10-Q 1 g10q-29482.txt 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2002 ------------------------------------------------- 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 V No --- --- 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 AUGUST 9, 2002 ------------------------------------------------------------------------ Common Stock (Voting), $.01 par value 5,228,461 FARREL CORPORATION INDEX

Page 2 of 23 Part I - Item 1 - Financial Information FARREL CORPORATION CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA)

See Accompanying Notes to Consolidated Financial Statements Page 3 of 23 FARREL CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE AND SHARE DATA)

See Accompanying Notes to Consolidated Financial Statements Page 4 of 23 FARREL CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)

See Accompanying Notes to Consolidated Financial Statements Page 5 of 23 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 U.S. generally accepted accounting principles 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 generally accepted accounting principles, the consolidated financial position of Farrel Corporation ("Farrel" or "the Company") as of June 30, 2002, and the consolidated results of its operations and its cash flows for the three and/or six month periods ended June 30, 2002 and July 1, 2001. These results are not necessarily indicative of results to be expected for the full fiscal year. For further information, the statements should be read in conjunction with the financial statements and notes thereto, included in the Company's Form 10-K for the year ended December 31, 2001. NOTE 2 - INVENTORY Inventory is comprised of the following:

NOTE 3 - COMPREHENSIVE INCOME (LOSS) The components of other comprehensive income (loss) are as follows:

Accumulated other comprehensive loss consists of the following:

