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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

(Mark One)

[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2004

OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the transition period from _________ to ____________.

Commission file number 1-5356

PENN ENGINEERING & MANUFACTURING CORP.
--------------------------------------
(Exact name of registrant as specified in its charter)

Delaware 23-0951065
- ------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

P.O. Box 1000, Danboro, Pennsylvania 18916
- ---------------------------------------- ----------
(Address of principal executive offices) (Zip Code)

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

N/A
----------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)

Indicate by check mark whether the registrant (1) has filed all documents and
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]

Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the last practicable date: 3,350,164 shares of Class A
common stock, $.01 par value, and 14,426,943 shares of common stock, $.01 par
value, outstanding on November 2, 2004.


PART 1. FINANCIAL INFORMATION

Item 1. Financial Statements

PENN ENGINEERING & MANUFACTURING CORP.
CONDENSED CONSOLIDATED BALANCE SHEETS



(Dollars in thousands)
ASSETS
------
(unaudited)
September 30, 2004 December 31, 2003*
CURRENT ASSETS ------------------ ------------------

Cash and cash equivalents $ 25,917 $ 8,361
Short-term investments 225 228
Accounts receivable - net 44,204 37,629
Inventories -- net 45,426 48,512
Refundable income taxes 0 2,129
Other current assets 2,946 1,881
--------- ---------
Total current assets 118,718 98,740
--------- ---------
PROPERTY
Property, plant and equipment 191,162 190,876
Less accumulated depreciation 106,457 99,774
--------- ---------
Property - net 84,705 91,102
--------- ---------

GOODWILL, NET 41,558 41,844
--------- ---------

OTHER ASSETS 4,312 4,438
--------- ---------
TOTAL ASSETS $ 249,293 $ 236,124
========= =========

LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES
Accounts payable $ 7,708 $ 6,865
Bank debt 1,510 9,042
Dividends payable 1,243 1,052
Accrued expenses:
Pension and profit sharing 3,539 2,104
Payroll and commissions 7,440 3,040
Other 5,313 7,129
--------- ---------
Total current liabilities 26,753 29,232
--------- ---------

ACCRUED PENSION COST 0 1,192
--------- ---------

DEFERRED INCOME TAXES 11,716 10,927
--------- ---------

LONG-TERM BANK DEBT 2,563 3,173
--------- ---------

STOCKHOLDERS' EQUITY
Common Stock 152 150
Class A common stock 35 35
Additional paid-in capital 45,440 42,573
Retained earnings 160,931 148,906
Accumulated other comprehensive income 7,789 6,022
Treasury stock (6,086) (6,086)
--------- ---------
Total stockholders' equity 208,261 191,600
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 249,293 $ 236,124
========= =========


See Notes to Condensed Consolidated Financial Statements

* Condensed Consolidated Balance Sheet at December 31, 2003 has been derived
from the audited financial statements at that date.

2

PENN ENGINEERING & MANUFACTURING CORP.
STATEMENTS OF CONDENSED CONSOLIDATED INCOME



(Dollars in thousands except per share amounts)

THREE MONTHS ENDED NINE MONTHS ENDED
-------------------------------- ---------------------------------
(unaudited) (unaudited)
September 30, September 30, September 30, September 30,
2004 2003 2004 2003
------------- ------------- ------------- -------------

Net Sales $ 59,962 $ 46,321 $ 184,978 $ 138,574
Cost of Products Sold 40,880 32,728 122,780 99,408
-------- -------- --------- ---------
Gross Profit 19,082 13,593 62,198 39,166

Selling Expenses 6,102 5,054 18,544 15,765
General and Administrative Expenses 6,649 6,562 20,966 18,911
-------- -------- --------- ---------
Operating Income 6,331 1,977 22,688 4,490
-------- -------- --------- ---------
Other Income (Expense):
Interest income 35 13 97 114
Interest expense (73) (176) (240) (701)
Other, net 150 201 336 488
-------- -------- --------- ---------
Total Other Income (Expense) 112 38 193 (99)
-------- -------- --------- ---------

