10-Q 1 pr111302-10q.txt QUARTERLY REPORT UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington D.C. 20549 FORM 10-Q (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2002. OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number: 333-33438 PRECISION PARTNERS, INC. ------------------------------------------------------ (Exact name of registrant as specified in its charter) Delaware 22-3639336 --------------------------------- ------------------------------------ (State or other jurisdiction (I.R.S. Employer Identification No.) of incorporation or organization) 100 Village Court Suite 301 Hazlet, New Jersey 07730 ---------------------------------------- (Address of principal executive offices) (732) 335-3300 Indicate by check mark whether 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 [_] The number of shares outstanding of the Registrant's Common Stock, $.01 par value, was 100 as of October 31, 2002. 1 PRECISION PARTNERS, INC. FORM 10-Q TABLE OF CONTENTS PAGE NO. Disclosure Concerning Forward Looking Statements 3 PART I: FINANCIAL INFORMATION Item 1. Financial Statements Condensed Consolidated Balance Sheets as of September 30, 2002 (Unaudited) and December 31, 2001 4 Unaudited Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2002 and 2001 5 Unaudited Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2002 and 2001 6 Notes to Unaudited Condensed Consolidated Financial Statements 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 18 Item 3. Quantitative and Qualitative Disclosure of Market Risk 39 Item 4. Controls and Procedures 40 PART II: OTHER INFORMATION Item 1. Legal Proceedings 41 Item 2. Changes in Securities and Use of Proceeds 41 Item 3. Defaults Upon Senior Securities 41 Item 4. Submission of Matters to a Vote of Securities Holders 41 Item 5. Other Information 41 Item 6. Exhibits and Reports on Form 8-K 41 SIGNATURE 2 DISCLOSURE CONCERNING FORWARD-LOOKING STATEMENTS With the exception of the historical information contained in this report, the matters described herein contain "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include, without limitation, any statement that may predict, forecast, indicate or imply future results, performance or achievements, and may contain the words "believe," "anticipate," "expect," "estimate," "intend," "project," "will be," "will likely continue," "will likely result," or words or phrases of similar meaning including, statements concerning: o our liquidity and capital resources, o our debt levels and ability to obtain financing and service debt, o competitive pressures and trends in the precision-machined parts, tooling and assembly industry, o prevailing interest rates, o legal proceedings and regulatory matters, o general economic and business conditions, and o other factors discussed under "Other Considerations" in Item 2. Forward-looking statements involve risks and uncertainties (including, but not limited to, economic, competitive, governmental and technological factors outside of our control) that may cause actual results to differ materially from the forward-looking statements. These risks and uncertainties may include the ability of management to implement its business strategy; our ability to comply with the covenants in our financing agreements and to service our debts; the highly competitive nature of the precision tooling industry and the intense competition from other makers of precision-machined metal parts, tooling and assemblies, our dependence on certain key customers; our ability to consummate suitable acquisitions, our ability to effectively integrate acquisitions or new production programs, our dependence on certain executive officers; and changes in environmental and other government regulations. We operate in a very competitive environment in which new risks can emerge from time to time. It is not possible for management to predict all such risks, nor can it assess the impact of all such risks on our business or the extent to which any risk, or a combination of risks, may cause actual results to differ materially from those contained in forward-looking statements. Given these risks and uncertainties, readers are cautioned not to place undue reliance on forward-looking statements. 3 PART I: FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS Precision Partners, Inc. Consolidated Balance Sheets (in thousands, except for share data) SEPTEMBER 30, DECEMBER 31, 2002 2001 ------------- ------------ (Unaudited) ASSETS Current assets: Cash and cash equivalents $ 1,599 $ 11,144 Trade accounts receivable less allowance for doubtful accounts of $776 at September 30, 2002 and $739 at December 31, 2001 21,280 18,465 Inventories 13,430 13,813 Assets held for sale 187 2,825 Other current assets 1,503 696 ------------- ------------ TOTAL CURRENT ASSETS 37,999 46,943 Property, plant, and equipment, at cost, net 62,299 64,971 Goodwill, net of accumulated amortization of $11,775 at September 30, 2002 and December 31, 2001 67,700 67,700 Other assets 8,141 6,056 ------------- ------------ TOTAL ASSETS $ 176,139 $ 185,670 ============= ============ LIABILITIES AND STOCKHOLDER'S EQUITY (DEFICIT) Current liabilities: Accounts payable $ 12,501 $ 13,929 Accrued expenses 10,083 13,219 Customer advances 2,934 3,853 Current portion of long term debt and capital lease obligations 5,017 1,305 Other current liabilities 2,158 2,531 ------------- ------------ TOTAL CURRENT LIABILITIES 32,693 34,837 Long term debt and capital lease obligations, less current portion 150,885 148,645 Non-current deferred income taxes 212 212 Commitments and contingencies Stockholder's equity (deficit): Common stock, $.01 par value; 100 shares authorized, issued and outstanding -- -- Additional paid in capital 48,080 48,076 Accumulated deficit (55,731) (46,100) ------------- ------------ TOTAL STOCKHOLDER'S EQUITY (DEFICIT) (7,651) 1,976 ------------- ------------ TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY (DEFICIT) $ 176,139 $ 185,670 ============= ============

See accompanying notes 4 Precision Partners, Inc. Unaudited Condensed Consolidated Statements of Operations (in thousands) Three months ended Nine months ended September 30, September 30, ------------------- ---------------------- 2002 2001 2002 2001 -------- -------- --------- --------- Net sales $ 40,726 $ 42,963 $ 124,101 $ 139,837 Cost of sales 33,902 39,685 102,845 117,276 Restructuring charges and impairment of long-lived assets (22) 5,150 (34) 5,150 -------- -------- --------- --------- GROSS PROFIT (LOSS) 6,846 (1,872) 21,290 17,411 Selling, general and administrative expenses 4,715 6,991 15,601 21,595 Restructuring charges and impairment of long-lived assets -- 1,315 -- 1,315 -------- -------- --------- --------- OPERATING INCOME (LOSS) 2,131 (10,178) 5,689 (5,499) Interest income 4 56 19 74 Interest expense (4,895) (4,320) (15,265) (13,306) Other expense, net (25) (16) (74) (326) -------- -------- --------- --------- LOSS BEFORE INCOME TAXES (2,785) (14,458) (9,631) (19,057) Benefit for income taxes -- (642) -- -- -------- -------- --------- --------- NET LOSS $ (2,785) $(13,816) $ (9,631) $ (19,057) ======== ======== ========= =========

See accompanying notes 5 Precision Partners, Inc. Unaudited Condensed Consolidated Statements of Cash Flows (in thousands) Nine months ended September 30, -------------------- 2002 2001 -------- -------- OPERATING ACTIVITIES Net loss $ (9,631) $(19,057) Adjustments to reconcile net loss to net cash (used in) provided by operating activities: Depreciation including amortization of assets under capital leases 11,147 11,595 Amortization of goodwill -- 2,970 Amortization and write-off of debt issue costs 2,234 658 Impairment of long-lived assets -- 5,275 Loss on disposal of fixed assets 27 361 Gain on disposal of assets held for sale (27) -- Changes in operating assets and liabilities: Trade accounts receivable (2,773) (759) Inventories 383 2,839 Other current assets (807) (271) Other assets (943) 71 Accounts payable (1,428) (2,960) Accrued expenses (3,136) (3,281) Customer advances (919) 2,459 Other current liabilities (373) 1,403 -------- -------- NET CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES (6,246) 1,303 INVESTING ACTIVITIES Proceeds from sale of assets held for sale 2,665 -- Proceeds from sale of property, plant and equipment 131 717 Purchases of property, plant and equipment (2,725) (3,498) -------- -------- NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES 71 (2,781) FINANCING ACTIVITIES Repayments of borrowings from revolving line of credit (40,476) (30,338) Proceeds from revolving line of credit 31,530 41,683 Proceeds from term loan 44,050 -- Repayments of long term debt (35,102) (5,477) Contributions of capital 4 13 Payment of debt issue costs (3,376) -- -------- -------- NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES (3,370) 5,881 -------- -------- Net (decrease) increase in cash and cash equivalents (9,545) 4,403 Cash and cash equivalents, beginning of period 11,144 -- -------- -------- CASH AND CASH EQUIVALENTS, END OF PERIOD $ 1,599 $ 4,403 -------- -------- SUPPLEMENTARY INFORMATION FOR THE STATEMENT OF CASH FLOWS: Interest payments $ 15,977 $ 16,238 Income tax payments (refunds) $ 20 $ (68) Non-cash investing activity: Capital lease obligations $ 5,950 $ -- Short-term receivable (included in accounts receivable) received upon sale of fixed assets $ 42 $ --

See accompanying notes 6 NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 1. DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION Precision Partners, L.L.C. ("LLC") was formed on September 9, 1998 for the purpose of acquiring and operating companies in the business of manufacturing and supplying precision-machined parts, tooling and assemblies for original equipment manufacturers. On September 30, 1998, investors contributed approximately $32 million of capital to LLC which was then contributed by LLC to two wholly-owned subsidiaries, Mid State Acquisition Corp. and Galaxy Acquisition Corp., which were established to acquire all of the outstanding capital stock of Mid State Machine Products ("Mid State") and Galaxy Industries Corporation ("Galaxy") on September 30, 1998 (Mid State and Galaxy, collectively the "1998 Acquisitions"). The purchase price, including transaction expenses, was approximately $54,725,000 and was financed by the proceeds of the contributed capital and borrowings under LLC's credit facilities. In February 1999, Precision Partners, Inc. ("Precision" or the "Company") was formed as a wholly-owned subsidiary of Precision Partners Holdings, Inc. ("Holdings"), a wholly-owned subsidiary of LLC. On March 19, 1999, as part of a reorganization, LLC contributed to Precision, through Holdings, its investments and related assets in Galaxy, Mid State and Precision Partners Management Corporation ("Management Corporation"), which comprised substantially all of the assets of LLC ("the 1999 Reorganization"). Simultaneous with this reorganization, Precision purchased all of the issued and outstanding capital stock of Certified Fabricators, Inc. and its sister company Calbrit Design, Inc. (together, "Certified") and purchased substantially all of the assets and assumed certain liabilities of General Automation, Inc. ("General Automation") and Nationwide Precision Products Corp. ("Nationwide"). Also, on September 1, 1999, Precision purchased all of the issued and outstanding capital stock of Gillette Machine & Tool Co., Inc. ("Gillette") using existing cash and borrowings under Precision's credit facilities. The acquisitions of Certified, General Automation, Nationwide, and Gillette are referred to collectively as the "1999 Acquisitions". The 1999 Acquisitions were financed through the net proceeds of the issuance of $100,000,000 aggregate principal amount 12% senior subordinated notes due 2009, together with borrowings under Precision's credit facilities, an equity contribution of approximately $10,000,000 and available cash. The total purchase price, including transaction expenses, was approximately $116,593,000. In connection with the refinancing of Precision's bank credit facilities and the execution of a term loan in December 2000, capital contributions of $6.0 million were made to LLC by investors in 2000 bringing the aggregate capital contributed to $48.1 million. LLC contributed this capital through Holdings to Precision. All significant inter-company balances and transactions have been eliminated in consolidation. Financial information of the guarantor subsidiaries has been omitted because Precision's outstanding senior subordinated notes are fully, unconditionally and jointly and severally guaranteed by all direct and indirect subsidiaries of Precision. Precision has no operations or 7 assets separate from its investments in its subsidiaries. The indenture governing the outstanding Notes, as well as the agreements governing the credit facilities (described in Note 6), restrict the ability of Precision and its subsidiaries to make dividend payments. The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles 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 three and nine month periods ended September 30, 2002 are not necessarily, and should not be construed as, indicative of the results that may be achieved for a full year. 2. RESTRUCTURING, IMPAIRMENT AND OTHER CHARGES Due to continuing