UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

OR

Commission file number 1-5356

PENN ENGINEERING & MANUFACTURING CORP.

Registrant’s telephone number, including area code: (215) 766-8853

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act: None.

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 þ.   No o.

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act 1934). Yes þ.   No o.

As of June 30, 2004, the aggregate market value based on the closing sales price on that date of the voting and non-voting common equity held by non-affiliates of the Registrant was approximately $290,100,000.

Indicate the number of shares outstanding of each of the Registrant’s classes of common stock as of the latest practicable date: 14,505,028 shares of Common Stock and 3,350,164 shares of Class A Common Stock outstanding on March 1, 2005.

DOCUMENTS INCORPORATED BY REFERENCE:

None.

PENN ENGINEERING & MANUFACTURING CORP.

INDEX TO FORM 10-K REPORT

(i)

PART I

     Item 1. Business.

     (a) General Development of Business.

     Penn Engineering & Manufacturing Corp., a Delaware corporation (the “Company”), was incorporated in 1942. The primary businesses of the Company are:

	•	The development, manufacture, and sale, through the Company’s PennEngineering Fastening Technologies division (“Fastening Technologies”), of PEM® self-clinching and broaching fasteners, automatic insertion equipment for such fasteners sold under the PEMSERTER® trademark, inserts for plastics sold under the SI® trademark, small screw insertion systems sold under the StickScrew® trademark, and blind-threaded inserts sold under the Atlas® trademark;
	•	The development, manufacture, and sale through the Company’s PennEngineering Motion Technologies division (“Motion Technologies”), of permanent magnet brush-commutated dc motors under the Pittman® brand and Lo-Cog® trademark, electronically commutated brushless dc servomotors under the Elcom® trademark, and stepper, brush, and brushless dc motors under the MAE™ trademark; and
	•	The distribution of fasteners and other components utilized by original equipment manufacturers (“OEMs”) and the provision of comprehensive logistical and inventory management services, through Arconix Group, Inc. and its subsidiaries (“Arconix Group”).

     On January 17, 2005, the Company announced that it has entered into a definitive merger agreement (the “Merger Agreement”) whereby the Company will be acquired by PEM Holding Co., an affiliate of Tinicum Capital Partners II, L.P., a New York-based private investment partnership, in a cash transaction.

     Under the terms of the Merger Agreement, stockholders of the Company will receive $18.25 in cash for each share of the Company’s Common Stock and Class A Common Stock. The market value of the transaction is expected to be approximately $330 million. The transaction is expected to be completed in the first half of 2005.

     A special committee of the Company’s Board of Directors consisting of the Company’s independent directors (the “Special Committee”) unanimously recommended to the Company’s full Board of Directors that it approve and authorize the Merger Agreement and the transactions contemplated thereby. The Company’s Board of Directors unanimously determined that the merger is fair to and in the best interests of the Company’s stockholders and that the merger is advisable, and approved and authorized the Merger Agreement and

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the related merger and resolved to recommend approval and adoption of the Merger Agreement and the related merger by holders of the Company’s Class A Common Stock. The obligations of the parties to the Merger Agreement to complete the merger are subject to various conditions including PEM Holding Co. or its wholly owned subsidiary having received the proceeds of a financing under a signed financing commitment letter. Upon termination of the Merger Agreement under specified circumstances, the Company has agreed to pay PEM Holding Co. a termination fee of $10.0 million and reimburse PEM Holding Co. up to $5.0 million for costs and expenses.

     Kenneth A. Swanstrom, the Company’s Chairman of the Board and Chief Executive Officer, Daryl L. Swanstrom, a director, and the Swanstrom family trusts, of which Kenneth A. Swanstrom and Daryl L. Swanstrom are the principal beneficiaries, who in the aggregate own 53.1% of the outstanding shares of the Company’s Class A Common Stock, have agreed with PEM Holding Co., if requested by PEM Holding Co., to grant PEM Holding Co. a proxy to vote shares representing approximately 49% of the outstanding shares of Class A Common Stock in favor of the Merger Agreement and the related merger and, unless PEM Holding Co. votes such shares directly pursuant to a proxy, to vote these shares in favor of the Merger Agreement and the related merger.

     (b) Financial Information About Industry Segments.

     The answer to this item is incorporated by reference to Note 13 of the Notes to Consolidated Financial Statements “Financial Reporting for Business Segments of the Company” included in Item 8 of this Form 10-K Annual Report.

     (c) Narrative Description of Business.

     Fastening Technologies is the world’s leading manufacturer of self-clinching fasteners, which are used principally by the computer, data communications, telecommunications, general electronics, automotive, and avionics industries. PEM® self-clinching fasteners were first developed by the Company’s founder in 1942. Self-clinching fasteners become an integral part of the material in which they are installed and provide a reliable means of attaching components to sheet metal and other thin materials. Typical applications for the Company’s fastener products include personal computers, computer cabinetry, power supplies, instrumentation, telecommunications equipment, and certain automobile components, such as air bags, sun roofs, and windshield wipers.

     The Company’s fasteners are primarily used by sheet metal fabricators, which utilize the Company’s fasteners to produce sub-assemblies for OEMs. Both OEMs and their subcontractors seek fastening solutions that provide lower total installed cost and high reliability, thereby lowering production and service costs. The Company’s application engineers, its distributors, and its independent distributors continually work in close collaboration with OEMs and their subcontractors early in the design process to determine

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appropriate fastener applications and to engineer fastening solutions. This collaboration often results in OEMs specifying the Company’s fasteners in their products. Self-clinching fasteners generally compete against loose hardware, such as nuts and bolts. Even though the Company’s fasteners typically sell at a premium to loose hardware, its fasteners generally result in lower overall manufacturing costs.

     Fastening Technologies also manufactures and sells manual and automated presses for fastener installation under the PEMSERTER® trademark, small screw insertion systems sold under the StickScrew® trademark, and blind-threaded inserts sold under the Atlas® trademark. The rapid and accurate installation provided by PEMSERTER® presses, together with the Company’s broad range of fastener products, provides the Company’s customers with a complete fastening system.

     Motion Technologies, under the Pittman® and Lo-Cog® trademarks, produces high-quality, high-performance, permanent magnet dc motors and electronically commutated brushless dc servomotors used in light-weight precision electronics, medical, and manufacturing applications such as archival storage, printing, copying, robotics, and medical diagnostic equipment and centrifuges, and, under the MAE trademark, produces high quality, high performance stepper, brush, and brushless dc motors serving similar applications and markets in Europe and Asia. Motion Technologies’ broad range of products are typically adapted to the specific requirements of individual customers.

     Arconix Group is a global distribution organization that offers a single source of supply for fastening and electronic hardware products and other components utilized by OEMs and their subcontractors. Arconix Group also provides a broad range of logistical and on-site inventory management services.