Income Before Income Taxes 6,443 2,015 22,881 4,391
Provision for Income Taxes 2,062 538 7,322 1,054
-------- -------- --------- ---------
Net Income $ 4,381 $ 1,477 $ 15,559 $ 3,337
======== ======== ========= =========

PER SHARE DATA:
Basic earnings $ 0.25 $ 0.08 $ 0.88 $ 0.19
======== ======== ========= =========

Diluted earnings $ 0.24 $ 0.08 $ 0.87 $ 0.19
======== ======== ========= =========

Cash dividends declared $ 0.07 $ 0.06 $ 0.20 $ 0.18
======== ======== ========= =========


See Notes to Condensed Consolidated Financial Statements

3

PENN ENGINEERING & MANUFACTURING CORP.
STATEMENTS OF CONDENSED CONSOLIDATED CASH FLOWS



(Dollars in thousands)
NINE MONTHS ENDED
--------------------------------------
(unaudited)
September 30, 2004 September 30, 2003
------------------ ------------------

CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 15,559 $ 3,337
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 7,897 8,484
Deferred income taxes (1) 0
Foreign currency transaction gains (101) (22)
Loss on disposal of property 206 81
Changes in assets and liabilities:
Increase in receivables (6,468) (7,792)
Decrease in inventories 3,051 8,903
Decrease in refundable income taxes 2,129 567
(Increase) decrease in other current assets (1,067) 150
Decrease (increase) in other assets 80 (477)
Increase (decrease) in accounts payable 879 (1,981)
Increase in accrued expenses 5,800 4,519
(Decrease) increase in accrued pension cost (1,192) 2,700
-------- --------
Net cash provided by operating activities 26,772 18,469
-------- --------

CASH FLOWS FROM INVESTING ACTIVITIES:
Property additions (2,085) (2,567)
Acquisitions of businesses (net of cash acquired) 0 (10,442)
Proceeds from disposal of property 89 17
-------- --------
Net cash used in investing activities (1,996) (12,992)
-------- --------

CASH FLOWS FROM FINANCING ACTIVITIES:
Net bank debt repayments (8,079) (17,341)
Dividends paid (3,343) (3,132)
Issuance of common stock 2,869 874
-------- --------
Net cash used in financing activities (8,553) (19,599)
-------- --------

Effect of exchange rate changes on cash 1,333 691
-------- --------
Net increase (decrease) in cash and cash equivalents 17,556 (13,431)
Cash and cash equivalents at beginning of period 8,361 20,927
-------- --------
Cash and cash equivalents at end of period $ 25,917 $ 7,496
======== ========

See Notes to Condensed Consolidated Financial Statements

4

PENN ENGINEERING & MANUFACTURING CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004

Note 1. Condensed Consolidated Financial Statements (Unaudited).
- ------ -------------------------------------------------------

The accompanying condensed consolidated financial statements
and notes should be read in conjunction with the annual financial statements and
notes thereto included in the Company's Annual Report for the year ended
December 31, 2003. The information contained in this report is unaudited and, in
the opinion of management, reflects all adjustments (which include only normal
recurring adjustments) necessary for a fair presentation of the Company's
condensed consolidated financial position at September 30, 2004 and 2003 and the
condensed consolidated statements of income and cash flows for the nine-month
periods then ended. The results of operations for the three and nine months
ended September 30, 2004 are not necessarily indicative of the results of
operations to be expected for the year ending December 31, 2004.

