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, 2002 Commission File Number 333-19257 KINETEK, INC. (Exact name of registrant as specified in charter) Delaware 36-4109641 (State or other jurisdiction of (I.R.S. Employer) 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 --- --- 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 August 14, 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 10 Condition and Results of Operations Item 3. Quantitative and Qualitative Disclosures About 12 Market Risk 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, 2002 4 and December 31, 2001 Condensed Consolidated Statements of Operations for the 5 three and six months ended June 30, 2002 and 2001 Condensed Consolidated Statements of Cash Flows for the six 6 months ended June 30, 2002 and 2001 Notes to Condensed Consolidated Financial Statements 7-8 3 KINETEK, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (ALL DOLLAR AMOUNTS IN THOUSANDS)

4 KINETEK, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (ALL DOLLAR AMOUNTS IN THOUSANDS)

5 KINETEK, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (ALL DOLLAR AMOUNTS IN THOUSANDS)

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: June 30, December 31, 2002 2001 ----------------------------- --------------------- (Dollar amounts in thousands) Raw materials $22,601 $22,268 Work in process 15,210 12,864 Finished goods 6,050 6,181 ------- ------- $43,861 $41,313 ======= ======= 4. Comprehensive Income Total comprehensive income (loss) for the three and six months ended June 30, 2002 and 2001 is as follows: Three Months Ended Six Months Ended June 30, June 30, --------------------------- ------------------ (Dollar amounts in thousands) ----------------------------- 2002 2001 2002 2001 ---- ---- ---- ---- Net income (loss) $ 1,954 $ 720 $(18,413) $ 2,614 Foreign currency translation adjustment 2,477 (2,107) 120 2,252 --------- ------- --------- ------- Comprehensive income (loss) $ 4,431 $(1,387) $(18,293) $ 4,866 ========= ======== ========= ======= 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 second quarter's net earnings and a $4.0 million increase to the first six 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: Three Months Ended Six Months Ended June 30, June 30, ---------------------- -------------------- (Dollar amounts in thousands) ----------------------------- 2002 2001 2002 2001 ---- ---- ---- ---- Reported net income (loss) $1,954 $ 720 $(18,413) $2,614 Goodwill amortization - 2,003 - 3,996 ---------- ---------- ---------- --------- Adjusted net income (loss) $1,954 $2,723 $(18,413) $6,610 ========== ========== ========== ========== The changes in the carrying amount of goodwill for the six months ended June 30, 2002 were as follows: Motors Controls Consolidated -------------- ------------- -------------- (Dollar amounts in thousands) ----------------------------- Balance as of January 1, 2002 $160,599 $ 35,870 $196,469 Foreign exchange (97) - (97) Acquisitions 2,552 - 2,552 Impairment loss (21,300) - (21,300) ------- -------- --------- Balance at June 30, 2002 $141,754 $ 35,870 $177,624 ======== ========= ========= As of June 30, 2002, the Company had no indefinite-lived intangible assets and $485 of other intangible assets, which is net of $1,636 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 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 second quarter of 2002 were equal to those of the same period for 2001 at $74.2 million. Net sales for the first six months of 2002 decreased 6.6% ($10.1 million) from 2001. The decline in sales resulted from general softness in substantially all of the Company's principal markets. The motors segment delivered a 0.7% decrease in second quarter sales versus 2001, with year to date sales 7.9% below the same period in 2001. Net sales of subfractional motors increased 3.6% for the second quarter and decreased 2.1% year to date, driven by protracted weakness in the bottle and can vending market, which was offset in part by increased demand for refrigeration appliance motors and by the Company's 10 new product introductions. Net sales of fractional/integral motors decreased 3.4% for the second quarter and 11.4% for the year to date, compared with the same periods in 2001. The reductions in sales were led by 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, and a weak market in Europe. The addition of the Kinetek DeSheng joint venture (see footnote 5) resulted in $1.7 million in added sales during the second quarter of 2002. Net sales in the controls segment rose 1.9% in the second quarter but fell 3.2% for the year to date compared with 2001 performance, driven by general softness and moderate pricing pressures in the elevator modernization market. Gross margins (excluding depreciation) improved slightly from 35.5% of sales for the second quarter of 2001 to 35.7% in 2002. For the first six months, gross margins (excluding depreciation) decreased from 36.3% of sales in 2001 to 35.8% 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 24.5% for the quarter to $11.8 million and increased 1.0% to $21.3 million for the year to date. The operating income of the controls segment increased 0.5% to $2.5 million for the quarter ending on June 30, 2002, and decreased 4.4% to $5.1 million for the six-month period then ending. Operating margins increased from 16.1% to 19.2% of sales for the three months ended June 30, 2001 and 2002, respectively, and from 17.3% to 18.5% for the six months ended June 30, 2001 and 2002, respectively. 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, which resulted in a $2.0 million reduction in amortization expense ($1.6 million and $0.4 million for motors and controls segments, respectively) for the second quarter, and a $4.0 million reduction in amortization expense ($3.3 million and $0.7 million for motors and controls segments, respectively) for the six 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 resulting from the decreased sales described above, and to increased research and development costs related to future products. Management fees and unallocated corporate overhead during the second quarter was $2.4 million, which was $0.1 million or 3.5% lower than in the previous year. For the six months ending June 30, management fees and unallocated overhead was $4.8 million, which is $0.4 million or 7.8% 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 headquarters costs. In the second quarter 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). 11 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 six months ended June 30, 2002 was $11.1 million, compared to $10.5 million provided from operating activities for the six months ended June 30, 2001. The increase is due to improved working capital management during the year 2002, which more than offset the Company's lower operating performance discussed under the heading "Consolidated Results of Operations". Investing activities. In the first half of 2002, the Company made $1.9 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 $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 14, 2002, the Company has approximately $22.1 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 June 30, 2002 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, 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. 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 Since the Company does not have securities registered under Section 12 of the Securities Exchange Act of 1934 and is not required to file periodic reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company is not an "issuer" as defined in the Sarbanes-Oxley Act of 2002, and therefore the Company is not filing the written certification statement pursuant to Section 906 of such Act. The Company files periodic reports with the Securities and Exchange Commission because it is required to do so by the terms of the indentures governing its notes. Item 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits None (b) Reports on Form 8-K On May 8, 2002 the Company filed a Current Report on Form 8-K in order to announce the notes offering by Kinetek Industries, Inc. and in order to file certain exhibits. 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 14, 2002 14

KINETEK INC 10-Q