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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

 

FORM 10-Q

 

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 29, 2012   Commission File No. 1-11333

 

 

KAYDON CORPORATION

(Exact name of registrant as specified in its charter)

 

 

 

Delaware    13-3186040

(State or other jurisdiction of

incorporation or organization)

  

(I.R.S. Employer

Identification No.)

Suite 300, 2723 South State Street, Ann Arbor, MI    48104
(Address of principal executive offices)    (Zip Code)

Registrant’s telephone number, including area code: (734) 747-7025

 

 

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company,” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

Common Stock Outstanding at October 22, 2012 – 32,103,254 shares, $.10 par value.

 

 

 


Table of Contents

KAYDON CORPORATION FORM 10-Q

INDEX

 

 

 

         Page
No.
 
Part I – Financial Information:   
  Item 1. Financial Statements.      3   
  Consolidated Balance Sheets (Unaudited) – September 29, 2012 and December 31, 2011      3   
 

Consolidated Statements of Operations (Unaudited) – Quarters and First Three Quarters Ended September 29, 2012 and October 1, 2011

     4   
 

Consolidated Statements of Other Comprehensive Income (Loss) (Unaudited) – Quarters and First Three Quarters Ended September 29, 2012 and October 1, 2011

     5   
 

Consolidated Statements of Cash Flows (Unaudited) – First Three Quarters Ended September 29, 2012 and October 1, 2011

     6   
  Notes to Consolidated Financial Statements (Unaudited)      7   
  Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.      17   
  Item 3. Quantitative and Qualitative Disclosures About Market Risk.      24   
  Item 4. Controls and Procedures.      24   
Part II – Other Information:   
  Item 6. Exhibits.      25   
  Signatures      26   

 

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Table of Contents

PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS.

KAYDON CORPORATION

CONSOLIDATED BALANCE SHEETS

(In thousands)

(Unaudited)

 

 

     September 29,
2012
     December 31,
2011
 

ASSETS

     

Current Assets:

     

Cash and cash equivalents

   $ 52,009       $ 225,214   

Accounts receivable, net

     93,391         78,441   

Inventories, net

     108,096         110,206   

Other current assets

     17,040         16,701   
  

 

 

    

 

 

 

Total current assets

     270,536         430,562   
  

 

 

    

 

 

 

Property, plant and equipment, net

     120,408         168,946   

Assets held for sale

     6,531         0   

Goodwill, net

     190,143         157,087   

Other intangible assets, net

     49,794         31,140   

Other assets

     2,736         3,962   
  

 

 

    

 

 

 

Total assets

   $ 640,148       $ 791,697   
  

 

 

    

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

     

Current Liabilities:

     

Accounts payable

   $ 21,945       $ 19,699   

Accrued expenses

     29,971         29,766   

Current portion long-term debt

     9,375         0   
  

 

 

    

 

 

 

Total current liabilities

     61,291         49,465   
  

 

 

    

 

 

 

Long-term debt

     186,875         0   

Long-term postretirement and post employment benefit obligations

     38,815         40,442   

Other long-term liabilities

     23,037         17,152   
  

 

 

    

 

 

 

Total long-term liabilities

     248,727         57,594   
  

 

 

    

 

 

 

Shareholders’ Equity:

     

Common stock

     3,693         3,693   

Other shareholders’ equity

     326,437         680,945   
  

 

 

    

 

 

 

Total shareholders’ equity

     330,130         684,638   
  

 

 

    

 

 

 

Total liabilities and shareholders’ equity

   $ 640,148       $ 791,697   
  

 

 

    

 

 

 

See accompanying notes to consolidated financial statements.

 

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KAYDON CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(Unaudited)

 

 

     Three Months Ended     Nine Months Ended  
     September 29,
2012
    October 1,
2011
    September 29,
2012
    October 1,
2011
 

Net sales

   $ 123,849      $ 121,637      $ 364,688      $ 352,007   

Cost of sales

     87,361        78,795        245,599        226,359   
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     36,488        42,842        119,089        125,648   

Selling, general and administrative expenses

     25,026        22,498        72,822        67,358   

Impairment charge

     42,953        0        42,953        0   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating income (loss)

     (31,491     20,344        3,314        58,290   

Interest expense

     (955     (98     (2,138     (293

Interest income

     59        88        238        377   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before taxes

     (32,387     20,334        1,414        58,374   

Provision for income taxes

     (1,084     5,830        8,902        17,722   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

   $ (31,303   $ 14,504      $ (7,488   $ 40,652   
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings (loss) per share:

        

Basic

   $ (0.99   $ 0.45      $ (0.24   $ 1.25   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

   $ (0.99   $ 0.45      $ (0.24   $ 1.25   
  

 

 

   

 

 

   

 

 

   

 

 

 

Dividends declared per share

   $ 0.20      $ 0.20      $ 11.10      $ 0.58   
  

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

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KAYDON CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(In thousands)

(Unaudited)

 

 

     Three Months Ended     Nine Months Ended  
     September 29,
2012
    October 1,
2011
    September 29,
2012
    October 1,
2011
 

Net income (loss)

   $ (31,303   $ 14,504      $ (7,488   $ 40,652   

Other comprehensive income

        

Cumulative currency translation adjustments

     4,162        (7,611     3,165        (2,348

Adjustment to pension benefit liability, net of tax

     852        516        2,402        1,548   

Adjustment to postretirement benefit liability, net of tax

     (172     (274     (532     (820
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other comprehensive income (loss)

     4,842        (7,369     5,035        (1,620
  

 

 

   

 

 

   

 

 

   

 

 

 

Total comprehensive income (loss)

   $ (26,461   $ 7,135      $ (2,453   $ 39,032   
  

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

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Table of Contents

KAYDON CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

     Nine Months Ended  
     September 29,
2012
    October 1,
2011
 

Cash Flows from Operating Activities:

    

Net income (loss)

   $ (7,488   $ 40,652   

Adjustments to reconcile net income (loss) to net cash from operating activities:

    

Depreciation

     15,329        15,095   

Amortization of intangible assets

     2,585        2,274   

Amortization of stock awards

     2,367        3,125   

Stock option compensation expense

     1,525        995   

Excess tax benefits from stock-based compensation

     (654     (95

Deferred financing fees

     593        291   

Non-cash postretirement benefits curtailment gain

     0        (142

Contributions to qualified pension plans

     (7,959     (1,952

Non-cash impairment charge

     42,953        0   

Net change in receivables, inventories and trade payables

     (2,622     (25,466

Net change in other assets and liabilities

     2,524        497   
  

 

 

   

 

 

 

Net cash from operating activities

     49,153        35,274   
  

 

 

   

 

 

 

Cash Flows from Investing Activities:

    

Capital expenditures

     (12,976     (11,865

Dispositions of property, plant and equipment

     2,012        210   

Acquisition of business, net of cash acquired

     (51,567     (39,610
  

 

 

   

 

 

 

Net cash used in investing activities

     (62,531     (51,265
  

 

 

   

 

 

 

Cash Flows from Financing Activities:

    

Cash dividends paid

     (355,297     (18,652

Purchase of treasury stock

     (1,199     (34,719

Proceeds from long-term borrowings

     200,000        0   

Repayments of long-term borrowings

     (3,749     0   

Debt issuance costs

     (1,357     0   

Excess tax benefits from stock-based compensation

     654        95   

Proceeds from exercise of stock options

     134        39   
  

 

 

   

 

 

 

Net cash used in financing activities

     (160,814     (53,237
  

 

 

   

 

 

 

Effect of exchange rate changes on cash and cash equivalents

     987        1,668   
  

 

 

   

 

 

 

Net decrease in cash and cash equivalents

     (173,205     (67,560

Cash and cash equivalents – Beginning of period

     225,214        286,648   
  

 

 

   

 

 

 

Cash and cash equivalents – End of period

   $ 52,009      $ 219,088   
  

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

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KAYDON CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

 

(1) Basis of Presentation:

The accompanying consolidated financial statements of Kaydon Corporation and subsidiaries (“Kaydon” or the “Company”) have been prepared in accordance with generally accepted accounting principles and SEC rules and regulations, without audit. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted in accordance with prescribed SEC rules. In the opinion of management, all adjustments considered necessary for a fair presentation have been included, and such adjustments are of a normal recurring nature. The December 31, 2011 consolidated balance sheet data was derived from audited financial statements, but does not include all disclosures required by generally accepted accounting principles. For further information, refer to the consolidated financial statements and footnotes included in the Company’s annual report on Form 10-K for the year ended December 31, 2011.

