**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

** **

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**FORM10-Q**

 

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**ýQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**FOR THEQUARTER ENDED JUNE 30, 2002**

 

**OR**

 

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

 

### **For the transition period from                to                **

 

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

 

**PENTACON, INC.**

(Exactname 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 STREETCHATSWORTH, CALIFORNIA 91311**           |
| (Address of principal executive offices)  (Zip Code)       |

 

(Registrant’stelephone number, including area code):** (818) 727-8000**

 

Indicate by check mark whether the Registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that the Registrantwas required to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.  Yes ý       No o

 

Number of shares ofcommon stock of the Registrant, par value $.01 per share, outstanding at July31, 2002 was 16,918,613.

 

 

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**PENTACON, INC.**

**FORM 10-Q FOR THE THREE MONTHS ENDED JUNE 30, 2002**

 

## **INDEX**

 
| Part I – Financial Information |
|-------------------------------------|
|                                |   |   |
|                                | Item 1 – Financial  Statements |   |   |
|                                |   |   |   |
|                                |   | Consolidated Balance Sheets  as of June 30, 2002 and December 31, 2001 |   |
|                                |   |   |   |
|                                |   | Consolidated  Statements of Operations for the Three Months and Six Months ended June 30,  2002 and 2001 |   |
|                                |   |   |   |
|                                |   | Consolidated  Statements of Cash Flows for the Six Months ended June 30, 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 3 –  Defaults Upon Senior Securities |   |   |
|                                |   |   |   |
|                                | Item 6 –  Exhibits and Reports on Form 8-K |   |   |
|                                |   |   |   |
|                                | Signature |   |   |
|                                     |  |  |  |  |  |

 

2

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**PENTACON,  INC.**

## **PART I – FINANCIAL INFORMATION**

 

#### **ITEM 1.  FINANCIALSTATEMENTS**

 

**PENTACON, INC.**

## **CONSOLIDATED BALANCE SHEETS**

 
|                                                                                                                                                 |   | **June 30, 2002**                      |    | **December 31, 2001** |   |
|------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------|---------|-----------------------|--------|
|                                                                                                                                                 |   | **(Unaudited)**                        |    |                  |   |
|                                                                                                                                                 |   | **(in  thousands, except share data)** |    |
| ASSETS                                                                                                                                               |   |                                   |    |                  |   |
| Cash and cash  equivalents                                                                                                                           |   | $                                      | 225     |                  | $      | 49 |   |
| Accounts  receivable                                                                                                                                 |   | 29,038                                 |    | 30,767                |   |
| Inventories                                                                                                                                          |   | 71,674                                 |    | 77,871                |   |
| Refundable  income taxes                                                                                                                             |   | 3,789                                  |    | 2,129                 |   |
| Other current  assets                                                                                                                                |   | 4,470                                  |    | 1,679                 |   |
|                                                                                                                                                 |   |                                   |    |                  |   |
| Total current  assets                                                                                                                                |   | 109,196                                |    | 112,495               |   |
|                                                                                                                                                 |   |                                   |    |                  |   |
| Property and  equipment, net                                                                                                                         |   | 11,382                                 |    | 12,780                |   |
| Goodwill, net                                                                                                                                        |   | 37,123                                 |    | 125,927               |   |
| Other assets                                                                                                                                         |   | 3,827                                  |    | 4,172                 |   |
|                                                                                                                                                 |   |                                   |    |                  |   |
| Total assets                                                                                                                                         |   | $                                      | 161,528 |                  | $      | 255,374 |   |
|                                                                                                                                                 |   |                                   |    |                  |   |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                                           |   |                                   |    |                  |   |
|                                                                                                                                                 |   |                                   |    |                  |   |
| LIABILITIES NOT  SUBJECT TO COMPROMISE:                                                                                                              |   |                                   |    |                  |   |
|                                                                                                                                                 |   |                                   |    |                  |   |
| Accounts payable                                                                                                                                     |   | $                                      | 5,007   |                  | $      | 18,191 |   |
| Accrued expenses                                                                                                                                     |   | 1,626                                  |    | 9,776                 |   |
| Accrued interest                                                                                                                                     |   | —                                 |    | 3,085                 |   |
| Current  maturities of long-term debt                                                                                                                |   | 50,417                                 |    | 60,341                |   |
|                                                                                                                                                 |   |                                   |    |                  |   |
| Total current  liabilities                                                                                                                           |   | 57,050                                 |    | 91,393                |   |
|                                                                                                                                                 |   |                                   |    |                  |   |
| Long-term debt,  net of current maturities                                                                                                           |   | —                                 |    | 99,120                |   |
|                                                                                                                                                 |   |                                   |    |                  |   |
| Total  liabilities not subject to compromise                                                                                                         |   | 57,050                                 |    | 190,513               |   |
|                                                                                                                                                 |   |                                   |    |                  |   |
| LIABILITIES  SUBJECT TO COMPROMISE:                                                                                                                  |   |                                   |    |                  |   |
|                                                                                                                                                 |   |                                   |    |                  |   |
| Accounts payable                                                                                                                                     |   | $                                      | 16,374  |                  | — |   |
| Accrued expenses                                                                                                                                     |   | 6,686                                  |    | —                |   |
| Accrued interest                                                                                                                                     |   | 7,950                                  |    | —                |   |
| Current  maturities of long-term debt                                                                                                                |   | 97,974                                 |    | —                |   |
| Long-term debt,  net of current maturities                                                                                                           |   | 1,366                                  |    | —                |   |
|                                                                                                                                                 |   |                                   |    |                  |   |
| Total  liabilities subject to compromise                                                                                                             |   | 130,350                                |    | —                |   |
|                                                                                                                                                 |   |                                   |    |                  |   |
| Total  liabilities                                                                                                                                   |   | 187,400                                |    | 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, 16,918,613 and 16,960,139  shares issued and outstanding in 2002 and 2001, respectively |   | 169                                    |    | 170                   |   |
| Additional paid  in capital                                                                                                                          |   | 101,354                                |    | 101,322               |   |
| Retained  deficit                                                                                                                                    |   | (127,390                               | )       | (36,643               | )      |
| Accumulated  comprehensive income (loss)                                                                                                             |   | (5                                     | )       | 12                    |   |
|                                                                                                                                                 |   |                                   |    |                  |   |
| Total  stockholders’ equity (deficit)                                                                                                           |   | (25,872                                | )       | 64,861                |   |
|                                                                                                                                                 |   |                                   |    |                  |   |
| Total  liabilities and stockholders’ equity (deficit)                                                                                           |   | $                                      | 161,528 |                  | $      | 255,374 |   |

 

The accompanying notes are an integral part of these statements.