     The following table sets forth information with respect to the percentage of total sales attributable to each of the Company’s principal segments that accounted for 10% or more of consolidated revenues in each of the fiscal years ended December 31, 2002, 2003, and 2004:

     The Company’s fastener products are sold through a worldwide network of approximately 60 authorized independent distributors located in approximately 40 countries, including the Company’s own subsidiaries in California, China, England, Singapore, and Mexico. Many of the independent distributors and engineering representative organizations have been affiliated with the Company for more than 20 years. The Company’s independent

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distributors, which maintain their own inventories of the Company’s products, typically sell other complementary industrial components. The Company’s return allowances, which are made through the exchange of inventory, have generally averaged less than 1% of sales. The Company supplies its customers and distributors through warehouses in: Oxnard, California; Shanghai, China; Doncaster, England; Singapore; and Guadalajara, Mexico, in addition to maintaining inventory at its facilities in Danboro, Pennsylvania, Winston-Salem, North Carolina, and Kent, Ohio.

     Domestic and European sales of the Company’s motor products are made through independent sales representatives and authorized independent distributors.

     During the year ended December 31, 2004, conditions in the domestic market for fasteners continued to be highly competitive. It is not possible to determine with accuracy the relative competitive position of Fastening Technologies in the market for self-clinching, broaching, and insert fasteners. The Company believes that Fastening Technologies has maintained its market share during 2004. Approximately ten other companies are known to be competing with the Company in the manufacture and sale of such fasteners, some of which also manufacture products other than self-clinching, broaching, and insert fasteners.

     The Company also believes that Motion Technologies has maintained its competitive position in the dc motor market in 2004, and that Arconix Group has maintained its competitive position in the distribution and inventory management services arena in 2004.

     Among Fastening Technologies’ principal customers for fasteners and PEMSERTER® presses are manufacturers of business machines, personal computers, computer peripherals, electronic and communications equipment, electrical equipment, industrial controls instrumentation, vending machines, automotive subcontractors, and other fabricated metal products. Motion Technologies’ principal customers for the dc motors, servomotors, and stepper motors are manufacturers of mass data storage units, automated production equipment, instruments, computer peripherals, business machines, medical equipment and textile industry equipment. Arconix Group’s customers are generally the same as those of Fastening Technologies. In the opinion of the Company, no material part of its business is dependent upon a single customer or a few customers, the loss of any one or more of which would have a material adverse effect on the business of the Company. For the year ended December 31, 2004, sales to one of the Company’s authorized distributors totaled approximately $25,887,000, or approximately 11% of the Company’s 2004 consolidated net sales. For the year ended December 31, 2003, sales to the same distributor totaled approximately $18,900,000, or approximately 10% of the Company’s 2003 consolidated net sales. For the year ended December 31, 2002, there were no sales to any one customer that exceeded 10% of the Company’s 2002 consolidated net sales.

     As of December 31, 2004, the Company had an order backlog of $87,243,000 compared with $79,498,000 as of December 31, 2003. The Company estimates that substantially all of its

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backlog as of December 31, 2004 will be shipped during its fiscal year ending December 31, 2005.

     The raw materials used by the Company are generally available in adequate supply.

     The Company holds a number of patents and trademarks, and has patent applications pending in the United States and various foreign countries. Management believes, however, that the Company’s business is not materially dependent on any patent or group of patents. The principal trademarks of the Company are registered in the United States and various foreign countries.

     Research and development is carried on by the operating personnel of the Company on a continuing basis. The amounts expended for research and development for the fiscal years ended December 31, 2002, 2003, and 2004 were approximately $4,342,000, $4,570,000, and $4,728,000, respectively.

     The Company believes that compliance with federal, state, and local laws and regulations that have been enacted or adopted regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, will not have a material adverse effect upon the earnings or competitive position of the Company.

     As of December 31, 2004, 1,361 persons were employed by the Company, or 94 more than were employed as of December 31, 2003. The Company believes that its labor rates are comparable to those of its competitors and that the Company’s relations with its employees are good. The Company does not consider its business to be seasonal in any material respect, nor is any material portion of the Company’s business subject to the renegotiation of profits or termination of contracts at the election of the Government.

(d)

Financial Information About Foreign and Domestic Operations and Export Sales.

     The answer to this Item is incorporated by reference to Note 13 of the Notes to Consolidated Financial Statements “Financial Reporting for Business Segments of the Company” included in Item 8 of this Form 10-K Annual Report.

     Approximately 37% of the Company’s foreign sales in 2004 were payable in U.S. dollars. Of the remaining foreign sales, sales by certain of the Company’s wholly owned subsidiaries are denominated as follows: (i) sales in the United Kingdom and Western Europe through Arconix/UK Ltd. and PennEngineering Fastening Technologies (Europe) Ltd. are denominated in pounds sterling, U.S. dollars, and Euros; (ii) sales in the Pacific Rim through Arconix/Singapore Pte Ltd. and Arconix Fastening & Inventory Management Solutions (Shanghai) Co., Ltd. are denominated in Chinese yuan, Singapore dollars, and U.S. dollars; and (iii) sales in Mexico through Arconix/Mexico, S. de R.L. de C.V., are denominated in Mexican pesos and U.S. dollars.

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     (e) Available Information.

     The Company maintains an Internet web site at http://www.penn-eng.com and makes available free of charge on or through the web site its Annual Report on Form 10-K, its quarterly reports on Form 10-Q and its current reports on Form 8-K as soon as reasonably practicable after it electronically files such material with, or furnishes it to, the Securities and Exchange Commission (the “Commission”). The Company is in compliance with the requirements of the New York Stock Exchange to make available on the Company’s website and in printed form upon request the Company’s Code of Business Conduct and Ethics and the respective charters of its Audit, Compensation, and Nominating/Corporate Governance Committees.

Risk Factors

     Many of the Company’s customers are in cyclical industries, and their purchases from the Company may decline substantially during periods of economic slowdown.

     A majority of the Company’s revenues are derived from customers and OEMs that are in industries and businesses that are cyclical in nature and subject to change in general economic conditions, such as business machines, personal computers, computer peripherals, electronic and communications equipment, and other electronic equipment. Demand for the Company’s products is affected by the business success of the Company’s OEM and indirect customers who purchase products from those OEM customers. General economic or industry-specific downturns, particularly such as those in the telecommunication and datacommunications industries, have had, and in the future could have, a material adverse effect on the Company and its business, results of operations, and financial condition.

     The Company’s foreign operations are subject to numerous risks, including currency fluctuations and other risks that may impact the Company’s results of operations.

     Foreign sales accounted for approximately 39% of the Company’s 2004 consolidated sales. Because approximately 63% of the Company’s foreign sales and expenses were incurred in foreign currencies, the Company’s operations have been and may continue to be affected by fluctuations in currency exchange rates. Furthermore, currency fluctuations may cause reported sales to fluctuate from period to period regardless of the fluctuation in the volume of such sales in foreign currencies. From time to time, the Company purchases forward foreign currency exchange contracts to attempt to insulate the Company from the impact of foreign currency exchange rate fluctuations.

