**UNITED STATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

** **

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** **

**FORM 10-Q**

** **

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| **ý    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)  OF THE SECURITIES EXCHANGE ACT OF 1934** |
|------------------------------------------------------------------------------------------------------------------|

** **

**FORTHE QUARTER ENDED MARCH 31, 2002**

 

**OR**

 
| **o****   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)  OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-----------------------------------------------------------------------------------------------------------------|

### ** **

### **Forthe transition period from             to             .**

 

#### **Commission File Number:  001-13931**

 

**PENTACON,INC.**

(Exact name of Registrant as specified in its charter)

 

| **DELAWARE**                                                                        |   | **76-0531585**                       |
|-------------------------------------------------------------------------------------|--------|--------------------------------------|
| (State or other jurisdiction of  incorporation or organization)                     |   | (I.R.S. Employer Identification No.) |
|                                                                                |   |                                 |
| **21123 NORDHOFF STREET  CHATSWORTH, CALIFORNIA  91311**                       |
| (Address of principal executive offices)  (Zip Code)                           |
|                                                                                |   |                                 |
| (Registrant’s telephone number, including area code):  **(818) 727-8000** |

 

Indicate by check markwhether the Registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the Registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.   Yes ý   No o

 

Number of sharesof common stock of the Registrant, par value $.01 per share, outstanding atApril 30, 2002 was 16,953,473.

 

 

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**PENTACON,INC.**

**FORM 10-Q FOR THE THREE MONTHS ENDEDMARCH 31, 2002**

 

## **INDEX**

 
| Part I – Financial Information |
|-------------------------------------|
|                                |
|                                | Item 1 – Financial  Statements |
|                                |   |
|                                | Consolidated Balance Sheets  as of March 31, 2002 and December 31, 2001 |
|                                |   |
|                                | Consolidated  Statements of Operations for the Three Months ended March 31, 2002 and 2001 |
|                                |   |
|                                | Consolidated  Statements of Cash Flows for the Three Months ended March 31, 2002 and 2001 |
|                                |   |
|                                | Notes to  Consolidated Financial Statements |
|                                |   |
|                                | Item  2 – Management’s Discussion and Analysis of Financial Condition and Results  of Operations |
|                                |   |
|                                | Item  3 – Quantitative and Qualitative Disclosures about Market Risk |
|                                |   |
| Part II – Other Information    |
|                                |   |
|                                | Item 6 –  Exhibits and Reports on Form 8-K |
|                                |   |
|                                | Signature |
|                                     |  |  |

 

2

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**PENTACON,  INC.**

**PART I – FINANCIAL INFORMATION**

 

#### **ITEM 1.  FINANCIAL STATEMENTS**

 

**PENTACON, INC.**

## **CONSOLIDATEDBALANCE SHEETS**

 
|                                                                                                                    |   | **March 31, 2002**  |    | **December 31, 2001** |   |
|-------------------------------------------------------------------------------------------------------------------------|--------|---------------------|---------|-----------------------|--------|
|                                                                                                                    |   | **(Unaudited)**     |    |                  |   |
|                                                                                                                    |   | **(in  thousands)** |    |
| ASSETS                                                                                                                  |   |                |    |                  |   |
| Cash  and cash equivalents                                                                                              |   | $                   | 206     |                  | $      | 49 |   |
| Accounts  receivable                                                                                                    |   | 31,186              |    | 30,767                |   |
| Inventories                                                                                                             |   | 75,628              |    | 77,871                |   |
| Refundable  income taxes                                                                                                |   | 3,789               |    | 2,129                 |   |
| Other  current assets                                                                                                   |   | 1,470               |    | 1,679                 |   |
|                                                                                                                    |   |                |    |                  |   |
| Total  current assets                                                                                                   |   | 112,279             |    | 112,495               |   |
|                                                                                                                    |   |                |    |                  |   |
| Property  and equipment, net                                                                                            |   | 12,018              |    | 12,780                |   |
| Goodwill                                                                                                                |   | 37,123              |    | 125,927               |   |
| Other  assets                                                                                                           |   | 4,046               |    | 4,172                 |   |
|                                                                                                                    |   |                |    |                  |   |
| Total  assets                                                                                                           |   | $                   | 165,466 |                  | $      | 255,374 |   |
|                                                                                                                    |   |                |    |                  |   |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                               |   |                |    |                  |   |
| Accounts  payable                                                                                                       |   | $                   | 19,152  |                  | $      | 18,191 |   |
| Accrued  expenses                                                                                                       |   | 9,248               |    | 9,776                 |   |
| Accrued  interest                                                                                                       |   | 6,148               |    | 3,085                 |   |
| Current  maturities of long-term debt                                                                                   |   | 153,759             |    | 60,341                |   |
|                                                                                                                    |   |                |    |                  |   |
| Total  current liabilities                                                                                              |   | 188,307             |    | 91,393                |   |
|                                                                                                                    |   |                |    |                  |   |
| Long-term  debt, net of current maturities                                                                              |   | 1,413               |    | 99,120                |   |
|                                                                                                                    |   |                |    |                  |   |
| Total  liabilities                                                                                                      |   | 189,720             |    | 190,513               |   |
|                                                                                                                    |   |                |    |                  |   |
| Commitments  and contingencies                                                                                          |   |                |    |                  |   |
|                                                                                                                    |   |                |    |                  |   |
| Preferred  stock, $.01 par value, 10,000,000 shares authorized, no shares issued and  outstanding                       |   | —              |    | —                |   |
| Common  stock, $.01 par value, 51,000,000 shares authorized, 16,960,139 shares issued  and outstanding in 2002 and 2001 |   | 170                 |    | 170                   |   |
| Additional  paid in capital                                                                                             |   | 101,350             |    | 101,322               |   |
| Retained deficit                                                                                                        |   | (125,785            | )       | (36,643               | )      |
| Accumulated  comprehensive income                                                                                       |   | 11                  |    | 12                    |   |
|                                                                                                                    |   |                |    |                  |   |
| Total  stockholders’ equity (deficit)                                                                              |   | (24,254             | )       | 64,861                |   |
|                                                                                                                    |   |                |    |                  |   |
| Total  liabilities and stockholders’ equity (deficit)                                                              |   | $                   | 165,466 |                  | $      | 255,374 |   |

 

The accompanying notesare an integral part of these statements.