 

3

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**PENTACON, INC.**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**(UNAUDITED**)

 
|                                                                      |   | **Three Months Ended June 30,**       |   | **Six Months Ended June 30,** |   |
|---------------------------------------------------------------------------|--------|---------------------------------------|--------|-------------------------------|--------|
|                                                                      |   | **2002**                              |   | **2001**                      |   | **2002** |   | **2001** |   |
|                                                                      |   | **(in thousands, except share data)** |   |
|                                                                      |   |                                  |   |                          |   |   |   |   |   |
| Revenues                                                                  |   | $                                     | 52,277 |                          | $      | 70,230 |   | $ | 108,082 |   | $ | 141,541 |   |
| Cost of sales                                                             |   | 36,981                                |   | 54,786                        |   | 76,549 |   | 104,778 |   |
| Gross  profit                                                             |   | 15,296                                |   | 15,444                        |   | 31,533 |   | 36,763 |   |
|                                                                      |   |                                  |   |                          |   |   |   |   |   |
| Operating  expenses                                                       |   | 13,951                                |   | 16,148                        |   | 27,673 |   | 31,900 |   |
| Goodwill  amortization                                                    |   | —                                |   | 864                           |   | — |   | 1,728 |   |
|                                                                      |   |                                  |   |                          |   |   |   |   |   |
| Operating income  (loss)                                                  |   | 1,345                                 |   | (1,568                        | )      | 3,860 |   | 3,135 |   |
|                                                                      |   |                                  |   |                          |   |   |   |   |   |
| Other (income)  expense, net                                              |   | (35                                   | )      | (7                            | )      | (71 | ) | (5 | ) |
| Interest expense                                                          |   | 2,985                                 |   | 4,559                         |   | 7,534 |   | 9,158 |   |
|                                                                      |   |                                  |   |                          |   |   |   |   |   |
| Income (loss)  before taxes                                               |   | (1,605                                | )      | (6,120                        | )      | (3,603 | ) | (6,018 | ) |
| Income taxes                                                              |   | —                                |   | (1,181                        | )      | (1,659 | ) | (1,161 | ) |
|                                                                      |   |                                  |   |                          |   |   |   |   |   |
| Income (loss)  before cumulative effect of change in accounting principle |   | (1,605                                | )      | (4,939                        | )      | (1,944 | ) | (4,857 | ) |
|                                                                      |   |                                  |   |                          |   |   |   |   |   |
| Cumulative  effect of change in accounting principle, net of tax          |   | —                                |   | —                        |   | (88,804 | ) | — |   |
|                                                                      |   |                                  |   |                          |   |   |   |   |   |
| Net income  (loss)                                                        |   | $                                     | (1,605 | )                             | $      | (4,939 | ) | $ | (90,748 | ) | $ | (4,857 | ) |
|                                                                      |   |                                  |   |                          |   |   |   |   |   |
| Net income  (loss) per share:                                             |   |                                  |   |                          |   |   |   |   |   |
| Basic                                                                     |   |                                  |   |                          |   |   |   |   |   |
| Before  cumulative effect of change in accounting principle               |   | $                                     | (0.09  | )                             | $      | (0.29 | ) | $ | (0.11 | ) | $ | (0.29 | ) |
| Cumulative effect of  change in accounting principle, net of tax          |   | —                                |   | —                        |   | $ | (5.24 | ) | — |   |
| Net  income (loss)                                                        |   | $                                     | (0.09  | )                             | $      | (0.29 | ) | $ | (5.35 | ) | $ | (0.29 | ) |
| Diluted                                                                   |   |                                  |   |                          |   |   |   |   |   |
| Before  cumulative effect of change in accounting principle               |   | $                                     | (0.09  | )                             | $      | (0.29 | ) | $ | (0.11 | ) | $ | (0.29 | ) |
| Cumulative effect of  change in accounting principle, net of tax          |   | —                                |   | —                        |   | $ | (5.24 | ) | — |   |
| Net  income (loss)                                                        |   | $                                     | (0.09  | )                             | $      | (0.29 | ) | $ | (5.35 | ) | $ | (0.29 | ) |
|                                                                      |   |                                  |   |                          |   |   |   |   |   |
| Reconciliation  of net income (loss) to comprehensive income (loss):      |   |                                  |   |                          |   |   |   |   |   |
| Net income  (loss)                                                        |   | $                                     | (1,605 | )                             | $      | (4,939 | ) | $ | (90,748 | ) | $ | (4,857 | ) |
| Currency  translation adjustment                                          |   | (16                                   | )      | (7                            | )      | (17 | ) | (2 | ) |
| Comprehensive  income (loss).                                             |   | $                                     | (1,621 | )                             | $      | (4,946 | ) | $ | (90,765 | ) | $ | (4,859 | ) |

 

The accompanying notes are an integral part of these statements.

 

4

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**PENTACON, INC.**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(UNAUDITED)**

 
|                                                                                                 |   | **Six Months  Ended  June 30,** |       |
|------------------------------------------------------------------------------------------------------|--------|---------------------------------|------------|
|                                                                                                 |   | **2002**                        | ** ** | **2001** | ** ** |
|                                                                                                 |   | **(in  thousands)**             | ** ** |
| Cash Flows From  Operating Activities:                                                               |   |                            |       |   |   |
| Net  income (loss)                                                                                   |   | $                               | (90,748    | ) | $ | (4,857 | ) |
| Adjustments to  reconcile net income (loss) to net cash provided by (used in) operating  activities: |   |                            |       |   |   |
| Depreciation and  amortization                                                                       |   | 1,707                           |       | 3,444 |   |
| Amortization of  discount on notes                                                                   |   | 102                             |       | 90 |   |
| Deferred income  taxes                                                                               |   | —                          |       | (641 | ) |
| Inventory write  down                                                                                |   | —                          |       | 5,623 |   |
| Write-off of  goodwill                                                                               |   | 88,804                          |       | — |   |
| Changes in  operating assets and liabilities:                                                        |   |                            |       |   |   |
| Accounts  receivable                                                                                 |   | 1,729                           |       | (5,406 | ) |
| Inventories                                                                                          |   | 6,197                           |       | 3,150 |   |
| Refundable  income taxes                                                                             |   | (1,659                          | )          | — |   |
| Other  current assets                                                                                |   | (2,791                          | )          | 236 |   |
| Other assets                                                                                         |   | 349                             |       | 552 |   |
| Accounts payable  and accrued expenses                                                               |   | 6,581                           |       | (2,548 | ) |
| Income taxes  payable                                                                                |   | —                          |       | (805 | ) |
| Net cash  provided by (used in) operating activities                                                 |   | 10,271                          |       | (1,162 | ) |
|                                                                                                 |   |                            |       |   |   |
| Cash Flows From  Investing Activities:                                                               |   |                            |       |   |   |
| Capital  expenditures                                                                                |   | (456                            | )          | (1,981 | ) |
| Other                                                                                                |   | 166                             |       | 67 |   |
| Net cash used in  investing activities                                                               |   | (290                            | )          | (1,914 | ) |
|                                                                                                 |   |                            |       |   |   |
| Cash Flows From  Financing Activities:                                                               |   |                            |       |   |   |
| Repayments of  term debt                                                                             |   | (87                             | )          | (244 | ) |
| Net borrowings  (repayments) under credit facility                                                   |   | (9,718                          | )          | 3,284 |   |
| Net  cash provided by (used in) financing activities                                                 |   | (9,805                          | )          | 3,040 |   |
|                                                                                                 |   |                            |       |   |   |
| Increase  (decrease) in cash and cash equivalents                                                    |   | 176                             |       | (36 | ) |
|                                                                                                 |   |                            |       |   |   |
| Cash and cash  equivalents, beginning of period                                                      |   | 49                              |       | 158 |   |
|                                                                                                 |   |                            |       |   |   |
| Cash and cash  equivalents, end of period                                                            |   | $                               | 225        |   | $ | 122 |   |

 

The accompanying notes are an integral part of these statements.