losses at Galaxy and Certified following the completion of reorganization plans announced in the third quarter of 2000, management approved and implemented plans to further restructure these operations in the third quarter of 2001. Management determined that it would consolidate the operations into one facility for each of Galaxy and Certified and dispose of excess equipment. Galaxy closed one of its two plants in the fourth quarter of 2001. The equipment that was located in the plant that closed was moved prior to December 31, 2001. The following summarizes the accruals remaining at September 30, 2002 related to the charges recorded during 2001 in connection with the restructuring of Galaxy (in thousands): Future rent and taxes on plant to be eliminated $ 466 Provision for terminating equipment leases 32 ---------- Total restructuring accruals - Galaxy $ 498 ========== During the three and nine months ended September 30, 2002, approximately $61,000 and $289,000, respectively, was paid and charged against the above noted accruals. Additionally, management incurred pre-tax cash costs of approximately $75,000 (included in cost of sales) in the first quarter of 2002 to move equipment in connection with the restructuring of Galaxy. Management expects that cash will be expended against the above noted accruals as follows (in thousands): Remaining 3 months of year ending December 31, 2002 $ 68 Year ending December 31, 2003 $ 178 Year ending December 31, 2004 $ 181 Year ending December 31, 2005 $ 71 Certified has substantially completed the consolidation of its operations into one of its current operating facilities. Equipment to be retained has been relocated from two other operating facilities, both of which are leased. Certified is marketing the equipment which has become excess as a result of this restructuring and has received approximately $240,000 in proceeds from related sales during the first three quarters of 2002. At September 30, 2002, an 8 accrual of approximately $277,000 remains for future rent and taxes on plants consolidated and closed in connection with the 2001 restructuring of Certified. 9 During the third quarter of 2002, approximately $62,000 was paid and charged against the above noted accrual. Additionally, management incurred pre-tax cash costs of approximately $434,000 (included in cost of sales) during the first three quarters of 2002 to move equipment in connection with the restructuring of Certified. Management expects that cash will be expended against the above noted accruals as follows (in thousands): Remaining 3 months of year ending December 31, 2002 $ 147 Year ending December 31, 2003 $ 105 Year ending December 31, 2004 $ 25 Additionally, General Automation entered into a contract for the sale and leaseback of its land and building during the fourth quarter of 2001. This transaction closed in March 2002 resulting in a small reduction of the impairment charge for the estimated loss on the sale recorded in the fourth quarter of 2001. 3. INVENTORIES Inventories consist of the following at: September 30, December 31, 2002 2001 --------------- ------------- (In thousands) Raw materials $ 5,289 $ 4,608 Work in process 7,183 6,309 Finished goods 2,095 3,407 ------- ------- 14,567 14,324 Less reserves 1,137 511 ------- ------- $13,430 $13,813 ======= ======= 4. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment, which are valued at cost, consists of the following at: September 30, December 31, 2002 2001 ---------------- ------------ (In thousands) Leasehold improvements $ 1,526 $ 962 Machinery and equipment 92,231 90,039 Furniture, fixtures and other 3,020 3,333 Equipment under capital leases 5,950 -- -------- ------- 102,727 94,334 Less accumulated depreciation and amortization 40,428 29,363 -------- ------- $ 62,299 $64,971 ======== ======= 10 5. ACCRUED EXPENSES Accrued expenses consist of the following at: September 30 December 31 2002 2001 ------------ ----------- (In thousands) Accrued interest $ 1,254 $ 4,147 Accrued bonuses 2,002 3,390 Accrued payroll and other employee expenses 1,931 1,771 Accrued trade payables 1,710 1,052 Accrued professional fees 1,009 839 Other 2,177 2,020 ------- ------- $10,083 $13,219 ======= ======= 11 6. DEBT AND CAPITAL LEASE OBLIGATIONS Long-term debt and capital lease obligations consists of the following at: September 30, December 31, 2002 2001 ------------- ------------ (In thousands) Precision Partners, Inc 12% Senior Subordinated Notes due 2009, interest due semiannually on March 15 and September 15 commencing on September 15, 1999. $ 100,000 $ 100,000 Term loan maturing January 31, 2006 payable in quarterly principal payments of 2.5% of the original principal amount in each of quarters three through twelve, 5.0% in each of quarters thirteen through fifteen and 60.0% in quarter sixteen. The first principal payment is due October 1, 2002. Interest is payable at an annual rate of LIBOR plus a margin of 5.00%, subject to a minimum interest rate of 10.00% through December 31, 2002, increasing to 11.00% through December 31, 2004 and to 12.00% thereafter. The interest rate was 10% at September 30, 2002 based on the minimum interest rate provision noted above. The loan, along with the capital lease obligation discussed below, is secured by a first priority lien in all assets and property of Precision and its subsidiaries except for inventories and receivables that secure the revolving line of credit discussed below, in which the term loan and capital lease holders have a second priority lien. 42,670 -- Capital lease obligation maturing January 31, 2006 payable in quarterly principal payments of 2.5% of the original principal amount in each of quarters three through twelve, 5.0% in each of quarters thirteen through fifteen and 60.0% in quarter sixteen. The first principal payment is due October 1, 2002. Interest is payable at an annual rate of LIBOR plus a margin of 5.00%, subject to a minimum interest rate of 10.00% through December 31, 2002, increasing to 11.00% through December 31, 2004 and to 12.00% thereafter. The interest rate was 10% at September 30, 2002 based on the minimum interest rate provision noted above. This obligation, along with the term loan discussed above, is secured by a first priority lien in all assets and property of Precision and its subsidiaries except for inventories and receivables that secure the revolving line of credit discussed below, in which the term loan and capital lease holders have a second priority lien. 5,950 -- Revolving line of credit with a limit of $25.0 million maturing January 31, 2006, secured by a first priority lien in all inventory and receivables of Precision and its subsidiaries and a second priority lien in all other assets and property of Precision and its subsidiaries. Advances under the line are available based upon 85% of eligible accounts receivable and 50% of eligible inventories. Interest is payable at an annual rate (6.50% as of September 30, 2002) of either LIBOR plus a margin of 3.25% or the lender's index rate plus a margin of 1.75%, at Precision's option; and there is a commitment fee of 0.5% per year based on the unused portion of the line, payable quarterly. 7,265 -- Term loans extinguished in February 2002 refinancing described below. -- 33,673 Revolving line of credit extinguished in February 2002 refinancing described below. -- 16,211 17 66 ------------- ------------ Other 155,902 149,950 Less current portion 5,017 1,305 ------------- ------------ Total long-term portion of debt and capital lease obligations $ 150,885 $ 148,645 ============= ============

12 In the fourth quarter of 2001, the Company was unable to comply with certain financial covenants of its credit facilities and master lease agreement. The lenders agreed to waive these covenant defaults through the completion of the refinancing discussed below. On February 1, 2002, Precision entered into a new credit agreement and a new master lease agreement (accounted for as a capital lease). Funding took place on February 4, 2002. A portion of the proceeds from the new credit agreement, along with available cash, were utilized to repay in full the senior debt previously outstanding and costs and expenses related to the refinancing, while the new master lease agreement was used to refinance all obligations under the Company's previous master lease agreement (accounted for as an operating lease). The remainder of the proceeds and availability under the new credit agreement will be used as needed for working capital and other general corporate purposes. The new credit agreement consists of a $44.050 million term loan that has been fully drawn and a $25.0 million revolving credit facility. The term loan amortizes over 47 months with quarterly principal payments of 2.5% of the original principal amount in each of quarters three through twelve, 5.0% in each of quarters thirteen through fifteen and 60.0% in quarter sixteen. The first principal payment was made October 1, 2002. Interest on the term loan is payable at an annual rate of LIBOR plus a margin of 5.00%, subject to a minimum interest rate of 10.00% through December 31, 2002, increasing to 11.00% through December 31, 2004 and to 12.00% thereafter. Principal payments totaling $1.380 million were made against the term loan during the first nine months of 2002, as required due to certain asset sales. The revolving credit facility matures January 1, 2006. Borrowings under this facility are limited to 85% of eligible accounts receivable and 50% of eligible inventory, each as defined in the new credit agreement, and subject to other eligibility requirements and reserves as per the new credit agreement. In certain instances, borrowings under the revolving credit facility can be further restricted due to limitations on Permitted Indebtedness, as defined in the indenture related to Precision's senior subordinated notes. Interest on the revolving credit facility is payable at an annual rate of either LIBOR plus a margin of 3.25% or the lender's index rate plus a margin of 1.75%, at Precision's option. There is also an unused facility fee payable at an annual rate of 0.50% on any unused portion of the revolving credit facility. As of November 8, 2002, $15.3 million of undrawn capacity was available for borrowing under the revolving credit facility. The new master lease agreement has a principal balance of $5.950 million and amortizes over 47 months with principal and interest payable as described above for the new term loan. This lease is being accounted for as a capital lease. If Precision's Consolidated Senior Leverage Ratio (as defined in the new credit agreement) exceeds 3.0x for the quarter ending September 30, 2002; 2.5x for the quarters ending December 31, 2002 or March 31, 2003; or 2.25x for any quarter thereafter, then Precision's borrowing rate will increase 200 basis points on an in-kind basis over the otherwise applicable annual rate on the term loan, capital lease obligation and the revolving credit facility. Such in-kind amounts would be payable at the maturity date of the new credit agreement, so long as Precision is not otherwise in default. As of September 30, 2002, based on the Company's calculations, no such change in the Company's borrowing rates is required. Due to the impact of difficult conditions in the power generation industry on Mid State, the borrowing rates may increase in future periods in accordance with certain provisions of the Company's credit facilities mentioned above. