documentation
Agent.
10.2* Security and Pledge Agreement, dated as of October 18, 2002,
among the Company, and its certain Subsidiaries as Grantors, the
other Grantors from time to time party thereto, and JPMorgan Chase
Bank, as Administrative and Collateral Agent.
10.3* Form of Ohio Open Ended Mortgage, Assignment of Leases and
Rents and Fixture Filing, each dated as of October 18, 2002, issued
by each of Friction Products Co., Logan Metal Stampings, Inc. and
S.K. Wellman Corp. and in Favor of JPMorgan Chase Bank.
10.4* Form of Pennsylvania Open Ended Mortgage Securing Future
and/or Revolving Advances up to a Maximum Principal Amount of Fifty
Three Million Dollars ($53,000,000) plus accrued interest and other
Indebtedness as described in 42 PA. C.S.A.ss.8143, dated as of
October 18, 2002, issued by Allegheny Clearfield, Inc. in favor of
JPMorgan Chase Bank.
10.5* Form of Illinois Mortgage, Assignment of Leases and Rents and
Fixture Filing, dated as of October 18, 2002, issued by Hawk Motors,
Inc. in favor of JPMorgan Chase Bank.
10.6* Form of Indiana Mortgage, Assignment of Leases and Rents and
Fixture Filing, dated as of October 18, 2002, issued by Helsel, Inc.
in favor of JPMorgan Chase Bank.
99.1* Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
36
99.2* Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
-----------------
* filed herewith
(b) Reports on Form 8-K:
Hawk Corporation has filed four reports on Form 8-K since June 30,
2002:
A report dated July 24, 2002 reporting information relating to the
Company's adoption of Statement of Financial Accounting Standards
(SFAS) No. 142, "Goodwill and Other Intangible Assets."
A report dated September 27, 2002 reporting information relating to
the Company entering into a commitment letter with J.P. Morgan
Business Credit, JPMorgan Chase Bank, Fleet Capital Corporation and
PNC Bank, National Association with respect to a new senior secured
credit facility.
A report dated October 2, 2002 reporting the extension of the
consent payment deadline in connection with the Company's offer to
exchange new 12% Senior Notes due 2006 for its outstanding 10 1/4%
Senior Notes due 2003 and its related solicitation of consents to
amend the indenture for the 10 1/4% Senior Notes due 2003.
A report dated October 14, 2002 reporting that on October 14, 2002,
Hawk Corporation filed a press release announcing, in connection
with its offer to exchange new 12% Senior Notes due 2006 for its
outstanding 10 1/4% Senior Notes due 2003 and its related
solicitation of consents to amend the indenture for the 10 1/4%
Senior Notes due 2003, that it has received valid and unrevoked
consents representing a majority in aggregate principal amount of
the 10 1/4% Senior Notes due 2003. In addition, Hawk announced the
extension of the exchange offer and related consent payment
deadline. Hawk also issued press releases on October 16, 17 and 18,
2002, further extending the exchange offer and consent payment
deadline. Later in the day on October 18, 2002, Hawk issued another
press release announcing the completion of the exchange offer and
its acceptance of $64,417,000 or approximately 99% in principal
amount of its 10 1/4% Senior Notes due 2003. Hawk further announced
that, concurrently with its acceptance of the 10 1/4% Senior Notes
due 2003, it completed its new $53.0 million credit facility.
37
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: November 14, 2002 HAWK CORPORATION
By: /s/ RONALD E. WEINBERG
-------------------------------------
Ronald E. Weinberg
Chairman and CEO
By: /s/ THOMAS A. GILBRIDE
-------------------------------------
Thomas A. Gilbride
Vice President - Finance and Treasurer
(Principal Financial Officer)
38
CERTIFICATION OF CHAIRMAN OF THE BOARD AND CHIEF EXECUTIVE OFFICER (PRINCIPAL
EXECUTIVE OFFICER)
I, Ronald E. Weinberg, Chairman of the Board and Chief Executive Officer of Hawk
Corporation, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Hawk
Corporation;
2. Based on my knowledge, this quarterly 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 quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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 quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a. designed such disclosure controls and procedures 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 quarterly report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and the audit committee of registrant's board of directors (or
persons performing the equivalent function):
a. all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes
in internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: November 14, 2002
/s/ RONALD E. WEINBERG
- -------------------------------------------------
Ronald E. Weinberg
Chairman of the Board and Chief Executive Officer
(Principal Executive Officer)
39
CERTIFICATION OF VICE PRESIDENT - FINANCE (PRINCIPAL FINANCIAL OFFICER)
I, Thomas A. Gilbride, Vice President - Finance of Hawk Corporation, certify
that:
1. I have reviewed this quarterly report on Form 10-Q of Hawk
Corporation;
2. Based on my knowledge, this quarterly 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 quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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 quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a. designed such disclosure controls and procedures 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 quarterly report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and the audit committee of registrant's board of directors (or
persons performing the equivalent function):
a. all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes
in internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: November 14, 2002
/s/ THOMAS A. GILBRIDE
- --------------------------------
Thomas A. Gilbride
Vice President - Finance
(Principal Financial Officer)
40