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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 MARCH 31, 2003
OR
[ ] 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 by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
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: 8,571,626
Class B Common Stock, $0.01 par value: None (0)
As used in this Form 10-Q, the terms "Company," "Hawk," "Registrant," "we,"
"us," and "our" mean Hawk Corporation and its consolidated subsidiaries, taken
as a whole, unless the context indicates otherwise. Except as otherwise stated,
the information contained in this Form 10-Q is as of March 31, 2003.
1
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited) 3
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 22
Item 3. Quantitative and Qualitative Disclosures about Market Risk 31
Item 4. Controls and Procedures 31
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 32
Item 2. Changes in Securities and Use of Proceeds 32
Item 5. Other Information 32
Item 6. Exhibits and Reports on Form 8-K 32
SIGNATURES 34
CERTIFICATIONS 35
2
PART I. FINANCIAL INFORMATION
ITEM I. FINANCIAL STATEMENTS (UNAUDITED)
HAWK CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
MARCH 31, DECEMBER 31,
2003 2002
------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 3,430 $ 1,702
Accounts receivable, less allowance of
$466 in 2003 and $482 in 2002 37,377 32,761
Inventories:
Raw material and work-in-process 20,155 20,597
Finished products 12,039 12,664
------------------------
32,194 33,261
Deferred income taxes 1,742 745
Taxes receivable 1,584 4,321
Other current assets 4,080 4,008
------------------------
Total current assets 80,407 76,798
Property, plant and equipment:
Land and improvements 1,679 1,676
Buildings and improvements 19,783 19,604
Machinery and equipment 104,331 100,840
Furniture and fixtures 8,071 7,920
Construction in progress 4,030 6,385
------------------------
137,894 136,425
Less accumulated depreciation and amortization 71,439 68,533
------------------------
Total property, plant and equipment 66,455 67,892
Other assets:
Goodwill 32,495 32,495
Other intangible assets 10,508 10,701
Shareholder notes 1,010 1,010
Other 4,722 4,972
------------------------
Total other assets 48,735 49,178
Total assets $195,597 $193,868
========================
3
HAWK CORPORATION
CONSOLIDATED BALANCE SHEETS - (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE DATA)
MARCH 31, DECEMBER 31,
2003 2002
---------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 21,853 $ 17,851
Accrued compensation 6,019 4,302
Other accrued expenses 9,448 5,172
Bank Facility 28,002 36,327
Current portion of long-term debt 2,317 3,103
---------------------------
Total current liabilities 67,639 66,755
Long-term liabilities:
Long-term debt 69,414 69,523
Deferred income taxes 6,244 6,233
Other 6,719 6,523
---------------------------
Total long-term liabilities 82,377 82,279
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 8,571,626
and 8,557,990 outstanding in 2003 and 2002,
respectively 92 92
Class B common stock, $.01 par value; 10,000,000
shares authorized; none issued or outstanding
Additional paid-in capital 54,547 54,616
Retained earnings 1,309 1,228
Accumulated other comprehensive loss (5,800) (6,436)
Treasury stock, at cost, 616,124 and 629,760
shares in 2003 and 2002, respectively (4,568) (4,667)
---------------------------
Total shareholders' equity 45,581 44,834
---------------------------
Total liabilities and shareholders' equity $ 195,597 $ 193,868
===========================
Note: The balance sheet at December 31, 2002 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
MARCH 31,
2003 2002
-------------------------
Net sales $ 58,590 $ 49,804
Cost of sales 45,643 39,025
-------------------------
Gross profit 12,947 10,779
Operating Expenses:
Selling, technical and administrative expenses 9,464 9,198
Amortization of intangibles 197 203
-------------------------
Total operating expenses 9,661 9,401
-------------------------
Income from operations 3,286 1,378
Interest expense (2,745) (2,451)
Interest income 12 63
Other expense, net (255) (202)
-------------------------
Income (loss) before income taxes 298 (1,212)
Income tax provision (benefit) 179 (612)
-------------------------
Net income (loss) before cumulative effect of change in
accounting principle 119 (600)
Cumulative effect of change in accounting principle, net of
tax of $4,252 (17,200)
-------------------------
Net income (loss) $ 119 $(17,800)
=========================
Earnings (loss) per share:
Basic earnings (loss) per share:
Basic earnings (loss) before cumulative effect of change
in accounting principle $ .01 $ (.07)
Cumulative effect of change in accounting principle (2.01)
-------------------------
Net earnings (loss) per basic share $ .01 $ (2.08)
=========================
Diluted earnings (loss) per share:
Diluted earnings (loss) before cumulative effect of
change in accounting principle $ .01 $ (.07)
Cumulative effect of change in accounting principle (2.01)
-------------------------
Net earnings (loss) per diluted share $ .01 $ (2.08)
=========================
See notes to consolidated financial statements.
5
HAWK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(IN THOUSANDS)
THREE MONTHS ENDED
MARCH 31,
2003 2002
------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ 119 $ (17,800)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Depreciation and amortization 3,108 3,093
Deferred income taxes (988)
Cumulative effect of change in accounting
principle, net of tax (17,200)
Loss on fixed assets 315
Accounts receivable (4,231) (7,067)
Inventories 1,370 (565)
Other assets 2,717 (185)
Accounts payable 3,827 1,847
Other 6,240 1,557
---------------------------
Net cash provided by (used in) operating activities 12,477 (1,920)
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property, plant and equipment (1,490) (1,931)
---------------------------
Net cash used in investing activities (1,490) (1,931)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from long-term debt 12,266 15,838
Payments on long-term debt (21,507) (12,569)
Payments of preferred stock dividends (38) (38)
---------------------------
Net cash (used in) provided by financing activities (9,279) 3,231
---------------------------
Effect of exchange rate changes on cash 20 (52)
---------------------------
Net increase (decrease) in cash and cash equivalents 1,728 (672)
Cash and cash equivalents at beginning of year 1,702 3,084
---------------------------
Cash and cash equivalents at end of year $ 3,430 $ 2,412
===========================
See notes to consolidated financial statements.
6
HAWK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2003
(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 March
31, 2003 are not necessarily indicative of the results that may be expected for
the year ending December 31, 2003. 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, 2002.
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. All significant intercompany accounts and
transactions have been eliminated in the accompanying financial statements.
Certain amounts have been reclassified in 2002 to conform to the 2003
presentation.
