Item 1. BUSINESS --------
The Company
Kinetek, Inc. (the "Company") was incorporated in the State of Illinois on September 8, 1995 (The Company was incorporated as Motors and Gears, Inc., and changed its name to Kinetek, Inc. on January 8, 2001). On November 1, 1996, the Company effected a reincorporation merger whereby MK Group, Inc., an Illinois corporation, was merged with and into the Company, with the Company being the surviving entity. The Company is a direct, wholly-owned subsidiary of Motors and Gears Holdings, Inc., a Delaware corporation ("Parent"). The Parent is a majority owned subsidiary of Jordan Industries, Inc. ("JII"), a private holding company which owns and manages a widely diversified group of operating companies. The Company was organized by JII to acquire and operate companies in the motors, gears and motion control industries. The Company and its subsidiaries are included in JII's consolidated financial statements.
The Company's principal executive offices are located at ArborLake Centre, Suite 550, 1751 Lake Cook Road, Deerfield, Illinois 60015, and its telephone number is (847)945-5591.
Business
The Company is a manufacturer of specialty purpose electric motors, gearmotors, gearboxes, gears, transaxles and electronic motion controls for a wide variety of consumer, commercial and industrial markets. The Company has a diverse base of customers and its products are used in a broad range of applications including vending machines, golf carts, lift trucks, industrial ventilation equipment, and elevators. The Company competes primarily in the electric motors and electronic motion control systems industries.
Business Segment Information
The Company operates in two separate business segments; electric motors ("motors") and electronic motion control systems ("controls"). See Note 12 to the Company's consolidated financial statements for financial segment data.
Products
The Company has established itself as a reliable niche manufacturer of high-quality, economical, custom electric motors, gearmotors, gears and electronic motion control systems used in a wide variety of applications including vending machines, refrigerator ice dispensers, commercial dishwashers, commercial floor care equipment, golf carts, lift trucks, and elevators. The Company's products are custom designed to meet specific application requirements. Less than 5% of the Company's products are sold as stock products.
The Company offers a wide variety of options to provide greater flexibility in its custom designs. These options include thermal protectors, special mounting brackets, custom leads and terminals, single or double shaft extensions, brakes, cooling fans, special heavy gearing, custom shaft machining and custom software solutions. The Company also provides value-added assembly work, incorporating some of the above options into its final motor and control products. All of the custom-tailored motors, gearmotors and control systems are designed for long life, quiet operation, and superior performance.
Electric Motors
Electric motors are devices that convert electric power into rotating mechanical energy. The amount of energy delivered is determined by the level of input power supplied to the electric motor and the size of the motor itself. An electric motor can be powered by alternating current ("AC") or direct current ("DC"). AC power is generally supplied by power companies directly to homes, offices and industrial sites whereas DC power is supplied either through the use of batteries or by converting AC power to DC power. Both AC motors and DC motors can be used to power most applications; the determination is made through the consideration of power source availability, speed variability requirements, torque considerations, and noise constraints.
The power output of electric motors is measured in horsepower. Motors are produced in power outputs that range from less than one horsepower up to thousands of horsepower.
Subfractional Motors. The Company's subfractional horsepower products are comprised of motors and gearmotors which power applications up to 30 watts (1/25 horsepower). These small, "fist-size" AC and DC motors are used in light duty applications such as snack and beverage vending machines, refrigerator ice dispensers and photocopy machines.
Fractional/Integral Motors. The Company's fractional/integral horsepower products are comprised of AC and DC motors and gearmotors having power ranges from 1/8 to 100 horsepower. Primary end markets for these motors include commercial floor care equipment, commercial dishwashers, commercial sewing machines, industrial ventilation equipment, golf carts, lift trucks and elevators.
Gears and Gearboxes. Gears and gearboxes are mechanical components used to transmit mechanical energy from one source to another source. They are normally used to change the speed and torque characteristics of a power source such as an electric motor. Gears and gearboxes come in various configurations such as helical gears, bevel gears, worm gears, planetary gearboxes, and right-angle gearboxes. For certain applications, an electric motor and a gear box are combined to create a gearmotor.
The Company's precision gear and gearbox products are produced in sizes of up to 16 inches in diameter and in various customized configurations such as pump, bevel, worm and helical gears. Primary end markets for these products include original equipment manufacturers ("OEMs") of motors, commercial floor care equipment, aerospace and food processing product equipment.
Electronic Motion Control Systems
Electronic motion control systems are assemblies of electronic and electromechanical components that are configured in such a manner that the systems have the capability to control a range of elevators. The components utilized in an elevator control system are typically electric motor drives (electronic controls that vary the speed and torque characteristics of electric motors), programmable logic controls ("PLCs"), transformers, capacitors, switches and software to configure and control the system.
Acquisitions
See Note 1 to the notes to consolidated financial statements in Item 8 for a description of acquisitions made during the three year period ended December 31, 2004.
Backlog
The Company's approximate backlog of unfilled orders at the dates specified was as follows:
The Company believes it will ship substantially its entire 2004 year-end backlog during 2005.
Marketing and Support Services
The Company's sales and marketing success is characterized by long-term customer relationships which are the result of continuity of management, outstanding delivery records, high-quality products, and competitive pricing. The Company utilizes a combination of direct sales personnel and manufacturers' representatives to market the Company's product lines. Generally, the inside sales organization is compensated through a fixed salary while the manufacturers' representative organizations receive commission.
National account managers serve large national original equipment manufacturers/OEM's such as General Electric, Whirlpool and the Raymond Corporation. More than 95% of the Company's sales are to OEM customers. However, the Company has a distribution program with three distributors in its subfractional horsepower product line to increase coverage and generate more revenue growth.
The Company's motion control systems business is served primarily through internal sales and marketing professionals as well as independent representatives. The Company continues to add sales talent to this product group in order to expand its presence into additional motion control markets.
The Company's advertising efforts consist of specific product literature which is printed and provided to customers as applications are developed. In addition, the Company attends various trade shows to market products and to stay abreast of industry trends. It also advertises in trade magazines on a periodic basis.
International Operations
The Company currently operates seven manufacturing, research and development, distribution and warehousing facilities in Europe and one manufacturing facility in Mexico. In addition, the Company has an 80% ownership interest in a Chinese joint venture that was formed in April 2002. For financial information about geographic area, see Note 13 to the Company's consolidated financial statements.
Employee and Labor Relations
As of December 31, 2004, the Company employed 2,631 employees, of which 1,447 were non-union and 1,184 were represented by unions. The Company has experienced no work stoppages since inception. It considers its relations with its employees to be good.
Competition
The electric motor and electronic motion control systems markets are highly fragmented with a multitude of manufacturing companies servicing numerous markets. Motor manufacturers range from small local producers serving a specific application or end user, to high volume manufacturers offering general-purpose "off the shelf" motors to a wide variety of end users. While there are numerous manufacturers of gears and gearboxes that service a wide variety of industries and applications, the Company competes in certain niche markets.
The Company's motion control systems business competes primarily within the automated conveyor system controls market and sells to conveyor manufacturers that serve the automotive manufacturing industry and the elevator modernization market. These niche markets consist of four to five major competitors.
The principal competitive factors in the electric motor and electronic motion control systems markets include price, quality and service. Major manufacturers include General Electric, Baldor Electric Company, Emerson Electric Company and Reliance Electric Company; however, the Company generally competes with smaller, specialized manufacturers. Many of the major motor manufacturers have substantially greater assets and financial resources than the Company does.
Raw Materials and Suppliers
The primary raw materials used by the Company to produce its products are steel, copper, and miscellaneous purchased parts such as endshield castings, powdered metal gears, commutators, electronic components and packaging supplies. All materials are readily available in the marketplace. The Company is not dependent upon any single supplier in its operations for any materials essential to its business or not otherwise commercially available to the Company. The Company has been able to obtain an adequate supply of raw materials, and no shortage of raw materials is currently anticipated. Surcharges and/or raw material price escalation clauses are often used to insulate the Company from fluctuations in prices.
Intellectual Property
The Company's patents and trademarks taken individually, and as a whole, are not critical to the ongoing success of its business. The proprietary nature of the Company's products is attributable to the custom application designs for particular customers' needs rather than attributable to proprietary patented or licensed technology.
Environmental Regulation
The Company is subject to a variety of U.S. Federal, state, provincial, local and foreign governmental regulations related to the storage, use, emission, discharge and disposal of toxic, volatile or otherwise hazardous materials used in its manufacturing processes. Moreover, the Company anticipates that such laws and regulations will become increasingly stringent in the future. Because of our efforts to monitor and maintain compliance and track changes in the laws and regulations, the Company does not currently anticipate any material adverse effect on its business, financial condition or results of operations as a result of compliance with U.S. Federal, state, provincial, local or foreign environmental laws or regulations or remediation costs. However, some risk of environmental liability and other costs is inherent in the nature of the Company's business. For example, pursuant to the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended, the Company could be responsible for the necessary costs of responding to any current, or previously undiscovered, releases of hazardous substances at our facilities or from those to which we send wastes. In addition, any failure by the Company to obtain and maintain permits that may be required for manufacturing operations could subject the Company to suspension of its operations. Such liability or suspension of manufacturing operations could have a material adverse effect on the Company's results of operations and financial condition.
Soils and groundwater contaminated by historic waste handling practices at the FIR property in Casalmaggiore, Italy is the subject of an investigation and remediation under the review of government authorities. In connection with the FIR Acquisition, the Company obtained indemnification from the former owners for this investigation and remediation.
Item 2.
Item 2. PROPERTIES ----------
The Company's headquarters are located in an approximately 37,400 square foot office space in Deerfield, Illinois that is provided by JII and for which we are allocated certain charges. (See Item 13 "Certain Relationships and Related Transactions").
The principal properties of the Company, the location, the primary use, the square feet and the ownership status thereof as of December 31, 2004, are set forth in the table below:
The Company believes that its existing leased facilities are adequate for the operations of the Company and its subsidiaries. The Company does not believe that any single leased facility is material to its operations and that, if necessary, it could readily obtain a replacement facility.
Item 3.
Item 3. LEGAL PROCEEDINGS -----------------
The Company is not a party to any pending legal proceeding the resolution of which, the management of the Company believes, would have a material adverse effect on the Company's results of operations or financial condition, nor to any other pending legal proceedings other than ordinary, routine litigation incidental to its business.
Item 4.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ---------------------------------------------------
No matters were submitted to a vote of security holders during the fiscal year ended December 31, 2004.
PART II - -------
Item 5.
Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS ------------------------------------------------------------------
The only authorized, issued and outstanding class of capital stock of the Company is common stock. There is no established public trading market for the Company's common stock. At December 31, 2004, the Parent held all common stock of the Company.
