**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

**______________**

**FORM 10-K/A**

**______________**

**(AMENDMENT NO. 2)**

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

For fiscal year ended December 31, 2004                                     Commission File Number 333-19257

______________

**KINETEK, INC.**(Exact name of registrant as specified in charter)

______________

          ** Illinois                                                                                                                   36-4109641**** **(State or other jurisdictionof                                                                                           (I.R.S. Employer   incorporation ororganization)                                                                                        Identification No.)

ArborLake Centre, Suite 550                                                                                                  600151751 Lake Cook Road                                                                                                       (Zip Code)Deerfield, Illinois(Address of Principal Executive Offices)

Registrant’s telephone number, including Area Code:(847) 945-5591 

Securities registered pursuant to Section 12(b) of the Act:

                                                                                                    Name of Each Exchange                                      Title of Each Class                                     On Which Registered                                                None                                                              N/A

Securities registered pursuant to Section 12(g) of the Act:None

        Indicate by checkmark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve (12) months (or for such shorter period that the Registrant was required to filesuch reports) and (2) has been subject to such filing requirements for the past ninety (90) days.

|                       Yes x      No |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

        Indicate by checkmark whether the Registrant is an accelerated filer (as defined in Exchange ActRule 12b-2).

                      Yes         No  x 

        The aggregate market value of voting stock held by non-affiliates of the Registrant is not determinable as such shares were privately placed and there is currently no public market for such shares.

The number of shares outstanding of Registrant’s Common Stock as of March 24, 2005:  10,000.

 

 

**Explanatory Note**

Kinetek, Inc. hereby amends the following items of its Annual Report on Form 10-K for the fiscal year ended December 31, 2004 originally filed with the Securities and Exchange Commission on March 24, 2005 (the “Original 10-K”) as set forth below and inthe pages attached hereto:

        **Item 15(3). Exhibits**

**        Signatures**

Except for the amendments described above, this Amendment No. 2 to the Annual Report on Form 10-K/A does not modify or update other disclosures in, or exhibits to the Original 10-K
| **TABLE OF CONTENTS** |
|-----------------------|
|                  |   |   |   |
|                  |   |   | **Page** |
| **Part I**            |   |   |   |
|                  |   |   |   |
| Item 1.               |   | Business | 3 |
| Item 2.               |   | Properties | 8 |
| Item 3.               |   | Legal Proceedings | 9 |
| Item 4.               |   | Submission of Matters to a Vote of Security Holders | 9 |
|                  |   |   |   |
| **Part II**           |   |   |   |
|                  |   |   |   |
| Item 5.               |   | Market for the Registrant’s Common Equity and Related Stockholder Matters | 9 |
| Item 6.               |   | Selected Financial Data | 10 |
| Item 7.               |   | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 11 |
| Item 7A.              |   | Quantitative and Qualitative Disclosures About Market Risks | 17 |
| Item 8.               |   | Financial Statements and Supplementary Data | 18 |
| Item 9.               |   | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure | 41 |
| Item 9A.              |   | Controls and Procedures | 41 |
|                  |   |   |   |
| **Part III**          |   |   |   |
|                  |   |   |   |
| Item 10.              |   | Directors and Executive Officers | 41 |
| Item 11.              |   | Executive Compensation | 44 |
| Item 12.              |   | Security Ownership of Certain Beneficial Owners and Management | 45 |
| Item 13.              |   | Certain Relationships and Related Transactions | 46 |
| Item 14.              |   | Principal Accountant Fees and Services | 48 |
|                  |   |   |   |
| **Part IV**           |   |   |   |
|                  |   |   |   |
| Item 15.              |   | Exhibits, Financial Statement Schedules, and Reports on Form 8-K | 49 |
|                  |   |   |   |
|                  |   | Signatures | 50 |

 

2

**Part I**

**Item 1.     BUSINESS**

**The Company**

Kinetek, Inc. (the “Company”) was incorporated in the State of Illinois on September 8, 1995 (The Company was incorporated as Motors and Gears, Inc., and changed its name to Kinetek, Inc. on January 8, 2001). On November 1, 1996, the Company effected areincorporation merger whereby MK Group, Inc., an Illinois corporation, was merged with and into the Company, with the Company being the surviving entity. The Company is a direct, wholly-owned subsidiary of Motors and Gears Holdings, Inc., a Delaware corporation(“Parent”). The Parent is a majority owned subsidiary of Jordan Industries, Inc. (“JII”), a private holding company which owns and manages a widely diversified group of operating companies. The Company was organized by JII to acquire andoperate companies in the motors, gears and motion control industries. The Company and its subsidiaries are included in JII’s consolidated financial statements.

        The Company’s principal executive offices are located at ArborLake Centre, Suite 550, 1751 Lake Cook Road, Deerfield, Illinois 60015, and its telephone number is (847)945-5591.

**Business**

        The Company is a manufacturer of specialty purpose electric motors, gearmotors, gearboxes, gears, transaxles and electronic motion controls for a wide variety of consumer, commercial and industrial markets. The Company has a diverse base of customers and itsproducts are used in a broad range of applications including vending machines, golf carts, lift trucks, industrial ventilation equipment, and elevators. The Company competes primarily in the electric motors and electronic motion control systems industries.

**Business Segment Information**

The Company operates in two separate business segments; electric motors (“motors”) and electronic motion control systems (“controls”). See Note 12 to the Company’s consolidated financial statements for financial segment data.

**Products**

        The Company has established itself as a reliable niche manufacturer of high-quality, economical, custom electric motors, gearmotors, gears and electronic motion control systems used in a wide variety of applications including vending machines, refrigerator icedispensers, commercial dishwashers, commercial floor care equipment, golf carts, lift trucks, and elevators. The Company’s products are custom designed to meet specific application requirements. Less than 5% of the Company’s products are sold as stockproducts.

        The Company offers a wide variety of options to provide greater flexibility in its custom designs. These options include thermal protectors, special mounting brackets, custom leads and terminals, single or double shaft extensions, brakes, cooling fans, specialheavy gearing, custom shaft machining and custom software solutions. The Company also provides value-added assembly work, incorporating some of the above options into its final motor and control products. All of the custom-tailored motors, gearmotors and controlsystems are designed for long life, quiet operation, and superior performance.

3

*Electric Motors*

        Electric motors are devices that convert electric power into rotating mechanical energy. The amount of energy delivered is determined by the level of input power supplied to the electric motor and the size of the motor itself. An electric motor can be powered byalternating current (“AC”) or direct current (“DC”). AC power is generally supplied by power companies directly to homes, offices and industrial sites whereas DC power is supplied either through the use of batteries or by converting AC powerto DC power. Both AC motors and DC motors can be used to power most applications; the determination is made through the consideration of power source availability, speed variability requirements, torque considerations, and noise constraints.

        The power output of electric motors is measured in horsepower. Motors are produced in power outputs that range from less than one horsepower up to thousands of horsepower.

*        Subfractional**Motors*. The Company’s subfractional horsepower products are comprised of motors and gearmotors which power applications up to 30 watts (1/25 horsepower). These small, “fist-size” AC and DC motors are used in light dutyapplications such as snack and beverage vending machines, refrigerator ice dispensers and photocopy machines.

*        Fractional/Integral Motors*. The Company’s fractional/integral horsepower products are comprised of AC and DC motors and gearmotors having power ranges from 1/8 to 100 horsepower. Primary end markets for these motors include commercial floor careequipment, commercial dishwashers, commercial sewing machines, industrial ventilation equipment, golf carts, lift trucks and elevators.

*        Gears and Gearboxes*. Gears and gearboxes are mechanical components used to transmit mechanical energy from one source to another source. They are normally used to change the speed and torque characteristics of a power source such as an electric motor. Gearsand gearboxes come in various configurations such as helical gears, bevel gears, worm gears, planetary gearboxes, and right-angle gearboxes. For certain applications, an electric motor and a gear box are combined to create a gearmotor.

        The Company’s precision gear and gearbox products are produced in sizes of up to 16 inches in diameter and in various customized configurations such as pump, bevel, worm and helical gears. Primary end markets for these products include original equipmentmanufacturers (“OEMs”) of motors, commercial floor care equipment, aerospace and food processing product equipment.

*Electronic Motion Control Systems*

        Electronic motion control systems are assemblies of electronic and electromechanical components that are configured in such a manner that the systems have the capability to control a range of elevators. The components utilized in an elevator control system aretypically electric motor drives (electronic controls that vary the speed and torque characteristics of electric motors), programmable logic controls (“PLCs”), transformers, capacitors, switches and software to configure and control the system.

4

**Acquisitions**

        See Note 1 to the notes to consolidated financial statements in Item 8 for a description of acquisitions made during the three year period ended December 31, 2004.

**Backlog**

        The Company’s approximate backlog of unfilled orders at the dates specified was as follows:

| **Year EndedDecember 31,** |   | **Backlog(Dollars inthousands)** |
|----------------------------|--------|----------------------------------|
|                       |   |                             |
| 2004                       |   |                             |
| Motors                     |   | $43,514                          |
| Controls                   |   | 37,250                           |
|                       |   | $80,764                          |
|                       |   |                             |
| 2003                       |   |                             |
| Motors                     |   | $42,002                          |
| Controls                   |   | 37,884                           |
|                       |   | $79,886                          |

         The Company believes it will ship substantially its entire 2004 year-end backlog during 2005.

**Marketing and Support Services**

        The Company’s sales and marketing success is characterized by long-term customer relationships which are the result of continuity of management, outstanding delivery records, high-quality products, and competitive pricing. The Company utilizes a combinationof direct sales personnel and manufacturers’ representatives to market the Company’s product lines. Generally, the inside sales organization is compensated through a fixed salary while the manufacturers’ representative organizations receivecommission.

        National account managers serve large national original equipment manufacturers/OEM’s such as General Electric, Whirlpool and the Raymond Corporation. More than 95% of the Company’s sales are to OEM customers. However, the Company has a distributionprogram with three distributors in its subfractional horsepower product line to increase coverage and generate more revenue growth.

        The Company’s motion control systems business is served primarily through internal sales and marketing professionals as well as independent representatives. The Company continues to add sales talent to this product group in order to expand its presence intoadditional motion control markets.

        The Company’s advertising efforts consist of specific product literature which is printed and provided to customers as applications are developed. In addition, the Company attends various trade shows to market products and to stay abreast of industry trends.It also advertises in trade magazines on a periodic basis.

