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United States
Securities and Exchange Commission
Washington, D.C. 20549
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For Quarterly period ended: June 30, 2003
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURTIES EXCHANGE ACT OF 1934
For the transition period from_______________ to________________
Commission File Number 1-5558
Katy Industries, Inc.
(Exact name of registrant as specified in its charter)
Delaware 75-1277589
(State of Incorporation) (I.R.S. Employer Identification No.)
765 Straits Turnpike, Suite 2000, Middlebury, Connecticut 06762
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (203)598-0397
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 |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes |_| No |X|
Indicate the number of shares outstanding of each of the issuer's classes
of common stock as of the latest practicable date.
Class Outstanding at August 6, 2003
Common Stock, $1 Par Value 8,255,677
KATY INDUSTRIES, INC.
FORM 10-Q
June 30, 2003
INDEX
Page
----
PART I FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets
June 30, 2003 and December 31, 2002 (unaudited) 2,3
Condensed Consolidated Statements of Operations
Three Months and Six Months Ended
June 30, 2003 and 2002 (unaudited) 4
Condensed Consolidated Statements of Cash Flows
Six Months Ended June 30, 2003 and 2002 (unaudited) 5
Notes to Condensed Consolidated Financial Statements (unaudited) 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 21
Item 3. Quantitative and Qualitative Disclosures about Market Risk 37
Item 4. Controls and Procedures 37
PART II OTHER INFORMATION
Item 1. Legal Proceedings 38
Item 4. Submission of Matters to a Vote of Security Holders 38
Item 6. Exhibits and Reports on Form 8-K 39
Signatures 40
Certifications 41-44
- 1 -
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
KATY INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Thousands of Dollars)
(Unaudited)
ASSETS
June 30, December 31,
2003 2002
--------- ------------
CURRENT ASSETS:
Cash and cash equivalents $ 6,673 $ 4,842
Trade accounts receivable, net 65,365 58,913
Inventories 58,975 57,967
Other current assets 1,883 1,942
Current assets of discontinued operations -- 5,970
--------- ---------
Total current assets 132,896 129,634
--------- ---------
OTHER ASSETS:
Goodwill 11,211 11,211
Intangibles 25,272 25,491
Equity method investment 7,095 7,306
Other 11,031 12,342
Non-current assets of discontinued operations -- 3,100
--------- ---------
Total other assets 54,609 59,450
--------- ---------
PROPERTY AND EQUIPMENT
Land and improvements 3,237 3,180
Buildings and improvements 16,904 14,707
Machinery and equipment 140,408 143,089
--------- ---------
160,549 160,976
Less - Accumulated depreciation (80,343) (74,083)
--------- ---------
Net property and equipment 80,206 86,893
--------- ---------
Total assets $ 267,711 $ 275,977
========= =========
See Notes to Condensed Consolidated Financial Statements.
- 2 -
KATY INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Thousands of Dollars, Except Share Data)
(Unaudited)
LIABILITIES AND STOCKHOLDERS' EQUITY
June 30, December 31,
2003 2002
--------- ------------
CURRENT LIABILITIES:
Accounts payable $ 29,655 $ 37,058
Accrued compensation 5,649 7,214
Accrued expenses 42,084 47,712
Current maturities of long-term debt 2,857 700
Revolving credit agreement 51,000 44,751
Current liabilities of discontinued operations 142 2,444
--------- ---------
Total current liabilities 131,387 139,879
LONG-TERM DEBT, less current maturities 14,239 --
OTHER LIABILITIES 17,770 17,526
NON-CURRENT LIABILITIES OF DISCONTINUED OPERATIONS 52 --
--------- ---------
Total liabilities 163,448 157,405
--------- ---------
COMMITMENTS AND CONTINGENCIES (Notes 13 and 16) -- --
--------- ---------
PREFERRED INTEREST OF SUBSIDIARY -- 16,400
--------- ---------
STOCKHOLDERS' EQUITY
15% Convertible Preferred Stock, $100 par value, authorized
1,200,000 shares, issued and outstanding 805,000 shares, liquidation
value $80,500 86,721 80,696
Common stock, $1 par value authorized 35,000,000 shares,
issued 9,822,204 shares 9,822 9,822
Additional paid-in capital 47,236 46,701
Accumulated other comprehensive loss (127) (3,046)
Accumulated deficit (18,819) (11,773)
Treasury stock, at cost, 1,539,927
and 1,460,027 shares, respectively (20,570) (20,228)
--------- ---------
Total stockholders' equity 104,263 102,172
--------- ---------
Total liabilities and stockholders' equity $ 267,711 $ 275,977
========= =========
See Notes to Condensed Consolidated Financial Statements.
- 3 -
KATY INDUSTRIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS AND SIX MONTHS ENDED JUNE 30, 2003 AND 2002
(Thousands of Dollars, Except Share and Per Share Data)
(Unaudited)
Three Months Six Months
Ended June 30 Ended June 30
2003 2002 2003 2002
--------- --------- --------- ---------
Net sales $ 105,359 $ 108,461 $ 201,199 $ 209,986
Cost of goods sold (89,804) (90,727) (168,876) (174,778)
--------- --------- --------- ---------
Gross profit 15,555 17,734 32,323 35,208
Selling, general and administrative expenses (16,120) (16,575) (31,867) (32,273)
Severance, restructuring and related charges (1,713) (3,785) (1,941) (6,081)
Impairments of long-lived assets (1,800) (2,394) (1,800) (2,394)
Loss on SESCO transaction -- -- -- (6,010)
--------- --------- --------- ---------
Operating loss (4,078) (5,020) (3,285) (11,550)
Equity in income (loss) of equity method investment 156 339 (211) 646
Interest, net (1,171) (1,450) (3,563) (2,904)
Other, net 483 (139) 1,197 (219)
--------- --------- --------- ---------
Loss before provision for income taxes (4,610) (6,270) (5,862) (14,027)
Provision for income taxes (396) (672) (939) (672)
--------- --------- --------- ---------
Loss from continuing operations before distributions on
preferred interest of subsidiary (5,006) (6,942) (6,801) (14,699)
Distributions on preferred interest of subsidiary (net of tax) -- (328) (123) (656)
--------- --------- --------- ---------
Loss from continuing operations (5,006) (7,270) (6,924) (15,355)
Income from operations of discontinued businesses -- 700 74 1,195
Loss on sale of discontinued businesses (196) -- (196) --
--------- --------- --------- ---------
Net loss (5,202) (6,570) (7,046) (14,160)
Gain on early redemption of preferred interest of subsidiary -- -- 6,560 --
Payment in kind dividends on convertible preferred stock (3,011) (2,615) (6,025) (5,237)
--------- --------- --------- ---------
Net loss attributable to common stockholders $ (8,213) $ (9,185) $ (6,511) $ (19,397)
========= ========= ========= =========
Income (loss) per share of common stock - Basic and diluted
Loss from continuing operations attributable
to common stockholders $ (0.96) $ (1.18) $ (0.76) $ (2.46)
Discontinued operations (0.02) 0.08 (0.02) 0.14
--------- --------- --------- ---------
Net loss attributable to common stockholders $ (0.98) $ (1.10) $ (0.78) $ (2.32)
========= ========= ========= =========
Weighted average common shares outstanding (thousands):
Basic and diluted 8,342 8,362 8,352 8,377
========= ========= ========= =========
See Notes to Condensed Consolidated Financial Statements.
- 4 -
KATY INDUSTRIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED JUNE 30, 2003 AND 2002
(Thousands of Dollars)
(Unaudited)
2003 2002
-------- --------
Cash flows from operating activities:
Net loss $ (7,046) $(14,160)
Loss (income) from operations of discontinued businesses 122 (1,195)
-------- --------
Loss from continuing operations (6,924) (15,355)
Depreciation and amortization 11,213 10,249
Impairments of long-lived assets 1,800 2,394
Write-off and amortization of debt issuance costs 1,766 797
Gain on sale of assets (803) (55)
Loss on SESCO transaction -- 6,010
Equity in loss (income) of equity method investment 211 (646)
-------- --------
7,263 3,394
-------- --------
Changes in operating assets and liabilities:
Accounts receivable (5,947) 1,180
Inventories (687) (5,320)
Accounts payable (7,615) 4,148
Accrued expenses (7,246) 696
Other 1,333 3,348
-------- --------
(20,162) 4,052
-------- --------
Net cash (used in) provided by continuing operations (12,899) 7,446
Net cash (used in) provided by discontinued operations (714) 4,319
-------- --------
Net cash (used in) provided by operating activities (13,613) 11,765
-------- --------
Cash flows from investing activities:
Capital expenditures of continuing operations (4,722) (6,207)
Capital expenditures of discontinued operations (20) (289)
Acquisition of subsidiary, net of cash acquired (1,161) --
Collections of notes receivable from sales of subsidiaries 930 447
Proceeds from sale of subsidiary, net 7,451 --
Proceeds from sale of assets 1,914 99
-------- --------
Net cash provided by (used in) investing activities 4,392 (5,950)
-------- --------
Cash flows from financing activities:
Net borrowings on revolving loans, prior to Refinancing 7,965 1,540
Repayment of term loans prior to Refinancing -- (9,484)
Repayment of borrowings under revolving loans at Refinancing (52,716) --
Proceeds on initial borrowings at Refinancing -- term loans 20,000 --
Proceeds on initial borrowings at Refinancing -- revolving loans 43,743 --
Net borrowings on revolving loans following Refinancing 7,257 --
Repayments of term loans following Refinancing (2,904) --
Direct costs associated with debt facilities (1,415) (311)
Redemption of preferred interest of subsidiary (9,840) --
Repayment of real estate and chattel mortgages (700) --
Repurchases of common stock (342) --
-------- --------
Net cash provided by (used in) financing activities 11,048 (8,255)
-------- --------
Effect of exchange rate changes on cash and cash equivalents 4 (178)
-------- --------
Net increase (decrease) in cash and cash equivalents 1,831 (2,618)
Cash and cash equivalents, beginning of period 4,842 7,836
-------- --------
Cash and cash equivalents, end of period $ 6,673 $ 5,218
======== ========
See Notes to Condensed Consolidated Financial Statements.
- 5 -
KATY INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2003
(1) Significant Accounting Policies
Consolidation Policy and Basis of Presentation
The condensed consolidated financial statements include the accounts of
Katy Industries, Inc. and subsidiaries in which it has a greater than 50%
interest, collectively "Katy" or "the Company". All significant intercompany
accounts, profits and transactions have been eliminated in consolidation.
Investments in affiliates that are not majority owned and where the Company
exercises significant influence are reported using the equity method. The
condensed consolidated financial statements at June 30, 2003 and December 31,
2002 and for the three month and six month periods ended June 30, 2003 and June
30, 2002 are unaudited and reflect all adjustments (consisting only of normal
recurring adjustments) which are, in the opinion of management, necessary for a
fair presentation of the financial condition and results of operations of the
Company. Interim figures may not be indicative of results to be realized for the
entire year. The condensed consolidated financial statements should be read in
conjunction with the consolidated financial statements and notes thereto,
together with management's discussion and analysis of financial condition and
results of operations, contained in the Company's Annual Report on Form 10-K.
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
Inventories
The components of inventories are as follows:
June 30, December 31,
2003 2002
-------- ------------
(Thousands of dollars)
----------------------
Raw materials $ 20,378 $ 19,472
Work in process 1,705 1,539
Finished goods 42,499 42,736
Inventory reserves (5,607) (5,780)
-------- --------
$ 58,975 $ 57,967
======== ========
At June 30, 2003 and December 31, 2002, approximately 33% and 35%,
respectively, of Katy's inventories were accounted for using the last-in,
first-out ("LIFO") method of costing, while the remaining inventories were
accounted for using the first-in, first-out ("FIFO") method. Current cost, as
determined using the FIFO method, exceeded LIFO cost by $2.1 million and $1.3
million at June 30, 2003 and December 31, 2002, respectively.
Property, Plant and Equipment
As of January 1, 2003, the Company revised its estimate of the useful life
of certain manufacturing assets, specifically molds and tooling equipment used
in the manufacture of plastic products, from seven to five years. This change in
estimate was made following significant impairments to these types of assets
recorded during 2002. This change in estimate resulted in approximately $1.2
million and $2.4 million of incremental depreciation during the three and six
month periods ended June 30, 2003, respectively, versus the amount that would
have been recorded had the useful life not been changed.
Refer to Note 5 for a discussion on impairments of long-lived assets shown
on the Condensed Consolidated Statements of Operations.
- 6 -
In accordance with Statement of Financial Accounting Standards (SFAS) No.
143, Accounting for Asset Retirement Obligations, the Company has recorded an
asset and related liability for retirement obligations associated with returning
certain leased properties to the respective lessor upon the termination of the
lease agreements.
Stock Options and Other Stock Awards
The Company follows the provisions of Accounting Principles Board (APB)
Opinion No. 25, Accounting for Stock Issued to Employees, regarding accounting
for stock options and other stock awards. APB Opinion No. 25 dictates a
measurement date concept in the determination of compensation expense related to
stock awards including stock options, restricted stock, and stock appreciation
rights. Katy's outstanding stock options all have established measurement dates
and therefore, fixed plan accounting is applied, generally resulting in no
compensation expense for stock option awards. However, the Company has issued
stock appreciation rights and restricted stock awards which are accounted for as
variable stock compensation awards and compensation expense has been recorded
for these awards. Compensation expense recorded relative to stock awards was
zero and $8.0 thousand for both the three and six months ended June 30, 2003 and
June 30, 2002, respectively. Compensation expense recorded pertinent to the
vesting of stock appreciation rights was $0.4 million and zero for both the
three and six months ended June 30, 2003 and June 30, 2002, respectively.
Compensation expense for stock awards is recorded in selling, general and
administrative expenses in the Condensed Consolidated Statements of Operations.
The Company applies APB Opinion No. 25 and related interpretations in
accounting for stock options. SFAS No. 123, Accounting for Stock-Based
Compensation was issued and, if fully adopted by the Company, would change the
method for recognition of expense related to option grants to employees. Under
SFAS No. 123, compensation cost would be recorded based upon the fair value of
each option at the date of grant using an option-pricing model that takes into
account as of the grant date the exercise price and expected life of the option,
the current price of the underlying stock and its expected volatility, expected
dividends on the stock and the risk-free interest rate for the expected term of
the option. Options granted in the second quarter of 2003 and the second quarter
of 2002 were zero and 6,000, respectively. No stock options were granted in
either the first quarter of 2003 or the first quarter of 2002.
