FORM 10-Q

 

SECURITIES AND EXCHANGE COMMISSION

 

Washington, D.C. 20549

 

 

Hardinge Inc.

(Exact name of Registrant as specified in its charter)

 

 

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   ý   No  o

 

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

 

As of September 30, 2004 there were 8,843,139 shares of Common Stock of the Registrant outstanding.

 

 

HARDINGE INC. AND SUBSIDIARIES
INDEX
Part I	Financial Information
	Item 1.	Financial Statements
		Consolidated Balance Sheets at September 30, 2004 and December 31, 2003.
		Consolidated Statements of Operations and Retained Earnings for the three months ended September 30, 2004 and 2003 and for the nine months ended September 30, 2004 and 2003.
		Consolidated Statements of Cash Flows for the nine months ended September 30, 2004 and 2003.
		Notes to Consolidated Financial Statements.
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations.
	Item 3.	Quantitative and Qualitative Disclosures About Market Risks
	Item 4.	Controls and Procedures
Part II	Other Information
	Item 1.	Legal Proceedings
	Item 2.	Changes in Securities
	Item 3.	Default upon Senior Securities
	Item 4.	Submission of Matters to a Vote of Security Holders
	Item 5.	Other Information
	Item 6.	Exhibits and Reports on Form 8-K
	Signatures
	Certifications

 

2

 

PART I, ITEM 1

HARDINGE INC. AND SUBSIDIARIES

 

Consolidated Balance Sheets

(In Thousands)

 

		Sept. 30, 2004				Dec. 31, 2003
		(Unaudited)
Assets
Current assets:
Cash		$		4,360		$	4,739
Accounts receivable, net		53,533				44,660
Notes receivable, net		6,192				6,354
Inventories		93,915				87,064
Prepaid expenses		5,045				4,540
Total current assets		163,045				147,357
Property, plant and equipment:
Property, plant and equipment		165,594				162,926
Less accumulated depreciation		102,800				96,741
		62,794				66,185
Other assets:
Notes receivable		6,920				7,733
Deferred income taxes		131				131
Intangible pension asset		3,915				3,900
Goodwill		18,180				18,314
Other		2,179				2,087
		31,325				32,165
Total assets		$	257,164			$		245,707

 

See accompanying notes.

 

3

 

		Sept. 30, 2004			Dec. 31, 2003
		(Unaudited)
Liabilities and shareholders' equity
Current liabilities:
Accounts payable		$	20,222		$	13,760
Notes payable to bank		5,015			624
Accrued expenses		14,107			18,224
Accrued income taxes		2,502			2,990
Deferred income taxes		3,708			3,477
Current portion long-term debt		4,885			5,002
Total current liabilities		50,439			44,077
Other liabilities:
Long-term debt		21,435			17,675
Accrued pension plan expense		20,813			23,693
Deferred income taxes		3,253			3,163
Accrued postretirement benefits		5,904			5,864
Derivative financial instruments		4,627			6,194
Other liabilities		4,196			2,267
		60,228			58,856
Equity of minority interest		5,205			3,688
Shareholders' equity:
Preferred stock, Series A, par value $.01:
Authorized - 2,000,000; issued - none
Common stock, $.01 par value:
Authorized shares - 20,000,000
Issued shares - 9,919,992 at September 30, 2004 and December 31, 2003		99			99
Additional paid-in capital		60,538			60,586
Retained earnings		96,158			94,150
Treasury shares - 1,076,853 at September 30, 2004 and 1,062,143 at December 31, 2003.		(13,960		)	(13,843		)
Accumulated other comprehensive loss		(356		)	(393		)
Deferred employee benefits		(1,187		)	(1,513		)
Total shareholders' equity		141,292			139,086
Total liabilities and shareholders' equity		$	257,164		$	245,707

 

See accompanying notes.