 

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**PENTACON, INC.**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**(UNAUDITED**)

 
|                                                                      |   | **Three Months Ended March 31,**       |    |
|---------------------------------------------------------------------------|--------|----------------------------------------|---------|
|                                                                      |   | **2002**                               |    | **2001** |   |
|                                                                      |   | **(in  thousands, except share data)** |    |
|                                                                      |   |                                   |    |   |   |
| Revenues                                                                  |   | $                                      | 55,805  |   | $ | 71,311 |   |
| Cost  of sales                                                            |   | 39,568                                 |    | 49,992 |   |
| Gross profit                                                              |   | 16,237                                 |    | 21,319 |   |
|                                                                      |   |                                   |    |   |   |
| Operating  expenses                                                       |   | 13,722                                 |    | 15,752 |   |
| Goodwill  amortization                                                    |   | —                                 |    | 864 |   |
|                                                                      |   |                                   |    |   |   |
| Operating  income                                                         |   | 2,515                                  |    | 4,703 |   |
|                                                                      |   |                                   |    |   |   |
| Other  (income) expense, net                                              |   | (36                                    | )       | 2 |   |
| Interest  expense                                                         |   | 4,549                                  |    | 4,599 |   |
|                                                                      |   |                                   |    |   |   |
| Income  (loss)  before taxes                                         |   | (1,998                                 | )       | 102 |   |
| Income  taxes                                                             |   | (1,659                                 | )       | 20 |   |
|                                                                      |   |                                   |    |   |   |
| Income  (loss) before cumulative effect of change in accounting principle |   | (339                                   | )       | 82 |   |
|                                                                      |   |                                   |    |   |   |
| Cumulative  effect of change in accounting principle, net of tax          |   | (88,804                                | )       | — |   |
|                                                                      |   |                                   |    |   |   |
| Net  income (loss)                                                        |   | $                                      | (89,143 | ) | $ | 82 |   |
|                                                                      |   |                                   |    |   |   |
| Net  income (loss) per share:                                             |   |                                   |    |   |   |
| Basic:                                                                    |   |                                   |    |   |   |
| Before  cumulative effect of change in accounting principle               |   | $                                      | (0.02   | ) | $ | 0.00 |   |
| Cumulative  effect of change in accounting principle, net of tax          |   | (5.24                                  | )       | — |   |
| Net  income (loss)                                                        |   | $                                      | (5.26   | ) | $ | 0.00 |   |
| Diluted:                                                                  |   |                                   |    |   |   |
| Before  cumulative effect of change in accounting principle               |   | $                                      | (0.02   | ) | $ | 0.00 |   |
| Cumulative  effect of change in accounting principle, net of tax          |   | (5.24                                  | )       | — |   |
| Net  income (loss)                                                        |   | $                                      | (5.26   | ) | $ | 0.00 |   |
|                                                                      |   |                                   |    |   |   |
| Reconciliation  of net income (loss) to comprehensive income (loss):      |   |                                   |    |   |   |
| Net  income (loss)                                                        |   | $                                      | (89,143 | ) | $ | 82 |   |
| Currency  translation adjustment                                          |   | (1                                     | )       | 5 |   |
| Comprehensive  income (loss)                                              |   | $                                      | (89,144 | ) | $ | 87 |   |

 

The accompanying notesare an integral part of these statements.

 

4

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**PENTACON, INC.**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(UNAUDITED)**

 
|                                                                                                 |   | **Three Months Ended March 31,** |    |
|------------------------------------------------------------------------------------------------------|--------|----------------------------------|---------|
|                                                                                                 |   | **2002**                         |    | **2001** |   |
|                                                                                                 |   | **(in  thousands)**              |    |
| Cash  Flows From Operating Activities:                                                               |   |                             |    |   |   |
| Net income (loss)                                                                                    |   | $                                | (89,143 | ) | $ | 82 |   |
| Adjustments  to reconcile net income (loss) to net cash provided by (used in) operating  activities: |   |                             |    |   |   |
| Depreciation and amortization                                                                        |   | 887                              |    | 1,634 |   |
| Amortization of discount on notes                                                                    |   | 50                               |    | 44 |   |
| Deferred income taxes                                                                                |   | —                           |    | 931 |   |
| Write-off  of goodwill                                                                               |   | 88,804                           |    | — |   |
| Changes  in operating assets and liabilities:                                                        |   |                             |    |   |   |
| Accounts receivable                                                                                  |   | (419                             | )       | (1,830 | ) |
| Inventories                                                                                          |   | 2,243                            |    | 888 |   |
| Refundable income taxes                                                                              |   | (1,659                           | )       | — |   |
| Other current assets                                                                                 |   | 209                              |    | 42 |   |
| Other assets                                                                                         |   | 130                              |    | 207 |   |
| Accounts payable and accrued expenses                                                                |   | 3,496                            |    | 2,273 |   |
| Income taxes payable                                                                                 |   | —                           |    | (988 | ) |
| Net cash provided by operating activities                                                            |   | 4,598                            |    | 3,283 |   |
|                                                                                                 |   |                             |    |   |   |
| Cash Flows From Investing Activities:                                                                |   |                             |    |   |   |
| Capital expenditures                                                                                 |   | (247                             | )       | (844 | ) |
| Other                                                                                                |   | 144                              |    | 17 |   |
| Net cash used in investing activities                                                                |   | (103                             | )       | (827 | ) |
|                                                                                                 |   |                             |    |   |   |
| Cash  Flows From Financing Activities:                                                               |   |                             |    |   |   |
| Repayments of term debt                                                                              |   | (50                              | )       | (142 | ) |
| Net  repayments under credit facility                                                                |   | (4,288                           | )       | (2,348 | ) |
| Net cash used in financing activities                                                                |   | (4,338                           | )       | (2,490 | ) |
|                                                                                                 |   |                             |    |   |   |
| Increase (decrease) in cash and cash equivalents                                                     |   | 157                              |    | (34 | ) |
|                                                                                                 |   |                             |    |   |   |
| Cash  and cash equivalents, beginning of period                                                      |   | 49                               |    | 158 |   |
|                                                                                                 |   |                             |    |   |   |
| Cash  and cash equivalents, end of period                                                            |   | $                                | 206     |   | $ | 124 |   |

 

The accompanying notesare an integral part of these statements.

 

5

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**PENTACON, INC.**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

**MARCH 31, 2002**

**(UNAUDITED)**

 

1.               BASISOF PRESENTATION

 

The consolidated financial statements of Pentacon,Inc. (the “Company”) included herein have been prepared without audit pursuantto the Rules and Regulations for reporting on Form 10-Q.  Accordingly, certain information andfootnotes required by generally accepted accounting principles for completefinancial statements are not included herein.  The Company believes all adjustments necessary for a fair presentationof these statements have been included and are of a normal and recurringnature.  There has been no significantchange in the accounting policies of the Company during the periods presented,with the exception of the adoption of the new accounting pronouncement on accountingfor goodwill described in Note 2.  Thestatements should be read in conjunction with the financial statements andrelated notes thereto included in the Company’s Annual Report on Form 10-K forthe year ended December 31, 2001.