 

5

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**PENTACON, INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**JUNE 30, 2002**

**(UNAUDITED)**

 

1.               BASIS OFPRESENTATION

 

The consolidatedfinancial statements of Pentacon, Inc. (the “Company”) included herein havebeen prepared without audit pursuant to the Rules and Regulations for reportingon Form 10-Q.  Accordingly, certaininformation and footnotes required by generally accepted accounting principlesfor complete financial statements are not included herein.   The Company believes all adjustmentsnecessary for a fair presentation of these statements have been included andare of a normal and recurring nature. There has been no significant change in the accounting policies of theCompany during the periods presented, with the exception of the adoption of theprovisions of bankruptcy accounting described below and the new accountingpronouncement on accounting for goodwill described in Note 2.  The statements should be read in conjunctionwith the financial statements and related notes thereto included in the Company’sAnnual Report on Form 10-K for the year ended December 31, 2001.

 

The balance sheet atDecember 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.

 

On May 23, 2002, theCompany and certain of its subsidiaries filed voluntary petitions for reliefunder Chapter 11 of the United States Bankruptcy Code with the United StatesBankruptcy Court for the Southern District of Texas.  A substantial portion of the Company’s business involves sales tothe aerospace industry.  Primarily as aresult of the September 11th events in New York and Washington D.C., aerospacemanufacturers substantially reduced their business, resulting in decreasedbusiness for the Company.  In addition,the Company’s senior lenders had imposed restrictions on the Company’s creditavailability.  The downturn in theCompany’s business since September 11th combined with the decrease in creditavailability resulted in the Company being unable to repay its debts inaccordance with stated terms. Therefore, the Company sought protection under Chapter 11 of theBankruptcy Code.  Also on May 23, 2002,the Company entered into an agreement to sell substantially all of its assetsto Anixter International, Inc. (“Anixter”). Under the agreement, Anixter has agreed to assume all pre and postpetition trade accounts payable.  Thesale to Anixter and the Company’s Plan of Reorganization have the support ofthe holders of a majority of the Company’s 12.25% Senior Subordinated Notes(the “Notes”) due April 1, 2009 and the committee of its unsecuredcreditors.  In addition, as of May 23,2002, the Company entered into a $60.5 million debtor-in-possession creditfacility (the “Credit Facility”) with its existing bank group (see Note 4).

 

Prior to the bankruptcyfiling, the Company did not make the $6.1 million interest payment due April 1,2002 under the terms of the Company’s Notes. As of May 23, 2002, the Company discontinued accruing interest on theNotes.  Contractual interest on theNotes for the quarter ended June 30, 2002 was $3.1 million, which is $1.4million in excess of recorded interest expense included in the accompanyingfinancial statements.

 

The Company is in possessionof its properties and assets and continues to manage its business as adebtor-in-possession subject to the supervision of the Bankruptcy Court.  Pursuant to the provisions of the BankruptcyCode, all actions to collect upon any of the Company’s liabilities as of thepetition date or to enforce pre-petition date contractual obligations,including the Notes, were automatically stayed.  Absent approval from the Bankruptcy Court, the Company isprohibited from paying pre-petition obligations.  However, the Bankruptcy Court has approved payment of certainpre-petition liabilities such as employee wages and benefits and certain otherpre-petition obligations.  Additionally,the Bankruptcy Court has approved the retention of legal and financialprofessionals.  As adebtor-in-possession, the

 

6

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Company has the right, subject to Bankruptcy Courtapproval and certain other conditions, to assume or reject any pre-petitionexecutory contracts and unexpired leases. Parties affected by such rejections may file claims with the BankruptcyCourt in accordance with bankruptcy procedures.

 

Although the Chapter 11Bankruptcy filing raises substantial doubt about the Company’s ability tocontinue as a going concern, the accompanying financial statements have beenprepared on a going concern basis.  Thisbasis contemplates the continuity of operations, realization of assets, anddischarge of liabilities in the ordinary course of business.  The statements also present the assets ofthe Company at historical cost and the current intention that they will berealized as a going concern and in the normal course of business.  The Plan of Reorganization could materiallychange the amounts currently disclosed in the financial statements.

 

The accompanyingfinancial statements do not present the amount which may ultimately be paid tosettle liabilities and contingencies which may be allowed in the Chapter 11Bankruptcy cases.  Under Chapter 11Bankruptcy, the right of, and ultimate payment by the Company to pre-petitioncreditors may be substantially altered. This could result in claims being paid in the Chapter 11 Bankruptcyproceedings at less (and possibly substantially less) than 100 percent of theirface value.  At this time, because ofmaterial uncertainties, pre-petition claims are carried at face value in theaccompanying financial statements. Under the Bankruptcy Code, the Company may elect to assume or rejectreal estate leases, employment contracts, personal property leases, servicecontracts and other executory pre-petition contracts, subject to BankruptcyCourt review.  The Company cannotpresently determine or reasonably estimate the ultimate liability that mayresult from claims filed as a result of rejecting leases and contracts, and noprovisions have been made for these items. Moreover, the interests of existing shareholders could, among otherthings, be very substantially diluted or even eliminated.  Further information about the financialimpact of the Chapter 11 Bankruptcy filing is set forth in item 2, Management’sDiscussion and Analysis of Financial Condition and Results of Operations.

 

The Company has preparedand distributed to its creditors a Plan of Reorganization and accompanyingDisclosure Statement which must be voted on by August 28, 2002.  A Plan confirmation hearing is scheduled tobe heard in the United States Bankruptcy Court for the Southern District ofTexas on September 9, 2002.  Theacquisition of Company assets by Anixter is scheduled to close approximatelyeleven days later.  There can be noassurance as to the actual timing for the approval of the Plan ofReorganization by the Bankruptcy Court.

 

*Bankruptcy Accounting:*  Since the Chapter 11 Bankruptcy filings, theCompany has applied the provisions in Statement of Position (“SOP”) 90-7“Financial Reporting by Entities in Reorganization Under the BankruptcyCode.”  SOP 90-7 does not change theapplication of generally accepted accounting principles in the preparation offinancials statements.  However, it doesrequire that the financial statements for periods including and subsequent tofiling the Chapter 11 petition distinguish transactions and events that aredirectly associated with the reorganization from the ongoing operations of thebusiness. The financial statements include reclassifications made to reflectthe liabilities which have been deferred under the Chapter 11 proceedings as“Liabilities Subject to Compromise”.

 

*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.