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Outlook". If Precision has a continuing Event of Default, as defined in the new credit agreement, 13 our borrowing rate will increase 200 basis points over the otherwise applicable annual rates under both the new credit and master lease agreements. The lenders have the right to syndicate the revolving credit facility. If the lenders determine that they are unable to syndicate the revolving credit facility under its agreed upon terms, they have the right to adjust the pricing and structure of the revolving credit facility whether or not it is eventually syndicated to a third party or held by one or both of the current lenders. Pricing changes of up to 300 basis points on inventory advances and up to 100 basis points on other advances are permitted. Changes to the structure could include, without limitation, adjusting advance rates, eligibility requirements and reserve requirements, going from a consolidated borrowing base to individual company borrowing bases and/or reducing the term of each of the credit facilities to three years. The lenders have a fully perfected first priority security interest in substantially all existing and after-acquired assets of Precision and its subsidiaries (other than inter-company debt). Precision and each of its principal subsidiaries are borrowers under the new credit agreement and each borrower guarantees the obligations of every other borrower. Precision's immediate parent, Precision Partners Holding Company, also guarantees the new credit agreement. Precision is subject to certain financial ratio covenants under the new credit and master lease agreements including, but not limited to, maximum Consolidated Senior Leverage Ratio, minimum Consolidated Senior Interest Coverage Ratio, minimum Consolidated Total Interest Coverage Ratio, minimum Consolidated Fixed Charge Coverage Ratio and maximum Capital Expenditures. If adverse industry conditions in the power generation markets continue as expected, the Company may not be able to comply with the terms and conditions of its credit agreements in future periods. The Company is assessing various alternatives such as asset sales, additional limitations on capital expenditures and reductions of operating expenses to improve its ability to comply with the terms and conditions of its credit agreements. There are mandatory repayment obligations related to certain asset dispositions, sales of equity and a portion of any excess cash flow, as defined. Under certain circumstances, prepayments on the term loan require prepayment premiums of 3.0%, 1.5%, 1.0% and 0.5% of the amounts prepaid in the first, second, third and fourth years, respectively. The indenture related to the senior subordinated notes and our other financing agreements as discussed above impose limitations on Precision's ability to, among other things, incur indebtedness (including capital leases), incur liens, pay dividends or make other restricted payments, consummate certain asset sales, enter into transactions with affiliates, issue preferred stock, merge or consolidate with any other person or sell, assign, transfer, lease, convey or otherwise dispose of all or substantially all of Precision's assets. In addition, the financing agreements limit our ability to enter into leases or sale and leaseback transactions, to make capital expenditures and to make acquisitions. Costs and expenses related to the refinancing totaled $4.5 million, of which $1.1 million had been incurred at December 31, 2001. The Company has aggregate unamortized debt issue costs of $7.0 million at September 30, 2002, related to all of its outstanding debt obligations. The costs are being amortized over the life of the related debts. In accordance with the Company's early adoption of SFAS No. 145, Rescission of FASB Statements No. 4, 44, 64, Amendment of FASB Statement No. 13, and Technical Corrections, the remaining unamortized debt issue costs relating to the obligations repaid via the refinancing have been written off as a component of interest expense in the first quarter of 2002. Such write-off totaled $0.9 million. See Note 9. 14 7. LITIGATION Precision and its subsidiaries are defendants from time to time in lawsuits and disputes arising in the normal course of business. Management believes that the ultimate outcome of most matters will not have a material adverse effect on the Company's consolidated financial position, results of operations or cash flows. However, the following claims, if the judgments or settlements are rendered in favor of the plaintiff and are not covered by insurance, could have a material impact on the Company's financial position, results of operations and cash flows. On May 18, 2001, our subsidiary, Galaxy Industries, Inc., was sued by a former temporary employee for work-related injuries. The case, entitled ERIC KELLY VS. GALAXY INDUSTRIES, INC., is pending before Circuit Court, Wayne County, Michigan. Suits involving workplace injuries are normally barred by applicable workers compensation statutes. However, the plaintiff is arguing that he is able to assert a civil action under an exception to the exclusive remedy provision of Michigan's workers compensation act because he claims the injury was intentionally caused by Galaxy. Galaxy denies the plaintiff's assertion. On May 20, 2002, Galaxy's motion for summary judgment was granted as to two counts of the Complaint, but denied with respect to the intentional injury claim. Galaxy has appealed the trial court's denial of its summary judgment motion, which appeal is currently pending. The plaintiff is seeking $10 million in damages. Although our comprehensive general liability insurance policy contains an exception for intentional injuries and leased employees, we believe this case is covered by insurance. We also believe that Galaxy has strong arguments to prevail on the merits of this case. On July 31, 2002, Jasco Tools, Inc. filed a complaint for tortious interference against our subsidiary, Nationwide Precision Products Corp. The case, JASCO TOOLS, INC. VS. NATIONWIDE PRECISION PRODUCTS CORP. and SPICER HEAVY AXEL & BRAKE DIVISION OF DANA CORPORATION, is before the New York State Supreme Court, Monroe County, New York. The Complaint arises from the termination of a business contract between Jasco Tools and Dana Corporation, under which Jasco had agreed to perform machining services on components for axle and heavy truck wheel assembly products manufactured by Dana. Jasco contends that prior to the termination of the agreement, two of its employees left Jasco to join Nationwide and that shortly thereafter Dana moved the contract from Jasco to Nationwide as a result of wrongful conduct on the part of both Nationwide and Dana. Specifically, Jasco contends that Nationwide tortiously interfered with Jasco's contract and business relations with Dana and that it misappropriated Jasco's trade secrets allowing it to obtain the Dana contract. It seeks a judgment in the amount of $20.0 million plus interest. We believe Nationwide has several strong defenses in this case. In particular, prior to filing this action, Jasco had filed a similar complaint against three of its former employees (two of whom left Jasco to work for Nationwide) asserting claims arising from the same facts alleged in this lawsuit. In the prior suit, all of the claims against the individuals were dismissed on the merits by the trial court, upon motion for the summary judgment. Jasco has appealed from that decision and the matter is now before the Appellate Division, Fourth Department, of the New York State Supreme Court. If the decision dismissing the claims against the individual defendants is affirmed, we believe that Nationwide will have a strong defense of collateral estoppel since the claims in this case arose from the same set of facts that were previously litigated and decided upon in the prior action. 8. INCOME TAXES 15 During the three months ended September 30, 2001 Precision reversed its $0.6 million provision for state taxes based on its expectation certain state tax obligations during the year would not be realized. Precision does not expect to incur federal or significant state tax obligations in 2002 and, therefore, has not recorded a tax provision in the first nine months of the year. 9. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 142, Goodwill and Other Intangible Assets. SFAS No. 142 prohibits the amortization of goodwill and intangible assets with indefinite useful lives and requires that these assets be reviewed for impairment upon adoption with completion of testing within one year of adoption and at least annually thereafter. The Company, as required, adopted SFAS No. 142 beginning January 1, 2002. Application of the nonamortization provisions of SFAS No. 142 will result in a reduction of amortization expense of approximately $4.0 million in 2002. The Company is performing its initial testing of goodwill for impairment using the two-step process prescribed in SFAS No. 142. The first step is a screen for potential impairment, while the second step measures the amount of impairment, if any. The Company has determined that certain subsidiaries with aggregate goodwill of approximately $44.1 million must undergo the second step impairment testing process. If any charge is required, it is expected to be less than the aggregate goodwill at these subsidiaries. The steps required by SFAS No. 142 to determine the existence of impairment and the amount of that impairment will be completed in the fourth quarter of 2002. Any impairment charge will be reflected as the cumulative effect of a change in accounting principle. The Company has not yet determined what the effect of these tests will be on its earnings and financial position. In addition to the transitional test discussed above, the Company will complete its annual goodwill impairment test in the fourth quarter of 2002. Mid State has net goodwill of $23.6 million as of September 30, 2002, which is not included in the $44.1 million undergoing the second step of initial testing. Adverse changes in the power generation market between the January 1, 2002 initial testing date and the October 1, 2002 annual testing date have led to lower operating results and lower forecasted results than anticipated at the initial testing date. As a result, there can be no assurance that Mid State will pass the first step of the October 1, 2002 impairment test. Further, there can be no assurance that the 2002 annual impairment test will not lead to impairment charges at any of our subsidiaries in excess of any that might be required in connection with the transitional testing. The following table sets forth the pro forma impact of applying the new non-amortization provisions of SFAS No. 142 on net loss in the relevant periods of 2001: For the Three For the Nine Months Ended Months Ended September 30, September 30, --------------------------- --------------------------- (In thousands) 2002 2001 2002 2001 (as reported) (proforma) (as reported) (proforma) ------------- ---------- ------------- ---------- Reported net loss $(2,785) $(13,816) $(9,631) $(19,057) Add back: Goodwill amortization -- 956 -- 2,970 ------------- ---------- ------------- ---------- Adjusted net loss $(2,785) $(12,860) $(9,631) $(16,087) ============= ========== ============= ==========

16 In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No. 4, 44, 64, Amendment of FASB Statement No. 13, and Technical Corrections. SFAS No. 145 is effective in fiscal years beginning after May 15, 2002. In its Form 10-K for the year ended December 31, 2001, the Company disclosed its intent to classify the loss on the extinguishment of debt as an extraordinary item in the first quarter of 2002 based on the accounting pronouncements in effect at that time; however, as SFAS No. 145 has been issued since that time, the Company has elected to early adopt its provisions as of January 1, 2002. Accordingly, the Company has recorded the loss on extinguishment of debt relating to its write-off of the unamortized debt issue costs of $0.9 million as a component of interest expense in the first quarter of 2002 instead of as an extraordinary item as previously required. 17 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This discussion and analysis should be read in conjunction with our unaudited condensed consolidated financial statements, including the notes thereto, included elsewhere in this report. GENERAL Due to continuing losses at Galaxy and Certified following the completion of reorganization plans announced in the third quarter of 2000, management approved and implemented plans to further restructure these operations in the third quarter of 2001. Management determined that it would consolidate the operations into one facility for each of Galaxy and Certified and dispose of excess equipment. Galaxy closed one of its two plants in the fourth quarter of 2001. The equipment that was located in the plant that closed was moved prior to December 31, 2001. The following summarizes the accruals remaining at September 30, 2002 related to the charges recorded during 2001 in connection with the restructuring of Galaxy (in thousands): Future rent and taxes on plant to be eliminated $ 466 Provision for terminating equipment leases 32 ---------- Total restructuring accruals - Galaxy $ 498 ========== During the three and nine months ended September 30, 2002, approximately $61,000 and $289,000, respectively, was paid and charged against the above noted accruals. Additionally, management incurred pre-tax cash costs of approximately $75,000 (included in cost of sales) in the first quarter of 2002 to move equipment in connection with the restructuring of Galaxy. Management expects that cash will be expended against the above noted accruals as follows (in thousands): Remaining 3 months of year ending December 31, 2002 $ 68 Year ending December 31, 2003 $ 178 Year ending December 31, 2004 $ 181 Year ending December 31, 2005 $ 71 Certified has substantially completed the consolidation of its operations into one of its current operating facilities. Equipment to be retained has been relocated from two other operating facilities, both of which are leased. Certified is marketing the equipment which has become excess as a result of this restructuring and has received approximately $240,000 in proceeds from related sales during the first three quarters of 2002. At September 30, 2002, an accrual of approximately $277,000 remains for future rent and taxes on plants consolidated and closed in connection with the 2001 restructuring of Certified. 18 During the third quarter of 2002, approximately $62,000 was paid and charged against the above noted accrual. Additionally, management incurred pre-tax cash costs of approximately $434,000 (included in cost of sales) during the first three quarters of 2002 to move equipment in connection with the restructuring of Certified. Management expects that cash will be expended against the above noted accruals as follows (in thousands): Remaining 3 months of year ending December 31, 2002 $ 147 Year ending December 31, 2003 $ 105 Year ending December 31, 2004 $ 25 Additionally, General Automation entered into a contract for the sale and leaseback of its land and building during the fourth quarter of 2001. This transaction closed in March 2002 resulting in a small reduction of the impairment charge for the estimated loss on the sale recorded in the fourth quarter of 2001. 19 RESULTS OF OPERATIONS The following table sets forth certain unaudited financial information for the periods indicated: For the Three For the Nine Months Ended Months Ended September 30, September 30, -------------------- ---------------------- (In thousands) 2002 2001 2002 2001 -------- -------- --------- --------- OPERATING DATA: NET SALES $ 40,726 $ 42,963 $ 124,101 $ 139,837 Cost of sales 33,902 39,685 102,845 117,276 Restructuring charges and impairment of long-lived assets (22) 5,150 (34) 5,150 -------- -------- --------- --------- GROSS PROFIT (LOSS) 6,846 (1,872) 21,290 17,411 Selling, general and administrative expenses 4,715 6,991 15,601 21,595 Restructuring charges and impairment of long-lived assets -- 1,315 -- 1,315 -------- -------- --------- --------- OPERATING INCOME (LOSS) 2,131 (10,178) 5,689 (5,499) Interest expense, net (4,891) (4,264) (15,246) (13,232) Other expense, net (25) (16) (74) (326) Benefit for income taxes -- 642 -- -- -------- -------- --------- --------- NET LOSS $ (2,785) $(13,816) $ (9,631) $ (19,057) ======== ======== ========= ========= OTHER FINANCIAL DATA: Depreciation and amortization $ 3,734 $ 4,851 $ 11,147 $ 14,565 EBITDA (1), (2) $ 5,865 $ (5,327) $ 16,836 $ 9,066 Non-cash impairment and other charges (22) 9,978 (34) 9,978 -------- -------- --------- --------- ADJUSTED EBITDA (1), (2) $ 5,843 $ 4,651 $ 16,802 $ 19,044 ======== ======== ========= ========= Cash flow (used in) provided by operating activities $ (2,720) $ (539) $ (6,246) $ 1,303