 

4

 

HARDINGE INC AND SUBSIDIARIES

 

Consolidated Statements of Operations and Retained Earnings

(In Thousands, Except Per Share Data)

 

		Three months ended September 30,								Nine months ended September 30,
		2004				2003				2004			2003
		(Unaudited)				(Unaudited)				(Unaudited)			(Unaudited)
Net Sales		$	54,606			$	43,993			$	159,853		$	132,389
Cost of sales		38,481				31,204				112,825			92,579
Gross profit		16,125				12,789				47,028			39,810
Selling, general and administrative expenses		13,829				11,648				39,990			36,372
Income from operations		2,296				1,141				7,038			3,438
Interest expense		641				615				1,854			2,157
Interest (income)		(110			)	(97			)	(309		)	(339		)
Income before income taxes and minority interest in consolidated subsidiary and investment of equity company		1,765				623				5,493			1,620
Income taxes		765				13,718				1,790			13,951
Minority interest in (profit) of consolidated subsidiary		(600			)	(374			)	(1,518		)	(691		)
Profit in investment of equity company						39							75
Net income (loss)		400				(13,430			)	2,185			(12,947		)
Retained earnings at beginning of period		95,847				106,007				94,150			105,612
Less dividends declared		89				0				177			88
Retained earnings at end of period		$		96,158		$		92,577		$	96,158		$	92,577
Per share data:
Basic earnings (loss) per share		$		.05		$		(1.54	)	$	.25		$	(1.49	)
Weighted average number of common shares outstanding		8,742				8,716				8,746			8,703
Diluted earnings (loss) per share		$		.05		$		(1.54	)	$	.25		$	(1.49	)
Weighted average number of common shares outstanding		8,785				8,716				8,792			8,703
Cash Dividends Declared		$		.01		$		.00		$	.02		$	.01

 

See accompanying notes.

 

5

 

HARDINGE INC AND SUBSIDARIES

 

Consolidated Statements of Cash Flows

(In Thousands)

 

		Nine months ended September 30,
		2004			2003
		(Unaudited)			(Unaudited)
Operating activities
Net income (loss)		$	2,185		$	(12,947	)
Adjustments to reconcile net income (loss) to net cash (used in) provided by operating activities:
Depreciation and amortization		6,722			6,446
Provision for deferred income taxes		760			13,375
Funds provided by minority interest		1,612			663
Foreign currency transaction (gain) loss		(200		)	49
Changes in operating assets and liabilities:
Accounts receivable		(8,935		)	(3,731		)
Notes receivable		1,003			947
Income tax receivable		—			7,144
Inventories		(6,959		)	6,106
Other assets		(969		)	(2,912		)
Accounts payable		6,516			(1,775		)
Accrued expenses		(7,093		)	171
Investment in equity company		—			(76		)
Accrued postretirement benefits		40			—
Net cash (used in) provided by operating activities		(5,318		)	13,460
Investing activities
Capital expenditures		(2,852		)	(1,181		)
Net cash (used in) investing activities		(2,852		)	(1,181		)
Financing activities
Increase (decrease) in short-term debt		4,245			(2,341		)
Increase (decrease) in long-term debt		3,846			(8,670		)
Net (purchases) sale of treasury stock		(188		)	26
Dividends paid		(177		)	(88		)
Net cash provided by (used in) financing activities		7,726			(11,073		)
Effect of exchange rate changes on cash		65			93
Net (decrease) increase in cash		(379		)	1,299
Cash at beginning of period		4,739			2,175
Cash at end of period		$	4,360		$	3,474

 

See accompanying notes.

 

6

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

September 30, 2004

 

NOTE A—BASIS OF PRESENTATION

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements.  In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.  Operating results for the three month period and the nine month period ended September 30, 2004, are not necessarily indicative of the results that may be expected for the year ending December 31, 2004.  For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s annual report for the year ended December 31, 2003.  The Company operates in only one business segment – industrial machine tools.

 

The consolidated balance sheet at December 31, 2003 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.

 

NOTE B—STOCK-BASED COMPENSATION

 

The Company grants restricted shares of common stock and stock options to certain officers, other key employees and directors.  The Company accounts for restricted share grants and stock option grants in accordance with APB Opinion No. 25, Accounting for Stock Issued to Employees.  The stock options issued under the 1996 and 2002 Incentive Stock Plans expire 10 years from the date of grant and are exercisable one-third after the first year, two-thirds after the second year, and 100 percent exercisable after the third year.

