UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended March 31, 2005
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 1-5356
PENN ENGINEERING & MANUFACTURING CORP.
--------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 23-0951065
------------------------------- --------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
P.O. Box 1000, Danboro, Pennsylvania 18916
(Address of principal executive offices) (Zip Code)
(215)-766-8853
(Registrant's telephone number, including area code)
N/A (Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all documents and
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the last practicable date: 3,350,164 shares of Class A
common stock, $.01 par value, and 14,507,438 shares of common stock, $.01 par
value, outstanding on April 29, 2005.
PART 1. FINANCIAL INFORMATION
Item 1. Financial Statements
PENN ENGINEERING & MANUFACTURING CORP.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
ASSETS
(unaudited)
March 31, December 31,
CURRENT ASSETS 2005 2004
--------- ---------
Cash and cash equivalents $ 32,179 $ 32,893
Short-term investments 222 225
Accounts receivable - net 44,755 37,138
Inventories - net 48,002 46,731
Refundable income taxes -- 1,410
Other current assets 2,916 3,120
--------- ---------
Total current assets 128,074 121,517
--------- ---------
PROPERTY
Property, plant and equipment 194,374 194,631
Less accumulated depreciation 111,618 109,872
--------- ---------
Property - net 82,756 84,759
--------- ---------
GOODWILL 43,957 45,090
--------- ---------
PREPAID PENSION COST 296 1,315
--------- ---------
OTHER ASSETS 764 800
--------- ---------
TOTAL ASSETS $ 255,847 $ 253,481
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 8,194 $ 8,135
Bank debt 1,531 1,664
Dividends payable -- 1,249
Accrued expenses:
Profit sharing 1,192 1,490
Payroll and commissions 4,337 3,887
Other 7,113 5,310
--------- ---------
Total current liabilities 22,367 21,735
--------- ---------
DEFERRED INCOME TAXES 11,953 12,169
--------- ---------
LONG-TERM BANK DEBT 2,379 2,819
--------- ---------
STOCKHOLDERS' EQUITY
Common stock 153 153
Class A common stock 35 35
Additional paid-in capital 47,447 47,354
Retained earnings 167,419 162,590
Accumulated other comprehensive income 10,180 12,712
Treasury stock (6,086) (6,086)
--------- ---------
Total stockholders' equity 219,148 216,758
--------- ---------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 255,847 $ 253,481
========= =========
See Notes to Condensed Consolidated Financial Statements
2
PENN ENGINEERING & MANUFACTURING CORP.
STATEMENTS OF CONDENSED CONSOLIDATED INCOME
(Dollars in thousands except per share amounts)
THREE MONTHS ENDED
(unaudited)
March 31, March 31,
2005 2004
-------- --------
Net Sales $ 63,832 $ 63,307
Cost of Products Sold 40,684 40,785
-------- --------
Gross Profit 23,148 22,522
Selling Expenses 6,226 6,409
General and Administrative Expenses 8,754 7,371
-------- --------
Operating Income 8,168 8,742
Other Income (Expense):
Interest income 89 49
Interest expense (49) (96)
Other, net (588) (128)
-------- --------
Total Other (Expense) Income (548) (175)
Income Before Income Taxes 7,620 8,567
Provision for Income Taxes 2,790 2,700
-------- --------
Net Income $ 4,830 $ 5,867
======== ========
PER SHARE DATA:
Basic earnings $ 0.27 $ 0.33
======== ========
Diluted earnings $ 0.27 $ 0.33
======== ========
Cash dividends declared $ -- $ 0.06
======== ========
See Notes to Condensed Conso6lidated Financial Statements
3
PENN ENGINEERING & MANUFACTURING CORP.
