10-Q 1 c07743e10vq.txt QUARTERLY REPORT 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, 2006 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 Securities registered pursuant to Section 12(b) of the Act: Name of Each Exchange Title of Each Class On Which Registered ------------------- ------------------- None N/A Securities registered pursuant to Section 12(g) of the Act: None Indicate by checkmark 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 a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check one): Large Accelerated Filer [ ] Accelerated Filer [ ] Non-Accelerated Filer [X] Indicate by checkmark whether the Registrant is a shell company (as defined in Exchange Act Rule 12b-2). Yes [ ] No [X] The number of shares outstanding of Registrant's Common Stock as of August 14, 2006: 100. 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 14 Market Risk Item 4. Controls and Procedures 14 PART II OTHER INFORMATION ------- ----------------- Item 1. Legal Proceedings 15 Item 2. Changes in Securities and Use of Proceeds 15 Item 3. Defaults Upon Senior Securities 15 Item 4. Submission of Matters to a Vote of Security 15 Holders Item 5. Other Information 15 Item 6. Exhibits and Reports on Form 8-k 15 Signatures 16 2 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS (UNAUDITED) PAGE NO. -------------------------------- -------- Condensed Consolidated Balance Sheets at June 30, 2006 4 and December 31, 2005 Condensed Consolidated Statements of Operations for the 5 three and six months ended June 30, 2006 and 2005 Condensed Consolidated Statements of Cash Flows for the six months 6 ended June 30, 2006 and 2005 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 KINETEK, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (ALL DOLLAR AMOUNTS IN THOUSANDS)

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, 2005, 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. Approximately 100% of the Company's long-term debt matures within the next 12 months. Currently, the Company is contemplating various avenues of refinancing this debt, and Management is confident that it will do so prior to the maturity. If the Company is unable to refinance or enter into a transaction that allows it to pay off this debt, then there is substantial doubt about the Company's ability to continue as a going concern. 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. Certain amounts in the prior year financial statements have been reclassified to conform to the 2006 presentation. The Company has recorded an income tax provision primarily attributable to foreign taxes, state taxes and the change in the Company's deferred tax liability. Due to the uncertainty of when the goodwill deferred tax liability will reverse, the Company has not considered any future reversal of the deferred tax liability related to goodwill to support the realization of deferred tax assets. Additionally, the Company continues to maintain a full valuation allowance against its deferred tax assets. In February 2006, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 155, "Accounting for Certain Hybrid Instruments" ("SFAS No. 155"). SFAS No. 155 is an amendment of SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133") and SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" ("SFAS No. 140") and allows financial instruments that have embedded derivatives to be accounted for as a whole (eliminating the need to bifurcate the derivative from its host) if the holder elects to account for the whole instrument on a fair value basis. SFAS No. 155 is effective for an entity's first fiscal year that begins after September 15, 2006. The Company does not expect the adoption to have a material impact. In June 2006, the Financial Accounting Standards Board, or the FASB, issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109, or FIN 48. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in a company's financial statements and prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or 7 expected to be taken in a tax return. FIN 48 also provides guidance on description, classification, interest and penalties, accounting in interim periods, disclosure and transition. We are required to adopt FIN 48 effective at the beginning of 2007. We are currently evaluating the impact of adopting FIN 48 on our future results of operations and financial condition. 3. INVENTORIES Inventories are summarized as follows:

4. COMPREHENSIVE INCOME (LOSS) Total comprehensive income (loss) for the three and six months ended June 30, 2006 and 2005 are as follows:

5. ADDITIONAL PURCHASE PRICE AGREEMENT Kinetek has a contingent purchase price agreement relating to its acquisition of Motion Control Engineering on December 18, 1997. The terms of this agreement provide for additional consideration to be paid to the sellers. The agreement is exercisable at the sellers' option during a five year period that began in 2003. When exercised, the additional consideration will be based on Motion Control Engineering's operating results over the two preceding fiscal years. Payments, if any, under the contingent agreement will be paid out in cash over a three or four-year period, in annual installments according to a schedule, which is included in the agreement. Additional consideration, if any, will be recorded as an addition to goodwill. 8 6. BUSINESS SEGMENT INFORMATION Summary financial information included in the financial statements of the Company is as follows:

7. DISCONTINUED OPERATION During 2004, the Company undertook a plan to sell Electrical Design and Control ("ED&C"), a wholly-owned subsidiary. Summarized selected financial information for the discontinued operation is as follows:

The major classes of assets and liabilities of the discontinued operation is as follows:

On May 2, 2005, the Company sold certain inventory, equipment, intellectual property assets and contracts of ED&C. The Company no longer has any ownership interest in ED&C, however it will continue to collect on the outstanding receivables which were not sold. 9 8. WARRANTIES The Company provides warranties on certain products for varying lengths of time. The Company estimates the costs at the time product revenue is recognized. Changes to the Company's product warranty accrual during the six months ended June 30, 2006 and 2005 are as follows:

10 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 the Company's 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. For additional information, see "Item 1A. Risk Factors" in the Company's Annual Report on Form 10-K for the year ended December 31, 2005. CONSOLIDATED RESULTS OF OPERATIONS Consolidated net sales for the three months ended June 30, 2006 were $96.5 million, an increase of $9.0 million, or 10.3%, from the same period in 2005. For the six month period June 30, 2006, consolidated net sales were $183.3 million, an increase of $15.6 million, or 9.3%, from the previous year. Sales for the Company's Motors segment increased $8.0 million, or 12.1%, for the quarter to $74.1 million; and increased $13.7 million, or 10.9% for the year to date to $140.1 million. Sales of subfractional motor products increased by $2.9 million for the second quarter of 2006, and by $5.4 million for the year to date. The subfractional sales increases for both periods were led by strong demand for gearmotors sold to manufacturers of alternative fuel pellet stoves. Rising global energy prices have stimulated significant growth of this product for sale in North America and Europe. Sales of fractional and integral motor products increased $5.1 million during the second quarter, and $8.3 million for the year 2006 to date. The increases in both periods were due primarily to favorable conditions in most of the Company's principal markets in North America and Europe, plus net increases in market share. The Company has experienced significant growth from sales of motors used in commercial floor care and golf cars, as well as from the introduction of AC motors used in material handling applications which have traditionally been served with DC motors. These increases were partially offset by the unfavorable impact of the Euro on European sales when translated into dollars. The stronger dollar caused unfavorable translation impacts to consolidated net sales of $1.0 million for the second quarter of 2006, and $2.0 million for the year to date. Sales for the Company's Controls segment increased $1.0 million, or 4.8%, to $22.4 million for the three months ended June 30, 2006. For the year to date period, Controls sales increased $1.9 million, or 4.6%, to $43.3 million. The sales increases for both periods were led by higher shipments of the Company's "I" family of elevator control products, which are up over 100% from 2005. These increases are 11 partially offset by lower shipments of the Company's traditional control products, which are being cannibalized by the "I" family of controllers. Operating income increased $2.8 million, or 25.5%, for the second quarter of 2006, to $13.9 million, and increased $5.8 million, or 32.0%, to $23.9 million for the year to date. Gross margin increased $1.9 million, to $27.6 million for the quarter, an increase of 7.5%. For the year to date, gross margin increased $4.3 million, or 9.1%, to $52.2 million. Gross margin declined slightly, from 29.3% of sales in the second quarter of 2005, to 28.6% of sales during the same period in 2006. For the six-month periods ending on June 30, gross margin was slightly lower at 28.5% of sales in 2006 compared with 28.6% in 2005. The increased gross margins are primarily attributable to the sales increases described above. In addition, several key factors affected the gross margin amount and percentage of sales: 1) During the first half of 2005, the Company incurred approximately $0.7 million in expenses and operating inefficiencies associated with the integration of the O. Thompson, a New York-based elevator control company, operations which were acquired in September, 2004, and other facility rationalization actions. These expenses had a favorable impact on the first six months of 2006 in comparison with the previous year. 2) Since 2003, and continuing through the first half of 2006, the Company has experienced severe increases in market prices paid for parts used in the assembly of motors, especially copper, steel, and zinc, and increases in the prices of plastic components and freight and transportation associated with rising global oil prices. 3) The Company has increased revenue by raising prices to customers and imposing surcharges linked to the cost of key commodities to partially offset the aforementioned inflation. 4) The Company's ongoing productivity actions, including rationalization of facilities and relocation of production to low-cost locales, have a favorable impact on gross margin, providing further offset to the aforementioned inflation. In total, the Company has been prevented by competitive pressures from achieving complete recovery of the higher costs, leading to the narrowing of gross margins as a percentage of sales. Selling, general, and administrative expenses ("SG&A") were $11.4 million for the quarter ended June 30, 2006, down $1.0 million from $12.4 million in the same period of 2005. For the first half of 2006, SG&A expenses were $23.8 million, a reduction of $1.6 million compared with 2005. The reduction is primarily driven by the timing of certain normal corporate overhead expenses which are expected to be incurred later in 2006, and to the Company's ongoing productivity actions. In addition, a $0.3 million gain from the sale of its land and building, once associated with its Gear Research facility, was recorded as a reduction of these expenses. 