 

In accordance with the provisions of Statement of Financial Accounting Standard No. 123 the Company has elected to continue applying the provisions of Accounting Principles Board Opinion No. 25 and related interpretations in accounting for its stock-based compensation plans.  The Company amortizes compensation expense for restricted stock over the vesting period of the grant.  The Company does not recognize compensation expense for stock options when the stock option price at the grant date is equal to or greater than the fair market value of the stock at that date.

 

7

 

The following illustrates the pro forma effect on net income (loss) and earnings (loss) per share if the Company had applied the fair value recognition provisions of SFAS No. 123 on stock options:

 

		Three months ended September 30,						Nine months ended September 30,
		2004			2003			2004			2003
		(dollars in thousands)
Reported net income (loss)		$	400		$	(13,430	)	$	2,185		$	(12,947	)
Add: Stock-based employee compensation expense included in reported net income (loss)		109			142			349			426
		509			(13,288		)	2,534			(12,521		)
Deduct: Total stock-based employee compensation expense determined under fair value method for all awards, net of related tax effects		(137		)	(172		)	(433		)	(514		)
Pro forma net income (loss)		$	372		$	(13,460	)	$	2,101		$	(13,035	)
Earnings (loss) per share:
Basic and Diluted - as reported		$	.05		$	(1.54	)	$	.25		$	(1.49	)
Basic and Diluted - pro forma		$	.04		$	(1.54	)	$	.24		$	(1.50	)

 

NOTE C—WARRANTIES

 

The Company offers warranties for its products.  The specific terms and conditions of those warranties vary depending upon the product sold and the country in which the Company sold the product.  The Company generally provides a basic limited warranty, including parts and labor for a period of one year.  The Company estimates the costs that may be incurred under its basic limited warranty, based largely upon actual warranty repair cost history, and records a liability in the amount of such costs in the month that product revenue is recognized. The resulting accrual balance is reviewed during the year. Factors that affect the Company’s warranty liability include the number of installed units, historical and anticipated rates of warranty claims, and cost per claim.

 

The Company also sells extended warranties for some of its products.  These extended warranties usually cover a 12-24 month period that begins 0-12 months after time of sale.  Revenues for these extended warranties are recognized monthly as a portion of the warranty expires.  Deferred extended warranty revenue was $120,000 at September 30, 2004.

 

A reconciliation of the changes in the Company’s product warranty liability during the three and nine month periods ended September 30, 2004 and 2003 is as follows:

 

		Three months ended September 30,						Nine months ended September 30,
		2004			2003			2004			2003
		(dollars in thousands)
Beginning balance		$	1,511		$	1,548		$	1,671		$	1,975
Provision for warranty		570			309			1,564			1,413
Warranties settlement costs		(591		)	(325		)	(1,733		)	(1,882		)
Other - currency translation impact		4			28			(8		)	54
Quarter end balance		$	1,494		$	1,560		$	1,494		$	1,560

 

8

 

NOTE D—INVENTORIES

 

Inventories are summarized as follows (dollars in thousands):

 

		September 30, 2004			December 31, 2003
Finished products		$	38,312		$	33,217
Work-in-process		26,824			25,705
Raw materials and purchased components		28,779			28,142
		$	93,915		$	87,064

 

 

NOTE E—INCOME TAXES

 

Statement of Financial Accounting Standards No.109 (SFAS 109) requires that a valuation allowance be established when it is “more likely than not” that all or a portion of deferred tax assets will not be realized.  A review of all available positive and negative evidence needs to be considered, including such matters as the company’s current and past performance, the market conditions in which the Company operates, the utilization of past tax credits, the length of carryback and carryforward periods, and sales backlogs that will result in future profits.  It further states that forming a conclusion that a valuation allowance is not needed is difficult when there is negative evidence such as cumulative losses in recent years.  Therefore, cumulative losses weigh heavily in the overall assessment.  As a result of the review undertaken at September 30, 2003, Hardinge, Inc. concluded that it was appropriate to establish a full valuation allowance for its U.S. net deferred tax assets.