NOTE 2 -INTANGIBLE ASSETS
Upon adoption of Statement of Financial Accounting Standards (SFAS) No. 142
(SFAS 142) on January 1, 2002, the Company changed its method of accounting for
goodwill and other indefinite-lived intangible assets from an amortization
methodology to an impairment-only methodology. SFAS 142 provided for a
six-month transitional period, from the effective date of adoption, for the
Company to perform an initial assessment of whether goodwill was impaired. The
Company performed the assessment during the second quarter of 2002, by
comparing the fair value of each of its reporting units to their respective
carrying values as of January 1, 2002. The Company, with the assistance of
independent valuation experts, concluded that as of January 1, 2002 certain of
its goodwill was impaired by $21,452 ($17,200 after tax) or $2.01 per basic and
diluted share, and such amount was reflected as a cumulative effect of change
in accounting principle. The following is a summary of the pre-tax impairment
charge by affected business segment:
Friction products $ 11,100
Performance racing 4,007
Motor 6,345
---------------
Total $ 21,452
===============
The fair value of goodwill was estimated using a combination of a discounted
cash flow valuation model and a market approach comparing the Company's
reporting units to similar peer group companies, as well as acquisitions having
similar characteristics. The discounted cash flow valuation model was based on
future estimated operating cash flows, incorporating a discount rate
commensurate with the risks for each reporting unit and assumptions that were
consistent with the Company's operating plans and estimates used to manage each
of the underlying reporting units. The impairment resulted from the carrying
value exceeding the fair value of certain reporting units, and was primarily due
7
to a shortfall in current and projected sales from levels anticipated at the
time of the respective acquisitions and other costs associated with the
Company's global expansion initiatives, as well as market conditions as of
January 1, 2002.
In accordance with SFAS No. 121 "Accounting for the Impairment of Long-Lived
Assets to be Disposed of" (SFAS 121), management concluded that no asset
impairment charges were deemed necessary in 2001. The Company determined that
the estimated future undiscounted cash flows associated with each unit tested
exceeded the carrying values of their respective long-lived assets.
Consequently, no impairment existed under SFAS 121.
The components of other intangible assets as of March 31, 2003 and December 31,
2002 are as follows:
MARCH 31, 2003 DECEMBER 31, 2002
------------------------------------ ------------------------------------
ACCUMULATED ACCUMULATED
GROSS AMORTIZATION NET GROSS AMORTIZATION NET
----- ------------ --- ----- ------------ ---
Intangible assets subject to
amortization:
Product certifications $20,820 $10,444 $10,376 $20,820 $10,264 $10,556
Other intangible assets 2,719 2,587 132 2,719 2,574 145
------- ------- ------- ------- ------- -------
Intangible assets subject to
amortization $23,539 $13,031 $10,508 $23,539 $12,838 $10,701
======= ======= ======= ======= ======= =======
The Company estimates its amortization expense for its finite-lived intangible
assets for each of the next five years to be $732.
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. As of March 31, 2003, the weighted
average amortization period for product certifications and other intangible
assets is 29 years and 14 years, respectively.
A summary of the Company's net goodwill at March 31, 2003 and December 31, 2002
by reportable operating segment is as follows:
Precision components $ 28,109
Performance racing 4,386
---------------
Total $ 32,495
===============
NOTE 3 - COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) is as follows:
THREE MONTHS ENDED
MARCH 31,
2003 2002
-------------- ---------------
Net income (loss) $ 119 $ (17,800)
Foreign currency translation 636 (329)
-------------- ---------------
Comprehensive income (loss) $ 755 $ (18,129)
============== ===============
NOTE 4 - INVENTORIES
Inventories are stated at the lower of cost or market. Cost includes materials,
labor and overhead and is determined by the first-in, first-out (FIFO) method.
9
NOTE 5 - EARNINGS (LOSS) PER SHARE
Basic and diluted earnings (loss) per share are computed as follows:
THREE MONTHS ENDED
MARCH 31,
2003 2002
-------------------------
Numerator:
Net earnings (loss) before cumulative effect of change in accounting
principle $ 119 $ (600)
Preferred stock dividend (38) (38)
-------------------------
Net earnings (loss) before cumulative effect of change in accounting
principle available to common shareholders $ 81 $ (638)
Cumulative effect of change in accounting principle (17,200)
-------------------------
Net earnings (loss) available to common shareholders $ 81 $(17,838)
=========================
Denominator:
Denominator for basic earnings (loss) per share-
Weighted average shares 8,562 8,555
Effect of dilutive securities:
Stock options and assumed conversion of debt
-------------------------
Denominator for diluted earnings (loss) per share-
adjusted weighted-average shares 8,562 8,555
Basic earnings (loss) per share:
Basic earnings (loss) before cumulative effect of change in
accounting principle $ .01 $ (.07)
Cumulative effect of change in accounting principle (2.01)
-------------------------
Net earnings (loss) per basic share $ .01 $ (2.08)
=========================
Diluted earnings (loss) per share:
Diluted earnings (loss) before cumulative effect of change in
accounting principle $ .01 $ (.07)
Cumulative effect of change in accounting principle (2.01)
-------------------------
Net earnings (loss) per diluted share $ .01 $ (2.08)
=========================
For the three months ended March 31, 2003 and 2002 the assumed conversion of
debt was not included in the computation of diluted earnings per share since it
would have resulted in an anti-dilutive effect.
10
NOTE 6 - EMPLOYEE STOCK OPTION PLAN
In accordance with the provisions of SFAS No. 123, "Accounting for Stock-Based
Compensation,"(SFAS 123) the Company has elected to continue applying the
provisions of Accounting Principles Board Opinion 25 and related interpretations
in accounting for it's stock-based compensation plans. Accordingly, the Company
does not recognize compensation expense for stock options when the stock option
price at the grant date is equal to or greater than the fair market value of the
stock at that date. In December 2002, the Company adopted the disclosure
provisions of SFAS No. 148, "Accounting for Stock-Based Compensation-Transition
and Disclosure" (SFAS 148). SFAS 148 requires prominent disclosure regarding the
method used by the Company to account for stock-based employee compensation and
the effect of the method used on reported results. The following illustrates the
pro forma effect on net income (loss) and earnings (loss) per share if the
Company had applied the fair value recognition provisions of SFAS 123:
THREE MONTHS ENDED
MARCH 31,
2003 2002
------------------------------
Net income (loss) as reported $ 119 $ (17,800)
Employee stock-based compensation expense determined
under fair value based methods, net of tax 133 307
------------------------------
Pro forma net loss $ (14) $ (18,107)
==============================
Earnings (loss) per share (basic and diluted):
As reported $ .01 $ (2.08)
=============== ==============
Pro forma $ (.01) $ (2.12)
==============================
11
NOTE 7 - BUSINESS SEGMENTS
The Company operates in four primary business segments: friction products,
precision components, performance racing 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
powder metal components, used primarily in industrial applications. The Company,
through this segment, targets four 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 and metal
injected molded parts for a variety of industries.
The performance racing segment engineers, manufactures and markets high
performance friction material for use in racing car brakes in addition to
premium branded clutch and drive train components. The Company, through this
segment, targets leading teams in several racing series, as well as
high-performance street vehicles and other road race and oval track competition
cars.
The motor segment engineers, manufactures and markets die-cast aluminum rotors
for use in the factional and subfractional horsepower electric motors. The
Company, through this segment, targets a wide variety of applications such as
appliances, business equipment, pumps and fans.
