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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from_________to______
Commission file number 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.)
5190 OLD EASTON HIGHWAY, P.O. BOX 1000, DANBORO, PENNSYLVANIA 18916
(Address of principal executive offices) (Zip Code)
(215)-766-8853
- --------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
NOT APPLICABLE
- --------------------------------------------------------------------------------
(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 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 14,062,481 shares of common stock, $.01 par
value, outstanding on November 8, 2002.
Page 1 of 20 pages.
1
PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PENN ENGINEERING & MANUFACTURING CORP.
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(Dollars in thousands) SEPTEMBER 30, 2002 DECEMBER 31, 2001
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 14,836 $ 8,421
Short-term investments 191 717
Accounts receivable-net 27,531 26,648
Inventories 59,844 61,646
Refundable income taxes 314 5,650
Other current assets 1,478 1,759
--------- ---------
Total current assets 104,194 104,841
--------- ---------
PROPERTY
Property, plant & equipment 173,143 170,101
Less accumulated depreciation 84,842 77,168
--------- ---------
Property - net 88,301 92,933
--------- ---------
GOODWILL, NET 26,561 25,860
--------- ---------
OTHER ASSETS 4,693 5,192
--------- ---------
TOTAL $ 223,749 $ 228,826
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable-trade $ 4,250 $ 4,146
Bank debt 17,000 12,664
Dividends payable 1,044 1,386
Accrued expenses:
Pension & profit sharing 1,108 1,114
Payroll & commissions 2,568 2,242
Other 2,920 2,744
--------- ---------
Total current liabilities 28,890 24,296
--------- ---------
ACCRUED PENSION COST 3,992 5,934
--------- ---------
DEFERRED INCOME TAXES 6,227 6,170
--------- ---------
LONG-TERM BANK DEBT 3,000 12,000
--------- ---------
STOCKHOLDERS' EQUITY
Common stock 148 147
Class A common stock 35 35
Additional paid-in capital 40,326 39,424
Retained earnings 147,626 149,090
Accumulated other comprehensive loss (1,059) (2,834)
Treasury stock (5,436) (5,436)
--------- ---------
Total stockholders' equity 181,640 180,426
--------- ---------
TOTAL $ 223,749 $ 228,826
========= =========
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
2
PENN ENGINEERING & MANUFACTURING CORP.
STATEMENTS OF CONDENSED CONSOLIDATED INCOME
(Unaudited)
(Dollars in thousands except per share amounts)
THREE MONTHS ENDED NINE MONTHS ENDED
------------------ -----------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2002 2001 2002 2001
---- ---- ---- ----
NET SALES $ 38,112 $ 36,616 $ 111,446 $ 156,822
COST OF PRODUCTS SOLD 25,995 25,511 76,648 105,303
-------- -------- --------- ---------
GROSS PROFIT 12,117 11,105 34,798 51,519
SELLING EXPENSES 4,838 4,967 14,389 16,321
GENERAL AND ADMINISTRATIVE EXPENSES 5,837 5,000 17,636 17,737
-------- -------- --------- ---------
OPERATING INCOME 1,442 1,138 2,773 17,461
-------- -------- --------- ---------
OTHER INCOME (EXPENSE):
Interest income 42 46 86 245
Interest expense (205) (269) (614) (790)
Other, net 128 (296) 1,077 344
-------- -------- --------- ---------
TOTAL OTHER INCOME (EXPENSE) (35) (519) 549 (201)
-------- -------- --------- ---------
INCOME BEFORE INCOME TAXES 1,407 619 3,322 17,260
PROVISION FOR INCOME TAXES 407 (200) 963 5,208
-------- -------- --------- ---------
NET INCOME $ 1,000 $ 819 $ 2,359 $ 12,052
======== ======== ========= =========
PER SHARE DATA:
Basic earnings $ 0.06 $ 0.05 $ 0.14 $ 0.70
======== ======== ========= =========
Diluted earnings $ 0.06 $ 0.05 $ 0.13 $ 0.68
======== ======== ========= =========
Cash dividends declared $ 0.06 $ 0.08 $ 0.22 $ 0.24
======== ======== ========= =========
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
3
PENN ENGINEERING & MANUFACTURING CORP.