5

**International Operations**

        The Company currently operates seven manufacturing, research and development, distribution and warehousing facilities in Europe and one manufacturing facility in Mexico. In addition, the Company has an 80% ownership interest in a Chinese joint venture that wasformed in April 2002. For financial information about geographic area, see Note 13 to the Company’s consolidated financial statements.

**Employee and Labor Relations**

        As of December 31, 2004, the Company employed 2,631 employees, of which 1,447 were non-union and 1,184 were represented by unions. The Company has experienced no work stoppages since inception. It considers its relations with its employees to be good.

**Competition**

        The electric motor and electronic motion control systems markets are highly fragmented with a multitude of manufacturing companies servicing numerous markets. Motor manufacturers range from small local producers serving a specific application or end user, to highvolume manufacturers offering general-purpose “off the shelf” motors to a wide variety of end users. While there are numerous manufacturers of gears and gearboxes that service a wide variety of industries and applications, the Company competes in certainniche markets.

        The Company’s motion control systems business competes primarily within the automated conveyor system controls market and sells to conveyor manufacturers that serve the automotive manufacturing industry and the elevator modernization market. These nichemarkets consist of four to five major competitors.

        The principal competitive factors in the electric motor and electronic motion control systems markets include price, quality and service. Major manufacturers include General Electric, Baldor Electric Company, Emerson Electric Company and Reliance Electric Company;however, the Company generally competes with smaller, specialized manufacturers. Many of the major motor manufacturers have substantially greater assets and financial resources than the Company does.

**Raw Materials and Suppliers**

        The primary raw materials used by the Company to produce its products are steel, copper, and miscellaneous purchased parts such as endshield castings, powdered metal gears, commutators, electronic components and packaging supplies. All materials are readilyavailable in the marketplace. The Company is not dependent upon any single supplier in its operations for any materials essential to its business or not otherwise commercially available to the Company. The Company has been able to obtain an adequate supply of rawmaterials, and no shortage of raw materials is currently anticipated. Surcharges and/or raw material price escalation clauses are often used to insulate the Company from fluctuations in prices.

6

**Intellectual Property**

        The Company’s patents and trademarks taken individually, and as a whole, are not critical to the ongoing success of its business. The proprietary nature of the Company’s products is attributable to the custom application designs for particularcustomers’ needs rather than attributable to proprietary patented or licensed technology.

**Environmental Regulation**

        The Company is subject to a variety of U.S. Federal, state, provincial, local and foreign governmental regulations related to the storage, use, emission, discharge and disposal of toxic, volatile or otherwise hazardous materials used in its manufacturingprocesses. Moreover, the Company anticipates that such laws and regulations will become increasingly stringent in the future. Because of our efforts to monitor and maintain compliance and track changes in the laws and regulations, the Company does not currentlyanticipate any material adverse effect on its business, financial condition or results of operations as a result of compliance with U.S. Federal, state, provincial, local or foreign environmental laws or regulations or remediation costs. However, some risk ofenvironmental liability and other costs is inherent in the nature of the Company’s business. For example, pursuant to the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended, the Company could be responsible for thenecessary costs of responding to any current, or previously undiscovered, releases of hazardous substances at our facilities or from those to which we send wastes. In addition, any failure by the Company to obtain and maintain permits that may be required formanufacturing operations could subject the Company to suspension of its operations. Such liability or suspension of manufacturing operations could have a material adverse effect on the Company’s results of operations and financial condition.

        Soils and groundwater contaminated by historic waste handling practices at the FIR property in Casalmaggiore, Italy is the subject of an investigation and remediation under the review of government authorities. In connection with the FIR Acquisition, the Companyobtained indemnification from the former owners for this investigation and remediation.

7

**Item****2.      PROPERTIES**

        The Company’s headquarters are located in an approximately 37,400 square foot office space in Deerfield, Illinois that is provided by JII and for which we are allocated certain charges. (See Item 13 “Certain Relationships and RelatedTransactions”).

        The principal properties of the Company, the location, the primary use, the square feet and the ownership status thereof as of December 31, 2004, are set forth in the table below:
| **Location**            | **Use**                                 | **SquareFeet** |   | **Owned/Leased** | **LeaseExpiration** |
|-------------------------|-----------------------------------------|----------------|--------|------------------|---------------------|
|                    |                                    |           |   |             |                |
| Des Plaines, IL         | Design/Administration                   | 38,000         |   | Leased           | March 2007          |
| Darlington, WI          | Manufacturing                           | 68,000         |   | Leased           | September 2005      |
| Richland Center, WI     | Manufacturing                           | 45,000         |   | Leased           | September 2006      |
| Des Plaines, IL         | Administration/Manufacturing            | 52,000         |   | Leased           | December 2008       |
| San Luis Potosi, Mexico | Manufacturing                           | 46,000         |   | Leased           | December 2009       |
| Shunde, Guangdong, PRC  | Manufacturing/Administration            | 926,000        |   | Owned            |                |
| Akron, OH               | Manufacturing                           | 106,000        |   | Leased           | August 2005         |
| Middleport, OH          | Manufacturing                           | 85,000         |   | Owned            |                |
| Alamagordo, NM          | Manufacturing                           | 40,200         |   | Leased           | February 2005       |
| Grand Rapids, MI        | Manufacturing/Administration            | 45,000         |   | Owned            |                |
| Perry, OH               | Research & Development              | 5,000          |   | Leased           | September 2005      |
| Solon, OH               | Manufacturing/Administration            | 66,500         |   | Leased           | November 2008       |
| Casalmaggiore,Italy     | Administration/Manufacturing            | 100,000        |   | Owned            |                |
| Varano, Italy           | Manufacturing                           | 30,000         |   | Owned            |                |
| Bedonia, Italy          | Manufacturing                           | 8,000          |   | Leased           | March 2005          |
| Genova, Italy           | Research &Development/Manufacturing | 33,000         |   | Leased           | July 2008           |
| Reggio Emilia, Italy    | Manufacturing/Distribution              | 30,000         |   | Leased           | June 2011           |
| Syracuse, NY            | Manufacturing                           | 18,500         |   | Leased           | January 2008        |
| Eternoz, France         | Manufacturing/Administration            | 19,000         |   | Leased           | December 2011       |
| Syracuse, NY            | Manufacturing/Administration            | 49,600         |   | Owned            |                |
| Putzbrunn, Germany      | Warehouse                               | 1,200          |   | Leased           | July 2005           |
| Troy, MI                | Manufacturing/Administration            | 33,000         |   | Leased           | November 2005       |
| Rancho Cordova, CA      | Manufacturing/Administration            | 108,300        |   | Leased           | March 2011          |
| Glendale, NY            | Manufacturing/Administration            | 11,200         |   | Leased           | March 2005          |
| New York, NY            | Sales                                   | 600            |   | Leased           | May 2005            |
|                    |                                    |           |   |             |                |

         The Company believes that its existing leased facilities are adequate for the operations of the Company and its subsidiaries. The Company does not believe that any single leased facility is material to its operations and that, if necessary, it could readily obtaina replacement facility.

8

**Item 3.       LEGAL PROCEEDINGS**

        The Company is not a party to any pending legal proceeding the resolution of which, the management of the Company believes, would have a material adverse effect on the Company’s results of operations or financial condition, nor to any other pending legalproceedings other than ordinary, routine litigation incidental to its business.

**Item 4.       SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

        No matters were submitted to a vote of security holders during the fiscal year ended December 31, 2004.

**PART II**

**Item 5.       MARKET FOR THE REGISTRANT’S COMMON EQUITY AND RELATED                   STOCKHOLDER MATTERS**

        The only authorized, issued and outstanding class of capital stock of the Company is common stock. There is no established public trading market for the Company’s common stock. At December 31, 2004, the Parent held all common stock of the Company.

        The Company has not declared or paid any cash dividends on its common stock since the Company’s formation in September 1995. The Indentures with respect to the 10 3/4% Senior Notes due 2006, the 5% Senior Secured Notes due 2007, and the 10% Senior SecuredNotes due 2007 contain restrictions on the Company’s ability to declare or pay dividends on its common stock. The Indentures also prohibit the declaration or payment of any dividends or the making of any distribution by the Company or any Restricted Subsidiary(as defined in the Indentures).

9

               **Item 6.        SELECTED FINANCIAL DATA**

        The following table presents selected financial information derived from  the Company’s financial statements. Such amounts have been restated to reflect  ED&C as a discontinued operation for all periods presented.

| ** **
** **
**(Dollars in thousands)**
**Year Ended December 31,**
** **
** **
** **
**2004**
**2003**
**2002**
**2001**
**2000** Statement of Operations      Data:  (1)        Net Sales
$313,867
$278,309
$274,818
$278,872
$307,656 Gross profit, excluding         depreciation
101,625
96,130
99,135
102,632
116,239  
 
 
 
 
    Depreciation
5,487
6,721
6,577
6,023
6,055   Amortization
134
169
408
8,491
8,864   Operating income
34,153
30,048
38,347
37,226
52,168   Interest expense
35,592
34,876
35,231
32,173
33,175   Income tax expense  (benefit)
6,991
5,721
11,575
4,666
9,435   Income (loss) from  continuing operations(2)
        (7,880)
(10,541)
(7,552)
746
9,465  
 
 
 
 
  Balance sheet data (at         end of period): (1)
 
 
 
 
    Working capital
65,781
70,503
62,260
66,895
35,904   Total assets
373,448
362,488
363,506
359,415
361,082   Long-term debt  including          current        portion
317,068
307,626
309,115
304,905
308,801   Stockholder’s equity (net   capital        deficiency)
(25,236)
(15,530)
(14,957)
10,684
7,139 ** **** **
** **
** **
** **
** ** 
**(1)          ** The Company has acquired a diversified group of operating companies over the five-year  period, which                significantly affects the comparability of the information shown.

**(2)          ** The Company’s operating income and loss from continuing operations for 2000 reflects a $14,636 write-down                of goodwill relating to one of its businesses.

10
**Item 7.        MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION                    ANDRESULTS OF OPERATIONS**
**Overview**

        The following discussion and analysis of the Company’s results of operations and of its liquidity and capital resources should be read in conjunction with the financial statements and the related notes thereto appearing elsewhere in this annual report.