12
The information by segment is as follows:
THREE MONTHS ENDED
MARCH 31,
2003 2002
------------------------
Net sales to external customers:
Friction products $ 31,299 $ 26,033
Precision components 19,059 17,206
Performance racing 3,996 3,895
Motor 4,236 2,670
------------------------
Consolidated $ 58,590 $ 49,804
========================
Gross profit:
Friction products $ 7,585 $ 6,036
Precision components 4,044 3,127
Performance racing 1,257 1,413
Motor 61 203
------------------------
Consolidated $ 12,947 $ 10,779
========================
Income from operations (loss):
Friction products $ 2,717 $ 1,038
Precision components 770 139
Performance racing 416 684
Motor (617) (483)
------------------------
Consolidated $ 3,286 $ 1,378
========================
Depreciation and amortization:
Friction products $ 1,909 $ 1,908
Precision components 895 944
Performance racing 68 38
Motor 236 203
------------------------
Consolidated $ 3,108 $ 3,093
========================
13
NOTE 8 - RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 2002, the FASB issued SFAS No. 146, "Accounting for Exit or Disposal
Activities" (SFAS 146). SFAS 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 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 146 is
effective for the Company in 2003. The adoption of SFAS 146 did not have a
material impact on the Company's consolidated financial condition or results of
operations as of March 31, 2003.
In November 2002, the FASB issued Interpretation No. ("FIN") 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others, an interpretation of FASB Statements No.
5, 57 and 107 and a rescission of FASB Interpretation No. 34" (FIN 45). FIN 45
elaborates on the disclosures to be made by a guarantor in its interim and
annual financial statements about its obligations under guarantees issued. FIN
45 also clarifies that a guarantor is required to recognize, at inception of a
guarantee, a liability for the fair value of the obligation undertaken. The
adoption of FIN 45 did not have an effect on the Company's consolidated
financial condition or results of operations.
In January 2003, the FASB issued FIN 46, "Consolidation of Variable Interest
Entities, an interpretation of ARB No. 51" (FIN 46). FIN 46 addresses the
consolidation by business enterprises of variable interest entities, as defined
in the Interpretation. FIN 46 expands existing accounting guidance regarding
when a company should include in its financial statements the assets,
liabilities and activities of another entity. Many variable interest entities
have commonly been referred to as special-purpose entities or off-balance sheet
structures. The consolidation requirements of FIN 46 apply immediately to
variable interest entities created after January 31, 2003. Certain of the
disclosure requirements apply in all financial statements issued after January
31, 2003. Since the Company does not have any variable interest in variable
interest entities, the adoption of FIN 46 will not impact the Company's
consolidated financial condition or results of operations as of March 31, 2003.
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 12% Senior Notes due
December 1, 2006. In addition, the Bank Facility prohibits the payment of any
dividends by the Company's subsidiaries to the Company or any other subsidiary.
The following supplemental unaudited consolidating condensed financial
statements present (in thousands):
1. Consolidating condensed balance sheets as of March 31, 2003 and
December 31, 2002, consolidating condensed statements of operations
for the three-month period ended March 31, 2003 and 2002 and
consolidating condensed statements of cash flows for the three months
ended March 31, 2003 and 2002.
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 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)
MARCH 31, 2003
-----------------------------------------------------------------------------------------
COMBINED COMBINED
GUARANTOR NON-GUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
-----------------------------------------------------------------------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 242 $ 78 $ 3,110 $ 3,430
Accounts receivable, net 26,081 11,296 37,377
Inventories, net 23,418 9,031 $ (255) 32,194
Deferred income taxes 1,565 177 1,742
Tax receivable 1,584 1,584
Other current assets 1,518 1,577 985 4,080
-----------------------------------------------------------------------------------------
Total current assets 4,909 51,154 24,599 (255) 80,407
Investment in subsidiaries 794 (3,050) 2,256
Inter-company advances, net 157,576 26,961 (22,649) (161,888)
Property, plant and equipment, net 7 55,725 10,723 66,455
Intangible assets 72 42,931 43,003
Other 4,914 759 1,069 (1,010) 5,732
-----------------------------------------------------------------------------------------
TOTAL ASSETS $168,272 $ 174,480 $ 13,742 $ (160,897) $ 195,597
=========================================================================================
LIABILITIES AND SHAREHOLDERS'
EQUITY
Current liabilities:
Accounts payable $ 16,065 $ 5,788 $ 21,853
Accrued compensation $ 328 4,524 1,167 6,019
Other accrued expenses 3,681 4,808 1,193 $ (234) 9,448
Bank facility 28,002 28,002
Current portion of long-term debt 583 1,405 329 2,317
-----------------------------------------------------------------------------------------
Total current liabilities 32,594 26,802 8,477 (234) 67,639
Long-term liabilities:
Long-term debt 66,184 2,636 594 69,414
Deferred income taxes 6,024 220 6,244
Other 4,914 1,805 6,719
Inter-company advances, net 1,128 155,140 5,696 (161,964)
-----------------------------------------------------------------------------------------
Total long-term liabilities 73,336 162,690 8,315 (161,964) 82,377
-----------------------------------------------------------------------------------------
Total liabilities 105,930 189,492 16,792 (162,198) 150,016
Shareholders' equity (deficit) 62,342 (15,012) (3,050) 1,301 45,581
-----------------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS'
EQUITY $168,272 $ 174,480 $ 13,742 $ (160,897) $ 195,597
=========================================================================================
16
SUPPLEMENTAL CONSOLIDATING CONDENSED
BALANCE SHEET (UNAUDITED)
DECEMBER 31, 2002
---------------------------------------------------------------------------
Combined Combined
Guarantor Non-Guarantor
Parent Subsidiaries Subsidiaries Eliminations Consolidated
---------------------------------------------------------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 116 $ 351 $ 1,235 $ 1,702
Accounts receivable, net 22,416 10,345 32,761
Inventories, net 24,692 8,569 33,261
Deferred income taxes 577 168 745
Taxes receivable 4,321 4,321
Other current assets 1,439 1,721 848 4,008
---------------------------------------------------------------------------
Total current assets 6,453 49,180 21,165 76,798
Investment in subsidiaries 794 (3,154) $ 2,360
Inter-company advances, net 160,859 25,515 (21,452) (164,922)
Property, plant and equipment 9 57,415 10,468 67,892
Intangible assets 72 43,124 43,196
Other 4,916 1,136 940 (1,010) 5,982
---------------------------------------------------------------------------
TOTAL ASSETS $ 173,103 $ 173,216 $ 11,121 $ (163,572) $ 193,868
===========================================================================
LIABILITIES AND SHAREHOLDERS'
EQUITY
Current liabilities:
Accounts payable $ 13,342 $ 4,509 $ 17,851
Accrued compensation 3,231 1,071 4,302
Other accrued expenses $ 1,358 2,899 915 5,172
Bank facility 36,327 36,327
Current portion of long-term debt 583 2,250 270 3,103
---------------------------------------------------------------------------
Total current liabilities 38,268 21,722 6,765 66,755
Long-term liabilities:
Long-term debt 66,059 2,885 579 69,523
Deferred income taxes 6,024 209 6,233
Other 4,902 1,621 6,523
Inter-company advances, net 1,128 158,808 5,101 $ (165,037)
---------------------------------------------------------------------------
Total long-term liabilities 73,211 166,595 7,510 (165,037) 82,279
---------------------------------------------------------------------------