When appropriate, certain items in the prior period financial statements may be reclassified to conform to the presentation used in the current period.

 

(2) Cash and Cash Equivalents:

The Company considers all highly liquid debt and investment instruments purchased with a maturity of three months or less to be cash equivalents and consist of the following (in thousands):

 

     September 29,
2012
     December 31,
2011
 

Cash and cash equivalents:

     

Money market and other short-term funds

   $ 11,129       $ 194,501   

Time deposits, other interest bearing accounts, and other cash

     40,880         30,713   
  

 

 

    

 

 

 

Total cash and cash equivalents

   $ 52,009       $ 225,214   
  

 

 

    

 

 

 

 

(3) Inventories:

Inventories consist of the following (in thousands):

 

     September 29,
2012
     December 31,
2011
 

Raw material

   $ 42,605       $ 42,168   

Work in process

     28,574         29,408   

Finished goods

     36,917         38,630   
  

 

 

    

 

 

 

Total inventories

   $ 108,096       $ 110,206   
  

 

 

    

 

 

 

 

(4) Special Dividend:

On February 22, 2012, Kaydon’s Board of Directors declared a special cash dividend of $10.50 per common share payable to shareholders of record as of March 5, 2012 with a payment date of March 26, 2012. The Company paid the $336.1 million special cash dividend on March 26, 2012 using existing cash balances and the net proceeds from borrowings under the senior term loan facility as more fully described in Note 7 Long-term Debt.

 

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(5) Earnings Per Share:

The following table sets forth the computation of basic and diluted earnings per share for the periods presented with amounts in thousands, except per share data:

 

     Three Months Ended  
     September 29,
2012
    October 1,
2011
 

Earnings per share – Basic

    

Net income (loss)

   $ (31,303   $ 14,504   

Less: Net earnings allocated to participating securities – Basic

     0        (144
  

 

 

   

 

 

 

Income (loss) available to common shareholders – Basic

   $ (31,303   $ 14,360   

Weighted average common shares outstanding – Basic

     31,756        31,931   
  

 

 

   

 

 

 

Earnings (loss) per share – Basic

   $ (0.99   $ 0.45   
  

 

 

   

 

 

 

Earnings per share – Diluted

    

Net income (loss)

   $ (31,303   $ 14,504   

Less: Net earnings allocated to participating securities – Diluted

     0        (144
  

 

 

   

 

 

 

Income (loss) available to common shareholders – Diluted

   $ (31,303   $ 14,360   
  

 

 

   

 

 

 

Weighted average common shares outstanding – Diluted

    

Weighted average common shares outstanding – Basic

     31,756        31,931   

Potential dilutive shares resulting from stock options

     0        19   
  

 

 

   

 

 

 

Weighted average common shares outstanding – Diluted

     31,756        31,950   
  

 

 

   

 

 

 

Earnings (loss) per share – Diluted

   $ (0.99   $ 0.45   
  

 

 

   

 

 

 

 

     Nine Months Ended  
     September 29,
2012
    October 1,
2011
 

Earnings per share – Basic

    

Net income (loss)

   $ (7,488   $ 40,652   

Less: Net earnings allocated to participating securities – Basic

     0        (422
  

 

 

   

 

 

 

Income (loss) available to common shareholders – Basic

   $ (7,488   $ 40,230   

Weighted average common shares outstanding – Basic

     31,748        32,229   
  

 

 

   

 

 

 

Earnings (loss) per share – Basic

   $ (0.24   $ 1.25   
  

 

 

   

 

 

 

Earnings per share – Diluted

    

Net income (loss)

   $ (7,488   $ 40,652   

Less: Net earnings allocated to participating securities – Diluted

     0        (422
  

 

 

   

 

 

 

Income (loss) available to common shareholders – Diluted

   $ (7,488   $ 40,230   
  

 

 

   

 

 

 

Weighted average common shares outstanding – Diluted

    

Weighted average common shares outstanding – Basic

     31,748        32,229   

Potential dilutive shares resulting from stock options

     0        25   
  

 

 

   

 

 

 

Weighted average common shares outstanding – Diluted

     31,748        32,254   
  

 

 

   

 

 

 

Earnings (loss) per share – Diluted

   $ (0.24   $ 1.25   
  

 

 

   

 

 

 

Certain options granted to purchase shares of common stock were excluded from the computation of diluted earnings per share because the option effect would have been antidilutive (in thousands):

 

     Three Months Ended      Nine Months Ended  
     September 29,
2012
     October 1,
2011
     September 29,
2012
     October 1,
2011
 

Shares excluded

     695         507         695         421   

 

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Holders of participating securities do not participate in losses. Therefore, for the third quarter and nine months ending September 29, 2012, no losses were allocated to the participating securities.

 

(6) Business Segment Information:

The Company has two reporting segments: Friction Control Products and Velocity Control Products. On April 8, 2011, the Company completed the acquisition of all of the outstanding shares of HAHN-Gasfedern GmbH and related real estate and intangible property (“Hahn”) from Ulrich Hahn e.K. Hahn, based in Aichwald, Germany, manufactures and sells high quality gas springs, tension springs and dampers for diverse industrial markets. Hahn’s results are included in the Velocity Control Products segment. On June 5, 2012, the Company completed the acquisition of all of the outstanding shares of Fabreeka Group Holdings, Inc. (“Fabreeka”). Fabreeka, based in Stoughton, Massachusetts, is a leading provider of engineered vibration-isolation and shock-control products across numerous end-markets. Fabreeka’s results are included in the Velocity Control Products segment. The Company’s remaining operating segments are combined and disclosed as “Other Industrial Products.” Sales between reporting segments are not material. Items not allocated to segment operating income include certain amortization expenses, certain corporate administrative expenses, and other amounts. Amounts shown below are in thousands.

 

     Three Months Ended      Nine Months Ended  
     September 29,
2012
     October 1,
2011
     September 29,
2012
     October 1,
2011
 

Net sales

           

Friction Control Products

   $ 66,709       $ 69,885       $ 204,037       $ 196,530   

Velocity Control Products

     29,865         24,373         78,652         69,330   

Other Industrial Products

     27,275         27,379         81,999         86,147   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total consolidated net sales

   $ 123,849       $ 121,637       $ 364,688       $ 352,007   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     Three Months Ended     Nine Months Ended  
     September 29,
2012
    October 1,
2011
    September 29,
2012
    October 1,
2011
 

Operating income (loss)

        

Friction Control Products

   $ (40,534   $ 11,080      $ (18,541   $ 32,480   

Velocity Control Products

     6,631        6,050        18,181        17,760   

Other Industrial Products

     2,687        2,937        7,616        9,869   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total segment operating income (loss)

     (31,216     20,067        7,256        60,109   

Items not allocated to segment operating income (loss)

     (275     277        (3,942     (1,819

Interest expense

     (955     (98     (2,138     (293

Interest income

     59        88        238        377   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before taxes

   $ (32,387   $   20,334      $     1,414      $   58,374   
  

 

 

   

 

 

   

 

 

   

 

 

 

The Friction Control Products operating loss included $46.0 million of impairment, severance and other charges associated with the previously announced wind restructuring in the three and nine months ended September 29, 2012, as more fully described in Note 16, and a net charge of $4.0 million associated with the conclusion of a customer arbitration as more fully described in Note 15. In connection with the wind restructuring asset impairments, total assets of the Friction Control Products reporting segment decreased to $290.4 million at September 29, 2012, compared to $332.1 million at December 31, 2011. Total assets of the Velocity Control Products reporting segment increased to $199.1 million at September 29, 2012, compared to $118.3 million at December 31, 2011, due primarily to the acquisition of Fabreeka.

 

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(7) Long-term Debt:

In September 2010, the Company entered into a credit agreement (the “2010 credit agreement”) with a syndicate of lenders providing for a $250.0 million senior revolving credit facility. The 2010 credit agreement was terminated on March 26, 2012. On March 26, 2012, the Company entered into a new $400.0 million credit agreement (the “2012 credit agreement”) with a syndicate of lenders providing for a $150.0 million senior term loan facility, which the Company borrowed to fund a portion of its $10.50 per common share special dividend paid to shareholders on March 26, 2012. In addition, the 2012 credit agreement also provides for a $250.0 million senior revolving credit facility, the proceeds of which may be used by the Company for working capital and general corporate purposes, including acquisitions, payment of dividends and repurchases of the Company’s capital stock. On June 5, 2012, the Company borrowed $50.0 million under the senior revolving credit agreement to fund the acquisition of Fabreeka.

