United States
Securities and Exchange Commission
Washington, D.C. 20549
FORM 10-Q
Quarterly Report Under Section 13
or 15(d) of the Securities Exchange Act of 1934
For Quarter Ended: September 30, 2001 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.)
984 Southford Road, Middlebury, Connecticut 06762
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (203) 598-0387
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 the number of shares outstanding of each of the issuer's classes
of common stock as of the latest practicable date.
Class Outstanding at November 12, 2001
Common stock, $1 par value 8,393,883
KATY INDUSTRIES, INC.
FORM 10-Q
September 30, 2001
INDEX
-----
Page
----
PART I FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets
September 30, 2001 (unaudited) and December 31, 2000 2,3
Condensed Consolidated Statements of Operations
Three and Nine Months Ended September 30, 2001 and 2000 (unaudited) 4
Condensed Consolidated Statements of Stockholders' Equity
Nine Months ended September 30, 2001 (unaudited) and Twelve Months ended
December 31, 2000 5
Condensed Consolidated Statements of Cash Flows
Nine Months Ended September 30, 2001 and 2000 (unaudited) 6
Notes to Condensed Consolidated Financial Statements (unaudited) 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 16
Item 3. Quantitative and Qualitative Discussion about Market Risk 24
PART II OTHER INFORMATION
Item 1. Legal Proceedings 25
Item 6. Exhibits and Reports on Form 8-K 25
Signatures 26
Exhibit Index 27
1
PART I FINANCIAL INFORMATION
----------------------------
Item 1. Financial Statements
----------------------------
KATY INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Thousands of Dollars)
ASSETS
------
(Unaudited)
September 30, December 31,
2001 2000 (A)
--------------------------------------------
CURRENT ASSETS:
Cash and cash equivalents $ 1,661 $ 1,810
Accounts receivable, net 81,986 84,896
Inventories 80,436 103,068
Deferred income taxes 7,800 7,544
Other current assets 4,042 5,769
Net current assets of operations to be disposed of - 941
-------------------------------------------
Total current assets 175,925 204,028
OTHER ASSETS:
Goodwill 15,434 39,500
Other intangibles 33,561 47,214
Deferred income taxes 4,825 -
Other 11,623 6,900
Net noncurrent assets of operations to be disposed of 18,301 16,471
-------------------------------------------
Total other assets 83,744 110,085
PROPERTIES AND EQUIPMENT:
Land and improvements 3,820 3,789
Buildings and improvements 23,211 23,273
Machinery and equipment 170,345 166,414
Accumulated depreciation (75,298) (61,922)
-------------------------------------------
Net properties and equipment 122,078 131,554
-------------------------------------------
$ 381,747 $ 445,667
===========================================
See Notes to Condensed Consolidated Financial Statements.
(A) Compiled from audited financial statements as of December 31, 2000.
2
KATY INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Thousands of Dollars, Except Share Data)
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
(Unaudited)
September 30, December 31,
2001 2000 (A)
---------------------------------------------
CURRENT LIABILITIES:
Accounts payable $ 44,718 $ 53,553
Accrued compensation 9,573 6,038
Accrued expenses 35,182 36,112
Accrued interest and taxes 2,047 3,523
Current maturities of long-term debt 6,067 133,067
Net current liabilities of operations to be disposed of 1,032 -
---------------------------------------------
Total current liabilities 98,619 232,293
LONG-TERM DEBT, less current maturities - Note 4 81,917 771
---------------------------------------------
OTHER LIABILITIES 7,578 7,609
---------------------------------------------
EXCESS OF ACQUIRED NET ASSETS OVER COST 514 1,792
---------------------------------------------
DEFERRED INCOME TAXES - 19,969
---------------------------------------------
COMMITMENTS AND CONTINGENCIES - Note 7
PREFERRED INTEREST OF SUBSIDIARY 16,400 32,900
---------------------------------------------
STOCKHOLDERS' EQUITY
15% Convertible Preferred Stock, $100 par value, authorized
1,200,000 shares, issued and outstanding 700,000 shares,
liquidation value $70,000 - Note 5 67,350 -
Common stock, $1 par values; authorized 35,000,000 and
25,000,000 shares; issued 9,822,204 shares 9,822 9,822
Additional paid-in-capital 58,314 51,127
Accumulated other comprehensive loss (3,888) (2,757)
Other adjustments (216) (518)
Retained earnings 65,389 112,697
Treasury stock, at cost, 1,427,821 and 1,427,446 shares,
respectively (20,052) (20,038)
---------------------------------------------
Total stockholders' equity 176,719 150,333
---------------------------------------------
---------------------------------------------
$ 381,747 $ 445,667
=============================================
See Notes to Condensed Consolidated Financial Statements.
(A) Compiled from audited financial statements as of December 31, 2000.
3
KATY INDUSTRIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000
(Thousands of Dollars, Except Share and Per Share Data)
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30, September 30, September 30,
2001 2000 2001 2000
-----------------------------------------------------------
Net sales $ 139,458 $ 155,438 $ 374,547 $ 428,055
Cost of goods sold 118,634 128,850 320,193 344,681
-----------------------------------------------------------
Gross profit 20,824 26,588 54,354 83,374
Selling, general and administrative 20,275 23,742 64,904 72,814
Impairment of long-lived assets 187 - 36,144 -
Severance and restructuring charges 6,519 2,119 10,555 2,119
-----------------------------------------------------------
Operating (loss) income (6,157) 727 (57,249) 8,441
Equity in income (loss) of operations to be disposed of 240 (270) (324) (897)
Interest and other, net (2,315) (3,701) (9,045) (10,457)
-----------------------------------------------------------
Loss before provision for income taxes, distributions on
preferred interest of subsidiary, and extraordinary loss on
early extinguishment of debt (8,232) (3,244) (66,618) (2,913)
Benefit from income taxes 2,881 1,128 23,316 1,011
-----------------------------------------------------------
Loss before distributions on preferred interest of
subsidiary and extraordinary loss on early extinguishment of
debt (5,351) (2,116) (43,302) (1,902)
Distributions on preferred interest of subsidiary (net of tax) (214) (430) (1,069) (1,281)
-----------------------------------------------------------
Loss from continuing operations before extraordinary loss on early
extinguishment of debt (5,565) (2,546) (44,371) (3,183)
Extraordinary loss on early extinguishment of debt (net of tax) - - (1,182) -
-----------------------------------------------------------
Net loss (5,565) (2,546) (45,553) (3,183)
Gain on early redemption of preferred interest of subsidiary - - 6,600 -
Payment in kind dividends on convertible preferred stock (1,755) - (1,755) -
-----------------------------------------------------------
Net loss available to common shareholders $ (7,320) $ (2,546) $ (40,708) $ (3,183)
===========================================================
Earnings per share - Basic and Diluted
Loss from continuing operations $ (0.87) $ (0.30) $ (4.71) $ (0.38)
Extraordinary loss on early extinguishment of debt - - (0.14) -
-----------------------------------------------------------
Net loss $ (0.87) $ (0.30) $ (4.85) $ (0.38)
===========================================================
Average shares outstanding (thousands)
Basic 8,393 8,405 8,394 8,406
===========================================================
Diluted 8,393 8,405 8,394 8,406
===========================================================
Dividends paid per share - common stock $ 0.000 $ 0.075 $ 0.000 $ 0.225
===========================================================
See Notes to Condensed Consolidated Financial Statements.