(1)EBITDA is defined as operating income plus depreciation and amortization, excluding amortization of debt issue costs. Adjusted EBITDA is defined as EBITDA plus non-cash impairment and other charges. EBITDA and Adjusted EBITDA are not measures of performance under generally accepted accounting principles. While EBITDA and Adjusted EBITDA should not be used in isolation or as a substitute for net income, cash flows from operating activities or other income or cash flow statement data prepared in accordance with generally accepted accounting principles, or as a measure of profitability or liquidity, management believes that they may be used by certain investors as supplemental information to evaluate a company's financial performance. In addition, the definition of EBITDA and Adjusted EBITDA used in this report may not be comparable to the definition of EBITDA and Adjusted EBITDA used by other companies. (2)EBITDA for the three and nine months ended September 30, 2001 includes non-cash restructuring, impairment and other charges of approximately $10.0 million consisting of restructuring charges of $1.2 million, impairment of property, plant and equipment of $5.3 million and inventory adjustments of $3.5 million. These amounts have been added back to EBITDA to arrive at Adjusted EBITDA. 20 THREE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 2001 NET SALES Net sales decreased 5.2% to $40.7 million in the third quarter of 2002 compared to $43.0 million in the third quarter of 2001. The decrease is primarily due to a significant reduction of demand for power generation component parts produced by Mid State as power companies rationalize excess capacity and cope with difficult capital market conditions by delaying or canceling the development and building of new power plants. This was offset in part by higher sales at all other operations. Higher sales of heavy truck axle components and other truck and automotive components at Nationwide, heavy construction and off-road diesel engine blocks at Galaxy, aerospace components at Certified and transportation component parts at Gillette provided the most significant improvements. As noted in our Form 10-K for the year ended December 31, 2001, the sale of power generation component parts provided a substantial portion of our sales growth in 2001. Based on current industry conditions and sales volumes as of the date of this filing, we currently expect that sales at Mid State in the fourth quarter and full year 2002 will be significantly less than in the comparable periods of 2001. Mid State is pursuing alternative sources of revenue to offset this expected decline, but we currently estimate the decline in sales at Mid State to approximate 40% for the full year with a related negative impact on Mid State's profitability. Mid State could have a similarly significant decline in sales in 2003. COST OF SALES Cost of sales decreased 14.6% to $33.9 million in the third quarter of 2002 compared to $39.7 million in the third quarter of 2001, which included inventory adjustments of $3.5 million. Excluding the inventory adjustments in the prior period, cost of sales decreased 6.3% from $36.2 million in the third quarter of 2001. The decrease is primarily driven by lower sales volume at Mid State in 2002 and the plant consolidation at Galaxy. The three months ended September 30, 2002 includes approximately $0.1 million of costs related to the reorganization and consolidation of plants at Certified. RESTRUCTURING AND IMPAIRMENT CHARGES AFFECTING GROSS PROFIT During the third quarter of 2001, management approved restructuring plans for its Galaxy and Certified operations. In connection with these plans, Precision recorded restructuring and impairment charges that affected gross profit in the amount of $4.5 million. Also during the third quarter of 2001, management determined that General Automation would dispose of certain under-utilized production equipment resulting in an impairment charge of $0.7 million. During the third quarter of 2002, Galaxy sub-leased its abandoned facility. The Company has recorded the $22,000 of sub-lease income received as a credit to the restructuring charges as this was not anticipated when such charges were recorded in 2001. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - General". 21 GROSS PROFIT Gross profit increased to $6.8 million in the third quarter of 2002 from a loss of $1.9 million in the third quarter of 2001. Excluding the $8.7 million of restructuring and impairment charges and the inventory adjustments recognized in the third quarter of 2001 as discussed above, gross profit remained flat at $6.8 million for the third quarter of 2002 compared to the adjusted gross profit of $6.8 million in the third quarter of 2001. Gross margin increased to 16.8% in the third quarter of 2002 from a gross margin, excluding the items described above, of 15.8% in the comparable period of 2001 due to cost-savings from plant consolidations and the rationalization of certain unprofitable programs. Lower gross profits at Mid State offset significant improvements in gross profits at Nationwide and Galaxy. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES Selling, general, and administrative expenses (SG&A) decreased 32.6% to $4.7 million in the third quarter of 2002 compared to $7.0 million in the third quarter of 2001. The reduction was due to the absence of goodwill amortization and the reduction in other SG&A expenses. The Company ceased amortizing goodwill January 1, 2002, in accordance with the required adoption of SFAS No. 142, Goodwill and Other Intangible Assets. Goodwill amortization totaled $1.0 million in the third quarter of 2001. The reduction in other SG&A expenses was driven by cost reductions at Gillette, at Galaxy, reflecting the plant consolidation, and at Mid State, as expense reductions paralleled its sales decline. RESTRUCTURING AND IMPAIRMENT CHARGES NOT AFFECTING GROSS PROFIT During the third quarter of 2001, management approved restructuring plans for its Galaxy and Certified operations. In connection with these plans, Precision recorded restructuring and impairment charges that affected operating loss, but not gross profit in the third quarter of 2001 in the amount of $1.3 million. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - General". OPERATING INCOME As a result of all of the foregoing, operating income increased to $2.1 million in the third quarter of 2002 from a loss of $10.2 million in the third quarter of 2001. Excluding the $10.0 million of restructuring and impairment charges and other adjustments impacting the third quarter of 2001 the operating loss for the third quarter of 2001 was $0.2 million compared to operating income of $2.1 million for the third quarter of 2002. The most significant contributions to the improvement in operating income resulted from a substantial reduction in operating losses at Galaxy, as a result of its plant consolidation, the elimination of goodwill amortization and the elimination of a prior period operating loss at Nationwide, which more than offset the decline in operating profits at Mid State. 22 NET INTEREST EXPENSE For the third quarter of 2002, net interest expense increased 14.8% to $4.9 million from $4.3 million for the comparable period of 2001. The increase is attributable to higher average borrowing rates and higher amortization of deferred financing fees relating to Precision's new financing facilities. Amortization of deferred financing fees also increased approximately $0.3 million in the third quarter of 2002 reflecting Precision's new financing facilities. Excluding the non-cash amortization of deferred financing fees, interest expense increased $0.3 million in the third quarter of 2002 versus the comparable period of the prior year. INCOME TAXES Precision does not expect to incur federal or significant state tax obligations in 2002 and, therefore, has not recorded a tax provision in the third quarter of 2002. During the first six months of 2001 Precision recorded a provision for taxes based on its expectation that it would incur certain state tax obligations during that year. At September 30, 2001 Precision no longer expected to incur state tax obligations for the year and therefore reversed the previously recorded tax provision in the third quarter of 2001. Accordingly, Precision recognized a state tax benefit of $0.6 million for the three months ended September 30, 2001. NET LOSS Net loss decreased 79.8% to $2.8 million in the third quarter of 2002 compared to $13.8 million in the third quarter of 2001 due primarily to the aforementioned reasons. DEPRECIATION AND AMORTIZATION Depreciation and amortization decreased 23.0% to $3.7 million in the third quarter of 2002 compared to $4.9 million in the third quarter of 2001. The decrease is primarily due to the required adoption of SFAS No. 142, Goodwill and Other Intangible Assets, which prohibits the amortization of goodwill and intangible assets with indefinite useful lives. Goodwill amortization totaled $1.0 million in the third quarter of 2001. Also contributing to the decrease in depreciation and amortization expense from the prior year's third quarter was the impairment and disposal of equipment at Galaxy and Certified resulting from the restructurings at those operations and the impairment and eventual disposal of General Automation's production facility in a sale-leaseback transaction. The decreases are partially offset by depreciation expense related to equipment leases capitalized as part of the February 2002 refinancing. NINE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30, 2001 NET SALES Net sales decreased 11.3% to $124.1 million in the first nine months of 2002 compared to $139.8 million in the first nine months of 2001. The decrease is primarily due to a significant 23 decline in demand for power generation component parts produced by Mid State as power companies rationalize excess capacity and cope with difficult capital market conditions by delaying or canceling the development and building of new power plants. The decline at Mid State was partially mitigated by higher sales of heavy truck axle components and other truck and automotive components at Nationwide and General Automation and aerospace related components at Certified, offset by lower business and medical machine component sales at Gillette and Nationwide. The prior year period also includes sales from business lines that were discontinued because they were unprofitable. As noted in our Form 10-K for the year ended December 31, 2001, the sale of power generation component parts provided a substantial portion of our sales growth in 2001. Based on current industry conditions and sales volumes as of the date of this filing, we currently expect that sales at Mid State in the fourth quarter and full year 2002 will be significantly less than in the comparable periods of 2001. Mid State is pursuing alternative sources of revenue to offset this expected decline. We currently estimate the decline in sales at Mid State to approximate 40% for the full year with a related negative impact on Mid State's profitability. Mid State could have a similarly significant decline in sales in 2003. COST OF SALES Cost of sales decreased 12.3% to $102.8 million in the first nine months of 2002 compared to $117.3 million in the same period of 2001, which included inventory adjustments of $3.5 million. Excluding these adjustments, cost of sales decreased 9.6% from $113.8 million in 2001 primarily due to the decrease in sales volume at Mid State in 2002 and the plant consolidation at Galaxy. The nine months ended September 30, 2002 include approximately $0.4 million of costs related to the reorganization and consolidation of plants at Certified. RESTRUCTURING AND IMPAIRMENT CHARGES AFFECTING GROSS PROFIT During the third quarter of 2001, management approved restructuring plans for its Galaxy and Certified operations. In connection with these plans, Precision recorded restructuring and impairment charges that affected gross profit in the amount of $4.5 million. Also during the third quarter of 2001, management determined that General Automation would dispose of certain under-utilized production equipment resulting in an impairment charge of $0.7 million and in the fourth quarter of 2001, the Company agreed to a sale and leaseback of General Automation's land and building in a sale-leaseback transaction. During the first quarter of 2002, General Automation's land and building and some of the equipment that was impaired as part of the restructurings at Galaxy and Certified were sold. During the third quarter of 2002, Galaxy sub-leased its abandoned facility. The Company has recorded the sub-lease income as a credit to the restructuring charges as this was not anticipated when such charges were recorded in 2001. The aggregate of these items resulted in a credit to restructuring charges of $34,000 for the nine months ended September 30, 2002. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - General". 24 GROSS PROFIT Gross profit increased 22.3% to $21.3 million in the first nine months of 2002 compared to $17.4 million in the first nine months of 2001. Excluding the $8.7 million of restructuring and impairment charges and the inventory adjustments impacting the nine months ended September 30, 2001 gross profit decreased 18.3% from $26.1 million in the first three quarters of 2001 to $21.3 million in the comparable period of 2002. Gross margin decreased to 17.2% in the first nine months of 2002 from a gross margin, excluding the items described above, of 18.6% in the comparable period of 2001. Lower gross profits primarily reflect the overall lower level of sales at Mid State, which offset the elimination of manufacturing losses at Galaxy and a significant improvement in gross profits at Nationwide. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES Selling, general, and administrative expenses (SG&A) decreased 27.8% to $15.6 million in the first nine months of 2002 compared to $21.6 million in the first nine months of 2001. The reduction was due to the absence of goodwill amortization and the reduction in other SG&A expenses. The Company ceased amortizing goodwill January 1, 2002, in accordance with the required adoption of SFAS No. 142, Goodwill and Other Intangible Assets. Goodwill amortization totaled $3.0 million in the first nine months of 2001. The reduction in other SG&A expenses was driven by cost reductions at Mid State, as expense reductions paralleled its sales and profit decline, at Galaxy reflecting the plant consolidation and at Gillette, the result of an expense reduction program. The first nine months of 2002 also include approximately $0.5 million in corporate expenses related to the evaluation of strategic alternatives. RESTRUCTURING AND IMPAIRMENT CHARGES NOT AFFECTING GROSS PROFIT During the third quarter of 2001, management approved restructuring plans for its Galaxy and Certified operations. In connection with these plans, Precision recorded restructuring and impairment charges that affected operating loss, but not gross profit in the amount of $1.3 million. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - General". OPERATING INCOME The most significant contributions to the improvement of operating income were the substantial reduction in operating losses at Galaxy. Additionally, the elimination of goodwill amortization and the elimination of operating losses at Nationwide more than offset the decline in profits at Mid State. As a result of all of the foregoing, operating income increased to $5.7 million in the first nine months of 2002 from a loss of $5.5 million in the comparable period of 2001. Excluding the $10.0 million of restructuring and impairment charges and other adjustments impacting the first nine months of 2001 as discussed above, operating income for the first nine months of 2002 increased 27.0% from $4.5 million in the comparable period of 2001. 25 NET INTEREST EXPENSE For the first nine months of 2002, net interest expense increased 15.2% to $15.2 million from $13.2 million for the comparable period of 2001. The increase is partly attributable to the write-off of deferred financing fees of $0.9 million related to debts that were refinanced in February 2002. The Company elected to early adopt SFAS No. 145, Rescission of FASB Statements No. 4, 44, 64, Amendment of FASB Statement No. 13, and Technical Corrections, and accordingly, the Company has recorded the loss on extinguishment of debt relating to its write-off of the unamortized debt issue costs as a component of interest expense instead of as an extraordinary item as previously required. Amortization of deferred financing fees also increased approximately $0.7 million in the first nine months of 2002 reflecting Precision's new financing facilities. Excluding the non-cash write-off and amortization of deferred financing fees, interest expense increased $0.4 million in the first nine months of 2002 compared to the first nine months of 2001 due to higher average borrowing rates. INCOME TAXES Precision does not expect to incur federal or significant state tax obligations in 2002 and, therefore, has not recorded a tax provision in the third quarter of 2002. During the first six months of 2001 Precision recorded a provision for taxes based on its expectation that it would incur certain state tax obligations during that year. At September 30, 2001 Precision no longer expected to incur state tax obligations for the year and therefore reversed the previously recorded tax provision in the third quarter of 2001. NET LOSS Net loss decreased 49.5% to $9.6 million in the first nine months of 2002 compared to $19.1 million in the first nine months of 2001 due primarily to the aforementioned reasons. DEPRECIATION AND AMORTIZATION Depreciation and amortization decreased 23.5% to $11.1 million in the first nine months of 2002 compared to $14.6 million in the first nine months of 2001. The decrease is primarily due to the required adoption of SFAS No. 142, Goodwill and Other Intangible Assets, which prohibits the amortization of goodwill and intangible assets with indefinite useful lives. Goodwill amortization totaled $3.0 million in the first nine months of 2001. Also contributing to the decrease in depreciation and amortization expense from the prior year period was the impairment and disposal of equipment at Galaxy and Certified resulting from the restructurings at those operations and the impairment and eventual disposal of General Automation's production facility in a sale-leaseback transaction. The decreases are partially offset by depreciation expense related to equipment leases capitalized as part of the February 2002 refinancing. OUTLOOK Improved sales of automotive, truck, aerospace and mass-transit components should only partially offset the continuing weakness in the power generation marketplace and a two-week shut down at a major customer's plant expected in December. As a result, we now expect our fourth quarter sales and 26 Adjusted EBITDA to be substantially lower than last year's fourth quarter and our full year sales and Adjusted EBITDA to be approximately 12% lower than 2001. Our fourth quarter and full year net income could also be negatively impacted by charges related to the impairment of goodwill as we complete the initial and 2002 annual testing required by SFAS No. 142, Goodwill and Other Intangible Assets." IMPACT OF NEW ACCOUNTING STANDARDS In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 142, Goodwill and Other Intangible Assets. SFAS No. 142 prohibits the amortization of goodwill and intangible assets with indefinite useful lives and requires that these assets be reviewed for impairment upon adoption with completion of testing within one year of adoption and at least annually thereafter. The Company, as required, adopted SFAS No. 142 beginning January 1, 2002. Application of the nonamortization provisions of SFAS No. 142 will result in a reduction of amortization expense of approximately $4.0 million in 2002. The Company is performing its initial testing of goodwill for impairment using the two-step process prescribed in SFAS No. 142. The first step is a screen for potential impairment, while the second step measures the amount of impairment, if any. The Company has determined that certain subsidiaries with aggregate goodwill of approximately $44.1 million must undergo the second step impairment testing process. If any charge is required, it is expected to be less than the aggregate goodwill at these subsidiaries. The steps required by SFAS No. 142 to determine the existence of impairment and the amount of that impairment will be completed in the fourth quarter of 2002. Any impairment charge will be reflected as the cumulative effect of a change in accounting principle. The Company has not yet determined what the effect of these tests will be on its earnings and financial position. In addition to the transitional test discussed above, the Company will complete its annual goodwill impairment test in the fourth quarter of 2002. Mid State has net goodwill of $23.6 million as of September 30, 2002, which is not included in the $44.1 million undergoing the second step of initial testing. Adverse changes in the power generation market between the January 1, 2002 initial testing date and the October 1, 2002 annual testing date have led to lower operating results and lower forecasted results than anticipated at the initial testing date. As a result, there can be no assurance that Mid State will pass the first step of the October 1, 2002 impairment test. Further, there can be no assurance that the 2002 annual impairment test will not lead to impairment charges at any of our subsidiaries in excess of any that might be required in connection with the transitional testing. The following table sets forth the pro forma impact of applying the new non-amortization provisions of SFAS No. 142 on net loss in the relevant periods of 2001: For the Three For the Nine Months Ended Months Ended September 30, September 30, -------------------------- -------------------------- (In thousands) 2002 2001 2002 2001 (as reported) (pro forma) (as reported) (pro forma) ------------- ---------- ------------- ---------- Reported net loss $(2,785) $(13,816) $(9,631) $(19,057) ------- -------- ------- -------- Add back: Goodwill amortization -- 956 -- 2,970 ------- -------- ------- -------- Adjusted net loss $(2,785) $(12,860) $(9,631) $(16,087) ======= ======== ======= ======== In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No. 4, 44, 64, Amendment of FASB Statement No. 13, and Technical Corrections. SFAS No. 145 is effective in fiscal 27 years beginning after May 15, 2002. In its Form 10-K for the year ended December 31, 2001, the Company disclosed its intent to classify the loss on the extinguishment of debt as an extraordinary item in the first quarter of 2002 based on the accounting pronouncements in effect at that time; however, as SFAS No. 145 has been issued since that time, the Company has elected to early adopt its provisions as of January 1, 2002. Accordingly, during the first quarter of 2002, the Company recorded the loss on extinguishment of debt relating to its write-off of the unamortized debt issue costs of $0.9 million as a component of interest expense instead of as an extraordinary item as previously required. 