Note 2. Inventories.
- ------ -----------

Substantially all of the Company's domestic fastener
inventories are priced on the last-in, first-out (LIFO) method, at the lower of
cost or market. The remainder of the inventories are priced on the first-in,
first-out (FIFO) method, at the lower of cost or market. Inventories are as
follows:

(Dollars in thousands)
September 30, 2004 December 31, 2003
------------------ -----------------
Raw material $2,638 $2,807
Tooling 7,524 5,540
Work-in-process 10,002 11,541
Finished goods 25,262 28,624
-------- --------
TOTAL $45,426 $48,512
======= =======

If the FIFO method of inventory valuation had been used by the
Company for all inventories, inventories would have been $10,342,000 and
$10,072,000 higher than reported at September 30, 2004 and December 31, 2003,
respectively, and net income would have been $183,000 and $106,000 higher than
reported for the nine months ended September 30, 2004 and 2003, respectively.
Long-term tooling inventory totaling $1,225,000 at September 30, 2004 and
$1,285,000 at December 31, 2003 is included in Other Assets.

Note 3. Bank Debt.
- ------ ---------

As of September 30, 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:

5


o a working capital facility that permits maximum borrowings of
$7,000,000, due on demand, under which no amounts were
outstanding at September 30, 2004;

o a facility that allows for borrowings of up to $15,000,000,
under which no amounts were outstanding at September 30, 2004;

o a facility that permits borrowings of up to $30,000,000, under
which no amounts were outstanding at September 30, 2004.

o a committed line-of-credit that permits borrowings of up to
$8,000,000, under which no amounts were outstanding at
September 30, 2004.

These line of credit facilities require that the Company
comply with certain financial covenants. At September 30, 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) S.r.l.,
has two short-term credit facilities under which $941,000 was outstanding at
September 30, 2004. PennEngineering Motion Technologies (Europe) S.r.l. also has
an outstanding mortgage on its building, of which $569,000 is classified as
short-term debt and $2,563,000 is classified as long-term debt at September 30,
2004.

Note 4. Comprehensive Income.
- ------ --------------------

Total comprehensive income amounted to $5,782,000 and
$2,191,000 for the three months ended September 30, 2004 and 2003, respectively,
and $17,326,000 and $6,296,000 for the nine months ended September 30, 2004 and
2003, respectively.

Note 5. Accounting for Stock Options.
- ------ ----------------------------

The Company follows Accounting Principles Board Opinion No. 25
("APB 25"), "Accounting for Stock Issued to Employees" and related
interpretations in accounting for stock options. Under APB 25, if the exercise
price of stock options granted equals or exceeds the market price of the
underlying common stock on the date of grant, no compensation expense is
recognized. Statement of Financial Accounting Standards No. 123 ("SFAS No. 123")
requires pro forma information regarding net income and earnings per share as if
the Company had accounted for its employee stock options under the fair value
method of SFAS No. 123. The fair value of each option granted was estimated on
the date of grant using the Black-Scholes option-pricing model. For purposes of
pro forma disclosures, the estimated fair value of the options is amortized to
expense over the options' vesting period. Had compensation costs for the
Company's plans been determined based on the fair value at the grant date for


6


awards under these plans consistently with the method of SFAS No. 123, the
impact on the Company's financial results would have been as follows:


THREE MONTHS ENDED NINE MONTHS ENDED
--------------------------- ------------------------
September 30 September 30
--------------------------- ------------------------
2004 2003 2004 2003
------- ------- -------- -------
(Dollars in thousands except per share amounts)

Net income as reported $ 4,381 $ 1,477 $ 15,559 $ 3,337
Pro forma compensation cost, net of tax (346) (302) (1,006) (797)
------- ------- -------- -------
Pro forma net income $ 4,035 $ 1,175 $ 14,553 $ 2,540
======= ======= ======== =======
Basic earnings per share:
As reported $0.25 $0.08 $0.88 $0.19
Pro forma 0.23 0.07 0.83 0.15
Diluted earnings per share:
As reported $0.24 $0.08 $0.87 $0.19
Pro forma 0.22 0.07 0.81 0.14


Note 6. Use of Estimates.
- ------ ----------------

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

Note 7. Components of Net Periodic Pension Cost.
- ------ ---------------------------------------

Net pension costs included the following components:


THREE MONTHS ENDED NINE MONTHS ENDED
---------------------- -------------------------
September 30 September 30
---------------------- -------------------------
(Dollars in thousands) 2004 2003 2004 2003
------ ------- ------- --------

Service cost $ 658 $ 595 $ 2,098 $ 1,785
Interest cost 769 770 2,269 2,310
Expected return on plan assets (640) (500) (1,840) (1,500)
Net amortization and deferral 173 35 533 105
------ ------- ------- --------
Net periodic pension cost $ 960 $ 900 $ 3,060 $ 2,700
====== ======= ======= ========



The Company previously disclosed in its Annual Report for the
year ended December 31, 2003, that it expected to contribute $5,100,000 to its
pension plan in 2004. As of September 30, 2004, $4,072,000 of contributions have
been made. The Company presently anticipates contributing an additional
$2,271,000 to fund its pension plan in 2004 for a total of $6,343,000.

7


Note 8. Segment Information.
- ------ -------------------



(Dollars in thousands)

THREE MONTHS ENDED THREE MONTHS ENDED
----------------------------------------- ---------------------------------------
September 30, 2004 September 30, 2003
----------------------------------------- ---------------------------------------
Fasteners Distribution Motors Fasteners Distribution Motors
--------- ------------ ------- --------- ------------ -------

Revenues from external customers $32,071 $14,741 $13,150 $21,954 $13,889 $10,478
Intersegment revenues 10,039 180 7,243 24
Operating income 6,617 626 1,141 2,320 953 570




NINE MONTHS ENDED NINE MONTHS ENDED
----------------------------------------- ---------------------------------------
September 30, 2004 September 30, 2003
----------------------------------------- ---------------------------------------
Fasteners Distribution Motors Fasteners Distribution Motors
--------- ------------ ------- --------- ------------ -------

Revenues from external customers $98,525 $48,332 $38,121 $70,420 $36,445 $31,709
Intersegment revenues 28,363 1,377 19,895 130
Operating income 23,578 3,428 2,560 6,743 1,741 1,907


A reconciliation of combined operating income for the reportable
segments to consolidated income before income taxes is as follows:


THREE MONTHS ENDED NINE MONTHS ENDED
---------------------- -------------------------
September 30 September 30
---------------------- -------------------------
(Dollars in thousands) 2004 2003 2004 2003
------ ------- ------- --------

Total income for reportable segments $ 8,384 $ 3,843 $29,566 $ 10,391
Unallocated corporate expenses (2,053) (1,866) (6,878) (5,901)
Other income (expense) 112 38 193 (99)
------- ------- ------- -------
Income before income taxes $ 6,443 $ 2,015 $22,881 $ 4,391
======= ======= ======= =======


8


Note 9. Earnings Per Share Data.
- ------ -----------------------

The following table sets forth the computation of basic and diluted
earnings per share for the periods indicated.


THREE MONTHS ENDED NINE MONTHS ENDED
------------------------ ------------------------
September 30 September 30
(In thousands, ------------------------ ------------------------
except per share data) 2004 2003 2004 2003
------- ------- ------- -------

Basic:
Net income $ 4,381 $ 1,477 $15,559 $ 3,337
Weighted average shares outstanding 17,704 17,451 17,632 17,424
------- ------- ------- -------
Basic earnings per share $ 0.25 $ 0.08 $ 0.88 $ 0.19
======= ======= ======= =======

Diluted:
Net income $ 4,381 $ 1,477 $15,559 $ 3,337
======= ======= ======= =======
Weighted average shares outstanding 17,704 17,451 17,632 17,424
Net effect of dilutive stock options-based on
treasury stock method 325 253 290 137
------- ------- ------- -------

Totals 18,029 17,704 17,922 17,561
======= ======= ======= =======
Diluted earnings per share $ 0.24 $ 0.08 $ 0.87 $ 0.19
======= ======= ======= =======


9


Item 2. Management's Discussion and Analysis of Financial Condition
- ------ -----------------------------------------------------------
and Results of Operations.
-------------------------