4
KATY INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Thousands of dollars, except per share data)
(Unaudited)
Convertible Common Other
Preferred Stock Stock Additional Compre-
Number of Par Number of Par Paid in hensive
Shares Value Shares Value Capital Loss
--------------------------------------------------------------------------------------
Balance, January 1, 2000 - - 9,822,204 $ 9,822 $ 51,127 $ (434)
Net loss - - - - - -
Foreign currency translation
adjustment - - - - - (2,323)
Comprehensive income
Common stock dividends - - - - - -
Issuance of shares under
Stock Option Plan - - - - - -
Other issuance of shares - - - - - -
Purchase of Treasury Shares - - - - - -
--------------------------------------------------------------------------------------
Balance, December 31, 2000 - - 9,822,204 $ 9,822 $ 51,127 $ (2,757)
- - - - - -
Net loss - - - - - -
Foreign currency translation
adjustment - - - - - (1,131)
Comprehensive loss
Issuance of convertible
preferred stock 700,000 70,000 - - - -
Direct costs related to
issuance of convertible
preferred stock - (4,405) - - - -
Redemption of preferred
interest in subsidiary - - - - 6,710 -
PIK Dividend 1,755
Stock option grant -
nonemployee 477
Other - - - - - -
Balance,September 30, 2001 700,000 $ 67,350 9,822,204 $ 9,822 $ 58,314 $ (3,888)
======================================================================================
Accumulated Compre-
Other Retained Treasury hensive
Adjustments Earnings Stock Loss
--------------------------------------------------------
Balance, January 1, 2000 $ (1,010) $ 120,689 $ (19,883)
Net loss - (5,458) - $ (5,458)
Foreign currency translation
adjustment - - - (2,323)
------------
Comprehensive income $ (7,781)
============
Common stock dividends - (2,520) -
Issuance of shares under
Stock Option Plan - - 63
Other 492 (14) 44
Purchase of Treasury Shares - - (262)
-------------------------------------------
Balance, December 31, 2000 $ (518) $ 112,697 $ (20,038)
- - -
Net loss - (45,553) - $ (45,553)
Foreign currency translation
adjustment - - - (1,131)
------------
Comprehensive loss $ (46,684)
============
Issuance of convertible
preferred stock - - -
Direct costs related to
issuance of convertible
preferred stock - - -
Redemption of preferred
interest in subsidiary - - -
PIK Dividend (1,755)
Stock option grant -
nonemployee
Other 302 - (14)
Balance,September 30, 2001 $ (216) $ 65,389 $ (20,052)
===========================================
See Notes to Condensed Consolidated Financial Statements
5
KATY INDUSTRIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000
(Thousands of Dollars)
(Unaudited)
2001 2000
--------------------------------------------
Cash flows from operating activities:
Net loss $ (45,553) $ (3,183)
Depreciation and amortization 17,694 18,056
Impairment of long-lived assets 36,144 -
Net changes in assets and liabilities (4,868) (10,708)
--------------------------------------------
Net cash flows provided by (used in) operating activities 3,417 (4,165)
Cash flows from investing activities:
Capital expenditures (8,694) (11,728)
Proceeds from sale of assets 98 850
Collections of notes receivable 113 167
Proceeds from sale of subsidiaries 1,576 -
--------------------------------------------
Net cash flows used in investing activities (6,907) (10,711)
Cash flows from financing activities:
Net borrowings on Former Credit Agreement, prior to Recapitalization 11,300 4,998
Repayment of borrowings under Former Credit Agreement at
Recapitalization (144,300) -
Proceeds on initial borrowings from New Credit Agreement at
Recapitalization 93,211 -
Net repayments on New Credit Agreement, following Recapitalization (6,066) -
Fees and costs associated with New Credit Agreement (6,507) -
Proceeds from issuance of Convertible Preferred Stock 70,000 -
Direct costs related to issuance of Convertible Preferred Stock (4,405) -
Redemption of preferred interest of subsidiary (9,900) -
Payment of dividends (630) (1,892)
Purchase of treasury shares - (262)
Other 83 83
--------------------------------------------
Net cash flows provided by financing activities 2,786 2,877
Effect of exchange rate changes on cash and cash equivalents 3 -
--------------------------------------------
Net decrease in cash and cash equivalents (701) (3,669)
Cash and cash equivalents, beginning of period 2,459 10,643
--------------------------------------------
Cash and cash equivalents, end of period 1,758 6,974
Cash of operations to be disposed of (97) (743)
--------------------------------------------
Cash and cash equivalents of continuing operations $ 1,661 $ 6,231
============================================
See Notes to Condensed Consolidated Financial Statements.
6
KATY INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2001
(Unaudited)
(1) Significant Accounting Policies
-------------------------------
Consolidation Policy
- --------------------
The condensed consolidated financial statements include, on a
consolidated basis, 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 does exercise significant influence are reported
using the equity method. The condensed consolidated financial statements at
September 30, 2001 and December 31, 2000 and for the three and nine month
periods ended September 30, 2001 and September 30, 2000 reflect adjustments
(consisting only of normal recurring adjustments) which are, in the opinion of
management, necessary for a fair presentation of financial condition and results
of operations. Interim figures are subject to year-end adjustments and may not
be indicative of results to be realized for the entire year. The condensed
consolidated financial statements and notes thereto, should be read in
conjunction with the Company's Annual Report on Form 10-K for the year ended
December 31, 2000.
Recently Issued Accounting Pronouncement
- ----------------------------------------
In June 2001, the Financial Accounting Standards Board authorized the
issuance of Statement of Financial Accounting Standards ("SFAS") No. 141,
Business Combinations and SFAS No. 142, Goodwill and Other Intangible Assets.
SFAS No. 141 requires the use of the purchase method of accounting for all
business combinations initiated after June 30, 2001. SFAS No. 141 requires
intangible assets to be recognized if they arise from contractual or legal
rights or are "separable", i.e., it is feasible that they may be sold,
transferred, licensed, rented, exchanged or pledged. As a result, it is likely
that more intangible assets will be recognized under SFAS No. 141 than its
predecessor, Accounting Principles Board ("APB") Opinion No.16 although in some
instances previously recognized intangibles will be subsumed into goodwill.
Under SFAS No. 142, goodwill will no longer be amortized on a straight
line basis over its estimated useful life, but will be tested for impairment on
an annual basis and whenever indicators of impairment arise. The goodwill
impairment test, which is based on fair value, is to be performed on a reporting
unit level. A reporting unit is defined as an operating segment determined in
accordance with SFAS No. 131 or one level lower. Goodwill will no longer be
allocated to other long-lived assets for impairment testing under SFAS No. 121,
Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed of. Additionally, goodwill on equity method investments will no
longer be amortized; however, it will continue to be tested for impairment in
accordance with APB Opinion No. 18, The Equity Method of Accounting for
Investments in Common Stock. Under SFAS No. 142 intangible assets with
indefinite lives will not be amortized. Instead they will be carried at the
lower of cost or market value and tested for impairment at least annually. All
other recognized intangible assets will continue to be amortized over their
estimated useful lives.
SFAS No. 142 is effective for fiscal years beginning after December 15,
2001 although goodwill on business combinations consummated after July 1, 2001
will not be amortized. On adoption the Company may need to record a cumulative
effect adjustment to reflect the impairment of previously recognized intangible
assets. In addition, goodwill on prior business combinations will cease to be
amortized. The Company is unable at this time to determine the impact that this
Statement will have on intangible assets at the time of adoption in the first
quarter of 2002, or whether a cumulative effect adjustment will be required upon
adoption. During the second quarter of 2001, the Company recorded an impairment
of $33.0 million on the long-lived assets of it mop, broom and brush division,
as discussed in Note 3. However, even considering this impairment, the terms of
the recently completed recapitalization of the Company (the "Recapitalization,"
see Note 2) indicate that the fair value of the Company may be less than the
carrying value represented on the condensed consolidated balance sheets.
Therefore, the Company recognizes the possibility of impairments of goodwill and
certain intangibles upon adoption in the first quarter of 2002.
7
Use of Estimates
- ----------------
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the 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.
Reclassifications
- -----------------
Certain amounts from prior years have been reclassified to conform to
the 2001 financial statement presentation.
