10-Q 1 l95310ae10vq.txt HAWK CORPORATION > FORM 10-Q 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 JUNE 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: 8,557,240 Class B Common Stock, $0.01 par value: None (0) 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 30 PART II. OTHER INFORMATION Item 1. Legal Proceedings 31 Item 4. Submission of Matters to a Vote of Security Holders 31 Item 6. Exhibits and Reports on Form 8-K 31 SIGNATURES 31
2 PART I. FINANCIAL INFORMATION ITEM I. FINANCIAL STATEMENTS (UNAUDITED) HAWK CORPORATION CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA)
JUNE 30, DECEMBER 31, 2002 2001 ---------------------------- Assets Current assets: Cash and cash equivalents $ 2,928 $ 3,084 Accounts receivable, less allowance of $536 in 2002 and $455 in 2001 34,740 25,773 Inventories 31,059 29,152 Deferred income taxes 1,211 1,200 Other current assets 4,382 4,638 -------------------------- Total current assets 74,320 63,847 Property, plant and equipment: Land and improvements 1,608 1,608 Buildings and improvements 18,657 18,657 Machinery and equipment 99,149 96,688 Furniture and fixtures 7,821 7,168 Construction in progress 3,035 1,450 -------------------------- 130,270 125,571 Less accumulated depreciation and amortization 64,175 58,208 -------------------------- Total property, plant and equipment 66,095 67,363 Other assets: Goodwill 32,495 53,877 Other intangible assets 12,105 12,828 Shareholder notes 1,010 1,010 Other 5,816 5,180 -------------------------- Total other assets 51,426 72,895 Total assets $191,841 $204,105 ==========================
3 HAWK CORPORATION CONSOLIDATED BALANCE SHEETS - (CONTINUED) (IN THOUSANDS, EXCEPT SHARE DATA)
JUNE 30, DECEMBER 31, 2002 2001 ------------------------------ Liabilities and shareholders' equity Current liabilities: Accounts payable $ 14,835 $ 13,432 Accrued compensation 5,518 5,233 Other accrued expenses 7,892 6,832 Current portion of long-term debt 35,347 6,862 ----------------------------- Total current liabilities 63,592 32,359 Long-term liabilities: Long-term debt 68,593 90,957 Deferred income taxes 6,737 10,978 Other 3,609 3,374 ----------------------------- Total long-term liabilities 78,939 105,309 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 Class 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 1,987 19,623 Accumulated other comprehensive loss (2,717) (3,201) Treasury stock, at cost, 630,510 and 634,830 shares in 2002 and 2001, respectively (4,672) (4,704) ----------------------------- Total shareholders' equity 49,310 66,437 ----------------------------- Total liabilities and shareholders' equity $ 191,841 $ 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 SIX MONTHS ENDED JUNE 30, JUNE 30, 2002 2001 2002 2001 ------------------------------------------------------------ Net sales $ 50,349 $ 47,419 $ 100,153 $ 101,200 Cost of sales 38,723 37,085 77,748 77,046 ------------------------------------------------------------ Gross profit 11,626 10,334 22,405 24,154 Operating Expenses: Selling, technical and administrative expenses 8,295 8,359 17,493 17,031 Restructuring costs 892 1,000 Amortization of intangibles 367 1,134 723 2,265 ------------------------------------------------------------ Total operating expenses 8,662 10,385 18,216 20,296 ------------------------------------------------------------ Income (loss) from operations 2,964 (51) 4,189 3,858 Interest expense (2,342) (2,391) (4,640) (4,834) Interest income 12 61 75 103 Other expense, net (93) (324) (295) (246) ------------------------------------------------------------ Income (loss) before income taxes 541 (2,705) (671) (1,119) Income tax provision (benefit) 302 (1,286) (310) (557) ------------------------------------------------------------ Net income (loss) before cumulative effect of change in accounting principle 239 (1,419) (361) (562) Cumulative effect of change in accounting principle, net of tax of $4,252 (17,200) ------------------------------------------------------------ Net income (loss) $ 239 $ (1,419) $ (17,561) $ (562) ============================================================ Earnings (loss) per share: Basic earnings (loss) per share: Basic earnings (loss) before cumulative effect of change in accounting principle $ .02 $ (.17) $ (.05) $ (.07) Cumulative effect of change in accounting principle (2.01) ------------------------------------------------------------ Net income (loss) per basic share $ .02 $ (.17) $ (2.06) $ (.07) ============================================================ Diluted earnings (loss) per share: Diluted earnings (loss) before cumulative effect of change in accounting principle $ .02 $ (.17) $ (.05) $ (.07) Cumulative effect of change in accounting principle (2.01) ------------------------------------------------------------ Net income (loss) per diluted share $ .02 $ (.17) $ (2.06) $ (.07) ============================================================
See notes to consolidated financial statements. 5 HAWK CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (DOLLARS IN THOUSANDS)
SIX MONTHS ENDED JUNE 30, 2002 2001 --------------------------- CASH FLOWS FROM OPERATING ACTIVITIES Net loss $(17,561) $ (562) Adjustments to reconcile net loss to net cash (used) provided by operating activities: Depreciation and amortization 6,260 7,905 Deferred income taxes (151) Cumulative effect of change in accounting principle, net of tax 17,200 Changes in operating assets and liabilities: Accounts receivable (8,241) (3,347) Inventories (1,250) 2,008 Other assets (345) (282) Accounts payable 1,023 2,283 Other liabilities 1,191 (1,398) --------------------------- Net cash (used in) provided by operating activities (1,723) 6,456 CASH FLOWS FROM INVESTING ACTIVITIES Purchases of property, plant and equipment (4,170) (4,830) --------------------------- Net cash used in investing activities (4,170) (4,830) CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from long-term debt 32,503 16,239 Payments on long-term debt (26,811) (18,436) Payments of preferred stock dividends (75) (75) --------------------------- Net cash provided by (used in) financing activities 5,617 (2,272) Effect of exchange rate changes on cash 120 (126) --------------------------- Net decrease in cash and cash equivalents (156) (772) Cash and cash equivalents at beginning of year 3,084 4,010 --------------------------- Cash and cash equivalents at end of year $ 2,928 $ 3,238 ===========================