The Company has not declared or paid any cash dividends on its common stock since the Company's formation in September 1995. The Indentures with respect to the 10 3/4% Senior Notes due 2006, the 5% Senior Secured Notes due 2007, and the 10% Senior Secured Notes due 2007 contain restrictions on the Company's ability to declare or pay dividends on its common stock. The Indentures also prohibit the declaration or payment of any dividends or the making of any distribution by the Company or any Restricted Subsidiary (as defined in the Indentures).
Item 6.
Item 6. SELECTED FINANCIAL DATA -----------------------
The following table presents selected financial information derived from the Company's financial statements. Such amounts have been restated to reflect ED&C as a discontinued operation for all periods presented.
Item 7.
Item 7. 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 annual report.
Forward-Looking Statements
This report on Form 10-K 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.
Acquisitions
Information regarding acquisitions made by the Company during the three year period ended December 31, 2004 is included in Note 1 to the notes to financial statements. The results of acquired operations are included in the Company's consolidated results from the respective date of acquisition.
Consolidated Results of Operations
The following financial information presents the consolidated results of operations of the Company for the years ended December 31, 2004, 2003 and 2002.
Year ended December 31, 2004 compared to year ended December 31, 2003
Consolidated net sales increased $35.6 million, from $278.3 million in 2003 to $313.9 million in 2004, a gain of 12.8 %. The increased sales were driven by the introduction of new products and net gains in market share, which contributed approximately $20.0 million, and improvements in the Company's principal markets in North America and Europe, which account for approximately $8.4 million in increased sales. The continued revaluation of the Euro against the dollar during 2004 caused a $4.5 million improvement in sales due to the favorable translation impact on the Company's European businesses. The acquisition of O. Thompson (see Note 1 to "Notes to Consolidated Financial Statements") contributed $4.3 million in sales since the acquisition date. The net impact of increases and decreases in selling prices is estimated to reduce sales from the prior year by approximately $1.6 million, reflecting the competitive global market for the Company's core products.
Sales in the Company's Motors segment increased from $201.7 million in 2003 to $230.4 million in 2004, a gain of $28.7 million, or 14.2 %. Subfractional motor sales increased $3.7 million on the strength of an improved market for products used in consumer refrigeration appliances, the partial year impact of a new ice crusher product sold to a major appliance manufacturer, and numerous share gains in smaller product categories. These gains were partly offset by the loss of "value-added subassembly" ice crusher products sold to several key refrigeration customers, for whom the Company continues to supply the ice crusher motor. Sales of fractional and integral motors increased $25.0 million on significant gains in market share and the sale of new products used in commercial floor care, and recovery in the markets for material handling and golf car motor products. The Company's European markets remained difficult during 2004, with sales down 4.6% from 2003, due to general market conditions and the impact of net share losses. The European sales declines were more than offset by the aforementioned increase in sales due to favorable Euro translation. Sales of the Company's products in China have benefited from that country's overall market strength and from share gains in elevator motors as the Company expands its market presence geographically.
Sales in the Company's Controls segment increased $6.8 million, to $83.5 million in 2004, an increase of 8.9% from $76.7 million in the prior year. The increase in sales was led by the inclusion of the partial year sales of O. Thompson (see Note 1 to "Notes to Consolidated Financial Statements"), which contributed $4.3 million in sales. Sales of elevator controls and accessory products increased $2.5 million, led by higher sales of the "I" family of control products, the SmarTraq door operator system, and other non-controller products.
Consolidated operating income increased to $34.2 million in 2004, an increase of $4.1 million, or 13.7%, from $30.0 million in 2003. Gross profit increased to $101.6 million (32.4% of net sales), from the prior year level of $96.1 million, (34.5% of net sales). The increase in gross profit is mainly attributable to the increases in sales described above. The impact of higher sales is partly offset by the unfavorable impact of net reductions in selling prices resulting from global market competition (approximately $1.6 million) and higher prices for purchased components and services, particularly steel, copper, zinc, aluminum, and freight. Gross margin as a percentage of sales declined in 2004 due to the impacts of net selling price reductions, purchase cost inflation, and the introduction of certain new products and share gains at competitive margins which are lower than the Company's historical average. Selling, general, and administrative expenses ("SG&A") increased from $56.3 million in 2003 to $58.7 million. SG&A increased modestly in line with the increases in sales, and from costs associated with the relocation of operations of the Grand Rapids, MI, Des Plaines, IL, and Oakwood Village, OH facilities. These increases were offset in part by a $1.3 million reduction of charges under the Transition Agreement (see Item 13 "Certain Relationships and Related Transactions"), and a one-time charge of $1.0 million in 2003 for excess medical claims incurred by the Company's subsidiaries during 2001 and 2002.
Year ended December 31, 2003 compared to year ended December 31, 2002
Consolidated net sales increased $3.5 million or 1.3% from $274.8 million in 2002 to $278.3 million in 2003. The sales variance is primarily due to the impact of the stronger Euro on translation of European sales ($6.9 million increase) and the net impact of market share gains and losses ($10.6 million increase) resulting from the Company's introduction of new products to the market. These gains were offset in part by the protracted sluggish economies in North America and Europe, which continued to depress revenues in most of the company's key market segments, for a revenue decline of $11.3 million. Pricing pressure throughout the Company's product lines resulted in a $2.7 million reduction in net sales.
Sales of the Company's Motors segment declined to $201.7 million in 2003 from $202.4 million in 2002, a decline of 0.4%. Subfractional motor sales declined by 0.6% compared to 2003, as market driven declines concentrated in the vending and appliance product lines, plus the loss of "value-added subassembly" manufacturing for certain appliance customers, were nearly replaced by the introduction of new products and share gains in other markets, such as medical, restaurant, and commercial refrigeration. Sales of Fractional/Integral motor products declined 0.3% from 2002. The variance was driven by general economic softness in markets for motors used in commercial floor care, golf car, elevator, and other applications. These declines were almost offset by net gains from changes in market share and new product introductions in floor care and elevator markets, and the translation impact on European sales described above.
Sales of the Company's Controls segment increased to $76.7 million in 2003, from $72.4 million in 2002, an increase of $4.3 million, or 5.9%. The increase is the result of recovery in the market for elevator control products and product line extensions in the elevator modernization market.
Consolidated operating income declined 21.6%, from $38.3 million in 2002 to $30.0 million in 2003. Gross profit decreased from $99.1 million in 2002 (36.1% of sales) to $96.1 million in 2003 (34.5% of sales). The decrease in gross profit is primarily due to the aforementioned price reduction and shifts in the mix of sales among the Company's product lines, some of which result from the high level of new product introductions. Selling, general, and administrative expenses increased to $56.3 million in 2003 from $50.9 million in 2002. The increase is driven by increases in corporate overhead costs allocated to the Company as discussed under Note 10, "Related Party Transactions", a one-time charge of $1.0 million in 2003 for excess medical insurance claims incurred by the Company's subsidiaries during 2001 and 2002, and increased development and marketing costs for the company's next-generation elevator control in anticipation of broad market introduction in 2004.
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 the Credit Agreement.
Operating activities. Net cash used by operating activities for the year ended December 31, 2004 was $3.3 million, compared to $6.8 million used during the year ended December 31, 2003. The improvement in cash from operating activities is mainly a result of the Company's higher operating performance discussed above, as well as improved working capital management, particularly from increased accounts payable. This was offset in part by increases in accounts receivable and inventories which were larger during 2004 than in 2003 as a result of the higher level of sales.
Investing activities. Net cash used in investing activities was $4.4, $4.1 and 13.4 million in 2004, 2003 and 2002, respectively. Cash used in investing activities in 2004 included the acquisition of the significant net assets of O. Thompson, which is detailed in Note 1 of the Consolidated Financial Statements. The remaining use of cash is related to capital expenditures. Cash used in investing activities in 2002 reflects the formation of Kinetek De Sheng for $8.6 million, and $4.7 million for net capital expenditures.
Financing activities. Net cash provided by (used in) financing activities was $8.9, $($1.9) and ($5.7) million in 2004, 2003 and 2002 respectively.
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 net proceeds were used for the formation of Kinetek De Sheng and for the Company's ongoing operations. The Company's annual cash interest expense on the Secured Senior Notes, which are due May 1, 2007, is approximately $1.8 million. Interest on the Secured Senior Notes is payable semi-annually on May 1 and November 1 of each year.
The Company's annual cash interest expense on the 10 3/4% Senior Notes, which are due November 15, 2006, is approximately $29.0 million. Interest on the Senior Notes is payable semi-annually on May 15 and November 15 of each year.
The Company's Loan and Security Agreement (Credit Agreement), is in the form of a revolving credit facility and provides for borrowings of up to $35.0 million to fund acquisitions and provide working capital, and for other general corporate purposes. Borrowings are limited by a borrowing base formula consisting of accounts receivable, inventory, machinery and equipment and real estate. Borrowings bear interest at a rate of prime plus 1.35% (6.6% at December 31, 2004), subject to change based on the Company's interest coverage ratio, as defined. Unused commitments under the revolving credit facility are subject to an availability fee of 0.375% per annum subject to change based on the Company's interest coverage ratio, as defined. Borrowings are secured by the stock and substantially all of the assets of the Company. The Company had $9.4 million of borrowing capacity under the Credit Agreement as of December 31, 2004. The Credit Agreement expires December 18, 2005. The Company intends to replace the credit facility made under the Credit Agreement in 2005. Management is confident such refinancing can be obtained under favorable terms to the Company, however, such terms will be subject to market conditions which may change significantly.
The Company expects its principal sources of liquidity to be from its operating activities and funding from the Credit Agreement. The Company further expects that these sources will enable it to meet its cash requirements for working capital, capital expenditures, interest, taxes, and debt repayment for at least the next 12 months.
Foreign Currency Impact
The functional currencies of the Company's foreign operations are the respective local currencies. Fluctuations in the value of foreign currencies relative to the U.S. dollar have resulted in gains from foreign currency translation (which are deferred and classified as a separate component of shareholder's equity) of $4.0 million, $8.2 million and $5.9 million in 2004, 2003, and 2002, respectively. There can be no assurance that foreign currency fluctuations in the future will not have a significant adverse effect on the Company's business, financial condition and results of operations.
Seasonality and Inflation
The Company's net sales typically show no significant seasonal variations.
The Company purchases certain raw materials for use in the manufacture of its products, including steel, aluminum, copper, and resin which are generally available from multiple sources with adequate supply. While certain commodities have experienced greater pricing volatility in the past year, the Company has used a number of programs to address this risk such as entering into longer term purchase contracts with suppliers of certain commodities and implementing selling price adjustments over time. The Company believes it is not significantly dependent on a limited number of suppliers and that practices are in place to ensure an adequate supply of raw materials in the future.
