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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OF 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 333-40076
KNOWLES ELECTRONICS HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 36-2270096
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
1151 MAPLEWOOD DRIVE 60143
ITASCA, ILLINOIS (Zip Code)
(Address of principal executive offices)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
(630) 250-5100
Indicate by check mark 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 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
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TABLE OF CONTENTS
PAGE
----
PART I -- FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Operations for the three months and six
months ended June 30, 2002 and 2001............................. 1
Consolidated Balance Sheets as of June 30, 2002 and December 31,
2001............................................................ 2
Consolidated Statements of Cash Flows for the three months and six
months ended June 30, 2002 and 2001............................. 3
Notes to the Consolidated Financial Statements..................... 4
Item 2. Management's Discussion and Analysis of Financial Condition 17
and Results of Operations...................................
Item 3. Qualitative and Quantitative Disclosures about Market 24
Risk........................................................
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings -- None
Item 2. Changes in Securities and Use of Proceeds -- None
Item 3. Defaults Upon Senior Securities -- None
Item 4. Submission of Matters to a Vote of Security Holders -- None
Item 5. Other Information -- None
Item 6. Exhibits and Report on Form 8-K -- None
i
KNOWLES ELECTRONICS HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------- ---------------------
2002 2001 2002 2001
------- ---------- -------- ----------
(RESTATED) (RESTATED)
(IN THOUSANDS) (IN THOUSANDS)
(UNAUDITED) (UNAUDITED)
Net sales........................................... $58,233 $57,280 $109,239 $112,009
Cost of sales....................................... 32,888 33,633 62,549 63,348
------- ------- -------- --------
Gross margin........................................ 25,345 23,647 46,690 48,661
Research and development expenses................... 3,885 3,421 7,364 6,984
Selling expenses.................................... 3,631 3,265 7,235 6,675
General and administrative expenses................. 7,252 6,686 13,598 13,558
Impairment of assets held for sale.................. 8,683 -- 8,683 --
Restructuring activity.............................. 607 (2,122) 618 (1,837)
------- ------- -------- --------
Operating income.................................... 1,287 12,397 9,192 23,281
Other income (expense):
Interest income..................................... 9 26 11 104
Interest expense.................................... (8,828) (9,640) (17,724) (19,839)
------- ------- -------- --------
Income (loss) before taxes.......................... (7,532) 2,783 (8,521) 3,546
Income tax (benefit)................................ 289 2,405 (293) 2,500
------- ------- -------- --------
Net income (loss)................................... $(7,821) $ 378 $ (8,228) $ 1,046
======= ======= ======== ========
1
KNOWLES ELECTRONICS HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
JUNE 30, DECEMBER 31,
2002 2001
----------- ------------
(IN THOUSANDS)
ASSETS
Current Assets:
Cash & cash equivalents................................... $ 5,731 $ 2,446
Accounts receivable, net.................................. 42,783 39,113
Inventories, net.......................................... 41,175 46,662
Prepaid expenses and other................................ 5,744 6,082
Deferred taxes, current portion........................... 6,145 6,096
--------- ---------
Total current assets........................................ 101,578 100,399
Property, plant and equipment, at cost:
Land...................................................... 6,764 6,758
Building and improvements................................. 26,992 26,826
Machinery and equipment................................... 55,708 53,879
Furniture and fixtures.................................... 26,841 26,117
Construction in progress.................................. 7,276 5,085
--------- ---------
Subtotal............................................... 123,581 118,665
Accumulated depreciation.................................... (70,411) (63,838)
--------- ---------
Net.................................................... 53,170 54,827
Assets held for sale, net of impairment..................... 3,858 10,800
Other assets, net........................................... 3,664 3,105
Deferred finance costs, net................................. 7,812 8,421
Deferred income taxes....................................... 330 330
--------- ---------
Total assets........................................... $ 170,412 $ 177,882
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable.......................................... $ 14,099 $ 17,727
Short term debt........................................... 11,957 5,287
Accrued compensation and employee benefits................ 7,260 7,403
Accrued interest payable.................................. 4,900 5,096
Accrued warranty & rebates................................ 8,330 7,545
Accrued restructuring costs............................... 3,129 4,197
Other liabilities......................................... 6,962 7,885
Income taxes.............................................. 5,230 6,940
Current portion of notes payable.......................... 11,250 9,000
--------- ---------
Total current liabilities................................... 73,117 71,080
Accrued pension liability................................... 9,544 8,872
Other noncurrent liabilities................................ 22 5
Notes payable............................................... 326,461 330,773
Preferred stock mandatorily redeemable in 2019 including
accumulating dividends of $61,235 June, 2002; $50,042
December 2001............................................. 246,235 235,042
Stockholders' equity (deficit):
Common stock, Class A, $0.001 par value, 1,052,632 shares
authorized outstanding: 981,667 June 2002; 981,667
December 2001.......................................... -- --
Common stock, Class B, $0.001 par value, 52,632 shares
authorized, none ever issued........................... -- --
Capital in excess of par value............................ 17,213 17,213
Retained earnings (accumulated loss)...................... (497,360) (477,937)
Accumulated other comprehensive income -- translation
adjustment............................................. (4,820) (7,166)
--------- ---------
Total stockholders' equity (deficit)........................ (484,967) (467,890)
--------- ---------
Total liabilities and stockholders' equity (deficit)........ $ 170,412 $ 177,882
========= =========
2
KNOWLES ELECTRONICS HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------- --------------------
2002 2001 2002 2001
------- ---------- ------- ----------
(RESTATED) (RESTATED)
(IN THOUSANDS) (IN THOUSANDS)
(UNAUDITED) (UNAUDITED)
OPERATING ACTIVITIES
Net income (loss).................................... $(7,821) $ 378 $(8,228) $ 1,046
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Depreciation and amortization...................... 2,943 3,336 6,432 6,838
Impairment of assets held for sale................. 8,683 -- 8,683 --
Restructuring costs................................ 607 550 618 835
Amortization of deferred financing fees and debt
discount........................................ 556 531 1,285 1,056
Inventory obsolescence provision................... 1,012 343 1,779 564
Deferred income taxes.............................. (10) -- (49) 8
Stock compensation expense......................... -- -- 200 --
Gain on disposal of fixed assets................... -- (3,046) -- (3,046)
Change in assets and liabilities:
Accounts receivable............................. (1,489) (1,664) (3,438) (1,356)
Inventories..................................... 3,247 3,781 4,218 673
Other current assets............................ (520) (731) (223) (1,626)
Accounts payable................................ 597 1,557 (3,628) 395
Accrued restructuring costs..................... (682) (696) (1,686) (4,193)
Accrued interest payable........................ (5,044) (4,600) (196) 961
Accrued compensation and benefits............... (918) (965) (143) (2,765)
Other current liabilities....................... 1,401 672 (138) (542)
Other noncurrent liabilities.................... 439 (196) 689 (512)
Income taxes payable............................ 147 1,124 (1,710) 880
------- ------- ------- --------
Net cash provided by (used in) operating
activities......................................... 3,148 374 4,465 (784)
INVESTING ACTIVITIES
Proceeds from sales of property, plant & equipment... -- 3,480 -- 3,480
Purchases of property, plant, and equipment, net..... (2,275) (6,418) (5,165) (12,212)
------- ------- ------- --------
Net cash used in investing activities................ (2,275) (2,938) (5,165) (8,732)
FINANCING ACTIVITIES
Debt proceeds (payments)............................. (1,872) (710) 4,420 (1,897)
Issuance of preferred stock and common stock......... -- 125 -- 125
Costs associated with debt........................... (480) -- (488) --
Repurchase of common stock........................... -- (300) (200) (300)
------- ------- ------- --------
Net cash provided by (used in) financing
activities......................................... (2,352) (885) 3,732 (2,072)
Effect of exchange rate changes on cash.............. 345 (170) 253 (481)
------- ------- ------- --------
Net increase (decrease) in cash and cash
equivalents........................................ (1,134) (3,619) 3,285 (12,069)
Cash and cash equivalents at beginning of period..... 6,865 8,626 2,446 17,076
------- ------- ------- --------
Cash and cash equivalents at end of period........... $ 5,731 $ 5,007 $ 5,731 $ 5,007
======= ======= ======= ========
3
KNOWLES ELECTRONICS HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE DATA)
JUNE 30, 2002 AND 2001
(UNAUDITED)
1. BASIS OF RECAPITALIZATION AND PRESENTATION
On June 23, 1999, the Company entered into a recapitalization agreement
with Key Acquisition L.L.C. (the Investor), and the preexisting common
stockholders' of the Company. All of the membership interests of Key Acquisition
LLC are held by limited partnerships for which Doughty Hanson & Co. Limited or
its affiliates ("Doughty Hanson") act as general partner. The recapitalization
transaction (the Recapitalization) closed on June 30, 1999.