STATEMENTS OF CONDENSED CONSOLIDATED CASH FLOWS
(Dollars in thousands)
THREE MONTHS ENDED
(unaudited)
March 31, March 31,
2005 2004
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 4,830 $ 5,867
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 2,524 2,650
Deferred income taxes (1) 1
Foreign currency transaction losses (gains) 81 (4)
(Gain) loss on disposal of property (2) 56
Changes in assets and liabilities:
Increase in receivables (7,938) (6,754)
(Increase) decrease in inventories (1,622) 1,577
Decrease in refundable income taxes 1,410 1,911
Decrease (increase) in other current assets 164 (317)
Decrease in prepaid pension cost 1,019 --
Decrease (increase) in other assets 36 (58)
Increase in accounts payable 231 338
Increase in accrued expenses 2,137 2,443
-------- --------
Net cash provided by operating activities 2,869 7,710
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Property additions (1,700) (473)
Proceeds from disposal of property 10 9
-------- --------
Net cash used in investing activities (1,690) (464)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net bank debt repayments (352) (770)
Dividends paid (1,249) (1,052)
Issuance of common stock 93 606
-------- --------
Net cash used in financing activities (1,508) (1,216)
-------- --------
Effect of exchange rate changes on cash (385) 673
-------- --------
Net (decrease) increase in cash and cash equivalents (714) 6,703
Cash and cash equivalents at beginning of period 32,893 8,361
-------- --------
Cash and cash equivalents at end of period $ 32,179 $ 15,064
======== ========
See Notes to Condensed Consolidated Financial Statements
4
PENN ENGINEERING & MANUFACTURING CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005
Note 1. Condensed Consolidated Financial Statements (Unaudited).
------ -------------------------------------------------------
The accompanying condensed consolidated financial statements
and notes should be read in conjunction with the annual financial statements and
notes thereto included in the Company's Annual Report for the year ended
December 31, 2004. The information contained in this report is unaudited and, in
the opinion of management, reflects all adjustments (which include only normal
recurring adjustments) necessary for a fair presentation of the Company's
condensed consolidated financial position at March 31, 2005 and 2004 and its
condensed consolidated statements of income and cash flows for the three-month
periods then ended. The results of operations for the three months ended March
31, 2005 are not necessarily indicative of the results of operations to be
expected for the year ending December 31, 2005.
Note 2. Inventories.
------ -----------
Substantially all of the Company's domestic fastener
inventories are priced on the last-in, first-out (LIFO) method, at the lower of
cost or market. The remainder of the inventories are priced on the first-in,
first-out (FIFO) method, at the lower of cost or market. Inventories are as
follows:
(Dollars in thousands)
March 31, 2005 December 31, 2004
-------------- -----------------
Raw material $ 3,253 $ 2,802
Tooling 6,354 6,392
Work-in-process 11,724 11,626
Finished goods 26,671 25,911
------- -------
TOTAL $48,002 $46,731
======= =======
If the FIFO method of inventory valuation had been used by the
Company for all inventories, inventories would have been $10,239,000 and
$10,175,000 higher than reported at March 31, 2005 and December 31, 2004,
respectively, and net income would have been $44,000 and $71,000 higher than
reported for the three months ended March 31, 2005 and 2004, respectively.
The inventory is also net of a reserve for obsolete, excess, and slow-moving
inventory of approximately $4,266,000 and $5,136,000 at March 31, 2005 and
December 31, 2004, respectively. Long-term tooling inventory totaling $764,000
at March 31, 2005 and $800,000 at December 31, 2004 is included in Other Assets.
5
Note 3. Bank Debt.
------ ---------
As of March 31, 2005, the Company had four unsecured
line-of-credit facilities available, all of which bear interest at interest rate
options provided in the facilities and are reviewed annually by the banks for
renewal. The facilities are as follows:
o a working capital facility that allows for borrowings of up to
$7,000,000, under which no amounts were outstanding at March
31, 2005;
o a facility that allows for borrowings of up to $15,000,000,
under which no amounts were outstanding at March 31, 2005;
o a facility that permits borrowings of up to $30,000,000, under
which no amounts were outstanding at March 31, 2005; and
o a committed line-of-credit that permits borrowings of up to
$8,000,000, under which no amounts were outstanding at March
31, 2005.
These line of credit facilities require that the Company
comply with certain financial covenants. At March 31, 2005, the Company was in
compliance with all financial covenants under these facilities.
In conjunction with the pending merger of the Company (see
Note 11), the Company's Board of Directors authorized management to terminate
the above working capital facilities and line of credit on May 3, 2005.
