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: September 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 November 8, 2002
Common Stock, $1 Par Value 8,362,427
KATY INDUSTRIES, INC.
FORM 10-Q
September 30, 2002
INDEX
Page
----
PART I FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets
September 30, 2002 and December 31, 2001 (unaudited) 2,3
Condensed Consolidated Statements of Operations
Three and Nine Months Ended September 30, 2002 and 2001 (unaudited) 4
Condensed Consolidated Statements of Cash Flows
Nine Months Ended September 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 17
Item 3. Quantitative and Qualitative Disclosures about Market Risk 27
Item 4. Controls and Procedures 27
PART II OTHER INFORMATION
Item 1. Legal Proceedings 29
Item 5. Other Information 29
Item 6. Exhibits and Reports on Form 8-K 29
Signatures 30
Certifications 31,32
- 1 -
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
KATY INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Thousands of Dollars)
(Unaudited)
ASSETS
September 30, December 31,
2002 2001
--------- ---------
CURRENT ASSETS:
Cash and cash equivalents $ 4,836 $ 7,858
Trade accounts receivable, net 91,537 71,164
Inventories 71,470 63,331
Deferred income taxes 8,160 8,243
Other current assets 3,173 2,787
Current assets of discontinued operations 4,476 4,553
--------- ---------
Total current assets 183,652 157,936
--------- ---------
OTHER ASSETS:
Goodwill 11,211 15,125
Intangibles 27,879 32,630
Deferred income taxes -- 2,278
Equity method investment in unconsolidated affiliate 7,617 7,011
Other 11,080 12,825
Non-current assets of discontinued operations 4,976 5,351
--------- ---------
Total other assets 62,763 75,220
--------- ---------
PROPERTIES:
Land and improvements 3,568 3,478
Buildings and improvements 20,551 20,838
Machinery and equipment 150,111 157,306
--------- ---------
174,230 181,622
Accumulated depreciation (75,765) (66,823)
--------- ---------
Net properties 98,465 114,799
--------- ---------
Total assets $ 344,880 $ 347,955
========= =========
See Notes to Condensed Consolidated Financial Statements.
- 2 -
KATY INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Thousands of Dollars, Except Share Data)
(Unaudited)
LIABILITIES AND STOCKHOLDERS' EQUITY
September 30, December 31,
2002 2001
--------- ---------
CURRENT LIABILITIES:
Accounts payable $ 52,410 $ 38,688
Accrued compensation 6,682 6,820
Accrued expenses 50,823 37,002
Current liabilities of discontinued operations 1,621 1,450
Current maturities of indebtedness 6,733 14,619
Revolving credit agreement 60,565 57,000
--------- ---------
Total current liabilities 178,834 155,579
--------- ---------
Long-term debt, less current maturities 9,316 12,474
Non-current liabilities of discontinued operations 714 705
Other liabilities 15,306 4,933
--------- ---------
Total liabilities 204,170 173,691
--------- ---------
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 77,412 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 (3,203) (4,625)
Unearned compensation (22) (106)
Retained earnings 2,215 44,976
Treasury stock, at cost, 1,459,777
and 1,430,621 shares, respectively (20,228) (20,077)
--------- ---------
Total stockholders' equity 124,310 157,864
--------- ---------
Total liabilities and stockholders' equity $ 344,880 $ 347,955
========= =========
See Notes to Condensed Consolidated Financial Statements.
- 3 -
KATY INDUSTRIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001
(Thousands of Dollars, Except Share and Per Share Data)
(Unaudited)
Three Months Nine Months
Ended September 30, Ended September 30,
----------------------- -----------------------
2002 2001 2002 2001
--------- --------- --------- ---------
Net sales $ 143,602 $ 135,801 $ 364,786 $ 365,284
Cost of goods sold 119,284 117,051 302,989 317,626
--------- --------- --------- ---------
Gross profit 24,318 18,750 61,797 47,658
Selling, general and administrative 17,983 18,962 52,650 61,724
Impairment of long-lived assets 10,986 187 13,380 36,144
Severance, restructuring and other charges 9,486 6,519 15,567 10,555
SESCO joint venture transaction -- -- 6,010 --
--------- --------- --------- ---------
Operating loss (14,137) (6,918) (25,810) (60,765)
Equity in income (loss) of unconsolidated investment (40) 303 606 462
Interest and other, net (1,758) (2,310) (4,661) (8,545)
Other, net (107) -- (326) (472)
--------- --------- --------- ---------
Loss before provision for income taxes (16,042) (8,925) (30,191) (69,320)
Income tax (provision) benefit (430) 3,124 (1,102) 24,262
--------- --------- --------- ---------
Loss before distributions on preferred interest in subsidiary (16,472) (5,801) (31,293) (45,058)
Distributions on preferred interest in subsidiary, net of tax (328) (214) (984) (1,069)
--------- --------- --------- ---------
Loss from continuing operations (16,800) (6,015) (32,277) (46,127)
Discontinued operations:
Income from discontinued operations, net of tax 241 450 1,558 1,756
--------- --------- --------- ---------
Loss before extraordinary item and cumulative effect of a
change in accounting principle (16,559) (5,565) (30,719) (44,371)
Extraordinary loss on early extinguishment of debt, net of tax -- -- -- (1,182)
Cumulative effect of a change in accounting principle (4,190) -- (4,190) --
--------- --------- --------- ---------
Net loss (20,749) (5,565) (34,909) (45,553)
Gain on early redemption of preferred interest in subsidiary -- -- -- 6,600
Payment in kind dividends on convertible preferred stock (2,615) (1,755) (7,852) (1,755)
--------- --------- --------- ---------
Net loss available to common shareholders ($23,364) ($7,320) ($42,761) ($40,708)
========= ========= ========= =========
Loss per share of common stock - Basic and Diluted:
Loss from continuing operations $ (2.32) $ (0.92) $ (4.79) $ (4.92)
Discontinued operations 0.03 0.05 0.18 0.21
Extraordinary loss on early extinguishment of debt -- -- -- (.14)
Cumulative effect of a change in accounting principle (0.50) -- (0.50) --
--------- --------- --------- ---------
Net loss (2.79) (0.87) (5.11) (4.85)
Goodwill, net of tax -- 0.04 -- 0.11
Negative goodwill -- (0.05) -- (.15)
--------- --------- --------- ---------
Net loss adjusted for goodwill amortization $ (2.79) $ (0.88) $ (5.11) $ (4.89)
========= ========= ========= =========
Average shares outstanding (Basic & Diluted) 8,362 8,393 8,372 8,394
========= ========= ========= =========
See Notes to Condensed Consolidated Financial Statements.