The 2012 credit agreement matures on March 27, 2017 and is guaranteed by the Company and certain of its subsidiaries. It is also secured by a pledge of a majority of the outstanding stock of a wholly-owned foreign subsidiary. In connection with the termination of the 2010 credit agreement, the Company accelerated the recognition of $0.2 million of deferred financing fees related to the unamortized portion of the debt issuance costs associated with lenders who are not parties to the 2012 credit agreement. The remaining unamortized portion of the 2010 debt issuance costs of $1.1 million and the $1.4 million of debt issuance costs related to the 2012 credit agreement are being amortized over the life of the 2012 credit agreement. Loans under the credit agreement bear interest at a floating rate, based on LIBOR plus an applicable margin, and are payable monthly, bimonthly or quarterly in accordance with the terms of the 2012 credit agreement.

The Company is obligated to make quarterly principal payments throughout the term of the term loan and has the option to prepay term loan amounts. The remaining balance of the term loan matures on March 27, 2017. At September 29, 2012, $9.4 million of the term loan was included in the current portion of long-term debt line and $136.9 million of the term loan was included in the long-term debt line of the balance sheet.

The 2012 credit agreement requires the Company to comply with maximum leverage and minimum interest coverage ratios. In addition, the 2012 credit agreement contains other standard covenants such as those which (subject to certain thresholds) limit the ability of the Company and its subsidiaries to, among other things, incur debt, sell assets, incur additional liens, make certain investments, enter into certain transactions with shareholders or affiliates, or enter into speculative hedging obligations. The 2012 credit agreement also includes customary events of default which would permit the lenders to accelerate the repayment of obligations under the 2012 credit agreement if not cured within applicable grace periods. The Company was in compliance with all restrictive covenants contained in the 2012 credit agreement at September 29, 2012. Taking into account the borrowings under the revolving credit agreement and $3.2 million of letters of credit issued under the credit agreement, the Company had availability under the 2012 credit agreement of $196.8 million at September 29, 2012.

 

(8) Goodwill and Other Intangible Assets:

The Company annually, or more frequently if events or changes in circumstances indicate a need, tests the carrying values of goodwill and indefinite-lived intangible assets for impairment.

During the third quarter of 2012, the Company completed its annual goodwill impairment test as of its July 31 annual testing date. The fair value of each reporting unit was estimated using the expected present value of future cash flows using a weighted average cost of capital discount rate of 11.5-12.5 percent depending on the assessed risk of the reporting unit and a growth rate in perpetuity of 1.0-2.0 percent depending on the assessed long-term growth of the reporting unit. In accordance with current accounting guidance, the Company has included deferred taxes in determining the carrying value of each reporting unit. During 2012, the Company’s goodwill impairment testing revealed that the estimated fair values of each of its reporting units exceeded their carrying values, which indicated no goodwill impairment. The Company’s goodwill impairment testing revealed that the excess of the estimated fair value of each of the reporting units tested over their carrying value (expressed as a percentage of the carrying value) as of the July 31, 2012 annual testing date ranged from approximately 18 percent to approximately 275 percent. Changes in estimates of future cash flows and the weighted average cost of capital may have a material effect on the valuation of reporting units and the results of the related impairment testing.

Certain trademarks are the Company’s only indefinite-lived intangible assets. The Company identifies impairment of these trademarks by comparing their fair values to their carrying values. The fair values of the trademarks are calculated based on estimates of discounted future cash flows related to the net amount of royalty expenses avoided due to the existence of the trademarks. At July 31, 2012, trademarks were tested for impairment and no impairment loss was realized.

 

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After the Company’s annual July 31 testing date, the Company recorded substantial asset impairments as part of its wind restructuring as more fully described in Note 16, which reduced the carrying value of the affected reporting unit, and which will reduce the future cash flows related to the wind business. The affected reporting unit, when tested at July 31 had a fair value that substantially exceeded its carrying value. The Company considered the effect the wind restructuring had on the affected reporting unit’s carrying value and the effect of the reduced future cash flows on its fair value and determined that no interim testing of goodwill was required.

Changes in the carrying value of goodwill for the nine months ended September 29, 2012, were as follows (in thousands):

 

     Friction
Control
Products
     Velocity
Control
Products
    Other
Industrial
Products
    Total  

Balance at January 1, 2012

         

Goodwill

   $ 56,381       $ 56,874      $ 62,532      $ 175,787   

Accumulated impairment losses

     0         0        (18,700     (18,700
  

 

 

    

 

 

   

 

 

   

 

 

 

Net Balance

   $ 56,381       $ 56,874      $ 43,832      $ 157,087   

Effect of foreign currency exchange rate changes

     761         (45     0        716   

Goodwill acquired

     0         32,340        0        32,340   

Balance at September 29, 2012

         

Goodwill

   $ 57,142       $ 89,169      $ 62,532      $ 208,843   

Accumulated impairment losses

     0         0        (18,700     (18,700
  

 

 

    

 

 

   

 

 

   

 

 

 

Net Balance

   $ 57,142       $ 89,169      $ 43,832      $ 190,143   
  

 

 

    

 

 

   

 

 

   

 

 

 

The accumulated impairment losses include impairment losses of $1.9 million recorded in 2004 and $16.8 million recorded in 2002. The Company recorded acquired goodwill of $32.3 million in the second quarter of 2012 associated with its June 5, 2012 acquisition of Fabreeka. The Company also recorded other intangible assets acquired in that acquisition. A value of $11.4 million was assigned to customer lists which are being amortized over ten years. A value of $9.7 million was assigned to the non-amortizing trade name intangible asset. Final purchase price adjustments, including a customary working capital adjustment, are expected to be completed in the fourth quarter of 2012.

Other intangible assets are summarized as follows (in thousands):

 

     September 29, 2012      December 31, 2011  

Amortized Intangible Assets

   Gross
Carrying
Value
     Accumulated
Amortization
     Gross
Carrying
Value
     Accumulated
Amortization
 

Customer relationships and lists

   $ 53,148       $ 22,276       $ 41,791       $ 20,096   

Patents and developed technology

     7,914         4,827         7,724         4,462   

Distributor agreements

     374         302         374         277   

Product names

     320         237         320         219   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 61,756       $ 27,642       $ 50,209       $ 25,054   
  

 

 

    

 

 

    

 

 

    

 

 

 

The intangible assets are being amortized at pro rata rates or on a straight-line basis, whichever is appropriate, over their respective useful lives.

Amounts shown below are in thousands.

 

Unamortized Intangible Assets

   September 29,
2012
Carrying
Value
     December 31,
2011
Carrying
Value
 

Trademarks and trade names

   $ 15,680       $ 5,985   

 

Aggregate Intangible Assets Amortization Expense

      

For the nine months ended September 29, 2012

   $ 2,585   

For the nine months ended October 1, 2011

   $ 2,274   

 

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Estimated Intangible Assets Amortization Expense

      

For the year ending December 31, 2012

   $ 3,603   

For the year ending December 31, 2013

   $ 3,833   

For the year ending December 31, 2014

   $ 3,537   

For the year ending December 31, 2015

   $ 3,202   

For the year ending December 31, 2016

   $ 3,104   

 

(9) Employee Benefit Plans:

The components of net periodic benefit cost (income) are as follows (in thousands):

 

Pension Benefits    Three Months Ended     Nine Months Ended  
     September 29,
2012
    October 1,
2011
    September 29,
2012
    October 1,
2011
 

Service cost

   $ 847      $ 673      $ 2,524      $ 2,226   

Interest cost

     1,923        1,726        5,475        5,155   

Expected return on plan assets

     (2,322     (2,121     (6,639     (6,361

Amortization of:

        

Unrecognized net prior service cost

     1        17        4        49   

Unrecognized net actuarial loss

     1,362        839        3,840        2,459   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ 1,811      $ 1,134      $ 5,204      $ 3,528   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

Postretirement Benefits    Three Months Ended     Nine Months Ended  
     September 29,
2012
    October 1,
2011
    September 29,
2012
    October 1,
2011
 

Service cost

   $ 20      $ 14      $ 59      $ 60   

Interest cost

     75        73        213        220   

Amortization of:

        

Unrecognized net prior service credit

     (175     (291     (526     (941

Unrecognized net actuarial gain

     (99     (136     (324     (361

Curtailment gain

     0        0        0        (142
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ (179   $ (340   $ (578   $ (1,164
  

 

 

   

 

 

   

 

 

   

 

 

 

On September 6, 2012, the Company amended a domestic qualified pension plan to allow certain eligible individuals with a vested pension benefit to elect a lump sum payment or an immediate annuity option in settlement of all future pension benefits to which they would otherwise have been entitled. The eligible individuals may elect to participate in this early payment program in the fourth quarter of 2012 with settlement to occur later in the fourth quarter of 2012. The Company will achieve cost certainty for the liability associated with each individual who elects the lump sum payment or immediate annuity option. Depending on the level of acceptance, the Company may incur a fourth quarter 2012 non-cash settlement after-tax charge of between $0.0 million and $4.1 million. The ultimate amount of the settlement charge will be actuarially determined when the election period closes and is associated with the acceleration of the recognition of the accumulated unrecognized actuarial loss. The lump sum payment and annuities will be distributed from the assets of the pension plan.