**Forward-Looking Statements**

        This report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. The statement regarding the Company in this document that are not historical innature, particularly those that utilize terminology such as “may”, “will,” “should,” “likely,” “expects,” “anticipates,” “estimates,” “believes” or “plans,” orcomparable terminology, are forward-looking statements based on current expectations about future events, which the Company has derived from information currently available. These forward-looking statements involve known and unknown risks and uncertainties that maycause our results to be materially different from results implied in such forward-looking statements. Those risks include, among others, risks associated with the industry in which the Company operates, the dependence on senior management, maintaining sufficientworking capital financing, competitive pressures, general economic conditions and a softening of consumer acceptance of the Company’s products leading to a decrease in anticipated revenue and gross profit margins.

**Acquisitions**

        Information regarding acquisitions made by the Company during the three year period ended December 31, 2004 is included in Note 1 to the notes to financial statements. The results of acquired operations are included in the Company’s consolidated results fromthe respective date of acquisition.

**Consolidated Results of Operations**

        The following financial information presents the consolidated results of operations of the Company for the years ended December 31, 2004, 2003 and 2002.
**(Dollars in thousands)****Year Ended December 31,**
 

** 2004**
 
** 2003**
 
** 2002**

 

 

Motors

$230,372
 
$201,654
 
$202,432

Controls

83,495    
 
76,655
 
72,386    

**Net sales**

$313,867
 
$278,309
 
$274,818

 

 
 
 
 
 

Motors

$68,609
 
$65,486
 
$68,801

Controls

33,016
 
30,644
 
30,334

**Gross profit (excluding depreciation)**

$101,625
 
$96,130
 
99,135

 

 
 
 
 
 

Motors

$35,858
 
$35,458
 
$39,496

Controls

10,571
 
8,686
 
10,660

Corporate Expenses

(12,276)
 
(14,096)
 
(11,809)

**Operating income**

$34,153
 
$30,048
 
38,347

 

 
 
 
 
 

**Interest expense**

35,592
 
34,876
 
35,231

 

 
 
 
 
 

Gross profit (excluding depreciation) (1)

32.4%
 
34.5%
 
36.1%

Operating margin (1)

10.9
 
10.8
 
14.0

(1)       All margins are calculated as a percentage of net sales.

**11**

**Year ended December 31, 2004 compared to year ended December 31, 2003**

Consolidated net sales increased $35.6 million, from $278.3 million in 2003 to $313.9 million in 2004, a gain of 12.8 %. The increased sales were driven by the introduction of new products and net gains in market share, which contributed approximately $20.0million, and improvements in the Company’s principal markets in North America and Europe, which account for approximately $8.4 million in increased sales. The continued revaluation of the Euro against the dollar during 2004 caused a $4.5 million improvement insales due to the favorable translation impact on the Company’s European businesses. The acquisition of O. Thompson (see Note 1 to “Notes to Consolidated Financial Statements”) contributed $4.3 million in sales since the acquisition date. The netimpact of increases and decreases in selling prices is estimated to reduce sales from the prior year by approximately $1.6 million, reflecting the competitive global market for the Company’s core products.

Sales in the Company’s Motors segment increased from $201.7 million in 2003 to $230.4 million in 2004, a gain of $28.7 million, or 14.2 %. Subfractional motor sales increased $3.7 million on the strength of an improved market for products used in consumerrefrigeration appliances, the partial year impact of a new ice crusher product sold to a major appliance manufacturer, and numerous share gains in smaller product categories. These gains were partly offset by the loss of “value-added subassembly” icecrusher products sold to several key refrigeration customers, for whom the Company continues to supply the ice crusher motor. Sales of fractional and integral motors increased $25.0 million on significant gains in market share and the sale of new products used incommercial floor care, and recovery in the markets for material handling and golf car motor products. The Company’s European markets remained difficult during 2004, with sales down 4.6% from 2003, due to general market conditions and the impact of net sharelosses. The European sales declines were more than offset by the aforementioned increase in sales due to favorable Euro translation. Sales of the Company’s products in China have benefited from that country’s overall market strength and from share gainsin elevator motors as the Company expands its market presence geographically.

Sales in the Company’s Controls segment increased $6.8 million, to $83.5 million in 2004, an increase of 8.9% from $76.7 million in the prior year. The increase in sales was led by the inclusion of the partial year sales of O. Thompson (see Note 1 to“Notes to Consolidated Financial Statements”), which contributed $4.3 million in sales. Sales of elevator controls and accessory products increased $2.5 million, led by higher sales of the “I” family of control products, the SmarTraq dooroperator system, and other non-controller products.

Consolidated operating income increased to $34.2 million in 2004, an increase of $4.1 million, or 13.7%, from $30.0 million in 2003. Gross profit increased to $101.6 million (32.4% of net sales), from the prior year level of $96.1 million, (34.5% of net sales).The increase in gross profit is mainly attributable to the increases in sales described above. The impact of higher sales is partly offset by the unfavorable impact of net reductions in selling prices resulting from global market competition (approximately $1.6million) and higher prices for purchased components and services, particularly steel, copper, zinc, aluminum, and freight. Gross margin as a percentage of sales declined in 2004 due to the impacts of net selling price reductions, purchase cost inflation, and the

12

 introduction of certain new products and share gains at competitive margins which are lower than the Company’s historical average. Selling, general, and administrative expenses (“SG&A”) increased from $56.3 million in 2003 to $58.7 million.SG&A increased modestly in line with the increases in sales, and from costs associated with the relocation of operations of the Grand Rapids, MI, Des Plaines, IL, and Oakwood Village, OH facilities. These increases were offset in part by a $1.3 million reductionof charges under the Transition Agreement (see Item 13 “Certain Relationships and Related Transactions”), and a one-time charge of $1.0 million in 2003 for excess medical claims incurred by the Company’s subsidiaries during 2001 and 2002.

**Year ended December 31, 2003 compared to year ended December 31, 2002**

Consolidated net sales increased $3.5 million or 1.3% from $274.8 million in 2002 to $278.3 million in 2003. The sales variance is primarily due to the impact of the stronger Euro on translation of European sales ($6.9 million increase) and the net impact ofmarket share gains and losses ($10.6 million increase) resulting from the Company’s introduction of new products to the market. These gains were offset in part by the protracted sluggish economies in North America and Europe, which continued to depress revenuesin most of the company’s key market segments, for a revenue decline of $11.3 million. Pricing pressure throughout the Company’s product lines resulted in a $2.7 million reduction in net sales.

Sales of the Company’s Motors segment declined to $201.7 million in 2003 from $202.4 million in 2002, a decline of 0.4%. Subfractional motor sales declined by 0.6% compared to 2003, as market driven declines concentrated in the vending and appliance productlines, plus the loss of “value-added subassembly” manufacturing for certain appliance customers, were nearly replaced by the introduction of new products and share gains in other markets, such as medical, restaurant, and commercial refrigeration. Sales ofFractional/Integral motor products declined 0.3% from 2002. The variance was driven by general economic softness in markets for motors used in commercial floor care, golf car, elevator, and other applications. These declines were almost offset by net gains fromchanges in market share and new product introductions in floor care and elevator markets, and the translation impact on European sales described above.

Sales of the Company’s Controls segment increased to $76.7 million in 2003, from $72.4 million in 2002, an increase of $4.3 million, or 5.9%. The increase is the result of recovery in the market for elevator control products and product line extensions inthe elevator modernization market.

Consolidated operating income declined 21.6%, from $38.3 million in 2002 to $30.0 million in 2003. Gross profit decreased from $99.1 million in 2002 (36.1% of sales) to $96.1 million in 2003 (34.5% of sales). The decrease in gross profit is primarily due to theaforementioned price reduction and shifts in the mix of sales among the Company’s product lines, some of which result from the high level of new product introductions. Selling, general, and administrative expenses increased to $56.3 million in 2003 from $50.9million in 2002. The increase is driven by increases in corporate overhead costs allocated to the Company as discussed under Note 10, “Related Party Transactions”, a one-time charge of $1.0 million in 2003 for excess medical insurance claims incurred bythe Company’s subsidiaries during 2001 and 2002, and increased development and marketing costs for the company’s next-generation elevator control in anticipation of broad market introduction in 2004.

13

**Liquidity and Capital Resources**

        In general, the Company requires liquidity for working capital, capital expenditures, interest, taxes, debt repayment and its acquisition strategy. Of primary importance are the Company’s working capital requirements, which increase whenever the Companyexperiences strong incremental demand or geographical expansion. The Company expects to satisfy its liquidity requirements through a combination of funds generated from operating activities and the funds available under the Credit Agreement.

        Operating activities. Net cash used by operating activities for the year ended December 31, 2004 was $3.3 million, compared to $6.8 million used during the year ended December 31, 2003. The improvement in cash from operating activities is mainly a result ofthe Company’s higher operating performance discussed above, as well as improved working capital management, particularly from increased accounts payable. This was offset in part by increases in accounts receivable and inventories which were larger during 2004than in 2003 as a result of the higher level of sales.

        Investing activities. Net cash used in investing activities was $4.4, $4.1 and 13.4 million in 2004, 2003 and 2002, respectively. Cash used in investing activities in 2004 included the acquisition of the significant net assets of O. Thompson, which isdetailed in Note 1 of the Consolidated Financial Statements. The remaining use of cash is related to capital expenditures. Cash used in investing activities in 2002 reflects the formation of Kinetek De Sheng for $8.6 million, and $4.7 million for net capitalexpenditures.

        Financing activities. Net cash provided by (used in) financing activities was $8.9, $($1.9) and ($5.7) million in 2004, 2003 and 2002 respectively.

        On April 12, 2002, Kinetek Industries, Inc., a wholly-owned subsidiary of the Company, issued $15 million principal amount of 5% Senior Secured Notes and $11 million principal amount of 10% Senior Secured Notes for net proceeds of approximately $20.5 million. Thenet proceeds were used for the formation of Kinetek De Sheng and for the Company’s ongoing operations. The Company’s annual cash interest expense on the Secured Senior Notes, which are due May 1, 2007, is approximately $1.8 million. Interest on theSecured Senior Notes is payable semi-annually on May 1 and November 1 of each year.

        The Company’s annual cash interest expense on the 103⁄4% Senior Notes, which are due November 15, 2006, is approximately $29.0 million. Interest on the Senior Notes is payable semi-annually on May 15 and November 15 of each year.