Quarter Ended September 30, 2004 vs. Quarter Ended September 30, 2003

Consolidated net sales for the quarter ended September 30, 2004 were
$60.0 million, versus $46.3 million for the quarter ended September 30, 2003, a
29.6% increase. Net sales to customers outside the United States for the quarter
ended September 30, 2004 were $22.8 million, versus $19.4 million for the
quarter ended September 30, 2003, a 17.5% increase. Net sales for the Fastening
Technologies segment for the quarter ended September 30, 2004 were $32.1
million, versus $22.0 million for the quarter ended September 30, 2003, a 45.9%
increase. Net sales for the Motion Technologies segment were $13.2 million for
the quarter ended September 30, 2004, versus $10.5 million recorded for the
quarter ended September 30, 2003, a 25.7% increase. Net sales for the
Distribution segment for the quarter ended September 30, 2004 were $14.7
million, versus $13.9 million for the quarter ended September 30, 2003, a 5.8%
increase.

Within the Fastening Technologies segment, sales volume increased 37.9%
in both the domestic and international markets from the third quarter of 2003 to
the third quarter of 2004, while the average selling price increased
approximately 4.0%, due to a change in product mix as well as price increases
that went into effect during the year to cover raw material cost increases.
Within the Motion Technologies segment, the number of motors sold under the
Pittman brand increased approximately 21.3% in the third quarter of 2004
compared to the third quarter of 2003, while the average selling price per motor
increased approximately 8.9%, primarily due to a price increase effective
January 1, 2004. Motor sales from PennEngineering Motion Technologies (Europe)
S.r.l. (formerly MAE) were $2.6 million in the third quarter of 2004 compared to
$2.3 million in the third quarter of 2003. Within the Distribution segment,
sales into Europe increased approximately 15.7%, sales into North America
increased 8.2%, while sales into Asia were the same in the third quarter of 2004
and the third quarter 2003.

Consolidated gross profit for the third quarter of 2004 was $19.1
million, versus $13.6 million for the third quarter of 2003, an increase of
40.4%. Gross profit as a percent of sales increased from 29.3% in the third
quarter of 2003 to 31.8% in the third quarter of 2004. The Company continues to
benefit from increased volume, especially in the manufacture of fasteners where
increased plant and machinery utilization occurred without corresponding
increases in fixed costs.

Consolidated selling, general, and administrative expenses ("SG&A") for
the third quarter of 2004 were $12.8 million, versus $11.6 million for the third
quarter of 2003, a 10.3% increase. This increase was caused mainly by increased
commission expense (up 10.5%) and other direct selling expenses due to the
higher sales volume.

10


Consolidated net income for the third quarter of 2004 was $4.4 million,
versus $1.5 million for the third quarter of 2003. The effective tax rate
increased from 26.7% in the third quarter of 2003 to 32.0% in the third quarter
of 2004 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
in which income was generated in the third quarter of 2003.

Nine Months Ended September 30, 2004 vs. Nine Months Ended September 30, 2003
- ------------------------------------------------------------------------------

Consolidated net sales for the nine months ended September 30, 2004
were $185.0 million, versus $138.6 million for the nine months ended September
30, 2003, a 33.5% increase. Net sales to customers outside the United States for
the nine months ended September 30, 2004 were $75.5 million, versus $55.3
million for the nine months ended September 30, 2003, an increase of 36.5%. Net
sales for the Fastening Technologies segment for the nine months ended September
30, 2004 were $98.5 million, versus $70.4 million for the nine months ended
September 30, 2003, a 39.9% increase. Net sales for the Motion Technologies
segment were $38.1 for the nine months ended September 30, 2004, versus $31.7
million for the nine months ended September 30, 2003, a 20.2% increase. Net
sales for the Distribution segment for the nine months ended September 30, 2004
were $48.3 million, versus $36.4 million for the nine months ended September 30,
2003, a 32.7% increase.