Total liabilities 111,479 188,317 14,275 (165,037) 149,034
Shareholders' equity (deficit) 61,624 (15,101) (3,154) 1,465 44,834
---------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS'
EQUITY $ 173,103 $ 173,216 $ 11,121 $ (163,572) $ 193,868
===========================================================================
17
SUPPLEMENTAL CONSOLIDATING CONDENSED
STATEMENT OF OPERATIONS (UNAUDITED)
THREE MONTHS ENDED MARCH 31, 2003
-------------------------------------------------------------------------
COMBINED COMBINED
GUARANTOR NON-GUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
-------------------------------------------------------------------------
Net sales $ 49,595 $ 10,822 $ (1,827) $ 58,590
Cost of sales 38,274 9,196 (1,827) 45,643
-------------------------------------------------------------------------
Gross profit 11,321 1,626 12,947
Expenses:
Selling, technical and
administrative expenses $ 85 8,188 1,191 9,464
Amortization of intangibles 2 195 197
-------------------------------------------------------------------------
Total expenses 87 8,383 1,191 9,661
-------------------------------------------------------------------------
(Loss) income from operations (87) 2,938 435 3,286
Interest (income) expense, net (910) 3,423 220 2,733
Loss from equity investees (608) (145) 753
Other (expense), net (252) (3) (255)
-------------------------------------------------------------------------
Income (loss) before income taxes 215 (882) 212 753 298
Income tax provision (benefit) 96 (274) 357 179
-------------------------------------------------------------------------
NET INCOME (LOSS) $ 119 $ (608) $ (145) $ 753 $ 119
=========================================================================
18
SUPPLEMENTAL CONSOLIDATING CONDENSED
STATEMENT OF OPERATIONS (UNAUDITED)
THREE MONTHS ENDED MARCH 31, 2002
-------------------------------------------------------------------------
COMBINED COMBINED
GUARANTOR NON-GUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
-------------------------------------------------------------------------
Net sales $ 44,293 $ 7,048 $ (1,537) $ 49,804
Cost of sales 34,337 6,225 (1,537) 39,025
-------------------------------------------------------------------------
Gross profit 9,956 823 10,779
Expenses:
Selling, technical and
administrative expenses $ 400 7,725 1,073 9,198
Amortization of intangibles 2 201 203
-------------------------------------------------------------------------
Total expenses 402 7,926 1,073 9,401
-------------------------------------------------------------------------
(Loss) income from operations (402) 2,030 (250) 1,378
Interest (income) expense, net (911) 3,091 208 2,388
Loss from equity investees (18,313) (581) 18,894
Other (expense) income, net (177) 20 (45) (202)
-------------------------------------------------------------------------
Loss before income taxes (17,981) (1,622) (503) 18,894 (1,212)
Income tax (benefit) provision (260) (430) 78 (612)
-------------------------------------------------------------------------
Net loss before cumulative effect of
change in accounting principle (17,721) (1,192) (581) 18,894 (600)
Cumulative effect of change in
accounting principle (79) (17,121) (17,200)
-------------------------------------------------------------------------
NET LOSS $(17,800) $ (18,313) $ (581) $ 18,894 $ (17,800)
=========================================================================
19
SUPPLEMENTAL CONSOLIDATING CONDENSED
CASH FLOW STATEMENT (UNAUDITED)
THREE MONTHS ENDED MARCH 31, 2003
--------------------------------------------------------------------------
COMBINED COMBINED
GUARANTOR NON-GUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
--------------------------------------------------------------------------
Net cash (used in) provided by
operating activities $ 8,365 $ 2,175 $ 1,937 $ 12,477
Cash flows from investing activities:
Purchase of property, plant and
equipment (1,355) (135) (1,490)
--------------------------------------------------------------------------
Net cash used in investing activities (1,355) (135) (1,490)
Cash flows from financing activities:
Proceeds from debt 12,141 34 91 12,266
Payments on debt (20,342) (1,126) (39) (21,507)
Payment of preferred stock dividend (38) (38)
--------------------------------------------------------------------------
Net cash (used in) provided by
financing activities (8,239) (1,092) 52 (9,279)
Effect of currency rate changes (1) 21 20
Net increase (decrease) in cash and
cash equivalents 126 (273) 1,875 1,728
--------------------------------------------------------------------------
Cash and cash equivalents
at beginning of period 116 351 1,235 1,702
--------------------------------------------------------------------------
Cash and cash equivalents
at end of period $ 242 $ 78 $ 3,110 $ 3,430
==========================================================================
20
CASH FLOW STATEMENT (UNAUDITED)
THREE MONTHS ENDED MARCH 31, 2002
--------------------------------------------------------------------------
COMBINED COMBINED
GUARANTOR NON-GUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
--------------------------------------------------------------------------
Net cash provided by (used in)
operating activities $ (3,865) $ 1,661 $ 284 $ (1,920)
Cash flows from investing activities:
Purchase of property, plant and
equipment (1,830) (101) (1,931)
--------------------------------------------------------------------------
Net cash used in investing activities (1,830) (101) (1,931)
Cash flows from financing activities:
Proceeds from debt 15,505 333 15,838
Payments on debt (11,955) (545) (69) (12,569)
Payment of preferred stock dividend (38) (38)
--------------------------------------------------------------------------
Net cash provided by (used in)
financing activities 3,512 (212) (69) 3,231
Effect of currency rate changes 242 (294) (52)
--------------------------------------------------------------------------
Net (decrease) increase in cash and
cash equivalents (353) (139) (180) (672)
Cash and cash equivalents
at beginning of period 1,073 247 1,764 3,084
--------------------------------------------------------------------------
Cash and cash equivalents
at end of period $ 720 $ 108 $ 1,584 $ 2,412
==========================================================================
21
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 reportable segments: friction products, precision
components, performance racing and motors. We focus on manufacturing products
requiring sophisticated engineering and production techniques for applications
in markets in which we have achieved a significant market share.
- Friction Products
We believe that, based on net sales, we are one of the top worldwide
manufacturers of friction products used in industrial, agricultural
and aerospace applications. Our friction products segment manufactures
products made from proprietary formulations of composite materials
that primarily consist of metal powders, synthetic and natural fibers.
Friction products are the parts used in brakes, clutches and
transmissions to absorb vehicular energy and dissipate it through heat
and normal mechanical wear. The principal markets served by our
friction products segment include construction vehicles, agricultural
vehicles, trucks, recreational vehicles, commercial aviation and
general aviation. We believe we are:
- a leading domestic supplier of friction products for
construction equipment, agricultural equipment and trucks,
- the only independent supplier of friction materials for
braking systems for new and existing series of many
commercial aircraft models, including the Boeing 737 and 757
and the MD-80, and several regional jets used by commuter
airlines, including the Canadair regional jet series,
- the largest supplier of friction materials for the growing
general aviation market, including numerous new and existing
series of Gulfstream, Cessna, Lear and Beech aircraft, and
- a leading domestic supplier of friction products into
specialty markets such as motorcycles, all terrain vehicles
(ATVs) and snowmobiles.