- 4 -
KATY INDUSTRIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001
(Thousands of Dollars)
(Unaudited)
2002 2001
-------- ---------
Cash flows from operating activities:
Net loss $(34,909) $ (45,553)
Depreciation and amortization 15,969 16,989
Impairment of long-lived assets 13,380 36,144
SESCO joint venture transaction 6,010 --
Income from discontinued operations (1,558) (1,756)
Cumulative effect of a change in accounting principle 4,190 --
Other, net 9,062 (3,473)
-------- ---------
Net cash flows provided by operating activities 12,144 2,351
Cash flows from investing activities:
Capital expenditures (7,924) (7,562)
Proceeds from the sale of assets 114 98
Collections of notes receivable 722 113
Proceeds from the sale of subsidiaries -- 1,576
-------- ---------
Net cash flows used in investing activities (7,088) (5,775)
-------- ---------
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 (10,994) --
Net borrowings on New Credit Agreement
following Recapitalization - revolving loans 3,565 (6,066)
Fees and costs associated with New Credit Agreement (547) (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)
Repayments of mortgage debt (50) --
Payment of dividends -- (630)
Other -- 83
-------- ---------
Net cash flows (used in) provided by financing activities (8,026) 2,786
-------- ---------
Effect of exchange rate changes on cash and cash equivalents (52) 3
-------- ---------
Net decrease in cash and cash equivalents (3,022) (635)
Cash and cash equivalents, beginning of period 7,858 2,344
-------- ---------
Cash and cash equivalents, end of period $ 4,836 $ 1,709
======== =========
See Notes to Condensed Consolidated Financial Statements.
- 5 -
KATY INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 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 September 30, 2002
and December 31, 2001 and for the three-and nine-month periods ended September
30, 2002 and September 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 our 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 as follows:
September 30, December 31,
2002 2001
------- -------
(Thousands of Dollars)
Raw materials $29,039 $29,697
Work in process 1,631 2,016
Finished goods 40,800 31,618
------- -------
$71,470 $63,331
At September 30, 2002 and December 31, 2001, approximately 40% of our
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 $1.3 million at September 30, 2002 and by $1.5 million at
December 31, 2001.
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
nine months ended September 30, 2002 as a result of the adoption of the
non-amortization provisions was $1.4 million, before tax. Negative goodwill,
which was created with the acquisition of Woods
- 6 -
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.
See Note 2 for further discussion of the final transition to SFAS No. 142.
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. See Notes 3
and 4 to the Condensed Consolidated Financial Statements for further discussion
of impairments and discontinued operations.
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. We are 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 our statements of operations, tending to spread
the costs out as opposed to recognition of a large portion of the costs at the
time we commit to such restructuring and exit plans. Katy has decided that it
will not adopt the provisions of SFAS No. 146 prior to the required date.
(2) Goodwill and Intangible Assets
During the third quarter of 2002, Katy completed the transition to SFAS
No. 142 with regard to accounting and reporting of goodwill and other intangible
assets.
The first phase in the determination of a potential transitional goodwill
impairment was completed in the second quarter of 2002. Valuations of the six
Katy reporting units carrying goodwill were completed, and the analyses
indicated that the fair values were less than the carrying values for three of
the six reporting units. The second phase in the determination of transitional
goodwill impairment was completed by September 30, 2002. Appraisals were
obtained on the relevant reporting units' property, plant and equipment and
intangible assets. The fair value balance sheets as of December 31, 2001 which
resulted from this work indicated that transitional goodwill impairment charges
of $4.2 million were required at the Loren Products and GC/Waldom Electronics
reporting units. The goodwill of the Contico business unit, which was also
evaluated in the second phase of the project, was determined to have an
appropriate carrying value as of December 31, 2001. The transitional goodwill
impairment of $4.2 million is shown in the Condensed Consolidated Statements of
Operations as a cumulative effect of a change in accounting principle, in
accordance with SFAS No. 142. Loren Products is part of the Maintenance Products
group and GC/Waldom Electronics is part of the Electrical/Electronics group.