 

The balance sheetat December 31, 2001 has been derived from the audited financial statements atthat date but does not include all of the information and footnotes required bygenerally accepted accounting principles for complete financial statements.

 

*Recently Issued AccountingStandards: *In August2001, the Financial Accounting Standards Board issued Statement of FinancialAccounting Standards (“SFAS”) No. 144, “Accounting for the Impairment orDisposal of Long-Lived Assets”.  SFASNo. 144 supercedes SFAS No. 121, “Accounting for the Impairment of Long-LivedAssets and for Long-Lived Assets to be Disposed of”.  SFAS No. 144 establishes a single accounting model for long-livedassets to be disposed of by sale and requires that those long-lived assets bemeasured at the lower of carrying amount or fair value less cost to sell.  The Company adopted this standard in thequarter ended March 31, 2002.  Theadoption had no impact on the Company’s financial position or results ofoperations.

 

2.               GOODWILL

 

Effective January1, 2002, the Company adopted SFAS No. 142, “Goodwill and Other IntangibleAssets,” which establishes new accounting and reporting requirements forgoodwill and other intangible assets. Under SFAS No. 142, all goodwill amortization ceased effective January1, 2002.  Goodwill amortization for thequarter ended March 31, 2002 would have otherwise been $864,000.  Recorded goodwill attributable to each ofthe Company’s reporting units were tested for impairment by comparing the fairvalue of each reporting unit with its carrying value.  Fair value was determined using discounted cash flows, marketmultiples and market capitalization. These impairment tests are required to be performed upon adoption ofSFAS No. 142 and at least annually thereafter.

 

Significantestimates used in the impairment tests include estimates of future cash flows,future short-term and long-term growth rates, weighted average cost of capitaland estimates of market multiples for each of the reportable units.  On an ongoing basis (absent any impairmentindicators), the Company expects to perform its impairment tests during thefourth quarter.

 

Based on itsinitial impairment tests, the Company recognized a charge of $88,804,000 ($5.24per share) in the first quarter of 2002 to reduce the carrying value ofgoodwill of each of its reporting units to the implied fair value.  This impairment is a result of adopting afair value approach, under SFAS No. 142, to testing impairment of goodwill ascompared to the previous method utilized in which evaluations

 

6

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of goodwill impairmentwere made using the estimated future undiscounted cash flows compared to theassets’ carrying amount.  Under SFAS No.142, the impairment adjustment recognized at adoption of the new rules wasreflected as a cumulative effect of change in accounting principle in the firstquarter 2002 statement of operations. Impairment adjustments recognized after adoption, if any, generally arerequired to be recognized as operating expenses.

 

The carryingamount of goodwill attributable to each reportable operating unit with goodwillbalances and changes therein follows:

 
|       |   | **January 1,  2002** |    | **Impairment  Adjustment** |   | **March 31,  2002** |   |
|------------|--------|----------------------|---------|----------------------------|--------|---------------------|--------|
|       |   | **(in  thousands)**  |    |
|       |   |                 |    |                       |   |                |   |
| Aerospace  |   | $                    | 74,675  |                       | $      | (70,944             | )      | $ | 3,731 |   |
| Industrial |   | 51,252               |    | (17,860                    | )      | 33,392              |   |
|       |   | $                    | 125,927 |                       | $      | (88,804             | )      | $ | 37,123 |   |

 

3.               MANAGEMENT’SPLAN

 

The Company’sconsolidated financial statements for the quarter ended March 31, 2002 havebeen prepared on a going concern basis, which contemplates the realization ofassets and the satisfaction of liabilities in the normal course ofbusiness.  The Company did not make thescheduled April 1, 2002 interest payment on its Senior Subordinated Notes due2009 (the “Notes”) and its credit facility (the “Bank Credit Facility”) matureson May 31, 2002. These conditions raise substantial doubt about the Company’sability to continue as a going concern. The consolidated financial statementsdo not include any adjustments that may result from the outcome of thisuncertainty.

 

A substantial portion ofthe Company’s business involves sales to the aerospace industry.  Primarily as a result of the September 11thevents in New York and Washington, D.C., aerospace manufacturers havesubstantially reduced their business, resulting in decreased business for theCompany.

 

The Company is highlyleveraged and has outstanding $100 million of Notes and approximately $56million of senior secured indebtedness under the Company’s Bank CreditFacility.  The downturn in the Company’sbusiness since September 11th has made it unlikely that it will be able torepay this indebtedness in accordance with its terms.

 

The Company took a numberof steps during the year ended December 31, 2001 to reduce costs.  On April 25, 2001, the Company hired a newChief Executive Officer and subsequently replaced four of its executiveofficers. The Company reduced its workforce by 14% and closed five facilitieswhich are estimated to result in future cost savings of $10 million in 2002.  In addition, the Company restructured themanner in which it purchases its inventory in an effort to increase its annualinventory turns. The Company also evaluated its inventory for excess inventory,primarily in the aerospace group, taking into consideration the downturn inbusiness resulting from the events of September 11th and the number of olderaircraft that have been taken out of use, resulting in an aerospace inventorywrite-down in the fourth quarter of 2001.

 

While the steps taken bythe Company will improve its 2002 operating results, the Company’s level ofindebtedness combined with restrictions imposed on the use of the Bank CreditFacility have resulted in debt service in excess of that which can be servicedby the Company’s current operations. The Company has entered into negotiationswith its lenders, holders of its Notes and other sources of capital torestructure its indebtedness.  On April30, 2002, the Company entered into a Restructuring Agreement (the “RestructuringAgreement”) with holders of a majority of its Notes to effect arecapitalization of the Company. Completion of the transaction contemplated by the RestructuringAgreement would result in

 

7

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the elimination ofbetween $60 and $65 million of debt, thereby reducing pro forma debt toapproximately $95 million compared to approximately $160 million.  The contemplated transaction provides forthe holders of the Notes to receive, in exchange for at least $95 million ofNotes, approximately 90% of the stock of Pentacon and $35 million principalamount of newly-issued senior subordinated notes due 2007.