On June 29, 1999 the Company distributed the equipment financing business
and certain real estate of the Company to certain preexisting stockholders in
exchange for 10% of the common stock. On June 30, 1999 the Company used the
proceeds from the sale of the preferred and common stock in addition to funds
obtained from a senior credit facility and bridge notes to finance the purchase
of 90% of the remaining 90% of the preexisting stockholders' common shares.
The Recapitalization has been treated as a leveraged recapitalization in
which the issuance of the debt has been accounted for as a financing
transaction, the sales and purchases of the Company's stock have been accounted
for as capital transactions at amounts paid or received, and no changes were
made to the carrying values of the Company's assets and liabilities.
The amount payable to our preexisting stockholders for the repurchase of
their common stock in the Recapitalization was subject to a post-closing
adjustment. As a result, the Company paid the preexisting stockholders
approximately $8.3 million, plus $0.7 million in interest. The price adjustment
was recorded as a reduction to stockholders' equity.
For the six months ended June 30, 2002 and 2001, total comprehensive (loss)
amounted to ($5,882) and ($181), respectively. For the three months ended June
30, 2002 and 2001, total comprehensive income (loss) amounted to ($4,996) and
$567, respectively. The difference between net income (loss) and comprehensive
income (loss) is related primarily to the Company's foreign currency
translation.
In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment
or Disposal of Long-Lived Assets, which the Company adopted on January 1, 2002.
The impact of the adoption was not significant to the Company's results of
operations or financial condition. Separately, based on current and expected
market conditions, the Company recorded an $8,683 impairment of the assets held
for disposal related to the Ruf Electronics division. These assets were
designated as held for sale prior to January 1, 2002, and therefore the Company
continues to account for these assets under the previous impairment guidance of
SFAS No. 121.
The accompanying unaudited consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States for interim financial information. Accordingly, they do not
include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements. In the opinion of our
management, all adjustments, consisting of normal recurring accruals, necessary
for a fair presentation have been included. Certain prior year amounts have been
reclassified to conform to current year presentation. The financial statements
for the first three quarters of 2001 were restated due to the significance of
two fourth quarter adjustments, namely the capitalization of $3.3 million of ERP
software implementation costs previously expensed in those quarters and the
identification of a $4.0 million unanticipated reduction in inventory in the
fourth quarter that related to previous quarters. The results for the period
ended June 30, 2002 do not necessarily indicate the results that may be expected
for the full year ending December 31, 2002. For further information, refer to
the Company's consolidated financial statements and notes thereto included in
the Company's Form 10-K dated for the year ended December 31, 2001.
4
KNOWLES ELECTRONICS HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
2. INVENTORY
Inventories are as follows:
JUNE 30, DECEMBER 31,
2002 2001
-------- ------------
Raw materials & components.................................. $27,129 $30,985
Work in process............................................. 4,424 5,789
Finished goods.............................................. 19,968 19,939
------- -------
51,521 56,713
Less allowances for:
Obsolescence and net realizable value..................... 10,346 10,051
------- -------
$41,175 $46,662
======= =======
3. NOTES PAYABLE
As part of the Recapitalization transaction, the Company entered into a
senior credit agreement dated June 28, 1999 and amended and restated as of July
21, 1999, and further amended as of December 23, 1999, April 10, 2000, December
12, 2001 and May 10, 2002 with certain lenders ("Senior Credit Agreement"). The
Senior Credit Agreement consists of $218,250 (as amended May 10, 2002), which
provides for revolving loans of $18,250 (Revolving Credit Facility) for a period
of seven years, a Term A Facility of $50,000 (Term A Facility), which has a
maturity of seven years, and a Term B Facility of $150,000 (Term B Facility),
which has a maturity of eight years. The Term A Facility and the Revolving
Credit facility bear interest, at the Company's option, at either (1) one-,
two-, three-, or six month LIBOR plus 3.50% (as amended May 10, 2002) or (2) the
greater of the prime rate, a base certificate of deposit rate plus 1.00%, or the
federal funds effective rate plus 0.50% (the Alternate Base Rate), in each case
plus an initial margin of 2.50%. The Term B Facility bears interest, at the
Company's option, at either (1) one-, two-, three-, or six-month LIBOR plus
4.50% (as amended May 10, 2002) or (2) Alternate Base Rate plus an initial
margin on 3.50%. The amendment to the Senior Credit Agreement dated May 10, 2002
increased the interest rate spread for each of the Term A Facility and Term B
Facility by 0.50%. At June 30, 2002, the weighted average interest rate was
5.69% for the Term A Facility and 6.67% for the Term B Facility.
The balance under the Term A Facility, Term B Facility and the Senior
Subordinated Notes ("Notes") is as follows:
JUNE 30, DECEMBER 31,
2002 2001
-------- ------------
Term A facility............................................. $ 40,875 $ 41,250
Term B facility............................................. 145,875 147,750
Senior Subordinated Notes................................... 150,961 150,773
-------- --------
337,711 339,773
Less: Current portion....................................... 11,250 9,000
-------- --------
Total Long-term notes payable............................... $326,461 $330,773
======== ========
At June 30, 2002 short-term debt includes $8,250 borrowed under the
Revolving Credit Facility and $3,707 drawn against a line of credit by our
Austrian subsidiary.
The Notes were issued in a private placement on October 1, 1999 and are due
October 15, 2009 with interest payable semiannually at 13 1/8% commencing April
15, 2000. The Company subsequently exchanged all of the privately placed Notes
for a like amount of identical Notes registered with the Securities and Exchange
Commission on October 20, 2000. The Notes rank equally with all other unsecured
senior
5
KNOWLES ELECTRONICS HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
subordinated indebtedness of the Company. The Notes are junior to all of the
Company's current and future indebtedness, except indebtedness which is
expressly not senior to the Notes.
The Company's Senior Credit Agreement requires that the Company comply with
certain covenants and restrictions, including specific financial ratios that
must be maintained. The Company was not in compliance with the required leverage
ratio and interest coverage ratio under the Senior Credit Agreement as of March
31, 2002. Additionally, the Company did not make the interest payment on the
senior subordinated notes scheduled for April 15, 2002 on that date. An
Amendment and Waiver to the Senior Credit Agreement was obtained dated as of May
10, 2002 and the Company made the interest payment on the senior subordinated
notes that was scheduled for April 15, 2002 on May 14, 2002. The Amendment and
Waiver waived the Company's non-compliance with the required interest coverage
ratio for the period ended March 31, 2002 and the leverage ratio for the period
January 1, 2002 through March 31, 2002, and amended these required ratios for
the periods after March 31, 2002 through the first quarter of 2003. This
Amendment and Waiver also limits capital expenditures for the year 2002 to $15
million, prevents any acquisitions of another company or business, decreases the
revolving credit facility to $18.25 million (from $25 million), caps at $2
million the amount of net cash proceeds from asset sales that can be applied to
buying new assets and requires the Company to receive additional funding of at
least $10 million by September 3, 2002 which must be used to pay down the
outstanding balance on the revolving credit facility to $8.25 million. In
connection with the Amendment and Waiver, the Company and Doughty Hanson entered
into an Investor Funding Agreement that requires Doughty Hanson to invest or
purchase participating bank loans in an amount up to $10 million if the Company
is unable to meet the September 3, 2002 funding requirement by other means. The
Company expects based on current operating forecasts that the amendments to the
covenants in the Credit Agreement will enable it to remain in compliance through
March 31, 2003 and provide sufficient financial flexibility to meet its debt
service requirements as well as other operating needs. However, there can be no
assurance of such compliance through March 31, 2003 or of compliance with the
more stringent covenants thereafter. If future actual results are lower than
planned, the Company may be unable to comply with the debt covenants or make
required debt service payments. Such inability could have a material adverse
impact on the Company's financial condition, results of operations or liquidity.
There are no assurances that the Company could favorably resolve such a
situation.