As part of the project to implement SFAS No. 142, certain changes to the
carrying value of goodwill at the Loren Products and Disco reporting units were
made, relating to 1) reclassification of formerly recognized work force
intangibles to goodwill, and 2) reclassification of formerly recognized goodwill
to a non-compete intangible. Below is a summary of activity in the goodwill
accounts during the nine-month period ending September 30, 2002 (in thousands):
Maintenance Electrical/
Products Electronics Total
-------- ----------- -----
Goodwill, net, at December 31, 2001 $ 13,571 $ 1,554 $ 15,125
Net changes to carrying value 276 -- 276
-------- ------- --------
Adjusted carrying value 13,847 1,554 15,401
Transitional impairment charge (2,636) (1,554) (4,190)
-------- ------- --------
Goodwill, net, at September 30, 2002 $ 11,211 -- $ 11,211
- 7 -
The Company adopted the non-amortization provisions of SFAS No. 142 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):
- 8 -
Three months ended Nine months ended
September 30, September 30,
2002 2001 2002 2001
-------- ------- -------- --------
(Thousands of dollars) (Thousands of dollars)
Reported net loss from continuing operations $(16,800) $(6,015) $(32,277) $(46,127)
Add back: Goodwill amortization -- 311 -- 933
Deduct: Negative goodwill amortization -- (426) -- (1,278)
-------- ------- -------- --------
Adjusted net loss from continuing operations (16,800) (6,130) (32,277) (46,472)
Discontinued operations 241 450 1,558 1,756
Extraordinary loss on early extinguishment of debt -- -- -- (1,182)
Cumulative effect of a change in accounting principle (4,190) -- (4,190) --
-------- ------- -------- --------
Adjusted net loss (20,749) (5,680) (34,909) (45,898)
Gain on early redemption of preferred interest in subsidiary -- -- -- 6,600
Paid-in-kind dividends (2,615) (1,755) (7,852) (1,755)
-------- ------- -------- --------
Adjusted net loss available to common shareholders $(23,364) $(7,435) $(42,761) $(41,053)
======== ======= ======== ========
During the third quarter, Katy reviewed its intangible assets for
impairment purposes, and determined in accordance with SFAS No. 144 that the
carrying value of a trade name intangible at the Contico business unit would not
be recovered by projected future undiscounted cash flows. As a result, an
impairment charge of $2.6 million was recorded in the third quarter of 2002 to
reduce the carrying value of the intangible to its fair value of $1.5 million.
Fair value was determined on a discounted cash flow basis, assuming a
theoretical cash flow stream of royalty payments based on the projected revenues
of products associated with the trade name. This charge is recorded in the line
entitled "Impairments of Long-Lived Assets" in the Condensed Consolidated
Statements of Operations. Contico is part of the Maintenance Products group.
Following is detailed information regarding Katy's intangible assets (in
thousands)
September 30, December 31,
2002 2001
-------- --------
Trade names $ 6,168 $ 9,668
Customer lists 25,035 25,035
Patents 4,232 4,232
Non-compete agreements 1,000 --
Work force -- 1,480
Other 36 27
-------- --------
Sub-total 36,471 40,442
Accumulated amortization (8,592) (7,812)
-------- --------
Intangible assets, net $ 27,879 $ 32,630
Katy recorded the following amounts of amortization expense on intangible
assets: $0.9 million and $0.4 million in the three-month periods ending
September 30, 2002 and 2001, respectively, and $1.9 million and $3.2 million for
the nine-month periods ending September 30, 2002 and 2001, respectively.
Estimated aggregate amortization expense related to intangible assets is
(in thousands):
2003 $2,103
2004 1,780
2005 1,780
2006 1,780
2007 1,780
(3) Impairments of Property, Plant and Equipment
During the third quarter, certain manufacturing equipment assets at the
Contico business unit were impaired, resulting in a
- 9 -
charge of $7.2 million. These impairments were the result of management's
analysis of the projected undiscounted future cash flows associated with the
assets, and the related conclusion that the carrying values of the assets would
not be recovered by future cash flows. The impaired assets consisted of $7.0
million (net book value) of molds and tooling equipment, which are used to shape
specific products in the plastic injection molding process. Most of the assets
supported the consumer/retail portion of Contico's business, and were impaired
as a result of non-performing or under-performing retail products.
The remaining portion of the $7.2 million impairment was a $0.2 million
charge related specifically to assets that will be abandoned as part of a
facility consolidation project (see note 9). The Contico business unit also
recorded an impairment charge of $2.4 million in the second quarter of 2002 as a
result of abandoning certain assets as part of a facility consolidation project.
Also during the third quarter, the Wilen business unit recorded an
impairment charge of $1.2 million related to certain of its property, plant and
equipment, as a result of the decision to reduce costs by sourcing product from
outside vendors. The Company is continuing its evaluation of its various
operating units and therefore additional impairments of long-lived assets may be
recorded in the fourth quarter.