 

The RestructuringAgreement with Noteholders provides that the transaction may be completedthrough an out-of-court exchange offer or a pre-negotiated Chapter 11bankruptcy proceeding.  An out-of-courtrestructuring will require that holders of 95% of the outstanding Notesparticipate in the exchange offer, and has a number of other conditions.  The Company is currently evaluating thebenefits of seeking to effect the transaction through the out-of-court exchangeoffer or through a Chapter 11 bankruptcy filing.   Because of the numerous contingencies associated with anout-of-court transaction, a Chapter 11 proceeding may prove to be the mostexpeditious way to consummate the Restructuring Agreement.   The agreement with these Noteholdersprovides that, under either restructuring scenario, all trade credit will beassumed and paid in full, which positions the Company to continue to provideuninterrupted service to its customers.

 

The restructuring isconditioned upon a number of factors, including completion and execution  of definitive documentation, completion of certain due diligence by theNoteholders and other conditions.  Inaddition, the Company and the Noteholders have the right to terminate theRestructuring Agreement to pursue an offer to purchase the Company’s stock, itsnotes or its assets if such an offer is deemed to be a superior proposal.  The restructuring is expected to becompleted in the third quarter of 2002. There can be no assurance that the contemplated recapitalization will besuccessful or completed.

 

In addition, the Companyis finalizing an agreement with the lenders under its Bank Credit Facility toextend the maturity of the facility for one year. The proposal is not acommitment by the lenders, and no assurances can be made regarding theCompany’s ability to enter into a new credit facility with the existinglenders.  The Company also has obtaineda commitment from a different senior lender to provide a new $60 million seniorcredit facility which will be available to the Company in the event it does notproceed with the proposed restructuring of its existing facility.

 

Whilethe Company has reached the understandings described above, the followingpoints should be noted.  The Company’slenders under its Bank Credit Facility have notified the Company that it is notin compliance with certain financial covenants under the Bank Credit Facilitythat, if acted upon by the lenders, would give the lenders the right toaccelerate the indebtedness under the Bank Credit Facility and give theNoteholders the right to terminate the restructuring agreement.  The Company and the senior lenders haveentered into a forbearance agreement in which the lenders have agreed not toexercise their remedies under the Bank Credit Facility prior to May 31,2002.  In addition, the scheduledinterest payment date for the Company’s Notes was April 1, 2002.  The Company did not make the interestpayment within the provided-for 30-day grace period, placing its Notes indefault.  As a result, the Notes whichwere previously classified as long-term debt have now been reclassified as acurrent liability.  A default under theNotes is also a default under the Company’s Bank Credit Facility.   The senior lenders have agreed not toexercise their remedies for this default as long as the principal amount of theNotes is not accelerated and declared immediately due and payable.

 

The Company believes thatits improved ongoing operating performance will enable it to successfullyrestructure its indebtedness to a level that can be adequately serviced by itscurrent and anticipated future operations, without materially impacting itsoperations. However, these negotiations involve numerous parties with differentinterests.  Additionally, the events ofSeptember 11th continue to affect the aerospace industry making it difficult toproject future results, and therefore more difficult to attract equitycapital.  No assurances can be giventhat one or more of these factors will not prevent the Company fromsuccessfully restructuring its indebtedness and continuing as a going concern.

 

8

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4.               RESTRUCTURINGAND OTHER CHARGES

 

In November 2001, the Company implemented arestructuring plan to reduce annual operating expenses.  The Company closed five distributionfacilities and implemented workforce reductions.  The Company recognized a $2,620,000 restructuring charge in thefourth quarter relating to implementation of the plan.  In the second quarter of 2001, the Companyrecorded a $967,000 restructuring charge for the relocation of its corporateoffice from Houston, Texas to Chatsworth, California and a $345,000restructuring charge for cost reduction initiatives in the industrial group.

 

Below is theactivity related to the restructuring charges recognized during the threemonths ended March 31, 2002 (amounts in thousands):

 
| **Income Statement Classification** |   | **Description  of Charges** |   | **Balance at  December 31,  2001** |   | **Noncash  Activity (1)** |   | **Cash  Activity** |   | **Balance at  March 31, 2002** |   |
|-------------------------------------|--------|-----------------------------|--------|------------------------------------|--------|---------------------------|--------|--------------------|--------|--------------------------------|--------|
| Restructuring  and other charges    |   | Termination benefit  costs  |   | $                                  | 1,392  |                      | $      | —             |   | $                              | (588   | ) | $ | 804 |   |
| Restructuring  and other charges    |   | Facility costs              |   | 1,622                              |   | (179                      | )      | (67                | )      | 1,376                          |   |
|                                     |        |                             |        |                                    |        |                           |        |                    |        |                                |        |  |  |  |  |

 

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(1)  Thenoncash activity relates to the write-off of leasehold improvements.

 

The Company recognized charges totaling $39,053,000for the write-off of excess inventory during the year ended December 31,2001.  The noncash write-offs of excessaerospace and telecommunications inventory were recorded based upon a review ofthe anticipated reduced future demand for the inventory resulting fromdecreased usage levels.  In addition,certain aerospace inventory was disposed of during the year ended December 31,2001 in order to take advantage of cash flows and tax benefits.  At December 31, 2001, the remainingallowance for this excess inventory was $36,066,000.  During the three months ended March 31, 2002, the Companyrecognized $178,000 as a result of disposing of the inventory to which theallowance related.

 

5.               DEBT

 

In March 1999, theCompany sold $100 million of Notes due April 1, 2009.  The net proceeds of $94.2 million, after the original issuediscount and paying underwriter’s commissions, were used to repay indebtednessunder the Company’s Bank Credit Facility. The Notes accrue interest at 12.25% per annum which is payable on April1 and October 1 of each year. The Notes are publicly-registered andsubordinated to all existing and future senior subordinated obligations andwill rank senior to all subordinated indebtedness.  The indenture governing the Notes contains covenants that limitthe Company’s ability to incur additional indebtedness, pay dividends, makeinvestments and sell assets. Each of the Company’s subsidiaries, which arewholly owned, fully, unconditionally and jointly and severally guarantees theNotes on a senior subordinated basis. At March 31, 2002, the Company was in compliance with the covenants.

 

The Company did not makethe interest payment on the Notes on April 1, 2002.  On April 30, 2002, the Company entered into the RestructuringAgreement with certain holders of a majority of the Notes to exchange the Notesfor new notes and an equity interest in the Company as described in Note3.  As a result, the Company did notmake the interest payment on the Notes due April 1, 2002 within the 30-daygrace period and is in default on the Notes. The Notes have been reclassified as a current liability as a result ofthe default.

