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 June 30, 2003 Commission File Number 333-19257 KINETEK, INC. (Exact name of registrant as specified in charter) Delaware 36-4109641 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) 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 --- -- Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes No x --- --- The number of shares outstanding of Registrant's Common Stock as of August 13, 2003: 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 9 Condition and Results of Operations Item 3. Quantitative and Qualitative Disclosures About 1 Market Risk Item 4. Controls and Procedures 12 Part II OTHER INFORMATION Item 1. Legal Proceedings 13 Item 2. Changes in Securities and Use of Proceeds 13 Item 3. Defaults Upon Senior Securities 13 Item 4. Submission of Matters to a Vote of Security 13 Holders Item 5. Other Information 13 Item 6. Exhibits and Reports on Form 8-k 13 Signatures 14 2 PART I. FINANCIAL INFORMATION Item 1. FINANCIAL STATEMENTS (Unaudited) -------------------------------- PAGE NO. -------- Condensed Consolidated Balance Sheets at June 30, 2003 4 and December 31, 2002 Condensed Consolidated Statements of Operations for the 5 three and six months ended June 30, 2003 and 2002 Condensed Consolidated Statements of Cash Flows for the six 6 months ended June 30, 2003 and 2002 Notes to Condensed Consolidated Financial Statements 7-8 3 KINETEK, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (ALL DOLLAR AMOUNTS IN THOUSANDS) June 30, December 31, 2003 2002 -------------- ------------ (Unaudited) ASSETS Current Assets: Cash and cash equivalents $ 16,614 $ 14,654 Accounts receivable, net 58,185 53,495 Inventories 52,120 47,524 Deferred income taxes 4,059 4,545 Prepaid expenses and other current assets 3,954 4,261 Due from affiliated company 5,480 6,540 -------- -------- Total Current Assets 140,412 131,019 Property, plant, and equipment, net 30,994 32,148 Goodwill, net 179,746 179,069 Deferred financing costs, net 8,616 9,939 Investment in affiliate 12,344 12,344 Other assets, net 883 738 -------- --------- Total Assets $372,995 $365,257 ======== ========= LIABILITIES AND SHAREHOLDER'S EQUITY (NET CAPITAL DEFICIENCY) Current Liabilities: Accounts payable $30,196 $ 27,083 Accrued interest payable 4,124 4,989 Accrued expenses and other current liabilities 11,802 12,313 Current portion of long term debt 11,355 17,448 -------- --------- Total Current Liabilities 57,477 61,833 Long-term debt 300,543 295,517 Deferred income taxes 18,145 16,067 Other non-current liabilities 5,412 5,046 Shareholder's Equity (Net Capital Deficiency): Common Stock 10 10 Additional paid-in-capital 49,996 49,996 Accumulated deficit 57,370) (55,997) Accumulated other comprehensive loss (1,218) (7,215) -------- --------- Total Shareholder's Equity (Net Capital Deficiency) (8,582) $(13,206) --------- --------- Total Liabilities and Shareholder's Equity (Net Capital Deficiency) $372,995 $365,257 ======== ========= See accompanying notes to condensed consolidated financial statements. 4

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, 2002, 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: June 30, December 31, 2003 2002 -------------------------------------------- Raw materials $21,693 $23,445 Work in process 22,673 16,842 Finished goods 7,754 7,237 ------- ------- $52,120 $47,524 ======= ======= 4. Comprehensive Income Total comprehensive income (loss) for the three and six months ended June 30, 2003 and 2002 is as follows: Three Months Ended Six Months Ended June 30, June 30, -------------------- ------------------- 2003 2002 2003 2002 ---- ---- ---- ---- Net income (loss) $ 783 $ 1,954 $(1,373) $(19,105) Foreign currency translation adjustment 681 2,477 5,997 120 ------- ------- ------- -------- Comprehensive income (loss) $ 1,464 $ 4,431 $ 4,624 $(18,985) ======= ======= ======= ======== 7 5. Goodwill On January 1, 2002, the Company adopted Statement of Financial Accounting Standards, No. 142, "Goodwill and Other Intangible Assets". As a result, the Company recorded a non-cash pretax and after-tax charge of $21,992, which has been shown as a cumulative effect of a change in accounting principle. 6. 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, 2002 consolidated financial statements with respect to segmentation or the measurement of segment profit. 