Operations to be Disposed Of
- ----------------------------
The historical operating results for "Operations to be Disposed Of"
have been segregated as "Equity in income (loss) of operations to be disposed
of" on the accompanying condensed consolidated statements of operations for all
periods presented. The related assets and liabilities have been separately
identified on the condensed consolidated balance sheets as "Net current
liabilities of operations to be disposed of" or "Net noncurrent assets of
operations to be disposed of". Operations to be disposed of have not been
segregated on the condensed consolidated statements of cash flows.
Inventories
- -----------
The components of inventories are as follows:
September 30, December 31,
2001 2000
---------------------------------------
(Thousands of Dollars)
Raw materials $ 33,478 $ 38,736
Work in progress 3,274 3,269
Finished goods 43,684 61,063
---------------------------------------
$ 80,436 $ 103,068
=======================================
At September 30, 2001 and December 31, 2000, 37% and 34% respectively,
of the Company'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 $1.9 million at September 30, 2001 and
$1.7 million at December 31, 2000.
During the third quarter of 2001, Katy recorded $2.6 million of
inventory valuation adjustments, primarily at its electrical products
distribution business. During the second quarter of 2001, Katy recorded $2.1
million of inventory valuation adjustments. These adjustments resulted from the
impact of lower sales or product line discontinuances during 2001, and
management strategies to reduce SKU's and monetize aged inventory. During the
first quarter of 2001, Katy recorded $3.3 million of inventory valuation
adjustments associated with the exit from the electrical licensed branded
product lines.
Earnings Per Share
- ------------------
There was no dilutive impact on earnings for the three and nine month
periods ended September 30, 2001 and September 30, 2000, respectively, as a
result of net losses reported for those periods.
8
(2) Recapitalization
----------------
On June 28, 2001, Katy announced that it had completed a
recapitalization of the Company (referred to as the "Recapitalization"). Katy
had reached a definitive agreement on June 2, 2001 with KKTY Holding Company,
LLC. ("KKTY"), an affiliate of Kohlberg Investors IV, L.P. ("Kohlberg") for the
Recapitalization. On June 28, 2001, 1) Katy shareholders approved proposals to
effectuate the transaction at their annual meeting, including classification of
the board of directors into two classes with staggered terms, and 2) Katy, KKTY
and a syndicate of banks agreed to a new credit facility (referred to as the
"New Credit Agreement") to finance the transaction and the future operations of
Katy. Under the terms of the Recapitalization, directors designated by KKTY
represent a majority of Katy's Board of Directors. Pursuant to the shareholder
vote at the annual meeting, four of the elected directors are considered Class I
directors, and were elected for one year terms. These directors include C.
Michael Jacobi, the new President and CEO, and three directors who were not
designated by KKTY. Five of the elected directors are considered Class II
directors, and will serve a two year term. All of the Class II directors are
designees of KKTY.
Under terms of the Recapitalization, KKTY purchased from Katy 700,000
shares of newly issued preferred stock, $100 par value per share (referred to as
the "Convertible Preferred Stock"), which is convertible into 11,666,666 common
shares, for an aggregate purchase price of $70.0 million (Note 5, Convertible
Preferred Stock, for a description of these securities). The Recapitalization
allowed Katy to retire obligations it had under its former revolving credit
agreement (referred to as the "Former Credit Agreement"), which was agented by
Bank of America. In connection with the Recapitalization, Katy entered the New
Credit Agreement, agented by Bankers Trust Company.
Also in connection with the Recapitalization, the Company entered into an
agreement with the holder of the preferred interest in its Contico
International, LLC subsidiary to redeem at a discount approximately half of such
interest, plus accrued distributions thereon, which had a stated value prior to
the Recapitalization of $32.9 million. Katy utilized approximately $10.2 million
of the proceeds from the issuance of the Convertible Preferred Stock for this
purpose. The difference between the amount paid on redemption and the stated
value of preferred interest redeemed ($6.7 million) was recognized as an
increase to Additional Paid in Capital on the Condensed Consolidated Balance
Sheets. The holder of the remaining preferred units will retain approximately
50% of the preferred interest, or a stated value of $16.4 million. Following is
summary of the sources and uses of funds involved at the consummation of the
Recapitalization:
(Thousands of Dollars)
Sources:
-------
Issuance of Convertible Preferred Stock $ 70,000
Borrowings under the New Credit Agreement 93,211
------------------
$ 163,211
==================
Uses:
----
Paydown of obligations under the Former Credit Agreement $ 144,924
Purchase of one-half of preferred interest of subsidiary at a discount 10,222
Certain costs associated with the recapitalization 8,065
------------------
$ 163,211
==================
(3) Impairments of Long-Lived Assets
--------------------------------
During the second quarter of 2001, the Company recorded an impairment of
certain long-lived assets, including goodwill and certain intangible assets, of
its mop, broom and brush division. The division had experienced consistently
worsening operating results for a number of periods, causing the Company to
evaluate the division for impairment. While the Company had plans to improve the
division's performance, the then current sales levels and operating results did
not support the pre-impairment carrying value of certain long-lived assets and
would not be recoverable through forecasted future cash flows. A determination
of the division's fair value was made using the income approach, specifically, a
discounted cash flow
9
analysis using the same cash flow stream used to initially determine that an
impairment existed. The adjustment to record at fair value amounted to a
reduction of goodwill amounting to $21.6 million and a reduction to other
intangible assets of $11.4 million, for a total reduction of the division's
carrying value of $33.0 million.
Also during the nine months ended September 30, 2001, the Company recorded
other impairments of long-lived assets totaling $3.1 million. These impairments
were primarily the result of management decisions regarding the discontinuance
of utilization of certain capitalized assets.
(4) Indebtedness
------------
In connection with the Recapitalization, Katy refinanced its
outstanding debt obligations under the Former Credit Agreement with a secured,
asset-based lending arrangement. The New Credit Agreement, which provides for a
total borrowing facility of $140.0 million, has a $30.0 million Term Loan
portion with a final maturity date of June 30, 2006, and quarterly repayments of
$1,500,000, beginning September 30, 2001. The remaining portion of the New
Credit Agreement is a $110.0 million Revolving Credit Facility that also has a
final maturity date of June 30, 2006. The borrowing base of the Revolving Credit
Facility is determined by eligible inventory and accounts receivable of the
Company. All extensions of credit to the Company are secured 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 the Company.
Customary financial covenants and restrictions on the payment of dividends apply
to the New Credit Agreement. Interest accrues on these obligations at prime plus
175 basis points on base rate loans and an adjusted Eurodollar rate plus 275
basis points on Eurodollar rate loans until the close of the second quarter of
2002. Following that, interest will be based on the Company's consolidated
leverage ratio, as defined in the New Credit Agreement.
September 30, December 31,
2001 2000
-----------------------------------------
(Thousands of Dollars)
Revolving loans payable under Former Credit Agreement, interest at
various LIBOR rates (7.41% - 8.75%), due through 2001, unsecured $ - $ 133,838
Term loans payable under New Credit Agreement, interest based on
Prime Rate (5.44%-7.75%), due through 2006 30,000 -
Revolving loans payable under New Credit Agreement, interest based on
Prime Rate (5.44%-7.75%), due through 2006 57,203 -
Real estate and chattel mortgages, with interest at fixed rates (7.14%),
due through 2013 781 -
Less current maturities (6,067) (133,067)
-----------------------------------------
Long-term debt $ 81,917 $ 771
=========================================
The Company incurred approximately $6.5 million of direct costs associated
with the New Credit Agreement, including $1.4 million paid to Kohlberg (who
worked on behalf of KKTY) for consulting fees and out-of-pocket expenses
relating to negotiation of terms and covenants associated with the New Credit
Agreement. These costs have been capitalized and are being amortized over the
five year length of the agreement.
