UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended January 1, 2005
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/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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Commission File Number 1-9789
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TECH/OPS SEVCON, INC.
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(Exact name of registrant as specified in its charter)
Delaware 04-2985631
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
155 Northboro Road, Southborough, Massachusetts, 01772
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(Address of principal executive offices and zip code)
(508) 281 5510
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(Registrant's telephone number, including area code:)
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such
shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements
for the past 90 days. Yes X No
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Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes No X
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Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
Class Outstanding at February 15, 2005
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Common stock, par value $.10 3,172,051
TECH/OPS SEVCON, INC.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
Consolidated Balance Sheets
ASSETS
(in thousands)
Jan 1, Sept 30,
2005 2004
--------- ------------
(unaudited) (derived from
audited
statements)
Current assets:
Cash and cash equivalents $ 600 $ 905
Accounts receivable, less allowances
of $222 at 1/1/2005
and $192 at 9/30/2004 6,370 6,109
Inventories 3,979 4,043
Prepaid expenses and other current
assets 980 931
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Total current assets 11,929 11,988
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Property, plant and equipment, at cost 9,842 9,270
Less: Accumulated depreciation
and amortization 6,606 6,085
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Net property, plant and equipment 3,236 3,185
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Goodwill 1,435 1,435
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$16,600 $16,608
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The accompanying notes are an integral part of these financial
statements.
TECH/OPS SEVCON, INC.
Consolidated Balance Sheets
LIABILITIES AND STOCKHOLDERS' INVESTMENT
(in thousands)
Jan 1, Sept 30,
2005 2004
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(unaudited) (derived from
audited
statements)
Current liabilities:
Accounts payable 2,465 3,001
Dividend payable 95 94
Accrued expenses 2,485 2,541
Accrued taxes on income 575 447
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Total current liabilities 5,620 6,083
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Deferred taxes on income 65 61
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Stockholders' investment
Preferred stock - -
Common stock 316 313
Premium paid in on common stock 4,226 4,047
Retained earnings 6,058 6,133
Unearned compensation on restricted stock (179) -
Cumulative other comprehensive
income (loss) 494 (29)
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Total stockholders' investment $10,915 $10,464
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$16,600 $16,608
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The accompanying notes are an integral part of these financial
statements.
TECH/OPS SEVCON, INC.
Consolidated Statements of Income
(Unaudited)
(in thousands except per share data)
Three Months Ended
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Jan 1, Dec 31,
2005 2003
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Net sales $ 7,542 $ 6,466
Costs and expenses:
Cost of sales 4,700 3,858
Selling, research and
administrative 2,822 2,435
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7,522 6,293
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Operating income 20 173
Other income (expense), net 10 (49)
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Income before income taxes 30 124
Income taxes (10) (43)
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Net income $ 20 $ 81
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Basic income per share $ .01 $ .03
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Fully diluted income per share $ .01 $ .03
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Consolidated Statement of Comprehensive Income
(Unaudited)
(in thousands)
Three Months Ended
------------------
Jan 1, Dec 31,
2005 2003
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Net income $ 20 $ 81
Foreign currency
translation adjustment 538 527
Change in fair market value
of cash flow hedge (15) (9)
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Comprehensive income $ 543 $ 599
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The accompanying notes are an integral part of these financial statements.
TECH/OPS SEVCON, INC.
Consolidated Statement of Cash Flows
(Unaudited)
(in thousands)
Three Months Ended
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Jan 1, Dec 31,
2005 2003
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Net cash flow from operating activities:
Net income $ 20 $ 81
Adjustments to reconcile net income to net cash
used by operating activities:
Depreciation and amortization 172 156
Stock-based compensation 3 -
Deferred tax provision 4 -
Increase (decrease) in cash resulting from
changes in operating assets & liabilities:
Receivables (261) (448)
Inventories 64 (16)
Pre-paid expenses and other current assets (34) (243)
Accounts payable (536) 435
Accrued compensation and expenses (56) (136)
Accrued taxes on income 128 135
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Net cash used by operating activities (496) (36)
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Cash flow used by investing activities:
Acquisition of property, plant, and
equipment, net (38) (144)
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Net cash used by investing activities (38) (144)
Cash flow used by financing activities:
Dividends paid (94) (94)
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Effect of exchange rate changes on cash 323 301
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Net (decrease) increase in cash (305) 27
Opening balance - cash and cash equivalents 905 524
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Ending balance - cash and cash equivalents $ 600 $ 551
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Supplemental disclosure of cash flow information
Cash paid for income taxes $ 72 $ 17
Cash paid for interest 6 5
Supplemental disclosure of non-cash
financing activity:
Dividend declared $ 95 $ 94
The accompanying notes are an integral part of these financial statements.
TECH/OPS SEVCON, INC.
Notes to Consolidated Financial Statements - January 1, 2005
(Unaudited)
(1) Basis of Presentation
In the opinion of management, the accompanying unaudited condensed
consolidated financial statements contain all adjustments (consisting of
only normally recurring accruals) necessary to present fairly the financial
position of Tech/Ops Sevcon as of January 1, 2005 and the results of
operations and cash flows for the three months ended January 1, 2005 and
December 31, 2003.
The significant accounting policies followed by Tech/Ops Sevcon are set
forth in Note 1 to the financial statements in the 2004 Tech/Ops Sevcon, Inc.
Annual Report filed on Form 10-K. The Company has expanded its accounting
policy disclosure for inventories and the revised policy is set out below.
G. Inventories
Inventories are valued at the lower of cost or market. Inventory costs
include materials, direct labor and manufacturing overhead, and are
relieved from inventory on a first-in, first-out basis. The Company's
reported financial condition includes a provision for estimated slow-
moving and obsolete inventory that is based on a comparison of inventory
levels with forecast future demand. Such demand is estimated based on
many factors, including management judgments, relating to each customer's
business and to economic conditions. The Company reviews in detail all
significant inventory items with holdings in excess of estimated normal
requirements. It also considers the likely impact of changing technology. It
makes an estimate of the provision for slow moving and obsolete stock on an
item-by-item basis based on a combination of likely usage based on forecast
customer demand, potential sale or scrap value and possible alternative use.
