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, 2002
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 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 8, 2002
Common Stock, $1 Par Value 8,362,427
KATY INDUSTRIES, INC.
FORM 10-Q
June 30, 2002
INDEX
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Page
PART I FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets
June 30, 2002 and December 31, 2001 (unaudited) 2,3
Condensed Consolidated Statements of Operations
Three and Six Months Ended June 30, 2002 and 2001
(unaudited) 4
Condensed Consolidated Statements of Cash Flows
Six Months Ended June 30, 2002 and 2001 (unaudited) 5
Notes to Condensed Consolidated Financial Statements
(unaudited) 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 13
Item 3. Quantitative and Qualitative Disclosures about Market Risk 22
PART II OTHER INFORMATION
Item 1. Legal Proceedings 23
Item 2. Submission of Matters to a Vote of Security Holders 23
Item 6. Exhibits and Reports on Form 8-K 23
Signatures 24
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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,
2002 2001
---- ----
CURRENT ASSETS:
Cash and cash equivalents $ 5,145 $ 8,064
Trade accounts receivable, net 71,423 72,810
Inventories 70,085 65,941
Deferred income taxes 8,160 8,243
Other current assets 3,234 2,878
------------ ------------
Total current assets 158,047 157,936
------------ ------------
OTHER ASSETS:
Goodwill 15,125 15,125
Intangibles 31,683 33,032
Deferred income taxes -- 2,278
Equity method investment in unconsolidated affiliate 7,657 7,011
Other 11,521 12,825
------------ ------------
Total other assets 65,986 70,271
------------ ------------
PROPERTIES:
Land and improvements 3,889 3,798
Buildings and improvements 23,850 23,526
Machinery and equipment 171,883 171,333
------------ ------------
199,622 198,657
Accumulated depreciation (84,602) (78,909)
------------ ------------
Net properties 115,020 119,748
------------ ------------
Total assets $ 339,053 $ 347,955
============ ============
See Notes to Condensed Consolidated Financial Statements.
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KATY INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Thousands of Dollars, Except Share Data)
(Unaudited)
LIABILITIES AND STOCKHOLDERS' EQUITY
June 30, December 31,
2002 2001
---- ----
CURRENT LIABILITIES:
Accounts payable $ 39,210 $ 39,181
Accrued compensation 6,312 7,201
Accrued expenses 44,566 37,578
Current maturities of indebtedness 6,733 14,619
Revolving credit agreement 58,540 57,000
------------ ------------
Total current liabilities 155,361 155,579
------------ ------------
LONG TERM DEBT, less current maturities 10,876 12,474
OTHER LIABILITIES 11,006 5,638
------------ ------------
Total liabilities 177,243 173,691
------------ ------------
COMMITMENTS AND CONTINGENCIES
PREFERRED INTEREST OF SUBSIDIARY 16,400 16,400
------------ ------------
STOCKHOLDERS' EQUITY:
15% Convertible Preferred Stock, $100 par value, authorized
1,200,000 shares, issued and outstanding 700,000 shares,
liquidation value $70,000 74,797 69,560
Common stock, $1 par value; authorized
35,000,000 shares; issued and outstanding 9,822,204 9,822 9,822
Additional paid-in capital 58,314 58,314
Accumulated other comprehensive loss (2,825) (4,625)
Unearned Compensation (49) (106)
Retained earnings 25,579 44,976
Treasury stock, at cost, 1,459,777
and 1,430,621 shares, respectively (20,228) (20,077)
------------ ------------
Total stockholders' equity 145,410 157,864
------------ ------------
Total liabilities and stockholders' equity $ 339,053 $ 347,955
============ ============
See Notes to Condensed Consolidated Financial Statements.
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KATY INDUSTRIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS AND SIX MONTHS ENDED JUNE 30,
2002 AND 2001 (Thousands of Dollars,
Except Share and Per Share Data)
(Unaudited)
Three Months Six Months
Ended June 30, Ended June 30,
-------------- --------------
2002 2001 2002 2001
---- ---- ---- ----
Net sales $ 118,425 $ 120,142 $ 229,445 $ 240,055
Cost of goods sold 97,555 103,187 188,159 206,294
---------- ---------- ---------- ----------
Gross profit 20,870 16,955 41,286 33,761
Selling, general and administrative 19,011 22,258 37,149 45,615
Impairment of long-lived assets 2,394 35,111 2,394 35,957
Severance, restructuring and other charges 3,785 2,719 6,081 4,036
SESCO joint venture transaction -- -- 6,010 --
---------- ---------- ---------- ----------
Operating loss (4,320) (43,133) (10,348) (51,847)
Equity in income of unconsolidated investments 339 285 646 159
Interest (1,444) (2,969) (2,892) (6,218)
Other, net (145) (349) (238) (480)
---------- ---------- ---------- ----------
Loss before provision for
income taxes, distributions on preferred
interest of subsidiary, and extraordinary loss on
early extinguishment of debt (5,570) (46,166) (12,832) (58,386)
(Provision for) benefit from income taxes (672) 16,159 (672) 20,435
---------- ---------- ---------- ----------
Loss before distributions on
preferred interest of subsidiary and extraordinary
loss on early extinguishment of debt (6,242) (30,007) (13,504) (37,951)
Distributions on preferred interest of
subsidiary (net of tax) (328) (427) (656) (855)
---------- ---------- ---------- ----------
Loss from operations before extraordinary
loss on early extinguishment of debt (6,570) (30,434) (14,160) (38,806)
Extraordinary loss on early extinguishment of debt (net of tax) -- (1,182) -- (1,182)
---------- ---------- ---------- ----------
Net loss (6,570) (31,616) (14,160) (39,988)
Payment in kind dividends on convertible preferred stock (2,615) -- (5,237) --
---------- ---------- ---------- ----------
Net loss available to common shareholders ($ 9,185) ($ 31,616) ($ 19,397) ($ 39,988)
========== ========== ========== ==========
Earnings per share - Basic and Diluted
Loss from operations ($ 1.10) ($ 3.63) ($ 2.32) ($ 4.62)
Goodwill, net of tax -- .04 -- .07
Negative goodwill -- (.05) -- (.10)
Extraordinary loss on early extinguishment of debt -- (.14) -- (.14)
---------- ---------- ---------- ----------
Net loss ($ 1.10) ($ 3.78) ($ 2.32) ($ 4.79)
========== ========== ========== ==========
Average shares outstanding (thousands)
Basic 8,362 8,394 8,377 8,394
========== ========== ========== ==========
Diluted 8,362 8,394 8,377 8,394
========== ========== ========== ==========
Dividends paid per share - common stock $ 0.000 $ 0.000 $ 0.000 $ 0.075
========== ========== ========== ==========
See Notes to Condensed Consolidated Financial Statements
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KATY INDUSTRIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED JUNE 30, 2002 AND 2001
(Thousands of Dollars)
(Unaudited)
2002 2001
---- ----
Cash flows from operating activities:
Net loss $ (14,160) $ (39,988)