(5) Convertible Preferred Stock
---------------------------
As discussed in Note 2, Recapitalization, above, KKTY purchased from Katy
700,000 shares of newly issued Convertible Preferred Stock, $100 par value per
share, which is convertible into 11,666,666 common shares, for an aggregate
purchase price of $70.0 million. The Convertible Preferred shares are entitled
to a 15% payment in kind ("PIK") dividend (that is, dividends in the form of
additional shares of Convertible Preferred Stock), compounded annually, which
started accruing on August 1, 2001, and are payable on the first day in August
of 2002. No dividends will accrue or be payable after December 31, 2004. If
converted, the 11,666,666 common shares, along with the 291,667 equivalent
common shares paid to KKTY as PIK dividends through September 30, 2001, would
represent 58.8% of the outstanding shares of common stock as of September 30,
2001, excluding outstanding options. If the holder continues to hold the
Convertible Preferred Stock for the three year and five month period, it will
receive an aggregated total of 431,555 shares of Convertible Preferred Stock,
which would be convertible into an additional 7,192,598 shares of common stock.
The shares of common stock issuable on the conversion of the Convertible
Preferred Stock issued at closing, together with the shares of common stock
issuable on the
10
conversion of the Convertible Preferred Stock issuable through the PIK dividend,
would represent 69.2% of the outstanding common shares of common stock,
excluding outstanding options. The accrual of the PIK dividends for August and
September of 2001 was recorded as a charge to Retained Earnings and an increase
to Convertible Preferred Stock. The dividends were recorded at fair value,
reduced earnings available to common shareholders in the calculation of basic
earnings per share, and are presented on the Condensed Consolidated Statement of
Operations as an item to arrive at Net Loss Available to Common Shareholders.
The Convertible Preferred Stock is convertible at the option of the holder
at any time after the earlier of 1) June 28, 2006, 2) board approval of a
merger, consolidation or other business combination involving a change in
control of the Company, or a sale of all or substantially all of the assets or
liquidation of the Company, or 3) a contested election for directors of the
Company nominated by KKTY. The preferred shares 1) are non-voting (with limited
exceptions), 2) are non-redeemable, except in whole, but not in part, at the
Company's option at any time after June 30, 2021, 3) are entitled to receive
cumulative PIK dividends, as mentioned above, at a rate of 15% percent, 4) have
no preemptive rights with respect to any other securities or instruments issued
by the Company, and 5) have registration rights with respect to any common
shares issued upon conversion of the Convertible Preferred Stock. The
Convertible Preferred Stock has a liquidation preference of $100.00 per share,
par value, before any distribution could be made to common shareholders.
The Company incurred approximately $4.4 million of direct costs related to
the issuance of the Convertible Preferred Stock, including $1.7 million paid to
Kohlberg (who worked on behalf of KKTY) for consulting fees and out-of-pocket
expenses relating to due diligence and structuring of the Recapitalization.
These costs have been netted against the stated amount of the Convertible
Preferred Stock on the condensed consolidated balance sheets.
(6) Employment Agreements and Stock Option Grants
---------------------------------------------
On June 28, 2001, the Company entered into an employment agreement with C.
Michael Jacobi, President and Chief Executive Officer. To induce Mr. Jacobi to
enter into the employment agreement, on June 28, 2001, the Compensation
Committee of the Board of Directors approved the Katy Industries, Inc. 2001
Chief Executive Officer's Plan. Under this plan, Mr. Jacobi will be granted
978,572 stock options. Mr. Jacobi will also be granted 71,428 stock options
under the Company's 1997 Incentive Plan. All stock options granted to Mr. Jacobi
will vest over a three year period provided that certain performance measures
are met in each year.
On September 4, 2001, the Company entered into an employment agreement with
Amir Rosenthal, Vice President, Chief Financial Officer and General Counsel. To
induce Mr. Rosenthal to enter into the employment agreement, on September 4,
2001, the Compensation Committee of the Board of Directors approved the Katy
Industries, Inc. 2001 Chief Financial Officer's Plan. Under this plan, Mr.
Rosenthal will be granted 123,077 stock options. Mr. Rosenthal will also be
granted 76,923 stock options under the Company's 1997 Incentive Plan. All stock
options granted to Mr. Rosenthal will vest over a three year period provided
that certain performance measures are met in each year.
(7) Commitments and Contingencies
-----------------------------
In December 1996, Banco del Atlantico, a bank located in Mexico, filed a
lawsuit against Woods Industries, Inc. ("Woods"), a subsidiary of the Company,
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 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 the Company's purchase of Woods.
The plaintiff also alleges that it made loans to an entity controlled by certain
officers and directors based upon fraudulent representations. The plaintiff
seeks to hold Woods liable for its alleged damage 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 the statutes. The
defendants have filed a motion, which has not been ruled on, to dismiss this
action on jurisdictional grounds. Because the litigation is in preliminary
stages, it is not possible at this time for the Company to determine an outcome
or reasonably estimate the range of potential exposure. The Company 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 the Company 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. The
extent or limit
11
of any such recourse cannot be predicted at this time.
The Company and certain of its current and former direct and indirect
corporate predecessors, subsidiaries and divisions have been identified by the
United States Environmental Protection Agency, 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 in the aggregate
amount of approximately $3.0 million at September 30, 2001. The ultimate cost
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.
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. It can take up to 10 years from the date of the injury to reach a
final outcome for such 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, 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.
(8) 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 and electronic components. Principal markets
are in the United States, Canada and Europe, and include the sanitary
maintenance, restaurant supply, retail, electronic, automotive, and computer
markets. These activities are grouped into two reporting segments:
Electrical/Electronics and Maintenance Products.
The tables below summarize financial information by segment:
Three Months Ended Nine Months Ended
September 30, September 30, September 30, September 30,
2001 2000 2001 2000
----------------- --------------- --------------- ----------------
(Thousands of Dollars)
Electrical/Electronics
Net external sales $ 53,405 $ 62,247 $ 119,758 $ 146,341
Net intercompany sales 24,986 22,383 42,605 43,886
Income (loss) from operations 353 2,615 (4,080) 5,087
Operating margin 0.7% 4.2% (3.4%) 3.5%
Depreciation & amortization 441 722 1,522 2,162
Impairment of long-lived assets 187 - 751 -
Identifiable assets 98,995 127,963 98,995 127,963
Capital expenditures 593 208 1,445 1,393
Maintenance Products
Net external sales 86,053 93,191 254,788 281,714
Net intercompany sales 3,445 2,295 10,476 6,844
Income (loss) from operations 1,907 1,181 (35,606) 10,811
12
Operating margin 2.2% 1.3% (14.0%) 3.8%
Depreciation & amortization 4,876 4,957 15,732 15,358
Impairment of long-lived assets - - 34,547 -
Identifiable assets 245,744 314,808 245,744 314,808
Capital expenditures 2,182 3,051 6,679 9,575
Operations to be Disposed Of
Net external sales 1,033 838 5,997 2,474
Net intercompany sales - - 2,424 -
Loss from operations (81) (127) (1,690) (1,191)
Operating margin (7.8%) (15.2%) (28.2%) (48.1%)
Depreciation & amortization 38 39 165 76
Impairment of long-lived assets - - 846 -
Identifiable assets 19,541 18,610 19,541 18,610
Equity investments 7,427 7,204 7,427 7,204
Capital expenditures - - 495 755
Three Months Ended Nine Months Ended
September 30, September 30, September 30, September 30,
2001 2000 2001 2000
---------------- --------------- --------------- ----------------
(Thousands of Dollars)
Corporate
Corporate expenses (8,418) (2,310) (16,717) (7,457)
Depreciation & amortization 59 39 275 460
Identifiable assets 18,707 19,412 18,707 20,700
Capital expenditures 75 - 75 5
Company
Net external sales $ 140,491 $ 156,276 $ 380,544 $ 430,529
Net intercompany sales 28,431 24,678 53,083 50,730
Income (loss) from operations (6,239) 555 (58,093) 7,250
Operating margin (4.4%) 0.4% (15.3%) 1.7%
Depreciation & amortization 5,414 6,150 17,694 18,056
Impairment of long-lived assets 187 - 36,144 -
Identifiable assets 382,988 482,081 382,988 482,081
Capital expenditures 2,850 3,264 8,694 11,728
The following tables reconcile the Company's total revenues, operating
income and assets to the Company's condensed consolidated statements of
operations and condensed consolidated balance sheets.