     Foreign sales are subject to numerous other risks, including political and economic instability in foreign markets, restrictive trade policies of foreign governments, economic conditions in local markets, the imposition of product tariffs, and the burdens of complying with a wide variety of international and U.S. export laws.

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Forward-Looking Statements

     Forward-looking statements, within the meaning of Section 27A of the Securities Act of 1933 (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), under the Private Securities Litigation Reform Act of 1995, are made throughout this Form 10-K. The Company’s results may differ materially from those set forth 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. The forward-looking statements contained in this Form 10-K reflect the Company’s views and assumptions only as of the date of this Form 10-K. Except as required by law, the Company does not intend to, and assumes no responsibility for, updating any forward-looking statements. The Company qualifies all of its forward-looking statements by these cautionary statements.

Item 2. Properties.

     The Company’s principal plants and offices, all of which (other than the Singapore, China, and Mexico offices) are owned by the Company, were as follows at December 31, 2004:

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     The Company also has leased 8,000 sq. ft. of office and warehouse space in Shanghai, China, 9,758 sq. ft. of office and warehouse space in Guadalajara, Mexico, and 7,000 sq. ft. of office and warehouse space in Singapore. The Company carries fire, casualty, business interruption, and public liability insurance for all of its facilities in amounts which it deems adequate.

Item 3. Legal Proceedings.

     As of March 14, 2005, the Company is aware that four complaints have been filed in the Delaware Court of Chancery against the Company and each of its directors. One of the complaints also names Tinicum Capital Partners II, L.P. and PEM Holding Co. as co-defendants. The complaints purport to be class actions filed on behalf of holders of the Company’s Common Stock arising from certain alleged actions by the Company and its directors in connection with the proposed merger of the Company with an affiliate of Tinicum Capital Partners II, L.P. The complaints include various allegations that: each of the defendants breached and/or aided and abetted the other defendants' breaches of fiduciary duties of loyalty, due care, candor, good faith and fair dealing; that the director defendants spent substantial effort tailoring the structural terms of the merger to meet the specific needs of Tinicum Capital Partners II, L.P. to ensure the sale of the Company to it on preferential terms instead of attempting to obtain the highest price reasonably available for the Company and its stockholders, which was subversive to the interests of the public stockholders of the Company; the directors structured and approved the transaction in contravention of the Company’s restated certificate of incorporation, agreeing to provisions in agreements that effectively preclude a competing bid and approving an acquisition that favors insiders to the detriment of the Company’s public stockholders, including the price per share offered to the holders of the Company’s Common Stock; and the defendants failed to provide material information concerning the transaction to the Company’s public stockholders. The complaints seek equitable relief in the form of an injunction enjoining the consummation of the merger or, if the merger is consummated to the detriment of the public stockholders, then rescission of the transaction or unspecified damages, in addition to costs and disbursements, including reasonable attorneys’ and experts’ fees.

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     The Company is in the process of preparing responses to these complaints, and the time for the Company to respond to these complaints has not yet expired.

Item 4. Submission of Matters to a Vote of Security Holders.

     None.

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PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities.

     The Company’s Common Stock (non-voting), par value $0.01 per share, is traded on the New York Stock Exchange under the symbol “PNN.” The Company’s Class A Common Stock (voting), par value $0.01 per share, is traded on the New York Stock Exchange under the symbol “PNNA.” As of March 1, 2005, there were approximately 540 holders of record of the Company’s Common Stock and 300 holders of record of the Company’s Class A Common Stock.

     The following table shows, for the quarters indicated, the high and low closing sales prices of the Company’s Common Stock and Class A Common Stock as reported by the New York Stock Exchange and the dividends declared on the Company’s Common Stock and Class A Common Stock.

     The Merger Agreement prevents the Company from declaring or paying any additional dividends on its Common Stock and Class A Common Stock before completion of the merger.

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Item 6. Selected Financial Data.

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

     Management’s discussion and analysis of results of operations and financial condition provides an account of the Company’s financial performance and financial condition that should be read in conjunction with the accompanying consolidated financial statements. It includes the following sections:

•

Consolidated Results

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	•	Business Segment Results
	•	Liquidity and Capital Resources
	•	Accounting Policies and Estimates
	•	Forward-Looking Statements

Consolidated Results

     Overview

     The following tables set forth for the periods indicated certain information derived from the Company’s consolidated statements of income expressed in dollars and as a percentage of total net sales.

               2004 vs. 2003

     Consolidated net sales increased 26.3% from 2003 to 2004 as a result of the strong business recovery that began in 2003 and continued throughout 2004. Increased volume accounted for the majority of this increase; however, average selling prices also increased for both fasteners and motors due to price increases as a result of higher material and transportation costs. The weaker dollar overseas also contributed somewhat to the Company’s sales increase.

     Consolidated gross profit increased 47.4% from 2003 to 2004. As a percentage of sales, consolidated gross margins increased from 28.5% in 2003 to 33.3% in 2004. Increased volume led to the improvement in gross margin as increased costs for wages and benefits were offset by productivity improvements and better utilization of capacity.

     Consolidated selling, general, and administrative (“SG&A”) expenses for 2004 increased 11.6% from 2003 to 2004; however, as a percent of sales, SG&A decreased from

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25.2% in 2003 to 22.2% in 2004. Legal and professional fees increased 110.5% from 2003 to 2004 due mainly to increased audit and expenses related to the implementation of the requirements under the Sarbanes-Oxley Act of 2002 and increased legal expenses relating to the proposed merger transaction.

     Because of the Company’s continued strong cash position during 2004, the Company repaid all domestic debt, which decreased interest expense. Interest income increased during the year due to increased cash on hand, and the Company benefited from the weaker dollar overseas. The Company’s effective tax rate increased to 32% due to the fact that a greater proportion of income was generated in the United States, with a higher corporate income tax rate compared to the locations where income had been generated in 2003.

               2003 vs. 2002

     Consolidated net sales increased 26.5% from 2002 to 2003. Business conditions improved in 2003 for all Company business segments and in all regions. In the United States, economic trends were positive, and that region continued to be the Company’s largest revenue producer. Sales volume increased in all business segments while average selling prices increased slightly as a result of the weaker dollar. M.A.E. S.p.A. (now called PennEngineering Motion Technologies (Europe) Srl), which the Company acquired on February 5, 2003, contributed $9.7 million of revenue in 2003 and helped to increase the Company’s percentage of foreign sales to 40% of consolidated net sales.

     Consolidated gross profit increased 16.9% from 2002 to 2003. As a percentage of sales, however, consolidated gross margins decreased from 30.9% in 2002 to 28.5% in 2003. All business segments experienced increases in wages and employee benefit costs that contributed to the decline in gross margin percentage. The cost for employee medical insurance increased 17.8% from 2002 to 2003, while the cost for the Company’s contribution to employee retirement plans increased 26.4%.

     Consolidated SG&A expenses for 2003 increased 13.8% from 2002 to 2003; however, as a percent of sales, SG&A decreased from 28.0% in 2002 to 25.2% in 2003. In addition to the increased cost for wages and benefits as mentioned above, software and hardware rental and maintenance costs increased 15.0% and insurance costs increased 23.1% from 2002 to 2003.