(4) Discontinued Operations
The net assets and results of operations of the Hamilton Precision Metals
business ("Hamilton") have been classified as a discontinued operation effective
September 30, 2002, in accordance with SFAS No. 144. Several attempts to divest
this business have been made since 1998, but the Company was unable to complete
a transaction. An agreement for the sale of Hamilton was signed on October 4,
2002. The transaction closed on October 31, 2002, with Katy collecting gross
proceeds of $14 million. These proceeds were used primarily to pay off the
remaining balance of the Company's term debt. The Company may receive additional
payments in the future dependent upon the occurrence of certain events
associated with Hamilton's financial performance. A gain on the sale of Hamilton
will be recognized in the fourth quarter of 2002; therefore, no impairment was
required of the long-lived assets of Hamilton. Katy does not expect to incur
current federal income taxes related to the gain as a result of existing net
operating loss tax assets that will be utilized. The Hamilton business had been
presented by Katy as part of the Electrical/Electronics group for segment
reporting purposes.
The historical operating results have been segregated as "Discontinued
operations" on the Condensed Consolidated Statements of Operations and the
related assets and liabilities have been separately identified on the Condensed
Consolidated Balance Sheets. Following is a summary of the major asset and
liability categories for the discontinued operations:
September 30, December 31,
2002 2001
------ ------
Current assets
Trade accounts receivable, net $1,173 $1,646
Inventories 3,123 2,610
Other 180 297
------ ------
4,476 4,553
Non-current assets
Net properties $4,976 $5,351
Current liabilities
Accounts payable $ 835 $ 493
Other 786 957
------ ------
1,621 1,450
Non-current liabilities
Post-retirement benefit obligations $ 714 $ 705
- 10 -
Selected financial data for the discontinued operation is summarized as
follows (in thousands):
Three months ended September 30, Nine months ended September 30,
2002 2001 2002 2001
------ ------ ------ -------
Net sales $2,805 $3,717 $9,519 $12,547
Pre-tax profit $ 241 $ 692 $1,558 $ 2,702
Katy anticipates that the implementation of SFAS No. 144 could have a
future impact on its financial reporting as 1) Katy is considering divestitures
of certain businesses and exiting of certain facilities and operational
activities, 2) the statement broadens the presentation of discontinued
operations, and 3) the Company anticipates that impairments of long-lived assets
may be necessitated as a result of the above contemplated actions. If certain
divestitures occur, they may qualify as discontinued operations under SFAS No.
144, whereas they would have not met the requirements of discontinued operations
treatment under APB Opinion 30. However, the Company does not feel that it is
probable that these divestitures will occur within one year, and concedes that
significant changes to plans or intentions may occur. Therefore, these
operations have not been classified as discontinued operations.
(5) SESCO Joint Venture Transaction
On March 14, 2002, Katy and Savannah Energy Systems Company ("SESCO"), an
indirect wholly owned subsidiary, 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, Katy determined that SESCO
was not a core component of the Company's long-term business strategy. Moreover,
Katy did not feel it had the management expertise to deal with certain risks and
uncertainties presented by the operation of SESCO's business, given that SESCO
was the Company's only waste-to-energy facility. Katy had explored options for
divesting SESCO for a number of years, and management felt that this transaction
offered a reasonable strategy to exit this business.
The 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 of 2002 a charge of $6.0
million, consisting of 1) the discounted value of the $6.6 million note, which
is payable over seven years, 2) the carrying value of certain assets contributed
to the 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 reduced 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 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 an opinion from outside legal counsel, SESCO has a legally
enforceable right to offset amounts it owes to the Authority under the Loan
Agreement against amounts that are owed from the Authority under the Service
Agreement. At September 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.
- 11 -
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.
- 12 -
(6) Income Taxes
As of December 31, 2001, the Company had federal net operating loss carry
forwards of $61.5 million, on which valuation allowances have been applied to an
extent that the Company feels these tax assets are adequately reserved. The
Company expects to have little or no taxable income during 2002, which appears
likely given the results of operations through September 30, 2002. The Company
has generated net operating losses for three consecutive years prior to 2002.
Given the history of net operating loss generation, the Company has decided it
is prudent to record a valuation allowance on all net operating losses generated
during 2002. Therefore, the Company will not currently recognize the tax
benefits generated by these operating losses, however, we will continue to
analyze and book any realizable future benefits. The Company has recorded
provisions through September 30, 2002, for current liabilities associated with
state and foreign income tax expenses.
The sale of Hamilton Precision Metals will allow a portion of the net
operating loss tax assets to be utilized during the 2002 tax year. Katy does not
expect to pay current federal income tax on the gain from the sale of Hamilton.
(7) 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. An adverse
judgment in this matter could have a material impact on Katy's liquidity and
financial position if the Company were not able to exercise recourse against the
former owner of Woods.
Katy also has a number of product liability and workers' compensation
claims pending against it and its subsidiaries. Many of these claims are
proceeding through the litigation process and the final outcome will not be
known until a settlement is reached with the claimant or the case is
adjudicated. The Company estimates that it can take up to 10 years from the date
of the injury to reach a final outcome on certain claims. With respect to the
product liability and workers' compensation claims, Katy has provided for its
share of expected losses beyond the applicable insurance coverage, including
those incurred but not reported to the Company or its insurance providers, which
are developed using actuarial techniques. Such accruals are developed using
currently available claim information, and represent management's best
estimates. The ultimate cost of any individual claim can vary based upon, among
other factors, the nature of the injury, the duration of the disability period,
the length of the claim period, the jurisdiction of the claim and the nature of
the final outcome.
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 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
- 13 -
respect to these matters in excess of the accruals will not be material. The
ultimate costs will depend on a number of factors and the amount currently
accrued represents management's best current estimate of the total costs to be
incurred. The Company expects this amount to be substantially paid over the next
one to four years. The most significant environmental matter in which the
Company is currently involved relates to the W.J. Smith site. In 1993, the
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.