Depreciation and amortization 11,021 12,280
Impairment of long-lived assets 2,394 35,957
SESCO joint venture transaction 6,010 --
Other, net 6,199 (9,747)
--------- ---------
Net cash flows provided by (used in) operating activities 11,464 (1,498)
--------- ---------
Cash flows from investing activities:
Capital expenditures (6,496) (5,844)
Proceeds from the sale of assets 99 194
Collections of notes receivable 447 90
Proceeds from the sale of subsidiaries -- 1,576
--------- ---------
Net cash flows used in investing activities (5,950) (3,984)
--------- ---------
Cash flows from financing activities:
Net borrowings on Former Credit Agreement, prior to Recapitalization -- 11,300
Repayment of borrowings under Former Credit Agreement at Recapitalization -- (144,300)
Proceeds on initial borrowings from New Credit Agreement
at Recapitalization - term loans -- 30,000
Proceeds on initial borrowings from New Credit Agreement
at Recapitalization - revolving loans -- 63,211
Repayments on New Credit Agreement - term loans (9,484) --
Net borrowings on New Credit Agreement
following Recapitalization - revolving loans 1,540 (4,100)
Fees and costs associated with New Credit Agreement (311) (6,507)
Proceeds from issuance of Convertible Preferred Stock -- 70,000
Direct costs related to issuance of Convertible Preferred Stock -- (4,008)
Redemption of preferred interest of subsidiary -- (9,900)
Payment of dividends -- (630)
--------- ---------
Net cash flows (used in) provided by financing activities (8,255) 5,066
--------- ---------
Effect of exchange rate changes on cash and cash equivalents (178) 3
--------- ---------
Net decrease in cash and cash equivalents (2,919) (413)
Cash and cash equivalents, beginning of period 8,064 2,459
--------- ---------
Cash and cash equivalents, end of period $ 5,145 $ 2,046
========= =========
See Notes to Condensed Consolidated Financial Statements.
- 5 -
KATY INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2002
(1) Significant Accounting Policies
Consolidation Policy
The condensed 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 exercises significant influence are reported using the equity
method. The condensed consolidated financial statements at June 30, 2002 and
December 31, 2001 and for the three and six month periods ended June 30, 2002
and June 30, 2001 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 financial condition and results of operations.
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 for
the year ended December 31, 2001.
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 qas follows:
June 30, December 31,
2002 2001
---- ----
(Thousands of Dollars)
Raw materials $ 28,846 $ 30,804
Work in process 2,944 3,256
Finished goods 38,295 31,881
------------ ------------
$ 70,085 $ 65,941
============ ============
At June 30, 2002 and December 31, 2001, approximately 40% of the Company's
inventories are 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 $0.9 million at June 30, 2002 and by $1.5 million at
December 31, 2001.
- 6 -
Goodwill
The Company adopted the non-amortization provisions of Statement of
Financial Accounting Standards ("SFAS ") No. 142, Goodwill and Other Intangible
Assets, during the first quarter of 2002. Below is a calculation of earnings,
removing the impact of amortization recorded on goodwill and negative goodwill
(shown net of tax):
Three months ended June 30, Six months ended June 30,
2002 2001 2002 2001
---- ---- ---- ----
(Thousands of dollars) (Thousands of dollars)
Reported net loss from operations before extraordinary
loss on early extinguishment of debt $ (6,570) $ (30,434) $ (14,160) $ (38,806)
Add back: Goodwill amortization -- 311 -- 622
Deduct: Negative goodwill amortization -- (426) -- (852)
---------- ---------- ---------- ----------
Adjusted net loss from operations before extraordinary
loss on early extinguishment of debt (6,570) (30,549) (14,160) (39,036)
Extraordinary loss on early extinguishment of debt -- (1,182) -- (1,182)
---------- ---------- ---------- ----------
Adjusted net loss (6,570) (31,731) (14,160) (40,218)
Paid-in-kind dividends (2,615) -- (5,237) --
---------- ---------- ---------- ----------
Adjusted net loss available to common shareholders $ (9,185) $ (31,731) $ (19,397) $ (40,218)
========== ========== ========== ==========
New Accounting Pronouncements - Under SFAS No. 142, Goodwill and Other
Intangible Assets, goodwill is no longer 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, Disclosures about Segments of an Enterprise and Related
Information, 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 fair value and
tested for impairment at least annually or when indications of impairment arise.
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. The Company has adopted the non-amortization provisions
of SFAS No. 142 with regards to goodwill that has been reported on the balance
sheets historically. The amount of goodwill amortization not recorded during the
six months ended June 30, 2002 as a result of the adoption of the
non-amortization provisions was $0.9 million, before tax. Negative goodwill,
which was created with the acquisition of Woods Industries in December 1996 and
was amortized over five years, was fully amortized by December 31, 2001;
therefore, the adoption of the non-amortization provisions of SFAS No. 142 had
no impact on negative goodwill. The Company is continuing to amortize assets
historically presented as intangible assets until the evaluation of all
intangibles is completed with regard to their continued presentation as
intangibles or their potential reclassification to goodwill.
The Company has completed the first phase in the determination of a
potential transitional goodwill impairment. Valuations of the six Katy reporting
units carrying goodwill have been completed, and the analyses indicate that the
fair value is less than the carrying value for three of the six reporting units.
The second phase in the determination of transitional goodwill impairment has
begun, and is expected to be completed by September 30, 2002. Upon the
completion of the second phase of the analysis, the Company expects to recognize
a transitional goodwill impairment of up to $11.5 million, which is the carrying
value of the goodwill on the books of the three reporting units referenced
above. If transitional goodwill impairment is recognized, the Company will
record it as a cumulative effect adjustment. The Company has tested long-lived
assets for impairment, including intangible assets at various points in the
past, including at year end 2001. The Company still carries $31.7 million of
finite lived intangible assets on the books, many of which represent customer
lists and relationships and similar intangibles. Tests for impairment of
intangible assets will continue to be performed as necessary, and impairments of
these assets are possible in 2002.