This provision represents the difference between original cost and market
value at the end of the financial period. In cases where there is no
estimated future use for the inventory item and there is no estimated scrap
or resale value, a 100% provision is recorded. Where the Company estimates
that only part of the total holding of an inventory item will not be used,
or there is an estimated scrap, resale or alternate use value, then a
proportionate provision is recorded. Once an item has been written down,
it is not subsequently revalued upwards. The provision for slow moving and
obsolete inventories at January 1, 2005 was $908,000, or 19% of the original
cost of gross inventory. At September 30, 2004 the provision was $879,000,
or 18% of gross inventory. Inventories comprised of:
(in thousands of dollars)
Jan 1, Sept 30,
2005 2004
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Raw materials $ 2,277 $ 2,076
Work-in-process 274 177
Finished goods 1,428 1,790
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Total inventories $ 3,979 $ 4,043
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The results of operations for the three-month periods ended January 1,
2005 and December 31, 2003 are not necessarily indicative of the results
to be expected for the full year.
(2) New Accounting Pronouncements
In October 2004, the President signed into law the American Jobs
Creation Act (the Act). The Act allows for a federal income tax deduction
for a percentage of income earned from certain domestic production
activities. The Company's domestic, or U.S., production activities may
qualify for the deduction. Based on the effective date of the Act, the
Company would be eligible for this deduction in the first quarter of fiscal
2006. Additionally, on December 21, 2004, the FASB issued FASB Staff Position
109-1, "Application of FASB Statement No. 109, Accounting for Income Taxes
(SFAS No. 109), to the Tax Deduction on Qualified Production Activities
Provided by the American Jobs Creation Act of 2004" (FSP 109-1). FSP 109-1,
which was effective upon issuance, states the deduction under this provision
of the Act should be accounted for as a special deduction in accordance with
SFAS 109. The Company has not yet quantified the benefit that may be realized
from this provision of the Act.
The Act also allows for an 85% dividends received deduction on the
repatriation of certain earnings of foreign subsidiaries. On December 21,
2004, the FASB issued FASB Staff Position 109-2, "Accounting and Disclosure
Guidance for the Foreign Earnings Repatriation Provision within the American
Jobs Creation Act of 2004" (FSP 109-2). FSP 109-2, which was effective upon
issuance, allows companies time beyond the financial reporting period of
enactment to evaluate the effect of the Act on its plan for reinvestment or
repatriation of foreign earnings for purposes of applying SFAS No. 109.
Additionally FSP 109-2 provides guidance regarding the required disclosures
surrounding a company's reinvestment or repatriation of foreign earnings.
The Company continues to evaluate this provision of the Act to determine
the amount of foreign earnings to repatriate. Currently the Company does
not expect the potential repatriation to have a material impact on its
effective tax rate.
In November 2004, the Financial Accounting Standards Board issued
SFAS #151, "Inventory Costs - an amendment of ARB No. 43" ("SFAS #151"),
which is the result of its efforts to converge U.S. accounting standards
for inventories with International Accounting Standards. SFAS #151
requires idle facility expenses, freight, handling costs, and wasted
material (spoilage) costs to be recognized as current-period charges.
It also requires that allocation of fixed production overheads to the
costs of conversion be based on the normal capacity of the production
facilities. SFAS #151 will be effective for inventory costs incurred
during fiscal years beginning after June 15, 2005. The Company is
evaluating the impact of this standard on our consolidated financial
statements.
In December 2004, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards (SFAS)#123R, "Share-Based
Payment". This Statement replaces SFAS #123 "Accounting for Stock based
Compensation" and supersedes APB #25 "Accounting for Stock Issued to
Employees". This Statement establishes fair value on the grant date as
the measurement objective in accounting for share-based payment
arrangements and requires all entities to apply a fair-value-based
measurement method in accounting for share-based payment transactions
with employees except for equity instruments held by employee share
ownership plans. This Statement is effective for public entities that
do not file as small business issuers as of the beginning of the first
interim or annual reporting period that begins after June 15, 2005.
The Company will adopt the provisions of SFAS #123R effective at the
beginning of the fourth quarter of fiscal 2005. The Company will adopt the
modified prospective application transition method. Under this method the
Company expects to incur expense relating to previously issued stock options
of approximately $14,000 in the fourth quarter of fiscal 2005. The
accounting for restricted stock issued in fiscal 2005 will be substantially
unchanged by the application of SFAS #123R.
(3) Stock-Based Compensation Plans
SFAS #123 "Accounting for Stock-Based Compensation" as amended by SFAS
#148 "Accounting for Stock-Based Compensation - Transition and Disclosure"
and to be replaced by SFAS 123R "Share-Based Payment" defines a fair value
based method of accounting for employee stock options or similar equity
instruments and encourages all entities to adopt that method of accounting.
However, it also allows an entity to continue to measure compensation costs
using the method of accounting proscribed by APB #25 "Accounting for Stock
Issued to Employees". Until SFAS #123R becomes effective in the fourth
quarter of fiscal 2005 the Company continues to account for its stock-based
compensation plans under APB #25, under which no compensation cost has been
recognized. Had compensation cost for these plans been determined consistent
with SFAS #123 the Company's net income and earnings per share would have
equaled the following pro forma amounts:
(in thousands of dollars, except for per share amounts)
Three Months Ended
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Jan 1, Dec 31,
2005 2003
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Net income - As reported $ 20 $ 81
Pro forma effect of expensing stock
options (net of income tax) (14) (17)
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Net income - Pro forma $ 6 $ 64
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Income per share:
Basic - As reported $ .01 $ .03
Basic - Pro forma $ .00 $ .02
Diluted - As reported $ .01 $ .03
Diluted - Pro forma $ .00 $ .02
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The effects of applying SFAS #123 in this pro forma disclosure are not
indicative of future amounts. SFAS #123 does not apply to awards prior to
fiscal 1996 and additional awards in future years are anticipated.