See notes to consolidated financial statements. 6 HAWK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) JUNE 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 June 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 (the "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 PRINCIPLE AND GOODWILL AND INTANGIBLE ASSETS In June 2001, the FASB issued 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 six and three months ended June 30, 2001 would have been to decrease amortization expense by approximately $1,542 and $767, respectively and would result in basic and diluted earnings (loss) per share of $0.04 and $(0.12), 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. The Company, with the assistance of independent valuation experts, has completed its initial assessment test and has 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 found 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 six month period ended June 30, 2002 was $2.06 per diluted share. The transitional impairment charge is a one-time non-cash charge and will not have an effect on the Company's current business activities or existing bank covenants. There can be no assurance that future goodwill impairments will not occur. 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. The components of goodwill and other intangible assets and the related accumulated amortization are as follows:
JUNE 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 70 428 428 Deletions 21,452 21,452 3,180 3,180 ---------------------------------------------------------------------------------- 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 9,904 10,916 20,820 9,544 11,276 Deferred financing 4,693 3,899 794 4,693 3,593 1,100 Other intangible assets 3,013 2,618 395 3,013 2,561 452 ---------------------------------------------------------------------------------- Subtotal 28,526 16,421 12,105 28,526 15,698 12,828 ---------------------------------------------------------------------------------- Total $74,952 $30,352 $44,600 $96,334 $29,629 $66,705 ==================================================================================
A summary of the Company's net goodwill at June 30, 2002 and December 31, 2001 by reportable operating segment is as follows:
JUNE 30, DECEMBER 31, 2002 2001 -------------------------- Friction products $11,100 Precision components $28,109 28,039 Performance automotive 4,386 8,392 Motor 6,346 -------------------------- Consolidated $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-$1,422; 2003-$1,257; 2004-$789; 2005-$789; and 2006-$776. 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. NOTE 3 - COMPREHENSIVE INCOME (LOSS) Comprehensive income (loss) is as follows:
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, 2002 2001 2002 2001 ---------------------------------------------------------------- Net income (loss) $ 239 $ (1,419) $(17,561) $ (562) Foreign currency translation 813 90 484 (415) ---------------------------------------------------------------- Comprehensive income (loss) $ 1,052 $ (1,329) $(17,077) $ (977) ================================================================
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:
JUNE 30, DECEMBER 31, 2002 2001 -------------------------------- Raw materials and work-in-process $ 21,176 $ 19,360 Finished products 13,021 12,542 Inventory reserves (3,138) (2,750) -------------------------------- $ 31,059 $ 29,152 ================================
7 NOTE 5 - EARNINGS (LOSS) PER SHARE Basic and diluted earnings (loss) per share are computed as follows:
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, 2002 2001 2002 2001 ----------------------------------------------------------- Numerator: Net income (loss) before cumulative effect of change in accounting principle $ 239 $ (1,419) $ (361) $ (562) Preferred stock (37) (37) (75) (75) ----------------------------------------------------------- Net income (loss) before cumulative effect of change in accounting principle available to common shareholders $ 202 $ (1,456) $ (436) $ (637) =========================================================== Net income (loss) $ 239 $ (1,419) $(17,561) $ (562) Preferred stock (37) (37) (75) (75) ----------------------------------------------------------- Net income (loss) available to common shareholders $ 202 $ (1,456) $(17,636) $ (637) =========================================================== Denominator: Denominator for basic earnings (loss) per share- Weighted average shares 8,557 8,553 8,556 8,552 Effect of dilutive securities: Stock options 100 ----------------------------------------------------------- Denominator for diluted earnings (loss) per share- adjusted weighted-average shares and assumed conversions 8,657 8,553 8,556 8,552 Basic earnings (loss) per share: Basic earnings (loss) before cumulative effect of change in accounting principle $ .02 $ (.17) $ (.05) $ (.07) Cumulative effect of change in accounting principle (2.01) ----------------------------------------------------------- Net income (loss) per basic share $ .02 $ (.17) $ (2.06) $ (.07) =========================================================== Diluted earnings (loss) per share: Diluted earnings (loss) before cumulative effect of change in accounting principle $ .02 $ (.17) $ (.05) $ (.07) Cumulative effect of change in accounting principle (2.01) ----------------------------------------------------------- Net income (loss) per diluted share $ .02 $ (.17) $ (2.06) $ (.07) ===========================================================
For the six months ended June 30, 2002 and the three and six months ended June 30, 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. 8 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 used in lawn and garden, appliance, automotive, business equipment and a variety of other applications. 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 and CART racing series, as well as drivers on 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 subfractional electric motors and integral horsepower custom motors and generators. The Company, through this segment, targets a wide variety of applications such as business equipment, small household appliances and HVAC systems. The company also designs and produces integral horsepower custom motors and generators. 9 The information by segment is as follows:
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, 2002 2001 2002 2001 --------------------------------------------------------------- Net sales to external customers: Friction products $ 27,102 $ 27,615 $ 53,135 $ 57,178 Precision components 17,125 14,422 34,331 32,268 Performance automotive 3,326 3,229 7,221 7,390 Motor 2,796 2,153 5,466 4,364 --------------------------------------------------------------- Consolidated $ 50,349 $ 47,419 $ 100,153 $ 101,200 =============================================================== Gross profit (loss): Friction products $ 6,946 $ 7,323 $ 12,982 $ 15,084 Precision components 3,576 2,226 6,703 6,672 Performance automotive 1,152 916 2,565 2,320 Motor (48) (131) 155 78 --------------------------------------------------------------- Consolidated $ 11,626 $ 10,334 $ 22,405 $ 24,154 =============================================================== Depreciation and amortization: Friction products $ 1,985 $ 2,314 $ 3,893 $ 4,620 Precision components 923 1,228 1,867 2,422 Performance automotive 48 190 86 373 Motor 211 262 414 490 --------------------------------------------------------------- Consolidated $ 3,167 $ 3,994 $ 6,260 $ 7,905 =============================================================== Operating income (loss): Friction products $ 2,678 $ 1,413 $ 3,450 $ 4,284 Precision components 896 (635) 1,017 467 Performance automotive 111 92 935 473 Motor (721) (921) (1,213) (1,366) --------------------------------------------------------------- Consolidated $ 2,964 $ (51) $ 4,189 $ 3,858 =============================================================== Cumulative effect of change in accounting principle, net of tax: Friction products $ 8,373 Performance automotive 2,484 Motor 6,343 --------------------------------------------------------------- Consolidated $ 17,200 ===============================================================
NOTE 7 - RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS Effective January 1, 2001, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 133 "Accounting for Derivative Instruments and Hedging Activities" (SFAS No. 133) as amended by SFAS No. 138 (SFAS No. 138). As amended, SFAS No. 133 requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position measure those instruments at fair value and recognize changes in the fair value of derivatives in earnings in the period of change unless the derivative qualifies as an effective hedge that offsets certain exposures. The Company periodically enters into interest-rate swap agreements to moderate exposure to interest-rate changes and to lower the overall cost of borrowing. During the quarter ended March 31, 2001, the Company entered into an interest-rate swap agreement that effectively converts a portion of its floating rate debt to a fixed rate of 5.34% on $10,000 notional amount on its variable-rate debt maturing in 2003. Although this financial instrument did not meet the hedge accounting criteria of SFAS No. 133, it continues to be effective in achieving the risk management objectives for which it was intended. The change in the fair value of the interest rate swap did not have a material impact on the Company's financial position or results of operations for the six months ended June 30, 2002. 10 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 FASB 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. 11 NOTE 8 - 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 10.25% Senior Notes due December 1, 2003. The Guarantor Subsidiaries are direct or indirect wholly owned subsidiaries of the Company. The following supplemental unaudited consolidating condensed financial statements present (in thousands): 1. Consolidating condensed balance sheets as of June 30, 2002 and December 31, 2001, consolidating condensed statements of operations for the six month periods ended June 30, 2002 and 2001 and consolidating condensed statements of cash flows for the six months ended June 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 Senior Notes are material to investors. Therefore, separate financial statements and other disclosures concerning the Guarantor Subsidiaries are not presented. 13 SUPPLEMENTAL CONSOLIDATING CONDENSED BALANCE SHEET (UNAUDITED)
JUNE 30, 2002 --------------------------------------------------------------------------------- COMBINED COMBINED GUARANTOR NON-GUARANTOR PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED --------------------------------------------------------------------------------- ASSETS Current assets: Cash and cash equivalents $ 572 $ 339 $ 2,017 $ 2,928 Accounts receivable, net 25,429 9,311 34,740 Inventories, net 22,170 8,889 31,059 Deferred income taxes 1,111 100 1,211 Other current assets 1,861 1,123 1,398 4,382 --------------------------------------------------------------------------------- Total current assets 3,544 49,061 21,715 74,320 Investment in subsidiaries 794 (1,888) $ 1,094 Inter-company advances, net 159,601 17,128 (16,109) (160,620) Property, plant and equipment, net 14 56,682 9,399 66,095 Intangible assets 72 44,528 44,600 Other 1,010 5,760 1,066 (1,010) 6,826 --------------------------------------------------------------------------------- TOTAL ASSETS $ 165,035 $ 171,271 $ 16,071 $(160,536) $ 191,841 ================================================================================= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 10,385 $ 4,450 $ 14,835 Accrued compensation $ 396 3,873 1,249 5,518 Other accrued expenses 1,738 4,071 2,083 7,892 Current portion of long-term debt 29,000 2,503 3,844 35,347 --------------------------------------------------------------------------------- Total current liabilities 31,134 20,832 11,626 63,592 Long-term liabilities: Long-term debt 65,000 3,201 392 68,593 Deferred income taxes 6,642 95 6,737 Other 2,165 1,444 3,609 Inter-company advances, net 1,128 155,205 4,402 $(160,735) --------------------------------------------------------------------------------- Total long-term liabilities 72,770 160,571 6,333 (160,735) 78,939 --------------------------------------------------------------------------------- Total liabilities 103,904 181,403 17,959 (160,735) 142,531 Shareholders' equity (deficit) 61,131 (10,132) (1,888) 199 49,310 --------------------------------------------------------------------------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 165,035 $ 171,271 $ 16,071 $(160,536) $ 191,841 =================================================================================
14 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 ==================================================================================
15 SUPPLEMENTAL CONSOLIDATING CONDENSED STATEMENT OF OPERATIONS (UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2002 --------------------------------------------------------------------- COMBINED COMBINED GUARANTOR NON-GUARANTOR PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED --------------------------------------------------------------------- Net sales $ 85,427 $ 14,726 $ 100,153 Cost of sales 65,132 12,616 77,748 --------------------------------------------------------------------- Gross profit 20,295 2,110 22,405 Expenses: Selling, technical and administrative expenses $ 14 15,211 2,268 17,493 Amortization of intangible assets 4 719 723 --------------------------------------------------------------------- Total expenses 18 15,930 2,268 18,216 --------------------------------------------------------------------- (Loss) income from operations (18) 4,365 (158) 4,189 Interest income (expense), net 1,823 (5,967) (421) (4,565) (Loss) income from equity investees (19,038) (951) $ 19,989 Other (expense) income, net (285) 7 (17) (295) --------------------------------------------------------------------- (Loss) income before income taxes (17,518) (2,546) (596) 19,989 (671) Income (benefit) tax provision (36) (629) 355 (310) --------------------------------------------------------------------- Net loss before cumulative effect of change in accounting principle (17,482) (1,917) (951) 19,989 (361) Cumulative effect of change in accounting principle, net of tax (79) (17,121) (17,200) --------------------------------------------------------------------- NET LOSS $(17,561) $ (19,038) $ (951) $ 19,989 $ (17,561) =====================================================================