 

(10) Stock-Based Compensation:

A summary of time vesting restricted stock award information pursuant to the Company’s equity incentive plans for the nine months ended September 29, 2012 is as follows:

 

     Restricted
Stock
    Wtd.
Avg.
Grant
Date
Fair
Value
 

Outstanding at January 1, 2012

     311,237      $ 36.21   

Granted

     107,865      $ 29.74   

Vested

     (112,549   $ 38.01   

Canceled

     (17,775   $ 35.81   
  

 

 

   

 

 

 

Outstanding at September 29, 2012

     288,778      $ 33.12   
  

 

 

   

 

 

 

 

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In addition to restricted stock shown in the above table, in the first three months of 2012, the Company granted performance based restricted stock awards under the Kaydon Corporation 1999 Long Term Stock Incentive Plan (the “Plan”). On the grant date, recipients were granted 34,800 restricted shares, which equal the target award that will vest upon 100 percent achievement of a designated growth rate of earnings performance goal, over a three year performance period, as set out in the award agreement. Partial vesting of a minimum of 50 percent of the target shares will occur in the case of achievement of 50 percent of the performance goal, at 150 percent achievement of the performance goal a maximum award equal to 200 percent of the target award will vest, and at achievement of less than 50 percent of the performance goal all award shares will be forfeited. Vesting will accelerate as to a portion of the restricted shares under certain circumstances upon the death, disability or retirement at or after age 65 of the holder. Awards will otherwise be forfeited if vesting does not occur or the employee leaves the Company. Awards will be fully vested upon a change of control as required by the Plan. The target awards were valued at the weighted average grant date stock price of $35.39. Compensation expense for these awards will be recorded over the three year performance period and will be adjusted as necessary whenever the estimate of the level of achievement of the performance goal is revised. In the second quarter of 2012, the Company granted 23,064 performance based restricted shares which will vest at specified levels similar to those granted in the first quarter 2012 upon achievement of a designated growth rate of earnings performance goal, over a three year performance period which begins in 2013. The target awards were valued at the weighted average grant date stock price of $21.66. Dividends on performance based restricted stock awards are calculated when dividends are paid on common stock and the equivalent value will be paid in common stock on the vesting date based on the number of restricted shares that vest. Compensation expense related to all restricted stock awards was $0.6 million and $2.4 million in the third quarter and first three quarters of 2012, respectively. Compensation expense related to restricted stock awards was $1.1 million and $3.1 million in the third quarter and first three quarters of 2011, respectively.

A summary of stock option information pursuant to the Company’s equity incentive plans for the nine months ended September 29, 2012 is as follows:

 

     Options     Wtd.
Avg.
Ex.
Price
 

Outstanding at January 1, 2012

     619,000      $ 28.33   

Granted

     115,500      $ 24.61   

Canceled

     (30,900   $ 25.95   

Exercised

     (9,100   $ 14.93   
  

 

 

   

 

 

 

Outstanding at September 29, 2012

     694,500      $ 28.01   
  

 

 

   

 

 

 

Exercisable at September 29, 2012

     500,800      $ 29.68   
  

 

 

   

 

 

 

Stock options are granted with an exercise price equal to the closing market price of Company common stock on the date of grant. Options granted become exercisable at the rate of 20 percent or 100 percent per year, commencing one year after the date of grant, and options expire ten years after the date of grant. The fair value of each new option grant is estimated on the date of grant using the Black-Scholes option-pricing model. For options granted in the first nine months of 2012, the option value was determined using the following weighted average assumptions, which represent the expectations of the risk-free interest rate, expected dividend yield, expected life and using historical volatility to project expected volatility:

 

Risk-free interest rate

     1.29

Expected dividend yield

     2.87

Expected life in years

     6.5   

Expected volatility

     36.4

Compensation expense related to stock options was $0.2 million and $1.5 million in the third quarter and first three quarters of 2012, respectively. Compensation expense related to stock options was $0.3 million and $1.0 million in the third quarter and first three quarters of 2011, respectively. The amount recorded in the first three quarters of 2012 included $0.8 million in costs associated with the modification of certain options to reduce the exercise price by the amount of the $10.50 per common share special dividend paid on March 26, 2012. This modification was required due to a February 2012 amendment of the adjustment provision of the Plan to provide for mandatory adjustment of awards, including outstanding awards, subject to compliance with Section 409A under the Internal Revenue Code, upon the occurrence of any dividend or other distribution (whether in the form of cash (other than

 

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regular, quarterly cash dividends), shares, other securities or other property), changes in the capital or shares of capital stock, recapitalization, stock split, reverse stock split, reorganization, merger, consolidation, split-up, spin-off, combination, or exchange of shares or other securities of the Company or other extraordinary transaction or event which effects the shares. Such adjustment is made as appropriate to the number and type of shares subject to the award, or the grant, purchase or exercise price of outstanding awards. Previously such adjustments were permitted but were not required under the Plan. All options granted under the Plan after the February 2012 amendment will require such modification. The weighted average prices in the above table reflect the modification of the prices of each option. An additional $0.2 million of costs associated with the modification of certain options is being recorded over the remaining vesting periods of those options. The fair value of the modification was estimated using a binomial option-pricing model with the following weighted average assumptions, which reflect current expectations of the risk-free interest rate, expected dividend yield, expected life and using historical volatility to project expected volatility:

 

Risk-free interest rate

     1.35

Expected dividend yield

     2.90

Expected remaining contractual life in years

     5.9   

Expected volatility

     35.1

 

(11) Taxes:

The effective tax rate for the three months ended September 29, 2012 equaled 3.3 percent compared to 28.7 percent in the three months ended October 1, 2011. The difference between the U.S. federal statutory income tax rate and the Company’s effective tax rate is due primarily to the effects of the wind restructuring impairment, severance, and other charges as more fully described in Note 16, as many of the impaired assets are owned by entities domiciled in lower effective tax rate jurisdictions, and is also due to foreign earnings in jurisdictions with lower tax rates than in the U.S.

 

(12) Acquisitions:

On April 8, 2011, the Company completed the purchase of all of the outstanding shares of HAHN-Gasfedern GmbH and related real estate and intangible property (“Hahn”) from Ulrich Hahn e.K. Hahn, based in Aichwald, Germany, manufactures and sells high quality gas springs, tension springs and dampers for diverse industrial markets. Hahn’s results are included in the Velocity Control Products reporting segment.

On June 5, 2012, the Company completed the acquisition of all of the outstanding shares of Fabreeka Group Holdings, Inc. (“Fabreeka”) for cash consideration of approximately $53 million. Fabreeka, based in Stoughton, Massachusetts, is a leading provider of engineered vibration-isolation and shock-control products, including isolation pads, isolation mounts and highly engineered vibration solutions. Fabreeka’s products control unwanted shock vibration to help reduce wear, maintenance costs and down time for its customers, serving a diverse customer base across numerous end-markets, such as test and measurement, industrial machinery, manufacturing, precision equipment and aerospace and defense. Fabreeka’s results are included in the Velocity Control Products segment. Final purchase price adjustments, including a customary working capital adjustment, are expected to be completed in the fourth quarter of 2012.

 

(13) Fair Value Measurement:

Except for wind energy related production assets which are valued in level three of the fair value hierarchy subsequent to their write down to fair value or fair value less costs to sell, as more fully described in Note 16, the Company had no material non-financial assets or liabilities recorded at fair value at September 29, 2012. The fair value of the Company’s debt approximated the carrying value and the carrying value is repayable at par at any time.

 

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(14) Impact of Recently Issued Accounting Pronouncements:

New accounting guidance was issued in 2011 to require more prominent disclosure of Comprehensive Income. The Company adopted this guidance and now includes the Consolidated Statements of Comprehensive Income to present net income, items of other comprehensive income and total comprehensive income as allowed under this guidance.