Page 6 of 23 NOTE 4 - 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 the Company's products are essentially the same. NOTE 5 - IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS In June 2001, the Financial Accounting Standards Board (the "FASB") 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 on January 1, 2002. The Company must adopt Statement No. 143 no later than January 2003. Statement No. 142 changed the accounting for Goodwill and other intangible assets, such that those assets whose life is determined to be indefinite are not subject to amortization. These assets 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. The adoption of Statement No. 142 did not have a significant effect on the Company's financial position or results of operations. 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 Company anticipates the adoption of Statement No. 143 will not have a significant effect on its financial position or results of operations. In August 2001, the FASB issued Statement No. 144 (Accounting for the Impairment or Disposals of Long-lived Assets). The Company adopted Statement No. 144 on January 1, 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 an effect on the Company's financial position or results of operations. NOTE 6 - FOREIGN CURRENCY CONTRACTS In June 1998, the FASB issued Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, which the Company adopted on January 1, 2001. The Statement provides a new method of accounting for derivatives and hedges. The adoption of this Statement did not have a significant effect on the Company's results of operations or financial position. The Company has entered into foreign exchange forward contracts which are designated as fair value hedges of accounts receivable and future receivables related to customer orders in backlog. The Company, from time to time, enters into foreign exchange forward contracts to hedge certain firm commitments that are denominated in currencies other than the Company's operating currencies. At June 30, 2002, all of the Company's 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 June 30, 2002, the difference between the spot rate and the contract rate for the foreign exchange forwards was a net unrealized loss of $97,000. NOTE 7 - BANK CREDIT ARRANGEMENTS In June 2001, the Company entered into a new worldwide multi-currency credit facility with a major U.S. bank. This facility 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 revolving credit facility, as amended in August 2002, expires on June 15, 2004. The facility contains limits on direct borrowings and issuance of letters of credit based upon stipulated percentages of accounts receivable and inventory. The facility, as amended, also 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 Page 7 of 23 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 agreement contains certain restrictions on investments, borrowings and the 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 giving notice or lapse of time or both, would become an Event of Default. The Company has approximately $2.8 million of letters of credit issued under its credit facility on June 30, 2002. In June 2001, the Company also entered into a term loan for (British pound)1.4 million (approximately $2 million) as part of this credit facility. The proceeds of this loan were used to repay an existing term loan of the same amount. The new term loan is repayable in monthly installments of (British pound)38,888 (approximately $60,000) through June 2004. The term loan has an interest rate of LIBOR plus 2.7%. NOTE 8 - PENSION At December 31, 2001, the Company was required to record a minimum pension liability related to the pension plan of its U.K. subsidiary since under Financial Accounting Standards Board Statement No. 87 ("FAS 87"), which prescribes the U.S. accounting for pension plans, the plan was underfunded. At December 31, 2001, under FAS 87 this plan was underfunded by approximately $2.6 million, as a result of which the Company was required to take a charge against stockholders' equity of $4.2 million. At December 31, 2002, the Company will be required to reflect the results of a FAS 87 computation as of that date in its financial statements. Based upon the decline in the plan's assets in 2002 described below, a charge to reduce stockholders' equity may be required at December 31, 2002. For the year ended December 31, 2000, the assets in the plan declined in value by $649,000 and in the first five months of 2001 the assets in the plan declined in value by approximately $1,089,000. As a result of the poor investment performance, the trustees of the plan changed to a new investment manager in May 2001. Under this new investment manager the assets in the plan declined in value by approximately $1,309,000 in the remainder of 2001 and for the period January 1, 2002 to June 30, 2002, the assets in the plan declined in value by approximately $1,900,000. For the period December 31, 1999 to June 30, 2002, the total decline in value of the assets was approximately $4,947,000. The majority of 2002 loss was incurred in June 2002 as a result of the decline in the stock market. The trustees of the plan moved the plan assets out of equities in July and are reviewing the long-term investment strategy of the plan. Benefits paid by the pension plan were $808,000, $1,017,000 and $966,000 in 1999, 2000 and 2001, respectively. At June 30, 2002, total assets in the plan were approximately $20.7 million. The value of the plan assets currently significantly exceeds the historical benefits paid for the past few years. In response to the funding situation, 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. Under laws governing the funding of U.K. defined benefit pension plans, the pension plan of the Company's U.K. subsidiary must be 90% funded on a non-wind up basis as computed under such funding rules by 2005 and 100% funded on a non-wind up basis as computed under such funding rules by 2012. The plan's actuary estimated that the plan was 87% funded as of January 31, 2002, on a non-wind up basis under the U.K. funding rules. The Company currently is contributing (British pound)36,000 (approximately $56,000) a month to the pension plan. This contribution amount was based upon the estimated funded status as of January 2002. A new formal funding computation is required by November 2002 and at such time a new rate of contributions from the Company will be determined. This new rate of contributions could be materially greater than the current contribution requirement. 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 under currently existing U.K. funding rules, including among other things an assessment of the U.K. subsidiary's business prospects and cash position, the securitization of the U.K. Page 8 of 23 subsidiary's assets, a parent company guarantee, or other assurances, in order to avoid a determination by the actuary that the trustees should wind up the plan. The Company's U.K. legal counsel has provided a written opinion that, so long as the U.K. subsidiary is complying with its non-wind up statutory funding obligations, the trustees and the actuary have no legal basis to implement a wind up. The Company's U.K. subsidiary has confirmed its intention to meet these funding obligations. Under the U.K. funding rules, on a wind up basis the amount of underfunding of the plan is computed differently than, and would be substantially greater than, the amount computed on a non-wind up basis. Additionally, on a wind up basis, the underfunding must be paid down within a substantially shorter time period. If a wind up were to occur, it could have a material adverse effect on the financial position and results of operations of the Company. Page 9 of 23 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 SIX MONTHS ENDED JUNE 30, 2002 COMPARED TO THE SIX MONTHS ENDED JULY 1, 2001 Net sales for the six month period ended June 30, 2002, were $17.0 million compared to $23.4 million for the six month period ended July 1, 2001, a decrease of $6.4 million. The decrease is primarily a result of lower sales of new machines of approximately $5.0 million and after-market parts and field service of approximately $1.4 million. 