In August 2001, the FASB released SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets.
- 7 -
Previously, two accounting models existed for long-lived assets to be disposed
of, as SFAS No. 121 did not address the accounting for a segment of a business
accounted for as a discontinued operation under APB Opinion 30. This statement
establishes a single model based on the framework of SFAS No. 121. This
statement also broadens the presentation of discontinued operations to include
more disposal transactions.
The Company has adopted SFAS No. 144 and has determined that for the six
months ended June 30, 2002, there are no operations that should be reported as
discontinued under the new standard. However, the Company anticipates that this
statement could have an impact on its financial reporting as 1) the Company is
considering certain divestitures of 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 the Company were to divest of certain businesses that are under
consideration, Katy anticipates they would qualify as discontinued operations
under SFAS No. 144, whereas they would have not met the requirements of
discontinued operations treatment under APB Opinion 30.
During July 2002, the FASB issued SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal Activities. The standard requires com panies 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, although earlier
application is encouraged. Katy is considering a number of restructuring and
exit activities at the current time, including plant closings and consolidation
of facilities. To the extent these activities are initiated after December 31,
2002, this statement could have a significant impact on the timing of the
recognition of these costs in the Company's 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 such restructuring and exit plans. It should
be noted that Katy is considering early adoption of this standard; if that
course is decided upon, then the statement could have a significant impact on
timing of the recognition of costs associated with exit or disposal activities
initiated prior to December 31, 2002.
(2) SESCO Joint Venture Transaction
On March 14, 2002, the Company and Savannah Energy Systems Company
("SESCO"), an indirect wholly owned subsidiary of Katy, signed an agreement to
enter into a joint venture that would effectively turn over operation of SESCO's
waste-to-energy facility to Montenay Power Corporation and its affiliates
("Montenay"). The transaction closed on April 29, 2002. The Company entered into
this agreement as a result of evaluations of SESCO's business. First, the
Company determined that SESCO was not a core component of Katy'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 feels that this transaction offers a reasonable exit strategy
from this business.
The joint venture, with Montenay's leadership, will essentially assume
SESCO's position in various contracts relating to the facility's operation.
Under the agreement, SESCO contributed its assets and liabilities (except for
its liability under the loan agreement (the Loan Agreement) with the Resource
Recovery Development Authority (the Authority) of the City of Savannah (the
City)) and the related receivable under the service agreement (the Service
Agreement) to a joint venture. While SESCO will maintain a 99% partnership
interest as a limited partner in the joint venture, Montenay will have most of
the day to day control of the joint venture, and accordingly, the joint venture
will not be consolidated. SESCO has recorded a liability for the present value
of committed future expenditures under the agreement with Montenay of $6.6
million due in installments through 2008. Certain amounts may be due to SESCO
upon expiration of the Service Agreement in 2008; also, Montenay may purchase
SESCO's interest in the joint venture at that time. Katy has not booked 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 a charge of $6.0 million,
consisting of 1) the discounted value of the $6,600,000 note, which is payable
over seven years, 2) the carrying value of certain assets contributed to the
joint venture, 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 written to a zero value at December 31, 2001, so no additional impairment
was required. On a going forward basis, Katy would expect little if any income
statement activity as a result of its involvement in the joint venture, and
Katy's
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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 facility that has now been transferred to the joint
venture. The funds required to repay the Loan Agreement come from the monthly
disposal fee, a component of which is for debt service, paid by the Authority
under the Service Agreement. To induce the required parties to consent to the
SESCO joint venture 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 consultations with 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, 2002, this amount was $40.3 million. Accordingly, the
amounts owed to and due from SESCO have been netted for financial reporting
purposes and are not shown on the consolidated statements of financial position.
In addition to SESCO retaining its liabilities under the Loan Agreement,
to induce the required parties to consent to the joint venture transaction, Katy
also continues to guarantee the obligations of the joint venture under the
Service Agreement. The joint venture 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 ($43.0 million), 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 joint venture.
(3) Income Taxes
As of December 31, 2001, the Company had federal net operating loss carry
forwards of $61.5 million, which the Company feels are adequately reserved. The
Company expects to incur a net operating loss during 2002, which appears likely
given the results of operations through June 30, 2002. The Company has generated
net operating losses for three straight years prior to 2002. Given the history
of net operating loss generation, the Company has decided it is prudent to
reserve all net operating losses generated during 2002. Therefore, the Company
will not recognize currently the tax benefits of operating losses, which will be
reanalyzed in the future. The Company has recorded provisions through June 30,
2002, for current liabilities associated with state and foreign income tax
expenses.
(4) Commitments and Contingencies
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 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 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. The extent or
limit of any such adjustment cannot be predicted at this time.
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.
As set forth more fully in the Company's 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, 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
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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 environmental liabilities at 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 matters in which the Company is currently involved
relates to the W.J. Smith site. In 1993, the United States Environmental
Protection Agency (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 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.
(5) 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 industry segments:
Electrical/Electronics and Maintenance Products.
The table below and the narrative which follows summarize the key factors
in the year-to-year changes in operating results.