In addition to the above domestic line-of-credit facilities,
the Company's subsidiary, PennEngineering Motion Technologies (Europe) S.r.l.,
has two short-term credit facilities under which $936,000 was outstanding at
March 31, 2005. PennEngineering Motion Technologies (Europe) S.r.l. also has an
outstanding mortgage on its building, of which $595,000 is classified as
short-term debt and $2,379,000 is classified as long-term debt at March 31,
2005.
Note 4. Comprehensive Income.
------ --------------------
Total comprehensive income amounted to $2,298,000 and
$6,042,000 for the three months ended March 31, 2005 and 2004, respectively.
Note 5. Accounting for Stock Options.
------ ----------------------------
The Company follows Accounting Principles Board Opinion No. 25
("APB 25"), "Accounting for Stock Issued to Employees" and related
interpretations in accounting for stock options. Under APB 25, if the exercise
price of stock options granted equals or exceeds the market price of the
underlying common stock on the date of grant, no compensation expense is
recognized. Statement of Financial Accounting Standards No. 123 ("SFAS No. 123")
requires pro forma information regarding net income and earnings per share as if
the Company had accounted for its employee stock options under the fair value
method of SFAS No. 123. The fair value of each option granted was estimated on
the date of grant using the Black-Scholes option-pricing model. For purposes of
pro forma disclosures, the estimated fair value of the options is amortized to
expense over the options' vesting period. Had compensation costs for the
6
Company's plans been determined based on the fair value at the grant date for
awards under these plans consistently with the method of SFAS No. 123, the
impact on the Company's results of operations would have been as follows:
THREE MONTHS ENDED
March 31
-------------------------
2005 2004
------- -------
(Dollars in thousands except per share amounts)
Net income as reported $ 4,830 $ 5,867
Pro forma compensation cost, net of tax (257) (353)
------- -------
Pro forma net income $ 4,573 $ 5,514
======= =======
Basic earnings per share:
As reported $0.27 $0.33
Pro forma 0.26 0.31
Diluted earnings per share:
As reported $0.27 $0.33
Pro forma 0.25 0.31
Note 6. Use of Estimates.
------ ----------------
The preparation of financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that may 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 reporting period. Actual results could differ
from those estimates.
Note 7. Components of Net Periodic Pension Cost.
------- ----------------------------------------
Net pension costs included the following components:
THREE MONTHS ENDED
March 31
-------------------------
(Dollars in thousands) 2005 2004
------- --------
Service cost $ 715 $ 720
Interest cost 845 750
Expected return on plan assets (750) (600)
Net amortization and deferral 210 180
------- --------
Net periodic pension cost $ 1,020 $ 1,050
======= ========
7
Note 8. Segment Information.
------ -------------------
(Dollars in thousands)
THREE MONTHS ENDED THREE MONTHS ENDED
------------------------------------------ ---------------------------------------
March 31, 2005 March 31, 2004
------------------------------------------ ---------------------------------------
Fasteners Distribution Motors Fasteners Distribution Motors
Revenues from external $34,986 $15,057 $13,789 $33,608 $17,142 $12,557
customers
Intersegment revenues 9,112 377 8,622 776
Operating income 8,931 1,093 1,291 8,681 1,728 723
A reconciliation of combined operating income for the reportable
segments to consolidated income before income taxes is as follows:
THREE MONTHS ENDED
---------------------
March 31
---------------------
(Dollars in thousands) 2005 2004
------- -------
Total operating income for reportable segments $11,315 $11,132
Unallocated corporate expenses (3,147) (2,390)
Other income (expense) (548) (175)
------- -------
Income before income taxes $ 7,620 $ 8,567
======= =======
8
Note 9. Earnings Per Share Data.
------ -----------------------
The following table sets forth the computation of basic and diluted
earnings per share for the periods indicated.
THREE MONTHS ENDED
March 31
---------------------
(In thousands, except per share data)
2005 2004
------- -------
Basic:
Net income $ 4,830 $ 5,867
Weighted average shares outstanding 17,854 17,557
------- -------
Basic earnings per share $ 0.27 $ 0.33
======= =======
Diluted:
Net income $ 4,830 $ 5,867
======= =======
Weighted average shares outstanding 17,854 17,557
Net effect of dilutive stock options-based on
treasury stock method 257 263
------- -------
Total 18,111 17,820
======= =======
Diluted earnings per share $ 0.27 $ 0.33
======= =======
Note 10. Impact of Recently Issued Accounting Standards.