     Because of the Company’s continued strong cash position during 2003, approximately $17.8 million of debt was repaid, which resulted in a decrease in interest expense from $845,000 in 2002 to $782,000 in 2003. In addition, the weaker dollar resulted in increased currency gains of approximately 37% from 2002 to 2003. The Company’s effective tax rate, which was unusually low in 2002 due to an increased tax benefit from foreign-source income, increased to 24%, resulting in an increase in the provision for income taxes from $326,000 in 2002 to $1.5 million in 2003.

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Business Segment Results

     Overview

     The Company operates in three reportable business segments. The Company’s Fastening Technologies segment, which accounted for 53% of consolidated net sales in 2004, includes the operations of PEM Fastening Systems, PennEngineering Technologies, (Europe) Ltd., and Atlas Engineering, Inc. This segment manufactures and sells PEM® brand and Atlas® brand fasteners, and PEMSERTER® fastener insertion machines. The Company’s Motion Technologies segment, which accounted for 21% of consolidated net sales in 2004, consists of the Pittman operation, which manufactures and sells Pittman® brush and brushless dc motors, and the PennEngineering Motion Technologies (Europe) Srl operation in Offenango, Italy, which manufactures and sells brush, brushless, and stepper dc motors. The Company’s Distribution segment, which accounted for 26% of consolidated net sales in 2004, consists of the Arconix Group, which sells a portion of the Company’s own manufactured products as well as complementary products from other manufacturers.

     In total, the sale of fasteners and fastener-related products, including Arconix Group products, accounted for 79.0% of total product sales in 2004 compared to 77.5% in 2003 and 79.1% in 2002. Of the total 2004 fastener sales, telecommunications, datacommunications, and computer markets accounted for 49%, automotive markets accounted for 13%, industrial markets accounted for 24%, and the remaining balance was distributed among other markets including medical, security, networking, and gaming. Motors are marketed in North America and Europe primarily through independent distributors and sales representatives. Of the total 2004 motor sales, data storage markets accounted for 25%, medical/biotech markets accounted for 20%, robotic markets accounted for 18%, electronic equipment markets accounted for 15%, and the balance was distributed among other markets including industrial automation, transportation, hobbyist, and other commercial and industrial products.

     The following tables set forth for the periods indicated certain segment information derived from the Company’s consolidated statements of income expressed in dollars and as a percentage of total net sales. Segment net income before taxes is segment net sales less segment costs and expenses, including an allocation of certain corporate expenses and excluding interest expense, certain other income and expenses and income taxes. Certain functions including payroll, information services, human resources, treasury, benefits administration, marketing, and general administration are centralized at the Company’s corporate office. Allocations of corporate expenses are made to specific segments when either a direct expense was incurred by the corporate office for a specific segment or a segment received general services that it would have otherwise incurred on a stand-alone basis. Any corporate expenses that do not meet these criteria are presented in the table below as unallocated corporate expenses.

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     Fastening Technologies

               2004 vs. 2003

     Within the Fastening Technologies segment, sales volume to outside customers increased 26.9% in 2004 from 2003, while the average selling price increased approximately 4.7%. This segment continues to benefit from the improved economy, especially in the gaming, security, and medical markets as well as the segment’s traditional telecommunications and datacommunications markets. In addition, a 2.0% price increase went into effect on January 1, 2004 as well as an additional 2.0% surcharge in May 2004 on selected products to cover additional raw material cost increases. The segment’s sales into Europe benefited from the weaker U.S. dollar. Gross profit increased 72.2% in 2004 compared to 2003 due to increased volume which led to greater plant and machinery utilization without corresponding increases in fixed costs. SG&A expenses increased 8.5% in 2004 from 2003 due mainly to wage increases (approximately 3.5%) and increases in certain benefits costs. Segment net income before income tax increased 178.2% primarily as a result of increased sales volume.

               2003 vs. 2002

     Within the Fastening Technologies segment, sales volume to outside customers increased 21.6% in 2003 from 2002, while the average selling price increased approximately 4.3%. As the business climate improved in all markets served by the Company, distributors gradually replenished inventory levels. The Company’s average selling price increased mainly as a result of the weaker dollar. Gross profit increased 26.1% in 2003 compared to 2002. The segment was able to maintain its gross profit margins in spite of increasing wage and benefits costs through productivity improvements as well as increased plant and

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machinery utilization. In addition, the segment was able to satisfy the increasing global demand for its products in Europe and Asia as well as lower costs by utilizing its Ireland production facility as well as outsourcing some manufacturing to sources within Asia. SG&A expenses remained level from 2002 to 2003 leading to a 119.2% increase in segment net income before income tax in 2003 from 2002.

     Motion Technologies

               2004 vs. 2003

     The Motion Technologies segment’s net sales to outside customers increased 18.1% in 2004 compared to 2003. The number of motors sold from the Pittman operation increased 12.9% in 2004 from 2003, while the average selling price increased 9.9%. An average price increase of 5% was effective January 1, 2004. Motor sales from PMT Europe increased 8.7% in 2004 from 2003. Gross profit increased 23.7% in 2004 from 2003 due to the volume and price increase as well as increased sales of higher margin brushless motors. SG&A expenses increased 18.8% from 2003 to 2004 due mainly to increased commission expense (up 20.4%) and increased advertising and marketing expense (up 23.9%) as well as increases in wages and certain benefits costs. Segment net income increased 50.7% in 2004 from 2003.

               2003 vs. 2002

     The Motion Technologies segment’s net sales to outside customers increased 35.7%. Sales from this segment’s most recent acquisition (PMT Europe, formerly MAE) amounted to $9.7 million, or approximately 85.8% of the total sales increase. The number of motors sold from the Pittman operation increased 6.4% in 2003 from 2002, while the average selling price remained the same. This segment’s gross profit increased 16.7% in 2003 from 2002. The segment was unable to realize the full effect of planned savings from outsourcing certain sub-assemblies that would have offset the wage and benefits increases. As a result, gross margins declined from 28.3% of sales in 2002 to 24.1% of sales in 2003. SG&A expenses increased 18.0% in 2003 from 2002 due to the acquisition of PMT Europe. Segment net income increased 10.5% from 2002 to 2003.

     Distribution

               2004 vs. 2003

     Within the Distribution segment, net sales to outside customers increased 20.3% in 2004 from 2003. By geographic region, sales in North America (approximately 42.8% of total segment sales in 2004) increased 12.2% in 2004 from 2003, sales in Europe (approximately 18.7% of total segment sales in 2004) increased 23.4% in 2004 from 2003, and sales in the Asia-Pacific region (approximately 38.5% of total segment sales in 2004) increased 29.2% in 2004 from 2003. All regions experienced favorable market conditions with the weaker dollar helping to increase international sales. Gross profit increased 14.4% in 2004 compared to

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2003. Gross profit was negatively affected in 2004 by increased transportation costs as well as increased provisions for slow-moving and obsolete inventory. SG&A expenses increased 8.5% in 2004 from 2003 due mainly to increased wage and benefits costs. Segment net income increased 78.4% in 2004 from 2003. This segment recorded a $261,000 foreign currency gain in 2004 versus a $153,000 foreign currency loss in 2003.