Three Months Ended Nine Months Ended
September 30, September 30, September 30, September 30,
2001 2000 2001 2000
---------------- --------------- ---------------- --------------
(Thousands of Dollars)
Revenues
Total net sales for reportable segments $ 168,922 $ 180,954 $ 433,627 $ 481,259
Elimination of net intercompany sales (28,431) (24,678) (53,083) (50,730)
Net sales included in equity in income of
operations to be disposed of (1,033) (838) (5,997) (2,474)
---------------- --------------- --------------- --------------
Total consolidated net sales $ 139,458 $ 155,438 $ 374,547 $ 428,055
================ =============== =============== ==============
13
Operating (loss) income
Total income (loss) from operations for $ (6,239) $ 555 $ (58,093) $ 7,250
reportable segments
Operating loss included in equity in
income of operations to be disposed of 82 172 844 1,191
---------------- --------------- --------------- --------------
Total consolidated operating income (loss) $ (6,157) $ 727 $ (57,249) $ 8,441
================ =============== =============== ==============
Assets
Total assets for reportable segments $ 382,988 $ 482,081 $ 382,988 $ 482,081
Liabilities included in net assets from
operations to be disposed of - (1,131) - (1,131)
Assets included in net liabilities from
operations to be disposed of (1,241) - (1,241) -
---------------- --------------- --------------- --------------
Total consolidated assets $ 381,747 $ 480,950 $ 381,747 $ 480,950
================ =============== =============== ==============
(9) Comprehensive Income (Loss)
--------------------------
Comprehensive income (loss) for the nine months ended September 30, 2001 and
2000 are as follows:
2001 2000
----------- ----------
(Thousands of Dollars)
Net loss $ (45,553) $ (3,183)
Foreign currency translation adjustments (1,131) (2,521)
----------- ----------
Comprehensive loss $ (46,684) $ (5,704)
=========== ==========
(10) Restructuring Charges
---------------------
During the third quarter of 2001, the Company recorded $6.5 million of
severance and restructuring charges, of which $5.1 million related to the
payment or accrual of severance and other payments associated with the
management transition as a result of the Recapitalization. The Company
anticipates recognizing an additional $0.4 million of expense in the fourth
quarter related to final charges for severance and other payments related to
management transitions. All of these amounts have been or are expected to be
paid during 2001. Additionally, $1.0 million of costs were incurred related
primarily to outside consultants working with the Company on strategic
operational and financial strategies. Included in this amount is a charge of
$0.5 million for the fair value of stock options awarded to this non-employee
firm. All of the remaining $0.5 million of costs were paid during the third
quarter.
During the second quarter of 2001, the Company's consumer and institutional
plastics division undertook restructuring efforts that resulted in severance
payments to various individuals. Forty three employees, including two members of
Contico and Katy executive management, received severance benefits. Total
severance costs were $1.6 million. Approximately 63% of these costs were paid
through the end of the third quarter.
Also during the second quarter of 2001, the Company recognized severance
and exit costs associated with the closing of a warehouse facility and
consolidation of certain administrative functions, both of which relate to the
mop, broom and brush business. Seven warehouse employees and 19 administrative
employees were being affected by these actions. Total severance and exit costs
associated with these efforts were $0.4 million. Approximately 41% of these
costs had been paid through the end of the third quarter of 2001.
Katy incurred charges for non-cancelable rent and other exit costs
associated with the planned closure of its Englewood, Colorado corporate office.
Total costs recognized in the second quarter of 2001 were $0.7 million, none of
which
14
have been paid through the end of the third quarter.
During the first quarter of 2001, the Company's Woods Industries division
undertook a restructuring effort that involved reductions in senior management
headcount as well as facilities closings. The Company closed facilities in
Loogootee and Bloomington, Indiana, as well as the Hong Kong office of Katy
International, a subsidiary which coordinates sourcing of products from Asia.
Sixteen management and administrative employees received severance packages.
Total severance and other exit costs were $0.7 million. Approximately 50% of
these costs were paid through the end of the third quarter.
During the third and fourth quarters of 2000, the Company implemented a
workforce reduction that reduced headcount by approximately 90. Employees
affected were primarily in general and administrative functions, with the
largest number of affected employees coming from the Maintenance Products
Segment.
The workforce reduction included severance and related costs for certain
employees. Total severance and related costs were $2.5 million pre-tax, which
are included as selling, general and administrative expenses in the consolidated
statements of operations. Approximately 72% of these costs were paid through
the end of the third quarter of 2001.
Severance expenses and exit costs are shown separately on the Consolidated
Statements of Operations. As of September 30, 2001, accrued severance and exit
costs totaled $5.0 million, which will be paid through the year 2006. The table
below summarizes the future obligation for the programs described:
(Thousands of Dollars)
2001 $ 3,501
2002 1,133
2003 264
2004 55
2005 55
2006 22
---------------
Total payments $ 5,030
===============
15
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
------------------------------------------------
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
---------------------------------------------
RESULTS OF OPERATIONS
Three months Ended September 30, 2001 and 2000
- ----------------------------------------------
Following are summaries of sales and operating income (loss) for the three
months ended September 30, 2001 and 2000 by industry segment (Thousands of
Dollars):
Increase (Decrease)
2001 2000 Amount Percent
---------------------------------------
Net Sales
- ---------
Electrical/Electronics $53,405 $62,247 $(8,842) (14.2)%
Maintenance Products 86,053 93,191 (7,138) (7.7)%
Operations to be Disposed Of 1,033 838 195 23.3%
Operating Income (Loss)
- -----------------------
Electrical/Electronics $ 353 $ 2,615 $(2,262) (86.5)%
Maintenance Products 1,907 1,181 726 61.5 %
Operations to be Disposed Of (81) (127) 46 36.2 %
The Electrical/Electronics Group's sales decreased as a result of lower
sales at the consumer electric corded business in both the U.S. and Canada, and
at the electrical parts and accessories business. General economic conditions
impacting the retail markets impacted the electrical corded business, and the
weaker market for electronic component parts and accessories, both contributed
to this decrease. Also, during 2000, the Company's Thorsen Tool business was
classified in the Electrical/Electronics group. This business was sold during
the second quarter of 2001, accounting for approximately $2.4 million of the
noted decrease.
The Group's operating income decreased as a result of lower gross margins
and several unusual adjustments recorded in the third quarter of 2001. Margins
were lower in the consumer electric corded businesses in the U.S. and Canada,
with a reduction in volume being a prime contributor to these shortfalls.
Significant unusual adjustments that impacted operating income included
increases to inventory reserves at the electrical parts and accessories business
of $1.8 million, and at the consumer electrical corded businesses of $0.5
million, receivables valuation adjustments of $0.2 million, and an impairment
charge on machinery and equipment of $0.2 million. In the third quarter of
2000, the Group recorded severance charges of $0.1 million, and incurred a
charge of $0.8 million related to a product recall.
Sales from the Maintenance Products Group decreased as a result of lower
sales at the consumer and institutional plastics business and the mop, broom and
brush business. The reductions were due primarily to softer demand in both
consumer markets and janitorial/sanitation markets. Specific customer losses
have impacted the mop, broom and brush business, which is recovering from
operational difficulties experienced during 2000.