------- ----------------------------------------------
On December 21, 2004, the Financial Accounting Standards Board
(FASB) issued FASB Staff Position No. FAS 109-2 (FSP No. 109-2), "Accounting and
Disclosure Guidance for the Foreign Earnings Repatriation Provisions within the
American Jobs Creation Act of 2004" (the Jobs Act). FSP No. 109-2 provides
guidance with respect to reporting the potential impact of the repatriation
provisions of the Jobs Act on an enterprise's income tax expense and deferred
tax liability. The Jobs Act was enacted on October 22, 2004, and provides for a
temporary 85% dividends received deduction on certain foreign earnings
repatriated during a one-year period. The deduction would result in an
approximate 5.25% federal tax rate on the repatriated earnings. To qualify for
the deduction, the earnings must be reinvested in the United States pursuant to
a domestic reinvestment plan established by a company's chief executive officer
and approved by a company's board of directors. Certain other criteria in the
Jobs Act must be satisfied as well. FSP No. 109-2 states that an enterprise is
allowed time beyond the financial reporting period to evaluate the effect of the
Jobs Act on its plan for reinvestment or repatriation of foreign earnings. The
Company has not yet completed its evaluation of the impact of the repatriation
provisions of the Jobs Act. Accordingly, as provided for in FSP No. 109-2, the
Company has not adjusted its tax expense or deferred tax liability to reflect
the repatriation provisions of the Jobs Act.
9
In December 2004, the FASB issued SFAS No. 123 (revised 2004),
"Share-Based Payment" (SFAS No. 123(R)), which replaces SFAS No. 123 and
supersedes APB Opinion No. 25. SFAS No. 123(R) requires all share-based payments
to employees, including grants of employee stock options, to be recognized in
the financial statements based on their fair values beginning with the first
interim period after June 15, 2005, with early adoption encouraged. The pro
forma disclosures previously permitted under SFAS No. 123 will no longer be an
alternative to financial statement recognition. Under SFAS No. 123(R), the
Company must determine the appropriate fair value model to be used for valuing
share-based payments, the amortization method for compensation cost and the
transition method to be used at the date of adoption. The permitted transition
methods include either retrospective or prospective adoption. Under the
retrospective option, prior periods may be restated either as of the beginning
of the year of adoption or for all periods presented. The prospective method
requires that compensation expense be recorded for all unvested stock options at
the beginning of the first quarter of adoption of SFAS No. 123(R), while the
retrospective methods would record compensation expense for all unvested stock
options beginning with the first period presented. The Company is currently
evaluating the requirements of SFAS No. 123(R) and expects that adoption of SFAS
No. 123(R) will have a material impact on the Company's consolidated financial
position and consolidated results of operations. The Company has not yet
determined the method of adoption or the effect of adopting SFAS No. 123(R), and
it has not determined whether the adoption will result in amounts that are
similar to the current pro forma disclosures under SFAS No. 123. See Accounting
for Stock Options in Note 5 above.
During the first quarter of 2005, the Securities and Exchange
Commission (the "SEC") approved a new rule for public companies which delays the
adoption of SFAS No. 123(R). The SEC's new rule allows companies to implement
SFAS No. 123(R) at the beginning of their next fiscal year, instead of the next
reporting period, that begins after June 15, 2005. The rule does not change the
accounting required by SFAS No. 123(R); it only changes the dates for compliance
for that standard. The Company expects to adopt SFAS No. 123(R) effective
January 1, 2006.
In November 2004, the FASB issued SFAS No. 151, "Inventory
Costs an Amendment of ARB No. 43, Chapter 4" (SFAS No. 151). SFAS No. 151 amends
the guidance in ARB No. 43, Chapter 4, "Inventory Pricing," to clarify the
accounting for abnormal amounts of idle facility expense, handling costs and
wasted material (spoilage). Among other provisions, the new rule requires that
such items be recognized as current-period charges, regardless of whether they
meet the criterion of "so abnormal" as stated in ARB No. 43. SFAS No. 151 is
effective for fiscal years beginning after June 15, 2005. The Company does not
expect that adoption of SFAS No. 151 will have a material effect on its
consolidated financial position, consolidated results of operations, or
liquidity.