 

Subsequent to September 30, 2003, Hardinge Inc. continued to maintain a full valuation allowance for its U.S. net deferred tax assets.  Hardinge Inc. expects to continue to record a full valuation allowance on these future tax benefits until an appropriate level of profitability is sustained in the U.S. operations.  Additionally, until an appropriate level of profitability is reached, the Company does not expect to recognize any significant U. S. tax benefits in future results of operations.

 

The difference in the three and nine months ended September 30, 2004 tax rates is due to changes in forecasted pre-tax results and taxes thereon for the year.  Each quarter, the Company estimates its full year tax rate based upon its most recent forecast of full year anticipated results and adjusts year to date tax expense to reflect its full year anticipated tax rate.

 

9

 

NOTE F—EARNINGS (LOSS) PER SHARE AND WEIGHTED AVERAGE SHARES OUTSTANDING

 

Earnings (loss) per share are computed in accordance with Statement of Financial Accounting Standards No. 128 Earnings per Share.  Basic earnings (loss) per share are computed using the weighted average number of shares of common stock outstanding during the period.  For diluted earnings (loss) per share, the weighted average number of shares includes common stock equivalents related primarily to restricted stock.

 

The following is a reconciliation of the numerators and denominators of the basic and diluted earnings (loss) per share computations required by Statement No. 128:

 

		Three months ended September 30,						Nine months ended September 30,
		2004			2003			2004			2003
Numerator: (dollars in thousands)
Net income (loss)		$	400		$	(13,430	)	$	2,185		$	(12,947	)
Numerator for basic earnings (loss) per share		400			(13,430		)	2,185			(12,947		)
Numerator for diluted earnings (loss) per share		400			(13,430		)	2,185			(12,947		)
Denominator: (shares in thousands)
Denominator for basic earnings (loss) per share- weighted average shares		8,742			8,716			8,746			8,703
Effect of diluted securities:
Restricted stock and stock options		43			—			46			—
Denominator for diluted earnings (loss) per share - adjusted weighted average shares		8,785			8,716			8,792			8,703
Basic earnings (loss) per share		$	.05		$	(1.54	)	$	.25		$	(1.49	)
Diluted earnings (loss) per share		$	.05		$	(1.54	)	$	.25		$	(1.49	)

 

 

NOTE G - DERIVATIVE FINANCIAL INSTRUMENTS

 

The Company follows the provision of Financial Accounting Standards Board Statement No. 133, Accounting for Derivative Instruments and Hedging Activities.  The statement requires companies to recognize all of its derivative instruments as either assets or liabilities in the statement of financial position at fair value.  The accounting for changes in the fair value (i.e., gains or losses) of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship and further, on the type of hedging relationship.  For those derivative instruments that are designated and qualify as hedging instruments, a company must designate the hedging instrument, based upon the exposure being hedged, as either a fair value hedge, cash flow hedge or a hedge of a net investment in a foreign operation.

 

The Company has a cross-currency swap agreement and an interest rate swap agreement related to their term loan accounted for as an investment hedge and a cash flow hedge, respectively.  The fair market values of the currency swap and interest rate swap are liabilities on the Company’s balance sheet.  Also, the Company regularly enters into foreign currency contracts to manage its exposure to fluctuations in foreign currency exchange rates on purchases of materials used in production and cash settlements of intercompany sales.  Gains or losses from these contracts are recognized in the income statement when the contract is settled.

 

10

 

NOTE H—REPORTING COMPREHENSIVE INCOME (LOSS)

 

During the three and nine months ended September 30, 2004 and 2003, the components of total comprehensive income (loss) consisted of the following (dollars in thousands):

 

		Three months ended September 30,						Nine months ended September 30,
		2004			2003			2004			2003
Net Income (Loss)		$	400		$	(13,430	)	$	2,185		$	(12,947	)
Other Comprehensive Income (Loss):
Foreign currency translation adjustments		534			1,947			(560		)	4,531
Foreign currency translation - pension		2						(3		)
Unrealized gain (loss) on derivatives, net of tax:
Cash flow hedges		63			183			644			185
Net investment hedges		(196		)	(643		)	(44		)	(1,055		)
Other comprehensive income		403			1,487			37			3,661
Total Comprehensive Income (Loss)		$	803		$	(11,943	)	$	2,222		$	(9,286	)