Within the Fastening Technologies segment, sales volume increased 31.7%
from the first nine months of 2003 compared to the first nine months of 2004,
while the average selling price increased 6.0%. 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. Within the
Motion Technologies segment, the number of motors sold under the Pittman brand
increased approximately 18.7% in the first nine months of 2004 compared to the
first nine months of 2003, while the average selling price increased
approximately 7.8%. Motor sales from PMT Europe were $7.9 million for the nine
months ended September 30, 2004 versus $7.1 million for the nine months ended
September 30, 2003. Within the Distribution segment, the Company experienced
strong international sales growth during the first nine months of 2004 compared
to the same period in 2003 as the Asian market increased 50.0% and the European
market increased 33.7%. The domestic market continues to strengthen also as
sales increased 19.8% in North America.

Consolidated gross profit for the first nine months of 2004 was $62.2
million, versus $39.2 million for the first nine months of 2003, a 58.7%
increase. 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.

11


Consolidated SG&A expenses for the first nine months of 2004 were $39.5
million, or 21.4% of sales, versus $34.7 million, or 25.0% of sales, for the
first nine months of 2003, an increase of 13.8%. In addition to increased wages
and employee benefits, legal and professional fees increased approximately 76%
from 2003 to 2004 due mainly to increased audit and Sarbanes-Oxley related
expenses.

Consolidated net income for the first nine months of 2004 was $15.6
million, versus $3.3 million for the first nine months of 2003. Interest expense
decreased from $701,000 in the first nine months of 2003 to $240,000 in the
first nine months of 2004 due to less debt outstanding. The effective tax rate
increased from 24.0% in the first nine months of 2003 to 32.0% in the first nine
months of 2004 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 was generated in the first nine months of 2003.

Liquidity and Capital Resources
- -------------------------------

Cash and cash equivalents at September 30, 2004 were $25.9 million
compared to $8.4 million at December 31, 2003. Working capital totaled $92.0
million at September 30, 2004 compared to $69.5 million at December 31, 2003.

Net cash of $26.8 million was provided by operating activities for the
nine months ended September 30, 2004 compared to $18.5 million provided by
operating activities for the nine months ended September 30, 2003. The Company
continued to generate cash from further reductions in overall inventory levels
during the first nine months of 2004. However, as sales volume increased, the
level of accounts receivable also increased, particularly in the European region
where payment terms are generally longer than domestic payment terms.

Net cash used in investing activities totaled $2.0 million for the nine
months ended September 30, 2004. The Company continues to exercise caution with
its capital expenditures as it attempts to utilize current capacity during the
economic recovery.

Net cash used in financing activities totaled $8.6 million for the nine
months ended September 30, 2004 compared to $19.6 million for the nine months
ended September 30, 2003. Because of the decreased capital expenditures, the
Company repaid short-term debt during both years.

The Company's principal contractual obligations are the repayment of
its short-term debt (see Note 3) and the payment of operating lease commitments
covering certain automobiles, office space, and office equipment that are listed
in Note 12 to the Company's Annual Report for the year ended December 31, 2003.
The Company anticipates that its existing capital resources and cash flow
generated from future operations as well as existing short-term lines of credit
will enable it to maintain its current level of operations and its planned
growth for the foreseeable future.

12


Critical Accounting Policies
- ----------------------------

The Company has identified a number of its accounting polices
that it has determined to be critical. These critical accounting policies
primarily relate to financial statement assertions that are based on the
estimates and assumptions of management, and the effect of changing those
estimates and assumptions could have a material effect on the Company's
financial statements. The following is a summary of those critical accounting
policies.

Inventories
- -----------

The Company's domestic fastener inventories are priced on the
last-in, first-out (LIFO) method of accounting. Other inventories, representing
approximately 79% of total inventories at September 30, 2004 and December 31,
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 September
30, 2004, the Company's inventory balance of $45,426,000 was net of a reserve
for obsolete, excess, and slow-moving inventories of approximately $4,210,000.
At December 31, 2003, the Company's inventory balance of $48,512,000 was net of
a reserve for obsolete, excess, and slow-moving inventories 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
reserve may be required.