 

(15) Other Matters:

At June 30, 2012, the Company had approximately $8.3 million of working capital, or $3.8 million after reserves, invested on behalf of an international wind energy customer. This included past due accounts receivable and inventory manufactured on the customer’s behalf and designed to its agreed upon specifications. The customer had not paid the Company and had made a claim for material damages alleging that certain field performance issues of its product were attributable to the quality of the supplied bearings. The Company agreed with the customer to enter into a mediation process, and if necessary, binding arbitration to resolve the parties’ claims. The mediation process was completed in March 2010, but was unsuccessful in resolving the matter. During the second quarter of 2010, a notice of binding arbitration was filed. An arbitration tribunal was selected in the third quarter of 2010 and the hearing phase of the arbitration process was conducted in November 2011. With the completion of the arbitration hearings and the absence of a settlement, the sale of the inventory was not expected in the ordinary course of business. Accordingly, in the fourth quarter of 2011, the Company reserved $4.1 million for the write down of the value of the inventory to scrap value. With regard to the customer’s claim for material damages, given the inherent uncertainty of the arbitration process, the substantial volume of evidence and testimony provided since commencement of the arbitration, and the complexity of the legal analysis involved, the Company believed that it was reasonably possible, but not probable, that the arbitrators would give credence to a portion of the customer’s claims and that a loss had been incurred. However, due to these uncertainties and complexities, the Company was unable to make an estimate of a reasonably possible loss or range of loss prior to the final decision of the arbitration tribunal.

On September 14, 2012, the arbitration tribunal issued its binding executed final award. While the tribunal noted that, for the most part, the Company successfully defended the substantial damages claim brought against it, the tribunal awarded the customer $4.4 million for recovery of replacement costs of a portion of the bearings supplied by the Company. The tribunal rejected the Company’s claim for the recovery of inventory costs and lost profits. As noted above, the related inventory had been written down to scrap value at December 31, 2011. The tribunal also awarded the Company $3.9 million related to the accounts receivable owed by the customer to the Company. As a result of the arbitration award, in the third quarter of 2012 the Company recorded a total net charge of $4.0 million related to the ruling which consisted of a $4.4 million charge to cost of sales for the replacement costs, and a reversal of $0.4 million of the previously recorded accounts receivable reserve which was recorded as a reduction in selling, general and administration expense. The Company paid $0.5 million to the customer early in the fourth quarter of 2012 in accordance with the terms of the executed final award. This matter is within the Friction Control Products segment.

 

(16) Wind Restructuring:

In the third quarter of 2012, the Company completed a comprehensive evaluation of its wind energy bearings business to align capacity with expected future market needs and determined to restructure this line of business. The decision to restructure this line of business is a response to current and expected conditions in the wind and military markets resulting from the effects of the global financial crisis, worldwide fiscal austerity, the emergence of new shale gas extraction techniques and continued regulatory uncertainty in the United States including the expected expiration of the federal Production Tax Credit on December 31, 2012. Based on the Company’s evaluation and decision to restructure this line of business, the Company determined that there were indicators of potential impairment to the carrying value of certain assets that became held for sale at September 28, 2012, and the ongoing value of certain long-lived assets to be held and used. The Company performed a recoverability test, assessed the fair value of the assets and determined that the carrying values of certain assets were no longer recoverable and were in fact impaired. The restructuring includes (i) the non-cash impairment of wind energy production equipment in Monterrey, Mexico and Sumter, South Carolina, certain portions of which will be held for sale and certain portions of which will be held and used to service select wind energy customers; (ii) the consolidation of one of the Company’s three facilities in Sumter, South Carolina, previously devoted to the wind energy and military ground vehicle markets, into other Company operations; and (iii) workforce reductions and realignments in those facilities. In addition, the Company expects to incur costs associated with the shutdown of the Sumter facility and transition costs related to the relocation of certain production capacity. The Company expects that the restructuring will be substantially complete by the end of 2013, subject to continuing efforts to sell equipment and the Sumter, South Carolina facility noted above.

 

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The Company therefore recorded a pre-tax non-cash impairment charge of $43.0 million associated with the wind restructuring. This charge included the reduction of the carrying cost to fair value, less costs to sell, for assets held for sale at September 29, 2012. These held for sale assets include equipment used in the manufacturing of large diameter bearings principally used in the wind energy business. The value of the assets held for sale, which had a net book value of $31.5 million, were written down to fair value, less costs to sell, and are recorded on the balance sheet at a value of $6.5 million. The charge also included the impairment to fair value of certain other equipment used in the manufacturing of large diameter bearings which continues to be held and used. The Company, with the assistance of a third party valuation firm, determined that the market approach was the most appropriate to estimate fair value using comparable sales data when available, or market derived valuation curves where comparable sales data was not available. For building related personal property assets and large over-head cranes, the fair value was determined based on the estimated salvage value. The assets to be held and used, which had a net book value of $22.8 million, were written down to the assets’ fair value of $4.8 million and remain on the balance sheet in property, plant and equipment, net. The Company also recorded a $1.1 million charge to cost of sales associated with the write down of certain inventory associated with the wind energy business, and a $1.3 million charge to selling, general and administrative expenses associated with the write down of certain accounts receivables associated with the wind energy business. The Company will evaluate the fair value of the held for sale assets each quarter, and may incur gains or losses due to changes in the fair value of the assets until they are sold. In addition, each quarter the Company will monitor the assets to be held and used for changes in market conditions that could require additional impairment tests and potentially additional future impairment charges.

The Company recorded in selling, general and administrative expenses severance costs of approximately $0.4 million in the third quarter of 2012, paid $0.2 million of the severance in the third quarter of 2012 and expects to pay the remaining $0.2 million in the fourth quarter of 2012. The non-cash asset impairment charges are expected to result in future cash expenditures of approximately $0.5 million.

In connection with the shutdown of the Sumter facility noted above, the Company expects to incur approximately $2 million to $3 million in equipment relocation costs, employee relocation, employee separation and relocated equipment startup costs during fiscal years 2012 and 2013. The wind restructuring is within the Friction Control Products segment.

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Overview

Kaydon Corporation is a leading designer and manufacturer of custom engineered, performance-critical products, supplying a broad and diverse group of alternative energy, military, industrial, aerospace, medical and electronic equipment, and aftermarket customers. Demand for our products depends, in part, upon a wide range of general economic conditions, which affect our markets in varying ways from quarter to quarter.

During the third quarter of 2012, we announced a comprehensive restructuring of our wind energy bearings business to realign capacity with expected future market needs. The decision to restructure this line of business is a response to current and expected conditions in the wind and military markets resulting from the effects of the global financial crisis, worldwide fiscal austerity, the emergence of new shale gas extraction techniques and continued regulatory uncertainty in the United States including the expected expiration of the federal Production Tax Credit on December 31, 2012. As a result of this decision, we recorded a $46.0 million pre-tax charge which included the impairment of assets, severance and other charges. In addition, a net charge of $4.0 million was incurred during the quarter related to the conclusion of a customer arbitration issue. The restructuring includes (i) the non-cash impairment of wind energy production equipment in Monterrey, Mexico and Sumter, South Carolina, certain portions of which will be held for sale and certain portions of which will be held and used to service select wind energy customers; (ii) the consolidation of one of our three facilities in Sumter, South Carolina, previously devoted to the wind energy and military ground vehicle markets, into our other operations; and (iii) workforce reductions and realignments in those facilities. In addition, we expect to incur costs associated with the shutdown of the Sumter facility and transition costs related to the relocation of certain production capacity. We expect that the restructuring will be substantially complete by the end of 2013, subject to continuing efforts to sell equipment and the Sumter, South Carolina facility noted above.

During the second quarter of 2012 we acquired Fabreeka Group Holdings, Inc. (“Fabreeka”) for approximately $53 million. Fabreeka is a leading provider of engineered vibration isolation and shock control products serving a diverse customer base across numerous end markets including test and measurement, industrial machinery, manufacturing, precision equipment and aerospace and defense. The acquisition was financed with $50.0 million of borrowings under the $250.0 million 2012 credit agreement and available cash.

During the first quarter of 2012, we completed the recapitalization of the Company. On March 26, 2012, the Company entered into a new $400.0 million credit agreement (the “2012 credit agreement”) with a syndicate of lenders providing for a $150.0 million senior term loan facility which was used to fund a portion of our $10.50 per common share special dividend to shareholders paid on March 26, 2012. The remaining portion of the dividend was funded from our available cash balances. Costs associated with the recapitalization totaled $1.3 million which included non-cash stock option modification costs, the immediate recognition of certain unamortized debt issuance costs associated with our prior credit agreement, and the effect of the special dividend on certain benefit costs.