28 LIQUIDITY AND CAPITAL RESOURCES Net cash used in operating activities for the nine months ended September 30, 2002 was $6.2 million compared to net cash provided by operating activities of $1.3 million for the nine months ended September 30, 2001. This increase primarily reflects the absence of new customer advances in 2002 and an increase in working capital. Net cash provided by investing activities was $0.1 million for the nine months ended September 30, 2002 compared to $2.8 million used by investing activities in the comparable period of 2001. The change primarily relates to net proceeds of $2.6 million from the sale of assets held for sale at General Automation and Certified in 2002 and a decrease in capital expenditures. Net cash used in financing activities in the nine months ended September 30, 2002 was $3.4 million, primarily reflecting the repayment of outstanding debt and the payment of approximately $3.4 million of financing fees related to the refinancing of Precision's credit facilities completed in February 2002, offset by the proceeds from the new financing facilities. Precision's principal sources of liquidity are cash generated by its subsidiaries and available borrowings under its revolving credit facility. Precision expects that its principal liquidity requirements will continue to be working capital, capital expenditures, debt service and required lease payments. Precision's credit facilities at September 30, 2002 consisted of a $42.7 million term loan, a $5.950 million capital lease obligation and a $25.0 million revolving credit facility, each maturing on January 31, 2006. Collectively, these items comprised our senior debt. As of September 30, 2002, Precision had total debt and capital lease obligations outstanding of approximately $155.9 million, primarily consisting of the aggregate principal amount of our $100 million senior subordinated notes, the principal amount of our term loan, the principal amount of our capital lease obligations and $7.3 million of borrowings under our revolving credit facility. Our outstanding senior subordinated notes have a face value of $100 million; bear interest at a rate of 12% per annum and mature March 15, 2009. The notes are fully and unconditionally guaranteed by all of our subsidiaries on a joint and several basis. These subsidiary guarantees are unsecured and subordinated in right of payment to each subsidiary guarantor's senior debt. In the fourth quarter of 2001, we were unable to comply with certain financial covenants of our credit facilities and our master lease agreement. The lenders agreed to waive these covenant defaults through the completion of the refinancing discussed below. On February 1, 2002, Precision entered into a new credit agreement and a new master lease agreement (accounted for as a capital lease). Funding took place on February 4, 2002. A portion of the proceeds from the new credit agreement, along with available cash, were utilized to repay in full the senior debt previously outstanding and costs and expenses related to the refinancing, while the new master lease agreement was used to refinance all obligations under our previous master lease agreement (accounted for as an operating lease). The remainder of the proceeds and availability under the new credit agreement will be used as needed for working capital and other general corporate purposes. 29 The new credit agreement consists of a $44.050 million term loan that has been fully drawn and a $25.0 million revolving credit facility. The term loan amortizes over 47 months with quarterly principal payments of 2.5% of the original principal amount in each of quarters three through twelve, 5.0% in each of quarters thirteen through fifteen and 60.0% in quarter sixteen. The first principal payment was made October 1, 2002. Interest on the term loan is payable at an annual rate of LIBOR plus a margin of 5.00%, subject to a minimum interest rate of 10.00% through December 31, 2002, increasing to 11.00% through December 31, 2004 and to 12.00% thereafter. Principal payments totaling $1.380 million were made against the term loan during the first nine months of 2002 as required due to certain asset sales. The revolving credit facility matures January 1, 2006. Borrowings under this facility are limited to 85% of eligible accounts receivable and 50% of eligible inventory, each as defined in the new credit agreement, and subject to other eligibility requirements and reserves as per the new credit agreement. In certain instances, borrowings under the revolving credit facility can be further restricted due to limitations on Permitted Indebtedness as defined in the indenture related to our senior subordinated notes. Interest on the revolving credit facility is payable at an annual rate of either LIBOR plus a margin of 3.25% or the lender's index rate plus a margin of 1.75%, at Precision's option. There is also an unused facility fee payable at an annual rate of 0.50% on any unused portion of the revolving credit facility. As of November 8, 2002, $15.3 million of undrawn capacity was available for borrowing under the revolving credit facility. The new master lease agreement has a principal balance of $5.950 million and amortizes over 47 months with principal and interest payable as described above for the new term loan. This lease is being accounted for as a capital lease. If Precision's Consolidated Senior Leverage Ratio (as defined in the new credit agreement) exceeds 3.0x for the quarter ending September 30, 2002; 2.5x for the quarters ending December 31, 2002 or March 31, 2003; or 2.25x for any quarter thereafter, then Precision's borrowing rate will increase 200 basis points on an in-kind basis over the otherwise applicable annual rate on the term loan, capital lease obligation and the revolving credit facility. Such in-kind amounts would be payable at the maturity date of the new credit agreement, so long as Precision is not otherwise in default. As of September 30, 2002, based on the Company's calculations, no such change in the Company's borrowing rates is required. Due to the impact of difficult conditions in the power generation industry on Mid State, the borrowing rates may increase in future periods in accordance with certain provisions of the Company's credit facilities mentioned above. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Outlook". If Precision has a continuing Event of Default, as defined in the new credit agreement, our borrowing rate will increase 200 basis points over the otherwise applicable annual rates under both the new credit and master lease agreements. The lenders have the right to syndicate the revolving credit facility. If the lenders determine that they are unable to syndicate the revolving credit facility under its agreed upon terms, they have the right to adjust the pricing and structure of the revolving credit facility whether or not it is eventually syndicated to a third party or held by one or both of the current lenders. Pricing changes of up to 300 basis points on inventory advances and up to 100 basis points on other advances are permitted. Changes to the structure could include, without limitation, adjusting advance rates, eligibility requirements and reserve requirements, going from a consolidated borrowing base to individual company borrowing bases and/or reducing the term of each of the credit facilities to three years. 30 The lenders have a fully perfected first priority security interest in substantially all existing and after-acquired assets of Precision and its subsidiaries (other than intercompany debt). Precision and each of its principal subsidiaries are borrowers under the new credit agreement and each borrower guarantees the obligations of every other borrower. Precision's immediate parent, Precision Partners Holding Company, also guarantees the new credit agreement. Precision is subject to certain financial ratio covenants under the new credit and master lease agreements including, but not limited to, maximum Consolidated Senior Leverage Ratio, minimum Consolidated Senior Interest Coverage Ratio, minimum Consolidated Total Interest Coverage Ratio, minimum Consolidated Fixed Charge Coverage Ratio and maximum Capital Expenditures. If adverse industry conditions in the power generation markets continue as expected, the Company may not be able to comply with the terms and conditions of its credit agreements in future periods. The Company is assessing various alternatives such as asset sales, additional limitations on capital expenditures and reductions of operating expenses to improve its ability to comply with the terms and conditions of its credit agreements. There are mandatory repayment obligations related to certain asset dispositions, sales of equity and a portion of any excess cash flow, as defined. Under certain circumstances, prepayments on the term loan require prepayment premiums of 3.0%, 1.5%, 1.0% and 0.5% of the amounts prepaid in the first, second, third and fourth years, respectively. Costs and expenses related to the refinancing totaled $4.5 million and were capitalized and will be amortized over the life of the related agreements. In accordance with the Company's early adoption of SFAS No. 145, Rescission of FASB Statements No. 4, 44, 64, Amendment of FASB Statement No. 13, and Technical Corrections, the remaining unamortized debt issue costs relating to the obligations repaid via the refinancing have been written off as a component of interest expense in the first quarter of 2002. Such write-off totaled $0.9 million. Unamortized deferred lease costs totaling $0.1 million related to the old master lease agreement was written off through cost of sales in the first quarter of 2002. The indenture related to the senior subordinated notes and our other financing agreements as discussed above impose limitations on Precision's ability to, among other things, incur indebtedness (including capital leases), incur liens, pay dividends or make other restricted payments, consummate certain asset sales, enter into transactions with affiliates, issue preferred stock, merge or consolidate with any other person or sell, assign, transfer, lease, convey or otherwise dispose of all or substantially all of Precision's assets. In addition, the financing agreements limit our ability to enter into leases or sale and leaseback transactions, to make capital expenditures and to make acquisitions. Precision's amortization requirements are limited to the new term loan and capital lease obligations under the new master lease agreement. Our significant contractual obligations from September 30, 2002 are as follows (in thousands):

31 Precision's other debt service requirements over the next two years consist primarily of interest expense on its outstanding debt and capital lease obligations. Any amounts then outstanding under the new revolving credit agreement are due in 2006. Our other short-term cash needs are expected to consist primarily of working capital requirements and capital expenditures to maintain and expand Precision's manufacturing capabilities. Precision currently expects that its capital expenditures will be approximately $4.0 million in 2002, depending on the determination of whether to proceed with certain projects under consideration. These amounts exclude the assets related to the capital lease entered into as discussed above. However, Precision's capital expenditures will be affected by, and may be greater or less than currently anticipated depending upon, among other things, the size and nature of new business opportunities and bank credit limitations. The terms of the new credit agreement limit capital expenditures in 2002 to $5.0 million, the amounts incurred under the capital lease agreement noted above plus amounts for certain capital expenditure commitments entered into prior to 2002. Precision's ability to fund its operations and to meet its anticipated requirements for working capital, capital expenditures, scheduled lease payments, and scheduled debt service over the next 12 months is dependent on its continued ability to comply with its financial covenants and to borrow under its revolving credit facility. If adverse industry conditions in the power generation markets continue as expected, the Company may not be able to comply with the terms and conditions of its credit agreements in future periods. The Company is assessing various alternatives such as asset sales, additional limitations on capital expenditures and reductions of operating expenses to improve its ability to comply with the terms and conditions of its credit agreements. In addition, Precision's ability to repay outstanding debt at maturity may depend on the availability of refinancing. At November 8, 2002, Precision had $4.7 million outstanding under its new revolving credit facility. Total unused availability at that date is approximately $15.3 million based on the borrowing base formula in the agreement and considering the limits on Permitted Indebtedness as defined and contained in the indenture related to our senior subordinated notes. INFLATION We do not believe that inflation has had a significant impact on our cost of operations. OTHER CONSIDERATIONS PRECISION'S SUBSTANTIAL DEBT AND THE SIGNIFICANT DEMANDS ON ITS CASH RESOURCES COULD AFFECT ITS ABILITY TO MAKE PAYMENTS ON ITS OUTSTANDING DEBT AND ACHIEVE ITS BUSINESS PLAN. Substantial Debt. Precision has incurred a substantial amount of indebtedness that requires significant interest payments. As of September 30, 2002, Precision had total consolidated debt of $155.9 million and net interest expense of approximately $4.9 million and $15.2 million for the three and nine months then ended, respectively. Precision refinanced its senior debt and master lease agreement on February 4, 2002. Subject to the limits contained in the indenture governing Precision's outstanding senior subordinated notes, the new credit and master lease agreements, Precision and its subsidiaries may incur additional indebtedness from time to time to finance capital expenditures, investments or for other general corporate purposes. As of November 8, 2002, $4.7 million was outstanding under the revolving credit facility. 