- 14 -
(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 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 Nine Months Ended
September 30, September 30, September 30, September 30,
2002 2001 2002 2001
(Thousands of Dollars)
Electrical/Electronics (a)
Net external sales $ 61,336 $ 49,633 $ 123,063 $ 110,205
(Loss) income from operations 4,508 (383) 2,382 (7,644)
Operating margin 7.3% (0.8%) 1.9% (6.9%)
Depreciation & amortization 560 230 1,538 817
Impairment of long-lived assets (d) -- 187 -- 1,597
Total assets 88,446 89,957 88,446 89,957
Capital expenditures (16,225) 1,908 (13,959) (35,595)
Maintenance Products
Net sales $ 82,266 $ 85,135 $ 240,546 $ 252,208
(Loss) income from operations (16,225) 1,908 (13,959) (35,595)
Operating margin (19.7%) 2.2% (5.8%) (14.1%)
Depreciation & amortization 4,797 4,876 14,320 15,732
Impairment of long-lived assets (d) 10,986 -- 13,380 34,547
Total assets 218,673 245,744 218,673 245,744
Capital expenditures 1,366 2,182 7,217 6,679
Other (c)
Net sales $ -- $ 1,033 $ 1,177 $ 2,871
Loss from operations (60) (25) (6,979) (809)
Operating margin -- (2.4%) (592.9%) (28.2%)
Depreciation & amortization -- 38 -- 165
Impairment of long-lived assets -- -- --
Total assets 7,934 18,594 7,934 18,594
Capital expenditures -- -- -- 495
- 15 -
Three Months Ended Nine Months Ended
September 30, September 30, September 30, September 30,
2002 2001 2002 2001
------------- ------------- ------------- -------------
(Thousands of Dollars)
Discontinued Operations (b)
Net sales $ 2,805 $ 3,717 $ 9,519 $ 12,545
Income from operations 250 679 1,575 2,668
Operating margin 8.9% 18.3% 16.5% (21.4%)
Depreciation & amortization 203 211 666 705
Impairment of long-lived assets -- -- -- --
Total assets 9,452 9,987 9,452 9,987
Capital expenditures 61 575 325 1,132
Corporate
Corporate expenses $ (2,360) $ (8,418) $ (7,254) $ (16,717)
Depreciation & amortization 33 59 111 275
Total assets 20,375 18,706 20,375 18,706
Capital expenditures -- 75 134 75
Company
Net sales $ 146,407 $ 139,518 $ 374,305 $ 377,829
Loss from operations (13,887) (6,239) (24,235) (58,097)
Operating margin (9.5%) (4.4%) (6.5%) (15.4%)
Depreciation & amortization 5,593 5,414 16,635 17,694
Impairment of long-lived assets (d) 10,986 187 13,380 36,144
Total assets 344,880 382,988 344,880 382,988
Capital expenditures 1,753 2,850 8,249 8,694
(a) 2001 amounts include the Thorsen Tools business, which was sold by Katy on
May 3, 2001. Amounts for Thorsen Tool were included in the
Electrical/Electronics group in 2001.
(b) Hamilton Precision Metals, L.P., which was sold on October 31, 2002, is
included in Discontinued Operations. Hamilton had formerly been reported in the
Electrical/Electronics group.
(c) The Other group includes SESCO and Katy's equity method investment in
Sahlman Holdings, Inc.
(d) Excludes transitional goodwill impairment charges of $2.6 million in the
Maintenance Products group and $1.6 million in the Electrical/Electronics group.
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.
- 16 -
Three Months Ended Nine Months Ended
September 30, September 30, September 30, September 30,
2002 2001 2002 2001
------------- ------------- ------------- -------------
(Thousands of Dollars)
Revenues
Total net sales for reportable segments $ 146,407 $ 139,518 $ 374,305 $ 377,829
Less: Net sales included in discontinued
operations (2,805) (3,717) (9,519) (12,545)
--------- --------- --------- ---------
Total consolidated net sales $ 143,602 $ 135,801 $ 364,786 $ 365,284
========= ========= ========= =========
Operating loss
Total loss from operations for
reportable segments $ (13,887) $ (6,239) $ (24,235) $ (58,097)
Less: Operating income included in discontinued
operations (250) (679) (1,575) (2,668)
--------- --------- --------- ---------
Total consolidated operating loss $ (14,137) $ (6,918) $ (25,810) $ (60,765)
========= ========= ========= =========
(9) Severance, Restructuring and Other Charges
During the third quarter of 2002, the Company recorded $9.5 million of
severance, restructuring and other charges. During the third quarter, management
committed to a plan to abandon Contico's Earth City distribution facility, and
to consolidate its operations into the Bridgeton, MO facility (both facilities
are in the St. Louis, Missouri area). As a result, a $7.1 million charge was
recorded to accrue a liability for non-cancelable lease payments associated with
the Earth City facility. Also during the third quarter, the Contico business
recorded a $1.4 million charge related to rent and other facility costs
associated with its Warson Road facility (also in the St. Louis area), whose
operations are also being consolidated into Bridgeton. A charge of $1.8 million
was recorded in the second quarter of 2002 for the Warson Road facility, and the
additional amount of $1.4 million was recorded after consideration of the market
for sub-leasing and to accrue costs to refurbish the facility. The Contico
business recorded related charges of $0.2 million incurred in moving inventory
and equipment from Warson to Bridgeton, and $0.2 million in severance costs. The
Corporate group recorded a $0.1 million charge for non-cancelable lease payments
related to the former corporate headquarters. Also in the third quarter of 2002,
a charge of $0.5 million was recorded for payments to consultants working with
the Company on sourcing and other manufacturing and production efficiency
initiatives.