        The Company’s Loan and Security Agreement (Credit Agreement), is in the form of a revolving credit facility and provides for borrowings of up to $35.0 million to fund acquisitions and provide working capital, and for other general corporate purposes.Borrowings are limited by a borrowing base formula consisting of accounts receivable, inventory, machinery and equipment and real estate. Borrowings bear interest at a rate of prime plus 1.35% (6.6% at December 31, 2004), subject to change based on theCompany’s interest coverage ratio, as defined. Unused commitments under the revolving credit facility are subject to an availability fee of 0.375% per annum subject to change based on the Company’s interest coverage ratio, as defined. Borrowings aresecured by the stock and substantially all of the assets of the Company. The Company had $9.4 million of borrowing capacity under the Credit Agreement as of December 31, 2004. The Credit Agreement expires December 18, 2005. The Company intends to replace the creditfacility made under the Credit Agreement in 2005. Management is confident such refinancing can be obtained under favorable terms to the Company, however, such terms will be subject to market conditions which may change significantly.

14

        The Company expects its principal sources of liquidity to be from its operating activities and funding from the Credit Agreement. The Company further expects that these sources will enable it to meet its cash requirements for working capital, capital expenditures,interest, taxes, and debt repayment for at least the next 12 months.

**Foreign Currency Impact**

        The functional currencies of the Company’s foreign operations are the respective local currencies. Fluctuations in the value of foreign currencies relative to the U.S. dollar have resulted in gains from foreign currency translation (which are deferred andclassified as a separate component of shareholder’s equity) of $4.0 million, $8.2 million and $5.9 million in 2004, 2003, and 2002, respectively. There can be no assurance that foreign currency fluctuations in the future will not have a significant adverseeffect on the Company’s business, financial condition and results of operations.

**Seasonality and Inflation**

        The Company’s net sales typically show no significant seasonal variations.

        The Company purchases certain raw materials for use in the manufacture of its products, including steel, aluminum, copper, and resin which are generally available from multiple sources with adequate supply. While certain commodities have experienced greaterpricing volatility in the past year, the Company has used a number of programs to address this risk such as entering into longer term purchase contracts with suppliers of certain commodities and implementing selling price adjustments over time. The Company believesit is not significantly dependent on a limited number of suppliers and that practices are in place to ensure an adequate supply of raw materials in the future.

**Adoption of Accounting Principles**

        In November 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 151, “Inventory Costs - An Amendment of Accounting Research Bulletin No. 43, Chapter 4”. SFAS No. 151 clarifies that abnormalamounts of idle facility expense, freight, handling costs and spoilage should be expensed as incurred and not included as overhead. SFAS 151 also requires that the allocation of fixed production overhead to conversion costs be based on normal capacity of theproduction facilities. SFAS 151 must be applied prospectively beginning January 1, 2006. The Company is still determining the impact of SFAS No. 151.

**Critical Accounting Policies and Estimates**

        The Company’s significant accounting policies are described in Note 2 to the consolidated financial statements included in Item 8 of this Form 10-K. The Company’s discussion and analysis of financial condition and results from operations are based uponthe Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of the financial statements requires the Company’s to make estimates and judgmentsthat affect the reported amounts of assets, liabilities, revenues, and expenses. On an on-going basis, the Company evaluates the estimates that it has made. These estimates have been based upon historical experience and on various other assumptions that the Companybelieves to be reasonable under the circumstances. However, actual results may differ from these estimates under different assumptions or conditions.

15

        The Company believes the following critical accounting policies affect the more significant judgments and estimates the Company’s has used in the preparation of the consolidated financial statements.

*Goodwill*

        In accordance with SFAS No. 142, the Company discontinued recording goodwill amortization effective January 1, 2002. SFAS No. 142 prescribes a two-step process for impairment testing goodwill. The first step is to identify when goodwill impairment has occurred bycomparing the fair value of a reporting unit with its carrying amount, including goodwill. If the fair value of a reporting unit exceeds its carrying value, the second step of the goodwill test should be performed to measure the amount of the impairment loss, if any.In this second step, the implied fair value of the reporting unit’s goodwill is compared with the carrying amount of the goodwill. If the carrying amount of the reporting unit’s goodwill exceeds the implied fair value of that goodwill, an impairment lossshould be recognized in an amount equal to that excess, not to exceed the carrying amount of the goodwill. If there is a decrease in product demand, market conditions or any condition that changes the assumptions used to measure fair value it could result inrequiring material impairment charge in the future.

*Investment in Affiliate*

        The Company has made a strategic investment in the Preferred Units of JZ International, LLC, an affiliated company. See Note 11 to the consolidated financial statements for details of this investment. These debt securities are not publicly traded on any majorexchange. The cost method of accounting is used to account for this investment. Each quarter, the Company evaluates the recoverability of this investment using information obtained from the management of this company. Based on the information obtained, the Companywill record an impairment charge when it believes the investment has experienced a decline in value below its current carrying amount that is other than temporary. Future adverse changes in market conditions or poor operating results could result in losses and/or aninability to recover the carrying value of this investment that may not be reflected in the investment’s current carrying value, thereby possibly requiring an impairment charge in the future.

*Allowance for Doubtful Accounts*

        Allowances for doubtful accounts are estimated at the individual operating companies based on estimates of losses on customer receivable balances. Estimates are developed by using standard quantitative measures based on historical losses, adjusting for currenteconomic conditions and, in some cases, evaluating specific customer accounts for risk of loss. The establishment of reserves requires the use of judgment and assumptions regarding the potential for losses on receivable balances. Though the Company considers itsallowance for doubtful accounts balance to be adequate, changes in economic conditions in specific markets in which the Company operates could have a material effect on future reserve balances required.

*Excess and Obsolete Inventory*

        The Company records reserves for excess and obsolete inventory equal to the difference between the cost of inventory and its estimated market value using assumptions about future product life-cycles, product demand and market conditions. If actual productlife-cycles, product demand and market conditions are less favorable than those projected by management, additional inventory reserves may be required.

16

*Income Taxes*

        As part of the process of preparing our consolidated financial statements, the Company is required to estimate its income taxes in each of the jurisdictions in which it operates. This process involves estimating the Company’s actual current tax exposuretogether with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within the Company’s consolidated balance sheet. TheCompany must then assess the likelihood that its deferred tax assets will be recovered from future taxable income and to the extent it believes that recovery is not likely, The Company must establish a valuation allowance. Increases (decreases) in the valuationallowance are included as an increase (decrease) to the Company’s consolidated income tax provision (benefit) in the statement of operations.

**Contractual Obligations**

The following table summarizes the Company’s contractual obligations as of December 31, 2004 (in thousands):

 

**Payments by Period**

 
** Total****2005****2006****2007****2008****2009****Thereafter**
Long-term debt
$ 316,453$ 20,636$ 272,827$ 22,990- -  - 
Interest on Long-term Debt
89,37931,24630,89827,235- - - 
Capital leases
61532319498- - - 
Operating leases
13,8683,0752,5402,3202,2731,7511,909
Total
$ 420,315$ 55,280$ 306,459$ 52,643$ 2,273$ 1,757$ 1,909
 

**Item 7A       QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS**

        The Company’s debt obligations are primarily fixed-rate in nature and, as such, are not sensitive to changes in interest rates. At December 31, 2004 the Company had no variable rate debt outstanding.

        The Company is exposed to market risk from changes in foreign currency exchange rates, including fluctuations in the functional currency of foreign operations. The functional currency of operations outside the United States is the respective local currency.Foreign currency translation effects are included in accumulated other comprehensive income in shareholder’s equity.

17

**Item 8.       FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**

 

**PAGE NO.**

 

 

Report of Independent Registered Public Accounting Firm

19

 

 

Consolidated Balance Sheets as of December 31, 2004 and 2003

20

 

 

Consolidated Statements of Operations for the years endedDecember 31, 2004, 2003 and 2002

21

 

 

Consolidated Statements of Changes in Shareholder’s Equity(Net Capital Deficiency) for the years ended December 31, 2004, 2003 and 2002

22

 

 

Consolidated Statements of Cash Flows for the years endedDecember 31, 2004, 2003 and 2002

23

 

 

Notes to Consolidated Financial Statements

24

 

 

 

 

 

 

 

 

18
****
**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMS**

The Board of Directors and ShareholderKinetek, Inc.

We have audited the accompanying consolidated balance sheets of Kinetek, Inc. as of December 31, 2004 and 2003 and the related consolidated statements of operations, shareholder’s equity (net capital deficiency), and cash flows for each of the three years inthe period ended December 31, 2004. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express anopinion on these financial statements and schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free ofmaterial misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that areappropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis,evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management and evaluating the overall financial statement presentation. We believe that our audits provide areasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Kinetek, Inc. at December 31, 2004 and 2003, and the consolidated results of its operations and its cash flows for each ofthe three years in the period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole,presents fairly in all material respects the information set forth therein.

As discussed in Note 13 to the financial statements, effective January 1, 2002, the Company changed its method of accounting for goodwill to conform with Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets”.

ERNST & YOUNG LLP

Chicago, IllinoisMarch 18, 2005

 

19

**KINETEK, INC.CONSOLIDATED BALANCE SHEETS(ALL DOLLAR AMOUNTS IN THOUSANDS)**

 

 

**December 31,**

 

 

 

** **

**Restated**

 

 

**2004**

** **

**2003**

 

 

 

 

 

**ASSETS**

 

 

 

Current Assets

 

 

 

 

Cash and cash equivalents

$10,863

 

$6,959

 

Accounts receivable, net of allowance of $4,110 and $4,579 at December 31, 2004 and 2003, respectively

62,379

 

54,897

 

Inventories

53,658

 

45,924

 

Prepaid expenses and other current assets

4,373

 

4,483

 

Taxes receivable

3,631

 

5,637

 

Assets from discontinued operation

2,024

 

7,482

 

         Total current assets

136,928

 

125,382

 

 

 

 

 

Property, plant and equipment, net

29,753

 

30,474

Goodwill, net

181,141

 

180,361

Deferred financing costs, net

4,646

 

7,293

Due from affiliated company

7,743

 

5,827

Investment in affiliate

12,344

 

12,344

Other non-current assets

893

 

807

 

          Total assets

$373,448

 

$362,488

 

 

 

 

 

**LIABILITIES AND SHAREHOLDER’S EQUITY (NET CAPITAL DEFICIENCY)**

 

 

 

Current liabilities:

 

 

 

 

Accounts payable

$33,262

 

$25,784

 

Accrued interest payable

4,109

 

4,104

 

Accrued expenses and other current liabilities

12,269

 

12,951

 

Current portion of long term debt

20,959

 

10,783

 

Liabilities from discontinued operation

548

 

1,257

 

          Total current liabilities

71,147

 

54,879

 

 

 

 

 

Long term debt

296,109

 

296,843

Deferred income taxes

25,801

 

20,552

Other non-current liabilities

5,627

 

5,744

 

 

 

 

 

Shareholder’s equity (net capital deficiency):

 

 

 

 

Common stock, $1 par value, 10,000 sharesauthorized, issued and outstanding

10

 

10

 

Additional paid-in capital

49,996

 

49,996

 

Accumulated deficit

(80,238)

 

(66,502)

 

Accumulated other comprehensive income

4,996

 

966

 

Total shareholder’s equity (net capital deficiency)

(25,236)

 

(15,530)

 

 

 

 

 

 

Total liabilities and shareholder’s equity (net capital deficiency)

$373,448

 

$362,488

 See accompanying notes to consolidated financial statements.