               2003 vs. 2002

     Within the Distribution segment, net sales to outside customers increased 24.6% in 2003 from 2002. By geographic region, sales in North America (approximately 46.0% of total segment sales in 2003) increased 6.6% in 2003 from 2002, sales in Europe (approximately 18.3% of total segment sales in 2003) increased 13.4% in 2003 from 2002, while sales in the Asia-Pacific region (approximately 35.7% of total segment sales in 2003) increased 69.9% in 2003 from 2002. This segment benefited from increased ordering activity in both the computer market in Asia and the automotive market in Europe. Gross profit increased 10.7% in 2003 compared to 2002. The gross profit margin as a percent of sales however decreased from 28.2% in 2002 to 25.1% in 2003 as increased freight and duty costs as well as inventory reserve adjustments negatively impacted gross profit. SG&A expenses increased 8.9% in 2003 from 2002 due to increased wages and benefits as well as increased costs to bring the Shanghai, China distribution facility into full operation including implementation of the Company’s distribution software system in both Singapore and China. Segment net income declined slightly in 2003 compared to 2002.

Unallocated Corporate Expenses

     2004 vs. 2003

     Unallocated corporate expenses increased 26.4% in 2004 from 2003 (approximately 4.4% of consolidated net sales in both years). Legal and professional expenses increased 110.5% in 2004 from 2003 and other public company related expenses such as registration fees, directors fees, and compliance fees increased 43.2% during the same period due primarily to expenses related to compliance with the requirements of the Sarbanes-Oxley Act of 2002 as well as expenses incurred relating to the proposed merger of the Company. The expenses in these two areas accounted for $1,500,000 of the total $2,202,000 increase in unallocated corporate expenses in 2004 from 2003.

     2003 vs. 2002

     Unallocated corporate expenses increased $4,894,000, or 142.1%, in 2003 from 2002. The primary reason for this increase was a change in the method of allocating corporate expenses in 2003. As stated above, allocation of corporate expenses are made to specific segments when either a direct expense was incurred by the corporate office for a specific segment or a segment received general services that it would have otherwise incurred on a

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stand-alone basis. Prior to 2003, other corporate expenses not meeting these criteria (mainly wages and benefits of employees including executive officers) were also allocated to segments. This change resulted in an allocation decrease of $2,103,000 in 2003 from 2002. Also contributing to the increase in 2003 from 2002 was an additional $1,237,000 of unallocated benefit expenses relating to bonuses, workers compensation, and medical insurance. Finally, the difference between the intercompany profit in inventory elimination amount in 2003 compared to 2002, which is also part of the unallocated corporate expenses, amounted to a $943,000 increase in expenses in 2003.

Liquidity And Capital Resources

     Cash and cash equivalents at December 31, 2004 were $32.9 million compared to $8.4 million at December 31, 2003. Working capital totaled $99.8 million at December 31, 2004 compared to $69.5 million at December 31, 2003.

     Net cash of $32.7 million was provided by operating activities for the year ended December 31, 2004 compared to $21.2 million provided by operating activities for the year ended December 31, 2003. The Company continues to generate cash from further reductions in overall inventory levels.

     Net cash used in investing activities totaled $1.5 million for the year ended December 31, 2004 compared to $14.0 million for the year ended December 31, 2003. The Company spent $3.4 million for capital additions in both 2003 and 2004, the majority of which was for machinery upgrades and additions at the Company’s fastener manufacturing facilities in Ireland and the United States. The Company also sold its former manufacturing site in Virginia in 2004 for $1.9 million.

     Net cash used in financing activities totaled $7.9 million for the year ended December 31, 2004 compared to $20.1 million for the year ended December 31, 2003. Because of the decreased capital expenditures and its strong cash position, the Company repaid bank debt in both years. The Company’s strong cash and working capital position have allowed for the payment of cash dividends of $4.6 million for the year ended December 31, 2004.

     The Company’s principal contractual obligations are the repayment of its bank debt, the planned funding of its defined benefit pension plan, and the payment of operating lease commitments covering certain automobiles, office space, and office equipment. The following table represents the expected significant contractual cash obligations of the Company as of December 31, 2004.

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     The Company anticipates that funding of its defined benefit pension plan in 2005 will approximate $7,000,000. The Company has not presented such estimated pension funding in the table above as the funding can vary from year to year based upon changes in the fair value of the plan assets and actuarial assumptions. The Company anticipates that existing capital resources and cash flow generated from future operations as well as existing short-term lines of credit will enable it to fully fund the Company’s current level of operations and its planned growth for the foreseeable future.

Accounting Policies and Estimates

     The Company has identified a number of its accounting polices that it has determined to be critical. These critical accounting policies primarily relate to financial statement assertions that are based on the estimates and assumptions of management and the effect that changes in those estimates and assumptions could have a material effect on the Company’s financial statements. The following summary describes 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 76% and 79% of total inventories at December 31, 2004 and 2003, respectively, are priced on the first-in, first-out (FIFO) method. Reserves are recorded for obsolete, excess, and slow-moving inventories based on management’s estimates about future demand and market conditions. At December 31, 2004, the Company’s inventory balance of $46,731,000 was net of a reserve for obsolete, excess, and slow-moving inventories of approximately $5,136,000. At December 31, 2003, the Company’s inventory balance of $48,512,000 was net of a reserve for obsolete, excess, and slow-moving inventory of approximately $3,512,000. If the estimated reserves for obsolete, excess, and slow-moving inventories are not sufficient based on actual future demand, additions to the reserves may be required.

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     Accounts Receivable

     The Company maintains an allowance for doubtful accounts for trade receivables for which collectibility is uncertain. At December 31, 2004 and 2003, this allowance was approximately $829,000 and $886,000, respectively. In estimating uncollectible accounts, the Company considers factors such as current overall economic conditions, industry-specific economic conditions, and historical and anticipated customer performance. While the Company believes that its processes effectively address exposure for doubtful accounts, changes in the economy, industry, or specific customer conditions may require adjustments to the allowance.

     Goodwill

     As discussed in Note 4 to the Company’s Consolidated Financial Statements, the Company adopted Statement of Financial Accounting Standards No. 142 (“SFAS No. 142”) “Goodwill and Other Intangible Assets” on January 1, 2002. SFAS No. 142 requires that goodwill no longer be amortized, and instead, be tested for impairment on a periodic basis. At December 31, 2004, the Company had $45,090,000 in goodwill. The process of evaluating the potential impairment of goodwill is highly subjective and requires significant judgments at many points during the analysis. In estimating the fair value of the reporting units with recognized goodwill for the purposes of the Company’s fiscal 2004 financial statements, the Company made estimates and judgments about the future cash flows of these reporting units. The Company’s cash flow forecasts were based on assumptions that are consistent with the plans and estimates the Company is using to manage the underlying businesses. In addition, the Company made certain judgments about allocating shared assets to the balance sheet for those reporting units. Based on the Company’s estimates, it has concluded that there is no impairment of the Company’s goodwill. However, changes in these estimates could cause one or more of the reporting units to be valued differently in the future.

