10-Q 1 d13526.txt 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 28, 2003 ------------------ OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to --------------- --------------- Commission file number 0 -19703 -------- Farrel Corporation ------------------------------------------------------ (Exact name of registrant as specified in its charter) Delaware 22-2689245 -------- ---------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 25 Main Street, Ansonia, Connecticut, 06401 ------------------------------------------- (Address of principal executive offices) (Zip Code) (203) 736-5500 -------------- (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ---- ----- Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes No X ---- --- APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. CLASS OUTSTANDING AT November 7, 2003 -------------------------------------------------------------------------------- Common Stock (Voting), $.01 par value 5,235,128 --------- Farrel Corporation Index

2 Part I - Financial Information FARREL CORPORATION CONSOLIDATED BALANCE SHEETS (In thousands, except share data)

See Accompanying Notes to Consolidated Financial Statements 3 FARREL CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share and share data)

See Accompanying Notes to Consolidated Financial Statements 4 FARREL CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)

See Accompanying Notes to Consolidated Financial Statements 5 Farrel Corporation Notes to Consolidated Financial Statements (Unaudited) Note 1 - Basis of Presentation In the opinion of management, the accompanying unaudited 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 accounting principles generally accepted in the U.S. for complete financial statements. In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments, consisting only of normal recurring adjustments, necessary to present fairly in accordance with accounting principles generally accepted in the U.S., the consolidated financial position of Farrel Corporation ("Farrel" or "the Company") as of September 28, 2003, and the consolidated results of its operations and its cash flows for the three and/or nine month periods ended September 28, 2003 and September 29, 2002. These results are not necessarily indicative of results to be expected for the full fiscal year. These statements should be read in conjunction with the financial statements and notes thereto, included in the Company's Annual Report and Form 10-K for the year ended December 31, 2002. Note 2 - Stock Options The Company accounts for stock options under Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and not the fair value method as provided by Statement of Financial Accounting Standard No. 123 ("Statement No. 123"), Accounting and Disclosure of Stock-Based Compensation. The Company's Stock Option Plan requires options to be granted at the market price of the Company's common stock on the date the options are granted, and as a result, under APB 25 no compensation expense is recognized. Pro forma information regarding net income (loss) and earnings (loss) per share is required by Statement No. 123, and has been determined as if the Company had accounted for its employee stock options under the fair value method of Statement No. 123. The fair value for these options was estimated at the date of grant using the Black-Scholes option pricing model, one of the allowable valuation models under Statement No. 123. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options vesting period. The current pro forma net loss will not necessarily be representative of pro forma net income (loss) in future years. The Company's pro forma information is as follows:

6 Note 3 - Inventory Inventory is comprised of the following:

Note 4 - Comprehensive Income (Loss) The components of other comprehensive income (loss) are as follows:

Accumulated other comprehensive income (loss) consists of the following:

Note 5 - Segment Information The Company's operations are considered one operating segment. The Company's products consist of new machines, aftermarket and spare parts and repair related services. The Company's products and services are sold to commercial manufacturers in the plastic and rubber industries. The manufacturing, assembly and distribution of each of the Company's products are essentially the same. Note 6 - Impact of Recently Issued Accounting Pronouncements In June 2001, the Financial Accounting Standards Board issued Statements No. 142 (Goodwill and Other Intangible Assets) and No. 143 (Accounting for Asset Retirement Obligations). Statement No. 142 was adopted by the Company in January 2002 and Statement No. 143 was adopted by the Company in January 2003. Statement No. 142 changes the accounting for other intangible assets, such that those assets whose life is determined to be indefinite are not subject to amortization. These assets and goodwill shall be tested for impairment at least annually, and the value will need to be written down if the fair value is less than the carrying value. Statement No. 143 requires that a liability must be recognized for an asset retirement obligation related to long lived tangible assets. The liability shall be recorded at fair value. The adoption of Statements No. 142 and No. 143 did not have a significant effect on the Company's financial position or results of operations. In August 2001, the Financial Accounting Standards Board issued Statement No. 144 (Accounting for the