STATEMENTS OF CONDENSED CONSOLIDATED CASH FLOWS
(Unaudited)
(Dollars in thousands)
NINE MONTHS ENDED
-----------------
SEPTEMBER 30, 2002 SEPTEMBER 30, 2001
------------------ ------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 2,359 $ 12,052
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation 7,770 7,567
Amortization 9 1,001
Deferred income taxes 56 4
Foreign currency transaction (gains) losses (642) 679
Loss on disposal of property 0 155
Loss on disposal of investments 137 0
Changes in assets and liabilities:
(Increase) decrease in receivables (111) 11,230
Decrease (increase) in inventories 2,186 (12,896)
Decrease in refundable income taxes 5,311 0
Decrease in prepaid expenses 300 2,578
Decrease in other assets 500 500
Increase (decrease) in accounts payable 76 (6,195)
Increase (decrease) in accrued expenses 36 (585)
Decrease in accrued pension cost (1,942) 0
-------- --------
Net cash provided by operating activities 16,045 16,090
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Property additions (1,960) (10,179)
Acquisitions of businesses (net of cash) 0 (16,707)
Proceeds from disposal of held-to-maturity investments 0 2,296
Proceeds from disposal of available-for-sale investments 531 0
Proceeds from disposal of property 7 242
-------- --------
Net cash used in investing activities (1,422) (24,348)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net short-term (repayments) borrowings (4,664) 15,377
Dividends paid (4,165) (2,760)
Issuance of common stock 903 1,206
-------- --------
Net cash (used in) provided by financing activities (7,926) 13,823
-------- --------
Effect of exchange rate changes on cash (282) 5
-------- --------
Net increase in cash and cash equivalents 6,415 5,570
Cash and cash equivalents at beginning of year 8,421 3,550
-------- --------
Cash and cash equivalents at end of period $ 14,836 $ 9,120
======== ========
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
4
PENN ENGINEERING & MANUFACTURING CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2002
NOTE 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
The accompanying interim financial statements 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, 2001. The
information contained in this report is unaudited and subject to year-end audit
and adjustment. In the opinion of management, all adjustments (which include
only normal recurring adjustments) have been made which are necessary for a fair
presentation of the Company's consolidated financial position at September 30,
2002 and 2001 and the consolidated statements of income and cash flows for the
nine-month periods then ended. The results of operations for the three and nine
months ended September 30, 2002 are not necessarily indicative of the results of
operations to be expected for the year ending December 31, 2002.
NOTE 2. INVENTORIES
Substantially all of the Company's domestic fastener inventories are
priced on the lower of last-in, first-out (LIFO) cost or market method. 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)
(UNAUDITED)
SEPTEMBER 30, 2002 DECEMBER 31, 2001
------------------ -----------------
Raw material $ 4,913 $ 5,697
Tooling 4,770 4,330
Work-in-process 9,653 10,417
Finished goods 40,508 41,202
------- -------
TOTAL $59,844 $61,646
======= =======
If the FIFO method of inventory valuation had been used by the Company for
all inventories, inventories would have been $11,170,000 and $10,618,000 higher
than reported at September 30, 2002 and December 31, 2001, respectively, and net
income would have been $392,000 and $576,000 higher than reported for the nine
months ended September 30, 2002 and 2001, respectively. Long-term tooling
inventory totaling $2,500,000 and $3,000,000 at September 30, 2002 and December
31, 2001, respectively, is included in Other Assets.
5
PENN ENGINEERING & MANUFACTURING CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2002
NOTE 3. BANK DEBT
As of September 30, 2002, the Company has three unsecured line of credit
facilities available. All lines of credit bear interest at interest rate options
provided in the facilities and are reviewed annually by the banks for renewal.