Three Months Ended Six Months Ended
June 30, June 30, June 30, June 30,
2002 2001 2002 2001
(Thousands of Dollars)
Electrical/Electronics (a)
Net external sales $ 35,680 $ 33,395 $ 68,524 $ 69,479
Loss from operations (387) (1,768) (801) (5,259)
Operating margin (1.1%) (5.3%) (1.2%) (7.6%)
Depreciation & amortization 766 558 1,421 1,103
Impairment of long-lived assets -- 564 -- 1,410
Total assets 72,058 88,798 72,058 88,798
Capital expenditures 387 394 511 852
Maintenance Products
Net sales 82,459 85,795 159,744 168,736
(Loss) income from operations (1,095) (38,009) 2,267 (37,507)
Operating margin (1.3%) (44.3%) 1.4% (22.2%)
Depreciation & amortization 4,747 5,424 9,523 10,856
Impairment of long-lived assets 2,394 34,547 2,394 34,547
Total assets 235,777 254,778 235,777 254,778
Capital expenditures 2,179 2,048 5,851 4,497
Other
Net sales 286 952 1,177 1,840
Loss from operations (161) (116) (6,920) (781)
Operating margin (56.3%) (12.2%) (587.9%) (42.5%)
Depreciation & amortization -- 68 -- 105
Impairment of long-lived assets -- -- -- --
Total assets 7,987 18,547 7,987 18,547
Capital expenditures -- 42 -- 495
- 10 -
Three Months Ended Six Months Ended
June 30, June 30, June 30, June 30,
2002 2001 2002 2001
---------- ---------- ---------- ----------
(Thousands of Dollars)
Corporate
Corporate expenses (2,677) (3,240) (4,894) (8,300)
Depreciation & amortization 50 103 77 216
Total assets 23,231 25,119 23,231 25,119
Capital expenditures 134 -- 134 --
Company
Net sales $ 118,425 $ 120,142 $ 229,445 $ 240,055
Loss from operations (4,320) (43,133) (10,348) (51,847)
Operating margin (3.6%) (35.9%) (4.5%) (21.6%)
Depreciation & amortization 5,563 6,153 11,021 12,280
Impairment of long-lived assets 2,394 35,111 2,394 35,957
Total assets 339,053 387,242 339,053 387,242
Capital expenditures 2,700 2,484 6,496 5,844
[a] 2001 amounts include the Thorsen Tools business, which was sold by Katy on
May 3, 2001. Amounts for Thorsen Tool were included in Electrical/Electronics in
2001.
(6) Severance, Restructuring and Other Charges
During the second quarter of 2002, the Company recorded $3.8 million of
severance, restructuring, and other charges. Approximately $1.6 million of the
charges related to accruals for payments to 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 in St. Louis, Missouri were
accrued at June 30, 2002, as well as involuntary termination benefits of $0.1
million. The Warson shutdown involves a reduction in workforce of nineteen
employees. The remaining $0.3 million was 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 to 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 were
costs associated with the consolidation of administrative and operational
functions.
During the second quarter of 2001, Contico 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 involuntary termination benefits were $1.6
million.
During the first quarter of 2001, Woods undertook a restructuring effort
that involved reductions in senior management headcount as well as facility
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 involuntary
severance benefits were $0.5 million and other exit costs were $0.3 million.
As of June 30, 2002, accruals for severance and other restructuring costs
totaled $6.2 million which will be paid through the year 2007. The table below
summarizes the future obligations for severance, restructuring and other charges
detailed above:
- 11 -
Additional Payments on
December 31, restructuring restructuring June 30,
2001 accruals liabilities 2002
--------------------------------------------------------------
2002 $ 3,209 3,225 (3,429) 3,005
2003 265 2,344 (84) 2,525
2004 55 146 -- 201
2005 55 139 -- 194
2006 22 132 (22) 132
Thereafter -- 95 -- 95
------------ -------- --------- --------
Total payments $ 3,606 $ 6,081 $ (3,535) $ 6,152
============ ======== ======== ========
- 12 -
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
Three Months Ended June 30, 2002 versus Three Months Ended June 30, 2001
Following are summaries of sales and operating income for the three months
ended June 30, 2002 and 2001 by industry segment (In thousands):
Net sales Increase (Decrease)
- --------- -------------------
2002 2001 Amount Percent
---- ---- ------ -------
Electrical/Electronics $ 35,680 $ 33,395 $ 2,285 6.84%
Maintenance Products 82,459 85,795 (3,336) (3.89)%
Other 286 952 (666) (69.96)%
Operating income Increase (Decrease)
- ---------------- -------------------
2002 2001 Amount Percent
---- ---- ------ -------
Electrical/Electronics $ (387) $ (1,768) 1,381 78.11%
Maintenance Products (1,095) (38,009) 36,914 97.12%
Other (161) (116) (45) 38.79%
The Electrical/Electronics Group's sales increased $2.3 million, or 6.8%.
If the sales of Thorsen Tools, which was sold in May 2001, are excluded from
2001, sales increased by $3.0 million, or 9%. Sales increases of 17% and 20%,
respectively, at Woods and Woods Canada were offset by significant sales
decreases of 17% and 10%, respectively, at GC/Waldom and Hamilton. The sales
increases reflect a strong year over year comparison in the retail markets
(which are served primarily by Woods and Woods Canada), which saw weak sales in
early 2001 as a result of retailer's efforts to reduce inventories. The sales
decreases reflect continued weakness in the electronics, communications, and
high-tech markets, to which both GC/Waldom and Hamilton sell. Hamilton lost a
single customer that accounted for the majority of its drop in sales.
The Electrical/Electronics Group's operating loss improved by $1.4
million, or 78%. Excluding unusual items, operating income increased from $0.4
million in the second quarter of 2001 to $0.7 million in the second quarter of
2002. The largest contributors to the higher operating income were GC/Waldom and
Woods Canada. Gross margins remained flat in the Electrical/Electronics group,
while SG&A as a percentage of sales improved from 16% to 14%, led by SG&A
improvement at Woods Canada and GC/Waldom. Operating income of the Woods U.S.
division was negatively impacted on a year over year basis as a result of the
amortization of negative goodwill, which added approximately $0.4 million to
operating income in the second quarter of 2002, but was fully amortized during
the second quarter of 2002.
The Electrical/Electronics group incurred charges during the second
quarter of 2002 of $1.1 million for consultant fees related to a company-wide
sourcing project. This sourcing project is expected to result in substantial
product cost savings, and may be the impetus for further facility and operations
restructuring projects in the future. During the second quarter of 2001,
- 13 -
the group incurred unusual charges of $2.2 million related to 1) inventory
valuation adjustments at GC/Waldom ($0.4 million) and Woods ($0.5 million), 2)
and increase to the litigation reserve at Woods ($0.6 million), 3) an impairment
of capitalized software licenses at Woods ($0.6 million), and 4) severance
charges at GC/Waldom ($0.1 million).
Sales in the Maintenance Products Group decreased $3.3 million or 3.9%.
The largest sales shortfall was in the retail plastics business of Contico, but
there were smaller sales decreases in the commercial janitorial/sanitation
business of Contico and the roofing products business of Loren. These decreases
were offset by significantly higher sales in the Glit/Microtron abrasives
business. The retail sales shortfall at Contico was the result of 1) a specific
loss of a shelving product line at a major retail customer, and 2) lower sales
on a major continuing product line at a different major retail customer. The
commercial businesses are vulnerable to reductions in the overall demand for
cleaning supplies. These businesses are vulnerable to slow-downs that have
occurred in the travel sector, which includes hotels, restaurants and airports.