As security for the obligations under the Senior Credit Agreement the
Company has pledged all of the shares of its U.S. subsidiaries and 65% of the
shares of its non-U.S. subsidiaries and has granted the lenders a security
interest in substantially all of its assets and the assets of its U.S.
subsidiaries.
The Notes are unconditionally guaranteed, on a joint and several basis, by
the following wholly owned U.S. subsidiaries of the Company: Knowles Electronics
LLC, Knowles Intermediate Holding, Inc., Emkay Innovative Products, Inc.,
Knowles Manufacturing Ltd., and Synchro-Start Products, Inc. The following
tables present summarized balance sheet information of the Company as of June
30, 2002 and December 31, 2001, and summarized income statement and cash flow
information for the three months and six months ended June 30, 2002 and 2001.
The column labeled "Parent Company" represents the holding company for each of
the Company's direct subsidiaries, which are guarantors of the Notes, all of
which are wholly owned by the parent company; and the column labeled
"Non-guarantors" represents wholly owned subsidiaries of the Guarantors, which
are not guarantors of the Notes. Pursuant to a contribution agreement effective
August 30, 1999, Knowles Electronics, Inc., recognized in prior periods as the
parent company, contributed substantially all of its operating assets and
liabilities (other than the capital stock of Knowles Intermediate Holding
Company, Inc. and certain foreign subsidiaries and Knowles Electronics, Inc.'s
liabilities under the Senior Credit Agreement and Subordinated Notes) to Knowles
Electronics, LLC, a newly created Delaware limited liability company. As a
result of this reorganization, Knowles Electronics, Inc., which changed its name
to Knowles Electronics Holdings, Inc., is now a holding company that does not
conduct any significant operations. The Company believes that separate financial
statements and other disclosures regarding the Guarantors, except as otherwise
required under Regulation S-X, are not material to investors.
6
KNOWLES ELECTRONICS HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Summarized balance sheet information as of June 30, 2002 and December 31,
2001 and summarized income statement and cash flow information for the three
months and six months ended June 30, 2002 and 2001 is as follows:
JUNE 30, 2002
---------------------------------------------------------------------
PARENT GUARANTORS NON-GUARANTORS ELIMINATIONS CONSOLIDATED
--------- ---------- -------------- ------------ ------------
Cash......................... $ 2,425 $ (117) $ 3,423 $ -- $ 5,731
Accounts receivable.......... -- 30,528 76,127 (63,872) 42,783
Inventories.................. -- 18,848 22,327 -- 41,175
Other current assets......... -- 6,808 5,081 -- 11,889
Net property, plant and
equipment.................. -- 24,950 28,220 -- 53,170
Assets held for sale, net of
impairment................. -- -- 3,858 -- 3,858
Investment in and advances to
subsidiaries............... 97,967 222,342 12,189 (332,498) --
Deferred finance costs,
net........................ 7,812 -- -- -- 7,812
Other non-current assets..... -- 3,547 447 -- 3,994
--------- -------- -------- --------- ---------
Total assets................. $ 108,204 $306,906 $151,672 $(396,370) $ 170,412
========= ======== ======== ========= =========
Accounts payable............. $ -- $ 27,624 $ 49,306 $ (62,831) $ 14,099
Accrued restructuring
costs...................... -- 2,781 348 -- 3,129
Advances from parent......... 109,202 48,613 23,913 (181,728) --
Other current liabilities.... 4,010 14,139 14,533 -- 32,682
Short-term debt.............. 8,250 -- 3,707 -- 11,957
Noncurrent liabilities....... -- 7,336 2,230 -- 9,566
Notes payable................ 337,711 -- -- -- 337,711
Preferred stock.............. 246,235 -- -- -- 246,235
Stockholders' equity
(deficit).................. (597,204) 206,413 57,635 (151,811) (484,967)
--------- -------- -------- --------- ---------
Total liabilities and
stockholders' equity
(deficit).................. $ 108,204 $306,906 $151,672 $(396,370) $ 170,412
========= ======== ======== ========= =========
7
KNOWLES ELECTRONICS HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 2001
---------------------------------------------------------------------
PARENT GUARANTORS NON-GUARANTORS ELIMINATIONS CONSOLIDATED
--------- ---------- -------------- ------------ ------------
Cash......................... $ 5 $ 32 $ 2,409 $ -- $ 2,446
Accounts receivable.......... -- 29,136 66,872 (56,895) 39,113
Inventories.................. -- 21,813 24,849 -- 46,662
Other current assets......... -- 6,801 5,377 -- 12,178
Net property, plant and
equipment.................. -- 29,412 25,415 -- 54,827
Assets held for sale, net of
impairment................. -- -- 10,800 -- 10,800
Investment in and advances to
subsidiaries............... 97,967 192,688 10,749 (301,404) --
Deferred finance costs,
net........................ 8,421 -- -- -- 8,421
Other non-current assets..... -- 3,311 124 -- 3,435
--------- -------- -------- --------- ---------
Total assets................. $ 106,393 $283,193 $146,595 $(358,299) $ 177,882
========= ======== ======== ========= =========
Accounts payable............. $ -- $ 26,917 $ 46,762 $ (55,972) $ 17,727
Accrued restructuring
costs...................... -- 3,553 644 -- 4,197
Advances from parent......... 93,567 36,398 20,770 (150,735) --
Other current liabilities.... 4,156 17,986 13,693 (966) 34,869
Short-term debt.............. 2,000 -- 3,287 -- 5,287
Noncurrent liabilities....... -- 6,919 1,958 -- 8,877
Notes payable................ 339,773 -- -- -- 339,773
Preferred stock.............. 235,042 -- -- -- 235,042
Stockholders' equity
(deficit).................. (568,145) 191,400 59,481 (150,626) (467,890)
--------- -------- -------- --------- ---------
Total liabilities and
stockholders' equity
(deficit).................. $ 106,393 $283,193 $146,595 $(358,299) $ 177,882
========= ======== ======== ========= =========
8
KNOWLES ELECTRONICS HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
THREE MONTHS ENDED JUNE 30, 2002
-------------------------------------------------------------------
PARENT GUARANTORS NON-GUARANTORS ELIMINATIONS CONSOLIDATED
------- ---------- -------------- ------------ ------------
Net Sales.................. $ -- $37,833 $53,064 $(32,664) $58,233
Cost of sales.............. -- 23,108 42,311 (32,531) 32,888
------- ------- ------- -------- -------
Gross margin............... -- 14,725 10,753 (133) 25,345
Selling, research and
administrative
expenses................. -- 10,718 4,202 (152) 14,768
Impairment of assets held
for sale................. -- -- 8,683 -- 8,683
Restructuring activity..... -- 601 6 -- 607
------- ------- ------- -------- -------
Operating income (loss).... -- 3,406 (2,138) 19 1,287
Other income (expense):
Interest income.......... -- 562 82 (635) 9
Interest expense......... (8,781) (387) (337) 677 (8,828)
Dividend income.......... -- 6,660 -- (6,660) --
------- ------- ------- -------- -------
Income (loss) before
taxes.................... (8,781) 10,241 (2,393) (6,599) (7,532)
Income taxes............... -- 2,075 (2,364) -- (289)
------- ------- ------- -------- -------
Net income (loss).......... $(8,781) $12,316 $(4,757) $ (6,599) $(7,821)
======= ======= ======= ======== =======
THREE MONTHS ENDED JUNE 30, 2001 (RESTATED)
-------------------------------------------------------------------
PARENT GUARANTORS NON-GUARANTORS ELIMINATIONS CONSOLIDATED
------- ---------- -------------- ------------ ------------
Net Sales.................. $ -- $43,558 $40,917 $(27,195) $57,280
Cost of sales.............. -- 29,029 30,769 (26,165) 33,633
------- ------- ------- -------- -------
Gross margin............... -- 14,529 10,148 (1,030) 23,647
Selling, research and
administrative
expenses................. -- 8,362 4,657 353 13,372
Restructuring activity..... -- 581 (2,703) -- (2,122)
------- ------- ------- -------- -------
Operating income........... -- 5,586 8,194 (1,383) 12,397
Other income (expense):
Interest income.......... 11 363 120 (468) 26
Interest expense......... (9,613) (195) (254) 422 (9,640)
Miscellaneous, net....... -- (178) (86) 264 --
Dividend income.......... -- 12,398 -- (12,398) --
------- ------- ------- -------- -------
Income (loss) before
taxes.................... (9,602) 17,974 7,974 (13,563) 2,783
Income taxes............... -- 1,684 (4,089) -- (2,405)
------- ------- ------- -------- -------
Net income (loss).......... $(9,602) $19,658 $ 3,885 $(13,563) $ 378
======= ======= ======= ======== =======
9
KNOWLES ELECTRONICS HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
SIX MONTHS ENDED JUNE 30, 2002
--------------------------------------------------------------------
PARENT GUARANTORS NON-GUARANTORS ELIMINATIONS CONSOLIDATED
-------- ---------- -------------- ------------ ------------
Net Sales................. $ -- $69,761 $99,382 $(59,904) $109,239
Cost of sales............. -- 44,901 77,301 (59,653) 62,549
-------- ------- ------- -------- --------
Gross margin.............. -- 24,860 22,081 (251) 46,690