Adoption of Accounting Principles
In November 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 151, "Inventory Costs - An Amendment of Accounting Research Bulletin No. 43, Chapter 4". SFAS No. 151 clarifies that abnormal amounts of idle facility expense, freight, handling costs and spoilage should be expensed as incurred and not included as overhead. SFAS 151 also requires that the allocation of fixed production overhead to conversion costs be based on normal capacity of the production facilities. SFAS 151 must be applied prospectively beginning January 1, 2006. The Company is still determining the impact of SFAS No. 151.
Critical Accounting Policies and Estimates
The Company's significant accounting policies are described in Note 2 to the consolidated financial statements included in Item 8 of this Form 10-K. The Company's discussion and analysis of financial condition and results from operations are based upon the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of the financial statements requires the Company's to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses. On an on-going basis, the Company evaluates the estimates that it has made. These estimates have been based upon historical experience and on various other assumptions that the Company believes to be reasonable under the circumstances. However, actual results may differ from these estimates under different assumptions or conditions.
The Company believes the following critical accounting policies affect the more significant judgments and estimates the Company's has used in the preparation of the consolidated financial statements.
Goodwill
In accordance with SFAS No. 142, the Company discontinued recording goodwill amortization effective January 1, 2002. SFAS No. 142 prescribes a two-step process for impairment testing goodwill. The first step is to identify when goodwill impairment has occurred by comparing the fair value of a reporting unit with its carrying amount, including goodwill. If the fair value of a reporting unit exceeds its carrying value, the second step of the goodwill test should be performed to measure the amount of the impairment loss, if any. In this second step, the implied fair value of the reporting unit's goodwill is compared with the carrying amount of the goodwill. If the carrying amount of the reporting unit's goodwill exceeds the implied fair value of that goodwill, an impairment loss should be recognized in an amount equal to that excess, not to exceed the carrying amount of the goodwill. If there is a decrease in product demand, market conditions or any condition that changes the assumptions used to measure fair value it could result in requiring material impairment charge in the future.
Investment in Affiliate
The Company has made a strategic investment in the Preferred Units of JZ International, LLC, an affiliated company. See Note 11 to the consolidated financial statements for details of this investment. These debt securities are not publicly traded on any major exchange. The cost method of accounting is used to account for this investment. Each quarter, the Company evaluates the recoverability of this investment using information obtained from the management of this company. Based on the information obtained, the Company will record an impairment charge when it believes the investment has experienced a decline in value below its current carrying amount that is other than temporary. Future adverse changes in market conditions or poor operating results could result in losses and/or an inability to recover the carrying value of this investment that may not be reflected in the investment's current carrying value, thereby possibly requiring an impairment charge in the future.
Allowance for Doubtful Accounts
Allowances for doubtful accounts are estimated at the individual operating companies based on estimates of losses on customer receivable balances. Estimates are developed by using standard quantitative measures based on historical losses, adjusting for current economic conditions and, in some cases, evaluating specific customer accounts for risk of loss. The establishment of reserves requires the use of judgment and assumptions regarding the potential for losses on receivable balances. Though the Company considers its allowance for doubtful accounts balance to be adequate, changes in economic conditions in specific markets in which the Company operates could have a material effect on future reserve balances required.
Excess and Obsolete Inventory
The Company records reserves for excess and obsolete inventory equal to the difference between the cost of inventory and its estimated market value using assumptions about future product life-cycles, product demand and market conditions. If actual product life-cycles, product demand and market conditions are less favorable than those projected by management, additional inventory reserves may be required.
Income Taxes
As part of the process of preparing our consolidated financial statements, the Company is required to estimate its income taxes in each of the jurisdictions in which it operates. This process involves estimating the Company's actual current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within the Company's consolidated balance sheet. The Company must then assess the likelihood that its deferred tax assets will be recovered from future taxable income and to the extent it believes that recovery is not likely, The Company must establish a valuation allowance. Increases (decreases) in the valuation allowance are included as an increase (decrease) to the Company's consolidated income tax provision (benefit) in the statement of operations.
Contractual Obligations
The following table summarizes the Company's contractual obligations as of December 31, 2004 (in thousands):
Item 7A.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS -----------------------------------------------------------
The Company's debt obligations are primarily fixed-rate in nature and, as such, are not sensitive to changes in interest rates. At December 31, 2004 the Company had no variable rate debt outstanding.
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 8.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA -------------------------------------------- PAGE NO. ----------
Report of Independent Registered Public Accounting Firm 19
Consolidated Balance Sheets as of December 31, 2004 and 2003 20
Consolidated Statements of Operations for the years ended December 31, 2004, 2003 and 2002 21
Consolidated Statements of Changes in Shareholder's Equity (Net Capital Deficiency) for the years ended December 31, 2004, 2003 and 2002 22
Consolidated Statements of Cash Flows for the years ended December 31, 2004, 2003 and 2002 23
Notes to Consolidated Financial Statements 24
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMS
The Board of Directors and Shareholder Kinetek, Inc.
We have audited the accompanying consolidated balance sheets of Kinetek, Inc. as of December 31, 2004 and 2003 and the related consolidated statements of operations, shareholder's equity (net capital deficiency), and cash flows for each of the three years in the period ended December 31, 2004. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company's internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Kinetek, Inc. at December 31, 2004 and 2003, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
As discussed in Note 13 to the financial statements, effective January 1, 2002, the Company changed its method of accounting for goodwill to conform with Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets".
ERNST & YOUNG LLP
Chicago, Illinois March 18, 2005
See accompanying notes to consolidated financial statements.
KINETEK, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (ALL DOLLAR AMOUNTS IN THOUSANDS)
See accompanying notes to consolidated financial statements.
KINETEK, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (ALL DOLLAR AMOUNTS IN THOUSANDS)
See accompanying notes to consolidated financial statements.
KINETEK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (ALL DOLLAR AMOUNTS IN THOUSANDS)
1. Description of Business and Acquisitions
Kinetek, Inc. (Company), a wholly-owned subsidiary of Motors and Gears Holdings, Inc. (Parent), a majority-owned subsidiary of Jordan Industries, Inc. (JII), operates in the motion control industry.
On April 6, 2001, the Company, through its wholly-owned subsidiary Merkle Korff, acquired substantially all of the assets, properties and business of Koford Engineering, Inc. for $690. This acquisition has been accounted for using the purchase method of accounting. Accordingly, the operating results of the acquired business have been included in the consolidated operating results of the Company since the date of acquisition. On November 30, 2004, Merkle Korff sold the assets related to the Koford Slot Car segment of the business. This consisted of cash, accounts receivable, machinery & equipment, and raw material. These assets were sold at book value which was $264K, therefore recognizing no gain or loss from the sale.
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. This acquisition has been accounted for using the purchase method of accounting. The JV also assumed approximately $7.2 million of outstanding debt.
On September 21, 2004, the Company acquired substantially all of the net assets of O. Thompson, a New York City-based elevator control company. The total acquisition cost was $887 of which $372 was paid in cash during the third and fourth quarters of 2004. The remaining $515 of deferred acquisition costs are a component of other current liabilities at December 31, 2004 and should be settled during the first quarter of 2005. The acquisition has been accounted for using the purchase method of accounting. Accordingly, the operating results of the acquired business have been included in the consolidated operating results of Kinetek since September 1, 2004, the effective date of the acquisition. The operating results of O. Thompson are included with those of Kinetek's wholly-owned subsidiary, Motion Control Engineering, within the "Controls" segment.
2. Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its majority-owned subsidiaries. All significant intercompany transactions and accounts have been eliminated. 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 the timely preparation of the Company's consolidated financial statements.
Reclassifications
Certain amounts in the prior years financial statements have been reclassified to conform to the 2004 presentation.
Cash and Cash Equivalents
Cash equivalents consist of highly liquid investments with an initial maturity of three months or less at the time of purchase.
Accounts Receivable and Allowance for Doubtful Accounts
Allowances for doubtful accounts are estimated at the individual operating companies based on estimates of losses on customer receivable balances. Estimates are developed by using standard quantitative measures based on historical losses, adjusting for current economic conditions and, in some cases, evaluating specific customer accounts for risk of loss. A receivable is considered past due if payments have not been received within agreed upon invoice terms. Uncollectible receivables are charged against the allowance for doubtful accounts when approved by operating company management after all collection efforts have been exhausted Inventories
Inventories are stated at the lower of cost or market. Inventories, which are valued at either average or first-in, first-out (FIFO) cost, accounted for approximately 78% and 73% of the Company's inventories at December 31, 2004 and 2003, respectively. All other inventories are valued using last-in, first-out (LIFO) cost, which approximated current cost at December 31, 2004 and 2003.
Property, Plant, and Equipment
Property, plant, and equipment are stated at cost, less accumulated depreciation. Depreciation is provided using the straight-line method over the estimated useful lives of the assets. Leasehold improvements and assets under capital leases are amortized using the straight-line method over the shorter of the lease term or their estimated productive lives. Amortization of leasehold improvements and assets under capital leases is included in depreciation expense.
The useful lives of plant and equipment for the purpose of computing book depreciation are as follows:
Buildings 5 to 33 years Machinery and equipment 3 to 10 years Dies and tooling 2 to 5 years Furniture and fixtures 3 to 7 years Vehicles 3 to 5 years
Foreign Currency Translation
The functional currencies of the Company's foreign operations are the local currencies. Accordingly, assets and liabilities of the Company's foreign operations are translated from foreign currencies into U.S. dollars at the exchange rates in effect at the balance sheet date while income and expenses are translated at the weighted-average exchange rates for the year. Adjustments resulting from translation are classified as a component of other comprehensive income.
Goodwill and Other Long-Lived Assets
Through 2001, goodwill was amortized using the straight-line method over a period of 30 to 40 years. On January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets." Under the new rules, goodwill is no longer amortized but is subject to annual impairment tests. See Note 13 for additional details.
Other long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the related asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of the asset to future undiscounted cash flows expected to be generated by the asset. If the asset is determined to be impaired, the impairment recognized is measured by the amount by which the carrying value of the asset exceeds its fair value.
Deferred Financing Costs
Deferred financing costs are amortized using the straight line method, which approximates the interest method, over the terms of the related loans. Deferred financing costs at December 31, 2004 and 2003 are net of accumulated amortization of $16,292 and $13,646, respectively. Amortization of deferred financing costs is included in interest expense.
Income Taxes
Deferred tax assets and liabilities are determined based on differences between the financial reporting and tax basis of assets and liabilities and are measured using the enacted tax rates and laws that are expected to be in effect when the differences reverse. The operating results of the Company and its subsidiaries are included in the consolidated federal income tax return of JII. In addition, the Company and its subsidiaries are party to a tax-sharing agreement with JII. The Company's income tax provision (benefit) has been calculated as if the Company would have filed a separate federal income tax return, except that the Company's net operating losses are eliminated if absorbed in the JII consolidated federal income tax return.