The first facility is a working capital facility that permits maximum borrowings
of $15,000,000, due on demand. At September 30, 2002, there was no outstanding
amount on this facility. The second facility is a general facility that allows
for borrowings up to $40,000,000. As of September 30, 2002, there was no
outstanding amount on this facility. The third facility allows for borrowings of
up to $12,000,000. A $12,000,000 term loan is currently outstanding on this
facility at an interest rate of 3.6%. This loan is payable in 12 equal monthly
installments commencing January 31, 2003 with the final payment due and payable
on December 31, 2003. Therefore, $9,000,000 of this loan is classified as
current.
In addition to the above facilities, the Company has an acquisition line
available that permits borrowings of up to $15,000,000 to finance acquisitions.
At September 30, 2002, $8,000,000, bearing interest at 2.56%, was outstanding on
this facility and has been classified as short-term debt.
These line of credit facilities require the Company to comply with certain
financial covenants. At September 30, 2002 the Company is not in compliance with
one of the required financial covenants. However all banks involved have waived
compliance for the measurement period ended September 30, 2002.
NOTE 4. COMPREHENSIVE INCOME
Total comprehensive income amounted to $1,274,000 and $2,623,000 for the
three months ended September 30, 2002 and 2001, respectively and $4,134,000 and
$11,619,000 for the nine months ended September 30, 2002 and 2001, respectively.
NOTE 5. IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
On January 1, 2002, the Company adopted Statement of Financial Accounting
Standards No. 141 ("SFAS No. 141"), "Business Combinations", Statement of
Financial Accounting Standards No. 142 ("SFAS No. 142"), "Goodwill and other
Intangible Assets", and Statement of Financial Accounting Standards No. 144
("SFAS No. 144"), "Accounting for the Impairment or Disposal of Long-Lived
Assets." SFAS No. 141 requires all business combinations initiated after June
30, 2001 to be accounted for using the purchase method of accounting. SFAS No.
142 establishes new accounting and reporting standards for goodwill and
intangible assets. SFAS No. 142 requires that goodwill and intangible assets
deemed to have indefinite lives no longer be amortized but be subject to an
annual impairment test in accordance with SFAS No. 142. Other intangible assets
will continue to be amortized over their useful lives. Application of the
nonamortization provisions of SFAS No. 142 for the three months and nine months
ended September 30, 2001 would have resulted in an increase in net income of
approximately $270,000 ($.02 per diluted share) and $745,000 ($.04 per diluted
share), respectively. The Company has performed the first of the required
impairment tests of goodwill as of January 1, 2002 and this test did not result
in any impairment. SFAS No. 144 addresses financial accounting and reporting for
the impairment or disposal of long-lived assets. The adoption of this standard
did not have a material impact on the quarterly consolidated financial position
or results of operations for the Company.
NOTE 6. USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
6
PENN ENGINEERING & MANUFACTURING CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2002
NOTE 7. SEGMENT INFORMATION
(Dollars in Thousands)
THREE MONTHS ENDED THREE MONTHS ENDED
SEPTEMBER 30, 2002 SEPTEMBER 30, 2001
------------------ ------------------
FASTENERS DISTRIBUTION MOTORS FASTENERS DISTRIBUTION MOTORS
--------- ------------ ------ --------- ------------ ------
Revenues from external customers $21,302 $ 8,822 $7,988 $20,999 $7,587 $ 8,030
Intersegment revenues 5,139 4,192
Operating profit (loss) 2,195 216 568 (1,068) 1,470 363
NINE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2002 SEPTEMBER 30, 2001
------------------ ------------------
FASTENERS DISTRIBUTION MOTORS FASTENERS DISTRIBUTION MOTORS
--------- ------------ ------ --------- ------------ ------
Revenues from external customers $ 62,085 $26,112 $23,249 $101,354 $28,466 $27,002
Intersegment revenues 15,508 21,113
Operating profit 3,570 913 1,312 17,060 2,116 972
A reconciliation of combined operating profit for the reportable segments to