During the second quarter of 2002, the Company recorded $3.8 million of
severance, restructuring, and 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 Road facility 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 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. 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
- 17 -
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, 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. All of these costs have been paid as of September 30, 2002.
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. All
of these costs have been paid as of September 30, 2002.
As of September 30, 2002, accruals for severance and other restructuring
costs totaled $13.8 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 September 30,
2001 accruals liabilities 2002
2002 $3,209 3,302 (4,580) 1,931
2003 265 5,493 (84) 5,674
2004 55 1,157 -- 1,212
2005 55 1,216 -- 1,271
2006 22 1,289 (22) 1,289
Thereafter -- 2,465 -- 2,465
------ ------- ------- -------
Total payments $3,606 $14,922 $(4,686) $13,842
====== ======= ======= =======
- 18 -
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
Three Months Ended September 30, 2002 versus Three Months Ended September
30, 2001
Following are summaries of sales and operating income for the three
months ended September 30, 2002 and 2001 by industry segment (In thousands):
Net sales Increase (Decrease)
---------------------
2002 2001 Amount Percent
-------- -------- -------- -------
Electrical/Electronics $ 61,336 $ 49,633 $ 11,703 23.6%
Maintenance Products 82,266 85,135 (2,869) (3.4)%
Other 0 1,033 (1,033) N/A
Discontinued Operations 2,805 3,717 (912) (24.5)%
Operating income Increase (Decrease)
---------------------
2002 2001 Amount Percent
-------- -------- -------- -------
Electrical/Electronics $ 4,508 $ (383) 4,891 N/A
Maintenance Products (16,225) 1,908 (18,133) N/A
Other (60) (25) (35) 140.0%
Discontinued Operations 250 679 (429) (63.2)%
The Electrical/Electronics group's sales increased $11.7 million, or
23.6%. A sales increase of 30% at Woods was the main reason for the increase.
Sales at Woods Canada were also up, offset by lower sales at GC/Waldom. 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. Woods sales
to its two largest mass market retail customers were significantly higher during
the third quarter of 2002 versus the same period of 2001. The sales decrease at
GC/Waldom reflects continued weakness in the electronics, communications, and
high-tech markets, to which GC/Waldom sells.
The Electrical/Electronics group's operating income improved by $4.9
million, from $(0.4) million to $4.5 million. Excluding unusual items, operating
income increased from $2.2 million in the third quarter of 2001 to $4.8 million
in the third quarter of 2002. Most of the increase in operating income came from
Woods, where operating margins increased from 3.3% to 7.1%, driven by higher
gross margins as the result of increased volume and the benefit of cost
reduction programs. Profitability was also higher at Woods Canada, where gross
margins were improved year-over-year. Operating income of the Woods 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 third quarter of 2001.
The Electrical/Electronics group incurred charges during the third quarter
of 2002 of $0.3 million for consultant fees related to a company-wide sourcing
project. This sourcing project is expected to result in substantial product cost
savings, and influenced our decision to announce the closure of four Woods
manufacturing facilities in Indiana, planned for December 2002. We expect to
report a restructuring charge during the fourth quarter of 2002 related to the
Woods closures. During the third quarter of 2001, the group incurred unusual
charges of $2.6 million related to 1) inventory valuation adjustments at
GC/Waldom ($1.8 million), Woods Canada ($0.3 million) and Woods ($0.1 million),
2) receivables valuation adjustments of ($0.2 million), and 3) an impairment of
machinery and equipment at Woods Canada ($0.2 million).
Sales in the Maintenance Products group decreased $2.9 million or 3.4%.
The largest sales shortfall was in the retail plastics business of Contico, and
there was a smaller sales decrease in the roofing products business of Loren.
These decreases were offset by significantly higher sales in the Glit/Microtron
abrasives business. The commercial businesses are vulnerable to
- 19 -
reductions in the overall demand for cleaning supplies, and 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.
The group's operating income decreased $18.1 million, to an operating loss
of $(16.2) million. Excluding any unusual or non-recurring charges (incurred in
both 2002 and 2001), operating income increased by $2.6 million, from $1.8
million to $4.4 million. Excluding the unusual and non-recurring charges, the
largest increases were experienced by 1) Glit/Microtron, which had significantly
higher sales 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, despite flat sales, and mainly as a result of cost
reductions.
The group recorded unusual and other non-recurring charges of $20.6
million during the third quarter of 2002. The largest of these charges related
to the planned shut down of Contico's Earth City distribution center, near St.