Revenue Recognition
The Company's revenue is derived primarily from product sales. Revenue is recognized in accordance with the terms of the sale, primarily upon shipment to customers, once the sales price is fixed or determinable, and collectibility is reasonably assured.
Shipping and Handling Costs
Shipping and Handling Costs are included in cost of sales in the statement of operations.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
Financial Instruments
The Company's financial instruments include cash equivalents, trade accounts receivable, accounts payable, accrued expenses, the Senior Notes, the Senior Secured Notes, the Subordinated Notes, and the revolving credit facility. Other than the Senior Notes (see Note 8), the fair values of the Company's financial instruments are not materially different from their carrying values at December 31, 2004 and 2003.
Concentration of Credit Risk
Financial instruments which potentially subject the Company to concentration of credit risk consist principally of cash and cash equivalents, accounts receivable and the investment in affiliate (see Note 11). The Company deposits cash and cash equivalents with high-quality financial institutions, which are federally insured up to prescribed limits. Cash balances may exceed these limits at any given time.
The Company closely monitors the credit quality of its customers and maintains allowances for potential credit losses which, historically, have not been significant and have been within the range of management's expectations. The Company generally does not require collateral or other security on trade receivables.
Derivative Financial Instruments
The Company recognizes derivative instruments as either assets or liabilities in the balance sheet at fair value. The accounting for changes in fair value (i.e., gains or losses) of a derivative financial instrument depends on whether it has been designated and whether it qualifies as part of an effective hedging relationship and, further, on the type of hedging relationship. The fair value of derivative financial instruments was not significant as of December 31, 2004 and 2003.
New Accounting Pronouncements
In January 2003, the FASB issued Interpretation No. 46 (FIN 46), "Consolidation of Variable Interest Entities - An Interpretation of Accounting Research Bulletin (ARB) No. 51" This interpretation provides guidance on how to identify variable interest entities and how to determine whether or not those entities should be consolidated. The Company is required to apply FIN 46 by March 31, 2005, for entities which were created before February 1, 2003. The adoption of FIN 46 was immediate for variable interest entities created after January 31, 2003. The Company has not created any significant variable interest entities since January 31, 2003. The Company is evaluating its interests in entities created before February 1, 2003 to determine if FIN 46 applies.
3. Inventories
Inventories consist of the following:
December 31, --------------------------- 2004 2003 ---- ---- Raw materials $30,509 $27,847 Work in process 11,507 10,325 Finished goods 11,642 7,752 ----------- ----------- $53,658 $45,924 =========== ===========
4. Property, Plant, and Equipment
Property, plant, and equipment consist of the following:
December 31, --------------------------- 2004 2003 ---- ---- Land, buildings and leasehold improvements $21,735 $21,027 Machinery and equipment 40,840 37,482 Furniture and fixtures 14,094 14,338 Other (vehicles, dies and tooling) 7,603 7,418 ----------- ----------- 84,272 80,265
Less: Accumulated depreciation and amortization (54,519) (49,791) ----------- -----------
$29,753 $30,474 =========== ===========
5. Short Term Notes Payable
FIR Group Holdings Italia and its subsidiaries, have a number of short-term borrowing facilities available from various banks. The total amount available under these facilities is approximately $9,136 at an average interest rate of 7.25% for the year ending December 31, 2004. There were no outstanding borrowings under these arrangements at December 31, 2004 and 2003. A portion of these facilities are secured by FIR's assets and a portion are in the form of overdraft coverage.
6. Discontinued Operation and Restatement of Financial Statements
During 2004, the Company undertook a plan to sell Electrical Design and Control ("ED&C"), a wholly-owned subsidiary. As a part of the Company's analysis of the realizable value of the assets recorded in the books and records of ED&C, an exhaustive analysis of all open projects was performed. During that analysis, it came to our attention that certain revenues had been erroneously recorded in prior years as a result of errors in ED&C's percentage of completion calculations on certain projects. The Company's results for 2003 and 2002 have been restated to reflect ED&C as discontinued operations in all periods presented, as well as to correct for the impact of errors discussed above. The portion of the restatement due to the errors mentioned above was additional charges of $3,408 and $1,751 in 2003 and 2002, respectively. Had the above amounts been recorded in the proper periods, no default of the Company's debt covenants would have occurred. The Company currently has no other subsidiaries using the percentage of completion accounting method and believes that the risk of future errors of this type is minimal. For this
reason, the Company believes that the above restatements are sufficient to properly state certain previously issued financial statements and that this restatement has no material impact on the results of the continuing operations of the Company.
Summarized selected financial information for the discontinued operation as restated is as follows:
2004 2003 2002 ---- ---- ---- Revenues $ 4,640 $ 6,358 $ 6,097
Loss from discontinued operations (5,856) 1,787 (1,986)
The major classes of assets and liabilities of the discontinued operation is as follows:
2004 2003 ---- ---- Current assets $ 1,978 $ 7,113 Property, plant and equipment 14 337 Other long term assets 32 32 ---------- ---------- Total assets 2,024 7,482 Current liabilities 548 1,257 ---------- ---------- Net assets of discontinued operations $ 1,476 $ 6,225 ---------- ----------
7. Income Taxes
Income from continuing operations before income taxes and cumulative effect of accounting change was comprised of the following:
Year Ended December 31, ----------------------------------------- 2004 2003 2002 ---- ---- ----
Domestic $ (3,447) $ (6,637) $ 178 Foreign 2,558 1,817 3,845 ----------- ----------- -----------
$ (889) $ (4,820) $ 4,023 =========== =========== ===========
The provision (benefit) for income taxes consists of the following:
Year Ended December 31, ----------------------------------------- 2004 2003 2002 ---- ---- ---- Current: Federal $ - $ - $ 8,234 State 610 644 535 Foreign 1,148 593 (2,576) ----------- ----------- ----------- Total current 1,758 1,237 6,193
Deferred: Federal 3,085 3,151 4,018 State 927 867 686 Foreign 1,221 466 678 ----------- ----------- ----------- Total deferred 5,233 4,484 5,382 ----------- ----------- ----------- Income tax provision $ 6,991 $ 5,721 $ 11,575 =========== =========== ===========
The provision (benefit) for income taxes differs from the amount of income tax provision (benefit) computed by applying the U.S. federal income tax rate to income before income taxes and cumulative effect of change in accounting principle. A reconciliation of the differences is as follows:
As of December 31, 2004 there was $18,856 of accumulated unremitted earnings from the Company's foreign subsidiaries on which deferred taxes have not been provided as undistributed earnings on foreign subsidiaries are considered to be indefinitely reinvested.
In 2002, the Company adopted SFAS No. 142, which provides that goodwill no longer be amortized. For tax purposes, goodwill continues to be amortized over a fifteen-year life. As such, the tax amortization generates a temporary difference and a corresponding deferred tax liability arises for financial statement purposes. Because goodwill is no longer amortized for book purposes, the Company cannot determine when the resulting deferred tax liabilities will
reverse. Therefore, the Company is not able to utilize any future reversal of the deferred tax liability related to goodwill to support the realization of the deferred tax assets.
As previously noted, the Company and its domestic subsidiaries (Kinetek Group) join in the annual filing of a U.S. federal consolidated income tax return with their ultimate parent company, Jordan Industries, Inc. (Parent). During 2004, Parent realized $88.4 million of cancellation of indebtedness income as a result of modifications to certain of its outstanding debt. However, the Internal Revenue Code provides exceptions to the recognition of certain types of cancellation of indebtedness income for U.S. federal income tax purposes. These exceptions generally will require the Parent and possibly certain subsidiaries including members of the Kinetek Group to reduce various specified tax attributes on January 1, 2005 to be determined by the Parent. Through some combination of these exceptions, net operating loss carryforwards and other future tax benefits of Kinetek may be reduced. The Parent's consolidated return group which includes the Kinetek Group does not expect to incur any material tax liability as a result of realizing this cancellation of indebtedness.
8. Long-Term Debt
Long-term debt consists of the following:
(A) Interest on the Senior Notes is payable in arrears on May 15 and November 15 of each year. The Senior Notes are unsecured obligations of the Company and mature on November 15, 2006. The Senior Notes are redeemable at the option of the Company, in whole or in part, at any time on or after November 15, 2001. The Indenture relating to the Senior Notes contains certain covenants which, among other things, restrict the ability of the Company to incur additional indebtedness, to pay dividends or make other restricted payments, engage in transactions with affiliates, to complete certain mergers or consolidations, or to enter into certain guarantees of indebtedness.
The fair value of the Senior Notes was approximately $273,375 at December 31, 2004. The fair value was calculated by multiplying the face amount by the market price at December 31, 2004.
(B) The Company's Loan and Security Agreement (Credit Agreement), expiring December 18, 2005, is in the form of a revolving credit facility and provides for borrowings of up to $35,000 to fund acquisitions and provide working capital, and for other general corporate purposes. Borrowings are limited by a borrowing base formula consisting of accounts receivable, inventory, machinery and equipment and real estate. Borrowings bear interest at a rate of prime plus 1.35% (6.6% at December 31, 2004), subject to change based on the Company's interest coverage ratio, as defined. Unused commitments under the revolving credit facility are subject to an availability fee of 0.375% per annum subject to change based on the Company's interest coverage ratio, as defined. Borrowings are secured by the stock and substantially all of the assets of the Company. The Company had $9,358 of borrowing capacity under the Credit Agreement as of December 31, 2004.
The Credit Agreement contains covenants which, among other things, provide for a minimum level of interest coverage, as defined, and limit the Company's ability to incur additional indebtedness, create liens, make restricted payments, engage in affiliate transactions or mergers and consolidations, and make asset sales.
The Credit Agreement expires December 18, 2005. The Company intends to replace the credit facility made under the Credit Agreement in 2005. Management is confident such refinancing can be obtained under favorable terms to the Company, however, such terms will be subject to market conditions which may change significantly.
(C) The Subordinated Notes Payable at December 31, 2004 consists of a $1,500 note payable to the former shareholder of Merkle-Korff, a subsidiary of the Company, and is due on January 1, 2006 and bears interest at 9% per annum.
(D) Interest rates on capital leases range from 6.4% to 7.6% and mature in installments through 2007.
The future minimum lease payments as of December 31, 2004 under capital leases consist of the following:
2005 $361 2006 220 2007 108 2008 - 2009 - ------------ Total 689 Less amount representing interest (74) ------------ Present value of future minimum lease payments $615 ============
The present value of the future minimum lease payments approximates the book value of property, plant and equipment under capital leases at December 31, 2004.
(E) Interest on the Secured Senior Notes is payable in arrears on May 1 and November 1 of each year. The Secured Senior Notes are secured obligations of the Company and mature on April 30, 2007. The Indenture relating to the Senior Notes contains certain covenants which, among other things, restricts the ability of the Company to
incur additional indebtedness, to pay dividends or make other restricted payments, engage in transactions with affiliates, to complete certain mergers or consolidations, or to enter into certain guarantees of indebtedness.