Impairment or Disposals of Long-lived Assets). Statement No. 144 was adopted by the Company in January 2002. This statement requires an impairment loss to be recognized if the carrying value of a long-lived asset (asset group) is not recoverable and exceeds its fair value. Long-lived 7 assets (asset group) shall be tested for impairment whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. The adoption of this statement did not have a significant effect on the Company's financial position or results of operations. In December 2002, the Financial Accounting Standards Board ("FASB") issued Statement No. 148 (Accounting for Stock-Based Compensation - Transition and Disclosures). Statement No. 148 amends the accounting for stock-based compensation by providing alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, Statement No. 148 amends the disclosure requirements to require prominent disclosures in both annual and interim financial statements of the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company adopted Statement No. 148 in December 2002. The Company does not anticipate changing to the fair value based method of accounting for stock-based compensation; therefore, the adoption only impacted disclosures. In October 2003, the FASB stated that it intends to issue an exposure draft in 2004 that would outline new accounting rules for stock based compensation which would require all companies to recognize in their income statements compensation expense related to stock options. Note 7 - Foreign Currency Contracts The Company, from time to time, enters into foreign exchange contracts for non-trading purposes, exclusively to minimize its exposure to currency fluctuations on trade receivables, firm commitments and payables. As a result, changes in the values of foreign currency contracts offset changes in the values of the underlying assets and liabilities due to changes in foreign exchange rates, effectively deferring cash gains and losses on trade receivables, firm commitments and payables and the related hedges until the date the transactions are settled in cash. The Company is exposed to loss in the event of nonperformance by the Company's bank, the other party to the foreign exchange contracts. The Company does not anticipate nonperformance by its bank. As of September 28, 2003, all of the Company's then existing foreign exchange forward contracts were designated as fair value hedges. As such, there were no charges to the statement of operations related to these contracts. At September 28, 2003, the net difference between the spot rate and the contract rate for the foreign exchange forwards was an unrealized gain of approximately $25,000. At September 28, 2003 the Company is committed to provide 1,737,000 EURO's in exchange for British Pound Sterling under forward contracts expiring thru July 2004. Note 8 - Bank Credit Arrangements The Company has a worldwide multi-currency credit facility, as amended, with a major U.S. bank, which includes a $10 million revolving credit facility for direct borrowings and letters of credit. The facility contains a sub-limit that caps the amount of direct borrowings the Company can make at $5 million. The facility contains limits on direct borrowings and issuances of letters of credit based upon stipulated percentages of accounts receivable and inventory. The revolving credit facility expires on June 15, 2004. Interest varies based upon prevailing market interest rates. The revolving credit facility requires payment to the bank of a fee equal to 0.375% per annum of the average daily unused principal under the facility. This credit facility also includes a term loan which the Company borrowed in June 2001. The term loan is repayable in monthly principal installments of (pound)38,888 (approximately $64,000) through June 2004. The term loan has an interest rate of LIBOR plus 2.7% (3.8% at September 28, 2003). In addition the Company pays a Mandatory Cost Rate fee on the outstanding balance which was approximately 2% at September 28, 2003. The proceeds of this term loan were used to repay an existing term loan. At September 28, 2003, there was $581,000 outstanding under the term loan. The credit facility contains certain restrictions on investments, borrowings and sale of assets. Dividend declarations or payments are allowed under this credit facility as long as there exists under the credit facility no Event of Default (as defined in the credit facility) or no condition which upon given notice or lapse of time or both, would become an Event of Default. The credit facility, as amended on March 25, 2003, contains covenants specifying minimum and/or maximum thresholds for operating results, selected financial ratios and backlog. The backlog covenant requires that end of month backlog will not be less than $20 million for more than two consecutive months. The Company did not achieve the backlog 8 covenant as of the end of January and February 2002; however, the bank waived the non-compliance. The Company's ability to meet the credit facility's covenants in the future may be affected by events beyond its control, including prevailing economic, financial and market conditions and there can be no assurance that the Company will achieve the required thresholds in the future. In addition to the term loan outstanding under the credit facility, the facility is primarily utilized for the issuance of letters of credit. The letters of credit are issued primarily in connection with bids