 

In March and April of 2002, the Company amended itsBank Credit Facility.  The $65 millionBank Credit Facility is subject to a borrowing base limitation and secured byCompany stock and assets.  Advancesunder the Bank Credit Facility bear interest at the banks’ prime rate plus 100basis points.  Commitment fees of 25 to37.5 basis points per annum are payable on the unused portion of the line of 

 

9

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credit.  The Bank Credit Facility contains aprovision for standby letters of credit up to $20 million.  The Bank Credit Facility prohibits thepayment of dividends by the Company, restricts the Company’s incurring orassuming other indebtedness and requires the Company to comply with certainfinancial covenants.  At March 31, 2002,the Company had approximately $4.6 million of availability under thefacility.  Borrowings under the BankCredit Facility are classified as current liabilities in accordance with EITF95-22 *BalanceSheet Classification of Borrowings Outstanding under Revolving CreditAgreements That Include Both a Subjective Acceleration Clause and a Lock-BoxArrangement.* In addition, the Company has entered into forbearanceagreements with respect to the default on the tangible net worth covenant ofthe facility caused by the restructuring and other charges recognized in thequarter ended December 31, 2001 and not making the April 1, 2002 interestpayment on the Notes.

 

6.               EARNINGS (LOSS) PERSHARE

 

Basic and diluted netincome (loss) per share is computed based on the following information:

 
|                                                |   | **Three  Months Ended March 31,** |    |
|-----------------------------------------------------|--------|-----------------------------------|---------|
|                                                |   | **2002**                          |    | **2001** |   |
|                                                |   | **(in  thousands )**              |    |
| BASIC:                                              |   |                              |    |
|                                                |   |                              |    |   |   |
| Net  income (loss)                                  |   | $                                 | (89,143 | ) | $ | 82 |   |
|                                                |   |                              |    |   |   |
| Average  common shares                              |   | 16,960                            |    | 16,788 |   |
|                                                |   |                              |    |   |   |
| DILUTED:                                            |   |                              |    |   |   |
|                                                |   |                              |    |   |   |
| Net  income (loss)                                  |   | $                                 | (89,143 | ) | $ | 82 |   |
|                                                |   |                              |    |   |   |
| Average  common shares                              |   | 16,960                            |    | 16,788 |   |
|                                                |   |                              |    |   |   |
| Common  share equivalents:                          |   |                              |    |   |   |
| Warrants                                            |   | —                            |    | — |   |
| Options                                             |   | —                            |    | 12 |   |
| Total  common share equivalents                     |   | —                            |    | 12 |   |
| Average  common shares and common share equivalents |   | 16,960                            |    | 16,800 |   |

 

Options to purchase1,081,396 and 1,205,218 shares of common stock were not included in the dilutednet income per share calculation for the three months ended March 31, 2002 and2001, respectively, because the exercise price was greater than the averagemarket price.

 

7.               INCOME TAXES

 

TheJob Creation and Workers Act, which was enacted in March 2002, provides thatnet operating loss carryback claims for the years ended December 31, 2001 and2002 are extended from two years to five years.  As a result, the Company can carryback its $5,696,000 tax losscarryover as of December 31, 2001 and realize $1,659,000 of additional incometax refunds.  The related benefit wasrecorded in the quarter ended March 31, 2002. The Company recorded a valuation allowance against the

 

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tax benefit whichresults from the loss in the quarter ended March 31, 2002 since realization ofthe benefit is not assured.

 

Forthe three months ended March 31, 2001, the provision for income taxes includedin the Consolidated Statements of Operations assumes the application ofstatutory federal and state income tax rates and the non-deductibility ofgoodwill amortization.

 

Interimperiod income tax provisions are based upon estimates of annual effective taxrates and events may occur which will cause such rates to vary.

 

8.               COMMITMENTS ANDCONTINGENCIES

 

The Company is involvedin various legal proceedings that have arisen in the ordinary course ofbusiness.  While it is not possible topredict the outcome of such proceedings with certainty, in the opinion of theCompany, all such proceedings are either adequately covered by insurance or, ifnot so covered, should not ultimately result in any liability which would havea material adverse effect on the financial position, liquidity or results ofoperations of the Company.

 

9.               SEGMENT INFORMATION

 

The Company has twoprincipal operating segments: the Industrial Group and the AerospaceGroup.  The Industrial Group serves abroad base of industrial manufacturers producing items such as diesel engines,locomotives, power turbines, motorcycles, telecommunications equipment, andrefrigeration equipment.  The AerospaceGroup serves the aerospace and aeronautics industries.  Financial information by industry segmentfollows:

 
|                                           |   | **Revenues**                       |   | **Operating Income**               |   |
|------------------------------------------------|--------|------------------------------------|--------|------------------------------------|--------|
|                                           |   | **Three  Months Ended  March 31,** |   | **Three  Months Ended  March 31,** |   |
|                                           |   | **2002**                           |   | **2001**                           |   | **2002** |   | **2001** |   |
|                                           |   | **(in thousands)**                 |   |
|                                           |   |                               |   |                               |   |   |   |   |   |
| Industrial                                     |   | $                                  | 30,236 |                               | $      | 36,348 |   | $ | 2,506 |   | $ | 3,171 |   |
| Aerospace                                      |   | 25,569                             |   | 34,963                             |   | 2,555 |   | 3,422 |   |
|                                           |   |                               |   |                               |   |   |   |   |   |
|                                           |   | $                                  | 55,805 |                               | $      | 71,311 |   | 5,061 |   | 6,593 |   |
|                                           |   |                               |   |                               |   |   |   |   |   |
| Reconciliation  to income (loss) before taxes: |   |                               |   |                               |   |   |   |   |   |
|                                           |   |                               |   |                               |   |   |   |   |   |
| Other  income (expense), net                   |   |                               |   |                               |   | 36 |   | (2 | ) |
| General  corporate expense (1)                 |   |                               |   |                               |   | (2,546 | ) | (1,026 | ) |
| Goodwill  amortization                         |   |                               |   |                               |   | — |   | (864 | ) |
| Interest  expense                              |   |                               |   |                               |   | (4,549 | ) | (4,599 | ) |
|                                           |   |                               |   |                               |   |   |   |   |   |
| Income  (loss) before taxes                    |   |                               |   |                               |   | $ | (1,998 | ) | $ | 102 |   |

 

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(1)  General corporate expense for the threemonths ended March 31, 2002 includes $1,560 of costs related to professionalfees incurred in connection with the Company’s restructuring and workforcereductions.