- Precision Components
We are a leading supplier of powder metal components for industrial
equipment, lawn and garden equipment, appliances, hand tools and
trucks. We use composite metal alloys in powder form to manufacture
high quality custom-engineered metal components. Our precision
components segment serves four specific areas of the powder metal
marketplace:
- tight tolerance fluid power components such as pump elements
and gears,
- large powder metal components used primarily in construction
equipment, agricultural equipment and trucks,
- high volume parts for the lawn and garden, appliance and
other markets, and
- metal injected molded parts for a variety of industries,
including small hand tools and telecommunications.
- Performance Racing
We engineer, manufacture and market premium branded clutch and
drive-train components for the performance racing market. Through this
segment, we supply parts for the National Association for
22
Stock Car Auto Racing (NASCAR), the Championship Auto Racing
Teams (CART) and the Indy Racing League (IRL) racing series as
well as for the weekend enthusiasts in the Sports Car Club of
America (SCCA), the American Speed Association (ASA) racing clubs
and other road racing and competition cars.
- Motor
We design and manufacture die-cast aluminum rotors for fractional
and subfractional horsepower electric motors. These parts are
used in a wide variety of motor applications, including
appliances, business equipment, pumps and fans. We believe our
motor segment is the largest independent U.S. manufacturer of
die-cast aluminum rotors for use in fractional and subfractional
horsepower electric motors.
As of March 31, 2003, Hawk had approximately 1,700 employees and 17
manufacturing, research and administrative sites in five countries.
CRITICAL ACCOUNTING POLICIES
Hawk's critical accounting policies require the application of significant
judgment by us in the preparation of our financial statements. In applying these
policies, we use our best judgment to determine the underlying assumptions that
are used in calculating the estimates that affect the reported values on our
financial statements. We base our estimates and assumptions on historical
experience and other factors that we consider relevant. If these estimates
differ materially from actual results, the impact on our consolidated financial
statements may be material. Hawk's critical accounting policies include the
following:
- Revenue Recognition. Revenues are recognized when products are
shipped and title has transferred to the customer.
- Allowance for Doubtful Accounts. Our policy regarding the
collectibility of accounts receivables is based on a number of
factors. In circumstances where a specific customer is unable to
pay its obligations, we record a specific allowance for bad debts
against amounts due to reduce the net recognized receivable to
the amount that we reasonably expect to collect. If circumstances
change, estimates of the recoverability of the amounts due to
Hawk could change.
- Inventory Reserves. Reserves for slow moving and obsolete
inventories are developed based on historical experience and
product demand. We continuously evaluate the adequacy of our
inventory reserves and make adjustments to the reserves as
required.
- Goodwill. Goodwill represents the excess of the cost of companies
acquired over the fair value of their net assets as of the date
of acquisition. In accordance with Statement of Financial
Accounting Standard (SFAS) No. 142, "Goodwill and Other
Intangible Assets" (SFAS 142), our policy is to periodically, and
in no case less than annually, review our goodwill and other
intangible assets based upon the evaluation of such factors as
the occurrence of a significant adverse event or change in the
environment in which one of our business units operate. An
impairment loss would be recorded in the period a determination
is made that the carrying value exceeded the fair value of the
related assets.
- Pension and Postretirement Benefits. We account for our defined
benefit pension plans in accordance with SFAS No. 87, "Employers'
Accounting for Pensions" (SFAS 87) which requires that amounts
recognized in financial statements be determined on an actuarial
basis. The most significant element in determining our pension
income (expense) in accordance with SFAS 87 is the expected
return on plan
23
assets. Based on our existing and forecasted asset allocation and
related long-term investment performance results, we believe that
our assumption of future returns is reasonable. The assumed
long-term rate of return on assets is applied to a calculated
value of plan assets, which recognizes changes in the fair value
of plan assets in a systematic manner over five years. This
produces the expected return on plan assets that is included in
pension income (expense). The difference between this expected
return and the actual return on plan assets is deferred. The net
deferral of past asset gains (losses) affects the calculated
value of plan assets and, ultimately, future pension income
(expense). Pension expense was $0.4 million in the first quarter
2003 compared to $0.1 million in the first quarter 2002.
- Insurance. We use a combination of insurance and self-insurance
for a number of risks including general liability, workers'
compensation, vehicle liability and employee-related health care
benefits. Liabilities associated with the risks that are retained
are estimated by considering various historical trends and
forward-looking assumptions. The estimated accruals for these
liabilities could be significantly affected if future occurrences
and claims differ from these assumptions and historical trends.
- Contingencies. Our treatment of contingent liabilities in the
financial statements is based on the expected outcome of the
applicable contingency. In the ordinary course of business, we
consult with legal counsel on matters related to litigation and
other experts both within and outside of Hawk. We will accrue a
liability if the likelihood of an adverse outcome is probable of
occurrence and the amount is estimable. We will not accrue a
liability if either the likelihood of an adverse outcome is only
reasonably possible or an estimate is not determinable.
- Income Taxes. Our effective tax rate, taxes payable and other tax
assets and liabilities reflect the current tax rates in the
domestic and foreign tax jurisdictions in which we operate.
- Foreign Currency Translation and Transactions. Assets and
liabilities of our foreign operations are translated using
period-end exchange rates and revenues and expenses are
translated using exchange rates as determined throughout the
year. Gains or losses resulting from translation are included in
a separate component of our shareholder's equity. As a result of
the strength of the Euro in the first quarter of 2003, we
recorded foreign currency translation gains through our
shareholder's equity of $0.6 million compared to losses of $0.3
million in the first quarter of 2002. 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 is
included in other expense, net in our Consolidated Statement of
Operations.
FIRST QUARTER 2003 COMPARED TO FIRST QUARTER 2002
Net Sales. Our consolidated net sales for the first quarter of 2003 were $58.6
million, an increase of $8.8 million, or 18 percent, from the comparable period
in 2002. The increase in our net sales was primarily the result of new product
introductions leading to market share gains in our friction products and
precision component segments, improved conditions in most of the markets we
serve and increased sales and production levels at our Mexican and Chinese
facilities during the quarter.
