10-Q 1 form10q.txt SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q -------------------------------------------------------------------------------- QUARTERLY REPORT PURSUANT TO SECTION 12 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For quarter ended September 30, 2002 Commission File Number 333-19257 KINETEK, INC. (Exact name of registrant as specified in charter) Delaware 36-4109641 (State or other jurisdiction of incorporation (I.R.S. Employer Identification No.) ArborLake Centre, Suite 550 60015 1751 Lake Cook Road (Zip Code) Deerfield, Illinois (Address of Principal Executive Offices) Registrant's telephone number, including area code: (847) 945-5591 Former name, former address and former fiscal year, if changed since last report: Not applicable 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 twelve (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 ninety (90) days. Yes x No --- --- The aggregate market value of voting stock held by non-affiliates of the Registrant is not determinable as such shares were privately placed and there is currently no public market for such shares. The number of shares outstanding of Registrant's Common Stock as of November 12, 2002: 10,000. KINETEK, INC. INDEX Part I FINANCIAL INFORMATION PAGE NO. ------ --------------------- -------- Item 1. Financial Statements (Unaudited) 3 Item 2. Management's Discussion and Analysis of Financial 11 Condition and Results of Operations Item 3. Quantitative and Qualitative Disclosures About 13 Market Risk Item 4. Controls and Procedures 13 Part II OTHER INFORMATION ------- ----------------- Item 1. Legal Proceedings 14 Item 2. Changes in Securities and Use of Proceeds 14 Item 3. Defaults Upon Senior Securities 14 Item 4. Submission of Matters to a Vote of Security 14 Holders Item 5. Other Information 14 Item 6. Exhibits and Reports on Form 8-k 14 Signatures 15 Certificates 16 2 PART I. FINANCIAL INFORMATION Item 1. FINANCIAL STATEMENTS (Unaudited) -------------------------------- PAGE NO. -------- Condensed Consolidated Balance Sheets at September 30, 2002 4 and December 31, 2001 Condensed Consolidated Statements of Operations for the 5 three and nine months ended September 30, 2002 and 2001 Condensed Consolidated Statements of Cash Flows for the nine 6 months ended September 30, 2002 and 2001 Notes to Condensed Consolidated Financial Statements 7-10 3 KINETEK, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (ALL DOLLAR AMOUNTS IN THOUSANDS)

See accompanying notes to condensed consolidated financial statements. 4 KINETEK, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (ALL DOLLAR AMOUNTS IN THOUSANDS)

See accompanying notes to condensed consolidated financial statements. 5

See accompanying notes to condensed consolidated financial statements. 6 KINETEK, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (ALL DOLLAR AMOUNTS IN THOUSANDS) 1. Organization The unaudited condensed consolidated financial statements, which reflect all adjustments that management believes necessary to present fairly the results of interim operations and which are of a normal recurring nature, should be read in conjunction with the Company's consolidated financial statements for the year ended December 31, 2001, included in the Company's annual report on Form 10-K. The Company conducts its operations exclusively through its subsidiaries. Results of operations for the interim periods are not necessarily indicative of annual results of operations. 2. Summary of Significant Accounting Policies The condensed consolidated financial statements include the accounts of Kinetek, Inc. and its subsidiaries. Material intercompany transactions and balances are eliminated in consolidation. Operations of certain subsidiaries outside the United States are included for periods ending two months prior to the Company's year-end and interim periods to ensure timely preparation of the condensed consolidated financial statements. 3. Inventories Inventories are summarized as follows: September 30, December 31, 2002 2001 ------------------------ --------------------- (Dollar amounts in thousands) Raw materials $23,701 $22,268 Work in process 16,002 12,864 Finished goods 6,386 6,181 ------- ------- $46,089 $41,313 ======= ======== 4. Comprehensive Income Total comprehensive income (loss) for the three and nine months ended September 30, 2002 and 2001 is as follows:

7 5. Acquisitions On April 11, 2002, the Company formed a cooperative joint venture with Shunde De Sheng Electric Motor Group Co., Ltd. ("De Sheng Group"), which is named Kinetek De Sheng (Shunde) Motor Co., Ltd. (the "JV"). The Company initially contributed approximately $8.0 million for 80% ownership of the JV, with an option to purchase the remaining 20% in the future. The JV acquired all of the net assets of Shunde De Sheng Electric Motor Co., Ltd. ("De Sheng"), a subsidiary of De Sheng Group. The JV also assumed approximately $7.2 million of outstanding debt. 6. Financing On April 12, 2002, Kinetek Industries, Inc., a wholly-owned subsidiary of the Company, issued $15 million principal amount of 5% Senior Secured Notes and $11 million principal amount of 10% Senior Secured Notes for net proceeds of approximately $20.5 million. The notes are due in 2007 and are guaranteed by the Company and substantially all of its domestic subsidiaries. The notes are also secured by a second priority lien on substantially all of the assets of the issuer and the guarantors, which lien is subordinate to the existing lien securing the Company's credit facility. Interest is payable semi-annually on May 1 and November 1 of each year. 7. New Accounting Standards The Company adopted the non-amortization provisions of Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets," on January 1, 2002, which resulted in a $2.0 million increase in the third quarter's net earnings and a $6.0 million increase to the first nine month's net earnings. The adoption of SFAS No. 142 is expected to increase full-year net earnings by approximately $8.0 million. The Company completed the transitional impairment review of its reporting units during the second quarter and recorded a non-cash pretax and after-tax charge of $21.3 million. This charge has been recorded as a cumulative effect of a change in accounting principle retroactive to January 1, 2002 and therefore reduced the previously reported first quarter 2002 net earnings of $0.9 million to a net loss of $20.4 million. The impaired goodwill was in the Motors segment and relates to the 1997 acquisition of FIR Electromeccanica and the 1999 acquisition of the L'Europea product line. The impairment is primarily attributable to a change in the evaluation criteria for goodwill utilized under previous accounting guidance, to the fair value approach stipulated in SFAS No. 142. Various external factors, especially foreign currency devaluation has negatively impacted the value of the FIR and L'Europea acquisitions. The Company determined the fair value of each reporting unit using a discounted cash flow approach taking into consideration projections based on the individual characteristics of the reporting units, historical trends and market multiples for comparable businesses. The cash flow estimates incorporate assumptions on future cash flow growth, terminal values and discount rates. Any such valuation is sensitive to these assumptions. 8 The following table provides comparative operating results had the non-amortization provisions of SFAS No. 142 been adopted for all periods presented:

As of September 30, 2002, the Company had no indefinite-lived intangible assets and $395 of other intangible assets, which is net of $1,726 accumulated amortization, which will continue to be amortized over their remaining useful lives ranging from 1 to 6 years. Amortization expense is estimated to be $100 in each of the next five years. These other intangible asset amounts are included in other assets in the Company's balance sheets. On January 1, 2002, the company adopted SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." There was no impact to the Company's operating results or financial position related to the adoption of this standard. 8. Business Segment Information See Part 1 "Financial Information" - Item 2 "Management's Discussion and Analysis of Financial Condition and Results of Operations" for the Company's business segment disclosures. There have been no changes from the Company's December 31, 2001 consolidated financial statements with respect to segmentation or the measurement of segment profit. 9 9. Additional Purchase Price Arrangements The terms of the Company's 1997 Motion Control Engineering ("MCE") acquisition agreement provide for additional consideration to be paid to the sellers. The agreement is exercisable at the seller's option during a five year period beginning in 2003. When exercised, the additional consideration will be based on MCE's operating results over the two preceding fiscal years. Payments, if any, under the contingent agreement will be placed in a trust and paid from the trust over a four-year period. These payments to the trust, when made, will be recorded as an addition to goodwill. Based on MCE's current projections for 2002, the Company would have to pay $4.6 million to the trust in September, 2003, if the agreement is exercised by March 31, 2003. 10. Subsequent Event On November 8, 2002, Ron Sansom resigned as President and CEO of Kinetek, Inc. He also resigned as a Director of Kinetek, Inc. Tom Quinn, Chairman of Kinetek, Inc., and President and COO of Jordan Industries, Inc., will act as interim CEO until a new CEO is appointed. 10 Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Summary financial information included in the financial statements of the Company is as follows:

Consolidated Results of Operations Net sales for the third quarter of 2002 were $74.5 million, an increase of 5.9% ($4.2 million) over those of the same period for 2001. Net sales for the first nine months of 2002 were $216.9 million, a decrease of 2.7% ($5.9 million) from 2001. The addition of the Kinetek DeSheng ("KDS") joint venture (see footnote 5) resulted in $3.0 million in added sales during the third quarter of 2002 and $4.7 million for the year to date. The increase in sales for the third quarter is mainly attributable to the inclusion of KDS results. The decline in total year to date sales resulted from general softness in substantially all of the Company's principal markets, somewhat offset by the KDS revenue. The motors segment delivered a 5.1% increase in third quarter sales versus 2001, with year to date sales 3.8% below the same period in 2001. 11 Net sales of subfractional motors increased 5.1% for the third quarter and increased 0.1% year to date, led by increased demand for refrigeration appliance motors and by the Company's new product introductions, but offset by protracted weakness in vending motor markets. Net sales of fractional and integral motors increased 8.4% for the third quarter and decreased 4.4% for the year to date, compared with the same periods in 2001. The increase in third quarter sales was led by the inclusion of KDS and from share gains and new products introduced in the floor care and elevator motor product lines. These increases more than offset sharp declines in sales of DC products used in material handling applications, and moderately reduced demand for AC and DC products used in the floor care end market, as well as a weak European market. Net sales in the controls segment rose 8.0% in the third quarter and 0.3% for the year to date compared with 2001 performance. The elevator modernization market that drives this segment has experienced general softness and moderate pricing pressure throughout 2002. The third quarter improvement is primarily the result of comparison to a very weak third quarter of 2001. Gross margins (excluding depreciation) decreased slightly from 36.2% of sales for the third quarter of 2001 to 35.5% in 2002. For the first nine months, gross margins (excluding depreciation) decreased from 36.3% of sales in 2001 to 35.7% of sales for 2002. Price competition in several key markets, and a shift in mix toward less profitable product lines have placed downward pressure on gross margins in 2002. This has been offset in part by the Company's continued emphasis on cost reduction through productivity and sourcing initiatives. Operating income for the motors segment increased 14.6% for the quarter ending on September 30, 2002, to $10.8 million, and increased 5.2% to $32.1 million for the nine month period then ending. The operating income of the controls segment increased 15.4% to $3.0 million for the quarter, and increased 2.0% to $8.0 million for the year to date. Operating margins increased from 17.1% to 18.5% of sales for the three months ended September 30, 2001, and 2002, respectively, and from 17.2% to 18.5% respectively for the nine month periods ending on those dates. The higher operating margins are driven by the non-amortization of goodwill due to the Company's adoption of Statement of Accounting Standards No. 142, "Goodwill and Other Intangible Assets". This adoption resulted in a $2.0 million reduction in amortization expense ($1.6 million and $0.4 million for the motors and controls segments, respectively) for the third quarter, and a $6.0 million reduction in amortization expense ($5.0 million and $1.0 million for motors and controls, respectively) for the nine month period. The improved operating margins also reflect lower selling, general, and administrative expenses from the Company's cost control efforts, such as facility closings and reductions in staff. These reductions in cost compared to the prior year are offset by unfavorable manufacturing leverage from the decreased sales described above, and by increased research and development costs related to future products. Management fees and unallocated corporate overhead during the third quarter were $2.3 million, which was marginally lower than in the previous year. For the nine months ending September 30, management fees and unallocated corporate overhead were $7.1 million, which is $0.4 million or 5.8% lower than in the same period in 2001. The lower costs are due to the impact of lower sales on the management fee and to actions taken by the Company to reduce administrative and headquarter costs. In the second quarter of 2002, a non-cash pretax and after-tax charge of $21.3 million was recognized as a result of adopting SFAS No. 142 "Goodwill and Other Intangible Assets" (see Note 7). 