 

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**ITEM 2.                  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONS**

 

INTRODUCTION

 

The followingdiscussion should be read in conjunction with the financial statements of theCompany and related notes thereto and management’s discussion and analysis offinancial condition and results of operations related thereto which areincluded in the Company’s Annual Report on Form 10-K for the year endedDecember 31, 2001. This discussion contains forward-looking statements that aresubject to certain risks, uncertainties and assumptions.  Should one or more of these risks oruncertainties materialize, or should underlying assumptions prove incorrect,actual results may vary materially from those anticipated, estimated orprojected. Key factors that could cause actual results to differ materially fromexpectations include, but are not limited to: (1) ability to make interest payments on the 12.25% Notes; (2) abilityto arrange for new financing and restructure existing indebtedness; (3)estimates of costs or projected or anticipated changes to cost estimatesrelating to entering new markets or expanding in existing markets; (4) changesin economic and industry conditions; (5) changes in regulatory requirements;(6) changes in interest rates; (7) levels of borrowings under the Company’sBank Credit Facility; (8) accumulation of excess inventories; (9) volume orprice adjustments with respect to sales to major customers; (10) instability inaerospace markets and general economic conditions resulting from the events ofSeptember 11th; (11) instability in the credit markets resulting from theevents of September 11th; (12) deterioration in the credit markets fornon-investment grade borrowers; (13) the ability to reduce cost structure as aresult of a revised business plan, or to effect the revised plan; (14) effectof a revised business plan on our relationships with our customers; (15) lossof sales due to uncertainty about the Company’s financial condition; and (16)loss of credit with vendors due to uncertainty about the Company’s financialcondition.  These and other risks andassumptions are described in the Company’s Annual Report of Form 10-K for theyear ended December 31, 2001.

 

CRITICAL ACCOUNTINGPOLICIES AND ESTIMATES

 

The preparation ofconsolidated financial statements requires the Company to make estimates andjudgments that affect the reported**amounts of assets, liabilities, revenuesand expenses, and related disclosure of contingent assets and liabilities.  On an on-going basis, the Company evaluatesits estimates, including those related to bad debts, inventories, goodwill,income taxes, financing, restructuring, and contingencies and litigation.  The Company bases its estimates onhistorical experience and on various other assumptions that are believed to bereasonable under the circumstances, the results of which form the basis formaking judgments about the carrying values of assets and liabilities that arenot readily apparent from other sources. Actual results may differ from these estimates under differentassumptions or conditions.

 

The Company believes thefollowing critical accounting policies affect its more significant judgmentsand estimates used in the preparation of its consolidated financialstatements.  The Company maintainsallowances for doubtful accounts for estimated losses resulting from theinability of its customers to make required payments.  If the financial condition of the Company’s customers were todeteriorate, resulting in an impairment of their ability to make payments, additionalallowances may be required.  The Companywrites down its inventory for estimated excess or slow-moving quantities equalto the difference between the cost of inventory and the estimated market valuebased upon assumptions about future demand and market conditions.  If actual market conditions are lessfavorable than those projected by management, additional inventory write-downsmay be required.  The Company records avaluation allowance to reduce its deferred tax assets to the amount that ismore likely than not to be realized. While the Company has considered future taxable income and ongoingprudent and feasible tax planning strategies in assessing the need for thevaluation allowance, in the event the Company were to determine that it wouldbe able to realize its deferred tax assets in the future in excess of its netrecorded amount, an adjustment of the deferred tax asset would increase incomein the period such determination

 

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was made.  The Company adopted Statement of FinancialAccounting Standards No. 142 “Goodwill and Other Intangible Assets” effectiveJanuary 1, 2002.  Estimates of futurecash flows, future short-term and long-term growth rates, weighted average costof capital and estimates of market multiples of each reporting unit arerequired in performing the required annual impairment tests.  If market conditions are less favorable thanthose projected by management, additional goodwill write-offs may be required.

 

RESULTS OF OPERATIONS

 

Quarterly resultsmay be materially affected by the timing and magnitude of assimilation costs,costs of opening or closing facilities, gain or loss of a material customer andvariation in product mix.  Accordingly,the operating results for any three-month period are not necessarily indicativeof the results that may be achieved for any subsequent three-month period orfor a full year.

 

THREE MONTH PERIODS ENDEDMARCH 31, 2002 AND 2001

 

The followingtable sets forth certain selected financial data and the related amounts as apercentage of revenues for the periods indicated:

 
|                   |   | **Three  Month Period Ended  March 31,** |   |
|------------------------|--------|------------------------------------------|--------|
|                   |   | **2002**                                 |   | **2001** |   |
|                   |   | **(dollars in thousands)**               |   |
| Revenues               |   | $                                        | 55,805 |   | 100.0 | % | $ | 71,311 |   | 100.0 | % |
| Cost  of  sales   |   | 39,568                                   |   | 70.9 |   | 49,992 |   | 70.1 |   |
| Gross profit           |   | 16,237                                   |   | 29.1 |   | 21,319 |   | 29.9 |   |
|                   |   |                                     |   |   |   |   |   |   |   |
| Operating expenses     |   | 13,722                                   |   | 24.6 |   | 15,752 |   | 22.1 |   |
| Goodwill  amortization |   | —                                   |   | — |   | 864 |   | 1.2 |   |
| Operating  income      |   | $                                        | 2,515  |   | 4.5 | % | $ | 4,703 |   | 6.6 | % |

 

##### Revenues

 

Revenues decreased $15.5 million, or 21.7%, to $55.8million for the three months ended March 31, 2002 from $71.3 million for thethree months ended March 31, 2001.  Thedecrease in revenues was attributable to revenue declines of 26.9% in theaerospace group and 16.8% in the industrial group.  The aerospace group decline primarily relates to the overallreduction in aerospace activity levels caused by the September 11th events inNew York and Washington, D.C. The reduction in industrial group revenues wasprimarily the result of a decline in sales to the heavy-duty truck and telecommunicationsmarkets.

 

##### Cost of Sales

 

Cost of sales decreased $10.4 million, or 20.8%, to$39.6 million for the three months ended March 31, 2002 from $50.0 million forthe three months ended March 31, 2001. As a percentage of revenues, cost of sales increased from 70.1% for thethree months ended March 31, 2001, to 70.9% for the three months ended March31, 2002. Gross margins for the quarter in the industrial group declined in thecurrent year quarter compared to the prior year quarter as a result of lowerpricing on existing contracts.  As aresult of the implementation of the new contracts in the aerospace group, grossmargins declined from the comparable year 2001 quarter. Contract business inthe aerospace group typically carries a lower margin than bid and buy businessbecause the working capital investment is lower.