consolidated income before income taxes is as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
------------ ------------
2002 2001 2002 2001
---- ---- ---- ----
Total profit for reportable segments $ 2,979 $ 765 $ 5,795 $ 20,148
Unallocated corporate income (expense) (1,537) 373 (3,022) (2,687)
Other income (expense) (35) (519) 549 (201)
------- ----- ------- --------
Income before income taxes $ 1,407 $ 619 $ 3,322 $ 17,260
======= ===== ======= ========
7
PENN ENGINEERING & MANUFACTURING CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2002
NOTE 8. 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 NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
------------ ------------
2002 2001 2002 2001
---- ---- ---- ----
(In Thousands, except per share data)
Basic:
Net income $ 1,000 $ 819 $ 2,359 $12,052
Average shares outstanding 17,392 17,286 17,372 17,253
------- ------- ------- -------
Basic EPS $ 0.06 $ 0.05 $ 0.14 $ 0.70
======= ======= ======= =======
Diluted:
Net income $ 1,000 $ 819 $ 2,359 $12,052
======= ======= ======= =======
Average shares outstanding 17,392 17,286 17,372 17,253
Net effect of dilutive stock options-
based on treasury stock method 122 329 269 418
------- ------- ------- -------
Totals 17,514 17,615 17,641 17,671
======= ======= ======= =======
Diluted EPS $ 0.06 $ 0.05 $ 0.13 $ 0.68
======= ======= ======= =======
8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
PENN ENGINEERING & MANUFACTURING CORP.
SEPTEMBER 30, 2002
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
QUARTER ENDED SEPTEMBER 30, 2002 VS. QUARTER ENDED SEPTEMBER 30, 2001
Consolidated net sales for the quarter ended September 30, 2002 were $38.1
million, versus $36.6 million for the quarter ended September 30, 2001, a 4.1%
increase. Net sales to customers outside the United States for the quarter ended
September 30, 2002 were $12.2 million, versus $11.6 million for the quarter
ended September 30, 2001, a 4.3% increase. Net sales for the fastener segment
for the quarter ended September 30, 2002 were $21.3 million, versus $21.0
million for the quarter ended September 30, 2001, a 1.4% increase. Motor segment
net sales were $8.0 million in both the quarter ended September 30, 2002 and the
quarter ended September 30, 2001. Net sales for the distribution segment for the
quarter ended September 30, 2002 were $8.8 million versus $7.6 million for the
quarter ended September 30, 2001, a 15.8% increase. Over half of this increase
occurred in the Asia-Pacific market as more assembly work in the electronics and
computer industry is being shifted to that region.
Within the fastener and distribution segments, sales volume increased 7.9%
in the third quarter of 2002 compared to the third quarter of 2001. Sales volume
within North America increased approximately 12.2% in the third quarter of 2002
compared to the third quarter of 2001 while sales volume into the Asia-Pacific
region increased 39.2% during the same period. These volume increases were
offset by a volume decrease of 8.6% in Europe in the third quarter of 2002
compared to the third quarter of 2001. While showing some recovery from a
depressed third quarter of 2001, the Company continues to be impacted by the
weakness in the personal computer, telecommunications, server, and electronics
markets, as well as our independent distributors efforts to reduce inventories.
Within the motor division the number of motors sold decreased 12.1% in the third
quarter of 2002 compared to the third quarter of 2001. However, the average
selling price in the motor division increased 13.2% during the same period.
Consolidated gross profit for the third quarter of 2002 was $12.1 million,
versus $11.1 million for the third quarter of 2001, an increase of 9.0%. The
fastener segment saw gross profit increase 64.3% in the third quarter of 2002
compared to the third quarter of 2001. The Company has undertaken many cost
saving measures since the third quarter of 2001, including workforce reductions
and a plant closing, that are positively impacting gross profit in 2002. The
motor segment gross profit increased 3.7% in the third quarter of 2002 compared
to the third quarter of 2001 while the distribution segment gross profit
decreased 34.6% due to competitive pricing pressures and a shift in product mix
to lower margin products.