(F) One of the Company's foreign subsidiaries has bank loans of $7,506 and $9,459 as of December 31, 2004 and 2003, respectively. Interest rates on these loans range from 4.8% to 5.8% and mature in 2005. The Company plans to renew these loans as they mature.
(G) The Company has loans due to a joint venture partner of one of its foreign subsidiaries of $887 and $1,494 for December 31, 2004 and 2003, respectively. Interest rate on loans range from 5.3% to 5.8% and mature in installments through 2005.
Aggregate maturities of long-term debt at December 31, 2004 are as follows:
2005 $ 20,959 2006 273,020 2007 23,089 2008 - 2009 - ----------- $317,068 ===========
9. Operating Leases
The Company leases certain land, buildings, and equipment under noncancellable operating lease agreements expiring in various years through 2011. Minimum future lease payments, by year, under noncancellable operating leases, including those with related parties (Note 10), are as follows at December 31, 2003:
2005 $ 3,075 2006 2,540 2007 2,320 2008 2,273 2009 1,751 Thereafter 1,909 ------------ $13,868 ============
Total rent expense was $3,305, $3,041 and $3,365 for the years ended December 31, 2004, 2003 and 2002, respectively.
10. Benefit Plans
Certain of the Company's subsidiaries participate in the JII 401(k) Savings Plan (the "Plan"), a defined contribution plan for salaried and hourly employees. In order to participate in the Plan, employees must be at least 21 years old and have worked at least 1,000 hours during the first 12 months of employment. Each eligible employee may contribute from 1% to 15% of their before-tax wages into the Plan. In addition to the JII 401(k) Plan, certain subsidiaries have additional defined contribution plans in which employees may participate. The Company made contributions to these plans totaling approximately $1,068, $1,324 and $1,505 for the years ended December 31, 2004, 2003 and 2002, respectively.
FIR provides for a severance liability for all employees at 8.3% of each respective employee's annual salary. In addition, the amount accrued is adjusted each year according to an official index (equivalent to 0.75% of the retail price index). This obligation is payable to employees when they leave the Company and approximated $3,358 and $3,380 at December 31, 2004 and 2003, respectively, which is included in other non-current liabilities in the Company's balance sheets.
11. Related Party Transactions
Services Agreements. The Company and each of its subsidiaries are subject to the following four agreements and arrangements with JII:
First, the Company and each of its subsidiaries are parties to a transaction advisory agreement (the "Subsidiary Advisory Agreement") with JII, pursuant to which the Company and its subsidiaries are charged by JII (i) investment banking and sponsorship fees of up to 2.0% of the purchase price of acquisitions, joint ventures, minority investments or sales involving the Company and its subsidiaries or their respective businesses or properties (which were $73, $0 and $514 in 2004, 2003, and 2002, respectively); (ii) financial advisory fees of up to 1.0% of debt, equity, or other financing or refinancing involving the Company or such subsidiary, in each case, arranged with the assistance of JII or its affiliates (which were $0, $0 and $260 in 2004, 2003 and 2002, respectively); and (iii) reimbursement for JII's out-of-pocket costs in connection with providing such services (which were $0 in 2004, 2003 and 2002). Mssrs. Jordan, Quinn, Boucher and Zalaznick, directors of Parent, are directors and shareholders of JII.
Second, the Company and each of its subsidiaries is party to a management consulting agreement (the "Subsidiary Consulting Agreement") with JII, pursuant to which the Company and its subsidiaries pay JII annual consulting fees of the greater of (i) 3.0% of the Company's net income before interest, tax, depreciation and amortization and other non-cash charges, or (ii) 1.0% of the Company's net sales for such services and are required to reimburse JII for its out-of-pocket costs related to its services. Pursuant to the Subsidiary Consulting Agreement, JII (but not JII's affiliates) is obligated to present all acquisition, business and investment opportunities that relate to manufacturing, assembly, distribution or marketing of products and services in the motors, gears and motion control industries to the Company, and JII is not permitted to pursue such opportunities or present them to third parties unless the Company determines not to pursue such opportunities or consents thereto. In accordance with this agreement, the Company paid approximately $3,193, $2,916 and $2,854 for the years ended December 31, 2004, 2003 and 2002, respectively, which are reflected as Management Fees and Other in the Consolidated Statement of Operations.
Third, the Company and each of its subsidiaries are parties to a services agreement (the "JI Properties Services Agreement") with JI Properties, Inc. ("JI Properties"), a subsidiary of JII, pursuant to which JI Properties provides certain real estate and other assets, transportation and related services to the Company. Pursuant to the JI Properties Services Agreement, the Company is charged for its allocable portion of such services based upon its usage of such services and its relative revenues, as compared to JII and its other subsidiaries.
Fourth, the Company and JII are parties to a transition agreement (the "Transition Agreement") pursuant to which JII provides office space and certain administrative and accounting services to the Company to facilitate the operations of the Company. Also, JII allocates its overhead, general and administrative charges and expense among JII and its subsidiaries, including the Company, based on the respective revenues and usage of corporate overhead by JII and its subsidiaries. The Company reimburses JII for services provided pursuant to the Transition Agreement on an allocated cost basis.
In accordance with the JI Properties Services Agreement and the Transition Agreement, such combined charges were $5,807, $7,084 and $5,103 for the years ended December 31, 2004, 2003 and 2002, respectively, and are reflected within Selling, General, and Administrative expenses in the Consolidated Statement of Operations.
The above agreements expire in December 2011, but are automatically renewed for successive one-year terms, unless either party provides written notice of termination 60 days prior to the scheduled renewal date.
Tax Sharing Agreement. The Company and each of its subsidiaries are parties to a Tax Sharing Agreement (the "Tax Sharing Agreement") between JII and each of its consolidated subsidiaries for U.S. federal income tax purposes. Pursuant to the Tax Sharing Agreement, the Company and each of its consolidated subsidiaries owes to JII an amount determined by reference to each entity's separate return tax liability as defined in Treasury Regulation ss.1.1552-1(a) (2) (ii). For the years ended December 31, 2004 and 2003, income tax payments made by the Company to JII under the Tax Sharing Agreement were $0 and $0, respectively.
Related Party Leases. The Company leases certain plants, warehouses, and offices under leases with affiliated entities. Rent expense, including real estate taxes attributable to these leases, amounted to $1,614, $1,653 and $1,822 for the years ended December 31, 2004, 2003 and 2002, respectively. Future minimum rental payments required under these leases are as follows:
2005 $1,701 2006 1,553 2007 1,173 2008 1,135 2009 1,135 Thereafter $1,419
Investment in Affiliate. The Company has a $12,344 investment in the Class A and Class B Preferred Units of JZ International, LLC. These debt securities are not publicly traded and do not have a determinable fair value. The cost method of accounting is used to account for this investment. The Preferred Units have a cumulative 5% annual return. The Class A Preferred Units may be redeemed at any time at the discretion of the Board of Directors of JZ International, but no later than December 31, 2017, whereas the Class B Preferred Units may be redeemed at any time at the discretion of the Board of Directors of JZ International, but no later than December 31, 2018. Each quarter, we evaluate the recoverability of this investment using information obtained from the management of this company. Based on the information obtained, we will record an impairment charge when we believe the investment has experienced a decline in value below its current carrying amount that is other than temporary. JZ International's Chief Executive Officer is David W. Zalaznick, and its members include Messrs. Jordan, Quinn, Zalaznick and Boucher, who are the Company's and/or Parent's directors and stockholders. JZ International and its subsidiaries are focused on making European and other international investments. The Company is accounting for this investment under the cost method.
Legal Fees. An individual who is a shareholder, General Counsel and Assistant Secretary of the Parent is also a partner in a law firm used by the Company. The firm was paid $174, $277 and $490 in fees and expenses during the years ended December 31, 2004, 2003 and 2002, respectively. The rates charged to the Company were at arms-length.
Due from Affiliate. The Company has a net receivable from JII of $7,743 and $5,827 at December 31, 2004 and 2003, respectively, that are reflected in the consolidated balance sheets as "due from affiliated company".
12. Additional Purchase Price Arrangements
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 placed in a trust and 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.
13. Segment Data
Description of Segments
The Company operates in two separate business segments; electric motors ("Motors") and electronic motion control systems ("Controls"). The Motors segment consists of subfractional motors, fractional/integral motors, and gears and gearboxes. The Controls segment consists of motion control systems.
The Company's subfractional horsepower products are comprised of motors and gearmotors which power applications up to 30 watts (1/25 horsepower). These small, "fist-size" AC and DC motors are used in light duty applications such as snack and beverage vending machines, refrigerator ice dispensers and photocopy machines.
The Company's fractional/integral horsepower products are comprised of AC and DC motors and gearmotors having power ranges from 1/8 to 300 horsepower. Primary end markets for these motors include commercial floor care equipment, commercial dishwashers, commercial sewing machines, industrial ventilation equipment, golf carts, lift trucks and elevators.
The Company's precision gear and gearbox products are produced in sizes of up to 16 inches in diameter and in various customized configurations such as pump, bevel, worm and helical gears. Primary end markets for these products include original equipment manufacturers ("OEMs") of motors, commercial floor care equipment, aerospace and food processing product equipment.
The Company's motion control systems are used primarily in the elevator modernization market. The systems typically control several components such as electric motors, hydraulic or pneumatic valves, actuators and switches that are required for the elevator systems to function properly.
Measurement of Segment Operating Income and Segment Assets
The Company evaluates performance and allocates resources based on operating income. The accounting policies of the reportable segments are the same as those described in Note 2, "Summary of Significant Accounting Policies". No single customer accounts for 10% or more of consolidated net sales. Identifiable assets are those used by each segment in its operations. Corporate assets consist primarily of cash, due from affiliate, investment in affiliate and deferred financing fees.
Goodwill at December 31, 2004 and 2003 was net of accumulated amortization of $82,032.
15. Legal Proceedings
The Company is subject to legal proceedings and claims which arise in the ordinary course of its business. The Company believes that the final disposition of such matters will not have a material adverse effect on the financial position or results of operations of the Company.
16. 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 was extinguished. The settlement is recognized as income on the Consolidated Statements of Operations within Income (Loss) from discontinued operations, net.
17. Warranties
The Company provides warranties on certain products for varying lengths of time. The Company estimates the costs that may be incurred and records a liability in the amount of such costs at the time product revenue is recognized. Changes to the Company's product warranty accrual during the year are as follows:
2004 2003 ------------ ------------ Balance, beginning of year $ 1,615 $ 1,056 Warranties issued 572 807 Settlements (253) (248) ------------ ------------ Balance, end of year $ 1,934 $ 1,615 ------------ ------------
18. Research and Development Costs
The Company incurred $4,542, $4,084 and $3,689 of research and development costs during 2004, 2003 and 2002, respectively.