In December 2002, the Financial Accounting Standards Board (FASB) issued
SFAS No. 148, Accounting for Stock-Based Compensation - Transition and
Disclosure. This standard provides alternative methods of transition for a
voluntary change to the fair value based methods of accounting for stock-based
employee compensation. In addition, SFAS No. 148 amends the disclosure
requirements of SFAS No. 123, Accounting for Stock-Based Compensation, to
require prominent disclosure in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. The disclosure provisions of the
new standard were adopted by the Company at December 31, 2002. Katy will
continue to comply with the provisions under APB Opinion No. 25, Accounting for
Stock Issued to Employees, for accounting for stock-based employee compensation.
The disclosure provisions of SFAS No. 148 were adopted in 2002.
The fair value of each option grant is estimated on the date of grant
using a Black-Scholes option-pricing model with an expected life of five to ten
years for all grants. Had compensation cost been determined based on the fair
value method of SFAS No. 123, the Company's net loss and loss per share would
have been reduced to the pro forma amounts indicated below (thousands of dollars
except per share data).
- 7 -
Three Months Six Months
Ended June 30 Ended June 30
2003 2002 2003 2002
------- ------- ------- --------
Net loss attributable to common stockholders, as reported $(8,213) $(9,185) $(6,511) $(19,397)
Deduct: Total stock-based employee
compensation expense determined under fair
value based method for all awards, net of
related tax effects (161) (50) (191) (80)
------- ------- ------- --------
Pro forma net loss $(8,374) $(9,235) $(6,702) $(19,477)
======= ======= ======= ========
Loss per share
Basic and diluted - as reported $ (0.98) $ (1.10) $ (0.78) $ (2.32)
Basic and diluted - pro forma $ (1.00) $ (1.11) $ (0.80) $ (2.33)
(2) New Accounting Pronouncements
In April 2002, the FASB released SFAS No. 145, Rescission of FASB
Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections. SFAS No. 145 rescinds and makes technical corrections regarding
various topics, including early extinguishments of debt and sale-leaseback
transactions. The statement is effective for fiscal years beginning after May
15, 2002. The Company adopted SFAS No. 145 on January 1, 2003. SFAS No. 145
requires that certain costs and losses associated with early extinguishments of
debt be reported as interest expense as a component of income from continuing
operations, whereas the prior accounting guidance provided for classification of
these costs and losses as extraordinary items, reported separately on a
tax-effected basis after income from continuing operations. The adoption of SFAS
No. 145 will require that the Company reclassify a $1.2 million after-tax ($1.8
million pre-tax) write-off of previously capitalized debt costs that occurred
during 2001 from its previous classification as an extraordinary item to
interest, net, a component of income from continuing operations during 2001.
Future write-offs of capitalized debt costs will be classified as interest
expense in a similar manner. As a result of the refinancing of our borrowing
facility in February 2003, the Company wrote off approximately $1.2 (pre-tax)
million of unamortized debt costs, during the first quarter of 2003. These costs
have been reported as interest expense, a component of income from continuing
operations.
In July 2002, the FASB issued SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal Activities. The standard requires companies to
recognize costs associated with exit or disposal activities when they are
incurred rather than at the date of a commitment to an exit or disposal plan.
Examples of costs covered by the standard include lease termination costs and
certain employee severance costs that are associated with a restructuring,
discontinued operation, plant closing, or other exit or disposal activity.
Previous accounting guidance was provided by Emerging Issues Task Force (EITF)
Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits
and Other Costs to Exit an Activity (Including Certain Costs Incurred in a
Restructuring). SFAS No. 146 nullifies EITF Issue No. 94-3. The new standard is
effective for exit or restructuring activities initiated after December 31,
2002. The Company has initiated since January 1, 2003 and is further considering
a number of restructuring and exit activities, including plant closings and
consolidation of facilities. Since these activities have been or will be
initiated after December 31, 2002, this statement could have a significant
impact on the timing of the recognition of these costs in our statements of
operations, tending to spread the costs out as opposed to recognition of a large
portion of the costs at the time the Company commits to and communicates such
restructuring and exit plans. Our operating plans call for additional
restructuring and facility consolidation activity during the remainder of 2003
and 2004, concerned mainly with the further consolidation of St. Louis, Missouri
plastics manufacturing facilities, and restructuring and consolidation of
certain abrasives manufacturing facilities. The Company has adopted the
provisions of SFAS No. 146 for all restructuring activities initiated after
December 31, 2002.
In January 2003, the FASB released FASB Interpretation No. (FIN) 46,
Consolidation of Variable Interest Entities - an Interpretation of ARB No. 51.
FIN 46 clarifies issues regarding the consolidation of entities which may
- 8 -
have features that make it unclear whether consolidation or equity method
accounting is appropriate. FIN 46 is effective in the third quarter of 2003 for
variable interest entities created prior to February 1, 2003. Katy is evaluating
FIN 46 to determine any potential impact on its financial reporting,
specifically relating to the potential consolidation of Savannah Energy Systems
Company (SESCO) and the equity method investment in Sahlman Holding Company,
Inc. (Sahlman).
In April 2003, the FASB released SFAS No. 149, Amendment of Statement 133
on Derivative Instruments and Hedging Activities. Katy does not expect SFAS No.
149 to impact its results of operations or financial position.
In May 2003, the FASB released SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of Liabilities and Equity. SFAS No.
150 establishes standards for how certain financial instruments with
characteristics of both liabilities and equity are to be classified and
measured. It requires that certain financial instruments within its scope be
classified as a liability (or an asset in some circumstances), while many of
those instruments were previously classified as equity. SFAS No. 150 is
effective in the third quarter of 2003. Katy is evaluating SFAS No. 150 to
determine any potential impact on its financial reporting, primarily with
respect to its 15% Convertible Preferred Stock.
(3) Goodwill and Intangible Assets
During 2002, Katy completed the transition to SFAS No. 142, Goodwill and
Other Intangible Assets. As a result, amortization of goodwill ceased as of
January 1, 2002. There have been no changes to goodwill during the six months
ended June 30, 2003.
Following is detailed information regarding Katy's intangible assets (in
thousands):
June 30, December 31,
2003 2002
-------- ------------
Tradenames $ 9,056 $ 8,916
Customer lists 21,868 21,447
Patents 4,641 4,283
Non-compete agreements 1,000 1,000
-------- --------
Subtotal 36,565 35,646
Accumulated amortization (11,293) (10,155)
-------- --------
Intangible assets, net $ 25,272 $ 25,491
======== ========
The increase in intangibles from December 31, 2002 to June 30, 2003 can be
primarily attributed to tradenames ($0.1 million) and customer lists ($0.4
million) acquired in connection with the purchase of Spraychem (see Note 7), as
well as the impact of exchange rates on patents ($0.4 million).
Katy recorded amortization expense on intangible assets of $1.1 million
and $1.1 million in the six-month periods ending June 30, 2003 and 2002,
respectively.
Estimated aggregate amortization expense related to intangible assets is
(in thousands):
2003 $1,941
2004 1,724
2005 1,724
2006 1,724
2007 1,724
- 9 -
Intangible assets are reviewed for impairment if events or circumstances
indicate the carrying amount of these assets may not be recoverable through
future undiscounted cash flows. If this review indicates that the carrying value
of these assets will not be recoverable, based on future undiscounted net cash
flows from the use of these assets, the carrying value is reduced to the fair
value. The carrying value of goodwill and intangible assets is reviewed by the
Company annually in accordance with SFAS No. 142. Management believes that no
impairments of goodwill or identifiable intangible assets has occurred at June
30, 2003.
(4) Discontinued Operations
Two of Katy's operations have been classified as discontinued operations
as of June 30, 2003, and for all periods shown, in accordance with SFAS No. 144,
Accounting for the Impairments or Disposal of Long Lived Assets. The Company
adopted SFAS No. 144 on January 1, 2002.
Hamilton Precision Metals, L.P. (Hamilton) was sold on October 31, 2002,
with Katy collecting net proceeds of $12.4 million. These proceeds were used
primarily to pay off the remaining balance of the Company's then outstanding
term debt. The Company may receive additional payments in the future dependent
upon the occurrence of certain events associated with Hamilton's financial
performance. These contingent amounts have not been recorded as receivables on
the Condensed Consolidated Balance Sheets. A gain (net of tax) on the sale of
Hamilton of $3.3 million was recognized in the fourth quarter of 2002 as a
result of the sale.
GC/Waldom Electronics, Inc. (GC/Waldom) was held for sale at December 31,
2002 and was sold on April 2, 2003, with Katy collecting net proceeds of $7.5
million. The proceeds were used to pay down a portion of the Company's term
loans ($2.2 million), as well as the Company's revolving credit loans. A loss on
the sale of GC/Waldom of $0.2 million was recognized in the second quarter of
2003 as a result of the sale.
Both Hamilton and GC/Waldom have historically been presented as part of
the Electrical Products group for segment reporting purposes. Management and the
board of Katy determined that these businesses were not core to the Company's
long-range strategic goals.
The historical operating results have been segregated as "Discontinued
operations" on the Condensed Consolidated Statements of Operations and the
related assets and liabilities have been separately identified on the Condensed
Consolidated Balance Sheets. Following is a summary of the major asset and
liability categories for the discontinued operations (in thousands):
- 10 -
June 30, December 31,
2003 2002
-------- ------------
Current assets
Trade accounts receivable, net $ -- $1,738
Inventories -- 4,164
Other -- 68
------ ------
$ -- $5,970
====== ======
Non-current assets
Net property and equipment $ -- 3,100
------ ------
$ -- $3,100
====== ======
Current liabilities
Accounts payable $ -- $1,415
Other 142 1,029
------ ------
$ 142 $2,444
====== ======
Non-current liabilities $ 52 $ --
====== ======
Selected financial data for the discontinued operations is summarized as
follows (in thousands):
Three Months Ended June 30, Six Months Ended June 30,
2003 2002 2003 2002
------ ------ ------- -------
Net sales $ -- $9,166 $ 6,032 $17,911
====== ====== ======= =======
(Loss) income before provision for income taxes $ (196) $ 700 $ (122) $ 1,195
====== ====== ======= =======
Katy anticipates that the implementation of SFAS No. 144 could have a
future impact on its financial reporting as 1) Katy is considering divestitures
of certain businesses and exiting of certain facilities and operational
activities, 2) the statement broadens the presentation of discontinued
operations, and 3) the Company anticipates that impairments of long-lived assets
may be necessitated as a result of the above contemplated actions. If certain
divestitures occur, they may qualify as discontinued operations under SFAS No.
144, whereas they would have not met the requirements of discontinued operations
treatment under APB Opinion No. 30. However, the Company does not feel that it
is probable that these divestitures will occur within one year, and notes that
significant changes to plans or intentions may occur. Therefore, these
operations have not presently been classified as discontinued operations.
(5) Impairments of Long-Lived Assets
During the second quarter of 2003, certain manufacturing assets at the
Contico business unit were evaluated and determined to be impaired, resulting in
charges of $1.8 million. These impairments were the result of management's
conclusion that the carrying values of the assets would not be recovered by
future cash flows. The assets are primarily injection molding machines at the
Hazelwood, Missouri operation (Hazelwood), a facility that is the subject of a
restructuring plan which is expected to take place during the last half of 2003.
The restructuring will involve the reduction in scope of the Hazelwood
operation, as a portion of its manufacturing capacity is expected to be
transferred to the Bridgeton, Missouri facility (Bridgeton) or sold. During the
second quarter of 2002, certain of Contico's other manufacturing assets were
impaired, resulting in charges of $2.4 million. These assets had been located at
the St. Louis, Missouri facility (Warson Road), which has been closed and
consolidated into the Bridgeton facility.
- 11 -
(6) Equity Method Investment
Katy owns a 43% equity investment in Sahlman that is accounted for under
the equity method. Sahlman is in the business of harvesting shrimp off the coast
of South and Central America, and farming shrimp in Nicaragua. Sahlman's
customers are primarily in the United States. Sahlman experienced poor results
of operations in 2002, primarily as a result of very low prices paid to
producers for shrimp. Increased foreign competition, especially from Asia, has
had a significant downward impact on shrimp prices in the United States. Based
upon a review of Sahlman's financial results for 2002 (and year to date in
2003), and an initial study of the status of the shrimp industry and markets in
the United States, Management has concluded there is a need for evaluating the
business further to determine if there is a loss in the value of the investment
that is other than temporary. In accordance with Accounting Principles Board
(APB) Opinion No. 18, The Equity Method for Accounting for Investments in Common
Stock, losses in the value of equity investments that are other than temporary
should be recognized. Once the Company completes a full evaluation and
determines a reasonable estimate of the value of its investment in Sahlman, the
carrying value will be adjusted to such estimate, if it is less than the
carrying value at that point in time.
(7) Acquisitions
During the second quarter of 2003, Katy acquired Spraychem, Limited
(Spraychem), a United Kingdom distributor of spray bottles and related products.
The purchase price for Spraychem was approximately $1.2 million, net of cash
acquired of $0.3 million. Spraychem's annual revenues were approximately $2.6
million. In connection with the acquisition, Katy allocated the purchase price
to the acquired net tangible assets, customer lists and tradenames at their
estimated fair values. The Spraychem acquisition is not material for
presentation of pro forma information.
(8) Sale of Assets
During February 2003, Katy's Woods Industries, Inc. (Woods U.S.)
subsidiary sold its wire fabrication facility in Moorseville, Indiana
(Moorseville). The assets sold consisted of land, building and equipment. The
sale of the Moorseville facility followed the shut down by Woods U.S. in
December 2002 of all manufacturing facilities in the U.S. Gross proceeds from
the sale were $1.9 million. Proceeds were used to pay off a $0.7 million
mortgage debt payable related specifically to the Moorseville property, with the
remainder reducing Katy's outstanding debt obligations. Katy recognized a gain
on the sale of $0.8 million, which is included as a component of other, net on
the Condensed Consolidated Statements of Operations.