Selling, research and
administrative
expenses................ -- 20,119 8,347 (269) 28,197
Impairment of assets held
for sale................ -- -- 8,683 -- 8,683
Restructuring activity.... -- 601 17 -- 618
-------- ------- ------- -------- --------
Operating income.......... -- 4,140 5,034 18 9,192
Other income (expense):
Interest income......... -- 1,078 243 (1,310) 11
Interest expense........ (17,631) (736) (663) 1,306 (17,724)
Dividend income......... -- 11,302 -- (11,302) --
-------- ------- ------- -------- --------
Income (loss) before
taxes................... (17,631) 15,784 4,614 (11,288) (8,521)
Income taxes.............. -- 4,575 (4,282) -- 293
-------- ------- ------- -------- --------
Net income (loss)......... $(17,631) $20,359 $ 332 $(11,288) $ (8,228)
======== ======= ======= ======== ========
SIX MONTHS ENDED JUNE 30, 2001 (RESTATED)
--------------------------------------------------------------------
PARENT GUARANTORS NON-GUARANTORS ELIMINATIONS CONSOLIDATED
-------- ---------- -------------- ------------ ------------
Net Sales................. $ -- $86,958 $84,935 $(59,884) $112,009
Cost of sales............. -- 56,466 66,533 (59,651) 63,348
-------- ------- ------- -------- --------
Gross margin.............. -- 30,492 18,402 (233) 48,661
Selling, research and
administrative
expenses................ -- 18,048 9,434 (265) 27,217
Restructuring activity.... -- 640 (2,477) -- (1,837)
-------- ------- ------- -------- --------
Operating income.......... -- 11,804 11,445 32 23,281
Other income (expense):
Interest income......... 63 703 187 (849) 104
Interest expense........ (19,786) (339) (522) 808 (19,839)
Dividend income......... 2,939 12,398 -- (15,337) --
-------- ------- ------- -------- --------
Income (loss) before
taxes................... (16,784) 24,566 11,110 (15,346) 3,546
Income taxes.............. -- 404 (2,904) -- (2,500)
-------- ------- ------- -------- --------
Net income (loss)......... $(16,784) $24,970 $ 8,206 $(15,346) $ 1,046
======== ======= ======= ======== ========
10
KNOWLES ELECTRONICS HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
THREE MONTHS ENDED JUNE 30, 2002
--------------------------------------------------------------------
PARENT GUARANTORS NON-GUARANTORS ELIMINATIONS CONSOLIDATED
-------- ---------- -------------- ------------ ------------
Net cash provided by (used
in) operating
activities.............. $(13,387) $ 19,402 $ 3,793 $(6,660) $ 3,148
Equity contributions into
subsidiaries............ -- 728 -- (728) --
Purchases of property,
plant and equipment,
net..................... -- (1,368) (907) -- (2,275)
-------- -------- ------- ------- -------
Net cash used in investing
activities.............. -- (640) (907) (728) (2,275)
Debt proceeds
(payments).............. (2,250) -- 378 -- (1,872)
Intercompany loans........ 15,295 (15,573) 278 -- --
Costs associated with
debt.................... (480) -- -- -- (480)
Intercompany dividends.... -- (3,330) (3,330) 6,660 --
Equity contributions into
subsidiaries............ -- -- (728) 728 --
-------- -------- ------- ------- -------
Net cash provided by (used
in) financing
activities.............. 12,565 (21,359) (5,858) 12,300 (2,352)
Effect of exchange rate
changes on cash......... -- -- 345 -- 345
-------- -------- ------- ------- -------
Net increase (decrease) in
cash and cash
equivalents............. (822) (141) (171) -- (1,134)
Cash and cash equivalents
at beginning of
period.................. 3,247 24 3,594 -- 6,865
-------- -------- ------- ------- -------
Cash and cash equivalents
at end of period........ $ 2,425 $ (117) $ 3,423 $ -- $ 5,731
======== ======== ======= ======= =======
11
KNOWLES ELECTRONICS HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
THREE MONTHS ENDED JUNE 30, 2001 (RESTATED)
--------------------------------------------------------------------
PARENT GUARANTORS NON-GUARANTORS ELIMINATIONS CONSOLIDATED
-------- ---------- -------------- ------------ ------------
Net cash provided by (used
in) operating
activities.............. $(16,459) $ 26,851 $ 2,472 $(12,490) $ 374
-------- -------- ------- -------- -------
Proceeds from sale of
property................ -- -- 3,480 -- 3,480
Equity contributions into
subsidiaries............ -- (751) -- 751 --
Purchases of property,
plant and equipment,
net..................... -- (4,122) (2,296) -- (6,418)
-------- -------- ------- -------- -------
Net cash used in investing
activities.............. -- (4,873) 1,184 751 (2,938)
Debt proceeds
(payments).............. (1,625) -- 915 -- (710)
Common stock
transactions............ (175) -- -- -- (175)
Intercompany loans........ 13,939 (13,216) (723) -- --
Intercompany dividends.... -- (6,245) (6,245) 12,490 --
Equity contributions into
subsidiaries............ -- -- 751 (751) --
-------- -------- ------- -------- -------
Net cash used in financing
activities.............. 12,139 (19,461) (5,302) 11,739 (885)
Effect of exchange rate
changes on cash......... -- -- (170) -- (170)
-------- -------- ------- -------- -------
Net increase (decrease) in
cash and cash
equivalents............. (4,320) 2,517 (1,816) -- (3,619)
Cash and cash equivalents
at beginning of
period.................. 4,329 55 4,242 -- 8,626
-------- -------- ------- -------- -------
Cash and cash equivalents
at end of period........ $ 9 $ 2,572 $ 2,426 $ -- $ 5,007
======== ======== ======= ======== =======
12
KNOWLES ELECTRONICS HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
SIX MONTHS ENDED JUNE 30, 2002
--------------------------------------------------------------------
PARENT GUARANTORS NON-GUARANTORS ELIMINATIONS CONSOLIDATED
-------- ---------- -------------- ------------ ------------
Net cash provided by (used
in) operating
activities.............. $(16,527) $ 25,131 $ 7,163 $(11,302) $ 4,465
Equity contributions into
subsidiaries............ -- (46) -- 46 --
Purchases of property,
plant and equipment,
net..................... -- (3,053) (2,112) -- (5,165)
-------- -------- ------- -------- -------
Net cash used in investing
activities.............. -- (3,099) (2,112) 46 (5,165)
Debt proceeds
(payments).............. 4,000 -- 420 -- 4,420
Common stock
transactions............ (200) -- -- -- (200)
Intercompany loans........ 15,635 (16,530) 895 -- --
Costs associated with
debt.................... (488) -- -- -- (488)
Intercompany dividends.... -- (5,651) (5,651) 11,302 --
Equity contributions into
subsidiaries............ -- -- 46 (46) --
-------- -------- ------- -------- -------
Net cash provided by (used
in) financing
activities.............. 18,947 (24,637) (6,746) 16,168 3,732
Effect of exchange rate
changes on cash......... -- -- 253 -- 253
-------- -------- ------- -------- -------
Net increase (decrease) in
cash and cash
equivalents............. 2,420 (149) 1,014 -- 3,285
Cash and cash equivalents
at beginning of
period.................. 5 32 2,409 -- 2,446
-------- -------- ------- -------- -------
Cash and cash equivalents
at end of period........ $ 2,425 $ (117) $ 3,423 $ -- $ 5,731
======== ======== ======= ======== =======
13
KNOWLES ELECTRONICS HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
SIX MONTHS ENDED JUNE 30, 2001 (RESTATED)
--------------------------------------------------------------------
PARENT GUARANTORS NON-GUARANTORS ELIMINATIONS CONSOLIDATED
-------- ---------- -------------- ------------ ------------
Net cash provided by (used
in) operating
activities.............. $(17,581) $ 29,518 $ 2,708 $(15,429) $ (784)
-------- -------- ------- -------- --------
Proceeds from sale of
property................ -- -- 3,480 -- 3,480
Equity contributions into
subsidiaries............ -- (1,751) -- 1,751 --
Purchases of property,
plant and equipment,
net..................... -- (8,581) (3,631) -- (12,212)
-------- -------- ------- -------- --------
Net cash used in investing
activities.............. -- (10,332) (151) 1,751 (8,732)
Debt proceeds
(payments).............. (3,250) -- 1,353 -- (1,897)
Common stock
transactions............ (175) -- -- -- (175)
Intercompany loans........ 13,939 (13,216) (723) -- --
Intercompany dividends.... -- (6,245) (9,184) 15,429 --
Equity contributions into
subsidiaries............ -- -- 1,751 (1,751) --
-------- -------- ------- -------- --------
Net cash used in financing
activities.............. 10,514 (19,461) (6,803) 13,678 (2,072)
Effect of exchange rate
changes on cash......... -- -- (481) -- (481)
-------- -------- ------- -------- --------
Net increase (decrease) in
cash and cash
equivalents............. (7,067) (275) (4,727) -- (12,069)
Cash and cash equivalents
at beginning of
period.................. 7,076 2,847 7,153 -- 17,076
-------- -------- ------- -------- --------
Cash and cash equivalents
at end of period........ $ 9 $ 2,572 $ 2,426 $ -- $ 5,007
======== ======== ======= ======== ========
4. SEGMENTS AND GEOGRAPHICAL INFORMATION
The Company's continuing business consists of three operating segments:
hearing aid components, acoustic and infrared technology, and automotive
components. These three operating segments were determined based on the
applications and markets for the Company's products.