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. In the short term, the Company expects to satisfy its liquidity requirements through a combination of funds generated from operating activities and the funds available under its Credit Agreement. As the Company's 10 3/4% Senior Notes mature on November 15, 2006, and the Credit Agreement expires on the earlier of December 18, 2006 or 30 days prior to the maturity of the Company's Senior Notes, the Company is actively pursuing alternative financing which would satisfy its existing creditors while providing working capital necessary to support ongoing operations and the Company's acquisition strategy. If the Company is unable to refinance or enter into a transaction that allows it to pay off this debt, then there is substantial doubt about the Company's ability to continue as a going concern. 12 Operating activities. Net cash provided by operating activities for the six months ended June 30, 2006 was $1.6 million, compared to $0.4 million for the six months ended June 30, 2005. The favorable performance year over year in cash is attributable to the higher operating income discussed under "Consolidated Results of Operations", which increased by $5.8 million. This was offset by net increases in working capital consisting mainly of a $7.2 million increase in accounts receivable and $8.9 million increase in inventory, offset by a favorable change in the Company's current liabilities as accounts payable and accrued expense and other current liabilities increased by $10.0 million and $0.4 million, respectively. Investing activities. In the six months ended June 30, 2006, net cash used in investing activities was $1.4 million, compared to $2.4 million used in the same period of 2005. The favorable change was primarily caused by acquisition costs of $0.5 million for O. Thompson during the first quarter of 2005. No such acquisition costs were incurred during the six months ended June 30, 2006. Additionally, during the first quarter of 2006, the Company sold its land and building related to its former Gear Research facility which was closed at the end of 2004. Proceeds from the sale were $0.7 million, which generated a gain of $0.3 million recorded as a reduction of selling, general, and administrative expenses. 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 June 30, 2006, the Company had approximately $13.7 million of available funds under this Credit Agreement. The Credit Agreement expires the earlier of December 18, 2006, or 30 days prior to the maturity of the Company's Senior Notes. Approximately 100% of the Company's long-term debt matures within the next 12 months. Currently, the Company is contemplating various avenues of refinancing this debt, and Management is confident that it will do so prior to the maturity. If the Company is unable to refinance or enter into a transaction that allows it to pay off this debt, then there is substantial doubt about the Company's ability to continue as a going concern. The Company is in compliance with the provisions of its Indentures. In February 2006, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 155, "Accounting for Certain Hybrid Instruments" ("SFAS 155"). SFAS 155 is an amendment of SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133") and SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" ("SFAS 140") and allows financial instruments that have embedded derivatives to be accounted for as a whole (eliminating the need to bifurcate the derivative from its host) if the holder elects to account for the whole instrument on a fair value basis. SFAS 155 is effective for an entity's first fiscal year that begins after September 15, 2006. The Company does not expect the adoption of SFAS 155 to have a material impact. In June 2006, the Financial Accounting Standards Board, or the FASB, issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109, or FIN 48. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in a company's financial statements and prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on description, classification, interest and penalties, accounting in interim periods, disclosure and transition. We are required to adopt FIN 48 effective at 13 the beginning of 2007. We are currently evaluating the impact of adopting FIN 48 on our future results of operations and financial condition. 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, 2006 the Company had variable rate debt outstanding of $12.9 million. A one-percentage point increase in interest rates would not have a material effect on the amount of annual interest paid. The Company does not believe that its market risk from financial instruments on June 30, 2006 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 Pursuant to Section 302 of the Sarbanes-Oxley Act and Rule 13a-15 of the Securities Exchange Act of 1934 ("Exchange Act") promulgated thereunder, the Company's chief executive officer and chief financial officer have evaluated the effectiveness of the Company's disclosure controls and procedures as of the end of the period covered by this report (the "Evaluation Date"). Based on such evaluation, the Company's chief executive officer and chief financial officer have concluded that the Company's disclosure controls and procedures were effective as of the Evaluation Date to ensure that information required to be disclosed in reports that the Company files or submits 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 the Company's 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, the Company's internal control over financial reporting. 14 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS None ITEM 1A. RISK FACTORS No significant changes since December 31, 2005. 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 A list of exhibits filed with this report is contained on the Exhibit Index immediately preceding such exhibits and is incorporated herein by reference. 15 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, 2006 16 EXHIBIT INDEX

KINETEK INC 10-Q