     Pensions

     The Company accounts for its defined benefit pension plan in accordance with FASB No. 132, “Employers’ Disclosures About Pensions and Other Postretirement Benefits,” which requires that amounts recognized in the financial statements be determined on an actuarial basis. The most significant elements in determining the Company’s pension expense are pension liability discount rates and the expected return on plan assets. The pension discount rate reflects the current interest rate at which pension liabilities could be settled at the end of the year. At the end of each year, the Company determines the rate to be used to discount plan liabilities. In estimating this rate, the Company looks to rates of return on high-quality, fixed-income investments. At December 31, 2004, the Company determined this rate to be 6.00%. Historically, the Company has assumed that the expected long-term rate of return on plan assets would be 8.00%, and this expected rate of return was used for many years. Because in the last two years pension plan assets have earned substantially less than 8.00%,

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the Company reduced the expected long-term rate of return to 7.00% in 2003 and no further adjustment was made for 2004. 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 FASB No. 132 and will ultimately affect future pension expense.

     Derivative Instruments and Hedging

     From time to time, the Company manages risks associated with foreign exchange rates and interest rates with derivative instruments. The Company does not use derivative instruments for trading or speculative purposes and only uses derivatives when there is an underlying exposure. The evaluation of hedge effectiveness is subject to assumptions based on the terms and the timing of the underlying exposures. All derivative instruments are recognized in the Consolidated Balance Sheet at fair value, which is generally based on quoted market prices. At December 31, 2004, no derivative instruments were outstanding.

Forward-Looking Statements

     Forward-looking statements, within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Exchange Act 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 7A. Quantitative and Qualitative Disclosures About Market Risk.

     The Company’s earnings and cash flow are subject to fluctuations due to changes in foreign currency exchange rates and interest rates. The Company has manufacturing and sales activities in foreign locations. The Company currently manufactures its products in the United States, Ireland, and Italy and sells those products in those markets as well as throughout Europe, North America, and the Asia-Pacific region. As a result, the Company’s financial results could be significantly affected by factors such as changes in foreign currency exchange rates or weak economic conditions in the foreign markets in which the Company distributes its products. The Company’s operating results are primarily exposed to changes in exchange rates between the U.S. dollar and the Euro, British pound sterling, and Singapore dollar. Generally, when the U.S. dollar strengthens against these foreign currencies, the

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value of nonfunctional currency sales decreases. When the U.S. dollar weakens, the value of functional currency sales increases.

     To mitigate a portion of the short-term effect of changes in the exchange rate between the U.S. dollar and the Euro and British pound sterling on the Company’s sales, the Company from time to time hedges forecasted sales by entering into foreign exchange contracts. The Company’s risk management objective is to reduce its exposure to the effect of changes in exchange rates on sales revenue over quarterly time horizons. To a certain extent, foreign currency rate movements also affect the Company’s competitive position compared to non-U.S. based competitors. The Company’s foreign currency risk policies entail entering into foreign currency derivative instruments only to manage risk, and not as speculative investments.

     The Company’s financial officers annually approve the outlook for expected currency exchange rate movements, as well as the policy on desired future foreign currency cash flow positions (i.e., long, short, balanced) for those currencies where there is significant activity. These officers receive reports on open foreign currency hedges on a regular basis. Expected future cash flow positions and strategies are continuously monitored. Foreign exchange practices, including the use of derivative financial instruments, are reviewed with the Audit Committee of the Company’s Board of Directors at least annually.

     At December 31, 2004, the Company had no foreign exchange contracts outstanding.

     Considering the forecasted 2005 cash flows from sales denominated in a foreign currency, a hypothetical 10% weakening of the U.S. dollar relative to all other currencies would not materially adversely affect expected 2005 earnings or cash flows. This analysis is dependent on actual non-functional currency sales during 2005 occurring within at-least 90% of the budgeted forecasts. The effect of the hypothetical change in exchange rates ignores the effect that this movement may have on other variables including competitive risk. If it were possible to quantify this competitive impact, the results could well be different from the sensitivity effect mentioned above. In addition, it is unlikely that all currencies would uniformly strengthen or weaken relative to the U.S. dollar. In reality, some currencies may weaken while others strengthen.

     The fair values of the Company’s bank loans are not significantly affected by changes in market interest rates. The change in fair value of the Company’s long-term debt resulting from a hypothetical 10% change in interest rates is not material.

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     Item 8. Financial Statements and Supplementary Data.

CONSOLIDATED BALANCE SHEETS

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See the accompanying notes to consolidated financial statements.

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STATEMENTS OF CONSOLIDATED INCOME

See the accompanying notes to consolidated financial statements.

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STATEMENTS OF CHANGES IN CONSOLIDATED STOCKHOLDERS’ EQUITY

(Dollars in thousands except per
share amounts)

See the accompanying notes to consolidated financial statements.

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STATEMENTS OF CONSOLIDATED CASH FLOWS

See the accompanying notes to consolidated financial statements.

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Notes to Consolidated Financial Statements
For the years ended December 31, 2004, 2003, and 2002

Note 1: Significant Accounting Policies

Principles of Consolidation

     The consolidated financial statements of the Company include the accounts of Penn Engineering & Manufacturing Corp. and its wholly owned subsidiaries. All significant intercompany transactions and balances are eliminated in consolidation.

Short-Term Investments

     Management determines the appropriate classifications of securities at the time of purchase and reevaluates such designation as of each balance sheet date. Bonds and commercial paper investments are classified as held-to-maturity as the Company has the positive intent and ability to hold the securities to maturity. Bonds are stated at amortized cost. Securities not classified as held-to-maturity have been classified as available-for-sale. Available-for-sale securities are stated at fair value, with unrealized gains and losses reported as a separate component of stockholders’ equity. The fair value of all securities is determined based upon the current value quoted on public exchanges. Investments are classified as short-term if the maturities at December 31 are less than one year.

Allowance for Doubtful Accounts

     The Company maintains an allowance for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. The allowance is determined through an analysis of the aging of accounts receivable and assessments of risk that are based on historical trends and an evaluation of the impact of current and projected economic conditions. The Company evaluates the past-due status of its trade receivables based on contractual terms of sale. If the financial condition of the Company’s customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.

Inventories

     The Company’s domestic fastener inventories are priced on the last-in, first-out (LIFO) method, at the lower of cost or market. Other inventories, representing approximately 76% and 79% of total inventories at December 31, 2004 and 2003, respectively, are priced on the first-in, first-out (FIFO) method, at the lower of cost or market.