12 Liquidity and Capital Resources In general, the Company requires liquidity for working capital, capital expenditures, interest, taxes, debt repayment and its acquisition strategy. Of primary importance are the Company's working capital requirements, which increase whenever the Company experiences strong incremental demand or geographical expansion. The Company expects to satisfy its liquidity requirements through a combination of funds generated from operating activities and the funds available under its revolving credit facility. Operating activities. Net cash provided by operating activities for the nine months ended September 30, 2002 was $18.4 million, compared to $20.9 million provided from operating activities for the nine months ended September 30, 2001. The decrease is due primarily to the Company's lower operating performance discussed under the heading "Consolidated Results of Operations". Investing activities. In the first nine months of 2002, the Company made $3.6 million in payments for capital expenditures. In addition, the Company made $9.5 million in payments for the De Sheng acquisition, including related transaction costs. Financing activities. The Company is party to a Credit Agreement under which the Company is able to borrow up to approximately $31.5 million to fund acquisitions and provide working capital, and for other general corporate purposes. Borrowings are secured by the stock and substantially all of the assets of the Company. As of November 12, 2002, the Company has approximately $17.9 million of available funds under this Credit Agreement. On April 12, 2002, Kinetek Industries, Inc., a wholly-owned subsidiary of the Company, issued $15 million principal amount of 5% Senior Secured Notes and $11 million principal amount of 10% Senior Secured Notes for net proceeds of approximately $20.5 million. Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company's debt obligations are primarily fixed-rate in nature and, as such, are not sensitive to changes in interest rates. At September 30, 2002 the Company had variable rate debt outstanding of $1.4 million. A one-percentage point increase in interest rates would increase the amount of annual interest paid by approximately $0.01 million. The Company does not believe that its market risk from financial instruments on September 30, 2002 would have a material effect on future operations or cash flow. The Company is exposed to market risk from changes in foreign currency exchange rates, including fluctuations in the functional currency of foreign operations. The functional currency of operations outside the United States is the respective local currency. Foreign currency translation effects are included in accumulated other comprehensive income in shareholder's equity. Item 4. CONTROLS AND PROCEDURES The Company's Chairman and the Company's Vice President, Chief Financial Officer and Treasurer have concluded that the Company's disclosure controls and procedures are effective for gathering, analyzing and disclosing information required to be disclosed in the Company's reports filed under the Securities Exchange Act of 1934. There have been no significant changes in the Company's internal controls or in other factors that could significantly affect these controls subsequent to the date of the foregoing evaluation. 13 PART II. OTHER INFORMATION ----------------- Item LEGAL PROCEEDINGS 1. ----------------- None Item CHANGES IN SECURITIES AND USE OF PROCEEDS 2. ----------------------------------------- None Item DEFAULTS UPON SENIOR SECURITIES 3. ------------------------------- None Item SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 4. --------------------------------------------------- None Item OTHER INFORMATION ----------------- 5. None Item EXHIBITS AND REPORTS ON FORM 8-K 6. -------------------------------- None 14 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. KINETEK, INC. By: /s/ Daniel D. Drury ----------------------- Daniel D. Drury Chief Financial Officer November 12, 2002 15 CERTIFICATE I, Thomas H. Quinn, certify that: 1) I have reviewed this quarterly report on Form 10-Q of Kinetek, Inc; 2) Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3) Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4) The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) Presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5) The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6) The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 12, 2002 By: /s/ Thomas H. Quinn ----------------------- Name: Thomas H. Quinn Title: Chairman 16 CERTIFICATE I, Daniel D. Drury, certify that: 1) I have reviewed this quarterly report on Form 10-Q of Kinetek, Inc; 2) Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3) Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4) The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) Presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5) The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6) The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 12, 2002 By: /s/ Daniel D. Drury ------------------------ Name: Daniel D. Drury Title: Chief Financial Officer 17

KINETEK INC 10-Q