16 SUPPLEMENTAL CONSOLIDATING CONDENSED STATEMENT OF OPERATIONS (UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2001 --------------------------------------------------------------------- COMBINED COMBINED GUARANTOR NON-GUARANTOR PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED --------------------------------------------------------------------- Net sales $ 88,345 $ 12,855 $ 101,200 Cost of sales 65,658 11,388 77,046 --------------------------------------------------------------------- Gross profit 22,687 1,467 24,154 Expenses: Selling, technical and administrative expenses $ (258) 15,077 2,212 17,031 Restructuring costs 1,000 1,000 Amortization of intangible assets 9 2,256 2,265 --------------------------------------------------------------------- Total expenses (249) 18,333 2,212 20,296 --------------------------------------------------------------------- Income (loss) from operations 249 4,354 (745) 3,858 Interest income (expense), net 1,836 (6,149) (418) (4,731) (Loss) income from equity investees (2,431) (1,306) $ 3,737 Other (expense) income, net (276) (40) 70 (246) --------------------------------------------------------------------- Loss before income taxes (622) (3,141) (1,093) 3,737 (1,119) Income (benefit) tax expense (60) (710) 213 (557) --------------------------------------------------------------------- NET LOSS $ (562) $ (2,431) $ (1,306) $ 3,737 $ (562) =====================================================================
17 SUPPLEMENTAL CONSOLIDATING CONDENSED INCOME STATEMENT (UNAUDITED)
THREE MONTHS ENDED JUNE 30, 2002 --------------------------------------------------------------------- COMBINED COMBINED GUARANTOR NON-GUARANTOR PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED --------------------------------------------------------------------- Net sales $ 42,671 $ 7,678 $ 50,349 Cost of sales 32,332 6,391 38,723 --------------------------------------------------------------------- Gross profit 10,339 1,287 11,626 Expenses: Selling, technical and administrative expenses $ (386) 7,486 1,195 8,295 Amortization of intangible assets 2 365 367 --------------------------------------------------------------------- Total expenses (384) 7,851 1,195 8,662 --------------------------------------------------------------------- Income (loss) from operations 384 2,488 92 2,964 Interest income (expense), net 912 (3,029) (213) (2,330) Loss from equity investees (725) (370) $ 1,095 Other (expense) income, net (108) (13) 28 (93) --------------------------------------------------------------------- Income (loss) before income taxes 463 (924) (93) 1,095 541 Income tax (benefit) expense 224 (199) 277 302 --------------------------------------------------------------------- NET INCOME (LOSS) $ 239 $ (725) $ (370) $ 1,095 $ 239 =====================================================================
18 SUPPLEMENTAL CONSOLIDATING CONDENSED STATEMENT OF OPERATIONS (UNAUDITED)
THREE MONTHS ENDED JUNE 30, 2001 --------------------------------------------------------------------- COMBINED COMBINED GUARANTOR NON-GUARANTOR PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED --------------------------------------------------------------------- Net sales $ 41,252 $ 6,167 $ 47,419 Cost of sales 31,296 5,789 37,085 --------------------------------------------------------------------- Gross profit 9,956 378 10,334 Expenses: Selling, technical and administrative expenses $ 154 7,111 1,094 8,359 Restructuring costs 892 892 Amortization of intangible assets 6 1,128 1,134 --------------------------------------------------------------------- Total expenses 160 9,131 1,094 10,385 --------------------------------------------------------------------- (Loss) income from operations (160) 825 (716) (51) Interest income (expense), net 911 (3,017) (224) (2,330) Loss from equity investees (2,218) (889) $ 3,107 Other (expense) income, net (276) 24 (72) (324) --------------------------------------------------------------------- (Loss) income before income taxes (1,743) (3,057) (1,012) 3,107 (2,705) Income (benefit) tax expense (324) (839) (123) (1,286) --------------------------------------------------------------------- NET LOSS $ (1,419) $ (2,218) $ (889) $ 3,107 $ (1,419) =====================================================================
19 SUPPLEMENTAL CONSOLIDATING CONDENSED CASH FLOW STATEMENT (UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2002 --------------------------------------------------------------------- COMBINED COMBINED GUARANTOR NON-GUARANTOR PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED --------------------------------------------------------------------- Net cash (used in) provided by operating activities $ (6,976) $ 3,367 $ 1,886 $ (1,723) Cash flows from investing activities: Purchase of property, plant and equipment (3,689) (481) (4,170) --------------------------------------------------------------------- Net cash used in investing activities (3,689) (481) (4,170) Cash flows from financing activities: Proceeds from debt 32,170 333 32,503 Payments on debt (25,620) (1,063) (128) (26,811) Payment of preferred stock dividend (75) (75) --------------------------------------------------------------------- Net cash provided by (used in) financing activities 6,475 (730) (128) 5,617 Effect of currency rate changes 1,144 (1,024) 120 Net (decrease) increase in cash and cash equivalents (501) 92 253 (156) --------------------------------------------------------------------- Cash and cash equivalents at beginning of period $ 1,073 $ 247 $ 1,764 $ 3,084 --------------------------------------------------------------------- Cash and cash equivalents at end of period $ 572 $ 339 $ 2,017 $ 0 $ 2,928 =====================================================================