(9) SESCO Partnership
On April 29, 2002, Katy and SESCO, an indirect wholly owned subsidiary,
entered into a partnership agreement with Montenay Power Corporation and its
affiliates (Montenay) that turned over the operation of SESCO's waste-to-energy
facility to Montenay. The Company entered into this agreement as a result of
evaluations of SESCO's business. First, Katy determined that SESCO was not a
core component of the Company's long-term business strategy. Moreover, Katy did
not feel it had the management expertise to deal with certain risks and
uncertainties presented by the operation of SESCO's business, given that SESCO
was the Company's only waste-to-energy facility. Katy had explored options for
divesting SESCO for a number of years, and management felt that this transaction
offered a reasonable strategy to exit this business.
The partnership, with Montenay's leadership, assumed SESCO's position in
various contracts relating to the facility's operation. Under the partnership
agreement, SESCO contributed its assets and liabilities (except for its
liability under the loan agreement with the Resource Recovery Development
Authority (the Authority) of the City of Savannah and the related receivable
under the service agreement with the Authority) to the partnership. While SESCO
will maintain a 99% interest as a limited partner, Montenay will have most of
the day to day responsibility for administration, operations, financing and
other matters of the partnership, and accordingly, the partnership will not be
consolidated. Katy agreed to pay Montenay $6.6 million over the span of seven
years under a note payable as part of the partnership and related agreements.
Certain amounts may be due to SESCO upon expiration of the service agreement in
2008; also, Montenay may purchase SESCO's interest in the partnership at that
time. Katy has not recorded any amounts receivable or other assets relating to
amounts that may be received at the time the service agreement expires, given
their uncertainty.
- 12 -
The Company made a payment of $0.8 million in July 2002 on the $6.6
million note. The table below schedules the remaining payments as of June 30,
2003 which are reflected in accrued expenses and other liabilities in the
Condensed Consolidated Balance Sheet (in thousands):
2003 $ 1,000
2004 1,000
2005 1,050
2006 1,100
2007 1,100
2008 550
-------
$ 5,800
=======
In the first quarter of 2002, the Company recognized a charge of $6.0
million, consisting of 1) the discounted value of the $6.6 million note, 2) the
carrying value of certain assets contributed to the partnership, consisting
primarily of machinery spare parts, and 3) costs to close the transaction. It
should be noted that all of SESCO's long-lived assets were reduced to a zero
value at March 31, 2002, so no additional impairment was required. On a going
forward basis, Katy would expect that income statement activity associated with
its involvement in the partnership will not be material, and Katy's consolidated
balance sheet will carry the liability mentioned above.
In 1984, the Authority issued $55.0 million of Industrial Revenue Bonds
and lent the proceeds to SESCO under the loan agreement for the acquisition and
construction of the waste-to-energy facility that has now been transferred to
the partnership. The funds required to repay the loan agreement come from the
monthly disposal fee, paid by the Authority under the service agreement for
certain waste disposal services, a component of which is for debt service. To
induce the required parties to consent to the SESCO partnership transaction,
SESCO retained its liability under the loan agreement. In connection with that
liability, SESCO also retained its right to receive the debt service component
of the monthly disposal fee.
Based on an opinion from outside legal counsel, SESCO has a legally
enforceable right to offset amounts it owes to the Authority under the loan
agreement against amounts that are owed from the Authority under the service
agreement. At June 30, 2003, this amount was $35.8 million. Accordingly, the
amounts owed to and due from SESCO have been netted for financial reporting
purposes and are not shown on the Condensed Consolidated Balance Sheet.
In addition to SESCO retaining its liabilities under the loan agreement,
to induce the required parties to consent to the partnership transaction, Katy
also continues to guarantee the obligations of the partnership under the service
agreement. The partnership is liable for liquidated damages under the service
agreement if it fails to accept the minimum amount of waste or to meet other
performance standards under the service agreement. The liquidated damages, an
off balance sheet risk for Katy, are equal to the amount of the bonds
outstanding, less $4.0 million maintained in a debt service reserve trust.
Management does not expect non-performance by the other parties. Additionally,
Montenay has agreed to indemnify Katy for any breach of the service agreement by
the partnership.
Following are scheduled principal repayments on the loan agreement (and
the Industrial Revenue Bonds) as of June 30, 2003 (in thousands):
2003 $5,385
2004 6,765
2005 8,370
2006 15,300
-------
Total $35,820
=======
(10) Indebtedness
On February 3, 2003, the Company refinanced its indebtedness (the
Refinancing) and entered into a new credit
- 13 -
facility agented by Fleet Capital Corporation (the Fleet Credit Agreement). The
new $110.0 million facility, which is comprised of a $20.0 million term loan
(Term Loan) and $90.0 million of revolving credit (Revolving Credit Facility),
involves a syndicate of banks, all of whom had participated in the credit
facility that was refinanced (the Deutsche Bank Credit Agreement). The Fleet
Credit Agreement is an asset-based lending agreement, and is generally on
similar terms to those found in the Deutsche Bank Credit Agreement.
Below is a summary of the sources and uses associated with the funding of
the Fleet Credit Agreement (in thousands):
Sources:
Term borrowings under the Fleet Credit Agreement $20,000
Revolving borrowings under the Fleet Credit Agreement 43,743
-------
$63,743
=======
Uses:
Payment of principal and interest under the Deutsche Bank Credit Agreement $52,895
Purchase of the remaining preferred interest of subsidiary at a discount 9,840
Payment of accrued distribtutions on one-half of preferred interest of subsidiary 122
Certain costs associated with the Fleet Credit Agreement 886
-------
$63,743
=======
Under the Fleet Credit Agreement, the Term Loan has a final maturity date
of February 3, 2008 and quarterly repayments of $0.7 million, two of which have
been made to date. A final payment of $4.2 million will be made in 2008. The
Term Loan is collateralized by the Company's property, plant and equipment. The
Revolving Credit Facility also has an expiration date of February 3, 2008. The
borrowing base of the Revolving Credit Facility is determined by eligible
inventory and accounts receivable. Unused borrowing availability on the
Revolving Credit Facility was $16.6 million at June 30, 2003. All extensions of
credit under the Fleet Credit Agreement are collateralized by a first priority
perfected security interest in and lien upon the capital stock of each material
domestic subsidiary (65% of the capital stock of each material foreign
subsidiary), and all present and future assets and properties of Katy. Customary
financial covenants and restrictions apply under the Fleet Credit Agreement,
with which the Company was in compliance at June 30, 2003. Until June 30, 2003,
interest accrued on Revolving Credit Facility borrowings at 225 basis points
over applicable LIBOR rates and at 250 basis points over LIBOR for Term Loan
borrowings. Subsequent to June 30, 2003, margins are determined on a pricing
matrix which factors operating performance into the pricing grid. Margins drop
an additional 25 basis points in the most favorable pricing grid from the
pre-June 30, 2003 levels for both revolving and term loans. Interest accrues at
higher margins on prime rates for swing loans.
As a result of the refinancing, Katy's borrowing capacity was reduced from
$140 million under the Deutsche Bank Credit Agreement to $110 million under the
Fleet Credit Agreement, a reduction of 21%. Therefore, a proportionate share of
previously capitalized debt costs, amounting to approximately $1.2 million, were
written off to interest expense during the first quarter of 2003. The remainder
of the previously capitalized costs, along with the newly capitalized costs from
the Fleet Credit Agreement of $0.9 million, will be amortized over the life of
the Fleet Credit Agreement through January 2008.
Long-term debt consists of the following:
- 14 -
June 30, December 31,
2003 2002
-------- ------------
(Thousands of Dollars)
Term loan payable under Fleet Credit Agreement, interest based on
LIBOR and Prime Rates (3.38% - 5.25%), due through 2008 $ 17,096 $ --
Revolving loans payable under Fleet Credit Agreement, interest based on
LIBOR and Prime Rates (3.63 - 5.00%) 51,000 --
Revolving loans payable under Deutsche Bank Credit Agreement, interest
based on Eurodollar and Prime Rates (3.75 - 5.50%) -- 44,751
Real estate and chattel mortgages, with interest at fixed rates (7.14%),
due through 2003 -- 700
-------- --------
Total debt 68,096 45,451
Less revolving loans, classified as current (see below) (51,000) (44,751)
Less current maturities (2,857) (700)
-------- --------
Long-term debt $ 14,239 $ --
======== ========
Aggregate remaining scheduled maturities of the Term Loan as of June 30,
2003 are as follows (in thousands):
2003 $ 1,429
2004 2,857
2005 2,857
2006 2,857
2007 2,857
2008 4,239
The Revolving Credit Facility under the Fleet Credit Agreement requires
lockbox agreements which provide for all receipts to be swept daily to reduce
borrowings outstanding. These agreements, combined with the existence of a
material adverse effect (MAE) clause in the Fleet Credit Agreement, causes the
Revolving Credit Facility to be classified as a current liability, per guidance
in the Emerging Issues Task Force (EITF) Issue No. 95-22, Balance Sheet
Classification of Borrowings Outstanding under Revolving Credit Agreements that
Include Both a Subjective Acceleration Clause and a Lock-Box Arrangement.
However, the Company does not expect to repay, or be required to repay, within
one year, the balance of the Revolving Credit Facility classified as a current
liability. The MAE clause, which is a fairly typical requirement in commercial
credit agreements, allows the lender to require the loan to become due if it
determines there has been a material adverse effect on our operations, business,
properties, assets, liabilities, condition or prospects. The classification of
the Revolving Credit Facility as a current liability is a result only of the
combination of the two aforementioned factors: the lockbox agreements and the
MAE clause. The Revolving Credit Facility does not expire or have a maturity
date within one year, but rather has a final expiration date of January 31,
2008. Also, the Company was in compliance with the applicable financial
covenants at June 30, 2003. The lender had not notified Katy of any indication
of a MAE at June 30, 2003, and to Management's knowledge, the Company was not in
default of any provision of the Fleet Credit Agreement at June 30, 2003.
(11) Preferred Interest in Subsidiary
Coincident with the refinancing of Katy's debt obligations discussed in
Note 10, the Company redeemed early, at a discount, the remaining half of the
preferred interest in Contico, plus accrued distributions thereon, which had a
stated value of $16.4 million. Katy utilized approximately $10.0 million of the
proceeds from the Fleet Credit Agreement for this purpose, with $9.8 million
applied toward the preferred interest and the remainder applied toward accrued
distributions through the date of the redemption. The difference between the
amount paid on redemption and the stated value of preferred interest redeemed
($6.6 million pre-tax) was recognized as an increase to Additional Paid-in
Capital on the Condensed Consolidated Balance Sheets, and is an addition to
earnings available to common shareholders
- 15 -
in the calculation of basic earnings per share during 2003.
(12) Income Taxes
As of December 31, 2002, the Company had deferred tax assets, net of
deferred tax liabilities, of $42.8 million. Domestic net operating loss (NOL)
carry forwards comprised $22.8 million of the deferred tax assets. Katy's
history of operating losses provides significant negative evidence with respect
to the Company's ability to generate future taxable income, a requirement in
order to recognize deferred tax assets on the Condensed Consolidated Balance
Sheets. For this reason, the Company was unable at June 30, 2003 and December
31, 2002 to conclude that NOLs and other deferred tax assets would be utilized
in the future. As a result, valuation allowances were recorded as of such dates
for the full amount of deferred tax assets, net of the amount of deferred tax
liabilities.
The provision for income taxes reflected on the Condensed Consolidated
Statements of Operations for the three months and six months ended June 30, 2003
and 2002 represents current tax expense associated with state and foreign taxes.
(13) Commitments and Contingencies
As set forth more fully in the Company's 2002 Annual Report on Form 10-K,
the Company and certain of its current and former direct and indirect corporate
predecessors, subsidiaries and divisions are involved in remedial activities at
certain present and former locations and have been identified by the United
States Environmental Protection Agency (EPA), state environmental agencies and
private parties as potentially responsible parties (PRPs) at a number of
hazardous waste disposal sites under the Comprehensive Environmental Response,
Compensation and Liability Act (Superfund) or equivalent state laws and, as
such, may be liable for the cost of cleanup and other remedial activities at
these sites. Responsibility for cleanup and other remedial activities at a
Superfund site is typically shared among PRPs based on an allocation formula.
Under the federal Superfund statute, parties could be held jointly and severally
liable, thus subjecting them to potential individual liability for the entire
cost of cleanup at the site. Based on its estimate of allocation of liability
among PRPs, the probability that other PRPs, many of whom are large, solvent,
public companies, will fully pay the costs apportioned to them, currently
available information concerning the scope of contamination, estimated
remediation costs, estimated legal fees and other factors, the Company has
recorded and accrued for indicated environmental liabilities amounts that it
deems reasonable and believes that any liability with respect to these matters
in excess of the accruals will not be material. The ultimate costs will depend
on a number of factors and the amount currently accrued represents management's
best current estimate of the total costs to be incurred. The Company expects
this amount to be substantially paid over the next one to four years.
The most significant environmental matter in which the Company is
currently involved relates to the W.J. Smith site. In 1993, the EPA initiated a
Unilateral Administrative Order Proceeding under Section 7003 of the Resource
Conservation and Recovery Act (RCRA) against W.J. Smith and Katy. The proceeding
requires certain actions at the W.J. Smith site and certain off-site areas, as
well as development and implementation of additional cleanup activities to
mitigate off-site releases. In December 1995, W.J. Smith, Katy and the EPA
agreed to resolve the proceeding through an Administrative Order on Consent
under Section 7003 of RCRA. Pursuant to the Order, W.J. Smith is currently
implementing a cleanup to mitigate off-site releases.