10
Note 11. Merger Agreement.
------- ----------------
On January 17, 2005, the Company entered into a definitive
merger agreement whereby the Company would be acquired by PEM Holding Co., an
affiliate of Tinicum Capital Partners II, L.P. in a cash transaction. Under the
terms of the agreement, stockholders of the Company will receive $18.25 in cash
for each share of the Company's Common Stock and Class A Common Stock. A special
meeting of stockholders has been scheduled for May 24, 2005 to consider and vote
on the proposed merger. The obligations of the parties to the Merger Agreement
to complete the merger are subject to various conditions including PEM Holding
Co. or its wholly owned subsidiary having received the proceeds of a financing
under a signed financing commitment letter. Upon termination of the Merger
Agreement under specified circumstances, the Company has agreed to pay PEM
Holding Co. a termination fee and reimburse certain costs and expenses of PEM
Holding Co.
11
Item 2. Management's Discussion and Analysis of Financial Condition
------ --------------------------------------------------------------
and Results of Operations.
--------------------------
Quarter Ended March 31, 2005 vs. Quarter Ended March 31, 2004
-------------------------------------------------------------
Consolidated net sales for the quarter ended March 31, 2005
were $63.8 million, versus $63.3 million for the quarter ended March 3, 2004.
Net sales to customers outside the United States were $26.5 million for the
quarter ended March 31, 2005 compared to $26.6 million for the quarter ended
March 31, 2004. Net sales for the Fastening Technologies segment for the quarter
ended March 31, 2005 were $35.0 million, versus $33.6 million for the quarter
ended March 31, 2004, a 4.1% increase. Net sales for the Motion Technologies
segment were $13.8 million for the quarter ended March 31, 2005, versus $12.6
million for the quarter ended March 31, 2004, a 9.5% increase. Net sales for the
Distribution segment for the quarter ended March 31, 2005 were $15.1 million,
versus $17.1 million for the quarter ended March 31, 2004, a 11.7% decrease.
Within the Fastening Technologies segment, sales volume
decreased 2.7% in both the domestic and international markets from the first
quarter of 2004 to the first quarter of 2005, while the average selling price
increased approximately 6.5%. Contributing to the higher average selling price
were price increases in the second quarter of 2004 in the United States and in
the first quarter of 2005 in Europe, more favorable currency translation rates
in Europe in 2005, and smaller distributor order quantities at corresponding
higher prices. Within the Motion Technologies segment, the number of motors sold
decreased approximately 6.9% in the first quarter of 2005 compared to the first
quarter of 2004, while the average selling price per motor increased
approximately 15.6% as a result of selective price increases. Within the
Distribution segment, sales into Europe decreased approximately 20.4%, sales
into North America decreased 8.4%, and sales into Asia decreased 12.1% from the
first quarter of 2004 to the first quarter of 2005. Softening in the major
markets served by the Company, as well as competitive pricing pressures,
contributed to the decline in all areas.
Consolidated gross profit for the first quarter of 2005 was
$23.1 million, versus $22.5 million for the first quarter of 2004, an increase
of 2.7%. In spite of decreasing volume, the Company was able to increase its
gross margin percentage from 35.6% of sales in the first quarter of 2004 to
36.3% of sales in the first quarter of 2005 due to price increases and more
favorable product mix.
Consolidated selling, general, and administrative expenses
("SG&A") for the first quarter of 2005 were $15.0 million, versus $13.8 million
for the first quarter of 2004, an 8.7% increase. Approximately $975,000 of this
increase represents transaction expenses associated with the forthcoming merger
of the Company (see Note 11) that is expected to be completed in the second
quarter of 2005.
12
Within the Fastening Technologies segment, operating income
was $8.9 million in the first quarter of 2005 compared to $8.7 million in the
first quarter of 2004, an increase of 2.3%. Within the Motion Technologies
segment, operating income was $1.3 million in the first quarter of 2005 compared
to $723,000 in the first quarter of 2004, an increase of 78.6%. Gross margins in
this segment increased $744,000, or 22.5%, from the first quarter of 2004 to the
first quarter of 2005 due to price increases, while commission expense decreased
$192,000, or 21.0%, during the same period due to a change in the commission
rates paid to outside sales representatives. Within the Distribution segment,
operating income was $1.1 million in the first quarter of 2005 compared to $1.7
million in the first quarter of 2004, a decrease of 36.7%. This reduction was
caused by the decrease in sales and the inability to lower fixed costs in the
selling, general and administrative area.