The fair value of each option grant is estimated on the date of grant
using the Black-Scholes option pricing model with the following weighted
average assumptions.
2005 2004 2003
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Risk-free interest rate N/A N/A 3.0%
Expected dividend yield N/A N/A 2.7%
Expected life (years) N/A N/A 7
Expected volatility of N/A N/A 47%
No options were granted in the first quarter of fiscal 2005 or in
fiscal 2004.
In November 2004 the Company granted 35,000 shares of restricted
stock to five employees which will vest in five equal annual installments
providing that the grantee remains an employee of the Company, or as
determined by the Compensation Committee. The estimated fair value of
the stock on the date of grant was $182,000 based on the fair market
value on the stock on date of issue and estimated forfeitures of 4%
per year. The estimated forfeitures are based on the historical rate
of turnover of the relevant group of employees. This amount was
credited to common stock and paid in surplus and the $182,000 was
recorded as "Unearned compensation on restricted stock", a deduction
from stockholders equity. The unearned compensation is being charged to
income on a straight line basis over the five year period during which the
forfeiture conditions lapse. The charge to income for employee restricted
stock grants in the first quarter of fiscal 2005 was $3,000 and the
subsequent regular quarterly charge will be approximately $9,000.
In January 2005 the Company granted 12,000 shares of restricted stock
to six non-employee directors which will vest on the day before the 2006
annual meeting, provided that the grantee remains a director of the
Company, or as determined by the Compensation Committee. The estimated
fair value of the stock on the date of grant was $85,000 based on the
fair market value on the stock on date of issue. Due to the short-term
vesting period no forfeitures have been estimated. This amount was
credited to common stock and paid in surplus and the $85,000 was recorded
as "Unearned compensation on restricted stock", a deduction from
stockholders equity. The unearned compensation is being charged to
income on a straight line basis over the one year period during which the
forfeiture conditions lapse. There was no charge to income for non-employee
director restricted stock grants in the first quarter of fiscal 2005.
During the restriction period, five years for employees and one year
for non-employee directors, ownership of unvested shares cannot be
transferred. Restricted stock has the same cash dividend and voting
rights as other common stock and is considered to be currently issued and
outstanding.
The estimated stock-based compensation expense in fiscal 2005 is as
follows. No stock-based compensation expense was recorded in fiscal 2004.
(in thousands of dollars)
First Second Third Fourth Fiscal
Quarter Quarter Quarter Quarter 2005
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Stock option expense under
SFAS #123R* $ - $ - $ - $14 $ 14
Restricted stock grants
- - Employees 3 9 9 9 30
- - Non-employee directors - 14 21 21 56
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Total $ 3 $23 $30 $44 $100
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* Pro forma expense of approximately $14,000 per quarter is expected to be
recorded for stock options accounted for under APB #25 in the first three
quarters of fiscal 2005.
(4) Cash Dividends
On December 8, 2004, the Company declared a quarterly dividend of $.03
per share for the first quarter of fiscal 2005, which was paid on January 6,
2005 to stockholders of record on December 22, 2004. The Company has paid
regular quarterly cash dividends since the first quarter of fiscal 1990.
(5) Calculation of Earnings Per Share and Weighted Average Shares
Outstanding
Basic and fully diluted earnings per share were calculated as follows:
(in thousands, except for per share amounts)
Three Months Ended
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Jan 1 Dec 31
2005 2003
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Net income $ 20 $ 81
Basic income per share $ .01 $ .03
Average shares outstanding 3,140 3,125
Options outstanding - common
stock equivalents 19 18
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Average common and common
equivalent shares outstanding 3,159 3,143
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Fully diluted income per share $ .01 $ .03
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(6) Segment information
The Company has two reportable segments: electronic controls and
capacitors. The electronic controls segment produces control systems and
accessories for battery powered vehicles. The capacitor segment produces
electronic components for sale to electronic equipment manufacturers. Each
segment has its own management team, manufacturing facilities and sales
force.
The significant accounting policies of the segments are the same as
those described in note(1) to the 2004 Annual Report filed on Form 10-K.
Inter-segment revenues are accounted for at current market prices. The
Company evaluates the performance of each segment principally based on
operating income. The Company does not allocate income taxes, interest
income and expense or foreign currency translation gains and losses to
segments. Information concerning operations of these businesses is as
follows:
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(in thousands)
- ---------------------------------------------------------------------
Three months ended January 1, 2005
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Controls Capacitors Corporate Total
- ---------------------------------------------------------------------
Sales to external customers $ 7,142 $ 400 - $ 7,542
Inter-segment revenues - 66 - 66
Operating income (loss) 158 (18) (120) 20
Identifiable assets 14,865 942 793 16,600
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- ---------------------------------------------------------------------
Three months ended December 31, 2003
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Controls Capacitors Corporate Total
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Sales to external customers $ 6,035 $ 431 - $ 6,466
Inter-segment revenues - 25 - 25
Operating income (loss) 229 9 (65) 173
Identifiable assets 12,898 1,190 591 14,679
- ---------------------------------------------------------------------
In the controls business segment the revenues were derived from the
following products and services.
(in thousands of dollars)
Three Months Ended
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Jan 1 Dec 31
2005 2003
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Electronic controllers for
battery driven vehicles $4,926 $4,362
Accessory and aftermarket
products and services 2,216 1,673
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Total controls segment revenues $7,142 $6,035
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(7) Research and Development
The cost of research and development programs is charged against
income as incurred and was as follows.