In December 1996, Banco del Atlantico, a bank located in Mexico, filed a
lawsuit against Woods, a subsidiary of Katy, and against certain past and
then-present officers and directors and former owners of Woods, alleging that
the defendants participated in a violation of the Racketeer Influenced and
Corrupt Organizations (RICO) Act involving allegedly fraudulently obtained loans
from Mexican banks, including the plaintiff, and "money laundering" of the
proceeds of the illegal enterprise. All of the foregoing is alleged to have
occurred prior to Katy's purchase of Woods. The plaintiff also alleged that it
made loans to an entity controlled by certain past officers and directors of
Woods based upon fraudulent representations. The plaintiff seeks to hold Woods
liable for its alleged damages directly, and under principles of respondeat
superior and successor liability. The plaintiff is claiming damages in excess of
$24.0 million and is requesting treble damages under RICO. Because certain
threshold procedural and jurisdictional issues have not yet been fully
adjudicated in this litigation, it is not possible at this time for the Company
to reasonably determine an
- 16 -
outcome or accurately estimate the range of potential exposure. Katy may have
recourse against the former owner of Woods and others for, among other things,
violations of covenants, representations and warranties under the purchase
agreement through which Katy acquired Woods, and under state, federal and common
law. In addition, the purchase price under the purchase agreement may be subject
to adjustment as a result of the claims made by Banco del Atlantico or other
issues relating to the litigation. The extent or limit of any such adjustment
cannot be predicted at this time. An adverse judgment in this matter could have
a material impact on Katy's liquidity and financial position if the Company were
not able to exercise recourse against the former owner of Woods.
Katy also has a number of product liability and workers' compensation
claims pending against it and its subsidiaries. Many of these claims are
proceeding through the litigation process and the final outcome will not be
known until a settlement is reached with the claimant or the case is
adjudicated. The Company estimates that it can take up to 10 years from the date
of the injury to reach a final outcome on certain claims. With respect to the
product liability and workers' compensation claims, Katy has provided for its
share of expected losses beyond the applicable insurance coverage, including
those incurred but not reported to the Company or its insurance providers, which
are developed using actuarial techniques. Such accruals are developed using
currently available claim information, and represent management's best
estimates. The ultimate cost of any individual claim can vary based upon, among
other factors, the nature of the injury, the duration of the disability period,
the length of the claim period, the jurisdiction of the claim and the nature of
the final outcome.
Although management believes that these actions individually and in the
aggregate are not likely to have a material adverse effect on the Company's
financial position, results of operations or cash flows, further costs could be
significant and will be recorded as a charge to operations when such costs
become probable and reasonably estimable.
(14) Stock Repurchase Program
On April 20, 2003, the Company announced a plan to spend up to $5.0
million to repurchase shares of its common stock. As of June 30, 2003, the
Company had spent $0.3 million in acquiring 79,900 shares in accordance with the
plan.
(15) Industry Segment Information
The Company is a manufacturer and distributor of a variety of industrial
and consumer products, including sanitary maintenance supplies, coated
abrasives, stains, and electrical components. Principal markets are the United
States, Canada and Europe, and include the sanitary maintenance, restaurant
supply, retail, electronic and automotive markets. These activities are grouped
into two industry segments: Electrical Products and Maintenance Products.
The following table sets forth information by segment:
- 17 -
Three months ended June 30, Six months ended June 30,
2003 2002 2003 2002
--------- --------- --------- ---------
(Thousands of dollars) (Thousands of dollars)
Maintenance Products Group
Net external sales $ 76,179 $ 81,714 $ 150,392 $ 158,280
Operating (loss) income (639) (1,799) 2,089 1,564
Operating (deficit) margin (0.8%) (2.2%) 1.4% 1.0%
Severance, restructuring and
related charges 1,128 2,413 1,337 3,141
Impairments of long-lived assets 1,800 2,394 1,800 2,394
Depreciation and amortization 4,799 4,726 9,924 9,501
Capital expenditures 3,189 2,254 4,431 5,851
June 30, December 31,
2003 2002
--------- ------------
Total assets $ 197,386 $ 197,865
Electrical Products Group
Net external sales $ 29,180 $ 26,437 $ 50,807 $ 50,505
Operating income (loss) 826 (1,088) 1,470 (2,003)
Operating margin (deficit) 2.8% (4.1%) 2.9% (4.0%)
Severance, restructuring and
related charges 211 1,116 225 2,429
Depreciation and amortization 264 385 562 670
Capital expenditures 232 193 277 222
June 30, December 31,
2003 2002
--------- ------------
Total assets $ 50,003 $ 48,228
Total
Net external sales - Operating segments $ 105,359 $ 108,151 $ 201,199 $ 208,785
- Other [a] -- 310 -- 1,201
--------- --------- --------- ---------
Total $ 105,359 $ 108,461 $ 201,199 $ 209,986
========= ========= ========= =========
Operating income (loss) - Operating segments $ 187 $ (2,887) $ 3,559 $ (439)
- Other [a] -- 63 -- (6,696)
- Unallocated corporate (4,265) (2,196) (6,844) (4,415)
--------- --------- --------- ---------
Total $ (4,078) $ (5,020) $ (3,285) $ (11,550)
========= ========= ========= =========
Severance, restructuring and
related charges - Operating segments $ 1,339 $ 3,529 $ 1,562 $ 5,570
- Unallocated corporate 374 256 379 511
--------- --------- --------- ---------
Total $ 1,713 $ 3,785 $ 1,941 $ 6,081
========= ========= ========= =========
Impairments of long-lived assets - Operating segments $ 1,800 $ 2,394 $ 1,800 $ 2,394
--------- --------- --------- ---------
Total $ 1,800 $ 2,394 $ 1,800 $ 2,394
========= ========= ========= =========
Depreciation and amortization - Operating segments $ 5,063 $ 5,111 $ 10,486 $ 10,171
- Unallocated corporate 705 14 727 78
--------- --------- --------- ---------
Total $ 5,768 $ 5,125 $ 11,213 $ 10,249
========= ========= ========= =========
Capital expenditures - Operating segments $ 3,421 $ 2,447 $ 4,708 $ 6,073
- Unallocated corporate 6 58 14 134
- Discontinued operations -- 195 20 289
--------- --------- --------- ---------
Total $ 3,427 $ 2,700 $ 4,742 $ 6,496
========= ========= ========= =========
June 30, December 31,
2003 2002
--------- ------------
Total assets - Operating segments $ 247,389 $ 246,093
- Other [a] 7,102 7,626
- Unallocated corporate 13,220 13,188
- Discontinued operations -- 9,070
--------- ---------
Total $ 267,711 $ 275,977
========= =========
- 18 -
[a] Amounts shown as "Other" represent items associated with the SESCO
partnership and an equity investment in a shrimp harvesting and farming
operation.
(16) Severance, Restructuring and Related Charges
During the first and second quarters of 2003, the Company recorded $0.2
million and $1.7 million, respectively, for severance, restructuring and related
charges pursuant to SFAS No. 146. These costs related to equipment moves,
adjustments to non-cancelable lease liabilities for abandoned facilities,
severance, and related charges associated with consolidation of facilities and
administrative functions. Included in these costs were severance charges related
to five administrative and fifteen operations employees at Contico's Santa Fe
Springs, California facility (Santa Fe Springs). Costs were also incurred
related to plastics manufacturing facilities at Warson Road, and the abrasives
manufacturing facility in Wrens, Georgia (Wrens).
During the fourth quarter of 2002, the Company recorded $2.4 million of
severance and other exit costs associated with the shut down of the Woods
manufacturing facilities in Indiana. Manufacturing operations were ceased in
order to implement a more cost-effective procurement of finished goods inventory
through sourcing with third party suppliers. As a result of this shut down, 361
employees were terminated. Woods incurred $1.5 million in severance, pension,
and other employee-related costs associated with the employee terminations.
Woods also incurred a charge for the creation of a liability for non-cancelable
lease costs at abandoned production facilities of $0.8 million. An additional
$0.1 million of other exit costs were incurred related to facility repairs and
other minor expenses. Woods also incurred $0.9 million of inventory write-offs
related to raw and packaging materials that will not be utilized efficiently
with the change-over to a fully sourced inventory strategy. Contico incurred
restructuring costs of $0.6 million in the fourth quarter of 2002 associated
with costs of revaluing their non-cancelable lease liability at the Warson Road
and Earth City, Missouri (Earth City) facilities, and $0.3 million of costs in
moving inventory and equipment from the Warson Road facility to the Bridgeton
facility, as discussed below. Each of these facilities is in the St. Louis,
Missouri area.
During the third quarter of 2002, the Company recorded $9.5 million of
severance, restructuring and related charges. During the third quarter, the
Company committed to a plan to abandon the Earth City facility and to
consolidate its operations into the Bridgeton facility. As a result, a $7.1
million charge was recorded to accrue a liability for non-cancelable lease
payments associated with the Earth City facility. Also during the third quarter,
the Contico business recorded a $1.4 million charge related to rent and other
facility costs associated with its Warson Road facility, whose operations are
also being consolidated into the Bridgeton facility. A charge of $1.8 million
was recorded in the second quarter of 2002 for the Warson Road facility, and the
additional amount of $1.4 million was recorded after consideration of the market
for sub-leasing and to accrue costs to refurbish the facility. The Contico
business recorded related charges of $0.2 million incurred in moving inventory
and equipment from the Warson Road facility to the Bridgeton facility, and $0.2
million in severance costs. The Corporate group recorded a $0.1 million charge
for non-cancelable lease payments related to the former corporate headquarters.
Also in the third quarter of 2002, a charge of $0.5 million was recorded for
payments for consultants working with the Company on sourcing and other
manufacturing and production efficiency initiatives.
During the second quarter of 2002, the Company recorded $3.8 million of
severance, restructuring and related charges. Approximately $1.6 million of the
charges related to accruals for payments for consultants working with the
Company on sourcing and other manufacturing and production efficiency
initiatives. Additionally, net non-cancelable rental payments of $1.8 million
associated with the shut down of Contico's Warson Road facility were charged to
operations during the quarter ended June 30, 2002, as well as involuntary
termination benefits of $0.1 million. The Warson Road facility shutdown involved
a reduction in workforce of nineteen employees. The remaining $0.3 million (for
involuntary termination benefits) related to SESCO and for various integration
costs in the consolidation of administrative functions into St. Louis, Missouri,
from various operating divisions in the Maintenance Products group.
During the first quarter of 2002, the Company recorded $2.3 million of
severance, restructuring and other charges. Approximately $1.9 million of the
charges related to accruals for payments for consultants working with the
Company on sourcing and other manufacturing and production efficiency
initiatives. Approximately $0.3 million related to involuntary termination
benefits for two management employees whose positions were eliminated, and $0.1
million
- 19 -
were costs associated with the consolidation of administrative and operational
functions.
Certain assumptions have been made regarding potential future sub-lease
revenue at rented facilities that have been, or will be, abandoned as a result
of restructuring and consolidation activities. If the Company is unable to
achieve its estimated sub-lease revenue estimates, charges could be recognized
in future periods to update the estimated liability and cost to Katy for these
facilities.
The table below details activity in restructuring reserves since December
31, 2002 (in thousands).
One-time Contract
Termination Termination
Total Benefits Costs Other
-------- ----------- ------------ -------
Restructuring liabilities at December 31, 2002 $ 14,499 $ 2,085 $ 10,885 $ 1,529
Additions to restructuring liabilities 1,941 703 631 607
Payments on restructuring liabilities (5,283) (1,696) (1,626) (1,961)
-------- ------- -------- -------
Restructuring liabilities at June 30, 2003 $ 11,157 $ 1,092 $ 9,890 $ 175
======== ======= ======== =======
The table below summarizes the remaining future obligations for severance
and restructuring charges detailed above as of June 30, 2003 (in thousands):
2003 $ 4,117
2004 1,592
2005 1,601
2006 1,368
2007 1,300
Thereafter 1,179
-------
Total Payments $11,157
=======
- 20 -
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
Three Months Ended June 30, 2003 versus Three Months Ended June 30, 2002
The table below and the narrative that follows summarize the key factors
in the year-to-year changes in operating results.
Three months ended June 30, Percentage
2003 2002 Variance
--------- --------- ----------
(Thousands of dollars)
Maintenance Products Group [d]
Net external sales $ 76,179 $ 81,714 (6.8%)
Operating loss (639) (1,799) 64.5%
Operating deficit (0.8%) (2.2%) N/A
Severance, restructuring and related charges 1,128 2,413 (53.3%)
Impairments of long-lived assets 1,800 2,394 (24.8%)
Depreciation and amortization 4,799 4,726 1.5%
Capital expenditures 3,189 2,254 41.5%
June 30, December 31, Percentage
2003 2002 Variance
--------- ------------ ----------
Total assets $ 197,386 $ 197,865 (0.2%)
Electrical Products Group [e]
Net external sales $ 29,180 $ 26,437 10.4%
Operating income (loss) 826 (1,088) 175.9%
Operating margin (deficit) 2.8% (4.1%) N/A
Severance, restructuring and related charges 211 1,116 (81.1%)
Depreciation and amortization 264 385 (31.4%)
Capital expenditures 232 193 20.2%
June 30, December 31, Percentage
2003 2002 Variance
--------- ------------ ----------
Total assets $ 50,003 $ 48,228 (3.7%)
Total Company [a]
Net external sales [b] $ 105,359 $ 108,461 (2.9%)
Operating loss [b] (4,078) (5,020) 18.8%
Operating deficit [b] (3.9%) (4.6%) N/A
Severance, restructuring and related charges [b] 1,713 3,785 (54.7%)
Impairments of long-lived assets [b] 1,800 2,394 (24.8%)
Depreciation and amortization [b] 5,768 5,125 12.5%
Capital expenditures [c] 3,427 2,700 26.9%
June 30, December 31, Percentage
2003 2002 Variance
--------- ------------ ----------
Total assets [c] $ 267,711 $ 275,977 (3.0%)
[a] Included in "Total Company" are certain amounts in addition to those shown
for the Maintenance Products and
- 21 -
Electrical Products segments, including amounts associated with 1)
unallocated corporate expenses, 2) our equity investment in a shrimp
harvesting and farming operation, and 3) our waste-to-energy facility
(SESCO). See Note 15 to the Condensed Consolidated Financial Statements
for detailed reconciliations of segment information to the Consolidated
Financial Statements.
[b] Excludes discontinued operations
[c] Includes discontinued operations
[d] Includes Contico, Continental Manufacturing, Contico U.K., Disco, Duckback
Products, Gemtex, Glit/Mictrotron, Loren Products, and Wilen Products.
[e] Includes Woods U.S. and Woods Canada
Sales in the Maintenance Products group decreased from $81.7 million to
$76.2 million, a decrease of $5.5 million or 6.8%. The most significant sales
shortfalls to prior year were realized in the businesses that sell to commercial
customers, including Contico's janitorial/sanitation plastics business. We
believe that this business continues to be impacted by the slow economy and
reduced demand for cleaning products, due to commercial real estate vacancy
rates and reduced demand in the travel and hospitality industries. Sales were
also lower at the Gemtex business unit, which sells abrasive products mainly to
industrial customers, primarily due to increased foreign competition. Sales were
lower at the Loren Products business unit, particularly with regard to their
roofing products, largely due to general economic conditions and their impact on
construction activity.