Our performance in the three months ended September 29, 2012 compared to the three months ended October 1, 2011 reflected the inclusion of the results of Fabreeka, which more than offset lower wind revenues and continued weakness in Europe. The favorable earnings impact of this revenue growth was more than offset by the large wind restructuring and arbitration costs mentioned above.

At September 29, 2012, our current ratio was 4.4 to 1 and net working capital totaled $209.2 million. We believe that our current cash position at quarter end of $52.0 million along with our future cash flows from operations and our borrowing capacity are adequate to fund our operational needs as well as our strategies for future growth, including selected stock repurchases, market share initiatives and corporate development efforts.

In summary, our future performance will be impacted by general economic conditions, national policy steps regarding renewable energy, national budgets for military expenditures, the overall strength of the manufacturing environment, the success of our efforts to continue to expand operations and improve operating efficiencies, as well as the use of available cash and borrowing capacity for future acquisitions.

The discussion that follows should be read in conjunction with the unaudited Consolidated Financial Statements (and the Notes thereto), included elsewhere in this report, and our 2011 Annual Report on Form 10-K, particularly “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations,” to assist in understanding our results of operations, financial position, cash flows, capital structure and other relevant financial information.

 

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Results of Operations

Three Months Ended September 29, 2012 Compared to the Three Months Ended October 1, 2011

 

     Three Months Ended  

Dollars in millions, except per share amounts

   Sept. 29,
2012
    % of
Sales
    Oct. 1,
2011
     % of
Sales
 

Net sales

   $ 123.8        100.0   $ 121.6         100.0

Cost of sales

     87.4        70.5     78.8         64.8
  

 

 

   

 

 

   

 

 

    

 

 

 

Gross profit

     36.5        29.5     42.8         35.2

Selling, general and administrative expenses

     25.0        20.2     22.5         18.5

Impairment charge

     43.0        34.7     0.0      
  

 

 

   

 

 

   

 

 

    

 

 

 

Operating income (loss)

     (31.5     (25.4 )%      20.3         16.7

Interest, net

     (0.9       0.0      
  

 

 

   

 

 

   

 

 

    

 

 

 

Income (loss) before taxes

     (32.4     (26.2 )%      20.3         16.7

Provision for income taxes

     (1.1       5.8      
  

 

 

   

 

 

   

 

 

    

 

 

 

Net income (loss)

   $ (31.3     (25.3 )%    $ 14.5         11.9
  

 

 

   

 

 

   

 

 

    

 

 

 

Earnings (loss) per share:

         

Basic

   $ (0.99     $ 0.45      
  

 

 

     

 

 

    

Diluted

   $ (0.99     $ 0.45      
  

 

 

     

 

 

    

Amounts and percentages in the above table may not total due to rounding.

Net sales for the three months ended September 29, 2012, were $123.8 million, up $2.2 million, or 1.8 percent from $121.6 million for the three months ended October 1, 2011. The increase from the prior year third quarter was a result of a 4.3 percent increase in volume, which was partially offset by a 0.2 percent decrease in price and a $2.7 million unfavorable impact from changes in foreign exchange rates. The sales volume increase from the prior year was primarily a result of the inclusion of the results of Fabreeka, which more than offset lower wind revenues and continued weakness in Europe.

Gross profit for the third quarter of 2012 declined $6.4 million from the third quarter of 2011. Gross profit comparisons were negatively impacted by some unusual, non-recurring charges including: $4.4 million of arbitration costs, wind restructuring charges of $1.3 million and purchase accounting costs of $0.2 million. In addition, unfavorable sales mix of $0.8 million, lower cost absorption due to a reduction in inventories of $1.1 million, a negative impact from changes in foreign exchange rates of $1.1 million, and lower pricing of $0.3 million also negatively impacted the gross profit comparison. These negative items were only partially offset by the favorable impact of increased sales volume of $2.9 million.

Selling, general and administrative expenses were $25.0 million or 20.2 percent of sales in the third quarter of 2012, compared to $22.5 million or 18.5 percent of sales in the third quarter of 2011. Selling expenses increased $1.2 million compared to the third quarter of 2011 which was primarily due to the addition of the Fabreeka business. General and administrative expenses increased $1.4 million compared to the third quarter of 2011. This increase was comprised of $1.4 million due to the addition of the Fabreeka business and $1.3 million resulted from wind related receivable reserves. These increases were partially offset by $0.4 million of bad debt recoveries related to the arbitration award and a decrease in professional services costs of $1.1 million.

Impacted by matters discussed above related to our wind energy bearings business, our operating loss was $31.5 million in the third quarter of 2012, compared to operating income of $20.3 million or 16.7 percent of sales in the third quarter of 2011.

During the third quarter of 2012, net interest expense was $0.9 million, compared to negligible net interest expense for the third quarter of 2011. The increase in interest expense relates to interest on debt incurred for our first quarter 2012 recapitalization and the financing of the Fabreeka acquisition. As of September 29, 2012, a balance of $146.3 million was outstanding on our term loan and $50.0 million was outstanding under our revolving credit facility.

The effective tax rate for the three months ended September 29, 2012 was 3.3 percent compared to 28.7 percent in the three months ended October 1, 2011. The low current quarter tax rate primarily relates to minimal tax benefits associated with the wind asset impairment and restructuring charges. Excluding these items, the effective tax rate for the quarter was 26.7 percent.

 

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The Company incurred a net loss for the third quarter of 2012 of $31.3 million, or $0.99 per share on a diluted basis, compared to net income for the third quarter of 2011 of $14.5 million, or $0.45 per share on a diluted basis.

Nine Months Ended September 29, 2012 Compared to the Nine Months Ended October 1, 2011

 

     Nine Months Ended  

Dollars in millions, except per share amounts

   Sept. 29,
2012
    % of
Sales
    Oct. 1,
2011
     % of
Sales
 

Net sales

   $ 364.7        100.0   $ 352.0         100.0

Cost of sales

     245.6        67.3     226.4         64.3
  

 

 

   

 

 

   

 

 

    

 

 

 

Gross profit

     119.1        32.7     125.6         35.7

Selling, general and administrative expenses

     72.8        20.0     67.4         19.1

Impairment charge

     43.0        11.8     
  

 

 

   

 

 

   

 

 

    

 

 

 

Operating income

     3.3        0.9     58.3         16.6

Interest, net

     (1.9       0.1      
  

 

 

   

 

 

   

 

 

    

 

 

 

Income before taxes

     1.4        0.4     58.4         16.6

Provision for income taxes

     8.9          17.7      
  

 

 

   

 

 

   

 

 

    

 

 

 

Net income (loss)

   $ (7.5     (2.1 )%    $ 40.7         11.5
  

 

 

   

 

 

   

 

 

    

 

 

 

Earnings (loss) per share:

         

Basic

   $ (0.24     $ 1.25      
  

 

 

     

 

 

    

Diluted

   $ (0.24     $ 1.25      
  

 

 

     

 

 

    

Amounts and percentages in the above table may not total due to rounding.

Net sales during the first nine months of 2012 increased $12.7 million or 3.6 percent compared to the first nine months of 2011. The increase in net sales was a result of a 4.9 percent increase in volume and a 0.4 percent increase in price which was partially offset by a $6.0 million unfavorable impact from changes in foreign currency exchange rates. The sales volume increase from the prior year was primarily a result of increased wind energy sales, the inclusion of the results of Hahn acquired in April 2011, and Fabreeka acquired in June 2012, which more than offset a decrease in sales of products serving industrial markets.

Gross profit for the first nine months of 2012 of $119.1 million decreased $6.6 million from the first nine months of 2011. The favorable impact of increased sales volume of $8.6 million and decreased manufacturing restructuring charges of $0.5 million were more than offset by unfavorable sales mix of $4.1 million, $4.4 million of arbitration costs, decreased cost absorption of $3.7 million due to a reduction in inventories, an unfavorable effect from changes in foreign exchange rates of $2.2 million, a $1.3 million inventory write off and an increase in non-cash amortization of previously incurred net actuarial losses related to postretirement benefit plans of $0.8 million.

Selling, general and administrative expenses were $72.8 million or 20.0 percent of sales during the first nine months of 2012, compared to $67.4 million or 19.1 percent of sales in the first nine months of 2011. Selling expenses increased $2.9 million compared to the first nine months of 2011 of which $1.9 million was due to the additions of Hahn and Fabreeka and $0.9 million was primarily related to costs associated with the Company’s focused global sales and marketing initiatives. General and administrative expenses in the first nine months of 2012 increased $2.5 million from the prior year, which was primarily due to the additions of Hahn and Fabreeka. In addition, other increases included: one-time costs associated with the Company’s 2012 recapitalization of $1.1 million, increased restructuring charges of $1.3 million, increased non-cash amortization costs of previously incurred net actuarial losses related to postretirement benefit plans of $0.6 million and increased acquisition related and due diligence costs of $0.3 million. These increases were partially offset by a decrease in arbitration costs of $1.3 million, decreased incentive compensation accruals of $1.3 million and $0.7 million of income associated with an insurance claim recovery.