32 Demands on Cash Resources. Precision has substantial demands on its cash resources in addition to operating expenses and interest expense on the senior subordinated notes, including, among others, interest and amortization payments under its new credit and master lease agreements. See "Liquidity and Capital Resources" above. Effects on Precision's Business Strategy. Precision's level of indebtedness and the corresponding demands on its cash resources could have important effects on Precision's business. For example, these demands could, among other things: o make it more difficult for Precision to satisfy its debt service obligations with respect to the senior subordinated notes and its secured indebtedness under its new credit and master lease agreements; o require Precision to dedicate a substantial portion of its cash flow from operations to debt service, thereby reducing the amount of its cash flow available for working capital, capital expenditures, acquisitions and other general corporate purposes; o limit Precision's flexibility in planning for, or reacting to, changes in its industry (including the pursuit of its growth strategy); o place Precision at a competitive disadvantage compared to its competitors that have fewer debts and significantly greater operating and financing flexibility than Precision does; o limit, along with the financial and other restrictive covenants applicable to Precision's indebtedness, among other things, its ability to borrow additional funds even when necessary to maintain adequate liquidity; and o increase Precision's vulnerability to general adverse economic and industry conditions. Precision's ability to pay interest on its long-term indebtedness and to satisfy its other debt obligations will depend upon its future operating performance and may depend upon the availability of refinancing indebtedness, which will be affected by the instruments governing its indebtedness, including the indenture, the credit facilities and the master lease, prevailing economic conditions and financial, business and other factors, certain of which are beyond its control. If Precision is unable to service its indebtedness and fund its business, it may be forced to change its strategy. Such change may include: o further reducing or delaying capital expenditures; o seeking additional debt financing or equity capital; o further asset sales; or o restructuring or refinancing its indebtedness. There can be no assurance that any such strategy could be affected on terms satisfactory to Precision or at all. Effect of Additional Debt. Subject to and within the limits of Precision's debt instruments and the master lease, Precision may incur additional indebtedness from time to time to finance capital expenditures, investments and operations or for other purposes, including the borrowing of amounts repaid under its credit facilities. This could further exacerbate the risks described below. PRECISION'S DEBT INSTRUMENTS AND AGREEMENTS RESTRICT ITS ABILITY AND THE ABILITY OF ITS SUBSIDIARIES TO ENGAGE IN SOME BUSINESS TRANSACTIONS. 33 Indenture. The indenture governing Precision's outstanding senior subordinated notes restricts our ability and the ability of some of our subsidiaries to, among other things: o incur additional debt; o pay dividends on or redeem or repurchase capital stock; o issue or allow any person to own preferred stock of subsidiaries; o incur or permit to exist indebtedness senior to the senior subordinated notes, but subordinated to any of its other indebtedness; o in the case of non-guarantor subsidiaries, guarantee debt without also guaranteeing the Notes; o in the case of restricted subsidiaries, create or permit to exist dividend or payment restrictions with respect to Precision; o make investments; o incur or permit to exist liens; o enter into transactions with affiliates; o merge, consolidate or amalgamate with another company; and o transfer or sell assets. Credit Facilities and Master Lease. Precision's credit facilities, and the master lease also contain similar covenants, as well as a restriction on acquisitions and a number of financial covenants requiring Precision to meet financial ratios and financial condition tests. If adverse industry conditions in the power generation markets continue as expected, the Company may not be able to comply with the terms and conditions of its credit agreements in future periods. The Company is assessing various alternatives such as asset sales, additional limitations on capital expenditures and reductions of operating expenses to improve its ability to comply with the terms and conditions of its credit agreements. Precision's ability to borrow under its revolving credit facility depends upon satisfaction of these covenants and borrowing base requirements. Precision's ability to meet these covenants and requirements can be affected by events beyond its control. There can be no assurance that Precision will meet these requirements. Effect of Future Breach. Precision's failure to comply with the obligations and covenants in the credit facilities, the master lease or the indenture could result in an event of default under one or more of those agreements that, if not cured or waived, could terminate its ability to borrow under the revolving credit facility, could preclude its ability to make scheduled payments on the relevant debt or other debt instruments, could permit acceleration of the relevant debt and acceleration of debt under other instruments and could permit foreclosure on any collateral granted. PRECISION IS STRUCTURED AS A HOLDING COMPANY AND IT DEPENDS ON ITS SUBSIDIARIES IN ORDER TO SERVICE ITS DEBT. Precision is structured as a holding company. Precision's only significant asset is the capital stock or other equity interests of Precision's operating subsidiaries. As a holding company, Precision conducts all of its business through its subsidiaries. Consequently, Precision's cash flow and ability to service its debt obligations are dependent upon the earnings of Precision's operating subsidiaries and the distribution of those earnings to Precision, or upon loans, advances or other payments made by these subsidiaries to Precision. The ability of Precision's subsidiaries to pay dividends or make other payments or advances to Precision will depend upon their operating 34 results and will be subject to applicable laws and contractual restrictions contained in the instruments governing their indebtedness, including Precision's credit facilities and the indenture. Although the indenture limits the ability of these subsidiaries to enter into consensual restrictions on their ability to pay dividends and make other payments to Precision, these limitations are subject to a number of significant qualifications. There can be no assurance that the earnings of Precision's operating subsidiaries will be adequate for Precision to service its debt obligations. PRECISION'S SUCCESS DEPENDS ON ITS ABILITY TO SUCCESSFULLY OPERATE ITS SUBSIDIARIES ON A COMBINED BASIS. Precision's operating subsidiaries operate independently of one another and there can be no assurance that Precision will be able to effectively manage these operating companies on a combined basis. In addition, to the extent management time may be diverted to any one or more of the companies, the other operating companies may be adversely affected. A failure by Precision to operate these businesses profitably or to manage them effectively on a combined basis could have a material adverse effect on its results of operations and financial condition. Although Precision performs a due diligence investigation of each business that it acquires, there may be liabilities of acquired companies, including those previously acquired and those that may be acquired in the future, that Precision fails or is unable to discover during its due diligence investigation and for which it, as a successor owner, may be responsible. In connection with acquisitions, Precision generally seeks to minimize the impact of these liabilities by obtaining indemnities and warranties from the seller that may be supported by deferring payment of a portion of the purchase price. However, these indemnities and warranties, if obtained, may not fully cover the liabilities due to their limited scope, amount, or duration, the financial limitations of the indemnitor or warrantor, or other reasons. THE SUCCESS OF PRECISION'S BUSINESS STRATEGY TO REALIZE A NUMBER OF CROSS SELLING OPPORTUNITIES COULD BE AFFECTED BY A NUMBER OF FACTORS BEYOND ITS CONTROL. As part of its business strategy, Precision intends to pursue and capitalize on a number of cross-selling opportunities it believes exist as a result of the complementary customer bases and manufacturing capabilities of its companies and to implement certain operating improvements. Precision's ability to implement and realize the benefits of this strategy could be affected by a number of factors beyond its control, such as operating difficulties, increased operating costs, regulatory developments, general economic conditions, increased competition, or the inability to obtain adequate financing for Precision's operations on suitable terms. In addition, Precision may decide to alter or discontinue certain aspects of this strategy. Any failure to implement aspects of Precision's strategy may adversely affect its results of operations, financial condition and ability to service debt. PRECISION'S INABILITY TO ACCESS ADDITIONAL CAPITAL COULD HAVE A NEGATIVE IMPACT ON ITS GROWTH STRATEGY. Precision's current business strategy will require additional capital investment. Capital will be required for, among other purposes, managing acquired companies, acquiring new equipment, maintaining the condition of Precision's existing equipment and completing new acquisitions. To the extent that cash generated internally and cash available, or permitted to be expended, under Precision's credit facilities is not sufficient to fund capital requirements, Precision will require additional debt and/or equity financing. There can be no assurance, however, that such 35 financing will be available or, if available, will be permitted under our current financing agreements or available on terms satisfactory to Precision. Future debt financing, if available, may result in increased interest and amortization expense, increased leverage and decreased income available to fund further acquisitions and expansion, and may limit Precision's ability to withstand competitive pressures and render it more vulnerable to economic downturns. If Precision fails to obtain sufficient additional capital in the future, it could be forced to curtail its growth strategy by reducing or delaying capital expenditures and acquisitions, selling assets or restructuring or refinancing its indebtedness. A LOSS OF KEY EMPLOYEES AND HIGHLY SKILLED WORKERS COULD ADVERSELY AFFECT PRECISION'S BUSINESS. Some of Precision's executive officers are key to Precision's management and direction. Precision's future success will depend on its ability to retain and/or attract capable management. Although Precision believes it will be able to attract and retain talented personnel and that it could replace key management personnel should the need arise, the inability to attract or retain such personnel could have a material adverse effect on its business. In addition, because its products and processes are complex and require a high level of precision, Precision is generally dependent on an educated and trained workforce. Precision would be adversely affected by a shortage of skilled employees. FAILURE TO MAINTAIN RELATIONSHIPS WITH PRECISION'S LARGER CUSTOMERS AND FAILURE BY PRECISION'S CUSTOMERS TO CONTINUE TO PURCHASE SUFFICIENT QUANTITIES DUE TO CHANGES IN MARKET CONDITIONS COULD HAVE AN ADVERSE EFFECT ON ITS OPERATIONS. Precision's largest customer, General Electric Power Systems, accounted for approximately 32% of net sales for the nine months ended September 30, 2002, and its top ten customers accounted for approximately 83% of its sales during the same period. The termination by General Electric Power Systems or any one or more of Precision's other top 10 customers of their relationship with Precision or their failure to purchase sufficient quantities from Precision could have a material adverse effect upon Precision's business, financial condition and results of operations. PRECISION'S REVENUES AND OPERATING RESULTS MAY BE SUBJECT TO SIGNIFICANT FLUCTUATION. A significant portion of Precision's revenues is derived from new projects and contracts, the timing of which is subject to a variety of factors beyond Precision's control, including customer budgets and modifications in customer products. Precision cannot predict the degree to which these trends will continue. A portion of Precision's operating expenses is relatively fixed. Cancellations, reductions or delays in orders by a customer or group of customers could have a material adverse effect on our business, financial condition or results of operations. Additionally, Precision may periodically incur cost increases due to hiring and training of new employees in anticipation of future growth. The size, timing and integration of possible future acquisitions may also cause substantial fluctuations in operating results from quarter to quarter. As a result, operating results for any fiscal quarter may not be indicative of the results that may be achieved for any subsequent fiscal quarter or for a full fiscal year. SIGNIFICANT COMPETITION FOR PRECISION PART MANUFACTURING OUTSOURCED BY ORIGINAL EQUIPMENT MANUFACTURERS MAY AFFECT PRECISION'S ABILITY TO SUCCEED. 