on foreign orders and to back up the Company's obligations under certain foreign orders for which it receives customer progress payments. The Company has approximately $2.9 million of letters of credit posted under its credit facility on September 28, 2003. The current credit facility expires on June 15, 2004. In October the Company and its bank signed a commitment letter to extend the credit facility to June 2005 in essentially similar terms. Management anticipates that it will be able to obtain a firm extension of the existing facility or an adequate replacement credit facility upon the expiration of the current bank credit facility; however, there is no assurance that an extension or adequate replacement facility will be obtained. Assuming the Company, upon the current facility's expiration, is able to obtain a new credit facility which provides letter of credit and borrowing availability comparable to the current facility, management anticipates that the Company's cash balances, operating cash flows and such new credit facility would be adequate to fund anticipated capital commitments and working capital requirements for at least the next twelve months. Should the Company not be able to extend its current facility upon its expiration, the Company would be required on June 15, 2004, to repay any borrowings then outstanding and to replace or secure with cash any then outstanding letters of credit. As of September 28, 2003, the Company had $7.8 million of cash, a term loan of $581,000 and issuances of letters of credit of $2.9 million. Due to many factors, including prevailing economic, financial and market conditions, the Company cannot predict with certainty that it would have adequate liquidity without a credit facility. Thus, without a credit facility the possibility exists that the Company could have a shortage of working capital which could be material and could have a material adverse effect on the Company's ability to continue as a going concern. Note 9 - Warranty Obligations and Contingencies (a) Warranty Obligations: Equipment sold is generally covered by a warranty of one to three years. The Company's estimate of costs to service its warranty obligations is based on historical experience and expectations of future conditions. To the extent the Company experiences increased warranty claim activity, or increased costs in servicing those claims, its warranty accrual will increase, resulting in decreased gross profit. The change in the warranty reserve was as follows:

(b) Contingencies: The Company is a defendant in certain lawsuits arising in the ordinary course of business, primarily related to product liability claims involving machinery manufactured by the Company or its predecessors. While the outcome of lawsuits or other proceedings against the Company cannot be predicted with certainty, the Company does not expect that these matters will have a material adverse effect on the Company's financial position or results of operations. 9 Note 10 - Income Taxes The Company provides for income taxes at the statutory rates in effect in each tax jurisdiction in which income is earned or losses are generated, adjusted for permanent differences in determining income for financial reporting and income tax purposes. Approximately $348,000 of deferred tax benefits (of which $116,000 relates to the quarter ended September 28, 2003) in the nine month period ended September 28, 2003 related to the Company's U.K. operations have not been recognized since these deferred tax benefits have been deemed not to meet the accounting requirements for realization as an asset. As a result, despite having a pretax loss in the three months ended September 28, 2003, the Company has a tax provision of $79,000. The effective income tax rate was 30% for the three month period ended September 29, 2002. The effective income tax benefit rate was 7% for the nine month period ended September 28, 2003, compared to 33% for the nine month period ended September 29, 2002. The effective tax rate also varies among periods due to the change in the proportion and amount of income and losses generated in different tax jurisdictions. Note 11 - Related Party Transactions The Company has modified its arrangement with First Funding Corporation. Effective July 1, 2003, the monthly service fee paid to First Funding Corporation was reduced from $31,250 to $28,125, and for the calendar year 2004 the monthly service fee will be reduced to $10,000 a month. Note 12 - Reclassifications Certain amounts in prior year financial statements have been reclassified to conform with the current year presentation. 10 PART I - ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS Safe Harbor Statements Under Private Securities Litigation Reform Act of 1995 Certain statements contained in the Company's public documents, including this report and in particular, this "Management's Discussion and Analysis of Financial Condition and Results of Operations", may be forward looking and may be subject to a variety of risks and uncertainties. Various factors could cause actual results to differ materially from these statements. These factors include, but are not limited to, pricing pressures from competitors and/or customers; continued economic and political uncertainty in certain of the Company's markets; the Company's ability to maintain and increase gross margin levels; the Company's ability to generate positive cash flow; changes in business conditions, in general, and, in