Impacted by matters discussed above related to our wind energy bearings business, our operating income was $3.3 million or 0.9 percent of sales in the first nine months of 2012, as compared to $58.3 million or 16.6 percent of sales in the first nine months of 2011.

Net interest during the first nine months of 2012 was $1.9 million of expense compared to $0.1 million of income in the first nine months of 2011. Current year-to-date interest expense of $2.1 million was partially offset by $0.2 million of interest income. This compares to $0.3 million of interest expense which was offset by $0.4 million of

 

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interest income for the first nine months of the prior year. The increase in interest expense relates to interest on borrowings to fund our first quarter 2012 recapitalization and the Fabreeka acquisition. As of September 29, 2012, we had outstanding borrowings of $50.0 million under our revolving credit facility and a $146.3 million balance under the term loan facility.

The effective tax rate for the first nine months of 2012 was an extraordinarily high percent compared to 30.4 percent in the first nine months of 2011, due to the minimal tax benefits associated with our current quarter wind asset impairment and restructuring charges. Excluding these items, the effective year to date tax rate was 28.6 percent which is lower than the prior year primarily due to a decrease in taxes on foreign earnings.

We incurred a net loss the first nine months of 2012 of $7.5 million, or $0.24 per share on a diluted basis, as compared to net income for the first nine months of 2011 of $40.7 million, or $1.25 per share on a diluted basis.

Results of Business Segments

The Company has two reporting segments: Friction Control Products and Velocity Control Products. The Company’s remaining operating businesses are combined and disclosed as “Other Industrial Products.” Sales between reporting segments are not material. Items not allocated to segment operating income include certain amortization and corporate administrative expenses.

Friction Control Products

 

     Three Months Ended     Nine Months Ended  

Dollars in millions

   Sept. 29,
2012
    Oct. 1,
2011
    %
Change
    Sept. 29,
2012
    Oct. 1,
2011
    %
Change
 

Sales

   $ 66.7      $ 69.9        (4.5 )%    $ 204.0      $ 196.5        3.8

Operating income (loss)

   $ (40.5   $ 11.1        nm      $ (18.5   $ 32.5        nm   

Operating margin

     (60.7 )%      15.9       (9.1 )%      16.5  

Three Months Ended September 29, 2012 Compared to the Three Months Ended October 1, 2011

During the three months ended September 29, 2012, sales from our Friction Control Products reporting segment totaled $66.7 million, a decrease of $3.2 million compared to the three months ended October 1, 2011. The decrease was a result of a 4.8 percent decrease in sales volume and a $0.4 million unfavorable effect of changes in foreign currency exchange rates which was only partially offset by increased prices of 1.0 percent. The sales decrease was primarily due to decreased wind energy shipments.

The third quarter of 2012 operating margin was a negative 60.7 percent, and declined significantly from 15.9 percent for the three months ended October 1, 2011. This large decrease in margin was primarily the result of the $46.0 million of wind energy restructuring charges and $4.0 million in charges related to the conclusion of the previously discussed customer arbitration. In addition, the effects of decreased volume and decreased cost absorption due to a reduction in inventories also negatively impacted results.

Nine Months Ended September 29, 2012 Compared to the Nine Months Ended October 1, 2011

During the nine months ended September 29, 2012, sales from our Friction Control Products reporting segment totaled $204.0 million, an increase of $7.5 million compared to the nine months ended October 1, 2011. The increase was a result of a 3.1 percent increase in sales volume and increased pricing of 1.3 percent, partially offset by a $1.1 million unfavorable effect of changes in foreign currency exchange rates. The sales increases were primarily in the wind energy and military markets which more than offset decreased sales to the semiconductor, medical and machinery markets.

During the first nine months of 2012, the operating margin was a negative 9.1 percent, and declined significantly from 16.5 percent for the first nine months ended October 1, 2011. This large decrease in margin was primarily the result of the $46.0 million of wind energy restructuring charges and $4.0 million in charges related to the conclusion of the customer arbitration. In addition, unfavorable sales mix and decreased cost absorption due to a reduction in inventories more than offset the increased pricing and income associated with an insurance recovery.

 

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Velocity Control Products

 

     Three Months Ended     Nine Months Ended  

Dollars in millions

   Sept. 29,
2012
    Oct. 1,
2011
    %
Change
    Sept. 29,
2012
    Oct. 1,
2011
    %
Change
 

Sales

   $ 29.9      $ 24.4        22.5   $ 78.7      $ 69.3        13.4

Operating income

   $ 6.6      $ 6.1        9.6   $ 18.2      $ 17.8        2.4

Operating margin

     22.2     24.8       23.1     25.6  

Three Months Ended September 29, 2012 Compared to the Three Months Ended October 1, 2011

During the three months ended September 29, 2012, sales from our Velocity Control Products reporting segment were $29.9 million, an increase of $5.5 million compared to the three months ended October 1, 2011. The increase in sales was the result of a 31.7 percent increase in volume which was partially offset by $2.3 million unfavorable effect of changes in foreign currency exchange rates. The volume increase was primarily the result of the contribution from acquired businesses.

The third quarter of 2012 operating margin of 22.2 percent was down 2.6 percentage points from the 24.8 percent for the three months ended October 1, 2011. The lower margin was primarily due to unfavorable mix, the unfavorable effect from changes in foreign currency exchange rates and purchase accounting costs.

Nine Months Ended September 29, 2012 Compared to the Nine Months Ended October 1, 2011

During the nine months ended September 29, 2012, sales from our Velocity Control Products reporting segment were $78.7 million compared to $69.3 million for the nine months ended October 1, 2011. The increase in sales was the result of an 18.8 percent increase in volume and increased pricing of 1.7 percent which was partially offset by a $4.9 million unfavorable effect of changes in foreign currency exchange rates. The volume increase was primarily due to the results of acquired businesses which more than offset decreased volume in our international markets.

During the first nine months of 2012, the operating margin of 23.1 percent declined 2.5 percentage points from 25.6 percent for the first nine months ended October 1, 2011. The lower margin was primarily a result of unfavorable sales mix, the effect of changes in foreign currency exchange rates, increased selling costs related to the Company’s focused global sales and marketing initiatives, and increased purchase accounting costs.

Other Industrial Products

 

     Three Months Ended     Nine Months Ended  

Dollars in millions

   Sept. 29,
2012
    Oct. 1,
2011
    %
Change
    Sept. 29,
2012
    Oct. 1,
2011
    %
Change
 

Sales

   $ 27.3      $ 27.4        (0.4 )%    $ 82.0      $ 86.1        (4.8 )% 

Operating income

   $ 2.7      $ 2.9        (8.5 )%    $ 7.6      $ 9.9        (22.8 )% 

Operating margin

     9.9     10.7       9.3     11.5  

Three Months Ended September 29, 2012 Compared to the Three Months Ended October 1, 2011

Third quarter 2012 sales of our remaining businesses, which are combined and shown above as Other Industrial Products, totaled $27.3 million and were essentially flat compared to $27.4 million in the third quarter of 2011. The slight reduction in sales was a result of lower prices of 3.4 percent principally in our metal alloys business primarily offsetting a 3.0 percent increase in volume.

The operating margin for the three months ended September 29, 2012 of 9.9 percent declined 0.8 percentage points from 10.7 percent for the three months ended October 1, 2011. The decrease was primarily due to lower prices in our metal alloys business and which were only partially offset by cost reductions.

 

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Nine Months Ended September 29, 2012 Compared to the Nine Months Ended October 1, 2011

Sales for the first nine months of 2012 for our remaining businesses, which are combined and shown above as Other Industrial Products, totaled $82.0 million, compared to $86.1 million in the first nine months of 2011. The reduction in sales was a result of a 2.0 percent decrease in volume and decreased pricing of 2.8 percent.

The operating margin for the nine months ended September 29, 2012 of 9.3 percent declined 2.2 percentage points from 11.5 percent for the nine months ended October 1, 2011. The decrease was primarily due to decreased volume, decreased prices and unfavorable mix which were only partially offset by cost reductions.