 

7

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2.               GOODWILL

 

Effective January 1,2002, the Company adopted SFAS No. 142, “Goodwill and Other Intangible Assets,”which establishes new accounting and reporting requirements for goodwill andother intangible assets.  Under SFAS No.142, all goodwill amortization ceased effective January 1, 2002.  Goodwill amortization for the quarter andsix months ended June 30, 2002 would have otherwise been $864,000 and$1,728,000, respectively.  Recordedgoodwill attributable to each of the Company’s reporting units were tested forimpairment by comparing the fair value of each reporting unit with its carryingvalue.  Fair value was determined usingdiscounted cash flows, market multiples and market capitalization.  These impairment tests are required to beperformed upon adoption of SFAS No. 142 and at least annually thereafter.

 

Significant estimatesused in the impairment tests include estimates of future cash flows, futureshort-term and long-term growth rates, weighted average cost of capital andestimates 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 its initialimpairment tests, the Company recognized a charge of $88,804,000 ($5.24 pershare) in the first quarter of 2002 to reduce the carrying value of goodwill ofeach 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 of goodwillimpairment were made using the estimated future undiscounted cash flowscompared to the assets’ carrying amount. Under SFAS No. 142, the impairment adjustment recognized at adoption ofthe new rules was reflected as a cumulative effect of change in accountingprinciple in the first quarter 2002 statement of operations.  Impairment adjustments recognized afteradoption, if any, generally are required to be recognized as operatingexpenses.

 

The carrying amount ofgoodwill attributable to each reportable operating unit with goodwill balancesand changes therein follows:

 
|       |   | **January 1,  2002** |       | **Impairment  Adjustment** |   | **June 30,  2002** |   |
|------------|--------|----------------------|------------|----------------------------|--------|--------------------|--------|
|       |   | **(in  thousands)**  | ** ** |
|       |   |                 |       |                       |   |               |   |
| Aerospace  |   | $                    | 74,675     |                       | $      | (70,944            | )      | $ | 3,731 |   |
| Industrial |   | 51,252               |       | (17,860                    | )      | 33,392             |   |
|       |   | $                    | 125,927    |                       | $      | (88,804            | )      | $ | 37,123 |   |

 

3.               RESTRUCTURING ANDOTHER CHARGES

 

In November 2001,the Company implemented a restructuring plan to reduce annual operatingexpenses.  The Company closed fivedistribution facilities and implemented workforce reductions.  The Company recognized a $2,620,000restructuring charge in the fourth quarter relating to implementation of theplan.  In the second quarter of 2001,the Company recorded a $967,000 restructuring charge for the relocation of itscorporate office from Houston, Texas to Chatsworth, California and a $345,000restructuring charge for cost reduction initiatives in the industrial group.

 

8

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Below is the activity related to the restructuringcharges recognized during the six months ended June 30, 2002 (amounts inthousands):

 
| **Income Statement   Classification** |   | **Description  of Charges** |   | **Unpaid  Balance  at December 31,  2001** |   | **Noncash  Activity (1)** |   | **Cash  Activity** |   | **Unpaid  Balance at  June 30, 2002** |   |
|---------------------------------------|--------|-----------------------------|--------|--------------------------------------------|--------|---------------------------|--------|--------------------|--------|---------------------------------------|--------|
| Restructuring and other charges       |   | Termination benefit costs   |   | $                                          | 1,392  |                      | $      | —             |   | $                                     | (828   | ) | $ | 564 |   |
| Restructuring and other charges       |   | Facility costs              |   | 1,622                                      |   | (179                      | )      | (213               | )      | 1,230                                 |   |
|                                       |        |                             |        |                                            |        |                           |        |                    |        |                                       |        |  |  |  |  |

 

----

(1)          The noncash activity relates to thewrite-off of leasehold improvements.

 

The Companyrecognized charges totaling $39,053,000 for the write-off of excess inventoryduring the year ended December 31, 2001. The noncash write-offs of excess aerospace and telecommunicationsinventory were recorded based upon a review of the anticipated reduced futuredemand for the inventory resulting from decreased usage levels.  In addition, certain aerospace inventory wasdisposed of during the year ended December 31, 2001 in order to take advantageof cash flows and tax benefits.  At December31, 2001, the remaining allowance for this excess inventory was$36,066,000.  During the six monthsended June 30, 2002, the Company recognized $300,000 as a result of disposingof the inventory to which the allowance related.

 

4.               DEBT

 

In March 1999, the Company sold $100 million of Notesdue April 1, 2009.  The net proceeds of$94.2 million, after the original issue discount and paying underwriter’scommissions, were used to repay indebtedness under the Company’s CreditFacility.  The Notes accrue interest at12.25% per annum which is payable on April 1 and October 1 of each year. TheNotes are publicly-registered and subordinated to all existing and futuresenior subordinated 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.

 

The Company did not make the interest payment on theNotes due April 1, 2002 and, as a result, was not in compliance with thecovenants.  On May 23, 2002, the Companyamended the Restructuring Agreement with certain holders of a majority of theNotes whereby the noteholders agreed to support the sale of substantially allthe Company’s assets to Anixter and the Company’s Plan of Reorganization inlieu of finalizing the transaction wherein the Company had agreed with theholders to effect a recapitalization of the Company.

 

As of May 23,2002, the Company entered into a debtor-in-possession Credit Facility.  The $60.5 million Credit Facility is subjectto a borrowing base limitation and secured by Company stock and assets.  Advances under the Bank Credit Facility bearinterest at the banks’ prime rate plus 175 basis points.  The Credit Facility contains a provision forstandby letters of credit up to $2.5 million. The Credit Facility prohibits the payment of dividends by the Company,restricts the Company’s incurring or assuming other indebtedness and requiresthe Company to comply with certain financial covenants.  At June 30, 2002, the Company was incompliance with the covenants and had approximately $9.9 million ofavailability under the facility.

 

5.               EARNINGS (LOSS) PERSHARE

 

Basic and diluted net income (loss) per share iscomputed based on the following information:

 

9

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|                                                |   | **Three  Months Ended  June 30,** |       | **Six Months  Ended  June 30,** |   |
|-----------------------------------------------------|--------|-----------------------------------|------------|---------------------------------|--------|
|                                                |   | **2002**                          |       | **2001**                        |   | **2002** |   | **2001** | ** ** |
|                                                |   | **(in  thousands)**               | ** ** |
| BASIC:                                              |   |                              |       |                            |   |   |   |   |   |
|                                                |   |                              |       |                            |   |   |   |   |   |
| Net income  (loss)                                  |   | $                                 | (1,605     | )                               | $      | (4,939 | ) | $ | (90,749 | ) | $ | (4,857 | ) |
|                                                |   |                              |       |                            |   |   |   |   |   |
| Average common  shares                              |   | 16,943                            |       | 16,906                          |   | 16,951 |   | 16,847 |   |
|                                                |   |                              |       |                            |   |   |   |   |   |
| DILUTED:                                            |   |                              |       |                            |   |   |   |   |   |
|                                                |   |                              |       |                            |   |   |   |   |   |
| Net income  (loss)                                  |   | $                                 | (1,605     | )                               | $      | (4,939 | ) | $ | (90,749 | ) | $ | (4,857 | ) |
|                                                |   |                              |       |                            |   |   |   |   |   |
| Average common  shares                              |   | 16,943                            |       | 16,906                          |   | 16,951 |   | 16,847 |   |
|                                                |   |                              |       |                            |   |   |   |   |   |
| Common share  equivalents:                          |   |                              |       |                            |   |   |   |   |   |
| Warrants                                            |   | —                            |       | —                          |   | — |   | — |   |
| Options                                             |   | —                            |       | 8                               |   | — |   | 11 |   |
| Total common  share equivalents                     |   | —                            |       | 8                               |   | — |   | 11 |   |
|                                                |   |                              |       |                            |   |   |   |   |   |
| Average common  shares and Common share equivalents |   | 16,943                            |       | 16,914                          |   | 16,951 |   | 16,858 |   |