particular, in the businesses of the Company's customers and competitors; the Company's access to adequate financing at competitive rates and other factors which might be described from time to time in the Company's filings with the Securities and Exchange Commission. Results of Operations Nine Months Ended September 28, 2003 Compared To The Nine Months Ended September 29, 2002 Net sales for the nine month period ended September 28, 2003, were $35.2 million compared to $29.7 million for the nine month period ended September 29, 2002, an increase of $5.5 million. The increase is primarily a result of higher sales of new machines. The timing of the Company's sales, particularly new machines sales, is highly dependent on when an order is received, the amount of lead time from receipt of order to delivery and specific customer requirements. The Company operates in markets that are extremely competitive with cyclical demand. Many of the Company's customers and markets operate at less than full capacity and certain remain particularly competitive and are subject to local economic events. Orders received for the nine month period ended September 28, 2003, were $37.9 million compared to $40.7 million for the nine month period ended September 29, 2002. The Company's products are primarily supplied to manufacturers and represent capital commitments for new plants, expansion or modernization. In the case of major equipment orders, up to 12 months are required to complete the manufacturing process. Accordingly, revenues reported in the statement of operations may represent orders received in the current or previous periods during which time economic conditions in various geographic markets of the world impact the Company's level of order intake. Many of the Company's traditional customers and markets are operating with excess capacity thereby reducing the number of projects for plant expansion and modernization. Certain of the Company's customers are scaling back operations in the U.S. and parts of Western Europe. At the same time, customers appear to be seeking opportunities in countries where they can reduce their product costs. Typically, the Company faces a more challenging sales environment and significant price competition in such countries, which negatively impact sales and margins. The Company is experiencing increased pricing pressures from competitors in an overall smaller market. Further, the cyclical nature of industry demand and, therefore, the timing of order intake may effect the Company's quarterly results of operations. The Company's ability to maintain and increase net sales, and maintain product margins depends upon a strengthening and stability in the Company's traditional markets and its ability to control costs to compete effectively. There can be no assurance that the current level of orders will continue, that market conditions will not worsen, that the Company can compete effectively in all markets or that improvements in the Company's traditional markets will lead to increased orders for the Company's products. The level of backlog considered firm by management at September 28, 2003, was $24.4 million compared to $21.3 million at December 31, 2002, and $30.2 million at September 29, 2002. Backlog at September 28, 2003 is 19% less than backlog at September 29, 2002. Substantially all the backlog as of 11 September 28, 2003, is scheduled to be shipped within the next 12 months. Such shipments are subject to various factors, such as customer requests for changes or manufacturing delays, which could result in shipments being delayed. Gross margin for the nine month period ended September 28, 2003, was $8.1 million compared to $7.5 million for the nine month period ended September 29, 2002, an increase of $0.6 million. The increase in gross margin is primarily a result of higher sales. The gross margin as a percent of sales for the nine month period ended September 28, 2003, was 23% compared to 25% for the nine month period ended September 29, 2002. This decline is due to lower margins generated on sales of new machines and rebuild service and equipment sales. The Company has a varied portfolio of products that have different ranges of profit margins. As a result, sales mix can make the gross margin as a percent of sales vary between periods. In addition, competitive conditions that exist at the time a customer order is received impacts the margin earned by the Company. Operating expenses for the nine month period ended September 28, 2003, were $9.8 million compared to $9.0 million for the nine month period ended September 29, 2002, an increase of $0.8 million. This amount includes increased (i) selling expenses of approximately $0.4 million primarily due to higher employee compensation and related expenses and trade show expenses, and (ii) administrative expenses of $0.5 million primarily due to higher pension costs. Interest income for the nine month period ended September 28, 2003, was $43,000 compared to $83,000 for the nine month period ended September 29, 2002. Interest expense for the nine month period ended September 28, 2003, was $89,000 compared to $77,000 for the nine months ended September 29, 2002. Other income (expense), net for the nine month period ended September 28, 2003, was income of $366,000 compared to income of $196,000 for the nine month period ended September 29, 2002. Other income for the period ended September 28, 2003 includes gains on the sale of fixed assets of $363,000. Other