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Property

     Depreciation is calculated under the straight-line method over the estimated useful lives of the respective assets, generally 3-5 years for tooling and computer equipment, 10-15 years for furniture, fixtures, and machinery, and 25-40 years for buildings. Maintenance and repairs are charged to income and major renewals and betterments are capitalized. At the time properties are retired or sold, the cost and related accumulated depreciation are eliminated and any gain or loss is included in income. As of December 31, 2001, the Company ceased operations at its Suffolk, Virginia fastener manufacturing plant and reclassified the net book value of the building to other assets until its sale in October 2004. The Company received proceeds of $1,874,000 and recorded a pre-tax loss of $325,000 in 2004 on the sale of the land and building.

Goodwill

     Goodwill is the excess of the purchase price over the fair value of identifiable net assets acquired in business combinations accounted for as purchases. The Company accounts for goodwill in accordance with Statement of Financial Accounting Standards No. 142 (“SFAS No. 142”), “Goodwill and Other Intangible Assets.” The Company tests goodwill for impairment using the two-step process prescribed by SFAS No. 142 for its three reporting units, which are the same as its operating segments (Note 13). The first step tests for potential impairment, while the second step measures the amount of impairment, if any. The Company uses a discounted cash flow analysis to complete the first step in this process.

Cash and Cash Equivalents

     For purposes of reporting cash flows, cash and cash equivalents include cash on deposit, cash in excess of daily requirements, which is invested in overnight repurchase agreements, and other interest-bearing accounts withdrawable on a daily basis.

Research and Development Costs

     Research and development costs were $4,728,000, $4,570,000, and $4,342,000 for the years ended December 31, 2004, 2003, and 2002, respectively. All research and development costs are charged to operations as incurred.

Foreign Currency Translation

     The effect of translating the financial statements of the Company’s foreign subsidiaries is recorded as a separate component of other comprehensive income in the consolidated financial statements. All assets and liabilities are translated at year-end exchange rates while all income and expense accounts are translated at weighted average exchange rates for the year.

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Use of Estimates

     The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that may affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Fair Values of Financial Instruments

     At December 31, 2004, the Company had the following financial instruments: cash and cash equivalents, short-term investments, accounts receivable, accounts payable, accrued expenses, and long and short-term bank debt. The carrying value of cash and cash equivalents, accounts receivable, accounts payable, and accrued expenses approximate their fair value because of their short-term nature. Short-term investments include available-for-sale securities whose carrying value approximates fair value based on quoted market prices. The carrying amounts of the bank debt approximate fair value because the interest rates are reflective of rates that the Company would be able to obtain on debt with similar terms and conditions.

Capital Stock

     The Company’s capital stock consists of $.01 par value Common Stock and $.01 par value Class A Common Stock. Holders of Class A Common Stock have one vote per share, while holders of Common Stock have no votes. All other rights of the Common Stock and Class A Common Stock, including rights with respect to dividends, stock splits, the consideration payable in a merger or consolidation, and distributions upon liquidation, are the same.

Revenue Recognition

     Revenues are recognized when the earnings process is complete. For all revenues, the earnings process is complete when products are shipped in accordance with terms of agreements, title and risk of loss transfers to customers, pricing is fixed or determinable and collection is reasonably assured.

Shipping and Handling Costs

     Shipping and handling costs are included in cost of products sold.

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Concentrations of Credit Risk

     The Company has operations and affiliates in the United States, the United Kingdom, Ireland, Italy, Singapore, Mexico, and China. The Company performs ongoing credit evaluations of its customers’ financial condition, and except where risk warrants, requires no collateral. The Company may require, however, prepayment terms for certain customers. Short-term investments are placed with high credit quality financial institutions. The Company limits the amount of credit exposure in any one institution or single investment.

Accounting for Stock Options

     The Company follows Accounting Principles Board Opinion No. 25 (“APB 25”), “Accounting for Stock Issued to Employees” and related interpretations in accounting for stock options. Under APB 25, if the exercise price of stock options granted equals or exceeds the market price of the underlying common stock on the date of grant, no compensation expense is recognized. Statement of Financial Accounting Standards No. 123 (“SFAS No. 123”) requires pro forma information regarding net income and earnings per share as if the Company had accounted for its employee stock options under the fair value method of SFAS No. 123. The fair value of each option granted was estimated on the date of grant using the Black-Scholes option-pricing model. No stock options were granted in 2004.

     The following assumptions were used in the Black-Scholes option-pricing model:

     For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options’ vesting period. Had compensation costs for the Company’s plans been determined based on the fair value at the grant date for awards under these plans consistent with the method of SFAS No. 123, the impact on the Company’s financial results would have been as follows:

     (Dollars in thousands except per share amounts)

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Net Income Per Share

     Basic and diluted earnings per share are calculated in accordance with FASB Statement No. 128, “Earnings Per Share.” Basic earnings per share is calculated by dividing net income by the weighted average shares outstanding for the year, and diluted earnings per share is calculated by dividing net income by the weighted average shares outstanding for the year plus the dilutive effect of stock options. For the year ended December 31, 2004, all options were dilutive and included in the calculation of diluted earnings per share. For the years ended December 31, 2003 and 2002, options to purchase approximately 1,169,000 and 818,000 shares of common stock, respectively, were excluded from the calculation of diluted earnings per share because the effect thereof would have been anti-dilutive.

Derivative Instruments And Hedging Activities

     The Company accounts for its derivative instruments and hedging activities under the provisions of Statement of Financial Accounting Standards No. 133 (“SFAS No. 133”), “Accounting for Derivative Instruments and Hedging Activities”. SFAS No. 133 requires that all derivative instruments be recorded on the balance sheet at fair value. Changes in the fair value of derivatives are recorded each period in current earnings or other comprehensive income, depending on whether a derivative is designated as part of a hedge transaction and, if it is, depending on the type of hedge transaction. For foreign currency cash flow hedges in which the Company is hedging the variability of cash flows related to forecasted foreign currency denominated sales, changes in the fair value of the derivative instruments are reported in other comprehensive income. Gains and losses on derivatives that are reported in other comprehensive income are reclassified as earnings or losses in the periods in which the forecasted transactions occur.

Impact Of Recently Issued Accounting Standards

     On December 21, 2004, the Financial Accounting Standards Board (FASB) issued FASB Staff Position No. FAS 109-2 (FSP No. 109-2), “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provisions within the American Jobs Creation Act of 2004” (the Jobs Act). FSP No. 109-2 provides guidance with respect to reporting the potential impact of the repatriation provisions of the Jobs Act on an enterprise’s income tax expense and deferred tax liability. The Jobs Act was enacted on October 22, 2004, and provides for a temporary 85% dividends received deduction on certain foreign earnings repatriated during a one-year period. The deduction would result in an approximate 5.25% federal tax rate on the repatriated earnings. To qualify for the deduction, the earnings must be reinvested in the United States pursuant to a domestic reinvestment plan established by a company’s chief

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executive officer and approved by a company’s board of directors. Certain other criteria in the Jobs Act must be satisfied as well. FSP No. 109-2 states that an enterprise is allowed time beyond the financial reporting period to evaluate the effect of the Jobs Act on its plan for reinvestment or repatriation of foreign earnings. The Company has not yet completed its evaluation of the impact of the repatriation provisions of the Jobs Act. Accordingly, as provided for in FSP No. 109-2, the Company has not adjusted its tax expense or deferred tax liability to reflect the repatriation provisions of the Jobs Act.