7. Settlement of Litigation In June 2003, the Company reached a settlement with the former shareholders of ED&C in which the Company received $1,150 cash, and $3,850 in Subordinated Notes Payable to the ED&C shareholders plus $693 of accrued and unpaid interest were extinguished. The settlement is recognized as income on the Condensed Consolidated Statement of Operations within Other (income)/expense - Miscellaneous, net. 8. Income taxes The second quarter tax provision consists primarily of federal tax of approximately $1,941, state and local tax of approximately $357 and foreign income tax of approximately $729. The tax provision also includes a charge of approximately $1,682 to increase the valuation allowance related to deferred tax assets. As a result of the adoption of Statement of Financial Accounting Standards, No. 142, "Goodwill and Other Intangible Assets", and ceasing amortization of goodwill for book purposes, the reversal of the temporary difference related to goodwill amortization for income tax purposes is indefinite and can no longer be utilized to offset deferred tax assets. 8 Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS --------------------------------------------------------------- Overview The following discussion and analysis of the Company's results of operations and of its liquidity and capital resources should be read in conjunction with the financial statements and the related notes thereto appearing elsewhere in this Form 10-Q. Forward-Looking Statements This report on Form 10-Q contains 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. The statement regarding the Company in this document that are not historical in nature, particularly those that utilize terminology such as "may," "will," "should," "likely," expects," "anticipates," "estimates," "believes" or "plans," or comparable terminology, are forward-looking statements based on current expectations about future events, which the Company has derived from information currently available. These forward-looking statements involve known and unknown risks and uncertainties that may cause our results to be materially different from results implied in such forward-looking statements. Those risks include, among others, risks associated with the industry in which the Company operates, the dependence on senior management, maintaining sufficient working capital financing, competitive pressures, general economic conditions and a softening of consumer acceptance of the Company's products leading to a decrease in anticipated revenue and gross profit margins. Summary financial information included in the financial statements of the Company is as follows:

9 Consolidated Results of Operations Net sales for the second quarter of 2003 were 3.1% ($2.3 million) below those of the same period for 2002 at $71.9 million. Net sales for the first six months of 2003 increased 0.5% ($0.8 million) from 2002, to $143.2 million. The decline in sales resulted from general softness in substantially all of the Company's principal markets. The motors segment delivered a 4.4% decrease in second quarter sales versus 2002, with year to date sales 0.5% above the same period in 2002. Net sales of subfractional motors decreased 6.8% for the second quarter, driven by protracted weakness in the bottle and can vending market and reduced demand for refrigeration appliance motors, which were offset in part by good demand for other products, such as those used in medical, restaurant, and automotive end markets. Net sales of subfractional products are even with the prior year to date, as a result of strong first quarter sales that were offset entirely by the second quarter softness described previously. Net sales of fractional/integral motors decreased 2.9% for the second quarter and increased 0.9% for the year to date, compared with the same periods in 2002. The reductions in sales were led by declines in sales of DC products used in material handling and golf car applications and reduced demand for AC and DC products used in the floor care end market, and a weak market in Europe. These declines were offset in part by the impact of Euro currency translation on sales by FIR, which resulted in increases in sales of $0.2 million and $1.5 million for the second quarter and year to date periods, respectively. Net sales in the controls segment rose 0.4% in the second quarter and 0.6% for the year to date compared with 2002 performance. The changes in controls segment sales were driven by an improved elevator modernization market (up 6.4% for the second quarter while remaining 1.2% below the first half of 2002) and higher automotive conveyor controls driven by share gains during the first quarter of 2003. Total company gross margin was $24.9 million in the second quarter, a decline of 6.3% from 2002. For the six-month period, gross margin fell 2.5% to $49.7 million. Gross margin as a percentage of sales fell from 35.7% in 2002's second quarter to 34.5% in 2003. For the year to date, gross margin fell from 35.8% of sales in 2002 to 34.7% in 2003. The slightly lower gross margins as a percentage of sales are primarily attributable to unfavorable product sales mix and to direct material cost inflation in China. Total operating income for the second quarter of 2003 was $8.6 million, a decline of $3.3 million, or 27.8% from the second quarter of 2002. Total year