income for the period ended September 29, 2002 includes approximately $167,000 received by the Company as a result of the demutualization of an insurance provider used by the Company. The Company provides for income taxes at the statutory rates in effect in each tax jurisdiction in which income is earned or losses are generated, adjusted for permanent differences in determining income for financial reporting and income tax purposes. The effective income tax benefit rate was 7% for the nine month period ended September 28, 2003, compared to an effective income tax benefit rate of 33% for the nine month period ended September 29, 2002. The effective tax rate varies among periods due to the change in the proportion and amount of income and losses generated in different tax jurisdictions. In addition, $348,000 of deferred tax benefits in the nine month period ended September 28, 2003 related to the Company's U.K. operations have not been recognized since these deferred tax benefits have been deemed not to meet the accounting requirements for realization as an asset. Three Months Ended September 28, 2003 Compared to The Three Months Ended September 29, 2002 Net sales for the three months ended September 28, 2003, were $11.3 million compared to $12.7 million for the three month period ended September 29, 2002, an increase of $1.4 million. The decrease is primarily a result of lower sales of rebuild services and equipment. Orders received for the three month period ended September 28, 2003, were $12.3 million compared to $11.3 million for the three month period ended September 29, 2002. The Company's sales, orders and backlog levels varied when comparing the two quarters due to market conditions and the nature of the industry in which the Company operates as more fully discussed in the results of operations for the nine month period on page 11. Gross margin for the three month period ended September 28, 2003, was $2.7 million compared to $3.4 million for the three month period ended September 29, 2002, a decrease of $0.7 million. The 12 decrease in gross margin is primarily a result of lower sales and lower margins generated on sales. The gross margin as a percent of sales for the three month period ended September 28, 2003, was 24% compared to 27% for the three month period ended September 29, 2002. The decrease in the gross margin as a percent of sales is primarily due to lower margins generated on sales of new machines and sales of repair equipment and services. The Company has a varied portfolio of products that have different ranges of profit margins. As a result, sales mix can make the gross margin as a percent of sales vary between periods. In addition, competitive conditions that exist at the time a customer order is received impacts the margin earned by the Company. Operating expenses for the three month period ended September 28, 2003, were $3.0 million compared to $3.0 million for the three month period ended September 29, 2002. The amount for 2003 includes increased administrative expenses of $0.2 million primarily due to higher pension costs partially offset by lower employee compensation and related expenses related to research and development. Interest income for the three month period ended September 28, 2003, was $12,000 compared to $27,000 for the three month period ended September 29, 2002, a decrease of $15,000. Interest expense for the three month periods ended September 28, 2003, was $26,000 compared to $24,000 for the three month period ended September 28, 2002, an increase of $2,000. Other income, net for the three month period ended September 28, 2003, was $234,000 compared to other income, net of $11,000 for the three month period ended September 29, 2002. Other income for the period ended September 28, 2003 includes a gain on the sale of property of $196,000. The Company provides for income taxes at the statutory rates in effect in each tax jurisdiction in which income is earned or losses are generated, adjusted for permanent differences in determining income for financial reporting and income tax purposes. Approximately $116,000 of deferred tax benefits in the three month period ended September 28, 2003, related to the Company's U.K. operations have not been recognized since these deferred tax benefits have been deemed not to meet the accounting requirements for realization as an asset. As a result, despite having a pretax loss in the three months ended September 28, 2003, the Company has a tax provision of $79,000.The effective income tax benefit rate was 30% for the three month period ended September 29, 2002. The effective tax rate also varies among periods due to the change in the proportion and amount of income and losses generated in different tax jurisdictions. Material Contingencies Pursuant to a settlement agreement entered into in 1995 between the Company and Black & Decker Corporation ("Black & Decker"), Black & Decker agreed to assume full responsibility for the investigation and remediation of any pre-May 12, 1986 environmental contamination at the Company's Ansonia and former Derby, Connecticut facilities, as required by the Connecticut Department of Environmental Protection ("DEP"). Black & Decker has conducted a preliminary environmental assessment of the facilities, has undertaken certain remedial actions and has proposed certain additional remedial actions. On the basis of the preliminary data now available there is no reason to believe that any activities which might