Louis, Missouri, and relocation of the janitorial/sanitation distribution
function to the Bridgeton, Missouri facility (which is in very close proximity
to Earth City). Management committed to a plan to vacate the facility by May 1,
2003. As a result, a charge of $7.1 million was recorded for the non-cancelable
rental payments due on the facility. We also recorded $0.2 million in asset
impairments on equipment at the Earth City facility. Also related to Contico
restructuring, we recorded a $1.4 million charge related to Contico's Warson
Road facility, in St. Louis, Missouri. Operations from Warson Road are being
transferred to the Bridgeton facility. Contico had recorded a liability during
the second quarter of 2002 for net non-cancelable rentals of the Warson facility
of $1.8 million; this additional $1.4 million charge was the result of further
evaluations of the sub-lease market and consideration of costs to refurbish the
facility. Other charges recorded during the third quarter of 2002 included 1) an
impairment of certain molds and tooling equipment at Contico totaling $7.0
million, which was the result of management analyses of future cash flows
associated with the assets, 2) an impairment of a trade name intangible at
Contico of $2.6 million, 3) a $1.2 million impairment of machinery and equipment
at Wilen Products, which was largely the result of management's decision to
source a higher level of Wilen products from outside vendors, making certain
existing assets less productive in the future, 4) costs to move inventory and
equipment to Bridgeton of $0.2 million, and 5) severance of $0.2 million.
Contico also recorded a LIFO inventory adjustment of $0.5 million (expense), and
$0.2 million for consultant fees associated with a company-wide sourcing
project. The group recorded unusual and other non-recurring charges during the
third quarter of 2001 of $(0.1) million. A $0.8 million favorable LIFO inventory
adjustment was offset by charges for receivables valuation ($0.4 million), and
severance charges ($0.3 million).
Sales from Other operations (SESCO) were non-existent at September 30,
2002 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 unusual charges in 2001, corporate expenses were flat year over
year. During the third quarter of 2001, the Corporate group incurred unusual
charges of $6.3 million, consisting primarily of severance and completion
bonuses related to the recapitalization of the company in mid-2001 and the
resulting changes in management and relocation of the headquarters.
Interest decreased $0.6 million in the third quarter of 2002 compared to
the third quarter of 2001, mainly as a result of lower outstanding borrowings
due and lower interest rates. These factors were offset by higher levels of
amortizing debt costs in 2002 versus 2001.
We did not record any income tax benefit on the pretax loss during the
third 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. Given the history of operating losses, and of the potential
for additional losses in 2002 if certain restructuring initiatives being
considered are implemented, we felt it was a prudent and conservative course of
action not to 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.
- 20 -
Nine Months Ended September 30, 2002 versus Nine Months Ended September 30, 2001
Following are summaries of sales and operating income for the nine months
ended September 30, 2002 and 2001 by industry segment (In thousands):
Increase (Decrease)
2002 2001 Amount Percent
---------------------------------------------------
Net Sales
Electrical/Electronics $ 123,063 $ 110,205 $ 12,858 11.7%
Maintenance Products 240,546 252,208 (11,662) (4.6)%
Other 1,177 2,871 (1,694) (59.0)%
Discontinued Operations 9,519 12,545 3,026 (24.1)%
Operating Income (Loss)
Electrical/Electronics $ 2,382 $ (7,644) $ 10,026 131.2%
Maintenance Products (13,959) (35,595) 21,636 60.8%
Other (6,979) (809) (6,170) 762.7%
Discontinued Operations 1,575 2,668 (1,093) (41.0)%
The Electrical/Electronics group's sales increased by $12.9 million, or
11.7%. Excluding the sales of Thorsen Tools, which was sold in May 2001, sales
increased by $16.0 million, or 13.7%. There were significant sales increases at
both Woods (21%) and Woods Canada (16%), whose sales of electronic corded
products to mass merchant retailers have improved significantly over the same
period of 2001. Woods sales to its two largest mass market retail customers were
significantly higher during the nine months ended September 30, 2002 versus the
same period of 2001. These increases were offset by sales declines at GC/Waldom,
which have suffered as a result of the slowdown in the high-tech and
telecommunications market segments.
The group's operating income improved by $10.0 million, or 131.2%.
Excluding any unusual or non-recurring items from both 2002 and 2001, operating
income increased by $2.9 million, from $2.2 million to $5.1 million. The
increase is due to higher operating income at Woods and Woods Canada, driven by
volume and cost reductions. 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 $1.3 million.
The group incurred unusual and non-recurring charges during the first nine
months of 2002 of $2.7 million, relating to consulting fees associated with a
company-wide sourcing project. During the first nine months of 2001, the group
incurred unusual and non-recurring charges of $9.8 million, consisting of 1)
inventory valuation adjustments of $6.6 million (mainly branded products at
Woods Industries and excess and obsolete inventory at GC/Waldom), 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, 5) receivables valuations related to customer bankruptcies of $0.2
million, 6) asset impairments at Woods Canada of $0.2 million, and 7) 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 $11.7 million, or
4.6%. The largest decrease was in the retail business of Contico, which was down
$9.2 million, or 12%. The Contico retail business has experienced a 13.4%
decrease in sales to its four largest mass market retail customers, representing
73% of Contico's consumer sales, year over year for the nine-month period now
ended. Sales were also lower at the Contico commercial business
(janitorial/sanitation) ($2.8 million), Wilen ($3.4 million), and Loren Products
($1.6 million). These sales reductions were offset by higher sales at
Glit/Microtron ($2.9 million) and Duckback ($0.9 million). Contico's U.K.
division increased sales year over year by $2.5 million.