Consolidated net income for the first quarter of 2005 was $4.8
million, versus $5.9 million for the first quarter of 2005. The effective tax
rate increased from 31.5% in the first quarter of 2004 to 36.6% in the first
quarter of 2005 due to the nondeductibility for federal income tax purposes of
the $975,000 of merger transaction expenses mentioned above.
Liquidity and Capital Resources
-------------------------------
Cash and cash equivalents at March 31, 2005 were $32.2 million
compared to $32.9 million at December 31, 2004. Working capital totaled $105.7
million at March 31, 2005 compared to $99.8 million at December 31, 2004.
Net cash of $2.9 million was provided by operating activities
for the three months ended March 31, 2005 compared to $7.7 million provided by
operating activities for the three months ended March 31, 2004. As sales volume
increased, the level of accounts receivable also increased, particularly in the
European region where payment terms are generally longer than domestic payment
terms.
Net cash used in investing and financing activities totaled
$3.2 million for the three months ended March 31, 2005 compared to $1.7 million
for the three months ended March 31, 2004. Included in the $3.2 million use of
cash for the three months ended March 31, 2005 was approximately $640,000 spent
for land acquisition in Ireland for the future expansion of that operation.
The Company's principal contractual obligations are the
repayment of its bank debt, the planned funding of its defined benefit pension
plan, and the payment of operating lease commitments covering certain
automobiles, office space, and office equipment that are listed in Note 12 to
the Company's Annual Report for the year ended December 31, 2004. The Company
anticipates that its existing capital resources and cash flow generated from
future operations will enable it to maintain its current level of operations and
its planned growth for the foreseeable future.
13
Critical Accounting Policies
----------------------------
The Company has identified a number of its accounting polices
that it has determined to be critical. These critical accounting policies
primarily relate to financial statement assertions that are based on the
estimates and assumptions of management, and the effect of changing those
estimates and assumptions could have a material effect on the Company's
financial statements. The following is a summary of those critical accounting
policies.
Inventories
-----------
The Company's domestic fastener inventories are priced on the
last-in, first-out (LIFO) method of accounting. Other inventories, representing
approximately 73% and 76% of total inventories at March 31, 2005 and December
31, 2004, respectively, are priced on the first-in, first-out (FIFO) method.
Reserves are recorded for obsolete, excess, and slow-moving inventories based on
management's estimates about future demand and market conditions. At March 31,
2005, the Company's inventory balance of $48,002,000 was net of a reserve for
obsolete, excess, and slow-moving inventories of approximately $4,266,000. At
December 31, 2004, the Company's inventory balance of $46,731,000 was net of a
reserve for obsolete, excess, and slow-moving inventories of approximately
$5,136,000. If the estimated reserves for obsolete, excess, and slow-moving
inventories are not sufficient based on actual future demand, additions to the
reserve may be required.
Accounts Receivable
-------------------
The Company maintains an allowance for doubtful accounts for
trade receivables for which collectability is uncertain. At March 31, 2005 and
December 31, 2004, this allowance was approximately $885,000 and $829,000,
respectively. In estimating uncollectible accounts, the Company considers
factors such as current overall economic conditions, industry-specific economic
conditions, and historical and anticipated customer performance. While the
Company believes that its procedures effectively address exposure for doubtful
accounts, changes in the economy, industry, or specific customer conditions may
require adjustments to the allowance.
Goodwill
--------
SFAS No. 142 requires that goodwill no longer be amortized,
and instead, be tested for impairment on a periodic basis. At March 31, 2005,
the Company had $43,957,000 in goodwill. The process of evaluating the potential
impairment of goodwill is highly subjective and requires significant judgments
at many points during the analysis. In estimating the fair value of the
reporting units with recognized goodwill for the purposes of the Company's 2004
financial statements, the Company made estimates and judgments about the future
14
cash flows of these reporting units. The Company's cash flow forecasts were
based on assumptions that are consistent with the plans and estimates the
Company is using to manage the underlying businesses. In addition, the Company
made certain judgments about allocating shared assets to the balance sheet for
those reporting units. Based on its estimates, the Company has concluded that
there is no impairment of its goodwill as of December 31, 2004. However, changes
in these estimates could cause one or more of the reporting units to be valued
differently in the future. The Company will evaluate its goodwill again for
impairment as of October 1, 2005.