Facilities in this sector were impacted significantly as a result of the events
of September 11, 2001, and we believe this has impacted demand for commercial
cleaning supplies. However, we have seen some stabilization in this market, as
sales trends have improved somewhat through the course of 2002. Sales at Wilen
(mops, brooms and brushes) were stable year over year, and as mentioned, sales
at Glit/Microtron were significantly higher year over year.
The group's operating income increased $36.9 million, or 97.1%. Excluding
any unusual or non-recurring charges (incurred in both 2002 and 2001), operating
income increased $3.9 million. Excluding the unusual and non-recurring charges,
the largest increases were experienced by 1) Glit/Microtron, which had
significantly higher sales, experienced favorable product mix, and implemented
cost reductions, 2) Wilen, which, while still performing at an unsatisfactory
level, was much improved over the same quarter in 2001 and 3) Contico, where
both the retail and commercial businesses showed higher operating income, mainly
as a result of cost reductions.
The group recorded unusual and other non-recurring charges of $5.2 million
during the second quarter of 2002. The largest of these charges related to the
shut down of Contico's Warson Road manufacturing facility in St. Louis,
Missouri. Operations from Warson Road are being transferred to the Bridgeton
facility, also in the St. Louis area. Contico recorded a liability for net
non-cancelable rentals of the Warson facility of $1.8 million, impairments of
machinery and equipment of $2.4 million, and severance of $0.1 million. Wilen
recorded consultant fees associated with a company-wide sourcing project of $0.3
million. Contico also recorded expense of $0.4 million as a result of LIFO
inventory accounting, as prices for plastic resins (a key raw material in
Contico's plastic products) climbed from first quarter levels. The remaining
$0.2 million of unusual and non-recurring costs were associated with severance
and integration costs associated with the transfer of certain administrative
functions of Glit/Microtron to St. Louis (Contico headquarters). The group
recorded unusual and other non-recurring charges during the second quarter of
2001 of $38.2 million. The largest of these charges was a $33.0 million
impairment of goodwill and other intangibles at Wilen. Other charges included
inventory valuation adjustments of $1.2 million, receivables valuation
adjustments of $0.2 million, impairments of property, plant and equipment of
$1.5 million, severance and restructuring charges of $2.0 million, and other
unusual and non-recurring charges of $0.3 million.
Sales from Other operations (SESCO) were down significantly as the
operation of SESCO was contractually turned over to a third party effective
April 29, 2002. Operating income from Other operations was not significantly
different year over year.
Excluding restructuring charges, corporate expenses were higher by
approximately $0.9 million. The primary reason for the higher expenses in the
corporate group is the accrual of company-wide bonus programs in the Corporate
group, which were not recorded in 2001. The Corporate group incurred
restructuring charges of approximately $0.3 million in the second quarter
related mainly to severance obligations related to SESCO. Costs were also
incurred related to consultant expenses for the company-wide sourcing project.
During the second quarter of 2001, the corporate group incurred unusual and
other non-recurring charges of $1.7 million, relating to valuation reserves on
aged notes receivable ($0.4 million), costs associated with the recapitalization
($0.4 million), restructuring charges related to relocating the corporate office
($0.7 million), and an accrual associated with an environmental liability ($0.2
million).
Interest decreased $1.5 million in the second quarter of 2002 compared to
the second quarter of 2001, mainly as a result of lower outstanding borrowings
due to the Recapitalization that occurred on June 28, 2001. Lower interest rates
also contributed to lower interest expense.
We did not record any income tax benefit on the pretax loss during the
second quarter of 2002. We feel that we will be able to generate taxable income
in the future in amounts that will allow us to utilize existing recorded
deferred tax assets. However, given the history of operating losses, and of the
potential for additional losses in 2002 if certain restructuring
- 14 -
initiatives being considered are implemented, we felt it was a prudent and
conservative course of action to not recognize currently the tax benefit of
operating losses which will be reanalyzed in the future. Tax expense was
recorded for expected payments associated with state and foreign income taxes.
- 15 -
Six Months Ended June 30, 2002 versus Six Months Ended June 30, 2001
Following are summaries of sales and operating income for the six months
ended June 30, 2002 and 2001 by industry segment (In thousands):
Increase(Decrease)
2002 2001 Amount Percent
----------------------------------------------------------------
Net Sales
- ---------
Electrical/Electronics $ 68,524 $ 69,479 $ (955) (1.4)%
Maintenance Products 159,744 168,736 (8,992) (5.3)%
Other 1,177 1,840 (663) (36.0)%
Operating Income (Loss)
- -----------------------
Electrical/Electronics $ (801) $ (5,259) $ 4,458 84.8%
Maintenance Products 2,267 (37,507) 39,774 106.0%
Other (6,920) (781) (6,139) (786.0)%
The Electrical/Electronics Group's sales decreased by $1.0 million, or
1.4%. Excluding the sales of Thorsen Tools, which was sold in May 2001, sales
increased by $2.1 million, or 3%. There were significant sales increases at both
Woods Industries (U.S.) and Woods Canada, whose sales of electronic corded
products to mass merchant retailers have improved significantly over the same
period of 2001. These increases were offset by sales declines at GC/Waldom and
Hamilton Precision Metals. GC/Waldom's sales have suffered as a result of the
slowdown in the high-tech and telecommunications market segments. Hamilton lost
a major customer, which accounts for most of the sales shortfall from the same
period in 2001.
The Group's operating income improved by $4.5 million, or 84.8%. Excluding
any unusual or non-recurring items from both 2002 and 2001, operating income
decreased by $0.3 million, or 16%. Increases in operating income at Woods and
Woods Canada were offset by lower operating income at Hamilton. The Woods
improvement is notable as it does not include income associated with the
amortization of negative goodwill, which provided a positive boost to operating
income in 2001 of $0.9 million, but was fully amortized in 2002. Margins were
roughly equal to 2001 levels. SG&A as a percentage of sales was lower at Woods
Canada but higher at Hamilton (mainly a result of sales volume). The group
incurred unusual and non-recurring charges during the first six months of 2002
of $2.4 million, relating to consulting fees associated with a company-wide
sourcing project. During the first six months of 2001, the group incurred
unusual and non-recurring charges of $0.7 million, consisting of 1) inventory
valuation adjustments of $4.4 million (mainly branded products at Woods
Industries), 2) impairments of the carrying values of unused computer system
licenses and prepaid software maintenance of $0.7 million, 3) an increase to the
Woods litigation reserve of $0.5 million, 4) severance and restructuring costs
at Woods and GC/Waldom of $0.8 million, and 5) an impairment of goodwill of $0.8
million at the Thorsen Tools business, which was sold in May 2001.