(in thousands of dollars)
Three Months Ended
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Jan 1 Dec 31
2005 2003
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Research and Development expense $ 834 $ 928
Percentage of sales 11.1% 14.4%
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Research and development expense decreased by $94,000, or 10%, compared
to the first quarter of last fiscal year. The decrease was principally due
to lower engineering consultancy costs on advanced new product development,
which was partially offset by the cost of increased internal engineering
resources and foreign currency fluctuations.
(8) Employee Benefit Plans
Tech/Ops Sevcon has defined benefit plans covering the majority of its
US and UK employees. There is also a small defined contribution plan. The
following table sets forth the components of the net pension cost as defined
by SFAS #132R.
(in thousands of dollars)
Three Months Ended
------------------
Jan 1, Dec 31,
2005 2003
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Components of net periodic benefit cost:
Service cost $ 110 $ 108
Interest cost $ 229 204
Expected return on plan assets $ (215) (205)
Amortization of transition obligation $ - -
Amortization of prior service cost $ 14 12
Recognized net actuarial gain (loss) $ - -
----- -----
Net periodic benefit cost $ 138 $ 119
----- -----
Net cost of defined contribution plans $ 7 $ 7
Tech/Ops Sevcon contributed $108,000 to its pension plans in the
three months ended January 1, 2005 and presently anticipates contributing a
further $461,000 to fund its plans in the remainder of fiscal 2005, for a
total contribution of $569,000. In addition employee contributions to the UK
plan were $62,000 in the first quarter and are estimated to total $252,000
in fiscal 2005.
(9) Accrued expenses
Set out below is an analysis of other accrued expenses at January 1,
2005 and September 30, 2004 which shows separately any items in excess of
5% of total current liabilities.
(In thousands of dollars)
- ----------------------------------------------------------------------------
Jan 1, Sept 30,
2005 2004
- ----------------------------------------------------------------------------
Accrued compensation and related costs $ 1,062 $ 979
Warranty reserves 429 386
Accrued director's pension 200 201
Other accrued expenses 794 975
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Total $ 2,485 $ 2,541
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(10) Warranty reserves
The movement in warranty reserves was as follows:
(In thousands of dollars)
- ---------------------------------------------------------------------------
Three months ended
Jan 1, 2005 Dec 31, 2003
- ----------------------------------------------------------------------------
Balance at beginning of period $ 386 $ 404
Decrease in opening balance for warranty
obligations settled during the period (117) (83)
Other changes to pre-existing warranties 17 2
Net increase in warranty reserves for
products sold during the period 143 51
- ----------------------------------------------------------------------------
Balance at end of period $ 429 $ 374
- ----------------------------------------------------------------------------
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
FORWARD LOOKING STATEMENTS
Statements in this discussion and analysis about the Company's
anticipated financial results and growth, as well as those about the
development of its products and markets, are forward-looking statements
that involve risks and uncertainties that could cause actual results to
differ materially from those projected. These include the risks discussed
under 'Risk Factors' below and throughout this Item 2.
NEW ACCOUNTING PRONOUNCEMENTS
The Company will adopt the following new accounting pronouncements in
fiscal 2005. See Notes to Consolidated Financial Statements (2) for a more
detailed description of these new accounting pronouncements.
FASB Staff Position 109-1, "Application of FASB Statement No. 109,
Accounting for Income Taxes (SFAS No. 109), to the Tax Deduction on
Qualified Production Activities Provided by the American Jobs Creation
Act of 2004" - The Company has not yet quantified the benefit that may be
realized from this provision of the Act.
FASB Staff Position 109-2, "Accounting and Disclosure Guidance for
the Foreign Earnings Repatriation Provision within the American Jobs
Creation Act of 2004" - Currently the Company does not expect the potential
repatriation to have a material impact on its effective tax rate.
SFAS #151, "Inventory Costs - an amendment of ARB No. 43" - The Company
is evaluating the impact of this standard on its consolidated financial
statements.
SFAS#123R, "Share-Based Payment" - Adoption is planned for the fourth
quarter of fiscal 2005 and is expected to decrease fourth quarter net income
by approximately $14,000. See the table at the end of footnote 3 above for
the impact by quarter in fiscal 2005.
CRITICAL ACCOUNTING ESTIMATES
The Company's significant accounting policies are summarized in Note 1
of its Consolidated Financial Statements in this Quarterly Report on Form
10-Q. While all these significant accounting policies impact its financial
condition and results of operations, certain of these policies require
management to use a significant degree of judgement and/or make estimates,
consistent with generally accepted accounting principles, that affect the
reported amounts of assets and liabilities and disclosures of contingent
assets and liabilities as of the date of the financial statements and the
reported amounts of income and expenses during the reporting periods. Since
these are judgements and estimates, they are sensitive to changes in
business and economic realities, and events may cause actual operating
results to differ materially from the amounts derived from management's
estimates and judgements.
The Company believes the following represent the most critical
accounting judgments and estimates affecting its reported financial
condition and results of operations:
Bad Debts
The Company estimates an allowance for doubtful accounts based on
known factors related to the credit risk of each customer and management's
judgment about the customer's business. Ten customers account for
approximately 56% of the Company's sales. At January 1, 2005 the
allowance for bad debts amounted to $222,000, which represented 3% of
receivables.
Because of the Company's long term relationships with the majority of
its customers, in most cases, the principal bad debt risk to the Company
arises from the insolvency of a customer rather than its unwillingness
to pay. In addition, in certain cases the Company maintains credit
insurance covering up to 90% of the amount outstanding from specific
customers. The Company also carries out some of its foreign trade,
particularly in the Far East, using letters of credit.