Accounts Receivable
- -------------------

The Company maintains an allowance for doubtful accounts for
trade receivables for which collectability is uncertain. At September 30, 2004
and December 31, 2003, this allowance was approximately $1,029,000 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 procedures effectively address exposure for doubtful
accounts, changes in the economy, industry, or specific customer conditions may
require adjustments to the allowance.

Goodwill
- --------

SFAS No. 142 requires that goodwill no longer be amortized,
and instead, be tested for impairment on a periodic basis. At September 30,
2004, the Company had $41,558,000 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


13


2003 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 its estimates, the Company has concluded that
there is no impairment of its goodwill as of December 31, 2003. However, changes
in these estimates could cause one or more of the reporting units to be valued
differently in the future. The Company will evaluate its goodwill again for
impairment as of October 1, 2004.

Pensions
- --------

Accounting for the Company's defined benefit pension plan
requires that amounts recognized in the financial statements be determined on an
actuarial basis. The most significant elements in determining the Company's
pension expense are pension liability discount rates and the expected return on
plan assets. The pension discount rate reflects the current interest rate at
which pension liabilities could be settled at the end of the year. At the end of
each year, the Company determines the discount rate to be used to discount plan
liabilities. In estimating this rate, the Company looks to rates of return on
high-quality, fixed-income investments. At December 31, 2003, the Company
determined this rate to be 6.25% and no adjustment to this rate has been made
for the nine months ended September 30, 2004. Historically, the Company has
assumed that the expected long-term rate of return on plan assets will be 8.00%,
and this expected rate of return was used for many years. Because the Company's
pension plan assets have earned substantially less than 8.00% in the last two
years, the Company reduced the expected long-term rate of return to 7.00% in
2003 and no adjustment has been made for the nine months ended September 30,
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 SFAS No. 132
and will ultimately affect future pension expense.

Derivative Instruments and Hedging
- ----------------------------------

The Company manages risks associated with foreign exchange
rates and interest rates with derivative instruments. The Company does not use
derivative instruments 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.

Section 404 of the Sarbanes-Oxley Act of 2002
- ---------------------------------------------

Section 404 of the Sarbanes-Oxley Act of 2002 requires the
Company's management to perform an evaluation of its internal control over
financial reporting and have the Company's independent auditors attest to such


14


an evaluation. Along with many other companies whose fiscal year ends on
December 31, the Company must implement these requirements for the first time in
connection with the preparation of the Company's annual report for the year
ending December 31, 2004. The Company has been actively preparing for the
implementation of this requirement by, among other things, establishing an
ongoing program to document, evaluate, and test the systems and processes
necessary for compliance. While the Company anticipates that it will be able to
comply with these requirements on a timely basis, unforeseen delays may occur
that could prevent the Company from achieving timely compliance. If the Company
is unable to complete its evaluation on a timely basis and in a satisfactory
manner, or if the Company's external auditors are unable to attest on a timely
basis to the adequacy of the Company's internal control, the Company may be
subject to additional scrutiny surrounding its internal control over financial
reporting.

Forward-Looking Statements
- --------------------------

Forward-looking statements, within the meaning of Section 27A
of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of
1934 under the Private Securities Litigation Reform Act of 1995, are made
throughout this Management's Discussion and Analysis. The Company's results may
differ materially from those in the forward-looking statements. Forward-looking
statements are based on management's current views and assumptions, and involve
risks and uncertainties that significantly affect expected results. For example,
operating results may be affected by external factors such as: changes in laws
and regulations, changes in accounting standards, fluctuations in demand in
markets served by the Company, particularly the computer and telecommunications
markets, fluctuations in the cost and availability of the supply chain
resources, and foreign economic conditions, including currency rate
fluctuations.

