10-Q 1 qrt10qq203rev8.txt SECOND QUARTER 10Q, 2003 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-Q [ X ] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended June 30, 2003 [ ] 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: 1-1212 DRIVER-HARRIS COMPANY (Exact name of registrant as specified in its charter) New Jersey 22-0870220 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 200 Madison Avenue Convent Station, New Jersey 07960 (Address of principal executive offices) Registrant's telephone no., including area code (973) 267-8100 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [ X ] No [ ] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Common Stock, $0.83 1/3 par value -- 1,474,346 shares as of September 24, 2003. DRIVER-HARRIS COMPANY I N D E X

DRIVER-HARRIS COMPANY AND SUBSIDIARIES UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS (Amounts in thousands)

DRIVER-HARRIS COMPANY AND SUBSIDIARIES UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Dollar amounts in thousands, except per share data)

DRIVER-HARRIS COMPANY AND SUBSIDIARIES UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW (Amounts in thousands)

NOTES TO FINANCIAL STATEMENTS 1 - Basis of Presentation These financial statements have been prepared in accordance with the instructions to Form 10-Q and therefore do not include all information, disclosures, and notes necessary for a fair presentation of financial position, results of operations, and cash flows in conformity with generally accepted accounting principles. Reference should be made to the financial statements contained in the Company's Annual Report on Form 10-K for the year ended December 31, 2002. These financial statements include all adjustments which are, in the opinion of management, necessary to a fair presentation of the results for the interim period. 2 - Investments in Related Company and Other Subsidiaries The Company owns Irish Driver-Harris Co. Ltd.,("IDH"), located in Ireland. 3 - Comprehensive Income The components of comprehensive loss as presented under Financial Accounting Standard 130, "Reporting Comprehensive Income", for the three and six months ended June 30, 2003 and 2002 are as follows:

4. - Industry Segments and Geographic Areas The Company classifies its revenues based upon the location of the facility and its function (i.e. manufacture or purchase for resale-distribution). Such revenues are regularly reviewed by the Directors and management and decisions are made on such basis. The operating expenses and resultant net profit (loss) and the assets are similarly reviewed and decisions made based upon whether they relate to manufacturing or purchase for resale (i.e. distribution).

5. - Subsequent Event During August, the Company moved its listing from the American Stock Exchange to the Over The Counter market. 6 - Employee Stock Options The Company has elected to follow Accounting Principles Board Opinion No. 25 "Accounting for Stock Issued to Employees" ("APB 25") and related interpretations in accounting for its employee stock options. Accordingly, compensation cost for stock options is measured as the excess, if any, of the fair market value of the Company's shares at the date of the grant over the amount an employee must pay to acquire the shares. This cost is deferred and charged to expense rateably over the vesting period (generally five years). Where shares are granted to employees at less than fair market value, the excess of the fair market value over the amount the employee must pay to acquire the shares is charged to expense as stock compensation and credited to additional paid-in capital in the period of transfer. In December 2002, the Financial Accounting Standards Board issued Statement No. 148, "Accounting for Stock- Based Compensation- Transition and Disclosure" ("SFAS 148"). SFAS 148 requires the following disclosures in the interim financial statements of all companies with stock based compensation regardless of whether they account for that compensation using the fair value method of SFAS 123 or the intrinsic value method of APB 25. Pro forma information regarding net income (loss) and income (loss) per share is required by SFAS 123 and has been determined as if the Company had accounted for its stock options under the fair value method of SFAS 123. No shares were issued as compensation during the six months of 2003 or 2002. The following table illustrates the effect on net loss and loss per share as if the Company had applied the fair value recognition provisions of SFAS 123 to stock-based employee compensation (in thousands, except per share data):