The hearing aid components operating segment utilizes the Company's
acoustic technologies to design, manufacture, and market transducers and other
components for hearing aids. The acoustic and infrared technology operating
segment utilizes the Company's acoustic and infrared technologies to design,
manufacture, and market products for high growth markets, including mobile
communications, computer telephony integration telematics (voice controlled
wireless services delivered to an automobile environment) and home entertainment
systems. The automotive component operating segment designs, manufactures, and
markets diesel engine solenoids, electronic governors, and position sensors
primarily for use in automobiles, trucks, and off road vehicles.
14
KNOWLES ELECTRONICS HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company uses the following financial information presented below to
assess performance and make resource allocation decisions:
ACOUSTIC AND
HEARING AID INFRARED AUTOMOTIVE
COMPONENTS TECHNOLOGY COMPONENTS TOTAL
----------- ------------ ---------- --------
Three months ended June 30, 2002
Revenues from external customers..... $34,609 $10,668 $12,956 $ 58,233
Operating income (loss) before
restructuring and impairment...... 12,962 226 1,115 14,303
Three months ended June 30, 2001
Revenues from external customers..... $35,117 $ 9,358 $12,805 $ 57,280
Operating income (loss) before
restructuring..................... 10,231 752 2,641 13,624
Six months ended June 30, 2002
Revenues from external customers..... $66,410 $18,199 $24,630 $109,239
Operating income (loss) before
restructuring and impairment...... 24,360 (674) 1,638 25,324
Six months ended June 30, 2001
Revenues from external customers..... $67,323 $17,407 $27,279 $112,009
Operating income (loss) before
restructuring..................... 23,508 (246) 4,578 27,840
The following is a reconciliation of segment operating income to the
Company's consolidated totals:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------- -------------------
2002 2001 2002 2001
-------- -------- -------- --------
Profit or Loss
Total operating income for reportable
segments before restructuring and
impairment charges...................... $14,303 $13,624 $ 25,324 $ 27,840
Unallocated amount -- corporate overhead... (3,726) (3,349) (6,831) (6,396)
Impairment of assets held for sale......... (8,683) -- (8,683) --
Restructuring activity..................... (607) 2,122 (618) 1,837
------- ------- -------- --------
Total consolidated operating income
(loss).................................. 1,287 12,397 9,192 23,281
Other expense.............................. (8,819) (9,614) (17,713) (19,735)
------- ------- -------- --------
Income (loss) before income taxes.......... $(7,532) $ 2,783 $ (8,521) $ 3,546
======= ======= ======== ========
Geographic Information
Revenues (based on billing location of
product shipment)
United States........................... $27,980 $35,968 $ 54,532 $ 68,854
Germany................................. 4,235 4,353 8,020 9,698
United Kingdom.......................... 15,136 8,966 28,365 18,346
Other geographic areas.................. 10,882 7,993 18,322 15,111
------- ------- -------- --------
$58,233 $57,280 $109,239 $112,009
======= ======= ======== ========
15
KNOWLES ELECTRONICS HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
5. RESTRUCTURING EXPENSES
The Company announced a major restructuring in March 2000, resulting in a
first quarter 2000 charge of $20.1 million. Under the restructuring plan, the
Company is consolidating its worldwide manufacturing operations by ending
production at five manufacturing facilities and either outsourcing component
production or moving final assembly to lower cost locations in Malaysia, China
and Hungary. The restructuring charge consists almost entirely of severance
payments to terminated employees and outplacement expenses. As of June 30, 2002,
1,006 positions have been eliminated of the 1,047 total positions that were
expected to be eliminated in the restructuring, thereby reducing our headcount
related to operations that existed in March 2000 by 18%. $19.4 million has been
spent on severance and outplacement costs through June 30, 2002. In June 2002
the Company identified an additional 25 positions at its U.S. locations to be
included in the restructuring, resulting in a second quarter 2002 charge of $0.6
million consisting of severance related payments.
16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The following table shows our net sales growth for the second quarter and
first six months of 2002 and 2001 compared to the same periods of their
respective prior years for each of our three operating segments.
SECOND QUARTER FIRST SIX MONTHS
--------------------------- ---------------------------
2002 VS 2001 2001 VS 2000 2002 VS 2001 2001 VS 2000
------------ ------------ ------------ ------------
KE................................... (1.5)% (1.9)% (1.4)% (6.2)%
Emkay................................ 14.0% 13.7% 4.6% 12.1%
Automotive Components................ 1.2% (23.3)% (9.7)% (18.0)%
Total........................... 1.7% (5.7)% (2.5)% (7.1)%
Overall, all three divisions enjoyed sales increases in the second quarter
compared to the first quarter of this year. However, Emkay sales were much
stronger in the second quarter compared to the prior year, while the Automotive
Group and KE sales were about the same as the second quarter of last year.
Sales for the second quarter of 2002 increased two percent compared to the
second quarter of 2001. The KE Division sales were down two percent in the
second quarter with most of the decline in the core transducer business. KE
transducer unit sales actually increased low single digits, but the increase was
offset by unfavorable sales price and mix. The Emkay Division sales increased
fourteen percent in the second quarter with higher sales in the components,
infrared, and finished goods businesses. The Automotive Components Group sales
increased one percent for the quarter with all of the increase at SSPI.
Sales for the first six months of 2002 declined three percent compared to
the first six months of 2001. The KE Division sales were down slightly in the
first six months with the decline split between the core transducer business and
the Deltek controls business. KE transducer unit sales actually increased low
single digits, but the increase was offset by unfavorable sales price and mix.
The Emkay Division sales increased five percent in the first six months with
higher sales in components and condensor mic businesses partially offset by a
decline in the finished goods business. The infrared business increased only
slightly for the first six months. The Automotive Components Group sales
declined ten percent for the first six months with the decline about equally
split between the Ruf and the SSPI businesses. However, the rate of decline was
greater at Ruf as the decline is off a lower sales base.
CONSOLIDATED RESULTS OF OPERATIONS
The following table shows the principal line items from our consolidated
statements of operations, as a percentage of our net sales, for the three months
and six months ended June 30, 2002 and 2001.