 

Options to purchase 1,018,396, 1,195,218, and 1,175,218shares of common stock were not included in the diluted net income per sharecalculation for the three and six months ended June 30, 2002, three monthsended June 30, 2001 and six months ended June 30, 2001, respectively, becausethe exercise prices were greater than the average market price.

 

6.               INCOME TAXES

 

The Job Creationand Workers Act, which was enacted in March 2002, provides that net operatingloss carryback claims for the years ended December 31, 2001 and 2002 areextended from two years to five years. As a result, the Company can carryback its $5,696,000 tax loss carryoveras of December 31, 2001 and realize $1,659,000 of additional income taxrefunds.  The related benefit wasrecorded in the quarter ended March 31, 2002. The Company recorded a valuation allowance against the tax benefit whichresults from the loss in the six months ended June 30, 2002 since realizationof the benefit is not assured.

 

For the six monthsended June 30, 2001, the provision for income taxes included in the ConsolidatedStatements of Operations assumes the application of statutory federal and stateincome tax rates and the non-deductibility of goodwill amortization.

 

Interim periodincome tax provisions are based upon estimates of annual effective tax ratesand events may occur which will cause such rates to vary.

 

7.               COMMITMENTS ANDCONTINGENCIES

 

The Company is involved in various legal proceedingsthat have arisen in the ordinary course of business.  While it is not possible to predict the outcome of such proceedingswith certainty, in the opinion of the Company, all such proceedings are eitheradequately covered by insurance or, if not so covered, should not ultimatelyresult in any liability which would have a material adverse effect on thefinancial position, liquidity or results of operations of the Company.

 

10

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8.               SEGMENT INFORMATION

 

The Company has two principal operating segments: theIndustrial Group and the Aerospace Group. The Industrial Group serves a broad base of industrial manufacturersproducing items such as diesel engines, locomotives, power turbines,motorcycles, telecommunications equipment, and refrigeration equipment.  The Aerospace Group serves the aerospace andaeronautics industries.  Financialinformation by industry segment follows:

 
|       |   | **Revenues**                     |       |
|------------|--------|----------------------------------|------------|
|       |   | **Three Months Ended  June 30,** |       | **Six Months Ended  June 30,** |   |
|       |   | **2002**                         |       | **2001** |   | **2002** |   | **2001** |   |
|       |   | **(in  thousands)**              | ** ** |
|       |   |                             |       |
| Industrial |   | $                                | 31,383     |   | $ | 33,893 |   | $ | 61,619 |   | $ | 70,241 |   |
| Aerospace  |   | 20,894                           |       | 36,337 |   | 46,463 |   | 71,300 |   |
|       |   |                             |       |   |   |   |   |   |   |
|       |   | $                                | 52,277     |   | $ | 70,230 |   | $ | 108,082 |   | $ | 141,541 |   |

 
|                                           |   | **Operating Income**             |   |
|------------------------------------------------|--------|----------------------------------|--------|
|                                           |   | **Three Months Ended  June 30,** |   | **Six Months Ended  June 30,** |   |
|                                           |   | **2002**                         |   | **2001** |   | **2002** |   | **2001** |   |
|                                           |   | **(in thousands)**               |   |
|                                           |   |                             |   |
| Industrial (1)                                 |   | $                                | 3,047  |   | $ | 2,838 |   | $ | 5,519 |   | $ | 6,009 |   |
| Aerospace (2)                                  |   | 1,414                            |   | (1,693 | ) | 3,969 |   | 1,729 |   |
|                                           |   |                             |   |   |   |   |   |   |   |
|                                           |   | 4,461                            |   | 1,145 |   | 9,488 |   | 7,738 |   |
|                                           |   |                             |   |   |   |   |   |   |   |
| Reconciliation  to income (loss) before taxes: |   |                             |   |   |   |   |   |   |   |
|                                           |   |                             |   |   |   |   |   |   |   |
| Other income  (expense), net                   |   | 35                               |   | 7 |   | 71 |   | 5 |   |
| General  corporate expense (3)                 |   | (3,116                           | )      | (1,849 | ) | (5,628 | ) | (2,875 | ) |
| Goodwill  amortization                         |   | —                           |   | (864 | ) | — |   | (1,728 | ) |
| Interest expense                               |   | (2,985                           | )      | (4,559 | ) | (7,534 | ) | (9,158 | ) |
|                                           |   |                             |   |   |   |   |   |   |   |
| Income (loss)  before taxes                    |   | $                                | (1,605 | ) | $ | (6,120 | ) | $ | (3,603 | ) | $ | (6,018 | ) |
|                                                |        |                                  |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(1)                Industrialoperating income for the three and six months ended June 30, 2002 includescosts of $26 and $61, respectively, related to the Company’s Chapter 11filing.  Industrial operating income forthe three and six months ended June 30, 2001 includes $345 of costs related tocost reduction initiatives.

(2)                Aerospaceoperating income for the three and six months ended June 30, 2001 includes a$5,623 charge related to the write down of inventory.

(3)                General corporateexpense for the three and six months ended June 30, 2002 includes $2,318 and$3,878, respectively, of costs related to professional fees incurred inconnection with the Company’s restructuring, Chapter 11 filing and workforcereductions.  General corporate expensefor the three and six months ended June 30, 2001 includes $967 of costs relatedto the relocation of the corporate office from Houston, Texas to Chatsworth,California.

 

11

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| **ITEM 2.** | **MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND 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 materiallyfrom expectations include, but are not limited to: (1) uncertainties caused bythe Company’s bankruptcy proceedings; (2) ability to consummate the AssetPurchase Agreement with Anixter; (3) estimates of costs or projected oranticipated changes to cost estimates relating to entering new markets orexpanding in existing markets; (4) changes in economic and industry conditions;(5) changes in regulatory requirements;****(6) changes in interest rates; (7) levelsof borrowings under the Company’s bank credit facility; (8) accumulation ofexcess inventories; (9) volume or price adjustments with respect to sales tomajor customers; (10) instability in aerospace markets and general economicconditions resulting from the events of September 11th; (11) instability in thecredit markets resulting from the events of September 11th; (12) deteriorationin the credit markets for non-investment grade borrowers; (13) the ability toreduce cost structure as a result of a revised business plan, or to effect therevised plan; (14) effect of a revised business plan on our relationships withour customers; (15) loss of sales due to the Company’s bankruptcy filing andproposed acquisition of assets by Anixter; and (16) loss of credit with vendorsdue to the Company’s bankruptcy filing and proposed acquisition of assets byAnixter.  These and other risks andassumptions are described in the Company’s Annual Report of Form 10-K for theyear ended December 31, 2001.