- Friction Segment. Net sales in our friction segment during the
first quarter of 2003 were $31.3 million, an increase of 20
percent compared to our net sales of $26.0 million in the first
quarter of 2002. Most of the increase in this segment was
generated by new product introductions primarily in the
construction and agriculture markets in both the United States
and Europe. In spite of a general
24
softness in the commercial aviation market, our net sales to the
aerospace market were also up during the quarter, as a result of
increased military aircraft sales, due to the buildup for the
Iraq conflict, and an inventory realignment by one of our
commercial aircraft customers. As a result, our net sales to the
aerospace market in the first quarter of 2003 were up 14 percent
when compared to the prior year quarter. However, we expect our
sales volumes in the aerospace market for the full year 2003 to
decline when compared to 2002, as a result of the continued
softness in commercial air travel. We expect that most of the
other markets our friction segment serves will continue to
experience gradual economic improvement during the remainder of
2003. We experienced strong sales activity at our foreign
operations during the quarter. As a result of new product
introductions and market share gains, our Italian operation
experienced a net sales increase, exclusive of any translations
gains, of 23 percent in the first quarter of 2003 compared to the
prior year period. We also benefited from the continuing ramp up
of sales and production activity at our Chinese operation. To
date, SARS has caused no adverse impact to production at our
Chinese facility. However, we have limited travel by our
employees to this facility until the situation in China has
stabilized. A prolonged SARS epidemic could delay new product
introductions in our friction segment.
- Precision Component Segment. Net sales in our precision
components segment for the first quarter of 2003 were $19.1
million, an increase of $1.9 million, or 11 percent, compared to
the first quarter of 2002. The increase in net sales was
primarily attributable to increased sales to our 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.
Additionally, we gained new customers and introduced new products
during the quarter which led to market share increases.
- Performance Racing. Net sales in our performance racing segment
were up slightly during the first quarter of 2003 at $4.0 million
compared to $3.9 million in the first quarter of 2002, an
increase of 3 percent.
- Motor Segment. Net sales in our motor segment during the first
quarter of 2003 were $4.2 million, an increase of $1.5 million,
or 56 percent, from the same period in 2002. The net sales growth
in the motor segment came primarily from new outsourcing business
at our manufacturing facilities in the United States and
Monterrey, Mexico.
Gross Profit. Our gross profit increased $2.1 million to $12.9 million during
the first quarter of 2003, a 19 percent increase compared to the comparable
period of 2002. The gross profit margin increased slightly in the first quarter
of 2003 compared to 2002. We experienced margin improvement in our friction
products and precision components segments, primarily as a result of higher
sales volumes, product mix and cost containment programs. These improvements
were partially offset by increased pension and employee benefit costs as well as
continuing production inefficiencies in our Mexican rotor facility.
- Friction Segment. Our friction segment reported gross profit of
$7.6 million, or 24 percent, of its net sales in the first
quarter of 2003 compared to $6.1 million or 23 percent of its net
sales in the first quarter of 2002. The increase in this
segment's gross profit margin during the quarter was primarily
the result of sales volume increases during the quarter and the
ability of the segment to leverage its fixed manufacturing costs
associated with the volume increase as well as favorable product
mix, including increased sales to the aerospace market. However,
if aerospace sales decline through the rest of 2003 as we expect,
our overall gross margin in this segment will be negatively
affected. In the first quarter of 2003, the gross margin
improvement was partially offset by increased costs, including
pension and employee benefit costs.
25
- Precision Components Segment. Gross profit in our precision
components segment during the first quarter of 2003 was $4.0
million, or 21 percent, of our net sales compared to $3.1
million, or 18 percent, of our net sales in 2002. The increase in
margin was primarily the result of product mix and sales volume
increases in this segment and our ability to leverage fixed
manufacturing costs associated with the volume increase.
- Performance Racing Segment. Our performance racing segment
reported gross profit of $1.3 million, or 33 percent, of its
sales in the first quarter of 2003 compared to $1.4 million, or
36 percent in 2002. The gross profit margin deterioration during
the quarter was primarily the result of increased labor costs.
- Motor Segment. Our motor segment reported a break-even gross
margin during the first quarter of 2003 compared to a gross
margin of $0.2 million for the comparable quarter of 2002. The
decline in our gross margin was primarily the result of higher
than anticipated operating expenses resulting from continued
operating inefficiencies and employee costs at our Mexican
facility. We continue to work to resolve the operational
inefficiencies at our Mexican facility, but can provide no
assurances as to when these inefficiencies will be resolved.
Selling, Technical and Administrative Expenses (ST&A). Our ST&A expenses
increased $0.3 million, or 3 percent, to $9.5 million in the first quarter of
2003 from $9.2 million in the comparable period of 2002. As a percentage of net
sales, our ST&A expense margin improved to 16 percent in the first quarter of
2003 from 18 percent in the comparable quarter of 2002. We continued to benefit
from the cost containment programs that we implemented in the second quarter of
2002. However, personnel upgrades in our precision components and performance
racing segments, as well as increased pension and employee benefit costs,
partially offset these cost reductions.
Income from Operations. Our income from operations increased to $3.3 million in
the first quarter of 2003, or 136 percent, from $1.4 million in the comparable
period of 2002. The increase in operating income was primarily the result of the
gross margin improvements in our friction and precision components segments due
to improved absorption of fixed costs, favorable product mix and our continuing
cost control initiatives. However, this improvement was partially offset by
increased pension and employee benefit costs, continued operating and employee
training inefficiencies at our Mexican facility during the quarter, and
increased labor costs in our performance racing segment. Our income from
operations as a percentage of our net sales increased to 6 percent in the first
quarter of 2003 compared to 3 percent in the comparable quarter of 2002.
As a result of the items discussed above, our results from operations at each
segment were as follows:
- Our friction segment's income from operations increased to $2.7
million, or 145 percent, in the first quarter of 2003 from $1.1
million in the comparable period of 2002.
- Income from operations in our precision components segment was
$0.8 million in the first quarter of 2003, an increase of $0.7
million compared to the year ago period in 2002.
- Our income from operations at the performance racing segment was
$0.4 million in the first quarter of 2003 compared to $0.7
million in the comparable period of 2002, a decline of 43
percent.
- The loss from operations in our motor segment increased $0.1
million to $0.6 million in the first quarter of 2003 from a loss
of $0.5 million in the comparable period in 2002.
Interest Expense. Our interest expense increased $0.2 million to $2.7 million in
the first quarter of 2003 from the prior year period. Our borrowing costs were
higher during the quarter as a result of the increased interest rate on the
Senior Notes, which were exchanged during the fourth quarter of 2002. This
increase was partially offset by lower borrowing costs during the quarter on our
Bank Facility.
26
Other Expense, Net. Other expense was $0.3 million in the first quarter of 2003,
primarily related to a write-off of assets no longer being used in our friction
products business. In the comparable quarter of 2002, the expense of $0.2
million consisted primarily of bank fees associated with an amendment to our old
bank credit facility.
Income Taxes. As a result of earnings in the first quarter, we recorded an
income tax provision in the first quarter of 2003 of $0.2 million compared to an
income tax benefit of $0.6 million in the comparable quarter of 2002. The tax
benefit in 2002 was the result of losses incurred by us during the quarter.
Cumulative Effect of Change in Accounting Principle. In accordance with the
requirements of SFAS 142, we recorded a charge for the cumulative effect of
change in accounting principle of $17.2 million in the first quarter of 2003.
This charge represents the write-off of $21.5 million of goodwill ($17.2
million, net of income taxes of $4.3 million). There was no write-off of
goodwill in the first quarter of 2003.