Pensions
--------
Accounting for the Company's defined benefit pension plan
requires that amounts recognized in the financial statements be determined on an
actuarial basis. The most significant elements in determining the Company's
pension expense are pension liability discount rates and the expected return on
plan assets. The pension discount rate reflects the current interest rate at
which pension liabilities could be settled at the end of the year. At the end of
each year, the Company determines the discount rate to be used to discount plan
liabilities. In estimating this rate, the Company looks to rates of return on
high-quality, fixed-income investments. At December 31, 2004, the Company
determined this rate to be 6.00% and no adjustment to this rate has been made
for the three months ended March 31, 2005. In 2004, the Company used an expected
long-term rate of return on pension plan assets of 7.00% and no adjustment has
been made for the three months ended March 31, 2005. Should a downward trend in
return on pension assets happen, future pension expense would likely increase.
The net effect of changes in the discount rate, as well as the effect of
differences between the expected return and the actual return on plan assets,
have been deferred in accordance with SFAS No. 132 and will ultimately affect
future pension expense.
Derivative Instruments and Hedging
----------------------------------
From time to time, the Company manages risks associated with
foreign exchange rates and interest rates with derivative instruments. The
Company does not use derivative instruments for trading or speculative purposes,
and only uses derivatives when there is an underlying exposure. The evaluation
of hedge effectiveness is subject to assumptions based on the terms and the
timing of the underlying exposures. All derivative instruments are recognized in
the Consolidated Balance Sheet at fair value, which is generally based on quoted
market prices.
Forward-Looking Statements
--------------------------
Forward-looking statements, within the meaning of Section 27A
of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of
1934 under the Private Securities Litigation Reform Act of 1995, are made
throughout this Management's Discussion and Analysis. The Company's results may
differ materially from those in the forward-looking statements. Forward-looking
statements are based on management's current views and assumptions, and involve
15
risks and uncertainties that significantly affect expected results. For example,
operating results may be affected by external factors such as: changes in laws
and regulations, changes in accounting standards, fluctuations in demand in
markets served by the Company, particularly the computer and telecommunications
markets, fluctuations in the cost and availability of the supply chain
resources, and foreign economic conditions, including currency rate
fluctuations.
Item 3. Quantitative and Qualitative Disclosure About Market Risk.
------ ---------------------------------------------------------
Reference is made to Part 2, Item 7A of the Company's Form
10-K Annual Report for the year ended December 31, 2004. There has been no
material change in the information reported in that report.
Item 4. Controls and Procedures.
------ -----------------------
Evaluation of Disclosure Controls and Procedures
As required by Rule 13a-15 under the Securities Exchange Act
of 1934, as of the end of the period covered by this report, the Company carried
out an evaluation, under the supervision and with the participation of the
Company's management, including the Chief Executive Officer and the Chief
Financial Officer, of the effectiveness of the design and operation of the
Company's disclosure controls and procedures. Based on this evaluation, the
Company's management, including the Chief Executive Officer and the Chief
Financial Officer, concluded that the Company's disclosure controls and
procedures are effective for recording, processing, summarizing, and reporting
the information the Company is required to disclose in the reports it files
under the Securities Exchange Act of 1934, within the time periods specified in
the SEC's rules and forms.
Changes in Internal Control Over Financial Reporting
There have been no significant changes in the Company's
internal control over financial reporting (as such term is defined in Rules
13a-15 and 15d-15 under the Securities Exchange Act of 1934) during the three
months ended March 31, 2005 that have materially affected, or are reasonably
likely to affect materially, the Company's internal control over financial
reporting.
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PART II OTHER INFORMATION
Item 1. Legal Proceedings.