20 SUPPLEMENTAL CONSOLIDATING CONDENSED CASH FLOW STATEMENT (UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2001 --------------------------------------------------------------------- COMBINED COMBINED GUARANTOR NON-GUARANTOR PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED --------------------------------------------------------------------- Net cash provided by (used in) operating activities $ 4,474 $ 4,163 $ (2,181) $ 6,456 Cash flows from investing activities: Purchase of property, plant and equipment (3,860) (970) (4,830) --------------------------------------------------------------------- Net cash used in investIng activities (3,860) (970) (4,830) Cash flows from financing activities: Proceeds from long-term debt 12,281 560 3,398 16,239 Payments on long-term debt (16,775) (1,482) (179) (18,436) Payments of preferred stock dividends (75) (75) --------------------------------------------------------------------- Net cash (used in) provided by financing activities (4,569) (922) 3,219 (2,272) Net (decrease) increase in cash and cash equivalents (95) (619) 68 (646) Effect of exchange rate changes on cash (126) (126) --------------------------------------------------------------------- Cash and cash equivalents, at beginning of period 553 1,027 2,430 4,010 --------------------------------------------------------------------- CASH AND CASH EQUIVALENTS, AT END OF PERIOD $ 458 $ 408 $ 2,372 $ 0 $ 3,238 =====================================================================
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 Company's 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 HVAC equipment. The Company also designs and produces integral horsepower custom motors and generators. As of June 30, 2002, Hawk had approximately 1,600 employees and 16 manufacturing sites in five countries. 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 22 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. 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) income in the Company's statement of operations. SECOND QUARTER 2002 COMPARED TO SECOND QUARTER 2001 Net Sales. Consolidated net sales for the second quarter of 2002 were $50.3 million, an increase of $2.9 million or 6 percent from the comparable period in 2001. The increase in net sales was primarily the result of improving conditions in most of its markets, increased sales and production levels at the Company's Mexican motor components facility, and new product introductions leading to market share gains. - Friction Segment. Net sales in the friction segment during the second quarter of 2002 were $27.1 million, a decrease of 2 percent compared to the second quarter of 2001. The major markets served by this segment, with the notable exception of aerospace, experienced improving operating conditions during the quarter when compared to the first quarter of 2001. Net sales to the aerospace market declined 33 percent during the second quarter 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 heavy truck, agriculture and construction markets as a result of the generally improving operating conditions in the United States and Europe. The Company continues to expect that most of the markets it serves other than aerospace will continue to experience gradual economic improvement during the remainder of 2002. Volumes in the aerospace market for all of 2002 are expected to decline approximately 10 to 20 percent compared to 2001, as a result of the decline in air travel. - Precision Component Segment. Net sales in the precision components segment for the second quarter of 2002 were $17.1 million, an increase of $2.7 million, or 19 percent compared to the second quarter 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 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 during the second quarter of 2002 were $3.3 million, an increase of 3 percent compared to net sales of $3.2 million in the second quarter of 2001. The increase in net sales was primarily attributable to new drive train product introductions at the Company's Tex Racing division, which were partially offset by declines in clutch sales during the quarter. 23 - Motor Segment. Net sales in the Company's motor segment during the second quarter of 2002 were $2.8 million, an increase of $0.6 million or 27 percent from the same period in 2001. The sales growth in the motor segment came primarily from the Company's rotor manufacturing facility in Monterrey, Mexico and new product introductions at its U.S. facility. Gross Profit. Gross profit increased $1.3 million to $11.6 million during the second quarter of 2002, a 13 percent increase compared to gross profit of $10.3 million in the comparable period of 2001. The gross profit margin increased to 23 percent of net sales in the second quarter of 2002 from 22 percent of net sales in the comparable period in 2001. The Company experienced margin improvement in all of its segments, with the exception of the motor segment, primarily as a result of higher sales volumes and cost containment programs partially offset by changes in product mix, especially as a result of the reduction in sales to the aerospace market during the quarter. - Friction Segment. The Company's friction segment reported gross profit of $6.9 million or 25 percent of its net sales in the second quarter of 2002 compared to $7.3 million or 26 percent of its net sales in the second quarter of 2001. The decline in the Company's gross profit margin was primarily the result of product mix during second quarter of 2002. - Precision Components Segment. Gross profit in the precision components segment during the second quarter of 2002 was $3.6 million or 21 percent of net sales in second quarter of 2002 compared to $2.2 million or 15 percent of net sales in 2001. The increase in this segment's margins was primarily the result of volume improvements to the end markets served by the segment and the ability of the Company to leverage the fixed manufacturing costs associated with this segment to the volume increase. - Performance Automotive Segment. The Company's performance automotive segment reported gross profit of $1.2 million or 36 percent of its net sales in the second quarter of 2002 compared to $0.9 million or 28 percent of its net sales in 2001. The increase in gross profit margin was primarily the result of new drive train product introductions at the Company's Tex Racing division as well as manufacturing efficiencies achieved by the segment. - Motor Segment. The Company's motor segment reported a gross margin loss of $0.1 million during the second quarter of 2002 and for the second quarter of 2001. The gross margin loss was primarily the result of the Company's continued support of its new rotor manufacturing facility in Mexico. Additionally, new product introduction costs during the quarter at the Company's U.S. manufacturing facility had a negative effect on margins during the second quarter of 2002. Selling, Technical and Administrative Expenses. ST&A expenses decreased $0.1 million, or 1 percent, to $8.3 million in the second quarter of 2002 from $8.4 million in the comparable period of 2001. The decrease in ST&A expenses was primarily attributable to cost reductions implemented by the Company partially offset by legal expenses related to litigation that was resolved during the quarter in the Company's performance automotive segment and personnel costs associated with the Company's long-term sales and growth initiatives. Restructuring Costs. During the second quarter of 2001, the Company recorded an expense of $0.9 million to support its cost cutting initiatives. The costs incurred during the quarter represent corporate-wide severance costs. There were no restructuring costs incurred by the Company during the comparable quarter of 2002. Amortization of Intangibles. Amortization of intangibles decreased by $0.7 million during the second quarter of 2002 as a result of the implementation by the Company of SFAS No. 142 on January 1, 2002. Upon adoption of SFAS No. 142, the Company stopped amortizing existing goodwill. 