to date operating income was $17.4 million, down $4.2 million, or 19.5% from the same period of 2002. Operating income for the motors segment decreased 16.4% for the quarter ended on June 30, 2003 to $9.9 million, and decreased 9.9% to $19.2 million for the year to date. The operating income of the controls segment decreased 5.9% to $2.3 million for the quarter, and decreased 0.7% to $5.0 million for the six-month period then ended. Selling, general, and administrative expenses ("SG&A") were $13.8 million for the second quarter, an increase of 13.6% ($1.6 million) from 2002. The increases during the second quarter are driven by unallocated corporate overhead that was $1.2 million higher and increases in research and development costs at Motion Control Engineering ("MCE") relating to upcoming new product introductions ($0.4 million). For the 2003 year to date, SG&A expenses were $27.2 million, an increase of 10.8% ($2.7 million) from the previous year. The year to date increases are driven by unallocated corporate overhead that was $2.1 million higher, and to the aforementioned research and development costs at MCE. 10 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 used by operating activities for the six months ended June 30, 2003 was $3.4 million, compared to $11.1 million provided from operating activities for the six months ended June 30, 2003. The decrease is due to the Company's lower operating performance discussed under the heading "Consolidated Results of Operations", and to increases in working capital in 2003. Current assets increased $9.0 million in the first half of 2003, primarily as the result of foreign currency revaluation ($3.1 million), increased inventory and accounts receivable associated with numerous long-term contracts in the Controls segment ($2.3 million), and increased inventory for the Company's strategic manufacturing initiatives ($1.0 million). Investing activities. In the first half of 2003, the Company made $1.9 million in payments for capital expenditures, an amount slightly lower than in the same period of 2002. In 2002, the Company made $9.5 million in payments, including related transaction costs, to form the Kinetek De Sheng joint venture. Financing activities. The Company is party to a Credit Agreement under which the Company is able to borrow up to approximately $35.0 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 August 13, 2003, the Company has approximately $17.7 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 total 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 June 30, 2003 the Company had variable rate debt outstanding of $5.3 million. A one-percentage point increase in interest rates would increase the amount of annual interest paid by approximately $0.1 million. The Company does not believe that its market risk from financial instruments on June 30, 2003 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. 11 Item 4. CONTROLS AND PROCEDURES ----------------------- Pursuant to Section 302 of the Sarbanes-Oxley Act and Rule 13a-15 of the Securities Exchange Act of 1934 ("Exchange Act") promulgated thereunder, our chief executive officer and chief financial officer have evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report (the "Evaluation Date") with the Securities and Exchange Commission. Based on such evaluation, our chief executive officer and chief financial officer have concluded that our disclosure controls and procedures were effective as of the Evaluation Date to ensure that information required to be disclosed in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms. There have been no changes in our internal controls over financial reporting during the period covered by this report that were identified in connection with the evaluation referred to above that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. 12 PART II. OTHER INFORMATION Item 1. LEGAL PROCEEDINGS ----------------- None Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS ----------------------------------------- None Item 3. DEFAULTS UPON SENIOR SECURITIES ------------------------------- None Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS --------------------------------------------------- None Item 5. OTHER INFORMATION ----------------- None Item 6. EXHIBITS AND REPORTS ON FORM 8-K -------------------------------- (a) A list of exhibits filed with this report is contained on the Exhibit Index immediately preceding such exhibits and is incorporated herein by reference. (b) None. 13 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 Drury ------------------------------ Daniel Drury Chief Financial Officer August 13, 2003 14 EXHIBIT INDEX Exhibit Number Description 31.1 Certificate of Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) 31.2 Certificate of Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) 15

KINETEK INC 10-Q