be required as a result of the findings of the assessment will have a material effect upon the capital expenditures, results of operations, financial position or the competitive position of the Company. Liquidity and Capital Resources; Capital Expenditures Working capital and the working capital ratio at September 28, 2003 were $16.4 million and 2.6 to 1, respectively, compared to $17.0 million and 2.4 to 1 at December 31, 2002, respectively. During the nine months ended September 28, 2003, the Company declared a dividend of $0.05 per share that was paid on April 25, 2003 to shareholders of record as of April 11, 2003. Due to the nature of the Company's business, many sales are of a large dollar amount. Consequently, the timing of recording such sales may cause the balances in accounts receivable and/or inventory to fluctuate dramatically between quarters and may result in significant fluctuations in cash 13 provided by operations. Historically, the Company has not experienced significant problems regarding the collection of accounts receivable. The Company also generally has financed its operations with cash generated by operations, progress payments from customers and borrowings under its bank credit facilities. The Company made capital expenditures of $0.2 and $0.1 during the nine month periods ended September 28, 2003 and September 29, 2002, respectively. The Company has a worldwide multi-currency credit facility, as amended, with a major U.S. bank, which includes a $10 million revolving credit facility for direct borrowings and letters of credit. The facility contains a sub-limit that caps the amount of direct borrowings the Company can make at $5 million. The facility contains limits on direct borrowings and issuances of letters of credit based upon stipulated percentages of accounts receivable and inventory. The revolving credit facility expires on June 15, 2004. Interest varies based upon prevailing market interest rates. The revolving credit facility requires payment to the bank of a fee equal to 0.375% per annum of the average daily unused principal under the facility. This credit facility also includes a term loan which the Company borrowed in June 2001. The term loan is repayable in monthly principal installments of (pound)38,888 (approximately $64,000) through June 2004. The term loan has an interest rate of LIBOR plus 2.7% (3.8% at September 28, 2003). In addition the Company pays a Mandatory Cost Rate fee on the outstanding balance which was approximately 2% at September 28, 2003. The proceeds of this term loan were used to repay an existing term loan. At September 28, 2003, there was $581,000 outstanding under the term loan. The credit facility contains certain restrictions on investments, borrowings and sale of assets. Dividend declarations or payments are allowed under this credit facility as long as there exists under the credit facility no Event of Default (as defined in the credit facility) or no condition which upon given notice or lapse of time or both, would become an Event of Default. The credit facility, as amended on March 25, 2003, contains covenants specifying minimum and/or maximum thresholds for operating results, selected financial ratios and backlog. The backlog covenant requires that end of month backlog will not be less than $20 million for more than two consecutive months. The Company did not achieve the backlog covenant as of the end of January and February 2002; however, the bank waived the non-compliance. The Company's ability to meet the credit facility's covenants in the future may be affected by events beyond its control, including prevailing economic, financial and market conditions and there can be no assurance that the Company will achieve the required thresholds in the future. In addition to the term loan outstanding under the credit facility, the facility is primarily utilized for the issuance of letters of credit. The letters of credit are issued primarily in connection with bids on foreign orders and to back up the Company's obligations under certain foreign orders for which it receives customer progress payments. The Company has approximately $2.9 million of letters of credit posted under its credit facility on September 28, 2003. The current credit facility expires on June 15, 2004. In October the Company and its bank signed a commitment letter to extend the credit facility to June 2005 in essentially similar terms. Management anticipates that it will be able to obtain a firm extension of the existing facility or an adequate replacement credit facility upon the expiration of the current bank credit facility; however, there is no assurance that an extension or adequate replacement facility will be obtained. Assuming the Company, upon the current facilities expiration, is able to obtain a new credit facility which provides letter of credit and borrowing availability comparable to the current facility, management anticipates that the Company's cash balances, operating cash flows and such new credit facility would be adequate to fund anticipated capital commitments and working capital requirements for at least the next twelve months. Should the Company not be able to extend its current facility upon its expiration, the Company would be required on June 15, 2004, to repay any borrowings then outstanding and to replace or secure with cash any then outstanding letters of credit. As of September 28, 2003, the Company had $7.8 million of cash, a term loan of $581,000 and issuances of letters of credit of $2.9 million. Due to many factors, including prevailing economic, financial and market conditions, the Company cannot predict with certainty that it would have adequate liquidity without a credit facility. Thus, without a credit facility the possibility exists that the Company could have a shortage of working capital, which could be material and could have a material adverse effect on the Company's ability to continue as a going concern. 