Consolidated selling, general, and administrative expenses ("SG&A") for
the third quarter of 2002 were $10.7 million, versus $10.0 million for the third
quarter of 2001. Contributing to the increase were higher employee benefit costs
and increased depreciation expense for the Company's new distribution software.
Consolidated net income for the third quarter of 2002 was $1.0 million,
versus $0.8 million for the third quarter of 2001. Other income benefited from
favorable foreign currency exchange rates in the third quarter of 2002 compared
to the third quarter of 2001.
9
PENN ENGINEERING & MANUFACTURING CORP.
SEPTEMBER 30, 2002
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 2002 VS. NINE MONTHS ENDED SEPTEMBER 30, 2001
Consolidated net sales for the nine months ended September 30, 2002 were
$111.4 million, versus $156.8 million for the nine months ended September 30,
2001, a 29.0% decrease. Net sales to customers outside the United States for the
nine months ended September 30, 2002 were $36.6 million, versus $45.9 million
for the nine months ended September 30, 2001, a 20.5% decrease. Net sales for
the fastener segment for the nine months ended September 30, 2002 were $62.1
million, versus $101.4 million for the nine months ended September 30, 2001, a
38.8% decrease. Motor segment net sales were $23.2 million for the nine months
ended September 30, 2002, versus $27.0 million for the nine months ended
September 30, 2001, a 14.1% decrease. Net sales for the distribution segment for
the nine months ended September 30, 2002 were $26.1 million, versus $28.5
million for the nine months ended September 30, 2001, a 8.4% decrease.
Within the fastener and distribution operations, sales volume decreased
31.9% from the first nine months of 2001 to the first nine months of 2002. Sales
volume within North America decreased approximately 38.0% in the first nine
months of 2002 compared to the first nine months of 2001, while sales volume
into Europe decreased approximately 30.7% during the same period. The major
markets served by the Company, personal computer, telecommunications, server,
and electronics, experienced a steep decline during the second and third
quarters of 2001 and are only showing small signs of recovering during 2002. In
addition, the Company is attempting to reduce its world-wide inventory levels to
better support its current demand. The Asia-Pacific region saw sales volume
increase approximately 39.3% in the first nine months of 2002 compared to the
first nine months of 2001 as companies shifted electronics production to that
region. The number of motors sold decreased 19.0% in the first nine months of
2002 compared to the first nine months of 2001. However, the average selling
price in the motor division increased 6.3% during the same period. The majority
of the motor segment sales are in the semiconductor and data storage markets,
which were significantly impacted by the 2001 recession.
Consolidated gross profit for the first nine months of 2002 was $34.8
million, versus $51.5 million for the first nine months of 2001, a 32.4%
decrease. All three operating segments experienced gross profit declines from
the first nine months of 2001 to the first nine months of 2002 due mainly to the
large sales volume decline and the resulting costs associated with workforce
reductions and decreased production requirements.
Consolidated SG&A expenses for the first nine months of 2002 were $32.0
million, versus $34.1 million for the first nine months of 2001. The Company
incurred $1.0 million of goodwill amortization in 2001 which it can no longer
amortize in 2002. However, higher costs for employee benefits, computer software
depreciation, and certain non-income related taxes prevented further SG&A
declines in 2002.
Consolidated net income for the first nine months of 2002 was $2.4
million, versus $12.1 million for the first nine months of 2001. Other income
for the first nine months of 2002 was higher than the first nine months of 2001
due to favorable foreign currency transactions and reduced interest expense
during the period.
10
PENN ENGINEERING & MANUFACTURING CORP.
SEPTEMBER 30, 2002
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents at September 30, 2002 were $14.8 million
compared to $14.5 million at June 30, 2002, $9.6 million at March 31, 2002, and
$8.4 million at December 31, 2001. Working capital totaled $75.3 million at
September 30, 2002 compared to $77.3 million at June 30, 2002, $79.2 million at
March 31, 2002, and $80.5 million at December 31, 2001.