 

Accumulated balances of the components of other comprehensive income (loss) consisted of the following at September 30, 2004 and December 31, 2003  (dollars in thousands):

 

		Accumulated balances
		Sept. 30,			Dec. 31,
		2004			2003
Accumulated Other Comprehensive Income (Loss):
Pension liability (net of tax of $3,133 and $3,133, respectively)		$	(9,055	)	$	(9,052	)
Foreign currency translation adjustments		11,947			12,507
Unrealized gain (loss) on derivatives, net of tax:
Cash flow hedges, (net of tax of $633 and $659, respectively)		(252		)	(896		)
Net investment hedges, (net of tax of $715 and $714, respectively)		(2,996		)	(2,952		)
Accumulated Other Comprehensive (Loss)		$	(356	)	$	(393	)

 

NOTE I—GOODWILL AND OTHER INTANGIBLE ASSETS

 

In June 2001, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards No. 141, Business Combinations, and No. 142, Goodwill and Other Intangible Assets.  Statement 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. Statement 141 also includes guidance on the initial recognition and measurement of goodwill and other intangible assets arising from business combinations completed after June 30, 2001.  Statement 142 prohibits the amortization of goodwill and intangible assets with indefinite useful lives. Statement 142 requires that these assets be reviewed for impairment at least annually. Intangible assets with finite lives will continue to be amortized over their estimated useful lives.

 

The Company adopted Statements of Financial Accounting Standards 142 on January 1, 2002.  The Company completed the transitional impairment testing of goodwill during the second quarter of 2002 and the subsequent annual impairment testing during the fourth quarter of 2002 and 2003.  In all cases, the Company determined that there was no goodwill impairment.

 

11

 

The total carrying amount of goodwill was $18,180,000 as of September 30, 2004 and $18,314,000 as of December 31, 2003.  This entire asset resulted from the December 2000 acquisition of HTT Hauser Tripet Tschudin AG.  The asset value of this goodwill decreased by $134,000, during the first nine months of 2004, with the entire change caused by the decreased dollar value of the Swiss franc, the functional currency of the Company’s HTT subsidiary, whose balance sheet includes this goodwill.

 

NOTE J—PENSION AND POST RETIREMENT PLANS

 

The Company accounts for the pension plans and postretirement benefits in accordance with Financial Accounting Standards Board Statements No. 87 and 106.  The following disclosures related to the pension and postretirement benefits are presented in accordance with Financial Accounting Standards Board Statement No. 132, as revised.

 

A summary of the components of net periodic pension costs for the consolidated company for the three and nine months ended September 30, 2004 and 2003 is presented below:

 

		Pension Benefits
		Three months ended September 30,						Nine months ended September 30,
		2004			2003			2004			2003
		(dollars in thousands)
Service cost		$	660		$	681		$	1,979		$	2,046
Interest cost		1,672			1,648			5,012			4,951
Expected return on plan assets		(1,925		)	(1,903		)	(5,770		)	(5,722		)
Amortization of prior service cost		42			98			126			293
Amortization of transition (asset) obligation		(98		)	(65		)	(293		)	(195		)
Amortization of (gain) loss		36			26			106			81
Net periodic benefit cost		$	387		$	485		$	1,160		$	1,454

 

A summary of the components of net postretirement benefits costs for the consolidated company for the three and nine months ended September 30, 2004 and 2003 is presented below:

 

		Postretirement Benefits
		Three months ended September 30,						Nine months ended September 30,
		2004			2003			2004			2003
		(dollars in thousands)
Service cost		$	20		$	22		$	59		$	64
Interest cost		95			90			285			272
Amortization of prior service cost		(6		)	(6		)	(18		)	(18		)
Net periodic benefit cost		$	109		$	106		$	326		$	318

 

Hardinge Inc. previously disclosed in its financial statements for the year ended December 31, 2003 that it expected to contribute $2,666,000 to its U. S. defined benefit plan in 2004.  As of September 30, 2004, the Company had made contributions of $3,769,747 to its domestic plan and will not make any more

 

12

 

contributions in 2004.  The additional $1,100,000 contribution will mean that no more contributions for the 2004 plan year will be made until September 2005.  This voluntary contribution was made to insure the fund continues to exceed the IRS funded gateway current liability percentage and will result in lower contributions in future years.  Hardinge expects to contribute $1,199,000 to its foreign defined benefit plans in 2004.  As of September 30, 2004, $839,000 of contributions has been made to the foreign plans.