Sales from the Maintenance Products Group decreased $9.0 million, or 5.3%.
The largest decrease was in the retail business of Contico, which was down $6.9
million. The retail sales shortfall at Contico was the result of 1) a specific
loss of a shelving product line at a major retail customer and 2) lower sales on
a major continuing product line at a different major retail customer. Sales were
also lower at Wilen ($2.0 million), mainly as a result of lower year over year
sales in the first quarter, and Glit/Disco ($0.8 million). These sales
reductions were offset by higher sales at Glit/Microtron ($1.8 million) and
Duckback ($0.8 million).
The Group's operating income increased by $39.8 million, or 106.0%, mainly
due to significant unusual and non-recurring charges in the six months ended
June 30, 2001, although charges of this nature existed in the six months ended
June 30, 2002, as well. Excluding these unusual items, operating income
increased by $5.2 million, or 245%. The lack of goodwill amortization in 2002 as
a result of the adoption of the non-amortization provisions of SFAS No. 142
Goodwill and Other
- 16 -
Intangible Assets contributed $0.9 million to the increase. Also, the write-off
of a significant level of intangible assets at Wilen has reduced intangible
amortization, having a positive impact on operating income of $0.8 million.
Excluding the impact of amortization on goodwill and intangibles from the
analysis, operating income increased by $3.5 million, or 70%. The largest
increase was at Glit/Microtron ($2.0 million), driven by higher sales, higher
gross margin percentages, and lower SG&A as a percentage of sales. Increases in
operating income were also realized at Loren ($0.4 million - higher gross
margins), Duckback ($0.4 million - higher sales, gross margin), and Wilen ($0.4
million - lower SG&A). Smaller increases were noted at Gemtex and Contico. The
group recorded unusual and non-recurring charges of $5.0 million during the
first six months of 2002. The largest of these charges were related to the shut
down of Contico's Warson Road manufacturing facility in St. Louis, Missouri.
Operations from Warson Road are being transferred to the Bridgeton facility,
also in the St. Louis area. Contico recorded a liability for net non-cancelable
rentals of the Warson facility of $1.8 million, impairments of machinery and
equipment of $2.4 million, and severance of $0.1 million. Wilen recorded
consultant fees associated with a company-wide sourcing project of $0.6 million.
Severance charges related to headcount reductions in both divisional executive
and operating ranks were $0.5 million. Contico also recorded income of $0.6
million as a result of LIFO inventory accounting, as prices for plastic resins
(a key raw material in Contico's plastic products) were low very early in 2002.
Other unusual charges of $0.2 million related to integration costs associated
with relocating certain administrative functions of Glit/Microtron and Wilen to
the Contico offices in St. Louis. The group recorded unusual and other
non-recurring charges during the first six months of 2001 of $39.6 million. The
largest of these charges was a $33.0 million impairment of goodwill and other
intangibles at Wilen. Other charges included inventory valuation adjustments of
$2.5 million, receivables valuation adjustments of $0.2 million, impairments of
property, plant and equipment of $1.5 million, severance and restructuring
charges of $2.1 million, and other unusual and non-recurring charges of $0.3
million.
Equity in Income of Unconsolidated Investments was lower as a result of
amounts recorded to reflect the transfer of the operation of SESCO to a third
party effective April 29, 2002.
The corporate group's expenses decreased from $8.3 million in the first
six months of 2001 to $4.9 in the same period of this year. During the first six
months of 2001, the corporate group incurred unusual and non-recurring charges
of $4.3 million, consisting of costs associated with the recapitalization ($3.0
million), severance and restructuring ($1.2 million), and other environmental
costs ($0.2 million). During the first six months of 2002, the corporate group
incurred $0.2 million of unusual charges, associated mainly with travel and
entertainment expenses associated with a consultant working on a company-wide
sourcing project. Excluding these unusual or non-recurring charges, corporate
expenses increased by approximately $0.7 million, due mainly to accruals for
company-wide bonus programs in the Corporate group, which were not recorded in
2001.
Interest decreased $3.3 million in the first six months of 2002 compared
to the same period of 2001, mainly as a result of lower outstanding borrowings
due to the Recapitalization which occurred on June 28, 2001. Lower interest
rates also contributed to lower interest expense.
LIQUIDITY AND CAPITAL RESOURCES
Combined cash and cash equivalents decreased to $5.1 million on June 30,
2002 compared to $8.1 million on December 31, 2001. Working capital excluding
current classifications of debt decreased to $68.0 million at June 30, 2002 from
$74.0 million on December 31, 2001 primarily as a result of higher accrued
expenses.
At June 30, 2002, Katy had total indebtedness of $76.1 million. Total debt
was 32% of total capitalization at June 30, 2002. Total borrowings decreased by
$7.9 million during the first six months of 2002.
In connection with the revolving credit facility, the Credit Agreement
requires lockbox arrangements, which provide for all receipts to be swept daily
to reduce borrowings outstanding. These arrangements, combined with the
existence of a material adverse effect (MAE) clause in the Credit Agreement,
cause the revolving credit facility to be classified as a current liability, per
guidance in the FASB's Emerging Issues Task Force 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, we do not expect to repay, or be required to repay, within one year,
the $58.5 million balance of the revolving credit facility classified as a
current liability. The MAE clause, which is a 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
- 17 -
current liability is a result only of the combination of the two aforementioned
factors: the lockbox agreements and the MAE clause. However, the revolving
credit facility does not expire or have a maturity date within one year, but
rather has a final expiration date of June 28, 2006. Also, we were in compliance
with the applicable financial covenants at June 30, 2002, the lender has not
notified us of any indication of a MAE at June 30, 2002, and to our knowledge,
we were not in default of any provision of the Credit Agreement at June 30,
2002.
The Credit Agreement calls for scheduled repayments of term loans of $6.0
million during 2002. However, the Credit Agreement also has a provision
requiring us to repay term loans by a percentage of excess cash flow
("Consolidated Excess Cash Flow" as calculated under the Credit Agreement)
generated during each annual reporting period. As a result of this provision,
and the calculation per the Credit Agreement of Consolidated Excess Cash Flow
generated during fiscal 2001, we repaid term loans in the approximate amount of
$7.9 million on April 4, 2002. Much of the Consolidated Excess Cash Flow was
generated by improved working capital during 2001. This repayment required us to
convert term loans to revolving loans. The most recently available calculations
of our borrowing base (eligible accounts receivable and inventory) performed as
of July 26, 2002, indicated that we had unused borrowing availability of $16.4
million.