The Maintenance Products group's operating results improved from an
operating loss of ($1.8) million in the second quarter of 2002 to an operating
loss of ($0.6) million in the second quarter of 2003, an improvement of 64.5%.
Operating loss was impacted in both years by severance, restructuring and
related charges, as well as by impairments of long-lived assets. Excluding these
items, operating income decreased by $0.7 million, or 23.9%. Profitability was
lower at Loren and Gemtex, driven by the issues described above, and also at the
consumer plastics business in the U.K., which saw operating income drop as a
result of higher than expected customer returns and high promotional activity.
Profitability was improved at both the consumer and janitorial/sanitation
businesses of Contico in the U.S., benefiting from the implementation of cost
reduction strategies. In addition, operating results were negatively impacted by
$1.2 million of incremental depreciation related to the revision of the
estimated useful lives of certain manufacturing assets related to plastic
products.
The Maintenance Products group recorded severance, restructuring and
related charges of $1.1 million during the second quarter of 2003 and $2.4
million during the second quarter of 2002. The 2003 costs were related primarily
to equipment moves, adjustments to non-cancelable lease liabilities for
abandoned facilities, severance, and other costs associated with consolidation
of facilities and administrative functions. During the second quarter of 2003,
the group also recorded impairments of long-lived assets of $1.8 million,
primarily associated with the injection molding machines at the Hazelwood
manufacturing facility. The 2002 costs consisted primarily of net non-cancelable
lease rentals and severance related to the Warson Road facility, as well as
consultant fees associated with the company-wide sourcing project, and
integration costs associated with consolidation of administrative functions.
During the second quarter of 2002, the group recorded impairments of long-lived
assets associated primarily with the Warson Road manufacturing facility (shut
down in the third quarter of 2002), of $2.4 million.
Sales in the Electrical Products group increased from $26.4 million to
$29.2 million, an increase of 10.4%. The increase was primarily attributable to
higher sales at the Woods Canada business unit, partially offset by a small
decrease at the Woods U.S. business unit. Woods Canada's sales to its larger
customers are all positive year over year through June 2003, and Woods Canada
continues to experience strength in their garden lighting business.
The Electrical Products group's operating income (loss) improved from a
loss of ($1.1) million to income of $0.8 million, an increase of 176%. Operating
income was impacted in both years by severance, restructuring and related
charges. Excluding these items, operating income increased by $1.0 million, from
$0.0 million to $1.0 million. Operating income was higher at both Woods U.S. and
Woods Canada. Cost reduction strategies implemented, which have focused on
increased sourcing of product from third party manufacturers, have reduced the
cost structures of both businesses, thereby improving margins and profitability.
The Electrical Products group recorded severance, restructuring and
related charges of $0.2 million in the
- 22 -
second quarter of 2003 and $1.1 million in the second quarter of 2002. For both
periods, these costs consisted of consulting fees incurred by both Woods U.S.
and Woods Canada related to the third party manufacturer sourcing project that
has been largely completed.
Equity in income of equity method investment was lower by $0.2 million.
See further discussion relating to the financial results of the equity method
investment in Note 6 to the Condensed Consolidated Financial Statements. Other,
net was favorable primarily as a result of the gain on the sale of the
Moorseville facility.
Interest expense decreased from $1.5 million in the second quarter of 2002
to $1.2 million in the second quarter of 2003. The decrease is due mainly to
lower average borrowings and lower interest rates.
Total Company assets between December 31, 2002 and June 30, 2003 were
impacted primarily by reductions in assets of discontinued operations, which
were reduced from $9.1 million to zero. The reduction in discontinued operations
assets is due to the assets of GC/Waldom being included in assets of
discontinued operations at December 31, 2002, however being removed at June 30,
2003 due to the sale of that business in April 2003.
Six Months Ended June 30, 2003 versus Six Months Ended June 30, 2002
The table below and the narrative that follows summarize the key factors
in the year-to-year changes in operating results.
Six months ended June 30, Percentage
2003 2002 Variance
--------- --------- ----------
(Thousands of dollars)
Maintenance Products Group [d]
Net external sales $ 150,392 $ 158,280 (5.0%)
Operating income 2,089 1,564 33.6%
Operating margin 1.4% 1.0% N/A
Severance, restructuring and related charges 1,337 3,141 (57.4%)
Impairments of long-lived assets 1,800 2,394 (24.8%)
Depreciation and amortization 9,924 9,501 4.5%
Capital expenditures 4,431 5,851 (24.3%)
Electrical Products Group [e]
Net external sales $ 50,807 $ 50,505 0.6%
Operating income (loss) 1,470 (2,003) (173.4%)
Operating margin (deficit) 2.9% (4.0%) N/A
Severance, restructuring and related charges 225 2,429 (90.7%)
Depreciation and amortization 562 670 (16.1%)
Capital expenditures 277 222 24.8%
Total Company [a]
Net external sales [b] $ 201,199 $ 209,986 (4.2%)
Operating loss [b] (3,285) (11,550) (71.6%)
Operating deficit [b] (1.6%) (5.5%) N/A
Severance, restructuring and related charges [b] 1,941 6,081 (68.1%)
Impairments of long-lived assets [b] 1,800 2,394 (24.8%)
Depreciation and amortization [b] 11,213 10,249 9.4%
Capital expenditures [c] 4,742 6,496 (27.0%)
[a] Included in "Total Company" are certain amounts in addition to those shown
for the Maintenance Products and
- 23 -
Electrical Products segments, including amounts associated with 1) unallocated
corporate expenses, 2) our equity investment in a shrimp harvesting and farming
operation, and 3) our waste-to-energy facility (SESCO). See Note 15 to Condensed
Consolidated Financial Statements for detailed reconciliations of segment
information to the Consolidated Financial Statements.
[b] Excludes discontinued operations
[c] Includes discontinued operations
[d] Includes Contico, Continental Manufacturing, Contico U.K., Disco, Duckback
Products, Gemtex, Glit/Mictrotron, Loren Products, and Wilen Products.
[e] Includes Woods U.S. and Woods Canada
Sales in the Maintenance Products group decreased from $158.3 million to
$150.4 million, a decrease of $7.9 million or 5.0%. The most significant sales
shortfalls to prior year were realized in the businesses that sell to commercial
customers, including Contico's janitorial/sanitation plastics business. We
believe that this business continues to be impacted by the slow economy and
reduced demand for cleaning products, due to commercial real estate vacancy
rates and reduced demand in the travel and hospitality industries. Sales were
lower at Loren, particularly with regard to their roofing products, primarily
due to general economic conditions and their impact on construction activity.
Sales were also lower at Gemtex, primarily due increased foreign competition.
The Maintenance Products group's operating income increased from $1.6
million to $2.1 million, an increase of 33.6%. Operating income was impacted in
both years by severance, restructuring and related charges, as well as the
impairment of long-lived assets. Excluding these items, operating income
decreased by $1.9 million, or 26.4%. Profitability was lower at Loren and Gemtex
due to volume-related issues, while the Contico consumer businesses in the U.S.
and in the U.K. were negatively impacted by top-line pricing pressures. These
shortfalls were partially offset by improved results in income at the Contico
janitorial/sanitation plastics business and the Wilen mop and broom division,
which both benefited from cost reduction efforts. In addition, operating results
were negatively impacted by $2.4 million of incremental depreciation related to
the revision of the estimated useful lives of certain manufacturing assets
related to plastic products.
The Maintenance Products group recorded severance, restructuring and
related charges of $1.3 million during the six months ended June 30, 2003, and
$3.1 million during the six months ended June 30, 2002. The 2003 costs were
related primarily to equipment moves ($0.4 million), adjustments to
non-cancelable lease liabilities for abandoned facilities ($0.5 million),
severance ($0.4 million), and other insignificant costs associated with
consolidation of facilities and administrative functions. During the six months
ended June 30, 2003, the group also recorded impairments of long-lived assets of
$1.8 million, primarily associated with the injection molding machines at the
Hazelwood manufacturing facility. The 2002 severance, restructuring and related
charges consisted of net non-cancelable rental payments associated with the shut
down of the Warson Road facility ($1.8 million), consulting fees associated with
our sourcing initiatives ($0.6 million), severance related to headcount
reduction ($0.1 million), and other costs associated with the consolidation of
administrative functions ($0.6 million). During the six months ended June 30,
2002, the group recorded impairments of long-lived assets associated primarily
with the Warson Road manufacturing facility (shut down in the third quarter of
2002), of $2.4 million.
Sales in the Electrical Products group increased from $50.5 million to
$50.8 million, an increase of 0.6%. The increase was primarily attributable to
higher sales at the Woods Canada business offset by lower sales at the Woods
U.S. business.
The Electrical Products group's operating income improved from a loss of
($2.0) million to income of $1.5 million, an increase of 173%. Operating income
was impacted in both years by severance, restructuring and related charges.
Excluding these items, operating income increased by $1.3 million, or 298%.
Operating income was higher at both Woods U.S and Woods Canada., driven
primarily by higher sales volumes and cost reductions at Woods Canada and by
cost reductions at Woods U.S.
The Electrical Products group recorded severance, restructuring and
related charges of $0.2 million in the six month periods ending June 30, 2003,
compared to $2.4 million recorded during the same period of 2002. The costs in
each period are primarily related to consulting fees for resourcing projects,
which have had a significant positive impact on the operations of both Woods
U.S. and Woods Canada.
- 24 -
Equity in (loss) income of equity method investment was lower by $0.9
million, due to weaker operating results at Sahlman. See further discussion
relating to the financial results of the equity method investment in Note 6 to
the Condensed Consolidated Financial Statements. Other, net was favorable
primarily as a result of the gain on the sale of the Moorseville facility.
Interest expense, net increased from $2.9 million to $3.6 million, an
increase of 23%. During the first quarter of 2003, we wrote off $1.2 million of
unamortized debt issuance costs due to the reduction in our borrowing capacity
as a result of the refinancing of our debt obligations in February 2003. The
amount of this write-off is included in interest expense. Excluding the
write-off, interest expense, net decreased by $0.5 million, or 17%, due mainly
to lower average borrowings and lower interest rates.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity was negatively impacted during the first six months of 2003 as a
result of lower operating cash flow during the first quarter. The Company used
$13.6 million of operating cash flow during the first six months of 2003
compared to operating cash flow generated during the first six months of 2002 of
$11.8 million. Debt obligations increased from December 31, 2002 by $22.6
million. However, $9.8 million of the increase in debt obligations related to
the early redemption of higher-interest preferred units of a subsidiary, which
were redeemed at a discount coincident with the refinancing of Katy's debt
obligations in February 2003. Excluding the impact on debt obligations of this
factor, debt increased by $12.8 million during the first six months of 2003 from
December 31, 2002. Most of this increase in debt was the result of working
capital changes, primarily higher accounts receivable due largely to seasonal
dating programs at the Duckback business unit, lower accounts payable balances
primarily because we have utilized vendor discounts, and payments on previously
recorded restructuring liabilities.
In February 2003, we funded a new credit agreement, agented by Fleet
Capital Corporation (Fleet Credit Agreement), which replaced the credit
agreement entered into at the time of the recapitalization in June of 2001
(Deutsche Bank Credit Agreement). The new $110.0 million facility, which is
comprised of a $20.0 million term loan (Term Loan) and $90.0 million of
revolving credit (Revolving Credit Facility), involves a syndicate of banks, all
of whom had participated in the Deutsche Bank Credit Agreement. The Fleet Credit
Agreement is an asset-based lending agreement, and is generally on similar terms
to those found in the Deutsche Bank Credit Agreement.
In April 2003, we sold the GC/Waldom business for net proceeds of $7.5
million, which allowed us to further reduce our debt obligations. The proceeds
of this sale resulted in a positive impact to cash flows from investing
activities for the six months ended June 30, 2003. A loss of $0.2 million was
recognized on the sale of GC/Waldom.
Due to the early pay down of the term loan in October 2002 after the sale
of our Hamilton Precision Metals subsidiary, we entered into a new term loan
under the Fleet Credit Agreement. The Fleet Credit Agreement allows us to more
efficiently leverage our entire asset base, and to create more borrowing room
under our Revolving Credit Facility, which is based on the liquidation values of
accounts receivable and inventories. The term loan is collateralized by real and
personal property. Below is a summary of the sources and uses associated with
the funding of the Fleet Credit Agreement (in thousands):
Sources:
Term loan borrowings under the Fleet Credit Agreement $20,000
Revolving loan borrowings under the Fleet Credit Agreement 43,743
-------
$63,743
=======
Uses:
Payment of interest and principal under the Deutsche Bank Credit Agreement $52,895
Purchase of outstanding preferred interest of Contico at a discount 9,840
Payment of accrued distributions on outstanding preferred interest of Contico 122
Certain costs associated with the Fleet Credit Agreement 886
-------
$63,743
=======
- 25 -
Under the Fleet Credit Agreement, the Term Loan has a final maturity date
of February 3, 2008 and quarterly repayments of $0.7 million, two of which were
made on April 1 and July 1, 2003, respectively. A final payment of $4.2 million
is scheduled to be made in 2008. The Revolving Credit Facility also has an
expiration date of February 3, 2008.
Unused borrowing availability on the Revolving Credit Facility was $16.6
million at June 30, 2003.
All extensions of credit under the Fleet Credit Agreement are
collateralized by a first priority perfected security interest in and lien upon
the capital stock of each material domestic subsidiary (65% of the capital stock
of each material foreign subsidiary), and all present and future assets and
properties of Katy. Customary financial covenants and restrictions apply under
the Fleet Credit Agreement, and we were in compliance with these covenants as of
June 30, 2003. Until June 30, 2003, interest accrued on revolving borrowings at
225 basis points over applicable LIBOR rates, and at 250 basis points over LIBOR
for term borrowings. Subsequent to June 30, 2003, margins are determined on a
pricing matrix which factors operating performance into the pricing grid.
Margins drop an additional 25 basis points in the most favorable pricing grid
from the pre-June 30 levels. Interest accrues at higher margins on prime rates
for swing loans, the amounts of which were nominal at June 30, 2003.