 

In January 2004, the FASB issued Financial Staff Position (“FSP”) No. 106-1 “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act 2003.”  The Medicare Prescription Drug, Improvement and Modernization Act (the “Act”) introduced a prescription drug benefit under Medicare (Medicare Part D) as well as a federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that is at least actuarially equivalent to Medicare Part D.  Under FSP No. 106-1, a plan sponsor may elect to defer recognizing the effects of the Act until authoritative guidance on the accounting for the federal subsidy is issued.  In May 2004, the FASB issued FSP 106-2, which addresses the accounting and disclosure implications that are expected to arise as a result of the Act.  Under FSP 106-2, the effect of the Federal subsidy shall be accounted for as an actuarial experience gain.  During the third quarter of 2004, in accordance with FSP 106-2, the Company began accounting for the effect of the federal subsidy under the Act and found that there was no impact to the financial statements as the Company does not expect to qualify for the subsidy as set forth in the Act due to the Company’s cost caps on the amount it pays for retiree medical benefits.

 

NOTE K—SUBSEQUENT EVENT

 

On November 3, 2004, Hardinge Inc. purchased the intellectual property rights and certain assets associated with Bridgeport Machine Tool worldwide operations from Bridgeport International, a portfolio company of American Capital Strategies Ltd.

 

Hardinge acquired the name, trademarks, copyrights, designs, patents, know-how, and all other intangibles associated with Bridgeport’s machine tool business throughout the world, with the exception of the Bridgeport knee mill business which Hardinge has the rights to under a previous licensing agreement signed in September, 2002.  Hardinge is also acquiring certain operating assets.  Hardinge will provide uninterrupted sales, service and support to Bridgeport’s customers from offices in Leicester, England and Raamsdonksveer, Holland, formerly owned by Bridgeport.  The total consideration for all of the above was $7,250,000, most of which will be recorded as intangible assets, and was paid in cash funded by the Company’s revolving loan agreement.  The Company will be revisiting the allocation of the purchase price in the fourth quarter to be sure it has been allocated properly among intangible assets & goodwill.  In addition Hardinge acquired finished goods (CNC machining centers) for $4,100,000 to enable uninterrupted service to the marketplace and to fill existing customer orders.

 

13

 

PART I, ITEM 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Overview

 

The Company’s primary business is manufacturing high-precision computer controlled metal-cutting and grinding machines and related accessories. The Company isgeographically diversified with manufacturing facilities in the U.S., Switzerland, Taiwan, and China and with sales to most industrialized countries. Over 60% of its sales are to customers outside North America, and approximately half of its employees are outside of North America.

 

The Company’s machine products are considered to be capital goods and are part of what has historically been a highly cyclical industry. The U.S. market activity metric most closely watched by management has been metal-cutting machine orders as reported by the Association of Manufacturing Technology (AMT), the primary industry group for U.S. machine tool manufacturers. Similar information regarding machine tool consumption in foreign countries is published in various trade journals.

 

Other closely followed U.S. market indicators are tracked to determine activity levels in U.S. manufacturing plants that might purchase the Company’s products.  One such measurement is the PMI (formerly called the Purchasing Manager’s Index), as reported by the Institute for Supply Management. Another is capacity utilization, as reported by the Federal Reserve Board.

 

Other key performance indicators are geographic distribution of sales and orders, gross margin as percent of sales, income from operations, working capital changes and debt level trends.  In an industry where constant product technology development has led to an average model life of three to five years, effectiveness of technological innovation and development of new products are also key performance indicators.