We expect to commit $12.0 to $15.0 million for capital projects over the
course of 2002, up to $3.0 million of which relates to projects begun in 2001.
Funding for these expenditures and for working capital needs is expected to be
accomplished through the use of available cash under the Credit Agreement. While
a maximum of $140.0 million is available under the Credit Agreement, our
borrowing base is limited under the revolving credit facility to eligible
accounts receivable and inventory. We feel that the Credit Agreement provides
sufficient liquidity for our operations going forward. As indicated above, our
borrowing availability at July 26, 2002, based on eligible accounts receivable
and inventory, exceeded our outstanding borrowings at year end by approximately
$16.4 million.
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.
Off-Balance Sheet Arrangements
An indirect wholly-owned subsidiary of Katy, Savannah Energy Systems
Company ("SESCO"), has historically operated a waste-to-energy facility in
Savannah, Georgia. On April 29, 2002, SESCO entered into a joint venture
transaction with Montenay Power Corporation and its affiliates for the operation
of the facility. Pursuant to the joint venture agreement, SESCO contributed its
facility to the joint venture. The joint venture now processes waste for the
Resource Recovery Development Authority for the City of Savannah (the
"Authority").
In 1984, the Authority issued $55.0 million of Industrial Revenue Bonds
and lent the proceeds to SESCO, under a loan agreement for the acquisition and
construction of the facility that has now been transferred to the joint venture.
The funds required to repay the loan agreement come from the monthly disposal
fee, a component of which is for debt service, paid by the Authority under a
Service Agreement between the Authority and SESCO. To induce the required
parties to consent to the SESCO joint venture 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 under the service agreement.
Based on consultations with 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, 2002, this amount was $40.3 million. Accordingly, the
amounts owed to and due from SESCO have been netted for financial reporting
purposes and are not shown on the consolidated statements of financial position.
In addition to SESCO retaining its liabilities under the Loan Agreement,
to induce the required parties to consent to the joint venture transaction, Katy
also continues to guarantee the obligations of the joint venture under the
Service Agreement. The joint venture 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 ($43.0 million), 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 joint venture.
SEVERANCE, RESTRUCTURING AND OTHER UNUSUAL CHARGES
During the second quarter of 2002, the Company recorded $3.8 million of
severance, restructuring, and other charges. Approximately $1.6 million of the
charges related to accruals for payments to 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 in St. Louis, Missouri were
accrued at June 30, 2002, as well as involuntary termination benefits of $0.1
million. The Warson shutdown involves a reduction in workforce of nineteen
employees. The remaining $0.3 million was 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 2002, the Company recorded $2.3 million of
severance and restructuring charges. Approximately $1.9 million of the charges
related to accruals for payments to 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 were
costs associated with the consolidation of administrative and operational
functions.
During the second quarter of 2001, Contico 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 involuntary termination benefits were $1.6
million.
During the first quarter of 2001, Woods undertook a restructuring effort
that involved reductions in senior management headcount as well as facility
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 involuntary
severance benefits were $0.5 million and other exit costs were $0.3 million.
- 18 -
As of June 30, 2002, accruals for severance and other restructuring costs
totaled $6.2 million which will be paid through the year 2007. The table below
summarizes the future obligations for severance, restructuring and other charges
detailed above:
Additional Payments on
December 31, restructuring restructuring June 30,
2001 accruals liabilities 2002
-----------------------------------------------------------------
2002 $ 3,209 3,225 (3,429) 3,005
2003 265 2,344 (84) 2,525
2004 55 146 -- 201
2005 55 139 -- 194
2006 22 132 (22) 132
Thereafter -- 95 -- 95
---------- ----- ------ ----------
Total payments $ 3,606 6,081 (3,535) $ 6,152
========== ===== ====== ==========
OUTLOOK FOR 2002
We anticipate a continuation of the difficult economic conditions and
Qbusiness environment in 2002, 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. However, we began
to see some improvement in this channel during the second quarter of 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.
Gross margins are expected to improve during 2002 as we realize the
benefits of various profit-enhancing strategies begun in 2001. These strategies
include sourcing previously manufactured products, as well as locating new
sources for products already sourced outside the Company. 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. We are also exposed to price changes for copper
(used by Woods and Woods Canada), corrugated packaging material and other raw
materials. We have not employed any hedging techniques in the past, but are
evaluating alternatives in the area of commodity price risk. We anticipate
mitigating these risks in part by creating efficiencies in and improvements to
our production processes.
Selling, general and administrative costs are expected to improve as a
percentage of sales from 2001 levels. Cost reduction efforts are ongoing
throughout the Company. Our corporate office has relocated, and we expect to
maintain modest headcount and rental costs. We have completed the process of
transferring most back-office functions of our Wilen subsidiary from Atlanta to
St. Louis, the headquarters of Contico. We are in the process of transferring
most back office functions of the Glit subsidiary in Wrens, Georgia to St.
Louis. We will evaluate the possibility of further consolidation of
administrative processes at our subsidiaries.
It should be noted that we may incur further unusual charges during 2002
for potential restructuring efforts related to decisions on manufacturing and
distribution facilities, as well as administrative operations. Options being
considered for various business units include shutting down manufacturing in
favor of sourcing products, and consolidating manufacturing and distribution
facilities while abandoning certain facilities. If we choose to implement
strategies such as this, we could incur substantial charges related to
liabilities for non-cancelable rents at abandoned facilities, severance,
impairments of machinery and equipment, and other plant closure costs. Certain
projects being considered may involve significant amounts of capital
expenditures as well. Charges for these items, especially for non-cancelable
rentals, could reach in total into the tens of millions of dollars.
We are also pursuing a strategy of developing the Katy Maintenance Group
(KMG). This process involves bundling certain products of the
janitorial/sanitation businesses of Contico, Wilen, Glit/Microtron and
Glit/Disco for customers in the janitorial/sanitation markets. The new
organization would allow customers to order certain products from all of the
companies
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using a single purchase order, and billing and collection would be consolidated
as well. In addition to administrative efficiencies, we believe that combining
sales and marketing efforts of these entities will allow us a unique marketing
opportunity to have improved delivery of both product and customer service. We
do not expect significant financial benefits from this project in 2002, but
believe it could significantly contribute to improving profitability over the
long-term.