The Group's operating income increased primarily due to improved
profitability at the mop, broom and brush business and the institutional
abrasives business, offset by lower profitability at the consumer and
institutional plastics business. The mop, broom and brush business is beginning
to stabilize after experiencing operational difficulties beginning in early
2000. Sales volume pressures on fixed costs and other overhead negatively
impacted profitability in the consumer and institutional plastics business.
There were several unusual items recorded in the Group during the third quarter
of 2001, including a decrease
16
to the Company's LIFO inventory accounting reserve of $1.1 million, which was
offset by a receivables valuation charge related to a bankrupt customer of $0.4
million, and other restructuring and reorganization charges of $0.3 million.
During the third quarter of 2000, the Group recorded severance charges of $1.1
million and an increase to the LIFO inventory accounting reserve of $0.9
million.
Sales from Operations to be Disposed Of increased as a result of higher
sales at the waste-to-energy facility. Operating income was higher in 2001 due
to reduced maintenance costs at the facility.
Expenses in the corporate segment were higher only because of the
incurrence of costs for payment or accrual of severance and other payments
associated with the management transition as a result of the Recapitalization.
Excluding these items, corporate expenses were lower year over year, mainly due
to reduced headcount.
Excluding certain unusual items, many of which were mentioned above,
selling, general and administrative costs as a percentage of net sales improved
slightly from 2000, even as sales decreased significantly, evidencing the
Company's efforts to control costs.
Interest and other, net decreased both as a result of a lower level of
interest-bearing borrowings and lower rates applied to the borrowings
outstanding under the New Credit Agreement versus the Former Credit Agreement.
Nine months Ended September 30, 2001
- ------------------------------------
Following are summaries of sales and operating income for the nine months
ended September 30, 2001 and 2000 by industry segment (Thousands of Dollars):
Increase (Decrease)
2001 2000 Amount Percent
-----------------------------------------
Net Sales
- ---------
Electrical/Electronics $119,758 $146,341 $(26,583) (18.2)%
Maintenance Products 254,788 281,714 (26,926) (9.6)%
Operations to be Disposed Of 5,997 2,474 3,523 142.4%
Operating Income (Loss)
- -----------------------
Electrical/Electronics $ (4,080) $ 5,087 $ (9,167) (180.2)%
Maintenance Products (35,606) 10,811 (46,417) (429.3)%
Operations to be Disposed Of (1,690) (1,191) (499) (41.9)%
The Electrical/Electronics Group's sales decreased as a result of lower
sales at the consumer electric corded business in both the U.S. and Canada, and
at the electrical parts and accessories business. General economic conditions
impacting the retail markets impacted the electrical corded business, and the
weaker market for electronic component parts and accessories, both contributed
to this decrease. Also, during 2000, the Company's Thorsen Tool business was
classified in the Electrical/Electronics group. This business was sold during
the second quarter of 2001, accounting for approximately $3.8 million of the
noted decrease.
The Group's operating income decreased primarily as a result of unusual
charges incurred. In addition to the unusual items mentioned in the three month
discussion, significant unusual adjustments from the second quarter that
impacted operating income included increases to inventory reserves at the
consumer electric corded business and the electrical parts and accessories
business of $0.9 million, an impairment of capitalized software costs of $0.5
million, and a charge for additional reserves for contingent liabilities of $0.5
million. Also, the consumer electric corded business incurred unusual first
quarter charges,
17
including severance and restructuring charges relating to the closing of two
satellite facilities ($0.7 million), and inventory losses incurred relating to
the exit of certain licensed branded product lines ($3.3 million). Excluding
these items, operating income was down approximately $0.8 million, with lower
results at the electrical parts and accessories business and the Canadian
consumer electric corded business offset by improved performance at the U.S.
consumer electric corded business and the precision metal rolling business. In
the first nine months of 2000, the Group recorded severance charges amounting to
$0.1 million and incurred a charge related to a product recall totaling $0.8
million.
The sales from the Maintenance Products Group decreased primarily as a
result of lower sales at the consumer and institutional plastics business and
the mop, broom and brush business. The reductions were due primarily to softer
demand in both retail markets and janitorial/sanitation markets. Specific
customer losses have impacted the mop, broom and brush business, which is
recovering from operational difficulties experienced during 2000.
The Group's operating income decreased due to both the recognition of a
number of unusual charges, as well as margin pressures in the underlying
businesses. Volume-related margin declines in the consumer and institutional
plastics businesses were the primary reasons for the decline from an operating
standpoint. Pricing pressures in the abrasives business also contributed to the
decline. In addition to the unusual items mentioned in the three month
discussion, during the second quarter of 2001 the Group recorded impairments of
long-lived assets of $34.5 million, most significantly goodwill and intangibles
at the mop, broom and brush division. Also during the second quarter, unusual
items recorded included severance and restructuring ($2.0 million), inventory
valuation adjustments ($1.1 million), and reserves for exposure relating to a
bankrupt former customer ($0.2 million). During the first quarter the plastics
business recorded a charge to increase its LIFO inventory accounting reserve
($1.3 million). The Group recorded severance charges in the first nine months
of 2000 amounting to $1.1 million and an increase to the LIFO inventory
accounting reserve of $0.9 million.
Sales from Operations to be Disposed Of were higher mainly because of the
inclusion of the Thorsen Tools business in this category for the first five
months of 2001 prior to its sale. Income from Operations to be Disposed Of were
lower as a result of impairments recorded in the first quarter related to the
Thorsen Tools business.
The corporate group incurred significant costs during the first nine months
of the year ($3.0 million) related to the Recapitalization. It should be noted
that other costs were incurred related to the Recapitalization that were not
recognized as part of operating income. Approximately $4.3 million of costs
were netted against preferred equity, $6.7 million of costs related to the New
Credit Agreement were capitalized to the balance sheet and will be amortized,
and $1.8 million (pre-tax) of previously capitalized debt costs related to the
Former Credit Agreement were written off as an extraordinary charge. Also, the
corporate group incurred costs for severance and restructuring during the first
nine months of 2001 totaling $7.3 million, mainly related to severance and other
payments associated with the management transition as a result of the
Recapitalization. The corporate group incurred severance charges of $0.9
million during the first nine months of 2000. Excluding these items, costs in
the corporate group were lower, due mainly to reduced headcount.
Excluding certain unusual items, many of which were mentioned above,
selling, general and administrative costs as a percentage of net sales improved
slightly from 2000, even as sales decreased significantly, evidencing the
Company's efforts to control costs.
Interest and other, net was lower than in 2000, due to a combination of
significantly lower borrowings during the third quarter (post-Recapitalization)
year over year, and lower rates of interest applied to borrowings.
LIQUIDITY AND CAPITAL RESOURCES
The Company's liquidity and capital resources were impacted significantly by
the end of the second quarter of 2001 as a result of the completion of the
Recapitalization. As a result of the Recapitalization, the Company had
borrowings outstanding under the New Credit Agreement at June 30, 2001 of $89.2
million, which was reduced to $88.0 million at September 30, 2001, $6.1 million
of which is due within one year, compared to borrowings under the Former Credit
Agreement at December 31, 2000 of $133.0 million, all of which was due within
one year. Following is a summary of the sources and uses of funds involved at
the consummation of the Recapitalization:
18
(Thousands of Dollars)
Sources:
--------
Purchase of Convertible Preferred Stock $ 70,000
Borrowings under the New Credit Agreement 93,211
------------
$ 163,211
============
Uses:
-----
Paydown of obligations under the Former Credit Agreement $ 144,924
Purchase of one half of preferred interest of subsidiary at a discount 10,222
Certain costs associated with the recapitalization 8,065
------------
$ 163,211
============
The Company feels that its liquidity and financial strength will be
increased as a result of the cash infusion by the purchaser of the Convertible
Preferred Stock and borrowing availability under the New Credit Agreement. The
New Credit Agreement, which provides for a total borrowing facility of $140.0
million, has a $30.0 million Term Loan portion with a final maturity date of
five years after the closing of the transaction and quarterly repayments of
$1,500,000, beginning September 30, 2001. The Term Loan is based on orderly
liquidation values of the Company's property, plant and equipment. The New
Credit Agreement has a $110.0 million Revolving Credit Facility that also has a
final maturity date of June 28, 2006. The borrowing base of the Revolving
Credit Facility is determined by eligible inventory and accounts receivable of
the Company. All extensions of credit to the Company are secured 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 the Company.