Net cash of $16.0 million was provided by operating activities for the
nine months ended September 30, 2002 compared to $16.1 million provided by
operating activities for the nine months ended September 30, 2001. During the
nine months ended September 30, 2002, non-cash items totaled $7.3 million and
the Company received $4.4 million from tax refunds due to overpayments of
estimated tax in 2002. Inventory levels decreased $2.2 million. The Company
intends to further reduce inventory levels by December 31, 2002.
Net cash used in investing activities totaled $1.4 million for the nine
months ended September 30, 2002 compared to $24.3 million for the nine months
ended September 30, 2001. The Company significantly curtailed capital
expenditures during 2002 because of the downturn in business activity.
Net cash used in financing activities totaled $7.9 million for the nine
months ended September 30, 2002 compared to net cash provided by financing
activities of $13.8 million for the nine months ended September 30, 2001.
Because of the decreased capital expenditures and lack of business acquisition
activity in 2002, the Company repaid $4.7 million of short-term debt. Despite
the economic downturn and its impact on the Company's earnings, the Company's
strong cash and working capital position have allowed for the continued payment
of cash dividends of $4.2 million for the nine months ended September 30, 2002.
As a result, the Company's dividend per share exceeded earnings per share for
the nine month period ended September 30, 2002. The Company's earnings per share
have historically exceeded dividends declared and paid, and the Company expects
this to be the case in the future as the business climate recovers.
The Company's main contractual obligations are the repayment of its
short-term and long-term debt (see Note 3) and the payment of operating lease
commitments covering certain automobiles, office space, and office equipment
which are listed in Note 11 to the Company's Annual Report for the year ended
December 31, 2001. As stated in Note 3, the Company was not in compliance with
one of the two required financial covenants of its two lending banks at
September 30, 2002. The first covenant requires that the ratio of funds flow
(net income plus depreciation and amortization plus interest expense less
dividends paid) for a rolling four quarters to current maturities of long-term
debt plus interest expense exceed 1.50. The Company did meet this covenant at
September 30, 2002. The second covenant requires that the ratio of the Company's
total funded debt at the end of the period to earnings before interest, taxes,
depreciation, and amortization for a rolling four quarters not exceed a maximum
of 1.75. The Company exceeded this ratio at September 30, 2002 due to a net loss
in the fourth quarter of 2001 as well as lower than expected net income in the
first nine months of 2002. As of September 30, 2002, the Company has received
letters from both banks waiving covenant compliance for the measurement period
ended September 30, 2002. Because a rolling four quarters are used for both
covenants, the Company expects to once again be in compliance by December 31,
2002. Also, because of the Company's strong cash position, a portion of the debt
can be paid down to maintain compliance in the future.
The Company anticipates that its existing capital resources and cash flow
generated from future operations as well as existing short-term lines of credit
will enable it to maintain its current level of operations and its planned
growth for the foreseeable future.
11
PENN ENGINEERING & MANUFACTURING CORP.
SEPTEMBER 30, 2002
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CRITICAL ACCOUNTING POLICIES
The Company has identified a number of its accounting policies 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 66%
and 65% of total inventories at September 30, 2002 and December 31, 2001,
respectively, are priced on the first-in, first-out (FIFO) method. Reserves are
recorded for obsolete, excess, and slow-moving inventory based on management's
estimates about future demand and market conditions. If the estimated reserves
for obsolete, excess, and slow-moving inventory are not sufficient based on
actual future demand, additions to the reserves may be required.
ACCOUNTS RECEIVABLE
The Company maintains an allowance for doubtful accounts for trade receivables
for which collectibility is uncertain. In estimating uncollectible amounts,
management considers factors such as current overall economic conditions,
industry-specific economic conditions, historical customer performance, and
anticipated customer performance. While management believes the Company's
processes effectively address its exposure for doubtful accounts, changes in the
economy, industry, or specific customer conditions may require adjustment to the
allowance for doubtful accounts recorded by the Company.