14 In fiscal 2000, new minimum funding guidelines for pension plans became effective in the U.K. which are significantly different than the prior guidelines. Based upon the new guidelines the Company is required to make significant cash contributions to the Company's U.K. pension plan. Prior to 2000, the Company was not required to make substantial contributions to the U.K. pension plans. In fiscal 2002, 2001 and 2000, the Company contributed approximately $723,000, $799,000 and $946,000, respectively, to the U.K. pension plan. For the years ended December 31, 2002, 2001 and 2000, the assets of the plan generated a negative return (lost value) of $2.2 million, $2.4 million and $0.6 million, respectively. The majority of 2002 loss was incurred in June 2002 as a result of the decline in the stock market. As described in the Financial Position section that follows, these losses have contributed to a substantial reduction in the Company's stockholders' equity. At September 28, 2003, total assets in the plan were approximately $22 million, which significantly exceed the historical benefits paid for the past few years. The trustees of the plan moved the plan assets out of equities in July 2002. After reviewing the long-term investment strategy of the plan, the trustees began investing a portion of the assets in equities in May 2003. As of September 28, 2003, the assets of the plan consisted of corporate and government bonds, equities and cash. In addition, in January 2002, the U.K. subsidiary officially informed the plan trustees that effective the end of the first quarter of 2002, the U.K. employees would no longer accrue additional benefits under this pension plan for future service. Beginning in 2002, the U.K. subsidiary, as required under U.K. law, offered a defined contribution plan to its employees. In July 2002, the Company, the plan trustees and the plan's actuary began discussing the appropriate means of ensuring the long term funding of the plan, including among other things an assessment of the U.K. subsidiary's business prospects and cash position, the securitization of the U.K. subsidiary's assets, a parent company guarantee, increasing contributions to the plan, or other assurances, in order to avoid a determination by the actuary that the trustees should wind up the plan. Under the rules of the plan, the trustees are to wind up the plan if they receive actuarial advice that the actual and expected Company contributions are so low as to prejudice seriously the long-term financial position of the plan. On a wind up basis the amount of underfunding of the plan is computed differently than, and would be substantially greater than, the amount reflected in the financial statements. Additionally, on a wind up basis, the underfunding must be paid down within a short time period. In February 2003, the Company, the plan trustees and the plan's actuary agreed upon an increased contribution schedule which provides for the Company to contribute (pound)50,600 (approximately $83,000) a month to the plan plus the costs of administering the plan, which are estimated to be $100,000 annually. The contribution schedule was based on an April 2002 actuarial computation and must be reviewed for adequacy by the actuary at least annually or, if deemed necessary by the actuary, on a more periodic basis. Financial Position The Accumulated Other Comprehensive Loss section of stockholders' equity reflects a cumulative charge of $12 million related to the Company's pension plans. This cumulative charge was required in order to reflect a minimum pension liability on the balance sheet for the pension plans. Of this amount, $11 million relates to the Company's U.K. pension plan. The U.K. plan experienced a significant decline in the value of its assets during 2002 and 2001. In addition, in December 2002, revised mortality tables were used in the determination of the pension liability for accounting in order to reflect updated mortality data. The change in the mortality tables along with the declines in the value of the pension assets, were the primary reasons for the cumulative charge to stockholders' equity for the U.K. plan. Impact of Recently Issued Accounting Standards In June 2001, the Financial Accounting Standards Board issued statements No. 142 (Goodwill and Other Intangible Assets) and No. 143 (Accounting for Asset Retirement Obligations). Statement No. 142 was adopted by the Company in January 2002 and statement No. 143 was adopted by the Company in January 2003. Statement No. 142 changes the accounting for other intangible assets, such that those assets whose life is determined to be indefinite are not subject to amortization. These assets and goodwill shall be tested for impairment at least annually, and the value will need to be written down if the fair value is less than the carrying value. Statement No. 143 requires that a liability must be recognized for an asset retirement obligation related to long lived tangible assets. The liability shall be