Item 9.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE ---------------------------------------------------------------
None.
Item 9A.
Item 9A. 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, we, with the participation of our chairman and our chief financial officer have evaluated the effectiveness of our disclosure controls and procedures as of December 31, 2004. Based on such evaluation, our chairman and our chief financial officer have concluded that our disclosure controls and procedures were effective.
Since December 31, 2004, there have been no changes in the internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.
Item 9B. OTHER INFORMATION -----------------
None.
Part III --------
Item 10.
Item 10. DIRECTORS AND EXECUTIVE OFFICERS --------------------------------
The following sets forth the names and ages of the Company's directors, executive officers (and those of our Parent) and other key employees and the positions they hold as of the date of this annual report:
Name Age Position with Company Thomas H. Quinn 57 Chairman of Company and Parent D. Randall Bays 49 President and Chief Operating Officer of Company and Director of Parent Daniel D. Drury 43 Chief Financial Officer of Company and Parent Richard D. Meyer 56 President, Merkle-Korff Industries Paolo Bergamaschi 35 President, FIR Group James M. Jackson 45 President, Advanced DC Motors Jonathan F. Boucher 48 Director of Parent John W. Jordan, II 57 Director of Company and Parent David W. Zalaznick 50 Director of Parent John D. Simms, Sr. 77 Director of Parent
Set forth below is a brief description of the business experience of each director and executive officer of the Company.
Mr. Quinn has served as Chairman of the Company since its inception and President from November 15, 2002 through November 2004. Since 1988, Mr. Quinn is also President, Chief Operating Officer and a director of JII. From November 1985 to December 1987, Mr. Quinn was a Group Vice President for Baxter International, Inc. ("Baxter"). From September 1970 through 1985, Mr. Quinn was employed by American Hospital Supply Corporation ("American Hospital") in a variety of management capacities, where he was a Group Vice President of the Hospital Group and a corporate officer when American Hospital was acquired by Baxter. Mr. Quinn is also Chairman and a member of the board of directors of a number of privately held companines. He is also a senior principal of The Jordan Company.
Mr. Bays was appointed President and Chief Operating Officer of Kinetek, Inc. in November 2004. As President, Mr. Bays succeeds Thomas H. Quinn, who will continue to be the Company's Chief Executive Officer and a Director. Chief Operating Officer is a newly created post. Since April 1997, Mr. Bays has been President of the Company's Imperial Electric subsidiary, and in January 2003 he was appointed President of the Company's Fractional/Integral Products Group, which is comprised of Imperial Electric, Euclid Universal, Gear Research, Advanced DC Motors, FIR Group, and Kinetek De Sheng. Before joining the Company, Mr. Bays held several senior management positions in General Electric's motor and control business from 1991 to 1997. Prior to that, Mr. Bays held senior management positions in Bomar Aerospace, Inc.
Mr. Drury has served as Chief Financial Officer since April 2000. Prior to joining the Company, Mr. Drury held a succession of financial management positions with various divisions of General Electric from 1982 to 2000, most recently as Finance Manager - Control Products at GE Industrial Systems.
Mr. Meyer joined Merkle-Korff Industries in March 2004 as President and COO and was named President and CEO in November 2004. Prior to joining Merkle-Korff Industries, Mr. Meyer held senior management positions at Regal-Beloit in its Electrical Group from 1998-2004 and at MagneTek from 1981-1997 in its Motor Group. Prior to that Mr. Meyer held various management positions with Franklin Electric and General Electric.
Mr. Bergamaschi has served as the President of FIR since 1998. Prior to that, Mr. Bergamaschi held several management positions within FIR.
Mr. Jackson has served as President of ADC since July 2000. From 1995 until joining ADC, Mr. Jackson held several senior management positions with VAPOR, a division of WABTEC. Prior to that, Mr. Jackson held various management positions at GE, Square D, and a variety of other companies.
Mr. Boucher has served as a director of the Parent since its inception. Since 1983, Mr. Boucher has been a partner of The Jordan Company, a private merchant banking firm. Mr. Boucher is also a director of JII and Jackson Products, Inc. as well as other privately held companies.
Mr. Jordan has served as a director of the Company since its inception. Mr. Jordan is a managing principal of The Jordan Company, a private merchant banking firm which he founded in 1982. Mr. Jordan is also Chairman of the Board of Directors and Chief Executive Officer of JII since 1988. Mr. Jordan is also President of Jordan Zalaznick Advisors, Inc. and TJC Management Corporation, Manager of JZ International, LLC, Managing Partner of Jordan Zalaznick Capital Company and Managing Member of Resolute Fund Partners, LLC. Mr. Jordan is also a director of a number of privately held companies.
Mr. Zalaznick has served as a director of the Parent since June 1997. Since 1982, Mr. Zalaznick has been a managing partner of The Jordan Company. Mr. Zalaznick is also the Managing Member, Chairman of the Management Board and Chief Executive Officer of JZ International, LLC, Managing Member of Resolute Fund Partners, LLC, President of TJC Management Corporation and Chairman of Jordan/Zalaznick Advisors, Inc. and President of Jordan/Zalaznick Capital Company. Mr. Zalaznick is also a director of Sensus Metering Systems, Inc., TAL International Group, Inc., Marisa Christina, Inc. as well as other privately held companies.
Mr. Simms has served as a director of the Parent since 1998. Mr. Simms was the owner of Merkle-Korff from 1966 until September 22, 1995 when Merkle-Korff was purchased by the Company. Mr. Simms has nearly fifty years of experience in the electric motor business.
Board of Directors
Liability Limitation. The Certificate of Incorporation provides that a director of the Company shall not be personally liable to it or its stockholders for monetary damages to the fullest extent permitted by Delaware Corporation Law. In accordance with Delaware Corporation Law, the Certificate of Incorporation does not eliminate or limit the liability of a director for acts or omissions that involve intentional misconduct by a director or a knowing violation of law by a director for voting or assenting to an unlawful distribution, or for any transaction from which the director will personally receive a benefit in money, property, or services to which the director is not legally entitled. Delaware Corporation Law does not affect the availability of equitable remedies such as an injunction or rescission based upon a director's breach of his duty of care. Any amendment to these provisions of the Delaware Corporation Law will automatically be incorporated by reference into the Certificate of Incorporation and the Bylaws, without any vote on the part of its stockholders, unless otherwise required.
Indemnification Agreements. The Company and each of its directors and certain executive officers have entered into indemnification agreements. The indemnification agreements provide that the Company will indemnify the directors against certain liabilities (including settlements) and expenses actually and reasonably incurred by them in connection with any threatened or pending legal action, proceeding or investigation (other than actions brought by or in the right of the Company) to which any of them is, or is threatened to be, made a party by reason of their status as a director, officer or agent of the Company, or serving at the request of the Company in any other capacity for or on behalf of the Company; provided that (i) such director acted in good faith and in a manner not opposed to the best interest of the Company, (ii) with respect to any criminal proceedings had no reasonable cause to believe his or her conduct was unlawful, (iii) such director is not finally adjudged to be liable for negligence or misconduct in the performance of his or her duty to the Company, unless the court views in light of the circumstances the director is nevertheless entitled to indemnification, and (iv) the indemnification does not relate to any liability arising under Section 16(b) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), or the rules or regulations promulgated thereunder. With respect to any action brought by or in the right of the Company, directors are also indemnified to the extent not prohibited by applicable laws or as determined by a court of competent jurisdiction, against expenses actually and reasonably incurred by them in connection with such action if they acted in good faith and in a manner they reasonably believed to be in or not opposed to the best interests of the Company.
Code of Ethics. The Board of Directors has adopted a Code of Ethics for the Chief Executive Officer, the Chief Financial Officer, the Chief Operating Officer, and other senior financial personnel. A copy of the Code is available on the Company's website at www.kinetekinc.com. The company will disclose any amendments or waivers of the Code of Ethics on the same website.
Audit Committee. The Company is not a "listed company" under SEC rules and is therefore not required to have an audit committee comprised of independent directors. The Company does not currently have an audit committee and does not have an audit committee financial expert. The Board of Directors has determined that each of its members is able to read and understand fundamental financial statements and has substantial business experience that results in that member's financial sophistication. Accordingly, the Board of Directors believes that each of its members have the sufficient knowledge and experience necessary to fulfill the duties and obligations that an audit committee would have.
Item 11.
Item 11. EXECUTIVE COMPENSATION ----------------------
Directors' Compensation
Directors of the Parent receive $20,000 per year for serving as a director of the Company. In addition, the Company reimburses directors for their travel and other expenses incurred in connection with attending meetings of the Board of Directors.
Executive Compensation
The following table sets forth a summary of certain information regarding compensation paid or accrued by the Company for services rendered to the Company for the fiscal year ended December 31, 2004 to those persons who were, (i) the Company's chief executive officer and (ii) the Company's most highly compensated executive officers other than the chief executive officer whose total salary and bonus exceeded $100,000 during such period.
(1) For the periods indicated, no executive officer named in the table received any Other Annual Compensation in an amount in excess of the lesser of either $50,000 or 10% of the total of Annual Salary and Bonus reported for him in the two preceding columns.
(2) Does not reflect compensation paid to Mr. Quinn by JII.
The Company does not maintain a stock option or stock purchase plan and has not awarded any of its employee's individual stock option grants.
Compensation Committee Interlock and Insider Participation
The Board of Directors does not maintain a Compensation Committee. During fiscal 2004, however, Messrs. Boucher, Jordan and Quinn participated in deliberations of the Board of Directors concerning executive officer compensation. During 2004, certain of the foregoing executive officers of the Company served and currently serve as directors, executive officers and members of a compensation committee of another entity, one of whose executive officers served and currently serves as a director of the Company.
Item 12.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT --------------------------------------------------------------
All of the outstanding common stock of the Company is owned by Parent. The table below sets forth as of March 23, 2005 certain information regarding beneficial ownership of the two classes of common stock of Parent (Class A and Class B) held by (i) each of its directors and executive officers who own shares of Class B common stock of Parent, (ii) all directors and executive officers of Parent as a group and (iii) each person known by Parent to own beneficially more than 5% of its common stock. The Company believes that each individual or entity named has sole investment and voting power with respect to shares of common stock of Parent indicated as beneficially owned by them, except as otherwise noted.