20****

**KINETEK, INC.CONSOLIDATED STATEMENTS OF OPERATIONS(ALL DOLLAR AMOUNTS IN THOUSANDS)**

 

 

**Year Ended December 31,**

 

 

 

** **

**Restated**

** **

**Restated**

 

 

**2004**

** **

**2003**

** **

**2002**

 

 

 

 

 

 

 

Net sales

$313,867

 

$278,309

 

$274,818

Cost of sales, excluding depreciation

212,242

 

182,179

 

175,683

Selling, general and administrative expenses,   excluding depreciation

58,658

 

56,276

 

50,949

Depreciation

5,487

 

6,721

 

6,577

Amortization of goodwill and other intangibles

134

 

169

 

408

Management fees and other

3,193

 

2,916

 

2,854

Operating income

34,153

 

30,048

 

38,347

 

 

 

 

 

 

 

Other (income) / expense:

 

 

 

 

 

 

Interest expense

35,592

 

34,876

 

35,231

 

Interest income

(169)

 

(140)

 

(367)

 

Miscellaneous, net

(381)

 

132

 

(540)

 

 

 

 

 

 

Income (loss) from continuing operations before incometaxes and cumulative  effect of accounting change

(889)

 

(4,820)

 

4,023

Income tax provision

6,991

 

5,721

 

11,575

 

 

 

 

 

 

 

Loss from continuing operations before cumulative    effect of accounting change

$(7,880)
 
$(10,541)
 
$ (7,552)

 

 
   
 

Income (loss) from discontinued operations, net of tax

(5,856)
 
1,787
 
(1,986)

Cumulative effect of change in accounting principle

        -  
 
          -   
 
(21,992)

 

 
   
 

Net loss

$ (13,736)
 
$ (8,754)
 
$(31,530)

See accompanying notes to consolidated financial statements.

21

 

**KINETEK, INC.CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDER’S   (Net Capital Deficiency)  (ALL DOLLAR AMOUNTS IN THOUSANDS)**

**Common Stock**
 
 
 
 

**Number of         Shares**
**Amount**
**Additional        Paid-In        Capital**
**Accumulated        Other        Comprehensive        (Loss) Income**
**Accumulated        Deficit**
**Total        Shareholder’s        Equity (net capital**
 

      Balance at December 31, 2001
      10,000
      $    10
      $      49,996
$           (13,104)
$             (26,218)
$                 10,684 
       Foreign currency  Translation  adjustments
      -
      -
      -
      5,889 
      - 
      5,889 
       Net loss (Restated)
-
-
-
- 
      (31,530)
(31,530)
       Comprehensive loss  (Restated)
-
-
-
- 
- 
(25,641
 

      Balance at December 31, 2002 (Restated)
      10,000
10
      49,996
      (7,215)
      $        (57,748)
      $          (14,957)
       Foreign currency Translation  adjustments
-
-
-
      8,181 
- 
      8,181 
       Net loss (Restated)
-
-

- 
      (8,754)
(8,754)
       Comprehensive loss  (Restated)
-
-
-
- 
-   
(573)
 

      Balance at December 31, 2003 (Restated)
      10,000
10
      49,996
966 
$             (66,502)
      $          (15,530)
       Foreign currency  Translation  adjustments
-
-
-
      4,030 
- 
4,030
       Net loss 
-
-
-
- 
      (13,7361)
(13,7361)
       Comprehensive loss 
-
-
-
- 
- 
(9,706)
 

      Balance at December 31, 2004
10,000
$        10
$     49,996
$                       4,996 
$        (80,238)
$                 (25,236)
 

See Accompany notes to consolidated financial statements
22
               **KINETEK, INC.CONSOLIDATED STATEMENTS OF CASH FLOWS(ALL DOLLAR AMOUNTS IN THOUSANDS)**

 

 

**Year Ended December 31,**

 

 

 

 

** **

**Restated**

** **

**Restated**

 

 

 

**2004**

** **

**2003**

** **

**2002**

 

 

 

 

 

 

 

 

Cash flows from operating activities:

 

 

 

 

 

 

 

Net loss

 

$(13,736)

 

$(8,754)

 

$(31,530)

Adjustments to reconcile net loss to net cashprovided by (used in) operating activities:

 

 

 

 

 

 

 

Cumulative effect of change in accounting principle

 

  -     

 

 -    

 

21,992

 

Depreciation and amortization

 

8,700

 

9,843

 

10,115

 

Deferred income taxes

 

5,249

 

4,366

 

13,319

 

 

 

 

 

 

 

 

Changes in operating assets and liabilities (netof effects from acquisitions):

 

 

 

 

 

 

 

Accounts receivable

 

(7,482)

 

(3,121)

 

15

 

Inventories

 

(5,495)

 

(4,626)

 

(712)

 

Prepaid expenses and other current assets

 

2,128

 

(1,405)

 

(785)

 

Accounts payable

 

6,518

 

353

 

81

 

Accrued expenses and other current liabilities

 

(1,687)

 

1,069

 

1,666

 

Net change in assets and liabilities from  discontinued operation

 

4,749

 

(5,181)

 

(642)

 

Non-current assets and liabilities

 

(346)

 

698

 

12

 

Due from affiliated company

 
(1,916)
 

(84)

 

(373)

 

Net cash provided by (used in) operating activities

 

(3,318)

 

(6,842)

 

13,158

 

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

 

 

Capital expenditures, net

 

(3,998)

 

(4,033)

 

(4,647)

 

Acquisition of subsidiaries, net of cash acquired

 

(372)

 

-    

 

(8,611)

 

Additional purchase price for acquisition

 
-    
 

-    

 

(100)

 

Net cash used in investing activities

 

(4,370)

 

(4,033)

 

(13,358)

 

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

 

 

Borrowings (repayments) on revolving credit  Facility, net

 

12,244

 

-    

 

(24,834)

 

Repayment of long-term debt

 

(10,818)

 

(2,811)

 

(2,972)

 

Proceeds from issuance of long term debt

 

7,505

 

874

 

23,927

 

Payment of deferred financing fees

 
-    
 

-    

 

(1,817)

 

Net cash provided by (used in) financing activities

 

8,931

 

(1,937)

 

(5,696)

 

 

 

 

 

 

 

Effect of exchange rate changes on cash

 
2,661
 

5,329

 

2,948

 

 

 

 

 

 

 

 

Net increase (decrease) in cash and cash equivalents

 

3,904

 

(7,483)

 

(2,948)

 

 

 

 

 

 

 

 

Cash and cash equivalents at beginning of year

 

6,959

 

14,442

 

17,390

Cash and cash equivalents at end of year

 
$ 10,863
 

$ 6,959

 

$14,442

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Supplemental disclosures of cash flow information:

 

 

 

 

 

 

Cash paid during the period for:

 

 

 

 

 

 

 

Interest

 

$31,871

 

$32,023

 

$31,386

 

Income taxes

 

1,081

 

2,837

 

2,540

Non cash investing and financing activities:

 

 

 

 

 

 

 

Capital leases

 

-    

 

142

 

332

See accompanying notes to consolidated financial statements.

23
****
**KINETEK, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(ALL DOLLAR AMOUNTS IN THOUSANDS)**

**1.        Description of Business and Acquisitions**

Kinetek, Inc. (Company), a wholly-owned subsidiary of Motors and Gears Holdings, Inc. (Parent), a majority-owned subsidiary of Jordan Industries, Inc. (JII), operates in the motion control industry.

On April 6, 2001, the Company, through its wholly-owned subsidiary Merkle Korff, acquired substantially all of the assets, properties and business of Koford Engineering, Inc. for $690. This acquisition has been accounted for using the purchase method ofaccounting. Accordingly, the operating results of the acquired business have been included in the consolidated operating results of the Company since the date of acquisition. On November 30, 2004, Merkle Korff sold the assets related to the Koford Slot Car segment ofthe business. This consisted of cash, accounts receivable, machinery & equipment, and raw material. These assets were sold at book value which was $264K, therefore recognizing no gain or loss from the sale.

On April 11, 2002, the Company formed a cooperative joint venture with Shunde De Sheng Electric Motor Group Co., Ltd. (“De Sheng Group”), which is named Kinetek De Sheng (Shunde) Motor Co., Ltd. (the “JV”). The Company initially contributedapproximately $8.0 million for 80% ownership of the JV, with an option to purchase the remaining 20% in the future. The JV acquired all of the net assets of Shunde De Sheng Electric Motor Co., Ltd. (“De Sheng”), a subsidiary of De Sheng Group. Thisacquisition has been accounted for using the purchase method of accounting. The JV also assumed approximately $7.2 million of outstanding debt.

On September 21, 2004, the Company acquired substantially all of the net assets of O. Thompson, a New York City-based elevator control company. The total acquisition cost was $887 of which $372 was paid in cash during the third and fourth quarters of 2004. Theremaining $515 of deferred acquisition costs are a component of other current liabilities at December 31, 2004 and should be settled during the first quarter of 2005. The acquisition has been accounted for using the purchase method of accounting. Accordingly, theoperating results of the acquired business have been included in the consolidated operating results of Kinetek since September 1, 2004, the effective date of the acquisition. The operating results of O. Thompson are included with those of Kinetek’s wholly-ownedsubsidiary, Motion Control Engineering, within the “Controls” segment.

**2.        Summary of Significant Accounting Policies**

*Principles of Consolidation*

The consolidated financial statements include the accounts of the Company and its majority-owned subsidiaries. All significant intercompany transactions and accounts have been eliminated. Operations of certain subsidiaries outside the United States are includedfor periods ending two months prior to the Company’s year-end and interim periods to ensure the timely preparation of the Company’s consolidated financial statements.