24 Income from Operations. Income from operations increased to $3.0 million in the second quarter of 2002 from a loss of $0.1 million in 2001. The increase was primarily the result of the sales volume increases, the reduction of goodwill amortization expense as a result of the implementation of SFAS No. 142, and costs reductions achieved during the quarter. This improvement was partially offset by legal expenses associated with litigation that was resolved during the quarter. Income from operations as a percentage of net sales was 6 percent in 2002 compared to a loss in 2001. 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 increased $1.3 million or 93 percent to $2.7 million in the second quarter of 2002 from $1.4 million in the comparable period in 2001. - Income from operations in the precision components segment was $0.9 million in the second quarter of 2002, an increase of $1.5 million compared to a loss of $0.6 million in the comparable period in 2001. - Income from operations at the performance automotive segment was flat at $0.1 million in the second quarter of 2002 and 2001. - The loss from operations in the motor segment decreased to $0.7 million in the second quarter of 2002 from $0.9 million in the comparable period in 2001. Interest Expense. Interest expense decreased $0.1 million or 4 percent to $2.3 million in the second quarter of 2002 from $2.4 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 quarter. Other (Expense) Income. Other expense was $0.1 million in the second quarter of 2002. The expense in the second quarter of 2002 consisted primarily of expense recorded in a mark to market adjustment from the Company's swap agreement partially offset by foreign currency transaction income due to the strength of the Euro during the quarter. Income Taxes. The Company's recorded a provision for income taxes in the second quarter of 2002 of $0.3 million compared to a credit of $1.3 million in the comparable quarter of 2001. The Company's effective tax rate during the quarter was 56 percent compared to a tax rate benefit of 48 percent in the comparable quarter of 2001. Net Income (Loss). As a result of the factors noted above, the Company reported net income of $0.2 million in the second quarter of 2002, compared to a net loss of $1.4 million in 2001. FIRST SIX MONTHS OF 2002 COMPARED TO FIRST SIX MONTHS OF 2001 Net Sales. Consolidated net sales for the first six months of 2002 were $100.1 million, a decrease of $1.1 million or 1 percent from the comparable period in 2001. The decrease in net sales was primarily the result of significant weakness in the aerospace market during the six month period ended June 30, 2002. This decline in net sales was partially offset by more favorable conditions in the truck, fluid power, lawn and garden markets as well increased sales from the Company's Mexican rotor manufacturing facility. - Friction Segment. Net sales in the friction segment during the first six months of 2002 were $53.1 million, a decrease of 7 percent compared to 2001. While the major markets served by this segment experienced improving operating conditions during the first six 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 30 percent during the first six 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 heavy truck, agriculture and construction markets as a result of the generally improving operating conditions in the United States and Europe 25 - Precision Component Segment. Net sales in the precision components segment for the first six months of 2002 were $34.3 million, an increase of $2.0 million, or 6 percent compared to the first six 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 quarter. - Performance Automotive. Net sales in the Company's performance automotive segment during the first six months of 2002 were $7.2 million, a decrease of 3 percent compared to net sales of $7.4 million in the first six months of 2001. The decrease in net sales was primarily attributable to declines in clutch sales during the period partially offset by new drive train product introductions at the Company's Tex Racing division. - Motor Segment. Net sales in the Company's motor segment during the first six months of 2002 were $5.5 million, an increase of $1.2 million, or 28 percent from the same period in 2001. The sales growth during the period came primarily from the Company's rotor manufacturing facility in Monterrey, Mexico and new product introductions at its U.S. facility. Gross Profit. Gross profit declined $1.8 million to $22.4 million during the first six months of 2002, a 7 percent decrease compared to gross profit of $24.2 million in the comparable period of 2001. The gross profit margin decreased to 22 percent of net sales in the first six months of 2002 from 24 percent of net sales in the comparable period in 2001. - Friction Segment. The Company's friction segment reported gross profit of $12.9 million or 24 percent of net sales in the first six months of 2002 compared to $15.1 million or 26 percent of net sales in the comparable period of 2001. The decline in the Company's gross profit margin was primarily the result of the decline in aerospace sales during period. - Precision Components Segment. Gross profit in the precision components segment during the first six months of 2002 was $6.7 million or 20 percent of net sales compared to $6.7 million or 21 percent of net sales in 2001. The decrease in this segment's margins were primarily the result of volume declines in the first three months of the period, partially offset by the economic improvements in the end markets served by the segment and the ability of the Company to leverage the fixed manufacturing costs associated with this segment to the volume increase during the latter half of the period. - Performance Automotive Segment. The Company's performance automotive segment reported gross profit of $2.6 million or 36 percent of net sales in the first six months of 2002 compared to $2.3 