Amount of Beneficial Ownership (1) -------------------------------- Number of Percentage Shares Owned Executive Officers and Directors: John W. Jordan II (2) (3) (4) (5) 7,136.8809 7.2 David W. Zalaznick (2) (4) (6) 3,531.2473 3.5 Jonathan F. Boucher (2) 1,116.5587 1.1 Thomas H. Quinn (2) 1,799.7294 1.8 D. Randall Bays 0.0000 0.0 Daniel D. Drury 0.0000 0.0 All directors and executive officers as a Group (10 persons) 13,584,4163 13.6
Other Principal Stockholders: Jordan Industries, Inc (7) 80,000.0000 80.2 Leucadia Investors, Inc. 2,019.7802 2.0 JII Partners (8) 1,500.0000 1.5
(1) Calculated pursuant to Rule 13d-3(d) under the Exchange Act. Under Rule 13d-3(d), shares not outstanding which are subject to options, warrants, rights or conversion privileges exercisable within 60 days are deemed outstanding for the purpose of calculating the number and percentage owned by such person, but not deemed outstanding for the purpose of calculating the percentage owned by each other person listed. As of March 31, 2003, there were 99,700 shares of Class A and Class B common stock issued, including (i) 80,000 shares of Class A common stock issued and outstanding and (ii) 19,700 shares of Class B common stock of Parent issued, of which 19,400 shares were issued and outstanding and 300 shares were issued and held in treasury.
(2) Does not include shares of Class B common stock of Parent owned by JII Partners Limited Partnership as to which the named individuals disclaim beneficial ownership.
(3) Includes 0.1650 shares of Class B common stock held personally and 7,136.7159 shares of Class B common stock held by the John W. Jordan II Revocable Trust. Does not include 51.025 shares of Class B common stock held by Daly Jordan O'Brien, a sister of Mr. Jordan. 51.025 shares of Class B common stock held by Elizabeth O'Brien Jordan, also a sister of Mr. Jordan or 51.025 shares of Class B common stock held by George C. Jordan, Jr., the brother of Mr. Jordan.
(4) Does not include 16.4973 shares of Class B common stock held by the Jordan/Zalaznick Capital Company or 577.4053 shares of Class B common stock held by JZ Equity Partners PLC, a publicly traded U.K. investment trust advised by an affiliate of The Jordan Company (which is controlled by Messrs. Jordan and Zalaznick).
(5) Does not include 535.8871 shares of Class B common stock held by The Jordan Family Trust, of which John W. Jordan II, George C. Jordan, Jr. and G. Robert Fisher are the Trustees.
(6) Does not include 13.5558 shares of Class B common stock held by Bruce H. Zalaznick, the brother of Mr. Zalaznick.
(7) JII owns all of the issued and outstanding of Class A common stock, which entitles JII to approximately 80% of the voting power as of the date hereof. The principal address of JII is ArborLake Centre, Suite 550, 1751 Lake Cook Road, Deerfield, IL 60015.
(8) JII Partners is an investment partnership whose partners include certain officers and employees of JII and its affiliates. The principal address of JI Partners is ArborLake Centre, Suite 550, 1751 Lake Cook Road, Deerfield, IL 60015.
The Company does not maintain any compensation plans under which equity securities are authorized for issuance.
Item 13.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ---------------------------------------------- (ALL DOLLAR AMOUNTS IN THOUSANDS)
Service Agreements. The Company, our parent, and substantially all of our subsidiaries are parties to a transaction advisory agreement (the "Subsidiary Advisory Agreement") with JII, pursuant to which we and our subsidiaries pay JII (i) investment banking and sponsorship fees of up to 2.0% of the purchase price of acquisitions, joint ventures, minority investments or sales involving us and our subsidiaries or their respective businesses or properties (which were $73, $0 and $514 in 2004, 2003 and 2002 pursuant to this agreement or the predecessor agreement, as applicable); (ii) financial advisory fees of up to 1.0% of any debt, equity or other financing or refinancing involving us or such subsidiary, in each case, arranged with the assistance of JII or its affiliates (which were $0, $0 and $260 in 2004, 2003 and 2002 pursuant to this agreement or the predecessor agreement, as applicable); and (iii) reimbursement of JII's out-of-pocket costs in connection with providing such services (which were $0 in 2004, 2003 and 2002, pursuant to this agreement or the predecessor agreement, as applicable). The amount of such fees payable in each such transaction will be no less favorable to us than those that could be obtained from comparable, unaffiliated third parties. We are not required to pay such fees (a) if and to the extent expressly prohibited by the provisions of any credit or financing arrangements, (b) if we have not paid cash interest on any interest payment date, or (c) we have not paid cash dividends on any dividend payment date or have not made redemptions on any redemption date, as applicable under our certificate of incorporation or other governing documents. Any required payment which is not paid when due shall accrue and bear interest at 10% per annum. If we acquire or create any new subsidiaries, we will cause them to be subject to this agreement. The Subsidiary Advisory Agreement expires in December 2011, but is automatically renewed for successive one-year terms, unless either party provides written notice of termination 60 days prior to the scheduled renewal date. Mssrs. Jordan, Quinn, Boucher and Zalaznick, directors of Holdings, are directors and shareholders of JII.
The Company, our parent and substantially all of our subsidiaries are parties to a management consulting agreement (the "Subsidiary Consulting Agreement"), pursuant to which we pay JII annual consulting fees (directly and through our Parent) of the greater of (i) 3.0% of our net income before interest, tax, depreciation and amortization and other non-cash charges of ours, or (ii) 1.0% of our net sales, and are required to reimburse JII for its out-of-pocket costs related to its services. We are not required to pay such fees (a) if and to the extent expressly prohibited by the provisions of any credit or financing arrangements, (b) if we have not paid cash interest on any interest payment date, or (c) we have not paid cash dividends on any dividend payment date or have not made redemptions on any redemption date, as applicable under our certificate of incorporation or other governing documents. Any required payment which is not paid when due shall accrue and bear interest at 10% per annum. If we acquire or create any new subsidiaries, we will cause them to be subject to this agreement. The Subsidiary Consulting Agreement expires in December 2011, but is automatically renewed for successive one-year terms, unless either party provides written notice of termination 60 days prior to the scheduled renewal date. In accordance with this agreement or the predecessor of this agreement pursuant to which we only paid under clause (ii) above, we were charged approximately $3,193, $2,916 and $2,854 for the years ended December 31, 2004, 2003 and 2002, respectively.
The Company, our parent and substantially all of our subsidiaries are parties to a properties services agreement (the "JI Properties Services Agreement") with JI Properties, Inc. ("JI Properties"), a subsidiary of JII, pursuant to which JI Properties provides to us the use of certain real estate and other assets, transportation and related services. Pursuant to the JI Properties Services Agreement, we are charged for our allocable portion of such services based upon (i) our usage of such services and (ii) our relative revenues, as compared to JII and its other subsidiaries. The Company is also required to reimburse JI Properties for all reasonable out of pocket expenses it incurs (unless such expenses are already included in the charges described above).
The Company, our parent and substantially all of our subsidiaries are parties to a transition agreement (the "Transition Agreement") pursuant to which JII provides office space and certain administrative and accounting services to the Company to facilitate the operations of the Company. Also, JII allocates its overhead, general and administrative charges and expense among JII and its subsidiaries, including the Company, based on the respective revenues and usage of corporate overhead by JII and its subsidiaries. The Company reimburses JII for services provided pursuant to the Transition Agreement on an allocated cost basis.
In accordance with the JI Properties Services Agreement and the Transition Agreement, such charges were $5,807, $7,084 and $5,103 for the years ended December 31, 2004, 2003 and 2002, respectively. The JI Properties Services Agreement and the Transition Agreement expires in December 2011, but is automatically renewed for successive one-year terms, unless either party provides written notice of termination 60 days prior to the scheduled renewal date.
Tax Sharing Agreement. The Company and each of its subsidiaries are parties to a Tax Sharing Agreement (the "Tax Sharing Agreement") between JII and each of its consolidated subsidiaries for U.S. Federal income tax purposes. Pursuant to the Tax Sharing Agreement, the Company and each of its consolidated subsidiaries owes to JII an amount determined by reference to each entity's separate return tax liability as defined in Treasury Regulation ss. 1.1552-1(a)(2)(ii). For the year ended December 31, 2004 no payments were made by the Company to JII under the Tax Sharing Agreement was $0.
If the Tax Sharing Agreement is terminated, then the Company and its subsidiaries will remain contingently liable to JII under the Tax Sharing Agreement in respect of any increases in their separate return tax liability for periods prior to such termination.
Directors. Directors of the Company, John W. Jordan II, David W. Zalaznick and Thomas H. Quinn each have a beneficial ownership interest of more than 10% of the common stock of Jordan Industries, Inc.
Investment in Affiliate. The Company has a $12,344 investment in the Class A and Class B Preferred Units of JZ International, LLC. JZ International's Chief Executive Officer is David W. Zalaznick, and its members include Messrs. Jordan, Quinn, Zalaznick and Boucher, who are the Company's directors and stockholders, as well as other members. JZ International and its subsidiaries are focused on making European and other international investments.
Merkle-Korff Leases. Merkle-Korff leases some of its plants, warehouse and offices under a net lease (the "Merkle-Korff Leases") from companies controlled by John Simms, Sr., a Director of the Company. Rent expenses, including real estate taxes attributable to the Merkle-Korff Leases, amounted to $446 for the year ended December 31, 2004. The Company has agreed to pay future minimum rental payments under the Merkle-Korff Leases amounting to approximately $451 for the year ended December 31, 2005. The Company has the right of first refusal to buy these facilities from Mr. Simms. See Note 10 to the Company's Consolidated Financial Statements. The Company believes the terms of the Merkle-Korff Leases are comparable to the terms it would obtain from a non-affiliated party.
Motion Control Leases. Motion Control leases substantially all of its production and office space under noncancellable operating leases from a limited partnership whose partners include officers of Motion Control. These leases expire in 2011. Rent expense under the leases was $1,154 for the year ended December 31, 2004. The Company believes the terms of the Motion Control leases are comparable to the terms it would obtain from a non-affiliated party.
Directors and Officers Indemnification. The Company has entered into indemnification agreements with each member of the Company's Board of Directors and certain executive officers whereby the Company agreed, subject to certain exceptions, to indemnify and hold harmless each director and certain executive officers from liabilities incurred as a result of such person's status as a director or executive officer of the Company. See Item 10, Directors and Executive Officers - Board of Directors - Indemnification Agreements.
Future Transactions. The Company has adopted a policy to provide that all transactions between the Company and its officers, directors and other affiliates must (i) be approved by a majority of the members of the Board of Directors and by a majority of the disinterested members of the Board of Directors and (ii) be on terms no less favorable to the Company than could be obtained from unaffiliated third parties.
Item 14.
Item 14. PRINCIPAL ACCOUNTANT FEES & SERVICES ------------------------------------
The following table presents fees for professional services rendered by Ernst & Young LLP for the audit of the Company's annual financial statements for the years ended December 31, 2004, 2003 and 2002, and fees billed for other services rendered by Ernst & Young LLP during those periods.
2004 2003 ---- ---- Audit $ 467 $ 279 Tax Fees 298 269 Audit-Related Fees - - ------- ------- Total $ 765 $ 548
Part IV - -------
Item 15.