The Company reviews all accounts receivable balances on a regular
basis, concentrating on any balances that are more than 30 days overdue,
or where there is an identified credit risk with a specific customer. A
decision is taken on a customer-by-customer basis as to whether a bad
debt reserve is considered necessary based on the specific facts and
circumstances of each account. In general, the Company would reserve
100% of the receivable, net of any recoverable value added taxes or
insurance coverages, for a customer that becomes insolvent or files for
bankruptcy, and lesser amounts for less imminent defaults. To a lesser
degree, the Company maintains a small bad debt reserve to cover the
remaining balances based on historical default percentages.
If the financial condition of any of the Company's customers is worse
than estimated or were to deteriorate, resulting in an impairment of its
ability to make payments, the Company's results may be adversely
affected and additional allowances may be required. With the exception
of a significant loss of $562,000 in fiscal 2001 relating to one US
customer, credit losses have not been significant in the past ten years.
Inventories
Inventories are valued at the lower of cost or market. Inventory
costs include materials, direct labor and manufacturing overhead, and
are relieved from inventory on a first-in, first-out basis. The Company
carries out a significant amount of customization of standard products
and also designs and manufactures special products to meet the unique
requirements of its customers. This results in a significant proportion
of the Company's inventory being customer specific. The Company's
reported financial condition includes a provision for estimated slow-
moving and obsolete inventory that is based on a comparison of inventory
levels with forecast future demand. Such demand is estimated based on
many factors, including management judgments, relating to each
customer's business and to economic conditions. The Company reviews in
detail all significant inventory items with holdings in excess of
estimated normal requirements. It also considers the likely impact of
changing technology. It makes an estimate of the provision for slow
moving and obsolete stock on an item-by-item basis based on a
combination of likely usage based on forecast customer demand, potential
sale or scrap value and possible alternative use. This provision
represents the difference between original cost and market value at the
end of the financial period. In cases where there is no estimated future
use for the inventory item and there is no estimated scrap or resale
value, a 100% provision is recorded. Where the Company estimates that
only part of the total holding of an inventory item will not be used, or
there is an estimated scrap, resale or alternate use value, then a
proportionate provision is recorded. Once an item has been written down,
it is not subsequently revalued upwards. The provision for slow moving
and obsolete inventories at January 1, 2005 was $908,000, or 19% of
the original cost of gross inventory. At September 30, 2004 the
provision was $879,000, or 18% of gross inventory. If actual future
demand or market conditions are less favorable than those projected by
management, or if product designs change more quickly than forecast,
additional inventory write-downs may be required, which may have a
material adverse impact on reported results.
Warranty Costs
The Company provides for the estimated cost of product warranties
at the time revenue is recognized. While the Company engages in product
quality programs and processes, the Company's warranty obligation is
affected by product failure rates and repair or replacement costs incurred
in correcting a product failure. Accordingly, the provision for warranty
costs is based upon anticipated in-warranty failure rates and estimated
costs of repair or replacement. Anticipating product failure rates involves
making difficult judgments about the likelihood of defects in materials,
design and manufacturing errors, and other factors that are based in part
on historical failure rates and trends, but also on management's expertise
in engineering and manufacturing. Estimated repair and replacement costs
are affected by varying component and labor costs. Should actual product
failure rates and repair or replacement costs differ from estimates,
revisions to the estimated warranty liability may be required and the
Company's results may be materially adversely affected. In the event that
the Company discovers a product defect that impacts the safety of its
products, then a product recall may be necessary, which could involve the
Company in substantial unanticipated expense significantly in excess of
the reserve. There were no significant safety related product recalls
during the past three fiscal years.
Goodwill Impairment
The Company carries out an annual assessment to determine if the
goodwill relating to the controls business amounting to $1,435,000 has
been impaired, in accordance with the requirements of SFAS #142 "Goodwill
and Other Intangible Assets". In fiscal 2004 the Company retained an
investment banking firm specializing in valuations to assist the
Company in performing this impairment assessment. The assessment was
based on three separate methods of valuing the controls business based
on expected free cash flows, the market price of the Company's stock
and an analysis of precedent transactions. These methods require
estimates of future revenues, profits, capital expenditures and working
capital requirements which are based on evaluation of historical trends,
current budgets, operating plans and industry data. Based on all of these
valuation methods the conclusion was that the goodwill had not been
impaired. If, in future periods, the Company's results of operations,
cash flows or the market price of the Company's stock were to decrease
significantly then it may be necessary to record an impairment charge
relating to goodwill of up to $1,435,000.
Pension Plan Assumptions
The Company makes a number of assumptions relating to its pension
plans in order to measure the financial position of the plans and the net
periodic benefit cost. The most significant assumptions relate to the
discount rate, the expected long term return on plan assets and the rate
of future compensation increase. If these assumptions prove to be incorrect
then the Company may need to record additional expense relating to the
pension plans which could have a material effect on the Company's results
of operations. The Company's pension plans are significant relative to the
size of the Company. Pension plan assets were $12,899,000 at September 30,
2004 and the total assets of the Company were $16,608,000. Although the
plan assets are not included in the assets of the Company they are 78% of
size of the Company's total assets. If, as a result of changes in
assumptions, the accumulated benefit obligation of either of the plans
were to exceed the fair value of assets of that plan, then an adjustment
to record this additional liability and corresponding decrease stockholders
equity would be necessary, which could have a material effect on the
Company's financial position.
RISK FACTORS
In addition to the market risk factors relating to foreign currency
and interest rate risk set out below, the Company believes that the
following represent the most significant risk factors for the Company:
Capital goods markets are cyclical
The Company's customers are mainly manufacturers of capital goods
such as fork lift trucks, aerial lifts and railway signaling equipment.
These markets are cyclical and are currently showing modest growth, but
demand in these markets could decrease or customers could decide to
purchase alternative products. In this event the Company's sales could
decrease below its current break even point and there is no certainty
that the Company would be able to decrease overhead expenses to enable
it to operate profitably.
Single source materials and sub-contractors may not meet the
Company's needs.