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
--------------- ---------------
2002 2001 2002 2001
------ ------ ------ ------
Net sales............................................ 100.0% 100.0% 100.0% 100.0%
Cost of sales........................................ 56.5% 58.7% 57.3% 56.6%
Research and development............................. 6.7% 6.0% 6.7% 6.2%
Sales and marketing expense.......................... 6.2% 5.7% 6.6% 6.0%
General and administrative expense................... 12.5% 11.7% 12.4% 12.1%
Impairment of assets held for sale................... 14.9% 0.0% 7.9% 0.0%
Restructuring activity............................... 1.0% (3.7)% 0.6% (1.6)%
----- ----- ----- -----
Income from operations............................... 2.2% 21.6% 8.4% 20.8%
EBITDA............................................... 7.3% 27.5% 14.3% 26.9%
EBITDA excluding impairment and restructuring........ 23.2% 23.8% 22.8% 25.3%
17
Operating income and EBITDA, as a percentage of net sales, excluding
impairment and restructuring charges, were 18.1% and 23.2%, respectively, for
the quarter ended June 30, 2002. Operating income and EBITDA, as a percentage of
net sales, excluding impairment and restructuring charges, were 17.9% and 23.8%,
respectively, for the quarter ended June 30, 2001. Operating income and EBITDA,
as a percentage of net sales, as reported, were 2.2% and 7.3%, respectively, for
the quarter ended June 30, 2002. Operating income and EBITDA, as a percentage of
net sales, as reported, were 21.6% and 27.5%, respectively, for the quarter
ended June 30, 2001. The lower operating income and EBITDA, as reported, in the
second quarter of 2002 compared to 2001 is due to lower Emkay and Automotive
Component results including the asset impairment charge for Ruf discussed below.
Operating income and EBITDA, as a percentage of net sales, excluding
impairment and restructuring charges, were 16.9% and 22.8%, respectively, for
the six months ended June 30, 2002. Operating income and EBITDA, as a percentage
of net sales, excluding impairment and restructuring charges, were 19.2% and
25.3%, respectively, for the six months ended June 30, 2001. Operating income
and EBITDA, as a percentage of net sales, as reported, were 8.4% and 14.3%,
respectively, for the six months ended June 30, 2002. Operating income and
EBITDA, as a percentage of net sales, as reported, were 20.8% and 26.9%,
respectively, for the six months ended June 30, 2001. The lower operating income
and EBITDA in the first six months of 2002 compared to 2001, as reported, is
primarily due to lower Automotive Component results including the asset
impairment charge for Ruf discussed below.
QUARTER ENDED JUNE 30, 2002 COMPARED TO QUARTER ENDED JUNE 30, 2001
The following table sets forth net sales by segment and segment net sales
as a percent of total sales.
PERCENT OF
NET SALES TOTAL SALES
---------------- ----------------
QUARTER ENDED QUARTER ENDED
JUNE 30, JUNE 30,
---------------- ----------------
SEGMENT 2002 2001 2002 2001
- ------- ------ ------ ------ ------
(IN MILLIONS, EXCEPT PERCENTAGES)
KE.................................................. $34.6 $35.1 59.4% 61.3%
Emkay............................................... 10.7 9.4 18.3% 16.3%
Automotive Components............................... 12.9 12.8 22.3% 22.4%
----- ----- ----- -----
Total............................................... $58.2 $57.3 100.0% 100.0%
===== ===== ===== =====
Consolidated sales increased $0.9 million or 1.7 percent the second quarter
2002 compared to the same quarter of 2001. KE Group sales declined $0.5 million
or 1.5 percent compared to the second quarter of last year. The small KE sales
decline occurred because unfavorable pricing and mix in the transducer product
line exceeded the low single digit unit volume increase. The Emkay Group sales
increased $1.3 million or 14.0 percent in the second quarter of this year
compared to the same quarter last year. The increase occurred in all parts of
the business, particularly in the components and finished goods product lines.
The Automotive Components Group sales increased $0.1 million or 1.2 percent in
the second quarter reversing a three-year trend. The SSPI sales product line was
up in the second quarter compared to the same quarter last year, while the Ruf
sales were flat.
18
The following table sets forth cost of sales by segment and segment cost of
sales as a percent of segment net sales.
PERCENT OF
COST OF SALES SEGMENT SALES
---------------- ----------------
QUARTER ENDED QUARTER ENDED
JUNE 30, JUNE 30,
---------------- ----------------
SEGMENT 2002 2001 2002 2001
- ------- ------ ------ ------ ------
(IN MILLIONS, EXCEPT PERCENTAGES)
KE.................................................... $17.7 $21.1 51.1% 60.3%
Emkay................................................. 6.6 5.1 61.5% 54.1%
Automotive Components................................. 8.6 7.4 66.6% 57.8%
----- -----
Total................................................. $32.9 $33.6 56.5% 58.7%
===== =====
Consolidated cost of sales declined by 2.2 percentage points as a percent
of sales in the second quarter 2002 compared to the same period the prior year.
The KE Group's cost of sales declined by $3.4 million or 9.2 percentage points.
The improvement was due to $1.7 million less inventory shrink, $1.0 million less
warranty expense, $0.5 million less currency losses, and $2.2 million less
manufacturing overhead absorption variance the second quarter of this year
compared to last year partially offset by $0.8 million increase due to volume
and $1.2 million loss due to pricing and mix this year. The Emkay Group's cost
of sales increased by $1.5 million or 7.4 percentage points with about one half
due to volume and the other half due to unfavorable mix. The Automotive
Components Group cost of sales increased by $1.2 million or 8.8 percentage
points, primarily due to the loss of high margin SSPI sales compared to the
prior year period and declining Ruf sales.
The following table sets forth operating income by segment and segment
operating income as a percentage of segment net sales.
PERCENT OF
OPERATING INCOME SEGMENT SALES
---------------- -------------
QUARTER ENDED QUARTER ENDED
JUNE 30, JUNE 30,
---------------- -------------
2002 2001 2002 2001
------ ------ ----- ----
(IN MILLIONS, EXCEPT PERCENTAGES)
KE................................................... $12.6 $12.7 36.4% 36.3%
Emkay................................................ 0.2 0.8 2.0% 8.0%
Automotive Components................................ (7.6) 2.2 (58.5)% 17.5%
Unallocated amount -- corporate overhead............. (3.9) (3.3) -- --
----- ----- ----- ----
Total................................................ $ 1.3 $12.4 2.2% 21.6%
===== ===== ===== ====
Notwithstanding the lower KE Group sales and much higher Emkay and Auto
Components cost of sales, which significantly reduced the gross margins in those
two divisions, the primary causes of the reduction in operating income are the
asset impairment charge, the year over year unfavorable swing in restructuring,
and higher SG&A expense. The improved KE margin more than offset the lower KE
sales and lower Emkay and Automotive Components margin. The Automotive Group
operating income was significantly reduced by the $8.7 million asset impairment
charge for Ruf. The Company is still attempting to divest its Ruf business and
based on current and expected market conditions, the Company wrote the Ruf
assets held for sale down to their fair value less costs to dispose. The KE
operating income was reduced $2.9 million due to the favorable second quarter
building sale in 2001 and the unfavorable personnel reduction during the second
quarter this year. Excluding the restructuring swing, the KE operating profit
increased $2.8 million. SG&A expense increased $1.4 million reducing operating
income in the second quarter of this year compared to the same period last year.
The KE Group operating income declined by $0.1 million primarily due to the
swing in restructuring which was $2.5 million favorable last year and $0.4
million unfavorable this year offsetting the net $2.9 million
19
improvement in the gross margin discussed above. Again, notwithstanding the
favorable gross margin the division's operating income was lowered by
unfavorable pricing and mix discussed above.
The Emkay Group operating income declined by $0.6 million primarily due to
unfavorable mix discussed above.
The Automotive Components Group operating income decreased by $9.8 million.
The decline was primarily caused by the $8.7 million impairment charge for Ruf.
The remaining $1.1 million was due to unfavorable mix at SSPI and lower Ruf
sales, which decreased faster than Ruf's manufacturing costs were reduced.
Unallocated corporate expenses increased by $0.6 million in the second
quarter compared to the same quarter last year. Restructuring activity was an
expense of $0.6 million this year compared to a benefit of $2.1 million the
second quarter of last year resulting in an unfavorable effect on operating
income of $2.7 million for this year compared to last year.