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 which are extremely competitive with cyclical demand. Many of the Company's customers and markets operate at less than full capacity and certain markets remain particularly competitive and are subject to local economic events. Orders received for the six month period ended June 30, 2002, were $29.4 million compared to $23.0 million for the six month period ended July 1, 2001. 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. The Company is experiencing increased pricing pressures from competitors in an overall smaller market. Until recently, the value of the Euro versus the U.S. dollar and British pound sterling had decreased significantly since it was introduced which resulted in increased pricing pressures. Although it would be expected that a stronger Euro would benefit the Company from a competitive standpoint, the Company cannot be certain that it will alleviate any of the current pricing pressures in the market place. Demand for capital expenditures remains weak. 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 depends upon a strengthening and stability in the Company's traditional markets and its ability to control costs to effectively compete in its current markets. There can be no assurance that the current level of orders will continue, that market conditions will not worsen, 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 June 30, 2002, was $31.3 million compared to $18.1 million at December 31, 2001, and $27.4 million at July 1, 2001. Substantially all of the backlog as of June 30, 2002, is scheduled for shipment in the next 12 months. Page 10 of 23 Gross margin for the six month period ended June 30, 2002, was $4.1 million compared to $4.9 million for the six month period ended July 1, 2001, a decrease of $0.8 million. The decrease in gross margin is a result of lower sales. The gross margin as a percent of sales for the six month period ended June 30, 2002, was 23.9% compared to 20.9% for the six month period ended July 1, 2001. The increase in gross margin as a percent of sales is primarily due to (i) sales of after-market related items representing a larger percent of total sales in 2002 versus 2001 and (ii) higher gross profit margins on new machine sales. After-market items such a spare parts typically have higher gross profit percents than new machine sales. The increase in gross margin as a percent of sales for new machines in 2002 versus 2001 is due to changes in sales mix of new machines. Operating expenses for the six month period ended June 30, 2002, were $6.1 million compared to $6.7 million for the six month period ended July 1, 2001, a decrease of $0.6 million. The selling and research and development components of operating expenses decreased primarily due to lower employee compensation and related expenses. The general and administrative component of operating expenses increased primarily due to higher pension related costs. Interest income for the six month period ended June 30, 2002, was $56,000 compared to $88,000 for the six month period ended July 1, 2001, a decrease of $32,000. The decrease is primarily due to lower interest rates. Interest expense for the six month period ended June 30, 2002, was $53,000 compared to $78,000 for the six month period ended July 1, 2001, a decrease of $25,000. The decrease is due to lower borrowings and lower interest rates. Other income, net for the six month period ended June 30, 2002, was $185,000 compared to other expense, net of $49,000 for the six month period ended July 1, 2001. Other income for the period ended June 30, 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 jurisdictions in which income is earned or losses generated, adjusted for permanent differences in determining income for financial reporting and income tax purposes. The effective income tax rate was 31.9% for the six month period ended June 30, 2002, compared to 36.3% for the six month period ended July 1, 2001. The effective tax rate varies among periods due to the change in the proportion and amount of income and losses generated in different taxing jurisdictions. THREE MONTHS ENDED JUNE 30, 2002 COMPARED TO THE THREE MONTHS ENDED JULY 1, 2001 Net sales for the three months ended June 30, 2002, were $9.2 million compared to $12.4 million for the three month period ended July 1, 2001, a decrease of $3.2 million. The decrease is primarily a result of lower sales of new machines of $2.7 million and after-market parts and field service of $0.8 million, offset to some extent by increased sales of in-house repair services. Orders received for the three month period ended June 30, 2002, were $15.2 million compared to $13.4 million for the three month period ended July 1, 2001. 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 six month period on page 10. Gross margin for the three month period ended June 30, 2002, was $2.2 million compared to $2.4 million for the three month period ended July 1, 2001, a decrease of $0.2 million. The decrease in gross margin is a result of lower sales. The gross margin as a percent of sales for the three month period ended June 30, 2002, was 24.2% compared to 19.6% for the three month period ended July 1, 2001. The increase in the gross margin as a percent of sales is primarily due to (i) sales of after-market related items representing a larger percent of total sales in 2002 versus 2001 and (ii) higher gross profit margins on new machine sales. After-market items such a spare parts typically have higher gross profit percents than Page 11 of 23 new machine sales. The increase in gross margin as a percent of sales for new machines in 2002 versus 2001 is due to changes in sales mix of new machines. Operating expenses for the three month period ended June 30, 2002, were $2.9 million compared to $3.2 million for the three month period ended July 1, 2001, a decrease of $0.3 primarily due to lower employee compensation and related expenses. Interest income for the three month period ended June 30, 2002, was $30,000 compared to $36,000 for the three month period ended July 1, 2001, a decrease of $6,000. The decrease is primarily due to lower interest rates. Interest expense for the three month periods ended June 30, 2002, was $26,000 compared to $36,000 for the three month period ended July 1, 2001, a decrease of $10,000. The decrease is primarily due to lower borrowings and lower interest rates. Other income, net for the three month period ended June 30, 2002, was $13,000 compared to other expense, net of $68,000 for the three month period ended July 1, 2002. 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 rate was 34.7% for the three month periods ended June 30, 2002, compared to 36.1% for the three months ended July 1, 2001. 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. 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. 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 or the competitive position of the Company. LIQUIDITY AND CAPITAL RESOURCES; CAPITAL EXPENDITURES Working capital and the working capital ratio at June 30, 2002 were $15.1 million and 2.2 to 1, respectively, compared to $15.8 million and 2.4 to 1 at December 31, 2001, respectively. During the six months ended June 30, 2002, the Company paid a dividend of $0.04 per share. 