The Company relies on certain suppliers and sub-contractors for all
of its requirements for certain components, sub-assemblies and finished
products. In the event that such suppliers and sub-contractors are unable
or unwilling to continue supplying the Company, or to meet the Company's
cost and quality targets or needs for timely delivery, there is no
certainty that the Company would be able to establish alternative
sources of supply in time to meet customer demand.
Damage to the Company's or sub-contractor's buildings would hurt
results.
In the controller business the majority of product is produced in a
single plant in England and uses sub-assemblies sourced from a
sub-contractor with single plant in Poland. The capacitor business is
located in a single plant in Wales. In the event that any of these plants
was to be damaged or destroyed, there is no certainty that the Company
would be able to establish alternative facilities in time to meet customer
demand. The Company does carry property damage and business interruption
insurance but this may not cover certain lost business due to the long-term
nature of the relationships with many customers.
The Company risks adverse litigation impact
In fiscal 2002 the Company received a demand for repayment of an
alleged preference payment of $180,000 received from a customer in the
90 days prior to their filing for protection under Chapter 11 during
fiscal 2000. At the time this customer filed for Chapter 11 protection
it owed the Company $50,000 and this amount was fully reserved in the
fiscal 2000 financial statements. The Company is vigorously contesting
this demand and believes that it has a good defense and that its
accruals for customer payments are adequate to cover its estimated
exposure to this customer.
OVERVIEW OF FIRST QUARTER
The Company reported net income of $20,000, or $.01 per share, for
the first fiscal quarter ended January 1, 2005. Net income decreased by
$61,000, or $.02 per share, from $81,000, or $.03 per share, for the
comparable period last year. Sales in the first quarter were $7,542,000
compared to $6,466,000 for the comparable period last year. Foreign
currency fluctuations caused an increase in reported revenues of
$370,000, or 6%, and volumes shipped were 11% ahead of the prior year
period.
Operating income for the first quarter was $20,000, a decrease of
$153,000 compared to the first quarter of last year. Higher sales, less
the adverse impact of foreign currency fluctuations, increased gross
profit by $234,000, which was offset by a $387,000 increase in operating
expenses. Foreign currency fluctuations caused $140,000 of the operating
expense increase, while lower engineering expense was more than offset by
higher selling expense as the Company starts to launch its new espAC
range of advanced new electric vehicle controls.
Cash balances decreased by $305,000 in the first quarter of fiscal
2005 to $600,000. Operating activities used cash of $496,000, principally
due to lower payables and increased receivables. Capital expenditure used
cash of $38,000 and dividend payments amounted to $94,000. Exchange rate
changes increased cash by $323,000.
Results of Operations
Three months ended January 1, 2005
The following table compares first quarter results by segment for
fiscal 2005 with the prior year period, and shows the percentage changes
in total and split between the currency impact and volume / other changes.
(in thousands of dollars)
% change due to:
-----------------------
Volume/
FY 2005 FY 2004 Total Currency other
----- ----- ----- -------- -------
Sales:
Controls - to external
customers 7,142 6,035 18% 6% 13%
- -------------------------------------------------------------------------
Capacitors- to external
customers 400 431 - 7% 7% -14%
Capacitors - inter-segment 66 25 164% 8% 156%
- -------------------------------------------------------------------------
Capacitors - total 466 456 2% 7% - 5%
- -------------------------------------------------------------------------
Total sales to external
customers 7,542 6,466 17% 6% 11%
- -------------------------------------------------------------------------
Gross Profit:
Controls 2,658 2,433 9% -3% 12%
Capacitors 184 165 12% 8% 4%
- -------------------------------------------------------------------------
Total 2,842 2,608 9% -2% 11%
- -------------------------------------------------------------------------
Selling general and
administrative expense:
Controls 2,500 2,214 13% 6% 7%
Capacitors 202 156 29% 8% 22%
Unallocated corporate
expense 120 65 85% 0% 85%
- -------------------------------------------------------------------------
Total 2,822 2,435 16% 6% 10%
- -------------------------------------------------------------------------
Operating income:
Controls 158 229 -31% -88% 57%
Capacitors (18) 9 -300% 11% -311%
Unallocated corporate expense (120) (65) 85% 0% 85%
- -------------------------------------------------------------------------
Total 20 173 -88% -116% 27%
- -------------------------------------------------------------------------
Other income and expense 10 (49) -120% -122% 2%
- -------------------------------------------------------------------------
Income before income taxes 30 124 -76% -113% 37%
Income taxes (10) (43) -77% -114% 38%
- -------------------------------------------------------------------------
Net Income 20 81 -75% -112% 37%
- -------------------------------------------------------------------------
Sales in the first fiscal quarter ended January 1, 2005 were
$7,542,000 compared to $6,466,000 in the first quarter of last year,
an increase of $1,076,000, or 17%. Foreign currency fluctuations,
principally the weakness of the US dollar compared to the Euro and the
British pound, accounted for an increase of $370,000, or 6%, in revenues.
Shipment volumes were 11% ahead of the first quarter of last year.
Volumes in the U.S. Controller business increased by 21% with gains in
shipments to the aerial lift, airport ground support and mining markets
partially offset by lower demand in the US fork lift truck market.
Volumes in the foreign controller markets grew by 8% compared to the
first quarter of fiscal 2004. Capacitor sales were 7% lower than last
year at $400,000, compared to $431,000 in the first quarter of fiscal
2004. There was a 14% decrease in capacitor volumes, mainly due to lower
demand in the audio capacitor market. This volume decrease was partially
offset by the impact of foreign currency fluctuations which resulted in
a 7% increase in reported sales of the capacitor segment when measured
in US dollars.
Gross profit of $2,842,000 was $234,000 higher than last year. The
increase in gross profit was mainly due to higher volumes, partially
offset by foreign currency fluctuations which reduced gross profit by
$60,000 in the first quarter. Sales mix also adversely impacted
gross profit with the increase in sales concentrated in low margin
products, particularly in the United States where costs have been
adversely impacted by the weakness of the US dollar. First quarter
gross profit was 37.7% of sales, a decrease of 2.6% from 40.3% of sales
in the same quarter of fiscal 2004.