*Reclassifications*

Certain amounts in the prior years financial statements have been reclassified to conform to the 2004 presentation.

24

*Cash and Cash Equivalents*

Cash equivalents consist of highly liquid investments with an initial maturity of three months or less at the time of purchase.

*Accounts Receivable and Allowance for Doubtful Accounts*

Allowances for doubtful accounts are estimated at the individual operating companies based on estimates of losses on customer receivable balances. Estimates are developed by using standard quantitative measures based on historical losses, adjusting for currenteconomic conditions and, in some cases, evaluating specific customer accounts for risk of loss. A receivable is considered past due if payments have not been received within agreed upon invoice terms. Uncollectible receivables are charged against the allowance fordoubtful accounts when approved by operating company management after all collection efforts have been exhausted.

*Inventories*

Inventories are stated at the lower of cost or market. Inventories, which are valued at either average or first-in, first-out (FIFO) cost, accounted for approximately 78% and 73% of the Company’s inventories at December 31, 2004 and 2003, respectively. Allother inventories are valued using last-in, first-out (LIFO) cost, which approximated current cost at December 31, 2004 and 2003.

*Property, Plant, and Equipment*

Property, plant, and equipment are stated at cost, less accumulated depreciation. Depreciation is provided using the straight-line method over the estimated useful lives of the assets. Leasehold improvements and assets under capital leases are amortized using thestraight-line method over the shorter of the lease term or their estimated productive lives. Amortization of leasehold improvements and assets under capital leases is included in depreciation expense.

The useful lives of plant and equipment for the purpose of computing book depreciation are as follows:

Buildings

 

5 to 33 years

Machinery and equipment

 

3 to 10 years

Dies and tooling

 

2 to 5  years

Furniture and fixtures

 

3 to 7  years

Vehicles

 

3 to 5  years

 

*Foreign Currency Translation*

The functional currencies of the Company’s foreign operations are the local currencies. Accordingly, assets and liabilities of the Company’s foreign operations are translated from foreign currencies into U.S. dollars at the exchange rates in effect atthe balance sheet date while income and expenses are translated at the weighted-average exchange rates for the year. Adjustments resulting from translation are classified as a component of other comprehensive income.

*Goodwill and Other Long-Lived Assets*

Through 2001, goodwill was amortized using the straight-line method over a period of 30 to 40 years. On January 1, 2002, the Company adopted SFAS No. 142, “Goodwill and Other Intangible Assets.”  Under the new rules, goodwill is no longeramortized but is subject to annual impairment tests. See Note 13 for additional details.

25

Other long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the related asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carryingamount of the asset to future undiscounted cash flows expected to be generated by the asset. If the asset is determined to be impaired, the impairment recognized is measured by the amount by which the carrying value of the asset exceeds its fair value.

*Deferred Financing Costs*

Deferred financing costs are amortized using the straight line method, which approximates the interest method, over the terms of the related loans. Deferred financing costs at December 31, 2004 and 2003 are net of accumulated amortization of $16,292 and $13,646,respectively. Amortization of deferred financing costs is included in interest expense.

*Income Taxes*

Deferred tax assets and liabilities are determined based on differences between the financial reporting and tax basis of assets and liabilities and are measured using the enacted tax rates and laws that are expected to be in effect when the differences reverse.The operating results of the Company and its subsidiaries are included in the consolidated federal income tax return of JII. In addition, the Company and its subsidiaries are party to a tax-sharing agreement with JII. The Company’s income tax provision(benefit) has been calculated as if the Company would have filed a separate federal income tax return, except that the Company’s net operating losses are eliminated if absorbed in the JII consolidated federal income tax return.

*Revenue Recognition*

The Company’s revenue is derived primarily from product sales. Revenue is recognized in accordance with the terms of the sale, primarily upon shipment to customers, once the sales price is fixed or determinable, and collectibility is reasonably assured.

*Shipping and Handling Costs*

Shipping and Handling Costs are included in cost of sales in the statement of operations.

*Use of Estimates*

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes.Actual results could differ from those estimates.

26

*Financial Instruments*

The Company’s financial instruments include cash equivalents, trade accounts receivable, accounts payable, accrued expenses, the Senior Notes, the Senior Secured Notes, the Subordinated Notes, and the revolving credit facility. Other than the Senior Notes(see Note 8), the fair values of the Company’s financial instruments are not materially different from their carrying values at December 31, 2004 and 2003.

*Concentration of Credit Risk*

Financial instruments which potentially subject the Company to concentration of credit risk consist principally of cash and cash equivalents, accounts receivable and the investment in affiliate (see Note 11). The Company deposits cash and cash equivalents withhigh-quality financial institutions, which are federally insured up to prescribed limits. Cash balances may exceed these limits at any given time.

The Company closely monitors the credit quality of its customers and maintains allowances for potential credit losses which, historically, have not been significant and have been within the range of management’s expectations. The Company generally does notrequire collateral or other security on trade receivables.

*Derivative Financial Instruments*

The Company recognizes derivative instruments as either assets or liabilities in the balance sheet at fair value. The accounting for changes in fair value (i.e., gains or losses) of a derivative financial instrument depends on whether it has been designated andwhether it qualifies as part of an effective hedging relationship and, further, on the type of hedging relationship. The fair value of derivative financial instruments was not significant as of December 31, 2004 and 2003.

*New Accounting Pronouncements*

In January 2003, the FASB issued Interpretation No. 46 (FIN 46), “Consolidation of Variable Interest Entities – An Interpretation of Accounting Research Bulletin (ARB) No. 51” This interpretation provides guidance on how to identify variableinterest entities and how to determine whether or not those entities should be consolidated. The Company is required to apply FIN 46 by March 31, 2005, for entities which were created before February 1, 2003. The adoption of FIN 46 was immediate for variable interestentities created after January 31, 2003. The Company has not created any significant variable interest entities since January 31, 2003. The Company is evaluating its interests in entities created before February 1, 2003 to determine if FIN 46 applies.

27

**3.       Inventories         **Inventories consist of the following:

 
**December 31,**
 

**2004**
 
**2003**

 

 
 
 

Raw materials

$30,509
 
$27,847

Work in process

11,507
 
10,325

Finished goods

11,642
 
7,752

 

$53,658
 
$45,924

 

**4.        Property, Plant, and Equipment          **Property, plant, and equipment consist of the following:

 

**December 31,**

 

**2004**
 
**2003**

 

 
 
 

Land, buildings and leasehold improvements

$21,735
 
$21,027

Machinery and equipment

40,840
 
37,482

Furniture and fixtures

14,094
 
14,338

Other (vehicles, dies and tooling)

7,603
 
7,418

 

84,272
 
80,265

 

 
 
 

Less:  Accumulated depreciation and amortization

(54,519)
 
(49,791)

 

 
 
 

 

$ 29,753
 
$30,474

 

**5.        Short Term Notes Payable**

FIR Group Holdings Italia and its subsidiaries, have a number of short-term borrowing facilities available from various banks. The total amount available under these facilities is approximately $9,136 at an average interest rate of 7.25% for the year endingDecember 31, 2004. There were no outstanding borrowings under these arrangements at December 31, 2004 and 2003. A portion of these facilities are secured by FIR’s assets and a portion are in the form of overdraft coverage.

**6.        Discontinued Operation and Restatement of Financial Statements**

During 2004, the Company undertook a plan to sell Electrical Design andControl (“ED&C”), a wholly-owned subsidiary. As a part of the Company’s analysisof the realizable value of the assets recorded in the books and records of ED&C,an exhaustive analysis of all open projects was performed. During that analysis,it came to our attention that certain revenues had been erroneously recorded inprior years as a result of errors in ED&C’s percentage of completioncalculations on certain projects. The Company’s results for 2003 and 2002 havebeen restated to reflect ED&C as discontinued operations in all periodspresented, as well as to correct for the impact of errors discussed above. Theportion of the restatement due to the errors mentioned above was additionalcharges of $3,408 and $1,751 in 2003 and 2002, respectively. Had the aboveamounts been recorded in the proper periods, no default of the Company’s debtcovenants would have occurred. The Company currently has no other subsidiariesusing the percentage of completion accounting method and believes that the riskof future errors of this type is minimal. For this reason, the Company believesthat the above restatements are sufficient to properly state certain previouslyissued financial statements and that this restatement has no material impact onthe results of the continuing operations of the Company.

28

Summarized selected financial information for the discontinued operation as restated is as follows:

 

**2004**

**2003**

**2002**

Revenues

$  4,640

$  6,358

$ 6,097
    
Loss from discontinued operations

  (5,856)

  1,787

 (1,986)

 

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

 

**2004**

**2003**

Current assets

$  1,978

$  7,113

Property, plant and equipment

14

337

Other long term assets

32

32

Total assets

2,024

7,482

Current liabilities

548

1,257

Net assets of discontinued operations

$  1,476

$  6,225

 

**7.        Income Taxes**

Income from continuing operations before income taxes and cumulative effect of accounting change was comprised of the following:
 
**Year Ended December 31,**
 

**2004**
 
**2003**
 
**2002**

 

 
 
 
 
 

Domestic

$    (3,447)

 
$(6,637)

 
$  178

Foreign

2,558

 
 1,817

 
3,845

 

 

 
 

 
 

 

$       (889)

 
$(4,820)

 
$4,023

 

The provision (benefit) for income taxes consists of the following:

 

 

** **

**Year Ended December 31,**

 

 

** **

**2004**

** **

**2003**

** **

**2002**

 

 

** **

 

** **

 

** **
 
Current:

** **

 

** **
 
 
 
 

Federal

** **

$          - 

** **

$             -

** **

$8,234

 

State

** **

610

** **

644

** **

535

 

Foreign

** **

1,148

** **

593

** **

(2,576)

 

 

** **

 

** **

 

** **

 

 

Total current

** **

1,758

** **

1,237

** **

6,193

 

 

** **

 

** **

 

** **
 
Deferred:

** **

 

** **

 

 
 
 

Federal

** **

3,085

** **

3,151

** **

4,018

 

State

** **

927

** **

867

** **

686

 

Foreign

** **

1,221

** **

466

** **

678

 

 

 

 

 

 

 

 

 

Total deferred

 

5,233

 

4,484

 

5,382

 

 

 