Katy incurred $0.9 million in debt issuance costs associated with the
Fleet Credit Agreement. Additionally, at the time of the inception of the Fleet
Credit Agreement, Katy had approximately $5.6 million of unamortized debt
issuance costs associated with the Deutsche Bank Credit Agreement. Based on the
pro rata reduction in borrowing capacity from the Deutsche Bank Credit Agreement
to the Fleet Credit Agreement, Katy charged to expense $1.2 million of the
Deutsche Bank Credit Agreement unamortized debt issuance costs. The remainder of
the previously capitalized costs, along with the newly capitalized costs from
the Fleet Credit Agreement of $0.9 million, will be amortized over the life of
the Fleet Credit Agreement through January 2008.
The Revolving Credit Facility under the Fleet Credit Agreement requires
lockbox agreements which provide for all receipts to be swept daily to reduce
borrowings outstanding. These agreements, combined with the existence of a
material adverse effect (MAE) clause in the Fleet Credit Agreement, causes the
Revolving Credit Facility to be classified as a current liability, per guidance
in the Emerging Issues Task Force (EITF) Issue No. 95-22, Balance Sheet
Classification of Borrowings Outstanding under Revolving Credit Agreements that
Include Both a Subjective Acceleration Clause and a Lock-Box Arrangement.
However, the Company does not expect to repay, or be required to repay, within
one year, the balance of the Revolving Credit Facility classified as a current
liability. The MAE clause, which is a fairly typical requirement in commercial
credit agreements, allows the lender to require the loan to become due if it
determines there has been a material adverse effect on our operations, business,
properties, assets, liabilities, condition or prospects. The classification of
the Revolving Credit Facility as a current liability is a result only of the
combination of the two aforementioned factors: the lockbox agreements and the
MAE clause. The Revolving Credit Facility does not expire or have a maturity
date within one year, but rather has a final expiration date of January 31,
2008. Also, we were in compliance with the applicable financial covenants at
June 30, 2003. The lender had not notified us of any indication of a MAE at June
30, 2003, and to our knowledge, we were not in default of any provision of the
Fleet Credit Agreement at June 30, 2003.
The Fleet Credit Agreement, and the additional borrowing ability on
revolving credit obtained by incurring new term debt, results in three important
benefits related to the long-term strategy of Katy: 1) it allowed us to redeem
early at a discount a preferred interest obligation of Contico, 2) it provides
borrowing power to invest in capital expenditures key to our strategic
direction, and 3) it provides working capital flexibility to build inventory
when necessary to accommodate lower cost outsourced finished goods inventory. We
believe that our operations and the Fleet Credit Agreement provide sufficient
liquidity for our operations going forward.
As a result of the refinance with the new Fleet Credit Agreement, we were
able to redeem at a 40% discount the remaining preferred interest that the
former owner of Contico had held. This balance sheet liability, which had a
carrying value of $16.4 million at December 31, 2002, was redeemed for $9.8
million in February 2003. The excess of carrying value over redemption price is
an addition to stockholders' equity, and favorably impacts earnings per share.
This will
- 26 -
result in a reduction of preferred cash distributions by approximately $1.3
million annually, which had accrued at an annual rate of 8%. After giving effect
to the interest cost incurred by the Company to fund the redemption, the net
decrease in financing cost for the Company will be approximately $1.0 million
annually.
We require cash to fund working capital needs, make payments on previously
recorded restructuring liabilities, and fund capital expenditures. These
requirements will be met principally through cash flows from operations and
available borrowings under the Fleet Credit Agreement. Anticipated capital
expenditures for 2003 are expected to be higher than in 2002 and 2001, mainly
due to investments planned for the restructuring of the abrasives businesses and
the various Contico facilities. These restructuring and consolidation activities
are important steps in reducing our cost structure to a competitive level.
Our borrowing base under the Fleet Credit Agreement is reduced by the
outstanding amount of standby and commercial letters of credit. Vendors,
financial institutions and other parties with whom Katy does business may
require letters of credit in the future that either 1) do not exist today, or 2)
would be at higher amounts than those that exist today. Currently, our largest
letters of credit relate to our casualty insurance programs. At June 30, 2003
and 2002, total outstanding letters of credit were $9.3 million and $7.6
million, respectively.
We are continually evaluating alternatives relating to divestitures of
certain of our businesses. Divestitures present opportunities to de-leverage our
financial position and free up cash for further investments in core activities.
On March 6, 2003, we announced that we were exploring the sale of Woods U.S. and
Woods Canada. However, on July 31, 2003, we announced that we have decided not
to pursue a sale of these businesses at this time. On April 2, 2003, we
announced the sale of GC/Waldom with net proceeds of $7.5 million, which were
used to reduce our debt obligations. On February 3, 2003, we announced that we
sold a Woods manufacturing facility in Mooresville, Indiana. Gross proceeds were
$1.9 million, of which $0.7 million was used to repay a mortgage loan payable on
the property. The remainder of the proceeds reduced our debt obligations.
We have recorded valuation allowances of $42.8 million on deferred tax
assets as of December 31, 2002. These deferred tax assets include $22.8 million
of domestic net operating loss carry forwards. To the extent we generate taxable
income in future years, these net operating loss carry forwards will be
available to reduce future income tax liabilities.
On April 20, 2003, we announced a plan to repurchase up to $5.0 million of
our common stock. This repurchase is being funded through our credit facility.
As of June 30, 2003, we had spent $0.3 million to repurchase 79,900 shares of
our common stock on the open market.
- 27 -
OFF-BALANCE SHEET ARRANGEMENTS
On April 29, 2002, Katy and SESCO, an indirect wholly owned subsidiary,
entered into a partnership agreement with Montenay Power Corporation and its
affiliates (Montenay) that turned over the operation of SESCO's waste-to-energy
facility to Montenay. The Company entered into this agreement as a result of
evaluations of SESCO's business. First, we determined that SESCO was not a core
component of our long-term business strategy. Moreover, we did not feel the
Company had the management expertise to deal with certain risks and
uncertainties presented by the operation of SESCO's business, given that SESCO
was the Company's only waste-to-energy facility. We had explored options for
divesting SESCO for a number of years, and management felt that this transaction
offered a reasonable strategy to exit this business.
The partnership, with Montenay's leadership, assumed SESCO's position in
various contracts relating to the facility's operation. Under the partnership
agreement, SESCO contributed its assets and liabilities (except for its
liability under the loan agreement with the Resource Recovery Development
Authority (the Authority) of the City of Savannah and the related receivable
under the service agreement) to the partnership. While SESCO will maintain a 99%
partnership interest as a limited partner, Montenay will have most of the day to
day responsibility for administration, financing and other matters of the
partnership, and accordingly, the partnership will not be consolidated. Katy
agreed to pay Montenay $6.6 million over the span of seven years under a note
payable as part of the partnership and related agreements. Certain amounts may
be due to SESCO upon expiration of the service agreement in 2008; also, Montenay
may purchase SESCO's interest in the partnership at that time. Katy has not
recorded any amounts receivable or other assets relating to amounts that may be
received at the time the service agreement expires, given their uncertainty.
The Company recognized in the first quarter of 2002 a charge of $6.0
million, consisting of 1) the discounted value of the $6.6 million note, which
is payable over seven years, 2) the carrying value of certain assets contributed
to the partnership, consisting primarily of machinery spare parts, and 3) costs
to close the transaction. All of SESCO's long-lived assets were reduced to a
zero value at December 31, 2001, so no additional impairment was required. Going
forward, Katy would expect that income statement activity associated with its
involvement in the partnership will not be material, and Katy's balance sheet
will carry the liability mentioned above.
In 1984, the Authority issued $55.0 million of Industrial Revenue Bonds
and lent the proceeds to SESCO, under the loan agreement, for the acquisition
and construction of the waste-to-energy facility that has now been transferred
to the partnership. The funds required to repay the loan agreement come from the
monthly disposal fee paid by the Authority to SESCO under the service agreement
for certain waste disposal services, a component of which is for debt service.
To induce the required parties to consent to the SESCO partnership transaction,
SESCO retained its liability under the loan agreement. In connection with that
liability, SESCO also retained its right to receive the debt service component
of the monthly disposal fee.
Based on an opinion from outside legal counsel, SESCO has a legally
enforceable right to offset amounts it owes to
- 28 -
the Authority under the loan agreement against amounts that are owed from the
Authority under the service agreement. At June 30, 2003, this amount was $35.8
million. Accordingly, the amounts owed to and due from SESCO have been netted
for financial reporting purposes and are not shown on the consolidated balance
sheets.
In addition to SESCO retaining its liabilities under the loan agreement,
to induce the required parties to consent to the partnership transaction, Katy
also continues to guarantee the obligations of the partnership under the service
agreement. The partnership is liable for liquidated damages under the service
agreement if it fails to accept the minimum amount of waste or to meet other
performance standards under the service agreement. The liquidated damages, an
off balance sheet risk for Katy, are equal to the amount of the bonds
outstanding, less $4.0 million maintained in a debt service reserve trust. We do
not expect non-performance by the other parties. Additionally, Montenay has
agreed to indemnify Katy for any breach of the service agreement by the
partnership.
Following are scheduled principal repayments on the loan agreement (and
the Industrial Revenue Bonds) as of June 30, 2003 (in thousands):
2003 $ 5,385
2004 6,765
2005 8,370
2006 15,300
-------
Total $35,820
=======
We also enter into operating lease agreements in the ordinary course of
business, and many of our facilities are leased. Contractual obligations
associated with these leases are listed in the table under the following section
entitled "Contractual Obligations and Commercial Obligations."
Contractual Obligations and Commercial Obligations
Katy's obligations as of June 30, 2003 are summarized below:
(In thousands of dollars)
Due in less Due in Due in Due after
Contractual Cash Obligations Total than 1 year 1-3 years 4-5 years 5 years
- ---------------------------- -------- ----------- --------- --------- ---------
Revolving credit facility [d] $ 51,000 $ -- $ -- $51,000 $ --
Term loans 17,096 2,857 5,714 5,714 2,811
Operating leases [c] 46,059 11,757 17,901 12,653 3,748
Severance and restructuring [c] 1,092 802 275 15 --
SESCO payable to Montenay [b] 5,800 1,000 2,050 2,200 550
-------- ------- ------- ------- ------
Total Contractual Obligations $121,047 $16,416 $25,940 $71,582 $7,109
======== ======= ======= ======= ======
Due in less Due in Due in Due after
Other Commercial Commitments Total than 1 year 1-3 years 4-5 years 5 years
- ---------------------------- -------- ----------- --------- --------- ---------
Commercial letters of credit $ 668 $ 668 $ -- $ -- $ --
Stand-by letters of credit 8,605 8,605 -- -- --
Guarantees [a] 35,820 5,385 15,135 15,300 --
-------- ------- ------- ------- ------
Total Commercial Commitments $ 45,093 $14,658 $15,135 $15,300 $ --
======== ======= ======= ======= ======
(a) As discussed in the Off-Balance Sheet Arrangements section above, SESCO,
an indirect wholly-owned subsidiary of Katy, is party to a partnership
that operates a waste-to-energy facility, and has certain contractual
obligations, for which Katy provides certain guarantees. If the
partnership is not able to perform its obligations under the contracts,
under certain circumstances SESCO and Katy could be subject to damages
equal to the amount of Industrial Revenue Bonds outstanding (which
financed construction of the facility) less amounts held by the
partnership in debt service reserve funds. Katy and SESCO do not
anticipate non-performance by parties to the contracts. See the
Off-Balance Sheet
- 29 -
Arrangements section above and Note 9 to Condensed Consolidated Financial
Statements.
(b) Amount owed to Montenay as a result of the SESCO partnership, discussed
above and in Note 9 to the Condensed Consolidated Financial Statements.
$1.0 million of this obligation is classified in the Condensed
Consolidated Balance Sheets as an Accrued Expense in Current Liabilities,
while the remainder is included in Other Liabilities, recorded on a
discounted basis.
(c) These "Severance and restructuring" obligations represent liabilities
associated with restructuring activities, other than liabilities for
non-cancelable lease rentals. Future non-cancelable lease rentals are
included in the line entitled "Operating leases." Our balance sheet at
June 30, 2003 includes $9.9 million in discounted liabilities associated
with non-cancelable operating lease rentals, net of estimated sub-lease
revenues, related to facilities that have been abandoned as a result of
restructuring and consolidation activities.
(d) As discussed in the Liquidity and Capital Resources section above, the
entire Fleet Revolving Credit Facility is classified as a current
liability on the Condensed Consolidated Balance Sheets as a result of the
combination in the Fleet Credit Agreement of 1) lockbox agreements on
Katy's depository bank accounts and 2) a subjective Material Adverse
Effect (MAE) clause. The revolving credit agreement expires in January of
2008.
SEVERANCE, RESTRUCTURING AND RELATED CHARGES
During the first and second quarters of 2003, we recorded $0.2 million and
$1.7 million, respectively, for severance, restructuring and related charges
pursuant to SFAS No. 146. These costs related to equipment moves, adjustments to
non-cancelable lease liabilities for abandoned facilities, severance, and
related costs associated with consolidation of facilities and administrative
functions. Included in these costs were severance charges related to five
administrative and fifteen operations employees at the Santa Fe Springs
facility. Related charges also were incurred related to plastics manufacturing
facilities at Warson Road, and the abrasives manufacturing facility in Wrens.
During the fourth quarter of 2002, we recorded $2.4 million of severance
and other exit costs associated with the shut down of the Woods manufacturing
facilities in Indiana. Manufacturing operations were ceased in order to
implement a more cost-effective procurement of finished goods inventory through
sourcing with third party suppliers. As a result of this shut down, 361
employees were terminated. Woods incurred $1.5 million in severance, pension,
and other employee-related costs associated with the employee terminations.
Woods also incurred a charge for the creation of a liability for non-cancelable
lease costs at abandoned production facilities of $0.8 million. An additional
$0.1 million of other exit costs were incurred related to facility repairs and
other minor expenses. Woods also incurred $0.9 million of inventory write-offs
related to raw and packaging materials that will not be utilized efficiently
with the change-over to a fully sourced inventory strategy. Contico incurred
restructuring costs of $0.6 million in the fourth quarter of 2002 associated
with costs of revaluing their non-cancelable lease liability at the Warson Road
and Earth City facilities, and $0.3 million of costs in moving inventory and
equipment from the Warson Road facility to the Bridgeton facility, as discussed
below. Each of these facilities is in the St. Louis, Missouri area.