     In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment” (SFAS No. 123(R)), which replaces SFAS No. 123 and supersedes APB Opinion No. 25. SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values beginning with the first interim period after June 15, 2005, with early adoption encouraged. The pro forma disclosures previously permitted under SFAS No. 123 will no longer be an alternative to financial statement recognition. The Company is required to adopt SFAS No. 123(R) in the third quarter of 2005. Under SFAS No. 123(R), the Company must determine the appropriate fair value model to be used for valuing share-based payments, the amortization method for compensation cost and the transition method to be used at the date of adoption. The permitted transition methods include either retrospective or prospective adoption. Under the retrospective option, prior periods may be restated either as of the beginning of the year of adoption or for all periods presented. The prospective method requires that compensation expense be recorded for all unvested stock options at the beginning of the first quarter of adoption of SFAS No. 123(R), while the retrospective methods would record compensation expense for all unvested stock options beginning with the first period presented. The Company is currently evaluating the requirements of SFAS No. 123(R) and expects that adoption of SFAS No. 123(R) will have a material impact on the Company’s consolidated financial position and consolidated results of operations. The Company has not yet determined the method of adoption or the effect of adopting SFAS No. 123(R), and it has not determined whether the adoption will result in amounts that are similar to the current pro forma disclosures under SFAS No. 123. See Accounting for Stock Options in Note 1 above.

     In November 2004, the FASB issued SFAS No. 151, “Inventory Costs an Amendment of ARB No. 43, Chapter 4” (SFAS No. 151). SFAS No. 151 amends the guidance in ARB No. 43, Chapter 4, “Inventory Pricing,” to clarify the accounting for abnormal amounts of idle facility expense, handling costs and wasted material (spoilage). Among other provisions, the new rule requires that such items be recognized as current-period charges, regardless of whether they meet the criterion of “so abnormal” as stated in ARB No. 43. SFAS No. 151 is effective for fiscal years beginning after June 15, 2005. The Company does not expect that adoption of SFAS No. 151 will have a material effect on its consolidated financial position, consolidated results of operations, or liquidity.

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Reclassifications

     Certain reclassifications have been made to prior year amounts and balances to conform with the 2004 presentation.

Note 2: Short-Term Investments

     Unrealized losses on short-term investments classified as available-for-sale were $15,000, net of taxes of $10,000, at December 31, 2004, and were $14,000, net of taxes of $8,000, at December 31, 2003. The Company’s only short-term available-for-sale investment is a state and municipal bond fund. The estimated fair value of this short-term available-for-sale investment was $225,000 and $228,000 at December 31, 2004 and 2003, respectively.

Note 3: Inventories

     Inventories consist of the following:

     If the FIFO method of inventory valuation had been used for all inventories held by the Company, inventories at December 31, 2004 and 2003 would have been $10,175,000 and $10,072,000 higher, respectively.

     Long-term tooling inventory, totaling $800,000 at December 31, 2004 and $1,285,000 at December 31, 2003, is included in Other Assets.

Note 4: Goodwill and Intangible Assets

     The Company conducted the required annual impairment review as of October 1, 2004 and 2003 in accordance with SFAS No. 142 and determined that there was no goodwill impairment as of those dates.

     The changes in the carrying value of goodwill for 2003 and 2004 by reporting unit are as follows:

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Note 5: Acquisitions

     On February 5, 2003, the Company acquired all of the issued and outstanding capital stock of Maelux SA and its sole operating company, M.A.E. S.p.A. (now called PennEngineering Motion Technologies (Europe) Srl) of Offanengo, Italy for $11,642,000, including acquisition-related expenses. The acquisition was accounted for using the purchase method. Of the total amount paid, $2,000,000 was placed in escrow, of which $1,000,000 remains in escrow, pending the final determination of the purchase price. The results of the operations of these companies have been included in the accompanying consolidated statements of income since the acquisition date. The purchase price was allocated to: accounts receivable — $4,100,000, inventory — $3,214,000, property - - $7,889,000, other current assets — $295,000, goodwill — $11,664,000, accounts payable - $2,809,000, short-term debt — $5,029,000, other current liabilities — $1,777,000, mortgage payable - - $3,713,000, and deferred tax liability — $2,192,000. Additional compensation to the seller may be required based on the future operating results of these companies through 2006. Such amount, if any, will be recorded as additional purchase price if and when it becomes payable in the future.

Note 6: Bank Debt

     As of December 31, 2004, the Company had four unsecured line-of-credit facilities available, all of which bear interest at interest rate options provided in the facilities and are reviewed annually by the banks for renewal. The facilities are as follows:

	•	a working capital facility that allows for borrowings of up to $7,000,000, under which no amounts were outstanding at December 31, 2004;
	•	a facility that allows for borrowings of up to $15,000,000, under which no amounts were outstanding at December 31, 2004;
	•	a facility that permits borrowings of up to $30,000,000, under which no amounts were outstanding at December 31, 2004.
	•	a committed line-of-credit that permits borrowings of up to $8,000,000, under which no amounts were outstanding at December 31, 2004.

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     These line-of-credit facilities require that the Company comply with certain financial covenants. At December 31, 2004, the Company was in compliance with all financial covenants under these facilities.

     In addition to the above domestic line-of-credit facilities, the Company’s subsidiary, PennEngineering Motion Technologies (Europe) Srl, has two short-term credit facilities in place under which a total of $1,038,000 was outstanding as of December 31, 2004. PennEngineering Motion Technologies (Europe) Srl also has an outstanding mortgage on its building, where $626,000 is classified as short-term debt and $2,819,000 is classified as long-term debt as of December 31, 2004.

Note 7: Pension and Profit Sharing Plans

     The Company has a defined benefit pension plan covering all eligible employees in the United States. Effective January 1, 2002, the plan was converted to a cash balance plan for all eligible employees. Participants were credited with an initial account balance equal to the present value of their accrued benefit as determined under the plan in effect on December 31, 2001. At the end of each Plan Year, participants receive pay credits equal to a percentage of annual compensation, and participant accounts are also credited with annual interest based on a one-year constant maturity Treasury bill rates plus 1%, equal to 3.63% and 2.39% in 2004 and 2003, respectively. The percentage of annual compensation credited to participant accounts is based on the participants’ age and length of service with the Company. Participants whose age and years of benefit service as of December 31, 2001 totaled 45 or more will have their pension benefit calculated under both the old and new formula and will automatically receive the higher of the two. Plan provisions and funding meet the requirements of the Employee Retirement Income Security Act of 1974. The following table sets forth the financial status of the plan:

Obligations and Funded Status

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Components of Net Periodic Pension Cost