36 Precision operates in an industry that is highly fragmented and competitive. A variety of suppliers with different subsets of Precision's manufacturing capabilities compete to supply the stringent demands of large original equipment manufacturers. In addition, Precision's customers are continually seeking to consolidate their business among one or more "Preferred" or "Qualified" suppliers. There can be no assurance that Precision will be able to successfully implement new production programs to supply products to original equipment manufacturers. If any customer becomes dissatisfied with Precision's prices, quality or timeliness of delivery, or perceives risks to our ability to comply with their requirements or execute in the future, among other things, it could award future business or move existing business to our competitors. There can be no assurance that Precision's products will continue to compete successfully with the products of its competitors, including original equipment manufacturers themselves, many of which are significantly larger and have greater financial and other resources than Precision does. THE CYCLICAL NATURE OF THE INDUSTRIES PRECISION CURRENTLY SERVES COULD HAVE A MATERIAL ADVERSE EFFECT ON ITS BUSINESS. A majority of Precision's revenues are derived from customers that are in industries and businesses that are cyclical in nature and subject to change in general economic conditions, such as the power generation, construction, aerospace and automotive industries. General economic or industry specific downturns could have a material adverse effect on Precision and its business, results of operations and financial condition. PRECISION'S BUSINESS COULD BE ADVERSELY AFFECTED IF IT IS UNABLE TO OBTAIN RAW MATERIALS AND COMPONENTS FROM ITS SUPPLIERS ON FAVORABLE TERMS. Generally, Precision's major raw materials consist of traditional materials such as steel, aluminum, iron, copper, magnesium and bronze, as well as exotic and difficult to machine materials such as titanium, inconel and invar. A portion of its raw materials is supplied by its customers on consignment. Raw materials not supplied by its customers are purchased from several suppliers. Although all of these materials have been available in adequate quantities to meet its production demands in the past, Precision can give you no assurance that such materials will be available in adequate quantities in the future. Precision does not presently anticipate any raw material shortages that would significantly affect production. However, the lead times between the placement of orders for certain raw materials and actual delivery to Precision may vary significantly and Precision may from time to time be required to order raw materials in quantities and at prices less than optimal to compensate for the variability of lead times of delivery. Precision's business could be adversely affected if Precision is unable to obtain raw materials and components from suppliers on favorable terms. PRECISION'S BUSINESS COULD BE ADVERSELY AFFECTED TO THE EXTENT THE U.S. GOVERNMENT TERMINATED OR MODIFIED A CONTRACT WITH PRECISION OR ONE OF ITS CUSTOMERS. Precision is generally not a direct party to any contracts with the U.S. government. However, a portion of its sales are to customers who use the parts, assemblies or tooling that Precision supplies to them to fill orders under U.S. government contracts to which they are a party. U.S. government contracts have significant inherent risks, including: o the ability of the U.S. government to terminate a contract for convenience, in which case the other party could be limited to receiving only costs already incurred or committed; 37 o modification of U.S. government contracts due to lack of Congressional funding or changes in such funds; and o an extensive and complex regulatory structure, which could subject the other party to contract termination, civil and criminal penalties and in some cases, suspension or disbarment from future U.S. government contracts. To the extent the U.S. government terminates or modifies a contract with one of Precision's customers, Precision could be adversely affected if the affected customer reduced its purchases from Precision as a result. In addition, in the few instances where Precision is a direct party to a U.S. government contract, the inherent risks described above, as well as risks associated with the competitive bidding atmosphere under which U.S. government contracts are awarded and unreimbursed cost overruns in fixed-price contracts, could have a material adverse effect on its results of operations and financial condition. PRECISION'S EQUIPMENT, FACILITIES AND OPERATIONS ARE SUBJECT TO NUMEROUS ENVIRONMENTAL AND OTHER GOVERNMENT REGULATIONS THAT MAY BECOME MORE STRINGENT IN THE FUTURE AND MAY RESULT IN INCREASED LIABILITY AND INCREASED CAPITAL EXPENDITURES. Precision's equipment, facilities and operations are subject to increasingly complex and stringent federal, state and local laws and regulations pertaining to protection of human health and the environment. These include, among other things, the discharge of contaminants into the environment and the handling and disposition of wastes (including industrial, solid and hazardous wastes). In addition, Precision is required to obtain and maintain regulatory approvals in the United States in connection with its operations. Many environmental laws and regulations provide for substantial fines and criminal sanctions for violations. It is difficult to predict the future development of such laws and regulations or their impact on future earnings and operations, but Precision anticipates that these laws and regulations will continue to require increased capital expenditures because environmental standards will become more stringent. Precision cannot assure you that material costs or liabilities will not be incurred. Certain environmental laws provide for strict, joint and several liability for investigation and remediation of spills and other releases of hazardous materials. These laws typically impose liability whether or not the owner or operator knew of, or was responsible for, the presence of any hazardous materials. Persons who "arrange", as defined under these laws, for the disposal or treatment of hazardous materials also may be liable for the costs of investigation, removal or remediation of such materials at the disposal or treatment site, regardless of whether the affected site is owned or operated by them. Such liability is strict, and may be joint and several. Because Precision operates a number of facilities, and because it arranges for the disposal of hazardous materials at many disposal sites, it may incur costs for investigation, removal and remediation, as well as capital costs associated with compliance with environmental laws and regulations. Although such environmental costs have not been material in the past and are not expected to be material in the future, changes in environmental laws and regulations or unexpected investigations and clean-up costs could have a material adverse effect on Precision's business, financial condition or results of operations. 38 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISK Precision's term loan and capital lease program, as refinanced in February 2002, provide for interest to be charged at LIBOR plus a margin of 5%, subject to a minimum interest rate of 10.00% through December 31, 2002, increasing to 11.00% through December 31, 2004 and to 12.00% thereafter. Because LIBOR plus a margin of 5% is significantly below the floor of 10% currently in effect on the term loan and capital lease arrangement, a 100 basis point change in LIBOR would not currently have an impact on interest expense. However, should LIBOR increase to a point where LIBOR plus the 5% margin equaled or exceeded 10%, based on Precision's level of outstanding borrowings from its term loan and obligations under the capital lease arrangement at November 8, 2002, a 100 basis point increase in interest rate would result in a $0.5 million annual increase in interest expense. Precision's revolving line of credit provides for interest to be charged at either the LIBOR rate or a base rate plus, in each case, a margin determined in accordance with the credit agreement. Based on Precision's level of outstanding borrowings under its revolving line of credit as of November 8, 2002, a 100 basis point change in interest rates would result in less than a $0.1 million annual change in interest expense. If Precision is unable to meet the quarterly Senior Leverage Ratio threshold as described in Note 6 to the financial statements and in "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources", its borrowing rates would increase by 200 basis points on an in-kind basis over the otherwise applicable annual rate on its term loan, capital lease obligations and revolving line of credit. Based on Precision's level of outstanding borrowings under these agreements at November 8, 2002, a 200 basis points increase in the Company's borrowing rates would result in $1.0 million annual change in interest expense. Cash payments on this 200 basis point increase would be due at the maturity of the credit agreement so long as Precision is not otherwise in default. Further, if Precision's lenders are unable to syndicate the revolving credit facility, the lenders have the right to make certain revisions to the terms (See Note 6 to the financial statements and in "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources") including increases in interest rates on borrowings under the revolving credit facility. If this were to occur, management estimates that the increase in annual interest expense, based on borrowings outstanding at November 8, 2002, would be less than $0.1 million. The remainder of Precision's debt is at fixed interest rates. Our senior subordinated notes have a carrying value of $100 million, but we believe that the fair value of the senior subordinated notes is substantially below the carrying value. Because the notes are held by a limited number of institutional investors and are not actively traded among those investors or the general public, we are unable to accurately determine the current fair value of the notes. Precision does not own nor is it obligated for other significant debt or equity securities that would be affected by fluctuations in market risk, and our exposure to foreign currency exchange rate risk and commodity price risk is not significant. 39 ITEM 4. CONTROLS AND PROCEDURES An evaluation was performed under the supervision and with the participation of the Company's management, including the CEO and CFO, of the effectiveness of the design and operation of the Company's disclosure controls and procedures within 90 days of the filing date of this quarterly report. Based on their evaluation, the Company's management, including the CEO and CFO, concluded that the Company's disclosure controls and procedures are effective. There have been no significant changes in the Company's internal controls or in other factors that could significantly affect internal controls subsequent to the date of their evaluation. 40 PART II: OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS Not applicable. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS Not applicable. ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not applicable. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. ITEM 5. OTHER INFORMATION Not applicable. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (A) EXHIBITS 99.1 Certification pursuant to 18 U.S.C. Section 1350 Adopted pursuant to Section 906 of the Sarbanes - Oxley Act of 2002 99.2 Certification pursuant to 18 U.S.C. Section 1350 Adopted pursuant to Section 906 of the Sarbanes - Oxley Act of 2002 (B) REPORTS ON FORM 8-K None. 41 PRECISION PARTNERS, INC. SIGNATURE 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. PRECISION PARTNERS, INC. Dated: November 14, 2002 By: /s/ Frank R. Reilly ------------------------------------ Frank R. Reilly Executive Vice President and Chief Financial Officer 42 CERTIFICATION PURSUANT TO RULE 13A-14 OR 15-D14 OF THE SECURITIES EXCHANGE ACT OF 1934, ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, John G. Raos, certify that to my knowledge: 1. I have reviewed this quarterly report on Form 10-Q of Precision Partners, Inc.; 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 officer 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 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 officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a. all significant deficiencies 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 officer and I have indicated in this quarterly report whether 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. /s/ John G. Raos ----------------------- John G. Raos Chief Executive Officer November 14, 2002 43 CERTIFICATION PURSUANT TO RULE 13A-14 OR 15-D14 OF THE SECURITIES EXCHANGE ACT OF 1934, ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Frank R. Reilly, certify that to my knowledge: 1. I have reviewed this quarterly report on Form 10-Q of Precision Partners, Inc.; 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 officer 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 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 officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a. all significant deficiencies 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 officer and I have indicated in this quarterly report whether 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. /s/ Frank R. Reilly ----------------------- Frank R. Reilly Chief Financial Officer November 14, 2002 44

PRECISION PARTNERS INC 10-Q