 

The Company recorded a deferred tax charge in September 2003. As explained in the Company’s Form 10-K report for the year ended December 31, 2003, this charge was made consistent with the specific requirements of Statement of Financial Accounting Standards No. 109 and established a valuation allowance offsetting the Company’s entire U.S. deferred tax asset.  Furthermore, no tax benefit can be recorded in the financial statements on net operating losses of the U.S. Company in the current year, even though they can be carried forward against future profits.  The Company’s management continues to believe that ultimately these deferred tax assets and currently generated net operating loss carryforwards will be fully utilized as credits against tax expense on future taxable income well before the assets would expire, since the Company’s U. S. operations earned $10,000,000 average annual pretax profit in the years 1990-2000 and the current tax law provides a lengthy carry-forward period, which for the Company’s current deferred tax assets extends until 2021-2024; however the recovery of these tax assets is currently not certain.

 

The Company’s management believes currency exchange rate changes are significant to reported results for several reasons. The Company’s primary competitors are now largely manufacturers in Japan, Germany, Switzerland, Taiwan, and Korea, which causes the worldwide valuation of the Yen, Euro, Swiss Franc, Taiwanese Dollar and Korean Won to be central to competitive pricing in all of the Company’s markets.  Also, the Company translates the results of its Swiss, Taiwanese, Chinese, English, German and Canadian subsidiaries into U.S. dollars for consolidation and reporting purposes.  Period to period changes in the exchange rate between their local currency and the U.S. dollar may affect comparative data significantly.  The Company also purchases computer controls and other components from suppliers throughout the world, with purchase costs reflecting currency changes.

 

In the past two years, pension liabilities have represented another significant uncertainty for the Company. The Company provides defined benefit pension plans for eligible employees in the U.S.,

 

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Switzerland, England, and Taiwan. Recent declines in interest rates used to calculate the present value of future pension obligations and negative U.S. and UK equity market investment returns in 2002 have resulted in deferred pension charges to equity of $3,940,000 in 2003 and $5,112,000 in 2002.  These non-cash charges were recorded in “other comprehensive income” in the equity section of the consolidated balance sheets.  The underlying economic causes for these charges reflect a risk of increased future pension expense. As discussed later, further large pension charges driven by declines in interest rates or lower than assumed investment returns may require the Company to negotiate changes to its current borrowing arrangements.

 

Results of Operations

 

Summarized selected financial data for the three and nine month periods ended September 30, 2004 and 2003:

 

		Three months ended September 30,											Nine months ended September 30,
		2004			2003			Change			% Change		2004			2003			Change			% Change
		(dollars in thousands, except per share data)
Net Sales		$	54,606		$	43,993		$	10,613		24.1	%	$	159,853		$	132,389		$	27,464		20.7	%
Gross Profit		16,125			12,789			3,336			26.1	%	47,028			39,810			7,218			18.1	%
Income from operations		2,296			1,141			1,155			101.2	%	7,038			3,438			3,600			104.7	%
Profit before taxes		1,765			623			1,142			183.3	%	5,493			1,620			3,873			239.1	%
Net income (loss)		400			(13,430		)	13,830			103.0	%	2,185			(12,947		)	15,132			116.9	%
Diluted earnings (loss) per share		$	.05		$	(1.54	)	$	1.59				$	.25		$	(1.49	)	$	1.74
Weighted average shares outstanding		8,785			8,716								8,792			8,703
Gross Profit as % of sales		29.5		%	29.1		%	.4		%			29.4		%	30.1		%	.7		%
Profit before taxes as % of sales		3.2		%	1.4		%	1.8		%			3.4		%	1.2		%	2.2		%
Net income (loss) as % of sales		.7		%	-30.5		%	31.2		%			1.4		%	-9.8		%	11.2		%

 

Net Sales.  Net sales of $54,606,000 in the third quarter of 2004 were 24.1% above net sales of $43,993,000 for the same three months of 2003.  Sales for the nine months ended September 30, 2004 totaled $159,853,000, a 20.7% increase over sales of $132,389,000 for the nine months ended September 30, 2003.  The table below summarizes the Company’s September 30, 2004 quarter to date and year to date sales by geographical region, with comparisons to the same periods in 2003:

 