PENSIONS
The Company accounts for its defined benefit pension plan in accordance with
SFAS No. 87, "Employers' Accounting for Pensions", which requires that amounts
recognized in 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 the 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, 2001, the Company
determined this rate to be 7.25%. The Company has assumed that the expected
long-term rate of return on plan assets will be 8.00%. This expected rate of
return has been used by the Company for many years. Although in the last two
years pension plan assets have earned substantially less than 8.00%, over the
long-term, the Company believes that its return assumption of 8.00% is
reasonable, based on its expectations about future returns. Should the downward
trend in return on pension assets continue, 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. 87 and will ultimately affect
future pension expense.
12
PENN ENGINEERING & MANUFACTURING CORP.
SEPTEMBER 30, 2002
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CRITICAL ACCOUNTING POLICIES - CONTINUED
DERIVATIVE INSTRUMENTS AND HEDGING
The Company manages risks associated with foreign exchange rates and interest
rates with derivative instruments. The Company does not use derivative
instruments unless there is an underlying exposure and, therefore, does not use
derivative instruments for trading or speculative purposes. The evaluation of
hedge effectiveness is subject to assumptions based on the terms and timing of
the underlying exposures. All derivative instruments are recognized in the
Consolidated Balance Sheet at fair value. The fair value of derivative
instruments 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
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.
There have been no material changes to Part 2, Item 7A of the Company's
Form 10-K Annual Report for the year ended December 31, 2001.
ITEM 4. CONTROLS AND PROCEDURES.
Within 90 days prior to the date of filing of 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 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
gathering, analyzing, and disclosing 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. There have been
no significant changes in the Company's internal controls or in other factors
that could significantly affect internal controls subsequent to the date of this
evaluation.
13
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Reference is made to Part 1, Item 3 of the Company's Form 10-K Annual
Report for the year ended December 31, 2001.
ITEM 2. CHANGES IN SECURITIES
Not Applicable
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not Applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not Applicable
ITEM 5. OTHER INFORMATION
Not Applicable
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) 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.)
99.1 Certification pursuant to 18 U.S.C. Section 1350, As
Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
99.2 Certification pursuant to 18 U.S.C. Section 1350, As
Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
b) Reports on Form 8-K
None.
14
] 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.
PENN ENGINEERING & MANUFACTURING CORP.
Dated: November 13, 2002 By: /s/ Kenneth A. Swanstrom
------------------------------------
Kenneth A. Swanstrom
Chairman/CEO
Dated: November 13, 2002 By: /s/ Mark W. Simon
------------------------------------
Mark W. Simon
Senior Vice-President/CFO
15
CERTIFICATION
I, Kenneth A. Swanstrom, certify that:
1) I have reviewed this quarterly report on Form 10-Q of Penn Engineering &
Manufacturing Corp. for the quarter ended September 30, 2002;
2) Based on my knowledge, this quarterly 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 quarterly report;
3) Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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
quarterly report.
4) The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:
(a) designed such disclosure controls and procedures 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
quarterly report is being prepared:
(b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as or the Evaluation Date;
5) The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
(a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6) The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
Dated: November 13, 2002
/s/ Kenneth A. Swanstrom
------------------------------------
Kenneth A. Swanstrom,
Chairman/CEO
16
CERTIFICATION
I, Mark W. Simon, certify that:
1) I have reviewed this quarterly report on Form 10-Q of Penn Engineering &
Manufacturing Corp. for the quarter ended September 30, 2002;
2) Based on my knowledge, this quarterly 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 quarterly report;
3) Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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
quarterly report.
4) The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:
(a) designed such disclosure controls and procedures 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
quarterly report is being prepared:
(b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as or the Evaluation Date;
5) The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
(a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6) The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
Dated: November 13, 2002
/s/ Mark W. Simon
------------------------------------
Mark W. Simon,
Senior Vice-President/CFO
17
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.)
3.3 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.)
99.1 Certification pursuant to 18 U.S.C. Section 1350, As
Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
99.2 Certification pursuant to 18 U.S.C. Section 1350, As
Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
18