Liquidity and Capital Resources

Kaydon’s primary capital requirements are to fund our operations, including working capital and capital expansion/improvements as well as to fund our strategies for future growth and increased shareholder value, including market share initiatives and business development activities. We will continue to invest in growth opportunities while continuously focusing on working capital and operational efficiencies. In addition, we expect to service our debt with cash generated from operations.

At September 29, 2012, the Company’s current ratio was 4.4 to 1 and working capital totaled $209.2 million, including $52.0 million of cash and cash equivalents. At December 31, 2011, the current ratio was 8.7 to 1 and working capital totaled $381.1 million, including cash and cash equivalents of $225.2 million. The reduction in working capital was primarily a result of a $336.1 million payment on March 26, 2012 for a special dividend of $10.50 per common share which was in part funded by $186.1 million in cash. This was partially offset by a $15.0 million increase in accounts receivable due primarily to increased sales.

Net cash from operating activities during the first nine months of 2012 was $49.2 million, compared to the first nine months of 2011 net cash from operating activities of $35.3 million. The increase was primarily due to the fact that the increase in receivables, inventory and payables in the first nine months of 2012 was $22.9 million smaller versus the comparable increase in the first nine months of 2011. This was partially offset by an increase in contributions to our qualified pension plans.

Net inventories at September 29, 2012 were $108.1 million, a decrease of $2.1 million compared to the $110.2 million of inventory at December 31, 2011, and a decrease of $6.3 million compared to June 30, 2012. Inventory turns at September 29, 2012 were 3.2, compared to 2.9 turns at October 1, 2011.

We closely monitor our accounts receivable and are reasonably assured that the net amount is fully collectible. Additionally, we believe that our inventory at September 29, 2012 is fully realizable.

During the third quarter of 2012, we paid regular cash dividends of $6.4 million compared to $6.1 million in the three months ended October 1, 2011, reflecting an increased dividend rate of $0.20 per common share paid in the third quarter of 2012 compared to $0.19 per common share paid in the third quarter of 2011. Regular dividends for the first nine months of 2012 totaled $19.2 million compared to $18.7 million for the first nine months of 2011. In addition, a special dividend of $10.50 per common share was paid in the first quarter of 2012 which totaled $336.1 million. There were no share repurchases in the third quarter of 2012. Share repurchases in the third quarter of 2011 totaled 205,000 shares for $6.6 million. First nine months of 2012 share repurchases totaled 36,742 shares for $1.2 million compared to 947,091 shares for $34.7 million in the first nine months of 2011. We expect that our planned capital requirements, which consist of capital expenditures, dividend payments and our stock repurchase program, will be financed by operations and existing cash balances. In addition, we believe that our available cash and borrowing capacity will be sufficient to support our growth objectives, including strategic acquisitions.

On March 26, 2012, we terminated our former 2010 credit agreement and entered into a new $400.0 million credit agreement (the “2012 credit agreement”) with a syndicate of lenders providing for a $150.0 million senior term loan facility, which the Company borrowed to fund a portion of its $10.50 per common share special dividend paid to shareholders on March 26, 2012. Under the provisions of the 2012 credit agreement, the Company is required to repay the term loan in quarterly installments of $1,875,000 each quarter from June 2012 to March 2013, $2,812,500 per quarter from June 2013 to March 2014, and $3,750,000 each quarter from June 2014 to March 2016, with the balance due on March 27, 2017. The Company expects to service this obligation through cash generated from operations over the term of the 2012 credit agreement. The 2012 credit agreement also provides for a $250.0 million

 

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senior revolving credit facility. The revolving credit facility provides for borrowings by the Company and our subsidiaries for working capital and other general corporate purposes, including acquisitions. The 2012 credit agreement requires us to comply with maximum leverage and minimum interest coverage ratios. We were in compliance with all restrictive covenants contained in the 2012 credit agreement at September 29, 2012. On June 5, 2012, we borrowed $50.0 million under the senior revolving credit agreement to fund our acquisition of Fabreeka. Taking into account the borrowings under the revolving credit agreement and $3.2 million of letters of credit issued under the 2012 credit agreement, we had availability under the 2012 credit agreement of $196.8 million at September 29, 2012.

Outlook

While the current quarter restructuring addresses certain sector specific concerns associated with our wind and military businesses, we still see economic uncertainty and softness around the world. Europe continues to be impacted by its own macroeconomic issues while growth in Asia has become increasingly challenging in recent months. That said, non-wind incoming orders during the most recent quarter were healthy as many of our traditional markets, including heavy equipment, medical and military, experienced gains. While we wait for a more balanced and sustained improvement in business conditions, a reprioritized focus on our powerful industrial brands, and the enhanced operating leverage we expect to experience, should serve us well.

Critical Accounting Policies and Estimates

Our consolidated financial statements are prepared in conformity with U.S. generally accepted accounting principles. The preparation of these financial statements requires the use of estimates, judgments, and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented.

We continually evaluate the estimates, judgments, and assumptions used to prepare the consolidated financial statements. In general, these estimates are based on historical experience, on information from first party professionals and on various other judgments and assumptions that are believed to be reasonable under the current facts and circumstances. Actual results could differ from our current estimates. Our critical accounting policies and estimates are discussed in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the year ended December 31, 2011. There have been no material changes to the critical accounting policies disclosed in that report.

Forward-Looking Statements

This Form 10-Q contains forward-looking statements within the meaning of the Securities Exchange Act of 1934 regarding our plans, expectations, estimates and beliefs. Forward-looking statements are typically identified by words such as “believes,” “anticipates,” “estimates,” “expects,” “intends,” “will,” “may,” “should,” “could,” “potential,” “projects,” “approximately,” and other similar expressions, including statements regarding pending litigation, general economic conditions, competitive dynamics and the adequacy of capital resources. These forward-looking statements may include, among other things, projections of our financial performance, anticipated growth, characterization of and our ability to control contingent liabilities and anticipated trends in our businesses. These statements are only predictions, based on our current expectation about future events. Although we believe the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, performance or achievements or that our predictions or current expectations will be accurate. These forward-looking statements involve risks and uncertainties that could cause our actual results, performance or achievements to differ materially from those expressed or implied by the forward-looking statements.

In addition, we or persons acting on our behalf may from time to time publish or communicate other items that could also be construed to be forward-looking statements. Statements of this sort are or will be based on our estimates, assumptions, and projections and are subject to risks and uncertainties that could cause actual results to differ materially from those included in the forward-looking statements. We do not undertake any responsibility to update our forward-looking statements or risk factors to reflect future events or circumstances.

 

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

The Company is exposed to certain market risks which exist as part of the Company’s ongoing business operations including interest rates and foreign currency exchange rates. The exposure to market risk for changes in interest rates relates primarily to our outstanding debt which is at a floating interest rate, currently LIBOR plus an applicable margin. A 10 percent increase in the weighted average interest rates paid by the Company would not have a material impact on the Company’s pre-tax earnings. The Company conducts business in various foreign currencies, primarily in Europe, Mexico, and Asia. Therefore, changes in the value of currencies of countries in these regions affect the Company’s financial position and cash flows when translated into U.S. dollars. The Company has mitigated and will continue to mitigate a portion of the Company’s currency exposure through operation of decentralized foreign operating companies in which many costs are local currency based. In addition, the Company periodically enters into derivative financial instruments in the form of forward foreign exchange contracts to reduce the effect of fluctuations in foreign exchange rates. A 10 percent change in the value of all foreign currencies would not have a material effect on the Company’s financial position and cash flows.

 

ITEM 4. CONTROLS AND PROCEDURES.

Kaydon’s management is responsible for establishing and maintaining effective disclosure controls and procedures, as defined under Rule 13a-15(e) of the Securities Exchange Act of 1934. As of the end of the period covered by this report, the Company performed an evaluation, under the supervision and with the participation of the Company’s management, including its principal executive and principal financial officers, of the effectiveness of the Company’s disclosure controls and procedures. Based upon that evaluation, the Company’s principal executive and principal financial officers concluded that the Company’s disclosure controls and procedures were effective to ensure that information required to be disclosed by the Company in the reports that it files or submits to the Securities and Exchange Commission under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Commission’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. No changes were made to the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) during the last fiscal quarter that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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ITEM 6. EXHIBITS.

 

Exhibit
No.

  

Description

  31.1    Certification Pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
  31.2    Certification Pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
  32    Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101    Interactive Data File

 

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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.

 

   

KAYDON CORPORATION

October 26, 2012    

/s/ Timothy J. Heasley

    Timothy J. Heasley
    Senior Vice President, Chief Financial Officer
October 26, 2012    

/s/ Laura M. Kowalchik

    Laura M. Kowalchik
    Vice President, Chief Accounting Officer

 

26