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 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. Management anticipates that its cash balances, operating cash flows and available credit line will be adequate to fund anticipated capital commitments and working capital requirements for at least the next twelve months. The Company made capital expenditures of $61,000 and $290,000 during the six month periods ended June 30, 2002 and July 1, 2001, respectively. In June 2001, the Company entered into a new worldwide multi-currency credit facility with a major U.S. bank. This facility 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 Page 12 of 23 can make at $5 million. The revolving credit facility, as amended in August 2002, expires on June 15, 2004. The facility contains limits on direct borrowings and issuances of letters of credit based upon stipulated percentages of accounts receivable and inventory. The facility, as amended, also 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 agreement contains certain restrictions on investments, borrowings and the 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 giving of notice or lapse of time or both, would become an Event of Default. The Company has approximately $2.8 million of letters of credit issued under its credit facility on June 30, 2002. In June 2001, the Company also entered into a term loan for (British pound)1.4 million (approximately $2 million) as part of this credit facility. The proceeds of this loan were used to repay an existing term loan of the same amount. The new term loan is repayable in monthly installments of (British pound)38,888 (approximately $60,000) through October 2004. The term loan has an interest rate of LIBOR plus 2.7%. At June 30, 2002 and December 31, 2001, there were $1.5 million and $1.7 million, respectively, outstanding under the term loan. At December 31, 2001, the Company was required to record a minimum pension liability related to the pension plan of its U.K. subsidiary since under Financial Accounting Standards Board Statement No. 87 ("FAS 87"), which prescribes the U.S. accounting for pension plans, the plan was underfunded. At December 31, 2001, under FAS 87 this plan was underfunded by approximately $2.6 million, as a result of which the Company was required to take a charge against stockholders' equity of $4.2 million. At December 31, 2002, the Company will be required to reflect the results of a FAS 87 computation as of that date in its financial statements. Based upon the decline in the plan's assets in 2002 described below, a charge to reduce stockholders' equity may be required at December 31, 2002. For the year ended December 31, 2000, the assets in the plan declined in value by $649,000 and in the first five months of 2001 the assets in the plan declined in value by approximately $1,089,000. As a result of the poor investment performance, the trustees of the plan changed to a new investment manager in May 2001. Under this new investment manager the assets in the plan declined in value by approximately $1,309,000 in the remainder of 2001 and for the period January 1, 2002 to June 30, 2002, the assets in the plan declined in value by approximately $1,900,000. For the period December 31, 1999 to June 30, 2002, the total decline in value of the assets was approximately $4,947,000. The majority of 2002 loss was incurred in June 2002 as a result of the decline in the stock market. The trustees of the plan moved the plan assets out of equities in July and are reviewing the long-term investment strategy of the plan. Benefits paid by the pension plan were $808,000, $1,017,000 and $966,000 in 1999, 2000 and 2001, respectively. At June 30, 2002, total assets in the plan were approximately $20.7 million. The value of the plan assets currently significantly exceeds the historical benefits paid for the past few years. In response to the funding situation, 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. Under laws governing the funding of U.K. defined benefit pension plans, the pension plan of the Company's U.K. subsidiary must be 90% funded on a non-wind up basis as computed under such funding rules by 2005 and 100% funded on a non-wind up basis as computed under such funding rules by 2012. The plan's actuary estimated that the plan was 87% funded as of January 31, 2002, on a non-wind up basis under the U.K. funding rules. The Company currently is contributing (British pound)36,000 (approximately $56,000) a month to the pension plan. This contribution amount was based upon the estimated funded status as of January 2002. A new formal funding computation is required by November 2002 and at such Page 13 of 23 time a new rate of contributions from the Company will be determined. This new rate of contributions could be materially greater than the current contribution requirement. 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 under currently existing U.K. funding rules, 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, or other assurances, in order to avoid a determination by the actuary that the trustees should wind up the plan. The Company's U.K. legal counsel has provided a written opinion that, so long as the U.K. subsidiary is complying with its non-wind up statutory funding obligations, the trustees and the actuary have no legal basis to implement a wind up. The Company's U.K. subsidiary has confirmed its intention to meet these funding obligations. Under the U.K. funding rules, on a wind up basis the amount of underfunding of the plan is computed differently than, and would be substantially greater than, the amount computed on a non-wind up basis. Additionally, on a wind up basis, the underfunding must be paid down within a substantially shorter time period. If a wind up were to occur, it could have a material adverse effect on the financial position and results of operations of the Company. IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS In June 2001, the Financial Accounting Standards Board (the "FASB") 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 on January 1, 2002. The Company must adopt statement No. 143 no later than January 2003. Statement No. 142 changed the accounting for Goodwill and other intangible assets, such that those assets whose life is determined to be indefinite are not subject to amortization. These assets 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. The adoption of Statement No. 142 did not have a significant effect on the Company's financial position or results of operations. 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 Company anticipates the adoption of Statement No. 143 will not have a significant effect on its financial position or results of operations. In August 2001, the FASB issued statement No. 144 (Accounting for the Impairment or Disposals of Long-lived Assets). The Company adopted statement No. 144 on January 1, 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 an effect on the Company's financial position or results of operations. Page 14 of 23 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 of 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. Page 15 of 23

Page 16 of 23 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: 8/13/02 /s/ Rolf K. Liebergesell ------------------------------ -------------------------------------- ROLF K. LIEBERGESELL CHIEF EXECUTIVE OFFICER, PRESIDENT AND CHAIRMAN OF THE BOARD DATE 8/13/02 /s/ Walter C. Lazarcheck ------------------------------ -------------------------------------- WALTER C. LAZARCHECK VICE PRESIDENT AND CHIEF FINANCIAL OFFICER (CHIEF ACCOUNTING OFFICER) Page 17 of 23

FARREL CORP 10-Q