During the third quarter of 2002, we recorded $9.5 million of severance,
restructuring and related charges. During the third quarter, we committed to a
plan to abandon the Earth City facility and to consolidate its operations into
the Bridgeton facility. As a result, a $7.1 million charge was recorded to
accrue a liability for non-cancelable lease payments associated with the Earth
City facility. Also during the third quarter, the Contico business recorded a
$1.4 million charge related to rent and other facility costs associated with its
Warson Road facility, whose operations are also being consolidated into the
Bridgeton facility. A charge of $1.8 million was recorded in the second quarter
of 2002 for the Warson Road facility, and the additional amount of $1.4 million
was recorded after consideration of the market for sub-leasing and to accrue
costs to refurbish the facility. The Contico business recorded related charges
of $0.2 million incurred in moving inventory and equipment from the Warson Road
facility to the Bridgeton facility, and $0.2 million in severance costs. The
Corporate group recorded a $0.1 million charge for non-cancelable lease payments
related to the former corporate headquarters. Also in the third quarter of 2002,
a charge of $0.5 million was recorded for payments for consultants working with
the Company on sourcing and other manufacturing and production efficiency
initiatives.
- 30 -
During the second quarter of 2002, we recorded $3.8 million of severance,
restructuring and related charges. Approximately $1.6 million of the charges
related to accruals for payments for consultants working with the Company on
sourcing and other manufacturing and production efficiency initiatives.
Additionally, net non-cancelable rental payments of $1.8 million associated with
the shut down of Contico's Warson Road facility were charged to operations
during the quarter ended June 30, 2002, as well as involuntary termination
benefits of $0.1 million. The Warson Road facility shutdown involved a reduction
in workforce of nineteen employees. The remaining $0.3 million (for involuntary
termination benefits) related to SESCO and for various integration costs in the
consolidation of administrative functions into St. Louis, Missouri, from various
operating divisions in the Maintenance Products group.
During the first quarter of 2002, we recorded $2.3 million of severance,
restructuring and related charges. Approximately $1.9 million of the charges
related to accruals for payments for consultants working with us on sourcing and
other manufacturing and production efficiency initiatives. Approximately $0.3
million related to involuntary termination benefits for two management employees
whose positions were eliminated, and $0.1 million were costs associated with the
consolidation of administrative and operational functions.
Certain assumptions have been made regarding potential future sub-lease
revenue at rented facilities that have been, or will be, abandoned as a result
of restructuring and consolidation activities. If we are unable to achieve its
estimated sub-lease revenue estimates, charges could be recognized in future
periods to update the estimated liability and cost to Katy for these facilities.
The table below details activity in restructuring reserves since December 31,
2002 (in thousands).
One-time Contract
Termination Termination
Total Benefits Costs Other
-------- ----------- ------------ -------
Restructuring liabilities at December 31, 2002 $ 14,499 $ 2,085 $ 10,885 $ 1,529
Additions to restructuring liabilities 1,941 703 631 607
Payments on restructuring liabilities (5,283) (1,696) (1,626) (1,961)
-------- ------- -------- -------
Restructuring liabilities at June 30, 2003 $ 11,157 $ 1,092 $ 9,890 $ 175
======== ======= ======== =======
The table below summarizes the future obligations for severance and
restructuring charges detailed above as of June 30, 2003 (in thousands):
2003 $ 4,117
2004 1,592
2005 1,601
2006 1,368
2007 1,300
Thereafter 1,179
-------
Total Payments $11,157
=======
OUTLOOK FOR 2003
We anticipate a continuation of the difficult economic conditions and
business environment in 2003, which will present challenges in maintaining net
sales. In particular, we expect to see softness continue in the restaurant,
travel and hotel markets to which we sell cleaning products. We have seen
improved sales performance from the Woods and Woods Canada retail electrical
corded products business, but we do not expect to see the same level of
year-over-year top line growth from those businesses in 2003 as we experienced
in 2002. We have a significant concentration of customers in the mass-market
retail, discount and do-it-yourself market channels. Our ability to maintain and
increase our sales levels depends in part on our ability to retain and improve
relationships with these customers. We face the continuing challenge of
recovering or offsetting cost increases for raw materials.
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Gross margins are expected to improve during 2003 as we realize the
benefits of various profit-enhancing strategies begun in 2001 and 2002. These
strategies include sourcing previously manufactured products, as well as
locating new sources for products already sourced outside of our facilities. We
have significantly reduced headcount, and continue to examine issues related to
excess facilities. Cost of goods sold is subject to variability in the prices
for certain raw materials, most significantly thermoplastic resins used by
Contico in the manufacture of plastic products. Prices of plastic resins, such
as polyethylene and polypropylene, increased during the early months of 2003,
but have fallen and stabilized by the end of the second quarter. Management has
observed that the prices of plastic resins are driven to an extent by prices for
crude oil and natural gas, in addition to other factors specific to the supply
and demand of the resins themselves. We cannot predict the direction resin
prices will take during the remainder of 2003 and beyond. We are also exposed to
price changes for copper (a primary material in many of the products sold by
Woods and Woods Canada), aluminum (a primary material in production of truck
boxes), corrugated packaging material and other raw materials. We have not
employed an active hedging program related to our commodity price risk, but are
employing other strategies for managing this risk, including contracting for a
certain percentage of resin needs through supply agreements and supplementing
these agreements with opportunistic spot purchases. In a climate of rising raw
material costs, we experience difficulty in raising prices to shift these higher
costs to our customers.
Depreciation expense is expected to be higher during 2003 as a result of
the reduction in depreciable lives for certain assets used in Contico's
manufacturing process, effective January 1, 2003. The estimated amount of
incremental depreciation expense during 2003 as a result of this reduction in
depreciable lives is approximately $4.7 million. However, many of these assets
will become fully depreciated during 2003 since the Contico acquisition occurred
in early 1999. Therefore, depreciation expense related to these assets is
expected to reduce again in 2004 and subsequent years. Our total depreciation
expense in 2004 and subsequent years will depend on changes in the level of
depreciable assets.
Selling, general and administrative expenses are expected to remain stable
as a percentage of sales from 2002 levels. Cost reduction efforts are ongoing
throughout the Company. Our corporate office was relocated in 2001 and we expect
to maintain modest headcount and rental costs for that office. We have completed
the process of transferring most back-office functions of our Wilen subsidiary
from Atlanta, Georgia to St. Louis, Missouri, the headquarters of Contico. We
are nearly complete with the process of transferring most back-office functions
of the Glit/Microtron subsidiary in Wrens, Georgia to St. Louis, Missouri. We
will evaluate the possibility of further consolidation of administrative
processes at our subsidiaries.
We have announced or committed to several restructuring plans involving
our operations. During the second and third quarters of 2002, respectively, we
announced plans to consolidate the Warson Road and Earth City facilities of
Contico into the Bridgeton facility. All of these facilities are located in the
St. Louis, Missouri area. The move from our Warson Road facility is complete.
Subsequent to June 30, 2003, the move from our Earth City facility will require
approximately an additional $1.0 million of capital expenditures. The
significant charges recorded during the second and third quarters of 2002
related to these facilities were mainly to accrue non-cancelable lease payments
for these facilities (i.e., non-incremental cash). We also intend to reduce the
capacity of Contico's Hazelwood facility, which currently provides injection
molding of plastic products for the janitorial/sanitation business. Hazelwood
will continue to operate on a satellite basis, but with reduced capacity.
Certain molding machines will be transferred to the Bridgeton facility, and
excess machinery will be sold. Capital expenditures of $1.3 million will be
required at Bridgeton to accommodate the former Hazelwood capacity, and other
severance and restructuring expenses will be incurred during the last half of
2003 to accommodate this move. We expect the Contico business unit to benefit
from lower overhead costs in 2003 and beyond as a result of these
consolidations. Further facility consolidations with respect to the Contico
operations are under review.
During October 2002, we also announced the planned closure of four Woods
manufacturing facilities in Indiana, necessitated by our decision to fully
outsource our supply of electrical consumer corded products in the United States
to lower cost sources. Prior to the plant closures, Woods U.S. already sourced
approximately half of its finished goods from vendors. The plant closures took
place in December 2002. While outsourcing of the Woods U.S products is a
cost-saving measure, Woods U.S. expects to maintain higher inventory levels,
especially through mid-2003, as a result of this move.
We have committed to other restructuring alternatives as well, most of
which center around consolidation of
- 32 -
operations into fewer facilities. Certain of these projects will require
significant levels of incremental cash for both capital expenditures and moving
and relocation costs. Expected capital needs for these projects may reach $6.0
million, which will be spent mainly in 2003.
We continue to pursue a strategy within the Maintenance Products group to
simplify our business transactions and improve our customer relationships. By
the latter portion of 2003, we expect to be operating centralized customer
service functions for Continental, Glit, Wilen and Disco, allowing customers to
order products from any division on one purchase order. We believe that
operating these businesses as a cohesive unit will improve customer service
because our customers' purchasing processes will be simplified, as will follow
up on order status, billing, collection and other related functions. We hope
that these steps will increase customer loyalty and help in attracting new
customers and increasing top line sales in future years.
Our integration cost reduction efforts, integration of back office
functions and simplifications of our business transactions are all dependent on
executing a system integration plan. This plan involves the migration of data
across data across information technology platforms and implementation of new
software and hardware.
We own a 43% equity investment in Sahlman Holding Company, Inc. (Sahlman)
that is accounted for under the equity method. Sahlman is in the business of
harvesting shrimp off the coast of South and Central America, and farming shrimp
in Nicaragua. Sahlman's customers are primarily in the United States. Sahlman
experienced poor results of operations in 2002, primarily as a result of very
low prices paid to producers for shrimp. Increased foreign competition,
especially from Asia, has had a significant downward impact on shrimp prices in
the United States. Based upon a review of Sahlman's financial results for 2002
(and year to date in 2003), and an initial study of the status of the shrimp
industry and markets in the United States, We have concluded there is a need for
evaluating the business further to determine if there is a loss in the value of
the investment that is other than temporary. In accordance with Accounting
Principles Board (APB) Opinion No. 18, The Equity Method for Accounting for
Investments in Common Stock, losses in the value of equity investments that are
other than temporary should be recognized. Once we complete a full evaluation
and determine a reasonable estimate of the value of its investment in Sahlman,
we will adjust the carrying value to such estimate, if it is less than the
carrying value at that point in time.
Interest expense in 2003 is expected to be stable to lower than the amount
reported in 2002, due primarily to similar or lower expected debt balances. We
cannot predict the future levels of interest rates. In addition, after June 30,
2003, margins are determined on a pricing matrix which factors operating
performance into the pricing grid. Margins drop an additional 25 basis points in
the most favorable pricing grid from the pre-June 30 levels. We believe our
operating performance will result in us obtaining the more favorable pricing for
our borrowings.
Given our history of operating losses, along with guidance provided by the
accounting literature covering accounting for income taxes, we were unable to
conclude it is more likely than not that we will be able to generate future
taxable income sufficient to realize the benefits of deferred tax assets carried
on our books. Therefore, a full valuation allowance on the net deferred tax
asset position was recorded at June 30, 2003 and December 31, 2002, and we do
not expect to record the benefit of any deferred tax assets that may be
generated in 2003. We will continue to record current expense associated with
foreign and state income taxes.
We are continually evaluating alternatives that relate to divestitures of
non-core businesses. Divestitures present opportunities to de-leverage our
financial position and free up cash for further investments in core activities.
On March 6, 2003, we announced that we were exploring the sale of the Woods and
Woods Canada businesses. However, on July 31, 2003, we announced that we have
decided not to pursue a sale of these businesses at this time. On April 2, 2003,
we announced the sale of GC/Waldom with net proceeds of $7.5 million. Katy
recorded a loss of $0.2 million on the sale of GC/Waldom.
Cautionary Statement Pursuant to Safe Harbor Provisions of the Private
Securities Litigation Reform Act of 1995
This report and the information incorporated by reference in this report
contain various "forward-looking statements" as defined in Section 27A of the
Securities Act of 1933 and Section 21E of the Exchange Act of 1934, as amended.
The forward-looking statements are based on the beliefs of our management, as
well as assumptions made by, and information currently available to, our
management. We have based these forward-looking statements on current
- 33 -
expectations and projections about future events and trends affecting the
financial condition of our business. These forward-looking statements are
subject to risks and uncertainties that may lead to results that differ
materially from those expressed in any forward-looking statement made by us or
on our behalf, including, among other things:
- Increases in the cost of, or in some cases continuation of, the
current price levels of, plastic resins, copper, paper board
packaging, and other raw materials.
- Our inability to reduce product costs, including manufacturing,
sourcing, freight, and other product costs.
- Greater reliance on third parties for our finished goods as we
increase the portion of our manufacturing that is outsourced.
- Our inability to reduce administrative costs through consolidation
of functions and systems improvements.
- Our inability to execute our systems integration plan.
- Our inability to successfully integrate our operations as a result
of the facility consolidations.
- Our inability to sub-lease rented facilities which have been
abandoned as a result of consolidation and restructuring
initiatives.
- Our inability to achieve product price increases, especially as they
relate to potentially higher raw material costs.
- The potential impact of losing lines of business at large retail
outlets in the discount and do-it-yourself markets.
- Competition from foreign competitors.
- The potential impact of new distribution channels, such as
e-commerce, negatively impacting us and our existing channels.
- The potential impact of rising interest rates on our LIBOR-based
Fleet Credit Agreement.
- Our inability to meet covenants associated with the Fleet Credit
Agreement.
- The potential impact of rising costs for insurance for properties
and various forms of liabilities.
- Labor issues, including union activities that require an increase in
production costs or lead to a strike, thus impairing production and
decreasing sales. We are also subject to labor relations issues at
entities involved in our supply chain, including both suppliers and
those involved in transportation and shipping.
- Changes in significant laws and government regulations affecting
environmental compliance and income taxes.
- Our inability to sell certain assets to raise cash and de-leverage
our financial condition.