Net Income (Loss). As a result of the factors noted above, we reported net
income of $0.1 million in the first quarter of 2003, compared to a net loss of
$17.8 million in the comparable quarter of 2002.
LIQUIDITY AND CAPITAL RESOURCES
Hawk's primary financing requirements are (1) for capital expenditures for
maintenance, replacement and acquisitions of equipment, expansion of capacity,
productivity improvements and product development, (2) for funding our
day-to-day working capital requirements and (3) to pay interest on, and to repay
principal of, our indebtedness. The primary source of funds for conducting our
business activities and servicing our indebtedness has been cash generated from
operations and borrowings under our Bank Facility.
Our Bank Facility, available for general corporate purposes, has a maximum
commitment of $53.0 million, including a letter of credit facility of up to $5.0
million, comprised of a $50.0 million revolving credit component and a $3.0
million capital expenditure loan component. The capital expenditure loan
component may be used to finance 80% of the cost of new equipment. The Bank
Facility matures 120 days prior to the maturity of the Senior Notes (described
below) in 2006. As of March 31, 2003, a total of $28.0 million was outstanding
under the Bank Facility and we had $1.4 million of undrawn letters of credit
allocated under the Bank Facility. As of March 31, 2003, we had approximately
$15.6 million available for future borrowings under our Bank Facility, and we
were in compliance with the financial covenants under our Bank Facility. The
$15.6 million of availability at March 31, 2003, represents an increase in our
availability of approximately $10.1 million compared to December 31, 2002.
Under EITF 95-22 "Balance Sheet Classification of Borrowings Outstanding under
Revolving Credit Agreements That Include both a Subjective Acceleration Clause
and a Lock-Box Arrangement", we are required to classify all of our outstanding
debt under the Bank Facility as a current liability. Under the subjective
acceleration clause of the Bank Facility, the lending banks may declare a
default if they reasonably believe that any of the following events have
occurred or could reasonably be expected to occur:
- a material adverse effect on our business, operations or
condition (financial or otherwise);
- a material adverse effect on our ability, or any subsidiary
borrower or guarantor, to comply with the terms and conditions of
the Bank Facility;
- a material adverse effect on the enforceability of any Bank
Facility document or the ability of the lending banks to enforce
any rights or remedies under any Bank Facility document; or
- a material adverse effect on the validity, perfection or priority
of any lien arising under the Bank Facility.
27
We do not believe that any of these material adverse effects have occurred or
can reasonably be expected to occur. Therefore, we do not believe that the
lending banks have any rights to declare a default under the subjective
acceleration clause of our Bank Facility. Hawk intends to manage the Bank
Facility as long-term debt with a final maturity date in 2006, as provided for
in the agreement that we signed. We expect the long-term availability under the
revolving credit portion of the Bank Facility to be $50.0 million for the next
twelve month period, subject to the borrowing base. However, if in the future
the lending banks do believe that a material adverse effect has occurred or
could reasonably be expected to occur, they may declare a default and declare
that all outstanding principal and interest under the Bank Facility is due and
payable. We do not have sufficient cash or other credit facilities that would
permit immediate repayment of the Bank Facility. If we were not able to
negotiate new terms with the lending banks or other banks or lending sources,
our financial condition and liquidity would be materially and adversely
affected.
In October 2002, we exchanged $64.4 million of our $65.0 million, 10 1/4% Senior
Notes due December 1, 2003 (Old Senior Notes), for 12% Senior Notes due December
1, 2006 (Senior Notes). The remaining principal of the Old Senior Notes in the
amount of $583 remain outstanding and will mature on December 1, 2003. In
addition, the holders of the Old Senior Notes that participated in the exchange
for Senior Notes received a consent payment of $25.63 for each $1,000.00 of Old
Senior Notes held as of October 23, 2002. The consent payment which totaled $1.6
million, was issued in the form of new Senior Notes and is payable to the
holders at maturity of the Senior Notes. The Senior Notes are general unsecured
senior obligations of Hawk and are fully and unconditionally guaranteed, on a
joint and several basis, by all of our domestic wholly-owned subsidiaries. The
Senior Notes accrue interest at a rate of 12% per annum. Interest payments are
due December 31 and June 30. In addition, in the event that our 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, we 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 required under this
test will be made by issuing additional new Senior Notes. On April 10, 2003, we
issued additional PIK interest in the amount of $124,778.11 in the form of
additional new Senior Notes. The additional PIK notes are identical in all
respects to the Senior Notes.
Hawk has the option to redeem the 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 Senior Note indenture, each
holder of the notes will have the right to require Hawk 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 Senior Notes permit Hawk and its subsidiaries to incur additional
indebtedness without limitation, provided that we continue to meet a cash flow
coverage and a leverage ratio. As of March 31, 2003, we did not meet the
prescribed ratios. The failure to meet these ratios does not constitute a
default under the Senior Note indenture. Rather, the Senior Note indenture
continues to permit certain other types of indebtedness subject to certain
limitations. Our Bank Facility, which is secured by liens on all of our assets
and the assets of our subsidiaries, is permitted. We do not believe that our
operations will be materially impacted by the limitation on indebtedness arising
under the Senior Note indenture.
The Senior Notes prohibit the payment of cash dividends on the Company's Class A
common stock. The Senior Notes also contain 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 Senior Notes considers non-compliance with the limitations events of
default. In addition to non-payment of interest and principal amounts, the
Senior Notes also considers default with respect to other indebtedness in excess
of $5.0 million 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.
28
Our net cash provided by operating activities was $12.5 million for the three
month period ended March 31, 2003. Net cash used in our operating activities was
$1.9 million for the comparable three month period of 2002. The increase in cash
from operations was attributable to our net income and the decrease in our
working capital assets during the quarter. The decrease in our net working
capital resulted from an increase in our accounts payable, other accrued
expenses and the receipt of $1.6 million in federal tax refunds during the
quarter partially offset by an increase in our accounts receivable as a result
of the net sales increase during the quarter. Our net working capital, exclusive
of the debt outstanding under the Bank Facility, which is classified as a
current liability for accounting purposes, was $40.8 million at March 31, 2003
compared to $46.4 million at March 31, 2002.
Our net cash used in investing activities was $1.5 million and $1.9 million for
the three month period ended March 31, 2003 and 2002, respectively, for the
purchase of property, plant and equipment.
Our net cash used in financing activities was $9.3 million for the three month
period ended March 31, 2003 as a result of debt paydowns. The decrease in
borrowings during the three month period ended March 31, 2003 resulted from
proceeds from the decrease in our working capital assets partially offset by the
purchases of property plant and equipment. Net cash provided by financing
activities was $3.2 million for the three month period ended March 31, 2002 as a
result of increased borrowings during the quarter primarily to support the
increase in our working capital assets during the quarter.
We believe that cash flow from operating activities and borrowings under our
Bank Facility will be sufficient to satisfy our working capital, capital
expenditures and debt requirements and to finance continued internal growth for
the next twelve months.