million or 31 percent of net sales in 2001. The increase in gross profit margin was primarily the result of new drive train product introductions at the Company's Tex Racing division as well as manufacturing efficiencies achieved by the segment during the period. - Motor Segment. The Company's motor segment reported gross profit of $0.2 million or 4 percent of net sales in the first six months of 2002 compared to $0.1 million or 2 percent of net sales in 2001. The increase in gross margin was primarily the result of the reduced support required by the Company of its new rotor manufacturing facility in Mexico as a result of increasing production levels. Partially offsetting the improvement were new product introduction costs during the last half of the period at the Company's U.S. manufacturing facility which had a negative effect on margins. Selling, Technical and Administrative Expenses. ST&A expenses increased $0.5 million, or 3 percent, to $17.5 million in the first six months of 2002 from $17.0 million in the comparable period of 2001. The increase in ST&A expenses was primarily attributable to legal expenses related to litigation incurred in the Company's performance automotive segment and personnel costs associated with the Company's long-term sales and growth initiatives. These 26 increases were partially offset by cost reduction programs implemented by the Company during the latter half of 2001. Amortization of Intangibles. Amortization of intangibles decreased by $1.6 million during the first six months of 2002, to $0.7 million from $2.3 million in the comparable period of 2001, as a result of the implementation by the Company of SFAS No. 142 on January 1, 2002. Upon adoption of SFAS No. 142, the Company stopped amortizing existing goodwill. Income from Operations. Income from operations increased to $4.2 million, or 8 percent, in the first six months of 2002 from $3.9 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, and costs reductions achieved during the quarter partially offset by the impact of the economic slowdown affecting net sales in the first quarter of the year, product mix and legal expenses associated with litigation that was resolved during the period. Additionally, the Company incurred a restructuring charge of $1.0 million during the 2001 reporting period. 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: - The friction segment's income from operations decreased $0.8 million or 19 percent to $3.5 million in the first six months of 2002 from $4.3 million in the comparable period in 2001. - Income from operations in the precision components segment was $1.0 million in the first six months of 2002, an increase of $0.5 million compared to $0.5 million in the comparable period in 2001. - Income from operations at the performance automotive segment was $0.9 million in the first six months of 2002 compared to $0.5 million in the comparable period of 2001. - The loss from operations in the motor segment decreased to $1.2 million in the first six months of 2002 from $1.4 million in the comparable period in 2001. Interest Expense. Interest expense decreased $0.2 million, or 4 percent, to $4.6 million in the first six months of 2002 from $4.8 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. Other (Expense) Income. Other expense was $0.3 million in the first six months of 2002. The expense in the period consisted primarily of fees paid by the Company to effect an amendment of its bank credit facility during the first quarter of 2002 partially offset by income recorded in a mark to market adjustment from the Company's swap agreement and 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 in the first six months of 2002 of $0.3 million compared to a benefit of $0.6 million in the comparable period of 2001. The Company's effective tax rate benefit during the period was 46 percent compared to a tax rate benefit of 49 percent in the comparable period of 2001. Cumulative Effect of Change in Accounting Principle. In accordance with the requirements of SFAS No. 142 "Goodwill and Other Intangible Assets," the Company recorded a charge for the cumulative effect of change in accounting principle of $17.2 million in the six months ended June 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 Income (Loss). As a result of the factors noted above, the Company reported a net loss of $17.6 million in the first six months of 2002, compared to a net loss of $0.6 million in 2001. 27 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. The Company's senior notes, which had an outstanding balance of $65.0 million at June 30, 2002, bear interest at 10.25% per annum and mature December 1, 2003. The 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 Company has the option to redeem the senior notes in whole or in part during the twelve months beginning December 1, 2001 at 102.563%, and beginning December 1, 2002 at 100% 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 senior notes will have the right to require the Company to repurchase all or any part of such holder's senior 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 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 June 30, 2002, the Company did not meet the prescribed ratio. The failure to meet the ratio 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. 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 senior note indenture. The senior note indenture prohibits the payment of cash dividends on the Company's Class A Common Stock. The 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 senior note indenture considers non-compliance with the limitations events of default. In addition to non-payment of interest and principal amounts, the 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, the principal and interest could be accelerated upon written notice by 25% or more of the holders of the senior notes. As of June 30, 2002, the Company was in compliance with these covenants. In addition, the Company has available a bank credit facility which may be used for general corporate purposes. At June 30, 2002, the facility was comprised of a $25.0 million revolving credit component and a $15.0 million amortizing term loan subject to a borrowing base formula. The term loan has quarterly maturities of $1.25 million and the facility has a maturity date of March 31, 2003. As of June 30, 2002, the Company had $17.8 million outstanding under the revolving credit component of the facility. The 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 subsidiaries, and the Company has pledged the stock of all of its U.S. 