Selling, research and administrative expenses were $2,822,000, an
increase of $387,000, or 16%, compared to last year's first quarter.
Foreign currency fluctuations increased these expenses by $140,000, or 6%.
In the first quarter of fiscal 2005, engineering and R&D expense was
lower by $94,000 compared to the same period last year. This was mainly
due to lower engineering consulting expense, partly offset by additional
internal engineering resources, as the development of new high quality
products is completed and these products move into the testing and
customer prototyping phases. Foreign currency fluctuations increased
the reported engineering and R&D expense by $56,000. In addition sales
and marketing expense increased by $295,000 compared to the same quarter
last year, due to foreign currency fluctuations of $52,000 and an increase
in number of sales employees and additional marketing expense related to
the introduction of advanced new products.
In the first quarter there was operating income of $20,000 compared
to $173,000 in the first quarter last year, a decrease in operating income
of $153,000. Foreign currency fluctuations decreased reported operating
income by $200,000. Operating income in the controller business of
$158,000 was $71,000 lower than in the first quarter of last year. The
decrease in controller business operating income was mainly due to
additional spending on sales and marketing of new products, partially
offset by higher volumes and lower engineering expense. There was an
operating loss in the capacitor business segment of $18,000 compared to
operating income of $9,000 in the prior year first quarter, mainly due
to lower volumes. Unallocated corporate expenses were $120,000 in the
current year compared to $65,000 in the first quarter of last year. The
increase in first quarter unallocated expense was mainly due to higher
professional fees in connection with compliance with section 404 of the
Sarbanes Oxley Act.
Other income in the first quarter of this year was $10,000 compared
to other expense of $49,000 in the same quarter last year, a difference of
$59,000. This was mainly due to foreign currency gains in the first quarter
of fiscal 2005 compared to losses last year.
Income before income taxes of $30,000 decreased by $94,000 compared
to last year when pre-tax income was $124,000. Income taxes were 33.3% of
pre-tax income compared to 34.7% in the same quarter last year. Net income
was $20,000 compared to $81,000 in the same quarter last year, a decrease
of $61,000. Basic and fully diluted income per share was down by $.02 per
share from the prior year at $.01 per share.
Financial Condition
The Company has, since January 1990, maintained a program of regular
cash dividends. The dividend for the first quarter of fiscal 2005 was paid
on January 6, 2005, and amounted to $95,000. Cash balances at the end of
the first quarter of 2005 were $600,000 compared to $905,000 in September
2004, a decrease in cash of $305,000.
In the first three months of fiscal 2005 net income was $20,000, and
operating activities used $496,000 of cash. There was an increase of
$261,000 in receivables due to both slower collections and foreign
currency fluctuations. The number of days sales in receivables increased
in the first three months of fiscal 2005 from 70 days to 75 days.
Inventories decreased by $64,000 and accounts payable decreased by
$536,000. Dividends paid in the first quarter of fiscal 2005 amounted to
$94,000. Capital expenditures were $38,000 offset by depreciation of
$172,000.
The Company has no long-term debt and has overdraft facilities in
the UK of approximately $2,112,000 and of $449,000 in France. The UK
overdraft facilities are secured by all of the Company's assets in the
UK and the French overdraft facilities are unsecured.
Tech/Ops Sevcon's capital resources, in the opinion of management,
are adequate for projected operations and capital spending programs.
Item 3. Quantitative and Qualitative Disclosures about Market Risk.
The Company's operations are sensitive to a number of market factors
any one of which could materially adversely affect its results of
operations in any given year. Other risks dealing with contingencies are
described in Note 5 to the Company's Consolidated Financial Statements
included under Item 8 of the Company's Form 10-K for the year ended
September 30, 2004 and other risks are described under the caption Risk
Factors in Management's discussion and analysis of financial condition
and results of operations above.
Foreign currency risk
The Company sells to customers throughout the industrialized world.
The majority of the Company's products are manufactured in the United
Kingdom. In the first quarter of fiscal 2005 approximately 37% of the
Company's sales were made in US Dollars, 25% were made in British Pounds
and 38% were made in Euros. Over 90% of the Company's cost of sales was
incurred in British Pounds. This resulted in the Company's sales and
margins being exposed to fluctuations due to the change in the exchange
rates of the US Dollar, the British Pound and the Euro. The Company has
trade accounts receivable and accounts payable denominated in both
British pounds and Euros which are exposed to exchange fluctuations.
In addition, the translation of the sales and income of foreign
subsidiaries into US Dollars is also subject to fluctuations in foreign
currency exchange rates.
The Company undertakes hedging activities to manage the foreign
exchange exposures related to forecast purchases and sales in foreign
currency and the associated foreign currency denominated receivables and
payables. The Company does not engage in speculative foreign exchange
transactions. Details of this hedging activity and the underlying exposures
are set out below.
The following table provides information about the Company's foreign
currency accounts receivable, accounts payable, firmly committed sales
contracts and derivative financial instruments outstanding as of
January 1, 2005. The information is provided in US Dollar amounts, as
presented in the Company's consolidated financial statements. The table
presents the notional amount (at contract exchange rates) and the
weighted average contractual foreign currency exchange rates. All
contracts mature in fiscal 2005.