 

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

 

The preparation of consolidated financial statementsrequires the Company to make estimates and judgments that affect the reported**amountsof assets, liabilities, revenues and expenses, and related disclosure ofcontingent assets and liabilities.  Onan on-going basis, the Company evaluates its estimates, including those relatedto bad debts, inventories, goodwill, income taxes, financing, restructuring,and contingencies and litigation.  TheCompany bases its estimates on historical experience and on various otherassumptions that are believed to be reasonable under the circumstances, theresults of which form the basis for making judgments about the carrying valuesof assets and liabilities that are not readily apparent from othersources.  Actual results may differ fromthese estimates under different assumptions or conditions.

 

The Company believes the following critical accountingpolicies affect its more significant judgments and estimates used in thepreparation of its consolidated financial statements.  The Company maintains allowances for doubtful accounts forestimated losses resulting from the inability of its customers to make requiredpayments.  If the financial condition ofthe Company’s customers were to deteriorate, resulting in an impairment oftheir ability to make payments, additional allowances may be required.  The Company writes down its inventory forestimated excess or slow-moving quantities equal to the difference between thecost of inventory and the estimated market value based upon assumptions aboutfuture demand and market conditions.  Ifactual market conditions are less favorable than those projected by management,additional inventory write downs may be required.  The Company records a valuation allowance to reduce its deferredtax assets to the amount that is more likely than not to be realized.  While the Company has considered futuretaxable income and ongoing prudent and feasible tax planning strategies inassessing the need for the valuation allowance, in the event the Company wereto determine that it would be able to realize deferred tax assets in the futurein excess of net recorded amounts, an adjustment of the deferred tax assetwould increase income in the period such determination was made.  The Company adopted Statement of FinancialAccounting Standards No. 142 “Goodwill and

 

12

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Other Intangible Assets” effective January 1, 2002.  Estimates of future cash flows, futureshort-term and long-term growth rates, weighted average cost of capital and estimatesof market multiples of each reporting unit are required in performing theannual impairment tests.  If marketconditions are less favorable than those projected by management, additionalgoodwill write-offs may be required. The Company adopted the provisions of Statement of Position 90-7,“Financial Reporting by Entities in Reorganization Under the Bankruptcy Code”as a result of its Chapter 11 Bankruptcy filing.  These provisions do not change the application of generallyaccepted accounting principles in the preparation of financial statements,however it requires that the financial statements for periods including andsubsequent to filing the Chapter 11 petition distinguish transactions andevents that are directly associated with reorganization from the ongoingoperations of the business.  TheCompany’s election to assume or reject real estate leases, employmentcontracts, personal property leases, service contracts and other executorypre-petition contracts could reduce recorded liabilities and future operatingexpenses.

 

RESULTS OF OPERATIONS

 

Quarterly results may be materially affected by thetiming and magnitude of assimilation costs, costs of opening or closingfacilities, gain or loss of a material customer and variation in productmix.  Accordingly, the operating resultsfor any three-month period are not necessarily indicative of the results thatmay be achieved for any subsequent three or six-month period or for a fullyear.

 

THREE MONTH PERIODS ENDED JUNE 30, 2002 AND 2001

 

The following table setsforth certain selected financial data and the related amounts as a percentageof revenues for the periods indicated:

 
|                     |   | **Three  Month Period Ended  June 30,** |       |
|--------------------------|--------|-----------------------------------------|------------|
|                     |   | **2002**                                |       | **2001** |   |
|                     |   | **(dollars  in thousands)**             | ** ** |
| Revenues                 |   | $                                       | 52,277     |   | 100.0 | % | $ | 70,230 |   | 100.0 | % |
| Cost of  sales      |   | 36,981                                  |       | 70.7 |   | 54,786 |   | 78.0 |   |
| Gross  profit            |   | 15,296                                  |       | 29.3 |   | 15,444 |   | 22.0 |   |
|                     |   |                                    |       |   |   |   |   |   |   |
| Operating  expenses      |   | 13,951                                  |       | 26.7 |   | 16,148 |   | 23.0 |   |
| Goodwill  amortization   |   | —                                  |       | — |   | 864 |   | 1.2 |   |
| Operating income  (loss) |   | $                                       | 1,345      |   | 2.6 | % | $ | (1,568 | ) | (2.2 | )% |

 

Revenues

 

Revenues decreased$17.9 million, or 25.5%, to $52.3 million for the three months ended June 30,2002 from $70.2 million for the three months ended June 30, 2001.  The decrease in revenues was attributable torevenue declines of 42.5% in the aerospace group and 7.4% in the industrialgroup.  The aerospace group declineprimarily relates to the overall reduction in aerospace activity levels causedby the September 11th events in New York and Washington, D.C. and lower levelsof sales based upon customer reaction to the Company’s Chapter 11 filing.  The reduction in industrial group revenueswas primarily the result of a decline in sales to the heavy-duty truck andtelecommunications markets.

 

Cost of Sales

 

Cost of salesdecreased $17.8 million, or 32.5%, to $37.0 million for the three months endedJune 30, 2002 from $54.8 million for the three months ended June 30, 2001.  As a percentage of revenues, cost of salesdecreased from 78.0% for the three months ended June 30, 2001, to 70.7% for thethree months ended June 30, 2002. Excluding a $5.6 million charge for the writedown in value of certain aerospace group inventory in the three months endedJune 30, 2001, cost of sales was 70.0% of revenue. As a result of theimplementation of a new freight contract in the aerospace group, gross marginsincreased from the comparable 2001 quarter. Gross margins in the industrial group declined in the current yearquarter compared to the prior year quarter as a result of lower pricing onexisting contracts.

 

13

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# Operating Expenses

 

Operating expensesdecreased $2.1 million, or 13.0%, to $14.0 million for the three months endedJune 30, 2002 from $16.1 million for the three months ended June 30, 2001.  As a percentage of revenues, operatingexpenses increased from 23.0% for the three months ended June 30, 2001, to26.7% for the three months ended June 30, 2002.  During the three months ended June 30, 2002, the Companyrecognized $2.3 million of costs with respect to its advisors and professionalsengaged by the Company,  its lenders andpotential lenders and investors and costs related to additional workforcereductions.  During the three monthsended June 30, 2001, the Company recognized $1.3 million of costs related tothe relocation of its corporate office and cost reduction initiatives in theindustrial group.  Excluding thesecharges, operating expenses were $11.7 million, or 22.4%, as a percentage ofrevenues in the three months ended June 30, 2002 as compared to $14.8 millionor 21.1% as a percentage of revenues in the three months ended June 30,2001.  The $3.1 million, or 20.9%,reduction compared to the three months ended June 30, 2001 results from costreduction initiatives and the restructuring activity in the second and fourthquarters of 2001.