ACCOUNTING CHANGES
Refer to Note 8 "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 our
confidence in our prospects and strategies and our expectations about growth of
existing markets and our 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 us or any other person that our objectives or plans will be
achieved. Many factors could cause our actual results to differ materially and
adversely from those in the forward-looking statements, including the following:
- our ability to continue to meet the terms of our Senior Debt and
Bank Facility which contain a number of significant financial
covenants and other restrictions;
- the effect of our debt service requirements on funds available
for operations and future business opportunities and our
vulnerability to adverse general economic and industry conditions
and competition;
29
- the continuing impact of the reduction in air travel, the
bankruptcy filings by a number of major airline companies and the
weak financial condition of other airlines on our aerospace
business, including the decline in gross profit margins in this
market as a result of the retirement of many older airplanes that
used our friction brake products;
- the impact on our gross profit margins as a result of a decline
in sales in the aerospace market;
- our ability to effectively utilize all of our manufacturing
capacity as the industrial and commercial end-markets we serve
gradually improve or if improvement is not achieved as we
anticipate;
- our ability to generate profits at our facility in Mexico,
including our ability to resolve the manufacturing inefficiencies
being incurred at that facility;
- the effect of competition by manufacturers using new or different
technologies;
- the effect on our international operations of unexpected changes
in legal and 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;
- our ability to negotiate new agreements, as they expire, with our
unions representing certain of our employees, on terms favorable
to us or without experiencing work stoppages;
- the effect of any interruption in our 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;
- the ability of our products to meet stringent Federal Aviation
Administration criteria and testing requirements;
- our ability to comply with the NYSE's continued listing
standards; and
- the impact of the SARS virus on our operations in China,
including the delay in new product introductions.
You must consider these risks and others that are detailed in this Form 10-Q in
deciding whether to invest in our Company.
30
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Market Risk Disclosures. The following discussion about our market risk
disclosures involves forward-looking statements. Actual results could differ
materially from those projected in the forward-looking statements. We are
exposed to market risk related to changes in interest rates and foreign currency
exchange rates. We do not use derivative financial instruments for speculative
or trading purposes.
Interest Rate Sensitivity. At March 31, 2003, approximately 29 percent, or $28.8
million, of our debt obligations bear interest at a variable rate. Our primary
interest rate risk exposure results from variable rate debt instruments. If
interest rates were to increase 100 basis points (1.0%) from March 31, 2003
rates, and assuming no changes in debt from March 31, 2003 levels, our
additional annual interest expense would be approximately $0.3 million. We do
not engage in activities using complex or highly leveraged instruments.
The interest rates on our long-term debt reflect market rates and therefore, the
carry value of long-term debt approximates fair value.
Foreign Currency Exchange Risk. The majority of our receipts and expenditures
are contracted in U.S. dollars, and we do not consider the market risk exposure
relating to currency exchange to be material at this time. We currently do not
hedge our foreign currency exposure and, therefore, have not entered into any
forward foreign exchange contracts to hedge foreign currency transactions. We
have operations outside the United States with foreign-currency denominated
assets and liabilities, primarily denominated in Euro, Canadian dollars, Mexican
pesos and Chinese renminbi. Because we have 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 March 31, 2003 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, we evaluated the
effectiveness of the design and operation of our disclosure controls and
procedures. The evaluation was carried out under the supervision of and with the
participation of our management, including our 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 our disclosure controls and procedures are effective
in timely alerting them to material information relating to Hawk, including our
consolidated subsidiaries, required to be included in reports we file with or
submit to the Securities and Exchange Commission under the Securities Exchange
Act of 1934. There have been no significant changes in our internal controls or
in other factors that could significantly affect our internal controls
subsequent to the date of the evaluation.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We are involved in lawsuits that have arisen in the ordinary course of our
business. We are contesting each of these lawsuits vigorously and believe we
have defenses to the allegations that have been made. In our opinion, the
outcome of these legal actions will not have a material adverse effect on our
financial condition, liquidity or results of operations.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Effective March 19, 2003, we issued 13,636 shares of our Class A common stock to
the following individuals as part of their annual compensation for services as
directors of Hawk: Paul R. Bishop, Jack Kemp, Dan T. Moore, III and Andrew T.
Berlin. Each of these directors received 3,409 shares having a market value of
approximately $7,500 at the time of issuance. The shares were issued without
registration in an offering not involving any public offering to these four
directors as permitted by Section 4(2) of the Securities Act of 1933.
ITEM 5. OTHER INFORMATION
On January 2, 2003 we announced that the New York Stock Exchange (NYSE) accepted
our business plan for continued listing on the exchange. As a result, we will
continue to be listed on the NYSE, subject to quarterly monitoring to the goals
outlined in our plan presented to the NYSE. Our plan includes steps to comply
with the NYSE's continued listing criteria of maintaining stockholders' equity
of not less than $50.0 million and an average market capitalization of not less
than $50.0 million over a 30 trading-day period. Hawk will work with the NYSE to
achieve the plan's goals by March 2004. Failure to achieve the plan's goal by
March 2004 will result in Hawk being subject to NYSE trading suspension and
delisting.
Our total market capitalization based on the 8.6 million shares of our common
stock and the $2.58 per share closing price of our common stock on March 31,
2003 was approximately $22.2 million. As of May 14, 2003, based on the closing
price of our common stock of $3.29 per share, our total market capitalization
was approximately $28.3 million. Our shareholder's equity at March 31, 2003 was
$45.6 million. Because our Bank Facility and Senior Notes do not contain a
financial covenant requiring continued NYSE listing, we do not believe our
liquidity will be adversely affected if we are unable to conduct our operations
in accordance with our business plan submitted to the NYSE. If we are unable to
reach the minimum NYSE listing standards by March 2004, we intend to seek an
alternative market for the listing of our common stock.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
10.1* Employment Agreement dated as of August 7, 2001, between
the Company and W. Michael Corkran
10.2* Employment Agreement dated as of January 27, 2000,
between the Company and Steven J. Campbell
99.1* Certification pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
99.2* Certification pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
32
-----------------
* filed herewith
(b) Reports on Form 8-K:
We have filed four reports on Form 8-K since December
31, 2002:
A report dated January 3, 2003, reporting information
relating to our announcement that the New York Stock
Exchange accepted our proposed plan for complying with
all of the NYSE's continued listing standards.
A report dated February 11, 2003, reporting our
financial results for the fourth quarter of 2002 and for
the full year of 2002.
A report dated April 29, 2003 reporting our financial
results for the first quarter of 2003.
A report dated May 6, 2003 reporting information
relating to a meeting we held with analysts to discuss
operations, markets, revenues, earnings and a 4-year
growth plan.
33
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: May 15, 2003 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)
34
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: May 15, 2003
/s/ RONALD E. WEINBERG
- ----------------------
Ronald E. Weinberg
Chairman of the Board and Chief Executive Officer
(Principal Executive Officer)
35
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: May 15, 2003
/s/ THOMAS A. GILBRIDE
- ----------------------
Thomas A. Gilbride
Vice President - Finance
(Principal Financial Officer)
36