- -----------------------------------------------------------------------------
(in thousands, except average contract rates)
- -----------------------------------------------------------------------------
Expected maturity or transaction date Fair
FY 2005 FY 2006 Total Value
- -----------------------------------------------------------------------------
On balance sheet financial
instruments:
In $US Functional Currency
Accounts receivable in pounds 1,439 - 1,439 1,439
Accounts receivable in euros 2,613 - 2,613 2,613
Accounts payable in pounds 2,160 - 2,160 2,160
Accounts payable in euros 134 - 134 134
Anticipated Transactions
and related derivatives
In $US Functional Currency
Firmly committed sales contracts
In pounds 697 - 697 -
In Euros 936 - 936 -
Forward exchange agreements
Sell Euros for British
Pounds 564 - 564 (20)*
Average contractual exchange rate 1.46 EUR - 1 GBP
Sell US Dollars for British
Pounds 1,400 - 1,400 127 *
Average contractual exchange rate $1.76 - 1 GPB
- -----------------------------------------------------------------------------
Amount recorded as other
comprehensive income $ - $ - $ - $ -
- -----------------------------------------------------------------------------
*The estimated fair value is based on the estimated amount at which the
contracts could be settled based on forward exchange rates.
Because the difference between the spot and hedged foreign exchange
rates at January 1, 2005 was less than 8%, and amounted to $106,000, the
risk of default by counterparties is not material to the Company.
Interest Rate Risk
The Company does not currently have any interest bearing debt. The
Company does invest surplus funds in instruments with maturities of less
than 12 months at both fixed and floating interest rates. The Company
incurs short-term borrowings from time-to-time on its overdraft facilities
in Europe at variable interest rates. Due to the short-term nature of the
Company's investments at January 1, 2005 the risk arising from changes in
interest rates was not material.
Item 4. Controls and Procedures.
(a) Evaluation of disclosure controls and procedures. Our management,
with the participation of our principal executive officer and principal
financial officer, has evaluated the effectiveness of our "disclosure
controls and procedures" (as defined in the Securities Exchange Act of
1934 Rule 13a-15(e)) as of January 1, 2005. Based on this evaluation, our
principal executive officer and principal financial officer have concluded
that, as of January 1, 2005, these disclosure controls and procedures were
effective and designed to ensure that the information required to be
disclosed in the reports filed or submitted by the Company under the
Securities Exchange Act of 1934 is recorded, processed, summarized and
reported within the requisite time periods.
(b) Changes in internal control over financial reporting. Our principal
executive officer and principal financial officer have identified no
change in our "internal control over financial reporting" (as defined in
Securities Exchange Act of 1934 Rule 13a-15(f)) that occurred during the
period covered by this Quarterly Report on Form 10-Q that has materially
affected, or is reasonably likely to materially affect, our internal
control over financial reporting.
PART II. OTHER INFORMATION
Item 6. Exhibits
See Exhibit Index immediately preceding the exhibits.
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.
TECH/OPS SEVCON, INC.
Date: February 15, 2005 By: /s/ Paul A. McPartlin
---------------------
Paul A. McPartlin
Chief Financial Officer(Principal
financial and chief accounting officer)
Exhibit Index
Exhibit Description
- ------- -----------
10.1 Resolution dated January 24, 2005 re: Compensation of
non-employee directors (incorporated by reference to Exhibit
99.1 to form 8-K filed January 26, 2005).
31.1 Certification of Principal Executive Officer pursuant to
section 302 of the Sarbanes-Oxley Act of 2002.
Filed herewith.
31.2 Certification of Principal Financial Officer pursuant to
section 302 of the Sarbanes-Oxley Act of 2002.
Filed herewith.
32.1 Certification of Principal Executive Officer and Principal
Financial Officer pursuant to section 906 of the
Sarbanes-Oxley Act of 2002. Furnished herewith.
EXHIBIT 31.1
CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Matthew Boyle, certify that:
1. I have reviewed this Quarterly Report on Form 10-Q of Tech/Ops Sevcon,
Inc.;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this report;
3. Based on my knowledge, the financial statements, and other
financial information included in this report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our supervision,
to ensure that material information relating to the registrant, including
its consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this report is being
prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end of
the period covered by this report based on such evaluation; and
c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in
the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation of internal control over financial reporting,
to the registrant's auditors and the audit committee of the registrant's
board of directors (or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are reasonably
likely to adversely affect the registrant's ability to record, process,
summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal control
over financial reporting.
Date: February 15, 2005 /s/ Matthew Boyle
---------------------
Matthew Boyle
President and
Chief Executive Officer
EXHIBIT 31.2
CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Paul A. McPartlin, certify that:
1. I have reviewed this Quarterly Report on Form 10-Q of Tech/Ops Sevcon,
Inc.;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects
the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our supervision, to
ensure that material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this report is being
prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end of
the period covered by this report based on such evaluation; and
c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's most
recent fiscal quarter (the registrant's fourth fiscal quarter in the case
of an annual report) that has materially affected, or is reasonably likely
to materially affect, the registrant's internal control over financial
reporting; and
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation of internal control over financial reporting,
to the registrant's auditors and the audit committee of the registrant's
board of directors (or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are reasonably
likely to adversely affect the registrant's ability to record, process,
summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal control
over financial reporting.
Date: February 15, 2005 /s/ Paul A. McPartlin
---------------------
Paul A. McPartlin
Chief Financial and
Accounting Officer
EXHIBIT 32.1
Certification of Periodic Financial Report
Pursuant to 18 U.S.C. Section 1350
Each of the undersigned officers of Tech/Ops Sevcon, Inc. (the
"Company") certifies, under the standards set forth in and solely for the
purposes of 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002, that the Quarterly Report on Form 10-Q of
the Company for the quarter ended January 1, 2005 fully complies with the
requirements of Section 13(a) or 15(d) of the Securities Exchange Act of
1934 and information contained in that Form 10-Q fairly presents, in all
material respects, the financial condition and results of operations of
the Company.
Dated: February 15, 2005 /s/ Matthew Boyle
-----------------------
Matthew Boyle
Chief Executive Officer
Dated: February 15, 2005 /s/ Paul A. McPartlin
-----------------------
Paul A. McPartlin
Chief Financial Officer