Customary financial covenants apply under the New Credit Agreement. Interest
accrues on these obligations going forward at approximately 275 basis points
over a Eurodollar rate. Total debt was 31.2% of total capitalization at
September 30, 2001.
As the result of an agreement related to the Recapitalization, the Company
reduced the amount outstanding of the preferred interest in the Contico
subsidiary by acquiring approximately one-half of such interest at a significant
discount. This will result in a reduction of preferred distributions required
to be made annually by approximately $1.3 million.
Excluding current maturities of indebtedness, working capital decreased
$21.4 at September 30, 2001 from December 31, 2000. Inventories decreased
approximately $22.6 million during this time frame. Approximately $8.1 million
of this decrease was attributable to valuation adjustments, and $.2 million of
the decrease was due to an increase to the LIFO inventory reserve. The
remaining decrease was due to operational reactions to lower sales levels and
focus on monetizing aged inventory. These decreases in working capital were
offset by lower accounts payable compared to year-end 2000.
Katy expects to commit an additional $6.0 million for capital projects in
the continuing businesses during the remainder of the year for a total of
approximately $15.0 million during 2000. Funding for these expenditures and for
working capital needs is expected to be accomplished through the use of
available cash under the New Credit Agreement and internally generated funds.
While a total of $140.0 million is available under the New Credit Agreement,
Katy's borrowing base is limited under the Revolving Credit Facility by eligible
accounts receivable and inventory. However, Katy feels that the New Credit
Agreement provides sufficient liquidity for the Company's operations going
forward. The Company is considering options to de-leverage its financial
position further by divesting certain of its businesses.
RESTRUCTURING CHARGES
- ---------------------
During the third quarter of 2001, the Company recorded $6.5 million of
severance and restructuring charges, of which $5.1 million related to the
payment or accrual of severance and other payments associated with the
management transition as a result of the Recapitalization. The Company
anticipates recognizing an additional $0.4 million of expense in the fourth
quarter related to final charges for severance and other payments related to
management transitions. All of these amounts have been or are expected to be
paid during 2001. Additionally, $1.0 million of costs were incurred related
primarily to outside consultants working with the Company on strategic
operational and financial strategies. Included in this amount is a charge of
$0.5 million for the fair value of stock options awarded to this non-employee
firm. All of the remaining $0.5 million of costs
19
were paid during the third quarter.
During the second quarter of 2001, the Company's consumer and institutional
plastics division undertook restructuring efforts that resulted in severance
payments to various individuals. Forty three employees, including two members
of Contico and Katy executive management, received severance benefits. Total
severance costs were $1.6 million. Approximately 63% of these costs were paid
through the end of the third quarter of 2001.
Also during the second quarter of 2001, the Company recognized severance
and exit costs associated with the closing of a warehouse facility and
consolidation of certain administrative functions, both of which relate to the
mop, broom and brush business. Seven warehouse employees and 19 administrative
employees were being affected by these actions. Total severance and exit costs
associated with these efforts were $0.4 million. Approximately 41% of these
costs had been paid through the end of the third quarter of 2001.
Katy incurred charges for non-cancelable rent and other exit costs
associated with the planned closure of its Englewood, Colorado corporate office.
Total costs recognized in the second quarter of 2001 were $0.7 million, none of
which have been paid through the end of the third quarter.
During the first quarter of 2001, the Company's Woods Industries division
undertook a restructuring effort that involved reductions in senior management
headcount as well as facilities closings. The Company closed facilities in
Loogootee and Bloomington, Indiana, as well as the Hong Kong office of Katy
International, a subsidiary which coordinates sourcing of products from Asia.
Sixteen management and administrative employees received severance packages.
Total severance and other exit costs were $0.7 million. Approximately 50% of
these costs were paid through the end of the third quarter.
During the third and fourth quarters of 2000, the Company implemented a
workforce reduction that reduced headcount by approximately 90. Employees
affected were primarily in general and administrative functions, with the
largest number of affected employees coming from the Maintenance Products
Segment.
The workforce reduction included severance and related costs for certain
employees. Total severance and related costs were $2.5 million pre-tax, which
are included as selling, general and administrative expenses in the consolidated
statements of operations. Approximately 72% of these costs were paid through
the end of the third quarter of 2001.
Severance expenses and exit costs are shown separately on the Consolidated
Statements of Operations. As of September 30, 2001, accrued severance and exit
costs totaled $5.0 million, which will be paid through the year 2006. The table
below summarizes the future obligation for the programs described:
(Thousands of Dollars)
2001 $ 3,501
2002 1,133
2003 264
2004 55
2005 55
2006 22
---------------
Total payments $ 5,030
===============
20
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board authorized the
issuance of Statement of Financial Accounting Standards ("SFAS") No. 141,
Business Combinations and SFAS No. 142, Goodwill and Other Intangible Assets.
SFAS No. 141 requires the use of the purchase method of accounting for all
business combinations initiated after June 30, 2001. SFAS No. 141 requires
intangible assets to be recognized if they arise from contractual or legal
rights or are "separable", i.e., it is feasible that they may be sold,
transferred, licensed, rented, exchanged or pledged. As a result, it is likely
that more intangible assets will be recognized under SFAS No. 141 than its
predecessor, Accounting Principles Board ("APB") Opinion No.16 although in some
instances previously recognized intangibles will be subsumed into goodwill.
Under SFAS No. 142, goodwill will no longer be amortized on a straight line
basis over its estimated useful life, but will be tested for impairment on an
annual basis and whenever indicators of impairment arise. The goodwill
impairment test, which is based on fair value, is to be performed on a reporting
unit level. A reporting unit is defined as an operating segment determined in
accordance with SFAS No. 131 or one level lower. Goodwill will no longer be
allocated to other long-lived assets for impairment testing under SFAS No. 121,
Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed of. Additionally, goodwill on equity method investments will no
longer be amortized; however, it will continue to be tested for impairment in
accordance with Accounting Principles Board Opinion No. 18, The Equity Method of
Accounting for Investments in Common Stock. Under SFAS No. 142 intangible
assets with indefinite lives will not be amortized. Instead they will be
carried at the lower cost or market value and tested for impairment at least
annually. All other recognized intangible assets will continue to be amortized
over their estimated useful lives.
SFAS No. 142 is effective for fiscal years beginning after December 15,
2001 although goodwill on business combinations consummated after July 1, 2001
will not be amortized. On adoption the Company may need to record a cumulative
effect adjustment to reflect the impairment of previously recognized intangible
assets. In addition, goodwill on prior business combinations will cease to be
amortized. The Company is unable at this time to determine the impact that this
Statement will have on intangible assets at the time of adoption in the first
quarter of 2002, or whether a cumulative effect adjustment will be required upon
adoption. During the second quarter of 2001, the Company recorded an impairment
of $33.0 million on the long-lived assets of it mop, broom and brush division,
as discussed in Note 3. However, even considering this impairment, the terms of
the recently completed Recapitalization indicate that the fair value of the
Company may be less than the carrying value represented on the condensed
consolidated balance sheets. Therefore, the Company recognizes the possibility
of impairments of goodwill and certain intangibles upon adoption in the first
quarter of 2002.