 

 

 

 

 

Income tax provision

 

$6,991

 

$5,721

 

$11,575

29

The provision (benefit) for income taxes differs from the amount of income tax provision (benefit) computed by applying the U.S. federal income tax rate to income before income taxes and cumulative effect of change in accounting principle. A reconciliation of thedifferences is as follows:

 

 

 

**Year Ended December 31,**

 

 

 

**2004**

** **

**2003**

** **

**2002**

 

 

 

 

 

 

 

 

Computed statutory tax provision

$  (311)

 

$(1,687)

 

$1,408

 

Increase/(decrease) resulting from:

 

 

 

 

 

 

 

State and local taxes, net of federal benefit

999

 

1,006

 

820

 

 

Differential in foreign tax rates and tax credits

49

 

(481)

 

(3,886)

 

 

Change in valuation allowance

4,772

 

5,589

 

14,325

 

 

Amortization of goodwill

3,410

 

3,414

 

3,366

 

 

Other

(1,928)

 

(2,120)

 

(4,458)

 

 

 

 

 

 

 

 

Income tax provision

$  6,991

 

$ 5,721

 

$11,575

 Deferred tax liabilities and assets are comprised of the following:
 
December 31,  
2004 
2003Deferred tax liabilities:     Goodwill 
$ (22,064) 
$(18,036) Foreign deferred taxes 
(3,737) 
(2,516)             Total deferred tax liabilities (25,801) (20,552)              Deferred tax assets:             Net operating losses 14,584 9,512 Property, plant and equipment 3.925 4,241 Intangibles other than goodwill 3,212 3,685 Vacation accrual 531 605 Employee benefits 848 244 Uniform capitalization 506 517 Allowance for doubtful accounts 707 914 Inventory obsolescence reserve 450 486 Warranty reserve 627 522 Other 1,520 1.421              Total deferred tax assets 26,919 22,147Valuation allowance (26,919) (22,147Net deferred tax liabilities $ (25,801) $ (20,552)
As of December 31, 2004 there was $18,856 ****of accumulated unremitted earnings from the Company’s foreign subsidiaries on which deferred taxes have not been provided as undistributed earnings on foreign subsidiaries are considered to be indefinitelyreinvested.

In 2002, the Company adopted SFAS No. 142, which provides that goodwill no longer be amortized. For tax purposes, goodwill continues to be amortized over a fifteen-year life. As such, the tax amortization generates a temporary difference and a correspondingdeferred tax liability arises for financial statement purposes. Because goodwill is no longer amortized for book purposes, the Company cannot determine when the resulting deferred tax liabilities will reverse. Therefore, the Company is not able to utilize any futurereversal of the deferred tax liability related to goodwill to support the realization of the deferred tax assets.

30

As previously noted, the Company and its domestic subsidiaries (Kinetek Group) join in the annual filing of a U.S. federal consolidated income tax return with their ultimate parent company, Jordan Industries, Inc. (Parent). During 2004, Parent realized $88.4million of cancellation of indebtedness income as a result of modifications to certain of its outstanding debt. However, the Internal Revenue Code provides exceptions to the recognition of certain types of cancellation of indebtedness income for U.S. federal incometax purposes. These exceptions generally will require the Parent and possibly certain subsidiaries including members of the Kinetek Group to reduce various specified tax attributes on January 1, 2005 to be determined by the Parent. Through some combination of theseexceptions, net operating loss carryforwards and other future tax benefits of Kinetek may be reduced. The Parent’s consolidated return group which includes the Kinetek Group does not expect to incur any material tax liability as a result of realizing thiscancellation of indebtedness.

**8.      Long-Term Debt        **Long-term debt consists of the following:

 

 

**December 31,**

 

 

**2004**

** **

**2003**

 

10.75% Senior Notes, including $1,327 and $1,925 of    unamortized premium at December 31, 2004 and    2003, respectively (A)

 

$271,326

 

$271,925

 

Revolving Credit Facility (B)

 

12,244

 

-

 

Subordinated Notes Payable (C)

 

1,500

 

1,500

 

Capital leases (D)

 

615

 

1,297

 

5.0% Secured Senior Notes, including $2,358 and    $3,173 of unamortized discount at December 31,    2004 and 2003, respectively (E)

 

12,642

 

11,827

 

10.0% Secured Senior Notes, including $652 and $876 of    unamortized discount at December 31, 2004 and 2003,    respectively (E)

 

10,348

 

10,124

 

Bank loans of foreign subsidiary (F)

 

7,506

 

9,459

 

Loan payable to JV partner (G)

 

887

 

1,494

 

 

 

317,068

 

307,626

 

Current Portion

 

(20,959)

 

(10,783)

 

 

 

$296,109

 

$296,843

 

 

(A)          Interest on the Senior Notes is payable in arrears on May 15 and November 15 of each year. The Senior Notes are unsecured obligations of the Company and mature on November 15, 2006. The Senior Notes areredeemable at the option of the Company, in whole or in part, at any time on or after November 15, 2001. The Indenture relating to the Senior Notes contains certain covenants which, among other things, restrict the ability of the Company to incur additionalindebtedness, to pay dividends or make other restricted payments, engage in transactions with affiliates, to complete certain mergers or consolidations, or to enter into certain guarantees of indebtedness.

31

                The fair value of the Senior Notes was approximately $273,375 at December 31, 2004. The fair value was calculated by multiplying the face amount by the market price at December 31, 2004.

(B)           The Company’s Loan and Security Agreement (Credit Agreement), expiring December 18, 2005, is in the form of a revolving credit facility and provides for borrowings of up to $35,000 to fundacquisitions and provide working capital, and for other general corporate purposes. Borrowings are limited by a borrowing base formula consisting of accounts receivable, inventory, machinery and equipment and real estate. Borrowings bear interest at a rate of primeplus 1.35% (6.6% at December 31, 2004), subject to change based on the Company’s interest coverage ratio, as defined. Unused commitments under the revolving credit facility are subject to an availability fee of 0.375% per annum subject to change based on theCompany’s interest coverage ratio, as defined. Borrowings are secured by the stock and substantially all of the assets of the Company. The Company had $9,358 of borrowing capacity under the Credit Agreement as of December 31, 2004.

                The Credit Agreement contains covenants which, among other things, provide for a minimum level of interest coverage, as defined, and limit the Company’s ability to incur additional indebtedness, create liens, make restricted payments, engage in affiliatetransactions or mergers and consolidations, and make asset sales.

                The Credit Agreement expires December 18, 2005. The Company intends to replace the credit facility made under the Credit Agreement in 2005. Management is confident such refinancing can be obtained under favorable terms to the Company, however, such terms will besubject to market conditions which may change significantly.

(C)           The Subordinated Notes Payable at December 31, 2004 consists of a $1,500 note payable to the former shareholder of Merkle-Korff, a subsidiary of the Company, and is due on January 1, 2006 and bearsinterest at 9% per annum.

(D)          Interest rates on capital leases range from 6.4% to 7.6% and mature in installments through 2007.

                The future minimum lease payments as of December 31, 2004 under capital leases consist of the following:

2005

 

$  361

2006

 

220

2007

 

108

2008

 

-

2009

 

-

 

Total

 

689

Less amount representing interest

 

(74)

Present value of future minimum lease payments

 

$615

                The present value of the future minimum lease payments approximates the book value of property, plant and equipment under capital leases at December 31, 2004.

(E)           Interest on the Secured Senior Notes is payable in arrears on May 1 and November 1 of each year. The Secured Senior Notes are secured obligations of the Company and mature on April 30, 2007. TheIndenture relating to the Senior Notes contains certain covenants which, among other things, restricts the ability of the Company to incur additional indebtedness, to pay dividends or make other restricted payments, engage in transactions with affiliates, to completecertain mergers or consolidations, or to enter into certain guarantees of indebtedness.

32

(F)           One of the Company’s foreign subsidiaries has bank loans of $7,506 and $9,459 as of December 31, 2004 and 2003, respectively. Interest rates on these loans range from 4.8% to 5.8% and mature in2005. The Company plans to renew these loans as they mature.

(G)           The Company has loans due to a joint venture partner of one of its foreign subsidiaries of $887 and $1,494 for December 31, 2004 and 2003, respectively. Interest rate on loans range from 5.3% to 5.8%and mature in installments through 2005.

                Aggregate maturities of long-term debt at December 31, 2004 are as follows:

2005

 

$ 20,959

2006

 

273,020

2007

 

23,089

2008

 

-

2009

 

-

 

 

$317,068

**9.      Operating Leases**

The Company leases certain land, buildings, and equipment under noncancellable operating lease agreements expiring in various years through 2011. Minimum future lease payments, by year, under noncancellable operating leases, including those with related parties(Note 10), are as follows at December 31, 2003:

2005

 

$ 3,075

2006

 

2,540

2007

 

2,320

2008

 

2,273

2009

 

1,751

Thereafter

 

1,909

 

 

$13,868

 Total rent expense was $3,305, $3,041 and $3,365 for the years ended December 31, 2004, 2003 and 2002, respectively.

**10.      Benefit Plans**

Certain of the Company’s subsidiaries participate in the JII 401(k) Savings Plan (the “Plan”), a defined contribution plan for salaried and hourly employees. In order to participate in the Plan, employees must be at least 21 years old and haveworked at least 1,000 hours during the first 12 months of employment. Each eligible employee may contribute from 1% to 15% of their before-tax wages into the Plan. In addition to the JII 401(k) Plan, certain subsidiaries have additional defined contribution plans inwhich employees may participate. The Company made contributions to these plans totaling approximately $1,068, $1,324 and $1,505 for the years ended December 31, 2004, 2003 and 2002, respectively.

FIR provides for a severance liability for all employees at 8.3% of each respective employee’s annual salary. In addition, the amount accrued is adjusted each year according to an official index (equivalent to 0.75% of the retail price index). Thisobligation is payable to employees when they leave the Company and approximated $3,358 and $3,380 at December 31, 2004 and 2003, respectively, which is included in other non-current liabilities in the Company’s balance sheets.