Item 3. Quantitative and Qualitative Disclosure About Market Risk.
- ------ ---------------------------------------------------------

Reference is made to Part 2, Item 7A of the Company's Form
10-K Annual Report for the year ended December 31, 2003. There has been no
material change in the information reported in that report.

Item 4. Controls and Procedures.
- ------ -----------------------

Evaluation of Disclosure Controls and Procedures

As required by Rule 13a-15 under the Securities Exchange Act
of 1934, as of the end of the period covered by this report, the Company carried
out an evaluation, under the supervision and with the participation of the
Company's management, including the Chief Executive Officer and the Chief
Financial Officer, of the effectiveness of the design and operation of the
Company's disclosure controls and procedures. Based on this evaluation, the
Company's management, including the Chief Executive Officer and the Chief
Financial Officer, concluded that the Company's disclosure controls and
procedures are effective for recording, processing, summarizing, and reporting
the information the Company is required to disclose in the reports it files
under the Securities Exchange Act of 1934, within the time periods specified in
the Securities and Exchange Commission's rules and forms.

Changes in Internal Control Over Financial Reporting

There have been no significant changes in the Company's
internal controls over financial reporting (as such term is defined in Rules
13a-15 and 15d-15 under the Securities Exchange Act of 1934) during the three
months and nine months ended September 30, 2004 that have materially affected,
or are reasonably likely to affect materially, the Company's internal control
over financial reporting.

15


PART II OTHER INFORMATION

Item 1. Legal Proceedings.
- ------ -----------------

Reference is made to Part 1, Item 3 of the Company's Form 10-K
Annual Report for the year ended December 31, 2003.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
- ------ -----------------------------------------------------------

Not applicable.

Item 3. Defaults upon Senior Securities.
- ------ -------------------------------

Not applicable.

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

Not applicable.

Item 5. Other Information.
- ------ -----------------

In order that the Company and its independent auditors have
sufficient time to complete their compliance with the requirements of Section
404 of the Sarbanes-Oxley Act, the Company anticipates that the Company's future
earnings announcements will be approximately a week before the scheduled filing
dates of its quarterly and annual reports with the Securities and Exchange
Commission.

Item 6. Exhibits.
- ------ ---------

Exhibit No. Description
----------- ---------------------------------------

3.1 Restated Certificate of Incorporation
(Incorporated by reference to Exhibit
3.1 of the Company's Form 10-Q
Quarterly Report for the period ended
March 31, 2001.)

3.2 By-laws, as amended (Incorporated by
reference to Exhibit 3.2 of the
Company's Form 10-K Annual Report for
the year ended December 31, 2001.)

31.1 Rule 13a-14(a)/15d-14(a) Certification.

31.2 Rule 13a-14(a)/15d-14(a) Certification.

32.1 Section 1350 Certification.

32.2 Section 1350 Certification.

16


SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934,
the Company has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

Dated: November 9, 2004 PENN ENGINEERING & MANUFACTURING CORP.

By: /s/ Kenneth A. Swanstrom
-----------------------------------
Kenneth A. Swanstrom
Chairman of the Board and
Chief Executive Officer


Dated: November 9, 2004 By: /s/ Mark W. Simon
-----------------------------------
Mark W. Simon
Senior Vice President and
Chief Financial Officer

17


PENN ENGINEERING & MANUFACTURING CORP.


EXHIBIT INDEX


Exhibit No. Description
----------- --------------------------------------------------

3.1 Restated Certificate of Incorporation
(Incorporated by reference to Exhibit 3.1 of the
Company's Form 10-Q Quarterly Report for the
period ended March 31, 2001.)

3.2 By-laws, as amended (Incorporated by reference to
Exhibit 3.2 of the Company's Form 10-K Annual
Report for the year ended December 31, 2001.)

31.1 Rule 13a-14(d)/15d-14(a) Certification.

31.2 Rule 13a-14(d)/15d-14(a) Certification.

32.1 Section 1350 Certification.

32.2 Section 1350 Certification.

18