Interest expense is expected to be significantly lower during 2002 as
opposed to 2001, given a full year of lower debt levels as a result of the
recapitalization. Also, we have benefited from lower prevailing rates of
interest in recent months as a result of variable rate borrowing facilities. We
cannot predict the future levels of these interest rates.
We do not expect to record income tax benefits from operating losses in
2002, given the history of operating losses and considering the amounts of
deferred tax assets already on our books. However, we expect to generate future
taxable income in amounts adequate to recover the carrying value of deferred tax
assets that have been recorded.
We are continually evaluating the possibility of divesting certain
businesses. This strategy would allow us to de-leverage our current financial
position and allow available cash, as well as management focus, to be directed
at core business activities.
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
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.
- Our inability to reduce administrative costs through consolidation
of functions and systems improvements.
- 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
Eurodollar-based New Credit Agreement.
- Our 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. 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
its financial condition.
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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.
- 21 -
ENVIRONMENTAL AND OTHER CONTINGENCIES
As set forth more fully in the Company's 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, 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 at 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 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 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.
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 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 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. The extent or
limit of any such adjustment cannot be predicted at this time.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
Under SFAS No. 142, Goodwill and Other Intangible Assets, goodwill is no
longer 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, Disclosures about
Segments of an Enterprise and Related Information, 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 fair value and tested for impairment at least annually. All
other recognized intangible assets will continue to be
- 22 -
amortized over their estimated useful lives or when indications of impairment
arise.
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. The Company has adopted the non-amortization provisions
of SFAS No. 142 with regards to goodwill that has been reported on the balance
sheets historically. The amount of goodwill amortization not recorded during the
six months ended June 30, 2002 as a result of the adoption of the
non-amortization provisions was $0.9 million, before tax. Negative goodwill,
which was created with the acquisition of Woods Industries in December 1996 and
was amortized over five years, was fully amortized by December 31, 2001;
therefore, the adoption of the non-amortization provisions of SFAS No. 142 had
no impact on negative goodwill. The Company is continuing to amortize assets
historically presented as intangible assets until the evaluation of all
intangibles is completed with regard to their continued presentation as
intangibles or their potential reclassification to goodwill.
The Company has completed the first phase in the determination of a
potential transitional goodwill impairment. Valuations of six Katy reporting
units carrying goodwill have been completed, and the analyses indicate that the
fair value is less than the carrying value for three of the six reporting units.
The second phase in the determination of transitional goodwill impairment has
begun, and is expected to be completed by September 30, 2002. Upon the
completion of the second phase of the analysis, the Company expects to recognize
a transitional goodwill impairment of up to $11.5 million, which is the carrying
value of the goodwill on the books of the three reporting units referenced
above. If transitional goodwill impairment is recognized, the Company will
record it as a cumulative effect adjustment. The Company has tested long-lived
assets for impairment, including intangible assets at various points in the
past, including at year end 2001. The Company still carries $31.7 million of
finite lived intangible assets on the books, many of which represent customer
lists and relationships and similar intangibles. Tests for impairment of
intangible assets will continue to be performed as necessary, and impairments of
these assets are possible in 2002.
In August 2001, the FASB released SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. Previously, two accounting models
existed for long-lived assets to be disposed of, as SFAS No. 121 did not address
the accounting for a segment of a business accounted for as a discontinued
operation under APB Opinion 30. This statement establishes a single model based
on the framework of SFAS No. 121. This statement also broadens the presentation
of discontinued operations to include more disposal transactions.
The Company has adopted SFAS No. 144 and has determined that for the six
months ended June 30, 2002, there are no operations that should be reported as
discontinued under the new standard. However, the Company anticipates that this
statement could have an impact on its financial reporting as 1) the Company is
considering certain divestitures of 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 the Company were to divest of certain businesses that are under
consideration, Katy anticipates they would qualify as discontinued operations
under SFAS No. 144, whereas they would have not met the requirements of
discontinued operations treatment under APB Opinion 30.
During 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, although earlier
application is encouraged. Katy is considering a number of restructuring and
exit activities at the current time, including plant closings and consolidation
of facilities. To the extent these activities are initiated after December 31,
2002, this statement could have a significant impact on the timing of the
recognition of these costs in the Company's 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 such restructuring and exit plans. It should
be noted that Katy is considering early adoption of this standard; if that
course is decided upon, then the statement could have a significant impact on
timing of the recognition of costs associated with exit or disposal activities
initiated prior to December 31, 2002.
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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.
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PART II - OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
Except for the item discussed below, 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 2. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of Stockholders of Katy Industries, Inc. was held at The
Hotel Inter-Continental Central Park South, 112 Central Park South, New York,
NY, at 10:00 AM on May 30, 2002. Stockholders voted on three proposals,
summarized below with the accompanying number of votes in favor, opposed, or
abstained.
PROPOSAL No. 1: Election of Directors
CLASS I DIRECTORS:
Name Votes For Votes Withheld
- ---- --------- --------------
C. Michael Jacobi 5,419,877 2,567,748
Robert M. Baratta 5,364,019 2,623,606
Daniel B. Carroll 5,359,519 2,628,106
Wallace E. Carroll, Jr. 5,359,419 2,628,206
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 four
nominees for Class I directors was elected.
PROPOSAL No. 2: To amend Katy's Restated Certificate of Incorporation to change
the treatment of the previously authorized convertible preferred stock in the
event of a liquidation of Katy.
Votes For Votes Against Votes Abstained
- --------- ------------- ---------------
4,565,768 2,112,341 411,054
The required vote for an amendment to Katy's Restated Certificate of
Incorporation was the affirmative vote of a majority of Katy's outstanding
common stock. As a result of the vote, the amendment passed.
PROPOSAL No. 3: To approve the 2002 Stock Incentive Plan.
Votes For Votes Against Votes Abstained
- --------- ------------- ---------------
3,829,911 3,002,487 256,765
The required vote for the approval of the 2002 Stock Incentive Plan 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 7,987,625 shares of common stock, a majority of which was 3,998,813
shares. As a result of the vote, the 2002 Stock Incentive Plan was not approved.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibit
10.22 Third Amendment Credit Agreement dated April 29, 2002, filed
herewith.
(b) Reports on Form 8-K
None.
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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 13, 2002 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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