Words and phrases such as "expects," "estimates," "will," "intends,"
"plans," "believes," "anticipates" and the like are intended to identify
forward-looking statements. The results referred to in forward-looking
statements may differ materially from actual results because they involve
estimates, assumptions and uncertainties. Forward-looking statements
included herein are as of the date hereof and we undertake no obligation
to revise or update such statements to reflect events or circumstances
after the date hereof or to reflect the occurrence of unanticipated
events. All forward-looking statements should be viewed with caution.
- 34 -
ENVIRONMENTAL AND OTHER CONTINGENCIES
As set forth more fully in our 2002 Annual Report on Form 10-K, we and
certain of our current and former direct and indirect corporate predecessors,
subsidiaries and divisions are involved in remedial activities at certain
present and former locations and have been identified by the United States
Environmental Protection Agency (EPA), state environmental agencies and private
parties as potentially responsible parties (PRPs) at a number of hazardous waste
disposal sites under the Comprehensive Environmental Response, Compensation and
Liability Act (Superfund) or equivalent state laws and, as such, may be liable
for the cost of cleanup and other remedial activities at these sites.
Responsibility for cleanup and other remedial activities at a Superfund site is
typically shared among PRPs based on an allocation formula. Under the federal
Superfund statute, parties could be held jointly and severally liable, thus
subjecting them to potential individual liability for the entire cost of cleanup
at the site. Based on its estimate of allocation of liability among PRPs, the
probability that other PRPs, many of whom are large, solvent, public companies,
will fully pay the costs apportioned to them, currently available information
concerning the scope of contamination, estimated remediation costs, estimated
legal fees and other factors, we have recorded and accrued for indicated
environmental liabilities amounts that we deem reasonable and believe that any
liability with respect to these matters in excess of the accrual will not be
material. The ultimate costs will depend on a number of factors and the amount
currently accrued represents management's best current estimate of the total
cost to be incurred. We expect this amount to be substantially paid over the
next one to four years.
The most significant environmental matter in which we are currently
involved relates to the W.J. Smith site. In 1993, the EPA initiated a Unilateral
Administrative Order Proceeding under Section 7003 of the Resource Conservation
and Recovery Act (RCRA) against W.J. Smith and Katy. The proceeding requires
certain actions at the W.J. Smith site and certain off-site areas, as well as
development and implementation of additional cleanup activities to mitigate
off-site releases. In December 1995, W.J. Smith, Katy and the EPA agreed to
resolve the proceeding through an Administrative Order on Consent under Section
7003 of RCRA. Pursuant to the Order, W.J. Smith is currently implementing a
cleanup to mitigate off-site releases.
In December 1996, Banco del Atlantico, a bank located in Mexico, filed a
lawsuit against our Woods subsidiary and against certain past and then-present
officers and directors and former owners of Woods, alleging that the defendants
participated in a violation of the Racketeer Influenced and Corrupt
Organizations (RICO) Act involving allegedly fraudulently obtained loans from
Mexican banks, including the plaintiff, and "money laundering" of the proceeds
of the illegal enterprise. All of the foregoing is alleged to have occurred
prior to Katy's purchase of Woods. The plaintiff also alleged that it made loans
to an entity controlled by certain past officers and directors of Woods based
upon fraudulent representations. The plaintiff seeks to hold Woods liable for
its alleged damages directly, and under principles of respondeat superior and
successor liability. The plaintiff is claiming damages in excess of $24.0
million and is requesting treble damages under RICO. Because certain threshold
procedural and jurisdictional issues have not yet been fully adjudicated in this
litigation, it is not possible at this time for the Company to reasonably
determine an outcome or accurately estimate the range of potential exposure.
Katy may have recourse against the former owner of Woods and others for, among
other things, violations of covenants, representations and warranties under the
purchase agreement through which Katy acquired Woods, and under state, federal
and common law. In addition, the purchase price under the purchase agreement may
be subject to adjustment as a result of the claims made by Banco del Atlantico
or other issues relating to the litigation. The extent or limit of any such
adjustment cannot be predicted at this time. An adverse judgment in this matter
could have a material impact on Katy's liquidity and financial position if the
Company were not able to exercise recourse against the former owner of Woods.
We also have a number of product liability and workers' compensation
claims pending against us and our subsidiaries. Many of these claims are
proceeding through the litigation process and the final outcome will not be
known until a settlement is reached with the claimant or the case is
adjudicated. We estimate that it can take up to 10 years from the date of the
injury to reach a final outcome on certain claims. With respect to the product
liability and workers' compensation claims, we have provided for our share of
expected losses beyond the applicable insurance coverage, including those
incurred but not reported to us or our insurance providers, which are developed
using actuarial techniques. Such accruals are developed using currently
available claim information, and represent our best estimates. The ultimate cost
of any individual claim can vary based upon, among other factors, the nature of
the injury, the duration
- 35 -
of the disability period, the length of the claim period, the jurisdiction of
the claim and the nature of the final outcome.
Although we believe that these actions individually and in the aggregate
are not likely to have a material adverse effect on Katy's financial position,
results of operations or cash flows, further costs could be significant and will
be recorded as a charge to operations when such costs become probable and
reasonably estimable.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In April 2002, the Financial Accounting Standards Board (FASB) released
Statement of Financial Accounting Standards (SFAS) No. 145, Rescission of FASB
Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections. SFAS No. 145 rescinds and makes technical corrections regarding
various topics, including early extinguishments of debt and sale-leaseback
transactions. The statement is effective for fiscal years beginning after May
15, 2002. We adopted SFAS No. 145 on January 1, 2003. SFAS No. 145 requires that
certain costs and losses associated with early extinguishments of debt be
reported as interest expense as a component of income from continuing
operations, whereas the prior accounting guidance provided for classification of
these costs and losses as extraordinary items, reported separately on a
tax-effected basis after income from continuing operations. The adoption of SFAS
No. 145 will require that we reclassify a $1.2 million after-tax ($1.8 million
pre-tax) write-off of previously capitalized debt costs that occurred during
2001 from its previous classification as an extraordinary item to interest
expense, a component of income from continuing operations during 2001. Future
write-offs of capitalized debt costs will be classified as interest expense in a
similar manner. As a result of the refinancing of our borrowing facility in
February 2003, we wrote off approximately $1.2 million of debt costs, pre-tax,
during the first quarter of 2003. These costs have been reported as interest
expense, a component of income from continuing operations.
In July 2002, the FASB issued SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal Activities. The standard requires companies to
recognize costs associated with exit or disposal activities when they are
incurred rather than at the date of a commitment to an exit or disposal plan.
Examples of costs covered by the standard include lease termination costs and
certain employee severance costs that are associated with a restructuring,
discontinued operation, plant closing, or other exit or disposal activity.
Previous accounting guidance was provided by EITF Issue No. 94-3, Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (Including Certain Costs Incurred in a Restructuring). SFAS No. 146
replaces EITF Issue No. 94-3. The new standard is effective for exit or
restructuring activities initiated after December 31, 2002. We have initiated
since January 1, 2003 and are further considering a number of restructuring and
exit activities, including plant closings and consolidation of facilities. Since
these activities have been or will be initiated after December 31, 2002, this
statement could have a significant impact on the timing of the recognition of
these costs in our statements of operations, tending to spread the costs out as
opposed to recognition of a large portion of the costs at the time we commit to
and communicate such restructuring and exit plans. Our operating plans call for
additional restructuring and facility consolidation activity during the
remainder of 2003 and 2004, concerned mainly with further consolidation of St.
Louis, Missouri plastics manufacturing facilities, and restructuring and
consolidation of certain abrasives manufacturing facilities. We have has adopted
the provisions of SFAS No. 146 for all restructuring activities initiated after
December 31, 2002.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure. This standard provides alternative
methods of transition for a voluntary change to the fair value based methods of
accounting for stock-based employee compensation. In addition, SFAS No. 148
amends the disclosure requirements of SFAS No. 123, Accounting for Stock-Based
Compensation, to require prominent disclosure in both annual and interim
financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. The
disclosure provisions of the new standard were adopted by the Company at
December 31, 2002. We will continue to comply with the provisions of APB Opinion
No. 25, Accounting for Stock Issued to Employees, for accounting for stock-based
employee compensation. The disclosure provisions of SFAS No. 148 were adopted in
2002.
In January 2003, the FASB released FASB Interpretation No. (FIN) 46,
Consolidation of Variable Interest Entities - an Interpretation of ARB No. 51.
FIN 46 clarifies issues regarding the consolidation of entities which may have
features that make it unclear whether consolidation or equity method accounting
is appropriate. FIN 46 is effective in the third quarter of 2003 for variable
interest entities created prior to February 1, 2003. Katy is evaluating FIN 46
to
- 36 -
determine any potential impact on its financial reporting, specifically relating
to the potential consolidation of SESCO and the equity method investment in
Sahlman.
In April 2003, the FASB released SFAS No. 149, Amendment of Statement 133
on Derivative Instruments and Hedging Activities. We do not expect SFAS No. 149
to impact our results of operations or financial position.
In May 2003, the FASB released SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of Liabilities and Equity. SFAS No.
150 establishes standards for how certain financial instruments with
characteristics of both liabilities and equity are to be classified and
measured. It requires that certain financial instruments within its scope be
classified as a liability (or an asset in some circumstances), while many of
those instruments were previously classified as equity. SFAS No. 150 is
effective in the third quarter of 2003. We are evaluating SFAS No. 150 to
determine any potential impact on our financial reporting, primarily with
respect to our 15% Convertible Preferred Stock.
CRITICAL ACCOUNTING POLICIES
We disclosed details regarding certain of our critical accounting policies
in the Management's Discussion and Analysis section of our 2002 Annual Report on
Form 10-K (Part II., Item 7). There have been no changes to policies as of June
30, 2003.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our exposure to market risk associated with changes in interest rates
relates primarily to our debt obligations and temporary cash investments. We
currently do not use derivative financial instruments relating to either of
these exposures. Our interest obligations on outstanding debt are indexed from
short-term Eurodollar rates. We do not believe our exposures to interest rate
risks are material to our financial position or results of operations. We have
not employed an active hedging program related to our commodity price risk, but
are employing other strategies for managing this risk, including contracting for
a certain percentage of resin needs through supply agreements and supplementing
these agreements with opportunistic spot buyers.
Item 4. CONTROLS AND PROCEDURES
We maintain disclosure controls and procedures that are designed to ensure
that information required to be disclosed in our SEC filings is reported within
the time periods specified in the SEC's rules, and that such information is
accumulated and communicated to the management, including the Chief Executive
Officer and Chief Financial Officer, as appropriate, to allow timely decisions
regarding required disclosure. We also have investments in certain
unconsolidated entities. As we do not control or manage these entities, the
disclosure controls and procedures with respect to such entities are necessarily
more limited than those we maintain with respect to our consolidated
subsidiaries.
Katy carried out an evaluation, under the supervision and with the
participation of our management, including the Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the design and operation of our
disclosure controls and procedures (pursuant to Rule 13a-15(e) under the
Securities Exchange Act of 1934, as amended) as of the end of the period of our
report. Based upon that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that our disclosure controls and procedures are
effective in timely alerting them to material information relating to Katy
(including its consolidated subsidiaries) required to be included in our
periodic SEC filings. There have been no changes in Katy's internal control over
financial reporting during the quarter ended June 30, 2003 that has materially
affected, or is reasonable likely to materially affect Katy's internal control
over financial reporting.
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PART II - OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
During the quarter for which this report is filed, there have been no
material developments in previously reported legal proceedings, and no other
cases or legal proceedings, other than ordinary routine litigation incidental to
the Company's business and other nonmaterial proceedings, brought against the
Company.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of Stockholders of Katy Industries, Inc. was held at
The Heritage - A Dolce Conference Resort, 522 Heritage Road, Southbury,
Connecticut, at 10:00 AM, on June 12, 2003. Stockholders voted on three
proposals, summarized below with the accompanying number of votes in favor, as
opposed, or abstained.
PROPOSAL No. 1: Election of Directors
CLASS II DIRECTORS:
Name Votes For Votes Withheld
- ---- --------- --------------
Christopher Anderson 5,322,323 2,339,404
William F. Andrews 5,202,887 2,458,840
Samuel P. Frieder 5,338,354 2,323,373
James A. Kohlberg 5,338,454 2,323,273
Christopher Lacovara 5,324,923 2,336,804
The required vote for directors was the affirmative vote of a plurality of the
votes cast at the annual meeting. As a result of the vote, each of the five
nominees for Class II directors was elected.
PROPOSAL No. 2: To ratify the selection of PricewaterhouseCoopers LLP as the
independent public accountants of Katy for the fiscal year ending December 31,
2003.
Votes For Votes Against Votes Abstained
- --------- ------------- --------------
7,598,746 23,161 39,820
The required vote to ratify the appointment of PricewaterhouseCoopers LLP was
the majority of Katy's outstanding common stock present, in person or by proxy,
at the annual meeting. As a result of the vote, the selection of
PricewaterhouseCoopers LLP was ratified.
PROPOSAL No. 3: To consider and vote upon a stockholders proposal regarding
Katy's Stockholder Rights Agreement.
Votes For Votes Against Votes Abstained
- --------- ------------- --------------
2,958,750 3,667,122 6,776
The required vote for the approval of the stockholder proposal was the majority
of Katy's outstanding common stock present, in person or by proxy, at the annual
meeting. There were present in person or by proxy at the annual meeting
7,661,727 shares of common stock, a majority of which was 3,830,864 shares. As a
result of the vote, the stockholder proposal was not approved.
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Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
31.1 Certification of Chief Executive Officer pursuant to Securities
Exchange Act Rule 13a-14, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Securities
Exchange Act Rule 13a-14, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K
- Form 8-K filed April 17, 2003, including press release and schedules
announcing results of operations for 2002.
- Form 8-K filed April 21, 2003, including press release announcing stock
repurchase program.
- Form 8-K filed May 12, 2003, including press release and schedules
announcing results of operations for the first quarter of 2003.
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Signatures
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
KATY INDUSTRIES, INC.
Registrant
DATE: August 11, 2003 By /s/ C. Michael Jacobi
--------------------------------------
C. Michael Jacobi
President and Chief Executive Officer
By /s/ Amir Rosenthal
--------------------------------------
Amir Rosenthal
Vice President, Chief Financial
Officer, General Counsel and Secretary
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