recorded at 15 fair value. The adoption of Statements No. 142 and No. 143 did not have a significant effect on the Company's financial position or results of operations. In August 2001, the Financial Accounting Standards Board issued statement No. 144 (Accounting for the Impairment or Disposals of Long-lived Assets). Statement No. 144 was adopted by the Company in January 2002. This statement requires an impairment loss to be recognized if the carrying value of a long-lived asset (asset group) is not recoverable and exceeds its fair value. Long-lived assets (asset group) shall be tested for impairment whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. The adoption of this statement did not have a significant effect on the Company's financial position or results of operations. In December 2002, the Financial Accounting Standards Board issued Statement No. 148 (Accounting for Stock-Based Compensation - Transition and Disclosures). Statement No. 148 amends the accounting for stock-based compensation by providing alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, Statement No. 148 amends the disclosure requirements to require prominent disclosures in both annual and interim financial statements of the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company adopted Statement No. 148 in December 2002. The Company does not anticipate changing to the fair value based method of accounting for stock-based compensation; therefore, the adoption only impacted disclosures. In October 2003, the FASB stated that it intends to issue an exposure draft in 2004 that would outline new accounting rules for stock based compensation which would require all companies to recognize in their income statements compensation expense related to stock options. 16 Part 1 - Item 3 - Quantitative and Qualitative Disclosures About Market Risk The Company is exposed to market risk from changes in foreign currency and interest rates. The Company manufactures many of its products and components in the United Kingdom and purchases many components in foreign markets. Approximately 50% of the Company's revenue is generated from foreign markets. The Company manages its risk to foreign currency rate changes by maintaining foreign currency bank accounts in currencies in which it regularly transacts business and the use of foreign exchange forward contracts. The Company does not enter into derivative contracts for trading or speculative purposes. The Company's cash equivalents and short-term investments and its outstanding debt bear variable interest rates. The rates are adjusted to market conditions. Changes in the market rate effects interest earned and paid by the Company. The Company does not use derivative instruments to offset the exposure to changes in interest rates. Changes in the interest rates related to these items are not expected to have a material impact on the Company's results of operations. Part 1 - Item 4 - Controls and Procedures The Company's management, with the participation of the CEO and CFO, have evaluated the effectiveness of the design and operation of the Company's disclosure controls and procedures as of September 28, 2003. Based on that evaluation, the Company's management, including the CEO and CFO, concluded that the Company's disclosure controls and procedures were effective as of September 28, 2003. Additionally during the past quarter, there have been no changes in the Company's internal controls over financial reporting that have materially affected, or would be reasonably likely to materially affect, the Company's internal control over financial reporting. 17 PART II - OTHER INFORMATION ITEM 1 - LEGAL PROCEEDINGS None ITEM 2 - CHANGES IN SECURITIES N/A ITEM 3 - DEFAULTS UPON SENIOR SECURITIES N/A ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS N/A ITEM 5 - OTHER INFORMATION N/A ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K a) Exhibits: Exhibit 10 Letter dated November 5, 2003, amending the Standard Corporate Financial Services contract between First Funding Corporation and the registrant dated June 17, 1986. Attached Exhibit 11 (Regulation S-K) Computation of Earnings Per Share. Attached Exhibit 31.1 Certification pursuant to section 10A of the Securities and Exchange Act of 1934, as adopted pursuant to section 302 of the Sarbanes-Oxley Act of 2002 Attached Exhibit 31.2 Certification pursuant to section 10A of the Securities and Exchange Act of 1934, as adopted pursuant to section 302 of the Sarbanes-Oxley Act of 2002 Attached Exhibit 32.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002 Attached Exhibit 32.2 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002 Attached

b) Reports on Form 8-K: Form 8-K dated August 11, 2003 - Item 12. Disclosure of Results of Operations and Financial Condition - Press release setting forth certain financial data related to the Company's half-year and second quarter 2003 financial results. 18 SIGNATURES ---------- PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED THEREUNTO DULY AUTHORIZED. FARREL CORPORATION ------------------ REGISTRANT DATE: 11/11/03 /s/Rolf K. Liebergesell ------------------------- ------------------------------------------ ROLF K. LIEBERGESELL CHIEF EXECUTIVE OFFICER, PRESIDENT AND CHAIRMAN OF THE BOARD DATE: 11/11/03 /s/Walter C. Lazarcheck ------------------------- ------------------------------------------ WALTER C. LAZARCHECK VICE PRESIDENT AND CHIEF FINANCIAL OFFICER (CHIEF ACCOUNTING OFFICER) 19

FARREL CORP 10-Q