ENVIRONMENTAL AND OTHER CONTINGENCIES
The Company and certain of its current and former direct and indirect
corporate predecessors, subsidiaries and divisions have been identified by the
United States Environmental Protection Agency, 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 in the aggregate
amount of approximately $3.0 million at September 30, 2001. The ultimate cost
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. The
Company expects this amount to be substantially paid over the next one to four
years.
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. It can take up to 10 years from the date of the injury to reach a
final outcome for such claims. With respect to the product liability and
workers' compensation claims, Katy has provided for its
21
share of expected losses beyond the applicable insurance coverage, including
those incurred but not reported, 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.
OUTLOOK
Net sales during 2001 have trailed sales levels from 2000, and are expected
to decrease year over year. Katy divisions continue to experience a slower
economy and struggling market sectors, especially in the retail sector, where
sales have been impacted significantly by customer efforts to reduce
inventories, and in the electronics distribution market, which has been
negatively impacted by the slowdown in the technology and telecommunications
sectors. The Company has a significant concentration of customers in the mass-
market retail, discount, and do-it-yourself market channels. The Company's
ability to maintain and increase its sales levels depends in part on its ability
to retain and improve relationships with these customers. The Company faces the
continuing challenge of recovering cost increases for items such as raw
materials given the market power of these customers.
The Company is aggressively working on specific programs to reduce costs
associated with manufacturing, sourcing of products, freight, and other
operating costs. Headcount at many Katy operations has been reduced
significantly since year-end as a result of reductions in force implemented by
the divisions. Also, three divisions have closed satellite manufacturing and
warehouse operations since the beginning of the year. Katy expects to see
benefits from these actions during the last quarter of 2001 and in future years.
The Company continues to be exposed to prices for thermoplastic resins, a
significant raw material used in the consumer and industrials plastics business,
although these costs have leveled or declined during 2001 after increasing
significantly beginning in mid-1999 and throughout 2000. Katy has not employed
any hedging techniques in the past regarding this commodity market risk, but may
do so in the future.
Selling, general and administrative costs as a percentage of sales in the
aggregate are expected to be stable or improve slightly from 2000 levels,
excluding severance, restructuring and other unusual charges. Certain cost
reduction efforts were implemented during the first quarter of 2001 at Woods,
including the closing of facilities and reduction of administrative and
executive staff. Also, significant reductions in force took place at Contico.
The Katy corporate office has relocated as well, and the corporate group expects
to maintain modest headcount and reduced rental costs. Katy has begun the
process of transferring most back-office functions of its mop, broom and brush
division from Atlanta to St. Louis, the headquarters of consumer and
institutional plastics business. It should be noted that the Company may incur
further unusual charges in the fourth quarter of 2001 for potential
restructuring efforts related to decisions on facilities, manufacturing and
administrative operations.
Interest expense is expected to be significantly lower in 2001 due to
significantly lower debt balances as a result of the Recapitalization that took
place on June 28, 2001, and continuingly decreasing interest rates.
The Company continues to evaluate the annualized effective income tax rate,
taking into account the tax and book treatment of costs associated with the
Recapitalization, as well as other potential permanent differences between tax
and book income. Katy feels that deferred tax assets will be realized through
the generation of future taxable income. However, the Company will continue to
assess the realizability of deferred tax assets, and will consider the need for
valuation allowances as future circumstances dictate.
Cautionary Statement Pursuant to Safe Harbor Provisions of the Private
- ----------------------------------------------------------------------
Securities Litigation Reform Act of 1995
- ----------------------------------------
This report contains "forward-looking statements" within the meaning of the
federal securities laws. The forward-looking statements include, among others,
statements concerning the Company's outlook for 2001, cost reduction strategies
and their results, the Company's expectations for funding its 2001 capital
expenditures and operations and other statements of expectations, beliefs,
future plans and strategies, anticipated events or trends, and similar
expressions concerning matters that are not historical facts. Words such as
"expects", "will", "believes", "anticipates", and the like indicate the presence
of forward-looking statements. These forward-looking statements are subject to
risks and uncertainties that could cause actual results to
22
differ dramatically from those expressed in or implied by the statements.
To improve its financial performance, the Company must reduce its cost
structure and improve its production efficiency, improve its management of
working capital, and grow its existing base of retail and distribution
customers. The most important factors that could influence the achievement of
these goals, and cause actual results to differ materially from those expressed
in the forward-looking statements, include, but are not limited to the
following:
- 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.
- The Company's inability to reduce product costs, including
manufacturing, sourcing, freight, and other product costs.
- The Company's inability to reduce administrative costs though
consolidation of functions and systems improvements.
- The inability of the Company 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 the Company and its existing channels.
- The potential impact of rising interest rates on the Company's prime
rate and Eurodollar rate-based credit facility.
- The Company's inability to meet covenants associated with the New
Credit Agreement.
- Labor issues, including union activities that require an increase in
production costs or lead to a strike, thus impairing production and
decreasing sales.
- Changes in significant laws and government regulations affecting
environmental compliance and income taxes.
These and other risks and uncertainties affecting the Company are discussed
in greater detail in this report and in the Company's other filings with the
Securities and Exchange Commission.
23
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
----------------------------------------------------------
The Company's exposure to market risk associated with changes in
interest rates relates primarily to its debt obligations and temporary cash
investments. The Company currently does not use derivative financial instruments
relating to either of these exposures. The Company's debt obligations are
currently indexed to the prime rate, and its temporary cash investments earn
rates of interest available on securities with maturities of three months or
less. Book value approximates fair value for both the debt obligations and
temporary cash investments. The holder of the preferred interest has a put
option which allows upon the occurrence of certain events, the preferred
interest to be exchangeable for Katy common stock. It should be noted that in
connection with the Recapitalization, the Company acquired approximately
one-half of the outstanding preferred interest at a 40% discount from its
stated value.
Expected Maturity Dates
(Thousands of Dollars)
There- Fair
2001 2002 2003 2004 2005 After Total Value
------------------------------------------------------------------------------------------
ASSETS
- ------
Temporary cash
investments
Fixed rate $ 880 $ - $ - $ - $ - $ - $ 880 $ 880
Average
interest rate 3.25% - - - - - 3.25%
LONG-TERM DEBT
- --------------
Fixed rate debt $ 17 $ 67 $ 697 $ - $ - $ - $ 781 $ 781
Average interest rate 7.14% 7.14% 7.14% - - 7.14%
Variable rate debt $ 3,000 $ 6,000 $ 6,000 $ 6,000 $ 6,000 $60,203 $ 87,203 $87,203
Average interest rate 5.55% 5.55% 5.55% 5.55% 5.55% 5.55% 5.55%
PREFERRED INTEREST OF SUBSIDIARY
- --------------------------------
Fixed rate obligation $ - $ - $ - $ - $ - $16,400 $ 16,400 $16,400
Average interest rate 8.00% 8.00% 8.00% 8.00% 8.00% 8.00% 8.00%
24
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, have been brought
against the Company.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
--------------------------------
(a) Exhibits
Exhibit
Number Exhibit Title
- ------ -------------
10.1 First Amendment and waiver to Credit Agreement dated as of September
27, 2001, filed herewith.
10.2 Employment Agreement dated as of September 4, 2001 between Amir
Rosenthal and the Company, filed herewith.
10.3 Katy Industries, Inc. 2001 Chief Financial Officer's Plan, filed
herewith.
(b) Reports on Form 8-K
None
25
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: November 14, 2001 By /s/ Amir Rosenthal
---------------------
Amir Rosenthal
Vice President &
Chief Financial Officer
26
INDEX OF EXHIBITS
Exhibit
Number Exhibit Title
- ------ -------------
10.1 First Amendment and waiver to Credit Agreement dated as of September
27, 2001, filed herewith.
10.2 Employment Agreement dated as of September 4, 2001 between Amir
Rosenthal and the Company, filed herewith.
10.3 Katy Industries, Inc. 2001 Chief Financial Officer's Plan, filed
herewith.
27