 

# Operating Expenses

 

Operating expenses decreased $2.1 million, or 13.3%,to $13.7 million for the three months ended March 31, 2002 from $15.8 millionfor the three months ended March 31, 2001. As a percentage of revenues, operating expenses increased from 22.1% forthe three months ended March 31, 2001, to 24.6%

 

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for the three months ended March 31, 2002.  During the quarter ended March 31, 2002, theCompany recognized $1.6 million of costs with respect to its advisors andprofessionals engaged by its lenders and potential lenders and investors andcosts related to additional workforce reductions.  Excluding these charges, operating expenses were $12.1 million,or 21.7%, as a percentage of revenues in the three months ended March 31,2002.  The $3.7 million, or 23.4%,reduction compared to the three months ended March 31, 2001 results from the restructuringactivity in the second and fourth quarters of 2001.

 

##### Operating Income

 

Due to the factors discussed above, operating incomedecreased $2.2 million to $2.5 million for the three months ended March 31,2002 from $4.7 million for the three months ended March 31, 2001.  As a percentage of revenues, operatingincome decreased to 4.5% for the three months ended March 31, 2002 from 6.6%for the three months ended March 31, 2001.

 

Non-Operating Costs andExpenses

 

Interest expense for the three months ended March 31,2002, totaled $4.5 million compared to $4.6 million for the three months endedMarch 31, 2001.  The decrease ininterest expense resulted from both lower debt levels and lower interest rates.

 

Provision for IncomeTaxes

 

The Companyrecorded an income tax benefit of $1.7 million for the three months ended March31, 2002 compared with an income tax provision of $20 thousand (an effectiverate of 19.6%) for the three months ended March 31, 2001. As a result of afirst quarter 2002 change in tax laws extending the tax loss carryback period,the Company can carryback existing tax losses and realize approximately $1.7million of additional income tax refunds.

 

LIQUIDITY AND CAPITALRESOURCES

 

The Company generated$4.6 million of net cash from operating activities during the quarter endedMarch 31, 2002, primarily from working capital improvements. Cash used forcapital expenditures was $0.2 million. Net cash used by financing activities was $4.3 million for the quarterended March 31, 2002 which consisted of net repayments of debt.  At March 31, 2002, the Company had totaldebt of $155.2 million.

 

In March 1999, theCompany sold $100 million of Senior Subordinated Notes (the “Notes”) due April1, 2009.  The net proceeds of $94.2million, after the original issue discount and paying underwriter’scommissions, from the offering of the Notes were used to repay indebtednessunder the Company’s credit agreement (the “Bank Credit Facility”).  The Notes accrue interest at 12.25% perannum which is payable on April 1 and October 1 of each year. The Notes arepublicly-registered and subordinated to all existing and future seniorsubordinated obligations and will rank senior to all subordinatedindebtedness.  The indenture governingthe Notes contains covenants that limit the Company’s ability to incuradditional indebtedness, pay dividends, make investments and sell assets. Eachof the Company’s subsidiaries which are wholly-owned, fully, unconditionallyand jointly and severally guarantees the Notes on a senior subordinated basis.  At March 31, 2002, the Company was incompliance with the covenants.

 

The Company did not makethe interest payment on the Notes on April 1, 2002.  On April 29, 2002, the Company entered into the RestructuringAgreement with certain holders of a majority on the Notes to exchange the Notesfor new notes and an equity interest in the Company as described in Note 3 ofthe Notes to Consolidated Financial Statements.  As a result, the Company did not make the interest payment on theNotes due April 1, 2002 within the 30-day grace period and is in default on theNotes.

 

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The Notes have beenreclassified as a current liability as a result of the default. The Company’sother contractual obligations at March 31, 2002, and the effect suchobligations are expected to have on its liquidity and cash flow in futureperiods, have not changed materially since December 31, 2001.

 

In March and April of 2002, the Company amended itsBank Credit Facility.  The $65 millionBank Credit Facility is subject to a borrowing base limitation and secured byCompany stock and assets.  Advancesunder the Bank Credit Facility bear interest at the banks’ prime rate plus 100basis points.  Commitment fees of 25 to37.5 basis points per annum are payable on the unused portion of the line ofcredit.  The Bank Credit Facilitycontains a provision for standby letters of credit up to $20 million.  The Bank Credit Facility prohibits thepayment of dividends by the Company, restricts the Company’s incurring or assumingother indebtedness and requires the Company to comply with certain financialcovenants.  At March 31, 2002, theCompany had approximately $4.6 million of availability under the facility.  Borrowings under the Bank Credit Facilityare classified as current liabilities in accordance with EITF 95-22 *BalanceSheet Classification of Borrowings Outstanding under Revolving CreditAgreements That Include Both a Subjective Acceleration Clause and a Lock-BoxArrangement.*  In addition,the Company has entered forbearance agreements with respect to the default onthe tangible net worth covenant of the facility caused by the restructuring andother charges recognized in the quarter ended December 31, 2001 and not makingthe April 1, 2002 interest payment on the Notes.

 

The Company’sconsolidated financial statements for the quarter ended March 31, 2002 havebeen prepared on a going concern basis, which contemplates the realization ofassets and the satisfaction of liabilities in the normal course of business.  The Company did not make the scheduled April1, 2002 interest payment on its Notes and the Bank Credit Facility matures onMay 31, 2002. These conditions raise substantial doubt about the Company’sability to continue as a going concern. The consolidated financial statementsdo not include any adjustments that may result from the outcome of thisuncertainty.

 

A substantial portion ofthe Company’s business involves sales to the aerospace industry.  Primarily as a result of the September 11thevents in New York and Washington, D.C., aerospace manufacturers havesubstantially reduced their business, resulting in decreased business for theCompany.

 

The Company is highlyleveraged and has outstanding $100 million of Notes and approximately $56million of senior secured indebtedness under the Company’s Bank CreditFacility.  The downturn in the Company’sbusiness since September 11th has made it unlikely that it will be able torepay this indebtedness in accordance with its terms.

 

The Company took a numberof steps during the year ended December 31, 2001 to reduce costs.  On April 25, 2001, the Company hired a newChief Executive Officer and subsequently replaced four of its executiveofficers. The Company reduced its workforce by 14% and closed five facilitieswhich are estimated to result in future cost savings of $10 million in2002.  In addition, the Companyrestructured the manner in which it purchases its inventory in an effort toincrease its annual inventory turns. The Company also evaluated its inventoryfor excess inventory, primarily in the aerospace group, taking intoconsideration the downturn in business resulting from the events of September11th and the number of older aircraft that have been taken out of use,resulting in an aerospace inventory write-down in the fourth quarter of 2001.