 

Operating Income

 

No goodwillamortization was recognized in the three months ended June 30, 2002 because ofthe adoption of SFAS No. 142 effective January 1, 2002.  Due to the factors discussed above and theabsence of goodwill amortization, operating income increased $2.9 million to$1.3 million for the three months ended June 30, 2002 from a loss of $1.6million for the three months ended June 30, 2001.  As a percentage of revenues, operating income increased to 2.6%for the three months ended June 30, 2002 from a loss of 2.2% for the threemonths ended June 30, 2001.

 

Non-Operating Costs and Expenses

 

Interest expensefor the three months ended June 30, 2002, totaled $3.0 million compared to $4.6million for the three months ended June 30, 2001.  The decrease in interest expense primarily resulted from the lackof interest expense on the Notes subsequent to the Chapter 11 filing and, to alesser extent, lower debt levels and lower interest rates.

 

Provision for Income Taxes

 

The Companyrecorded a valuation allowance against the income tax benefit which resultsfrom the loss for the three months ended June 30, 2002 since realization of thebenefit is not assured. An income tax benefit of $1.2 million (an effectiverate of 19.3%) was recorded for the three months ended June 30, 2001.  The income tax benefit in the prior yearprimarily resulted from the charges taken for aerospace inventory disposals andthe charge for relocating the corporate office.

 

SIX MONTH PERIODS ENDED JUNE 30, 2002 AND 2001

 

The following table setsforth certain selected financial data and the related amounts as a percentageof revenues for the periods indicated:

 
|                   |   | **Six Month Period Ended   June 30,** |       |
|------------------------|--------|---------------------------------------|------------|
|                   |   | **2002**                              |       | **2001** |   |
|                   |   | **(dollars in  thousands)**           | ** ** |
| Revenues               |   | $                                     | 108,082    |   | 100.0 | % | $ | 141,541 |   | 100.0 | % |
| Cost of  sales    |   | 76,549                                |       | 70.8 |   | 104,778 |   | 74.0 |   |
| Gross profit           |   | 31,533                                |       | 29.2 |   | 36,763 |   | 26.0 |   |
|                   |   |                                  |       |   |   |   |   |   |   |
| Operating  expenses    |   | 27,673                                |       | 25.6 |   | 31,900 |   | 22.6 |   |
| Goodwill  amortization |   | —                                |       | — |   | 1,728 |   | 1.2 |   |
| Operating  income      |   | $                                     | 3,860      |   | 3.6 | % | $ | 3,135 |   | 2.2 | % |

 

14

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##### Revenues

 

Revenues decreased$33.4 million, or 23.6%, to $108.1 million for the six months ended June 30,2002 from $141.5 million for the six months ended June 30, 2001.  The decrease in revenues was attributable toa 34.8% revenue decline in the aerospace group and a 12.3% revenue decline inthe industrial group.  The revenuedecrease resulted from a $24.8 million revenue decline in the aerospace groupand an $8.6 million decline in industrial group revenues. The decrease inaerospace group revenues resulted from the overall reduction in aerospaceactivity levels caused by the September 11th events in New York and Washington,D.C. and lower levels of sales based upon customer reaction to the Company’sChapter 11 filing. The reduction in industrial group revenues resulted fromdecreased sales to the heavy-duty truck and telecommunications markets.

 

##### Cost of Sales

 

Cost of salesdecreased $28.3 million, or 27.0%, to $76.5 million for the six months endedJune 30, 2002 from $104.8 million for the six months ended June 30, 2001.  As a percentage of revenues, cost of salesdecreased from 74.0% for the six months ended June 30, 2001, to 70.8% for thesix months ended June 30, 2002. Excluding the $5.6 million charge for the write down in value of certainaerospace group inventory in the six months ended June 30, 2001, cost of saleswas 70.1% of revenue.  As a result ofthe implementation of a new freight contract in the aerospace group, grossmargins increased from the comparable period in 2001.  Gross margins in the industrial group declined in the six monthsended June 30, 2002 as compared to the corresponding prior year period as aresult of lower pricing on existing contracts.

 

##### Operating Expenses

 

Operating expensesdecreased to $27.7 million for the six months ended June 30, 2002 from $31.9million for the six months ended June 30, 2001.  As a percentage of revenues, operating expenses increased from22.6% for the six months ended June 30, 2001, to 25.6% for the six months endedJune 30, 2002.  During the six monthsended June 30, 2002, the Company recognized $3.9 million with respect to costsincurred by advisors and professionals engaged by the Company, its lenders andpotential lenders and investors and costs related to additional workforcereductions.  During the six months endedJune 30, 2001, the Company recognized a $1.0 million charge for the relocationof the corporate office from Houston, Texas to Chatsworth, California and a$0.3 million charge for cost reduction initiatives in the industrialgroup.  Excluding these charges,operating expenses were $23.8 million, or 22.0%, as a percentage of revenues inthe six months ended June 30, 2002 as compared to $30.6 million, or 21.6%, as apercentage of revenues in the six months ended June 30, 2001.  The $6.8 million, or 22.2%, reduction fromthe June 30, 2001 six month period results from cost reduction initiatives andthe restructuring activity in the second and fourth quarters of 2001.

 

##### Operating Income

 

No goodwillamortization was recognized in the six months ended June 30, 2002 because ofthe adoption of SFAS No. 142 effective January 1, 2002.  Due to the factors discussed above and theabsence of goodwill amortization, operating income increased $0.8 million to$3.9 million for the six months ended June 30, 2002 from $3.1 million for thesix months ended June 30, 2001.  As apercentage of revenues, operating income increased to 3.6% for the six monthsended June 30, 2002 from 2.2% for the six months ended June 30, 2001.

 

Non-Operating Costs and Expenses

 

Interest expensefor the six months ended June 30, 2002, totaled $7.5 million compared to $9.2million for the six months ended June 30, 2001.  The decrease in interest expense primarily resulted from

 

15

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the lack of interestexpense on the Notes subsequent to the Chapter 11 filing and, to a lesserextent, lower debt levels and lower interest rates.

 

Income Taxes

 

The Company recorded a valuation allowance against theincome tax benefit which results from the loss for the six months ended June30, 2002 since realization of the benefit is not assured.  During the same period, the Company recordedan income tax benefit of $1.7 million as a result of the first quarter 2002change in tax laws extending the loss carryback period which will enable theCompany to carryback existing tax losses and realize approximately $1.7 millionof additional income tax refunds.  TheCompany recognized an income tax benefit for the six months ended June 30, 2001of $1.2 million (an effective rate of 19.3%).

 

LIQUIDITY AND CAPITAL RESOURCES

 

The Company generated $10.3 million of net cash fromoperating activities during the six months ended June 30, 2002, primarily fromimproved working capital improvements. Cash used for capital expenditures was$0.3 million.  Net cash used byfinancing activities was $9.8 million for the six months ended June 30, 2002which consisted of net repayments of debt. At June 30, 2002, the Company had total debt of $149.8 million.