We had operating income of $1.3 million in the second quarter 2002 compared
to operating income of $12.4 million the same quarter last year, primarily as a
result of the Ruf impairment charge, the restructuring fluctuation, the lower
Emkay and Automotive Components Group gross margin, and the increased SG&A
discussed above. After adjusting out the impairment and restructuring charges,
we had adjusted operating income of $10.6 million the second quarter this year
compared to $10.3 million the same quarter last year. On an adjusted basis our
operating income increased $0.3 million or 0.5 percentage points the second
quarter this year compared to the same quarter last year.
In connection with our June 1999 recapitalization, we currently have
significant senior debt and senior subordinated debt. As a result, interest
expense was $8.8 million the second quarter of this year compared to $9.6
million the same quarter last year. The reduction in interest expense is due
primarily to lower interest rates on the senior debt.
Income tax expense was a $0.3 million expense the second quarter this year
compared to $2.4 million expense the second quarter last year. We are providing
tax at this year's expected worldwide amount of approximately $5 million
prorated over the pretax income adjusted for nondeductible items such as the Ruf
asset impairment charge.
After interest expense and taxes, we reported a net loss of $7.8 million
the second quarter of this year compared to net income of $0.4 million for the
same period last year.
SIX MONTHS ENDED JUNE 30, 2002 COMPARED TO SIX MONTHS ENDED JUNE 30, 2001
The following table sets forth net sales by segment and segment net sales
as a percent of total sales.
PERCENT OF
NET SALES TOTAL SALES
----------------- -----------------
SIX MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
----------------- -----------------
SEGMENT 2002 2001 2002 2001
- ------- ------ ------ ------ ------
(IN MILLIONS, EXCEPT PERCENTAGES)
KE............................................ $ 66.4 $ 67.3 60.8% 60.1%
Emkay......................................... 18.2 17.4 16.7% 15.5%
Automotive Components......................... 24.6 27.3 22.5% 24.4%
------ ------ ----- -----
Total......................................... $109.2 $112.0 100.0% 100.0%
====== ====== ===== =====
Consolidated sales declined $2.8 million or 2.5 percent the first six
months 2002 compared to the same period of 2001. The Automotive Components Group
sales declined the most significantly and accounted for almost all the sales
decline. KE Group sales declined $0.9 million or 1.4 percent primarily due to
pricing and mix as unit volumes increased low single digits. The Emkay Group
sales increased $0.8 million or 4.6 percent with all product lines increasing
some except for finished goods. The Automotive Components Group sales declined
$2.7 million or 9.7 percent in the first six months continuing a three-year
trend. Ruf sales were down
20
approximately 16 percent in the first six months compared to the same period
last year, while the SSPI sales were down 7 percent again largely due to
unfavorable mix.
The following table sets forth cost of sales by segment and segment cost of
sales as a percent of segment net sales.
PERCENT OF
COST OF SALES SEGMENT SALES
----------------- -----------------
SIX MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
----------------- -----------------
SEGMENT 2002 2001 2002 2001
- ------- ------ ------ ----- -----
(IN MILLIONS, EXCEPT PERCENTAGES)
KE.............................................. $34.5 $36.4 51.9% 54.1%
Emkay........................................... 11.3 10.2 62.2% 58.7%
Automotive Components........................... 16.8 16.7 68.2% 61.2%
----- -----
Total........................................... $62.6 $63.3 57.3% 56.6%
===== =====
Consolidated cost of sales decreased by $0.7 million, but increased by 0.7
percent of sales in the first six months 2002 compared to the same period the
prior year. The KE Group's cost of sales decreased by $1.9 million or 2.2
percentage points, primarily due to favorable second quarter performance
discussed above being greater than the price and mix decline for the first half.
The Emkay Group cost of sales increased by $1.1 million or 3.5 percentage points
with about one third due to increased volume, one third due to unfavorable
manufacturing absorption, and one third due to unfavorable mix. The Automotive
Components Group cost of sales increased $0.1 million or 7.0 percentage points
with little volume change primarily due to the loss of high margin SSPI sales
compared to the prior year and the Ruf sales declining faster than the cost
reduction impact of product transfers to Hungary.
The following table sets forth operating income by segment and segment
operating income as a percentage of segment net sales.
PERCENT OF
OPERATING INCOME SEGMENT SALES
----------------- -----------------
SIX MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
----------------- -----------------
2002 2001 2002 2001
------ ------ ------ -----
(IN MILLIONS, EXCEPT PERCENTAGES)
KE............................................... $24.0 $25.9 36.1% 38.5%
Emkay............................................ (0.6) (0.3) (3.8)% (2.0)%
Automotive Components............................ (7.1) 4.1 (28.5)% 15.1%
Unallocated amount -- corporate overhead......... (7.1) (6.4)
----- -----
Total............................................ $ 9.2 $23.3 8.4% 20.8%
===== =====
The decline in operating income the first six months of 2002 compared to
the first six months of 2001 is due the asset impairment charge, the swing in
restructuring from benefit to expense, lower Automotive Component sales, and
much lower Auto Components and Emkay margins. Operating income declined $14.1
million or 12.4 percentage points in the first six months of 2002 compared to
the same period of 2001. The Ruf impairment charge accounted for $8.7 million of
the difference and the swing in the restructuring expense from $1.8 million
credit in 2001 to $0.6 million expense in 2002 accounted for another $2.4
million. Therefore after adjusting for these two charges the difference in the
first six months of 2002 compared to the same period of 2001 is a $3.0 million
decline in operating income. SG&A expense increased $0.9 million in the first
six months and the remaining $2.0 million net decline in operating income was
due to the decline in gross margin discussed above.
The KE Group operating income declined by $1.9 million primarily due to the
fluctuation in the restructuring expense. If the restructuring expense is added
back, the KE operating income improved by $0.9 million despite the lower sales
and unfavorable pricing and mix.
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The Emkay Group operating income declined by $0.3 million the first six
months despite higher sales volume due to unfavorable mix in the first six
months and unfavorable absorption in the first quarter.
The Automotive Components Group operating income decreased by $11.2
million. If the Ruf impairment charge is added back, the Automotive Components
operating income declined by $2.5 million primarily due to lower sales and
unfavorable mix. The primary cause was lower SSPI gross margin and lower Ruf
sales, which decreased faster than Ruf's manufacturing costs were reduced.
Unallocated corporate expenses increased by $0.7 million in the six months
compared to the same quarter last year. Corporate general and administrative
expense increases account for $0.5 million and restructuring for $0.2 million.
We had operating income of $9.2 million in the first six months 2002
compared to operating income of $23.3 million the same period last year,
primarily as a result of the Ruf impairment charge, the unfavorable swing in
restructuring, lower Automotive Components sales, and lower Automotive
Components and Emkay gross margins discussed above. After adjusting out the
impairment and restructuring charges, we had adjusted operating income of $18.5
million the first six months this year compared to $21.4 million the same period
last year. On an adjusted basis operating income declined $2.9 million or 2.7
percentage points the first six months this year compared to the same period
last year, primarily due to the first quarter results.
In connection with our June 1999 recapitalization, we currently have
significant senior debt and senior subordinated debt. As a result, interest
expense was $17.7 million the first six months this year compared to $19.8
million the same period last year. The reduction in interest expense is due
primarily to lower interest rates on the senior debt.
Income tax expense was a $0.3 million benefit the first six months this
year compared to $2.5 million expense the first quarter last year. We are
providing tax at this year's expected worldwide amount of approximately $5
million prorated over the pretax income adjusted for nondeductible items such as
the Ruf asset impairment charge.
After interest expense and taxes, we reported a net loss of $8.2 million
the first six months this year compared to net income of $1.0 million for the
same period last year.
LIQUIDITY AND CAPITAL RESOURCES
We have historically used available funds for capital expenditures,
inventory, accounts receivable and acquisitions. These funds have been obtained
from operating activities and from lines of credit. In the future, we will
continue to have these funding needs, and we will also need to fund repayments
of principal under our term loans ($9.0 million in 2002, $10.25 million in 2003,
and additional amounts thereafter). We also will have substantial interest
expense of approximately $35 million each year.
We are a holding company. Our subsidiaries conduct substantially all of our
consolidated operations and own substantially all of our consolidated assets.
Consequently, our cash flow and our ability to meet our debt service obligations
depends substantially upon the cash flow of our subsidiaries and the payment of
funds by our subsidiaries to us in the form of loans, dividends or otherwise.