Item 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES ------------------------------------------
Documents filed as part of this report:
(1) Financial Statements --------------------
Reference is made to the Index to Consolidated Financial Statements Appearing in Item 8, which Index is incorporated herein by reference.
(2) Financial Statement Schedule ----------------------------
The following financial statement schedule for the years ended December 31, 2004, 2003 and 2002 is submitted herewith:
Item Page Number ---- -----------
Schedule II - Valuation and qualifying accounts 55
All other schedules for which provision is made is in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions, are not applicable and therefore have been omitted, or the information has been included in the consolidated financial statements or is considered immaterial.
(3) Exhibits --------
An index to the exhibits required to be listed under this Item 15(a)(3) follows the "Signatures" section hereof and is incorporated herein by reference.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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/ Thomas H. Quinn ------------------------------- Dated: March 24, 2005 Thomas H. Quinn Chairman of the Board
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
By /s/ Thomas H. Quinn -------------------------- Dated: March 24, 2005 Thomas H. Quinn Chairman of the Board
By /s/ John W. Jordan II -------------------------- Dated: March 24, 2005 John W. Jordan II Director
By /s/ Daniel D. Drury -------------------------- Dated: March 24, 2005 Daniel D. Drury Chief Financial Officer
EXHIBIT INDEX
Exhibit Number Description
2.1 Contingent Earnout Agreement, dated as of November 7, 1996, by and among Kinetek, Inc., Kinetek Industries, Inc., The New Imperial Electric Company, The New Scott Motors Company, New Gear Research, Inc., The Imperial Electric Company, The Scott Motors Company and Gear Research, Inc. (incorporated by reference to Exhibit 2.2 to Kinetek, Inc.'s Form S-4 Registration Statement) (File No. 333-19257) (The "1996 S-4")
2.2 Share Purchase Agreement, dated March 2, 1997, by and among Motors and Gears Holdings, Inc. and the stockholders of FIR Group Holdings Italia, S.r.l. (incorporate by reference to exhibit 2.1 to Form 8-K of Kinetek, Inc., date March 31, 1998)
2.3 Purchase Agreement, dated November 17, 1997, by and among Motion Holdings, Inc. and the shareholders of Motion Control Engineering, Inc. (incorporated by reference to exhibit 2.2 to Form 8-K of Kinetek, Inc., dated March 31, 1998)
2.4 Agreement for purchase and sale of stock of Electrical Design and Control Company by and among ED&C Holdings, Inc. and the shareholders of Electrical Design and Control Company, (incorporated by reference to exhibit 2.3 to Form 8-K of Kinetek, Inc., dated March 31, 1998)
2.5 Share Purchase Agreement, dated April 9, 1998, for the direct and indirect sale of all the shares of Advanced DC (incorporated by reference to exhibit 99.1 to Form 8-K of Kinetek, Inc., dated January 28, 2000)
2.6 Amendment No. 1 to Agreement for Purchase and Sale of Stock, dated May 15, 1998, for the direct and indirect sale of all the shares of Advanced DC (incorporated by reference to exhibit 99.2 to Form 8-K of Kinetek, Inc., dated January 28, 2000)
3.1 Certificate of Amendment of Certificate of Incorporation of Motors And Gears, Inc. and Certificate of Incorporation of Motors And Gears, Inc. (incorporated by reference to Exhibit 3.1 to Kinetek Inc.'s Form 10-K Annual Report, dated March 28, 2001)
3.2 Bylaws of Kinetek, Inc. (incorporated by reference to Exhibit 3.2 to the 1996 S-4)
4.1 Indenture, dated November 7, 1996, between Kinetek, Inc. and Fleet National Bank (incorporated by reference to Exhibit 4.1 to the 1996 S-4)
4.2 First Supplemental Indenture, dated December 17, 1997, between Kinetek, Inc. and State Street Bank and Trust Company, as Trustee (incorporated by reference to Kinetek Inc.'s Form S-4 Registration Statement) (File No. 333-44057) (the "1998 S-4")
4.3 Indenture, dated December 17, 1997, between Kinetek, Inc. and State Street Bank and Trust Company, as Trustee (incorporated by reference to Exhibit 4.3 to the 1998 S-4)
4.4 5% Indenture, dated as of April 12, 2002, among Kinetek Industries, Inc., U.S. Bank National Association, as Trustee and the Guarantors listed therein (this Indenture is the same as the 10% Indenture other than the interest rate) (incorporated by reference to Exhibit 4.4 to Form 8-K of Kinetek, Inc., dated May 8, 2002)(the "2002 8-K")
4.5 Global 5% Note of Kinetek Industries, Inc. (incorporated by reference to Exhibit 4.5 to the 2002 8-K)
4.6 Global 10% Note of Kinetek Industries, Inc. (incorporated by reference to Exhibit 4.5 to the 2002 8-K)
4.7 Registration Rights Agreement, dated as of April 12, 2002, among Kinetek Industries, Inc., Jefferies & Company, Inc. and the Guarantors listed therein (incorporated by reference to Exhibit 4.7 to the 2002 8-K)
4.8 Intercreditor Agreement, dated as of April 12, 2002, between U.S. Bank National Association and Fleet Capital Corporation, as agent (incorporated by reference to Exhibit 4.8 to the 2002 8-K)
4.9 Security Agreement, dated as of April 12, 2002, between Kinetek Industries, Inc. and U.S. Bank National Association (incorporated by reference to Exhibit 4.9 to the 2002 8-K)
4.10 Guarantor Security Agreement, dated as of April 12, 2002, between Kinetek, Inc. and U.S. Bank National Association (substantially identical agreements were entered into with 9 subsidiaries that are also guarantors) (incorporated by reference to Exhibit 4.9 to the 2002 8-K)
4.11 Pledge Agreement, dated as of April 12, 2002, between Kinetek Industries, Inc. and U.S. Bank National Association (substantially identical agreements were entered into with Kinetek, Inc. and 3 subsidiaries) (incorporated by reference to Exhibit 4.9 to the 2002 8-K)
4.12 Copyright, Patent and Trademark License Mortgage, dated as of April 12, 2002, between Kinetek, Inc. and U.S. Bank National Association (substantially identical agreements were entered into with 3 subsidiaries) (incorporated by reference to Exhibit 4.9 to the 2002 8-K)
4.13 Real Property Mortgage, dated as of April 12, 2002, between Advanced D.C. Motors, Inc. and U.S. Bank National Association (substantially identical agreements were entered into with 2 other subsidiaries) (incorporated by reference to Exhibit 4.9 to the 2002 8-K)
10.1 Loan and Security Agreement, dated December 18, 2001 by and among Kinetek Industries, Inc., the lenders listed thereto and Fleet Capital Corporation, as Agent (incorporated by reference to Exhibit 10.1 to Form 10-K/A of Kinetek, Inc., dated April 19, 2002
10.2 Consent and Amendment No. 1 to Loan and Security Agreement, dated as of April 12, 2002, among Kinetek Industries, Inc., the lenders listed thereon and Fleet Capital Corporation, as agent (incorporated by reference to Exhibit 10.2 to the 2002 8-K)
10.3 Management Consulting Agreement, dated December 14, 2001, by and among Jordan Industries, Inc., the Company and the other signatories thereto (incorporated by reference to Exhibit 10.2 to Form 10-K of Kinetek, Inc., dated March 29, 2002 (the "2002 10-K")
10.4 Properties Services Agreement, dated December 14, 2001, by and among JI Properties, Inc., the Company and the other signatories thereto (incorporated by reference to Exhibit 10.3 to the 2002 10-K)
10.5 Transaction Advisory Agreement, dated December 14, 2001, by and among Jordan Industries, Inc., the Company and the other signatories thereto (incorporated by reference to Exhibit 10.4 to the 2002 10-K)
10.6 Agreement to Join in the Filing of Consolidated Tax Return, dated December 14, 2001 by and among Jordan Industries, Inc., the Company and the other signatories thereto (incorporated by reference to Exhibit 10.5 to the 2002 10-K)
10.7 Transition Agreement, dated July 25, 1997, by and between Motors and Gears Holdings, Inc. and Jordan Industries, Inc. (incorporated by reference to Exhibit 10.8 to the 1998 S-4).
10.8 Indemnification Agreement, dated November 7, 1996, between Kinetek, Inc. and Thomas H. Quinn (incorporated by reference to Exhibit 10.1(a) to the 1998 S-4)
10.9 Indemnification Agreement, dated November 7, 1996, between Kinetek, Inc. and Jonathan F. Boucher (incorporated by reference to Exhibit 10.1(b) to the 1996 S-4)
10.10 Indemnification Agreement, dated November 7, 1996, between Kinetek, Inc. and David W. Zalaznick (incorporated by reference to Exhibit 10.1(c) to the 1996 S-4)
10.11 Indemnification Agreement, dated November 7, 1996, between Kinetek, Inc. and John W. Jordan II (incorporated by reference to Exhibit 10.1(d) to the 1996 S-4)
10.12 Merkle-Korff Industries, Inc. Non-negotiable Subordinated Note in the principal aggregate amount of $5,000,000 payable to John D. Simms Revocable Trust Under Agreement (incorporated by reference to Exhibit 10.9 to the 1996 S-4)
10.13 Electrical Design and Control Company, Inc. Non-negotiable Subordinated Note in the principal aggregate amount of $1,333,333 payable to Tina Levire (incorporated by reference to Exhibit 10.13 to the 1998 Form S-4)
10.14 Electrical Design and Control Company, Inc. Non-negotiable Subordinated Note in the principal aggregate amount of $1,333,333 payable to Marta Monson (incorporated by reference to Exhibit 10.14 to the 1998 form S-4)
10.15 Electrical Design and Control Company, Inc. Non-negotiable Subordinated Note in the principal aggregate amount of $1,333,334 payable to Eric Monson (incorporated by reference to Exhibit 10.15 to the 1998 form S-4)
10.16 Industrial Building Leases, each dated as of September 22, 1996, by and between Merkle-Korff Industries, Inc. and the signatory thereto (incorporated by reference to Exhibits 10.16 - 10.19 to the 1996 S-4)
10.17 Employment and Non Competition Agreement, dated as of September 22, 1995, by and between Merkle-Korff Industries, Inc. and John D. Simms (incorporated by reference to Exhibit 10.20 to the 1996 S-4)
10.18 Employment and Non Competition Agreement, dated as of September 22, 1995, by and between Merkle-Korff Industries, Inc. and John W. Brown (incorporated by reference to Exhibit 10.21 to the 1996 S-4)
12.1* Computations of the Ratios of Earnings to Fixed Charges
21.1* Subsidiaries of Kinetek, Inc.
31.1* Certification of Thomas H. Quinn
31.2* Certification of Daniel D. Drury
* filed herewith