33

**11.      Related Party Transactions**

*Services Agreements*. The Company and each of its subsidiaries are subject to the following four agreements and arrangements with JII:

First, the Company and each of its subsidiaries are parties to a transaction advisory agreement (the “Subsidiary Advisory Agreement”) with JII, pursuant to which the Company and its subsidiaries are charged by JII (i) investment banking and sponsorshipfees of up to 2.0% of the purchase price of acquisitions, joint ventures, minority investments or sales involving the Company and its subsidiaries or their respective businesses or properties (which were $73, $0 and $514 in 2004, 2003, and 2002, respectively); (ii)financial advisory fees of up to 1.0% of debt, equity, or other financing or refinancing involving the Company or such subsidiary, in each case, arranged with the assistance of JII or its affiliates (which were $0, $0 and $260 in 2004, 2003 and 2002, respectively);and (iii) reimbursement for JII’s out-of-pocket costs in connection with providing such services (which were $0 in 2004, 2003 and 2002). Mssrs. Jordan, Quinn,  Boucher and Zalaznick, directors of Parent, are directors and shareholders of JII.

Second, the Company and each of its subsidiaries is party to a management consulting agreement (the “Subsidiary Consulting Agreement”) with JII, pursuant to which the Company and its subsidiaries pay JII annual consulting fees of the greater of (i)3.0% of the Company’s net income before interest, tax, depreciation and amortization and other non-cash charges, or (ii) 1.0% of the Company’s net sales for such services and are required to reimburse JII for its out-of-pocket costs related to itsservices. Pursuant to the Subsidiary Consulting Agreement, JII (but not JII’s affiliates) is obligated to present all acquisition, business and investment opportunities that relate to manufacturing, assembly, distribution or marketing of products and servicesin the motors, gears and motion control industries to the Company, and JII is not permitted to pursue such opportunities or present them to third parties unless the Company determines not to pursue such opportunities or consents thereto. In accordance with thisagreement, the Company paid approximately $3,193, $2,916 and $2,854 for the years ended December 31, 2004, 2003 and 2002, respectively, which are reflected as Management Fees and Other in the Consolidated Statement of Operations.

Third, the Company and each of its subsidiaries are parties to a services agreement (the “JI Properties Services Agreement”) with JI Properties, Inc. (“JI Properties”), a subsidiary of JII, pursuant to which JI Properties provides certainreal estate and other assets, transportation and related services to the Company. Pursuant to the JI Properties Services Agreement, the Company is charged for its allocable portion of such services based upon its usage of such services and its relative revenues, ascompared to JII and its other subsidiaries.

Fourth, the Company and JII are parties to a transition agreement (the “Transition Agreement”) pursuant to which JII provides office space and certain administrative and accounting services to the Company to facilitate the operations of the Company.Also, JII allocates its overhead, general and administrative charges and expense among JII and its subsidiaries, including the Company, based on the respective revenues and usage of corporate overhead by JII and its subsidiaries. The Company reimburses JII forservices provided pursuant to the Transition Agreement on an allocated cost basis.

34

In accordance with the JI Properties Services Agreement and the Transition Agreement, such combined charges were $5,807, $7,084 and $5,103 for the years ended December 31, 2004, 2003 and 2002, respectively, and are reflected within Selling, General, andAdministrative expenses in the Consolidated Statement of Operations.

The above agreements expire in December 2011, but are automatically renewed for successive one-year terms, unless either party provides written notice of termination 60 days prior to the scheduled renewal date.

*Tax Sharing Agreement*. The Company and each of its subsidiaries are parties to a Tax Sharing Agreement (the “Tax Sharing Agreement”) between JII and each of its consolidated subsidiaries for U.S. federal income tax purposes. Pursuant to the TaxSharing Agreement, the Company and each of its consolidated subsidiaries owes to JII an amount determined by reference to each entity’s separate return tax liability as defined in Treasury Regulation §1.1552-1(a) (2) (ii). For the years ended December 31,2004 and 2003, income tax payments made by the Company to JII under the Tax Sharing Agreement were $0 and $0, respectively.

*Related Party Leases*. The Company leases certain plants, warehouses, and offices under leases with affiliated entities. Rent expense, including real estate taxes attributable to these leases, amounted to $1,614, $1,653 and $1,822 for the years endedDecember 31, 2004, 2003 and 2002, respectively. Future minimum rental payments required under these leases are as follows:

2005

 

$  1,701

2006

 

1,553

2007

 

1,173

2008

 

1,135

2009

 

1,135

Thereafter

 

$  1,419

 

*Investment in Affiliate*. The Company has a $12,344 investment in the Class A and Class B Preferred Units of JZ International, LLC. These debt securities are not publicly traded and do not have a determinable fair value. The cost method of accounting is usedto account for this investment. The Preferred Units have a cumulative 5% annual return. The Class A Preferred Units may be redeemed at any time at the discretion of the Board of Directors of JZ International, but no later than December 31, 2017, whereas the Class BPreferred Units may be redeemed at any time at the discretion of the Board of Directors of JZ International, but no later than December 31, 2018. Each quarter, we evaluate the recoverability of this investment using information obtained from the management of thiscompany. Based on the information obtained, we will record an impairment charge when we believe the investment has experienced a decline in value below its current carrying amount that is other than temporary. JZ International’s Chief Executive Officer is DavidW. Zalaznick, and its members include Messrs. Jordan, Quinn, Zalaznick and Boucher, who are the Company’s and/or Parent’s directors and stockholders. JZ International and its subsidiaries are focused on making European and other internationalinvestments. The Company is accounting for this investment under the cost method.

*35*

*Legal Fees*. An individual who is a shareholder, General Counsel and Assistant Secretary of the Parent is also a partner in a law firm used by the Company. The firm was paid $174, $277 and $490 in fees and expenses during the years ended December 31, 2004,2003 and 2002, respectively. The rates charged to the Company were at arms-length.

*Due from Affiliate*. The Company has a net receivable from JII of $7,743 and $5,827 at December 31, 2004 and 2003, respectively, that are reflected in the consolidated balance sheets as “due from affiliated company”.

**12.      Additional Purchase Price Arrangements**

Kinetek has a contingent purchase price agreement relating to its acquisition of Motion Control Engineering on December 18, 1997. The terms of this agreement provide for additional consideration to be paid to the sellers. The agreement is exercisable at thesellers’ option during a five year period that began in 2003. When exercised, the additional consideration will be based on Motion Control Engineering’s operating results over the two preceding fiscal years. Payments, if any, under the contingentagreement will be placed in a trust and paid out in cash over a three or four-year period, in annual installments according to a schedule, which is included in the agreement. Additional consideration, if any, will be recorded as an addition to goodwill.

**13.      Segment Data**

*Description of Segments*

The Company operates in two separate business segments; electric motors (“Motors”) and electronic motion control systems (“Controls”). The Motors segment consists of subfractional motors, fractional/integral motors, and gears and gearboxes.The Controls segment consists of motion control systems.

The Company’s subfractional horsepower products are comprised of motors and gearmotors which power applications up to 30 watts (1/25 horsepower). These small, “fist-size” AC and DC motors are used in light duty applications such as snack andbeverage vending machines, refrigerator ice dispensers and photocopy machines.

The Company’s fractional/integral horsepower products are comprised of AC and DC motors and gearmotors having power ranges from 1/8 to 300 horsepower. Primary end markets for these motors include commercial floor care equipment, commercial dishwashers,commercial sewing machines, industrial ventilation equipment, golf carts, lift trucks and elevators.

The Company’s precision gear and gearbox products are produced in sizes of up to 16 inches in diameter and in various customized configurations such as pump, bevel, worm and helical gears. Primary end markets for these products include original equipmentmanufacturers (“OEMs”) of motors, commercial floor care equipment, aerospace and food processing product equipment.

The Company’s motion control systems are used primarily in the elevator modernization market. The systems typically control several components such as electric motors, hydraulic or pneumatic valves, actuators and switches that are required for the elevatorsystems to function properly.

36

*Measurement of Segment Operating Income and Segment Assets*

The Company evaluates performance and allocates resources based on operating income. The accounting policies of the reportable segments are the same as those described in Note 2, “Summary of Significant Accounting Policies”. No single customer accountsfor 10% or more of consolidated net sales. Identifiable assets are those used by each segment in its operations. Corporate assets consist primarily of cash, due from affiliate, investment in affiliate and deferred financing fees.

 

 

 

 

 

 

 

37

****
*Factors Used to Identify the Enterprise’s Reportable Segments*

The Company’s reportable segments are business unitsthat offer different products. The reportable segments are each managedseparately because they manufacture and distribute distinct products withdifferent production processes.

Summary financial information by business segment isas follows:
  
**Year Ended      December 31,****   2004   **
**   2003   **
**   2002   ****Net Sales**

Motors

$        230,372     
$        201,654 

$        202,432  Controls
  83,495 
76,655 

  72,386 
$        313,867 
$        278,309 

$        274,818  **Operating Income and Income    before Income Tax**

Motors
$          35,858 
$          35,458 
$          39,496 Controls
10,571 
8,686 
10,660 Corporate Expenses (1)
(12,276)
(14,096)
(11,809)Total Operating Income

34,153 
30,048 
38,347 Interest Expense

(35,592)
(34,876)
(35,231)Interest Income
169 
140 
367 Miscellaneous, net
381 
(132)
540 Income (loss)    before Income Tax
    $                 (889)
 
    $           (4,820)

    $                4,023 **Identifiable Assets**

Motors
$        275,335     

$        263,411 
$         263,369 Controls
67,441 

65,675 
63,067 Corporate
28,648 

22,651 
29,237 
$        371,424 

$        351,737 
$         355,673 

**Capital Expenditures**

Motors
$            3,516 
$            3,240 
$             3,893 Controls
482 
793 
748 
$            3,998 
$            4,033 
$             4,647 

**Depreciation**

Motors
$            4,281 
$            5,235 
$             5,055 Controls
1,206 
1,486 
1,522 
$            5,487 
$            6,721 
$             6,577 **Amortization of Intangibles**

Motors
$               134 
$               169 
$                215 Controls
- 
- 
193 
$               134 
$               169 
$                   408 
(1) Fees paid to JII under the Services Agreements (note 11) are included incorporate expenses.

38

Summary financial information by geographic area isas follows:
 
**Year Ended      December 31,** 
**2004**
 
**2003**
 
**2002****Net sales to unaffiliated    customers**North America
$246,865  

$229,011  

$227,669  Europe
50,982  

42,138 

40,288  Asia
16,020  

7,160 

6,861
$313,867

$278,309 

$274,818 

**Identifiable long-lived assets    (including intangible assets)**

North America
$193,021  

$193,589 

$195,262   Europe
15,500  

14,497 

12,230   Asia
15,610  

15,900  

16,358   |
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