These amounts may not necessarily be indicative of the pro-forma effect of SFAS No. 123 for future periods in which options may be granted. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Financial Condition The ratio of current assets to current liabilities was 0.56 at June 30, 2003 compared to 0.63 at December 31, 2002. At June 30, 2003, the Company's subsidiaries had approximately $5.7 million in available bank credit lines of which $4.5 million was in use. The maximum amount the Company may borrow under these credit lines at any point in time fluctuates in proportion to and is limited to the value of the Company's receivables. The Company has a note payable to the Pension Benefit Guarantee Corporation ("PBGC") for which the due date was extended on April 10, 2000 to April 16, 2001. On April 13, 2001, the Company re-negotiated the terms of the note whereby all payments of such note were deferred for two years. The note will be payable in ten equal annual payments beginning April 16, 2003 and ending April 16, 2012. The Company is in dispute with the PBGC as to the terms of this re-negotiated note. As a result of this dispute, the PBGC has notified the Company that it considers it in default and pending the determination of this issue the Company has considered it prudent to reclassify the note to short-term debt in the Company's consolidated balance sheet. Until the note is paid in full, the Company may not pay cash dividends on its capital stock without permission from the PBGC. On February 12, 2003 DRH Investments, LLC and DRH Equity Investments, LLC (collectively DRH LLC) jointly filed a Schedule 13D, notifying the Security and Exchange Commission that DRH Investments LLC had purchased the Note from the PBGC and that they had purchased 60,400 and 85,000 shares of the Company equal to 4.1% and 5.8% of the outstanding equity of the Company. The joint filers indicated that they were considering a wide variety of possible courses of action with respect to the Note and the Company. DRH LLC is not a related party to the Company, its officers or directors. On April 30, 2003, DRH Investments, LLC filed suit against the Company for breach of the Note and money had and received. DRH seeks (i) payment of US$1,484,150 plus interest from February, 10, 2003, (ii) not less than 30,400 shares of Common Stock of the Company, (iii) penalties, costs and expenses associated with registering the Company shares, (iv) fees and costs incurred pursuant to the Note and other agreements, and (v) such other and further relief as the Court may deem just and proper. The Company believes it has adequate cash flow to meet its ongoing operating obligations including debt repayments and capital commitments in Ireland, based on a plan of continuous cost reductions, increased margins and minimal capital expenditure which will permit the Company to remain within the limits of its receivables discounting bank facility. The Company believes the actions it has taken will result in a return to stability and reduce its exposure to the competitive pressures of the ongoing consolidation in its industry. The Company has struggled to meet supplier payments in the past two years due to the impact of cumulative losses and their impact on the net worth and reduced borrowing capacity. Going forward, the Company is dependent upon good collection of debtors and maintaining inventories at low levels in order to meet payments to creditors. On March 31, 2003, the administration and finance function was moved from Dublin to the main factory location in New Ross, Ireland. Significant systems and personnel changes were made in order to streamline the finance activity and reduce costs. Preparation of the second quarter results was significantly delayed as a result. While management believes that this change will significantly improve controls and measurement of the business, certain controls and financial measurements were not to the standard management expects. Management has addressed these weakenesses and expects resolution during the third quarter. Market Risks Foreign Currency Fluctuations With operations in two different countries, the Company's operating results may be adversely affected by significant fluctuations in the relative values among the U.S. dollar, Euro and the British Pound Sterling. The Company is periodically involved in hedging currency between the Euro and the British Pound Sterling through the use of futures contracts which are relatively short term in nature. The Company historically has experienced minimal gains and losses on such foreign currency hedging. Debt Instruments The Company's long term debt of $2.2 million including the current portion, is primarily fixed rate debt of which $1.7 million is U.S. denominated with the remaining balance denominated in Euro. The Company's remaining debt of $4.5 million is solely comprised of variable rate, short-term facilities denominated primarily in Euro to cover banking overdraft that does not subject the Company to significant interest rate risk. The Company estimates that a 1% increase in the interest rate on the borrowings would increase annual interest expense by approximately $46,000. Results of Operations Six Months of 2003 Compared to 2002: Net sales to customers increased by 18.3% during the first six months of 2003 compared to 2002. Units shipped in manufacturing decreased by 9.0%. Net sales increased due to higher shipments and the impact of a stronger Euro versus US dollar from 2002 to 2003. The gross profit percentage decreased to 8.0% in 2003 compared to 10.0% in 2002. This is primarily attributable to poor demand which led to increased price competition. Selling, general and administrative expenses decreased by 5.3% in dollar terms when compared with the first