The Company borrowed $200 million under a bank credit agreement plus $153.2
million under a senior subordinated note agreement associated with its
recapitalization June 30, 1999. The Company is required to maintain certain
ratios of EBITDA in order to be in compliance with its bank credit agreement
covenants and to access its $18.25 million revolving credit facility (as
amended). The two primary ratios the Company must maintain are the leverage
ratio, which is total net debt divided by EBITDA, and the interest coverage
ratio, which is EBITDA, divided by net cash interest expense. The Company is
required to maintain its leverage ratio below a specified level and its interest
coverage ratio above a specified level.
First quarter 2002 sales and resulting EBITDA were considerably less than
projected at the time of the December 2001 amendment to the bank credit
agreement, resulting in $6 million less cash collections and higher payable
disbursements than expected. Therefore, we were not in compliance with our
required leverage ratio and interest coverage ratio under the bank credit
agreement as of March 31, 2002. As a result, we did not
22
make the interest payment on our senior subordinated notes scheduled for April
15, 2002 on that date. We subsequently obtained an Amendment and Waiver dated as
of May 10, 2002 to our Credit Agreement and on May 14, 2002 made the interest
payment on our senior subordinated notes that were scheduled for April 15, 2002.
The Company is required to maintain the following amended leverage ratios
and interest coverage ratios for 2002 as follows:
LEVERAGE RATIO INTEREST COVERAGE RATIO
-------------- -----------------------
March 31, 2002....................................... Waived Waived
June 30, 2002........................................ 6.75 1.45
September 30, 2002................................... 6.65 1.45
December 31, 2002.................................... 6.45 1.45
We did meet the financial ratios required at the end of the second quarter.
Our leverage ratio was 6.49 compared to a required ratio less than 6.75 and our
interest expense coverage ratio was 1.6 compared to a required ratio greater
than 1.45. We also were in compliance with the capital expenditure limit and
other terms and conditions of our credit agreement.
We expect to be able to comply with the required covenants through March
31, 2003. However, we can provide no assurance that we will meet the revised
covenants through March 31, 2003 or the more stringent covenants thereafter. The
inability to meet the required covenants could have a material adverse effect on
the Company's financial condition, results of operations, and liquidity.
Net cash provided by operating activities was $3.1 million in the second
quarter of 2002 compared to $0.4 million in the first quarter of 2001 or $2.8
million better. Although income was a net loss of $7.8 million in the second
quarter of this year compared to net income of $0.4 million the second quarter
of last year, after adjusting for non cash items, cash earnings from operations
were $3.9 million better the second quarter of 2002 compared to the second
quarter of 2001. Accounts payable was a $1.0 million use of working capital year
over year accounting for most of the $1.1 million increase in working capital
year over year.
Net cash used in investing activities was $2.3 million in the second
quarter this year compared to a net $2.9 million the second quarter of last
year. Capital expenditures were $6.4 million the second quarter last year offset
by $3.5 provided by the sale of the United Kingdom building. Investing
activities for both years is primarily net purchases of property, plant and
equipment. The major reason the second quarter capital expenditures last year
were higher than the second quarter this year was the significant ERP related
investment and automation equipment spending last year.
Net cash used by financing activities was $2.4 million in the second
quarter of 2002, as compared to a $0.9 million use in the second quarter of last
year. The effect of exchanges rates on cash was $0.3 million increase the second
quarter this year compared to a $0.2 million decrease the second quarter of last
year.
The net result of the cash provided by operating activities, investing
activities and financing activities was a $1.1 million decrease in cash the
second quarter of this year, compared to a $3.6 million reduction in cash for
the same period last year. Our cash balance was $5.7 million at June 30 this
year compared to $5.0 million at June 30 last year.
Net cash provided by operating activities was $4.5 million in the first six
months of 2002 compared to a $0.8 million use of cash by operating activities in
the first six months of 2001 or $5.2 million better. Although income was a net
loss of $8.2 million in the first six months of this year compared to net income
of $1.0 million the first six months of last year, after adjusting for non cash
items, cash earnings from operations were $3.4 million more the first six months
of 2002 compared to the first six months of 2001. Net working capital improved
$1.8 million in the first six months. Items consuming working capital included
accounts payable of $4.0 million, income taxes of $2.6 million, accounts
receivable of $2.1 million, and accrued interest expense of $1.2 million or a
total of $9.9 million. The net of these four uses of working capital and the
cash earnings improvement were more than made up by a reduction in five other
areas of working capital totaling more than
23
$11.6 million -- namely, a $3.5 million year over year reduction in inventory, a
$2.6 million reduction in accrued compensation and benefits, a $2.5 million
reduction in accrued restructuring, a $1.6 million reduction in other current
and non current liabilities, and a $1.4 million reduction in other current
assets.
Net cash used in investing activities was $5.2 million in the first six
months this year compared to $8.7 million the first six months of last year.
Capital expenditures were $12.2 million the first six months last year offset by
$3.5 million provided by the sale of the United Kingdom building. Investing
activities for both years is primarily net purchases of property, plant and
equipment. The major reason the first six months last year was higher than the
first six months this year was the significant ERP related investment and
automation project the first six months of last year.
Net cash from financing activities was $3.7 million in the first six months
of 2002, primarily due to borrowing in order to increase cash in anticipation of
debt and interest payments in the second quarter of this year, compared to a
$2.1 million use of cash from financing activities in the first six months of
last year, primarily to pay down debt in the first six months of last year. The
effect of exchanges rates on cash was $0.3 million increase in cash the first
six months this year compared to a $0.5 million decrease in cash the first six
months of last year.
The net result of the cash provided by operating activities, investing
activities and financing activities was a $3.3 million increase in cash the
first six months of this year, compared to a $12.1 million reduction in cash for
the same period last year. Our cash balance was $5.7 million at June 30 this
year compared to $5.0 million at June 30 last year.
We expect capital expenditures of $12 to $13 million in 2002. We expect our
major capital expenditures in 2002 will be to support new product introductions
for Emkay, for new production equipment for KE, and for new product
introductions for SSPI and Ruf. We may also pursue joint ventures in lower wage
locations, which would require additional capital resources. The amount and
timing of actual capital expenditures may be different than our current
expectations.
ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to market risk from changes in foreign exchange
rates and interest rates.
We do not hedge our foreign currency exchange rate exposure. Therefore, we
are exposed to foreign currency exchange rate risks. Our revenues are primarily
denominated in the U.S. dollar and the Euro. During the first six months of
2002, approximately 77% of our revenue was denominated in U.S. dollars,
approximately 16% of our revenue was denominated in Euros, and the balance was
denominated in other foreign currencies including the British pound and the
Japanese yen. Our expenses are principally denominated in the same currencies,
in which we have sales, allowing us to essentially hedge through offsetting
revenue and expense exposures. As a result, during the first six months of 2002,
our operating income and margins were not significantly affected by the change
in the Euro exchange rate. As we discussed earlier, we believe currency changes
added about $0.5 million to income in the first six months. Some of our expenses
are denominated in the local currencies of Austria, the United Kingdom, Hungary,
China, Japan, Malaysia and Taiwan, some of which are closely tied to the U.S.
dollar and Euro. Our primary exposure longer term is the relation of the Euro to
the U.S. dollar and major Asian currencies.
We do not invest in speculative or derivative financial instruments. We
have significant amounts of debt that are subject to interest rate fluctuation
risk. The amounts outstanding under the term loans of the Credit Agreement have
variable interest rates and, therefore, adjust to market conditions. An increase
or a decrease of 1 percentage point in the interest rate of the loans under the
Credit Agreement would change our annual interest expense by $2 million. The
amount outstanding under the existing notes accrues interest at a fixed rate of
13.125%. We have estimated the fair value of the notes as of June 30, 2002 to be
$125.6 million based on current market prices, and as of August 7, 2002 we
estimate the fair value of the notes to be $107.2 million.
24
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Quarterly Report on Form 10-Q for the quarter
ended June 30, 2002, to be signed on its behalf by the undersigned thereunto
duly authorized.
Knowles Electronics Holdings, Inc.
By /s/ JAMES H. MOYLE
------------------------------------
James H. Moyle, Vice President &
CFO,
(As duly authorized officer and as
the principal financial and
accounting officer)
By /s/ JAMES F. BRACE
------------------------------------
James F. Brace, Executive Vice
President,
(As duly authorized officer)
Date: August 12, 2002
25