 

On May 23, 2002, theCompany filed a voluntary petition for relief under Chapter 11 of the UnitedStates Bankruptcy Court for the Southern District of Texas.  A substantial portion of the Company’sbusiness involves sales to the aerospace industry.  Primarily as a result of the September 11th events in New Yorkand Washington D.C., aerospace manufacturers substantially reduced theirbusiness, resulting in decreased business for the Company.  The downturn in the Company’s business sinceSeptember 11th made it unlikely that the Company would be able to repay itsdebts in accordance with stated terms. Therefore, the Company sought protection under Chapter 11 of theBankruptcy Code.  Also on May 23, 2002,the Company entered into an agreement to sell substantially all of its assetsand operations to Anixter.  The sale toAnixter and the Company’s Plan of Reorganization have the support of theholders of a majority of the Company’s Notes. In addition, as of May 23, 2002, the Company entered into a $60.5million debtor-in-possession Credit Facility with its existing bank group (seeNote 4 to the financial statements).

 

Prior to the bankruptcyfiling, the Company did not make the $6.1 million interest payment due April 1,2002 under the terms of the Company’s Notes. As of May 23, 2002, the Company discontinued accruing interest on theNotes.  Contractual interest on theNotes for the quarter ended June 30, 2002 was $3.1 million, which is $1.4million in excess of recorded interest expense included in the accompanyingfinancial statements.

 

The Company is inpossession of its properties and assets and continues to manage its business asa debtor-in-possession subject to the supervision of the Bankruptcy Court.  Pursuant to the provisions of the BankruptcyCode, all actions to collect upon any of the Company’s liabilities as of thepetition date or to enforce pre-petition date contractual obligations,including the Notes, were automatically stayed.  Absent approval from the Bankruptcy Court, the Company isprohibited from paying pre-petition obligations.  However, the Bankruptcy Court has approved payment of certainpre-petition liabilities such as employee wages and benefits and certain otherpre-petition obligations.  Additionally,the Bankruptcy Court has approved the retention of legal and financialprofessionals.  As a debtor-in-possession,the Company has the right, subject to Bankruptcy Court approval and certain otherconditions, to assume or reject any pre-petition executory contracts andunexpired leases.  Parties affected bysuch rejections may file pre-petition claims with the Bankruptcy Court inaccordance with bankruptcy procedures.

 

Although the Chapter 11 Bankruptcyfiling raises substantial doubt about the Company’s ability to continue as agoing concern, the accompanying financial statements have been prepared on agoing concern basis.  This basiscontemplates the continuity of operations, realization of assets, and dischargeof

 

16

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liabilities in the ordinary course of business.  The statements also present the assets ofthe Company at historical cost and the current intention that they will berealized as a going concern and in the normal course of business.  The Plan of Reorganization could materiallychange the amounts currently disclosed in the financials statements.

 

The financial statementsdo not present the amount which may ultimately be paid to settle liabilitiesand contingencies which may be allowed in the Chapter 11 Bankruptcy cases.  Under Chapter 11 Bankruptcy, the right of,and ultimate payment by the Company to pre-petition creditors may besubstantially altered.  This couldresult in claims being paid in the Chapter 11 Bankruptcy proceedings at less(and possibly substantially less) than 100 percent of their face value.  At this time, because of materialuncertainties, pre-petition claims are carried at the Company’s face value inthe accompanying financial statements. Under the Bankruptcy Code, the Company may elect to assume or rejectreal estate leases, employment contracts, personal property leases, servicecontracts and other executory pre-petition contracts, subject to BankruptcyCourt review.  The Company cannotpresently determine or reasonably estimate the ultimate liability that mayresult from rejecting leases and from filing claims for any rejected contracts,and no provisions have been made for these items.  Moreover, the interests of existing shareholders could, amongother things, be very substantially diluted or even eliminated.

 

The Company has preparedand distributed to its creditors a Plan of Reorganization and accompanyingDisclosure Statement which must be voted on by August 28, 2002.  A Plan confirmation hearing is scheduled tobe heard in the United States Bankruptcy Court for the Southern District ofTexas on September 9, 2002.  Theacquisition of Company assets by Anixter is scheduled to close approximatelyeleven days later.  There can be noassurance as to the actual timing for the approval of the Plan ofReorganization by the Bankruptcy Court.

 

SEASONALITY AND INFLATION

 

The Companyexperiences seasonal declines in the fourth quarter due to declines in itscustomers’ activities in that quarter. The Company’s volume of business may be adversely affected by a declinein projects as a result of regional or national downturns in economicconditions. Inflation has not had a material impact on the Company’s results ofoperations.

 

#### **ITEM 3.                  QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**

#### ** **

Informationcontained in Item 3 updates and should be read in conjunction with informationset forth in Part II, Item 7a of the Company’s Annual Report on Form 10-K forthe year ended December 31, 2001, in addition to the interim condensedconsolidated financial statements and accompanying notes presented in Item 1and 2 of this Form 10-Q.  There are nomaterial changes in the market risks faced by the Company from those reportedin the Company’s Annual Report Form 10-K for the year ended December 31, 2001.

 

## **PART II – OTHER INFORMATION**

 

#### **ITEM 3.                  DEFAULTS UPON SENIORSECURITIES**

 

The Company is in default under its 12.25% SeniorSubordinated Notes due April 1, 2009 (the “Notes”).  Interest is due on the Notes on April 1st and October 1st of eachyear.  The Company did not make theinterest payment of $6,125,000 on the Notes due on April 1, 2002 and is indefault on the Notes.  As of August 14,2002, $7,949,839 in interest was due under the Notes.  In addition, the full principal amount of the Notes of$100,000,000 is due and payable.  TheCompany’s Chapter 11 filing also constituted a default under the Notes.  The Chapter 11 filing of the Company mayalso have automatically

 

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accelerated covenants under leases and other agreements which may bedeemed to constitute indebtedness.

#### ** **

#### **ITEM 6.                  EXHIBITS AND REPORTS ON FORM8-K**

 

(a)           EXHIBITS

 

None.

 

(b)  REPORTS ON FORM 8-K

 

#### **The Company filed a report on Form8-K dated May 24, 2002 which included a copy of a press release announcing,among other things, that it had signed an agreement to sell substantially allof its assets and operations to Anixter, filed for protection under Chapter 11in connection with the sale, reached an agreement with the lenders under itsBank Credit Facility to provide debtor-in-possession financing and amended itsrestructuring agreement with certain holders of a majority of its Notes tosupport the sale of the Company.  Inaddition, copies of the Chapter 11 plan of the Company, the asset purchaseagreement with Anixter and the amendment to the restructuring agreement withthe holders of the Notes were included in the filing.**

 

 

SIGNATURE

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.

 
|                                | PENTACON, INC. |                                           |
|-------------------------------------|----------------|------------------------------------------------|
|                                |           |                                           |   |
| Dated:    August 14, 2002 | By:            | /s/ JAMES C. JACKSON                           |   |
|                                |           | JAMES C. JACKSON                               |
|                                |           | Vice President & Controller                |
|                                |           | (Principal Financial & Accounting Officer) |
|                                     |                |                                                |  |  |

 

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