half of last year and decreased to 12.3% of net sales compared to 15.4% for the same period last year due to centralization of administrative activities. During the second quarter, a credit of $155,000 was taken to reflect an over payment of pension obligations. On April 17, 2002 the Company sold the goodwill, stocks and certain other assets of its UK distribution subsidiary to a competitor. The Company recovered approximately $400,000 in working capital that had been invested in this subsidiary. The Company had a foreign exchange loss of $107,000 for the six months ended June 30, 2003 compared to a gain of $90,000 for the six months ended June 30, 2002. The loss was due to the effect of the translation of Sterling denominated receivables and payables into Euro. Second Quarter of 2003 Compared to 2002: Net sales to customers increased by 24.0% during the second quarter of 2003 compared to the same period in 2002. Units shipped in the second quarter of 2003 increased by 3.2% compared to the second quarter of 2002. The gross profit percentage decreased to 4.5% in 2003 compared to 8.9% in 2002 due to reduced selling prices. Selling, general and administrative expenses decreased to 11.3% of net sales compared to 15.8% in 2002 due to consolidation of administration activities at the end of March. During the second quarter, a credit of $155,000 was taken to reflect an over payment of pension obligations. The Company has tax loss carry forwards of approximately $3,994,000 available to offset future U.S. taxable income which expire between 2003 and 2022. Critical accounting policies The Company believes it follows conservative and prudent accounting policies in all areas of its disclosed accounts. There is little subjectivity in the application of GAAP and few areas where management has discretion over accounting methods which could substantially alter the reported results. Areas where discretion in accounting policies could notably impact the results of the company if implemented differently include: Going Concern - The accounts have been prepared on the basis that the company is a going concern. Due to continuing losses including the heavy losses in 2002 and the fact that the Company has a deficiency of net assets and negative stockholders' equity, there are certain risks regarding the Company's ability to continue to trade in a normal manner. In the event that the Company was not a going concern, the asset values reflected in the balance sheet would likely have to be revised or reclassified and additional liabilities could arise and the classification of liabilities could be revised. Risks which exist for the Company's status as a going concern include the fact that lenders to the Irish operating subsidiary have severely limited the amount of funds that can be repatriated to the US parent company for payment of US operating expenses. Several of these expenses are critical to the viability of the Company and should funds be unavailable, the Company's going concern status could be threatened. In addition, certain creditors of the parent Company have potential claims against the Company. While these claims are not necessarily accepted by the Company and its attorneys, successful legal action by any of these creditors would impose severe cash requirements on the Company that could also place the Company's going concern status at risk. With regard to the preceding the Company is presently in negotiations to refinance the PBGC note. Further, the Company is dependent upon several key suppliers for raw materials. Should an interruption in supply of raw materials occur with any of these organizations, the Company would struggle to replace them with alternate suppliers. Finally, due to the serious nature of the losses, the lenders to the Company are constantly reviewing their ongoing level of support to the Company. If any of the credit lines to the Company are substantially reduced, the Company will face a liquidity shortfall. Management believes that the PBGC note can be satisfactorily renegotiated and that based on budgeted cash flows it has adequate cash flow to meet its ongoing operating obligations including debt repayments and capital commitments in Ireland, based on a plan of continuous cost reductions, increased margins and minimal capital expenditure which will permit the Company to remain within the limits of its receivables discounting banking facility. Accounts Receivable - The Company reviews its accounts receivable on a regular basis and makes provision for amounts that are doubtful. PART II - OTHER INFORMATION Exhibit 99.1 CERTIFICATION I, Frank L. Driver, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Driver-Harris Company; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. I am responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and I have; a) Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to me by others within those entities, particularly during the period in which this quarterly report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) Presented in this quarterly report my conclusions about the effectiveness of the disclosure controls and procedures based on my evaluation as of the Evaluation Date; 5. I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent function): a) All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of my most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Dated: September 24, 2003 Frank L. Driver Chairman of the Board, President and Chief Executive Officer (Principal Executive Officer and Principal Financial Officer) SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. DRIVER-HARRIS COMPANY Date: September 24, 2003 By: Frank L. Driver --------------------- ----------------------- Chief Financial Officer

DRIVER HARRIS CO 10-Q