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The Company is aware that four complaints have been filed in
the Delaware Court of Chancery against the Company and each of its directors,
one of which has been dismissed with prejudice. One of the complaints also names
Tinicum Capital Partners II, L.P. ("Tinicum") and its affiliate, PEM Holding
Co., as co-defendants. The complaints purport to be class actions filed on
behalf of holders of the Company's common stock and Class A common stock arising
from certain alleged actions by the Company and its directors in connection with
the Company's proposed merger with an affiliate of Tinicum. The complaints
include various allegations that: each of the defendants breached and/or aided
and abetted the other defendants' breaches of fiduciary duties of loyalty, due
care, candor, good faith and fair dealing; that the director defendants spent
substantial effort tailoring the structural terms of the merger to meet the
specific needs of Tinicum to ensure the Company's sale to it on preferential
terms instead of attempting to obtain the highest price reasonably available for
the Company and its stockholders, which was subversive to the interests of the
Company's public stockholders; the directors structured and approved the
transaction in contravention of the Company's restated certificate of
incorporation, agreeing to provisions in agreements that effectively preclude a
competing bid and approving an acquisition that favors insiders to the detriment
of the Company's public stockholders, including the price per share offered to
the holders of its common stock and Class A common stock; and the defendants
failed to provide material information concerning the transaction to the
Company's public stockholders. The complaints seek equitable relief in the form
of an injunction enjoining the consummation of the merger or, if the merger is
consummated to the detriment of the Company's public stockholders, then
rescission of the transaction or unspecified damages, in addition to costs and
disbursements, including reasonable attorneys' and experts' fees.
The parties have reached a settlement regarding all claims
under these complaints, subject to the approval of the Delaware Court of
Chancery. As part of the settlement, the Company has agreed to provide
additional disclosures, including a description of an amendment to the Merger
Agreement, in supplemental proxy materials to be filed with the SEC and
distributed to the Company's stockholders.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
------ -----------------------------------------------------------
Not applicable.
Item 3. Defaults upon Senior Securities.
------- --------------------------------
Not applicable.
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Item 4. Submission of Matters to a Vote of Security Holders.
------ ---------------------------------------------------
Not applicable.
Item 5. Other Information.
------ -----------------
Not applicable.
Item 6. Exhibits.
------ ---------
Exhibit No. Description
------------------- ---------------------------------------
3.1 Restated Certificate of Incorporation
(Incorporated by reference to Exhibit
3.1 of the Company's Form 10-Q
Quarterly Report for the period ended
March 31, 2001.)
3.2 By-laws, as amended (Incorporated by
reference to Exhibit 3.2 of the
Company's Form 10-K Annual Report for
the year ended December 31, 2001.)
31.1 Rule 13a-14(a)/15(d)-14(a)
Certification of Chief Executive
Officer.
31.2 Rule 13a-14(a)/15(d)-14(a)
Certification of Chief Financial
Officer.
32.1 Section 1350 Certification of Chief
Executive Officer.
32.2 Section 1350 Certification of Chief
Financial Officer.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Company has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Dated: May 10, 2005 PENN ENGINEERING & MANUFACTURING CORP.
By: /s/ Kenneth A. Swanstrom
--------------------------------------------------
Kenneth A. Swanstrom
Chairman of the Board and Chief Executive Officer
Dated: May 10, 2005 By: /s/ Mark W. Simon
--------------------------------------------------
Mark W. Simon
Senior Vice President and Chief Financial Officer
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PENN ENGINEERING & MANUFACTURING CORP.
EXHIBIT INDEX
Exhibit No. Description
------------------- --------------------------------------------------
3.1 Restated Certificate of Incorporation
(Incorporated by reference to Exhibit 3.1 of the
Company's Form 10-Q Quarterly Report for the
period ended March 31, 2001.)
3.2 By-laws, as amended (Incorporated by reference to
Exhibit 3.2 of the Company's Form 10-K Annual
Report for the year ended December 31, 2001.)
31.1 Rule 13a-14(d)/15(d)-14(a) Certification of Chief
Executive Officer.
31.2 Rule 13a-14(d)/15(d)-14(a) Certification of Chief
Financial Officer.
32.1 Section 1350 Certification of Chief Executive
Officer.
32.2 Section 1350 Certification of Chief Financial
Officer.
20