		Three months ended September 30, (dollars in thousands)								Nine months ended September 30, (dollars in thousands)
Sales to Customers in:		2004			2003			% Change		2004			2003			% Change
North America		$	21,496		$	20,487		4.9	%	$	63,047		$	56,832		10.9	%
Europe		21,659			16,576			30.7	%	64,203			53,279			20.5	%
Asia & Other		11,451			6,930			65.2	%	32,603			22,278			46.4	%
		$	54,606		$	43,993		24.1	%	$	159,853		$	132,389		20.7	%

 

Quarterly sales and year to date sales increased in each area of the world, with the largest percentage increase coming in Asia.  Comparisons for sales in Asia do reflect some impacts of the slowdown in commerce in China during 2003 related to the SARS outbreak.  During that period, travel to complete

 

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orders and to finalize arrangements for shipments, such as customers’ approvals of machines prior to shipment, were delayed.   The Company’s expanding manufacturing base in Asia continues to help capture additional share in this expanding market, and is expected to continue to generate year over year improvements.  Sales to customers in Europe increased 30.7% in the third quarter and 20.5% year to date compared to the same periods last year.  Activity has returned to a more normal level after a depressed 2003.

 

Machine sales represented 69.1% of revenues in the third quarter of 2004 compared to 67.0% during the third quarter of 2003.  Machine sales represented 68.5% of revenues in the nine months ended September 30, 2004 compared to 66.7% during the same period of 2003.  Sales of non-machine products and services, primarily repair parts and accessories, made up the balance.

 

Orders and Backlog:     The table below summarizes the Company’s orders by geographical region for the three and nine months ended September 30, 2004 compared to the same periods in 2003:

 

		Three months ended September 30,								Nine months ended September 30,
Orders from Customers in:		2004			2003			% Change		2004			2003			% Change
North America		$	25,221		$	22,867		10.3	%	$	72,296		$	64,136		12.7	%
Europe		22,587			16,360			38.1	%	62,225			47,145			32.0	%
Asia & Other		13,663			11,485			19.0	%	36,928			25,455			45.1	%
		$	61,471		$	50,712		21.2	%	$	171,449		$	136,736		25.4	%

 

Orders throughout the world are growing due to new products introduced by the Company in late 2003 and early 2004 and also due to the improved economic climate.  The increased North American orders reflect the general increase in manufacturing activity in the U.S.  The increase in European orders reflects an increase in business activity in Europe resulting in increased orders in all of the Company’s product lines.  Orders in Asia continued to grow in 2004, due to increased demand in China and expanded marketing efforts in other areas of Asia.

 

The Company’s consolidated backlog was $54,279,000 at September 30, 2004. This was 33.4% above the September 30, 2003 backlog of $40,700,000, and 27.0% above the December 31, 2003 backlog of $42,747,000.

 

The Company’s third quarter 2004 gross margin was 29.5% of sales, compared to 29.1% in the same quarter of 2003.  Year to date 2004 gross margin was 29.4% versus 30.1% in the same period of 2003.  The year to year margin percentages comparisons have been affected by product mix.  Margins on non-machine products and services, which includes repair parts, service, and consumable accessories, generally tend to be higher than margins on machines.  When the company experiences higher growth in machine sales versus non-machines, the overall gross margin percentage tends to be lower.  Product mix within the machine category can have an impact also as the Company typically achieves better margins on its complex, high dollar machines, versus its more standard machine lines.

 

Selling, General and Administrative Expenses.   Selling, general and administrative (SG&A) expenses were $13,829,000 or 25.3% of net sales during the three months ended September 30, 2004 compared to $11,648,000, or 26.5% of net sales, during the third quarter of 2003. For the first nine months of 2004, SG&A was $39,990,000, or 25.0% of net sales compared to $36,372,000, or 27.5% of net sales, during the same period of 2003.   The increase in expenses for the quarterly and year to date comparisons reflect higher volume based expenses such as commissions to agents and increased promotional expenses, such as the biennial IMTS show which took place in Chicago in September.  The third quarter amount also includes approximately $250,000 of incremental expenses from temporary help and audit fees due to the work the company is performing to document, evaluate, and test its internal controls in compliance with section 404 of the Sarbanes Oxley act.  The Company anticipates spending a similar amount on such services in the fourth quarter.

 

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