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, interest coverage and fixed charge ratios, and comply with other loan covenants. The Company was in compliance with the financial covenants as of June 30, 2002. As of June 30, 2002, the Company had approximately $4.5 million available for future borrowings, as determined by the borrowing base under its credit facility. Net cash used in operating activities was $1.7 million for the six month period ended June 30, 2002. Net cash provided by operating activities was $6.4 million for the comparable six month period of 2001. The decline in cash 28 from operations was caused primarily by the net loss for the period, reduction in amortization expense 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 by the Company during the six month period compared to the fourth quarter of 2001, as well as customary extended payment term programs to the lawn and garden markets in the Company's precision component segment. Customer payments under these programs are due during the second and third quarter. Net cash used in investing activities was $4.2 million and $4.8 million for the six month period ended June 30, 2002 and 2001, respectively. The cash used in investing activities during the six month periods ended June 30, 2002 and 2001, was for the purchase of property, plant and equipment. To achieve long-term growth prospects and enhance product quality, the Company planned for its capital spending program in 2002 to be approximately $12.0 million. Net cash provided by (used in) financing activities was $5.6 million and $2.3 million for the six month period ended June 30, 2002 and 2001, respectively, as a result of increased borrowings by the Company. The increase in borrowings during the six month period ended June 30, 2002 was used primarily to support the increase in the Company's working capital assets and the purchases of property plant and equipment. The Company believes that if it is able to improve its working capital, through the active management of its working capital assets, along with its available cash, anticipated cash flow from operations, and availability under its credit facility, the Company will be able to fund its operations for at least the next twelve months. However, should the Company not achieve its working capital initiatives, its operations and its capital expenditures program may be adversely impacted, including the ability to borrow under its credit facility. The Company believes it is taking appropriate steps, including the reduction of operating expenses which are not critical to meeting the Company's business objectives to ensure that it has adequate sources of cash to meet its working capital needs for at least the next twelve months. In addition, the Company is pursuing strategic financing alternatives, including the modification, extension or refinancing of its senior notes and bank facility both of which are due during 2003. There can be no assurance that the Company will be able to modify, extend or refinance its senior notes and bank facility. Nor can there be any assurance that if the Company is able to modify, extend or refinance its senior notes and bank facility that the new terms will be as favorable to the Company as its existing facilities. If the Company is unable to modify, extend or refinance its senior notes and bank facility, the Company's financial position will be materially and adversely effected. 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: 29 - 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 ability of the Company to modify, extend or refinance its senior notes and bank facility, both of which mature in 2003; - 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 continuing 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 as the ability of the company to generate a profit at the start-up operations at the Company's Hawk MIM subsidary; - the effect of any additional impairment of goodwill as a result of the change in accounting treatment under SFAS No. 142; - 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. 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 June 30, 2002, approximately 32 percent, or $32.8 million, of the Company's debt obligations bear interest at a variable rate. 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 is used to calculate the contractual cash flow to be exchanged and does not represent exposure to credit loss. Although this financial instrument did not meet the hedge accounting criteria of SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities," it continues to be effective in achieving the risk management objectives for which it was intended. The carrying value and the fair value of the interest rate swap at June 30, 2002 is $0.4 million (liability). The change in the fair value is reflected in the Consolidated Statement of Operations in other (expense) income, net. The Company's primary interest rate risk exposure results from floating rate debt. If interest rates were to increase 100 basis points (1.0%) from June 30, 2002 rates, and assuming no changes in debt from June 30, 2002 levels, the additional annual interest expense to the Company would be approximately $0.2 million. The Company does not engage in activities using complex or highly leveraged instruments. 30 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 June 30, 2002 are not expected to result in a significant impact on earnings or cash flows. 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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS On May 15, 2002, the Company held its 2002 Annual Meeting of Stockholders to act on a proposal to elect Directors for a one year term expiring in 2003. The following table sets forth the number of shares voted for and withheld with respect to each nominee.
NOMINEE VOTES FOR VOTES WITHHELD ------- --------- -------------- Jeffrey H. Berlin 7,713,700 10,816 Paul R. Bishop 7,712,363 12,153 Jack Kemp 7,684,986 39,530 Dan T. Moore, III 7,711,863 12,653
Pursuant to the terms of the Company's Series D Preferred Stock, the holders of the Series D Preferred Stock have the right to elect a majority of the Company's Board of Directors. The holders of the Series D Preferred Stock are Norman C. Harbert, Ronald E. Weinberg, Byron S. Krantz, the Harbert Family Limited Partnership, the Weinberg Family Limited Partnership and the Krantz Family Limited Partnership. The holders of the Series D Preferred Stock elected Norman C. Harbert, Ronald E. Weinberg and Byron S. Krantz at the Annual Meeting. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits: 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 ---------- * filed herewith 31 (b) Reports on Form 8-K: Hawk Corporation filed one report on Form 8-K since March 31, 2002. A report dated July 24, 2002 reported information relating to the Company's adoption of Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets." 32 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: August 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) 33