 

While the steps taken bythe Company will improve its 2002 operating results, the Company’s level ofindebtedness combined with restrictions imposed on the use of the Bank CreditFacility have resulted in debt service in excess of that which can be servicedby the Company’s current operations. The Company has entered into negotiationswith its lenders, holders of its Notes and other sources of capital torestructure its indebtedness.  On April30, 2002, the Company entered into the Restructuring Agreement with holders ofa majority of its Notes to effect a recapitalization of the Company.  Completion of the transaction contemplatedby the Restructuring Agreement would result in the elimination of between $60and $65 million of debt, thereby reducing pro forma debt to approximately

 

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$95 million compared toapproximately $160 million.  Thecontemplated transaction provides for the holders of the Notes to receive, inexchange for at least $95 million of Notes, approximately 90% of the stock ofPentacon and $35 million principal amount of newly-issued senior subordinatednotes due 2007.

 

The RestructuringAgreement with Noteholders provides that the transaction may be completed throughan out-of-court exchange offer or a pre-negotiated Chapter 11 bankruptcyproceeding.  An out-of-courtrestructuring will require that holders of 95% of the outstanding Notesparticipate in the exchange offer, and has a number of other conditions.  The Company is currently evaluating thebenefits of seeking to effect the transaction through the out-of-court exchangeoffer or through a Chapter 11 bankruptcy filing.   Because of the numerous contingencies associated with anout-of-court transaction, a Chapter 11 proceeding may prove to be the mostexpeditious way to consummate the Restructuring Agreement.   The agreement with these Noteholdersprovides that, under either restructuring scenario, all trade credit will beassumed and paid in full, which positions the Company to continue to provideuninterrupted service to its customers.

 

The restructuring isconditioned upon a number of factors, including completion and execution  of definitive documentation, completion of certain due diligence by theNoteholders and other conditions.  Inaddition, the Company and the Noteholders have the right to terminate theRestructuring Agreement to pursue an offer to purchase the Company’s stock, itsnotes or its assets if such an offer is deemed to be a superior proposal.  The restructuring is expected to becompleted in the third quarter of 2002. There can be no assurance that the contemplated recapitalization will besuccessful or completed.

 

In addition, the Companyis finalizing an agreement with the lenders under its Bank Credit Facility toextend the maturity of the facility for one year. The proposal is not acommitment by the lenders, and no assurances can be made regarding theCompany’s ability to enter into a new credit facility with the existinglenders.  The Company also has obtaineda commitment from a different senior lender to provide a new $60 million seniorcredit facility which will be available to the Company in the event it does notproceed with the proposed restructuring of its existing facility.

 

Whilethe Company has reached the understandings described above, the followingpoints should be noted.  The Company’slenders under its Bank Credit Facility have notified the Company that it is notin compliance with certain financial covenants under the Bank Credit Facilitythat, if acted upon by the lenders, would give the lenders the right toaccelerate the indebtedness under the Bank Credit Facility and give theNoteholders the right to terminate the Restructuring Agreement.  The Company and the senior lenders haveentered into a forbearance agreement in which the lenders have agreed not toexercise their remedies under the Bank Credit Facility prior to May 31,2002.  In addition, the scheduledinterest payment date for the Company’s Notes was April 1, 2002.  The Company did not make the interestpayment within the provided-for 30-day grace period, placing its Notes indefault.  As a result, the Notes whichwere previously classified as long-term debt have now been reclassified as acurrent liability.  A default under theNotes is also a default under the Company’s Bank Credit Facility.   The senior lenders have agreed not toexercise their remedies for this default as long as the principal amount of theNotes is not accelerated and declared immediately due and payable.

 

The Company believes thatits improved ongoing operating performance will enable it to successfullyrestructure its indebtedness to a level that can be adequately serviced by itscurrent and anticipated future operations, without materially impacting itsoperations. However, these negotiations involve numerous parties with differentinterests.  Additionally, the events ofSeptember 11th continue to affect the aerospace industry making it difficult toproject future results, and therefore more difficult to attract equitycapital.  No assurances can be giventhat one or more of these factors will not prevent the Company fromsuccessfully restructuring its indebtedness and continuing as a going concern.

 

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SEASONALITY ANDINFLATION

 

The Company experiences seasonal declines in thefourth quarter due to declines in its customers’ activities in thatquarter.  The Company’s volume ofbusiness may be adversely affected by a decline in projects as a result ofregional or national downturns in economic conditions. Inflation has not had amaterial impact on the Company’s results of operations.

 

#### **ITEM3.**     QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK

#### ** **

Information contained in Item 3 updates and should beread in conjunction with information set forth in Part II, Item 7a of theCompany’s Annual Report on Form 10-K for the year ended December 31, 2001, inaddition to the interim condensed consolidated financial statements andaccompanying notes presented in Item 1 and 2 of this Form 10-Q.  There are no material changes in the marketrisks faced by the Company from those reported in the Company’s Annual ReportForm 10-K for the year ended December 31, 2001.

 

## **PART II –OTHERINFORMATION**

#### ** **

#### **ITEM6.  EXHIBITS AND REPORTS ON FORM 8-K**

 

(a)   EXHIBITS

 

10.1                           SixthAmendment to Second Amended and Restated Loan and Security Agreement.

10.2                           RestructuringAgreement dated April 30, 2002 among the Company and the holders of a majorityof its Senior Subordinated Notes (incorporated by reference from Exhibit 10.1to the Company’s Form 8-K dated May 2, 2002).

 

(b)   REPORTS ON FORM 8-K

 

#### **TheCompany filed a report on Form 8-K dated May 2, 2002 which included a copy of apress release announcing, among other things, that it had entered into arestructuring agreement with certain holders of a majority of its Notes wherebythe parties agreed to enter into a transaction to significantly deleverage theCompany.  In addition, a copy of therestructuring agreement was included in the filing.**

 

SIGNATURE

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the Registrant has duly caused this report to be signedon its behalf by the undersigned, thereunto duly authorized.

 

 

 
|                                  | PENTACON, INC. |                                            |
|---------------------------------------|----------------|-------------------------------------------------|
|                                  |           |                                            |   |
| Dated:    May 13, 2002 | By:            | /s/ JAMES C. JACKSON                            |   |
|                                  |           | JAMES C. JACKSON                                |
|                                  |           | Vice President &  Controller                |
|                                  |           | (Principal Financial  & Accounting Officer) |

 

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