The group's operating income increased by $21.6 million, or 60.8%, mainly
due to significant unusual and non-
- 21 -
recurring charges in the nine months ended September 30, 2001, although charges
of this nature existed in the nine months ended September 30, 2002, as well.
Excluding these unusual items, operating income increased by $7.5 million, or
185%. 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 Intangible
Assets contributed $1.3 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 $5.4 million, or 87%. The largest
increase was at Glit/Microtron ($3.4 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 ($0.6 million - higher gross
margins), Duckback ($0.6 million - higher sales, gross margin), and Wilen ($2.3
million - lower SG&A). Smaller increases were noted at Gemtex and Contico.
The group recorded unusual and non-recurring charges of $25.8 million
during the first nine months of 2002. The largest of these charges related to
the planned shut down of Contico's Earth City distribution center, near St.
Louis, Missouri, and relocation of the janitorial/sanitation distribution
function to the Bridgeton, Missouri facility (which is in very close proximity
to Earth City). Management committed to a plan to vacate the facility by May 1,
2003. As a result, a charge of $7.1 million was recorded for the non-cancelable
rental payments due on the facility. We also recorded $0.2 million in asset
impairments on equipment at the Earth City facility. Also related to Contico
restructuring, we recorded a $1.4 million charge related to Contico's Warson
Road facility in St. Louis, Missouri. Operations from Warson Road are being
transferred to the Bridgeton facility. Contico had recorded a liability during
the second quarter of 2002 for net non-cancelable rentals of the Warson facility
of $1.8 million; an additional third quarter charge of $1.4 million was the
result of further evaluations of the sub-lease market and consideration of costs
to refurbish the facility. The Contico division also recorded impairments of
machinery and equipment at the Warson Road facility totaling $2.4 million, and
severance related to the Warson closure of $0.1 million. Other charges recorded
during the nine months ended September 30, 2002, included 1) an impairment of
certain molds and tooling equipment at Contico totaling $7.0 million, which was
the result of management analyses of future cash flows associated with the
assets, 2) an impairment of a trade name intangible at Contico of $2.6 million,
3) a $1.2 million impairment of machinery and equipment at Wilen Products, which
was largely the result of management's decision to source a higher level of
Wilen products from outside vendors, making certain existing assets less
productive in the future, 4) costs to move inventory and equipment to Bridgeton
of $0.2 million, 5) severance of $0.7 million, 6) fees paid to a consultant
working with us on sourcing and other manufacturing initiatives of $0.8 million,
7) positive LIFO inventory adjustments of $0.1 million, and 8) other costs
associated with consolidating administrative operations of the Maintenance group
of $0.2 million.
The group recorded unusual and other non-recurring charges during the
first nine 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 $1.7 million, receivables
valuation adjustments of $0.7 million, impairments of property, plant and
equipment of $1.5 million, severance and restructuring charges of $2.4 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 $16.7 million in the first
nine months of 2001 to $7.3 in the same period of this year. During the first
nine months of 2001, the corporate group incurred unusual and non-recurring
charges of $10.7 million, consisting of costs associated with the
recapitalization ($3.0 million), severance and restructuring. Excluding these
unusual or non-recurring charges, corporate expenses increased by approximately
$0.8 million, due mainly to higher costs for incentive compensation.
Interest decreased $3.9 million in the first nine 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 $4.8 million on September
30, 2002 compared to $7.9 million on December 31, 2001. Working capital
excluding current classifications of debt decreased to $72.1 million at
September 30, 2002 from $74.0 million on December 31, 2001 primarily as a result
of higher accounts payable and accrued expenses roughly offsetting higher
accounts receivable and inventory. Strong sales in September 2002, especially at
the Woods business, and
- 22 -
inventory build for seasonal sales drove the increases in receivables and
inventory balances, along with the related payables.
At September 30, 2002, Katy had total indebtedness of $76.6 million. Total
debt was 35% of total capitalization at September 30, 2002. Total borrowings
decreased by $7.5 million during the first nine months of 2002.
In connection with our revolving credit facility, our 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 our 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 $60.6 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 current liability is a result only of the
combination of the two aforementioned factors: the lockbox agreements and the
MAE clause. The revolving credit facility does not expire or have a maturity
date within one year, but rather has a final expiration date of June 28, 2006.
Also, we were in compliance with the applicable financial covenants at September
30, 2002, the lender has not notified us of any indication of a MAE at September
30, 2002, and to our knowledge, we were not in default of any provision of the
Credit Agreement at September 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) as of October
25, 2002, indicated that we had unused borrowing availability of $13.7 million.
On October 31, 2002, we completed the sale of the Hamilton Precision
Metals business for $14.0 million. We may receive additional payments in the
future dependent upon certain events concerning Hamilton's financial
performance. We used the proceeds from the sale to pay off our remaining term
loans, which had a balance of $13.8 million at the time of the sale. The term
loans had an original balance of $30.0 million at June 28, 2001, and were
scheduled to be repaid through equal quarterly amortizations through June 28,
2006. The early payoff is the result of 1) the sale of Hamilton Precision Metals
($14.0 million - October 2002), 2) the Consolidated Excess Cash Flow payment
described in the previous paragraph ($7.9 million - April 2002), 3) several
small asset sales over the past fifteen months ($0.6 million), and 4) regularly
scheduled payments ($7.5 million). We are evaluating various alternatives with
our lender banks regarding the refinancing of our debt capital, including new
term loans, which would provide more borrowing availability under the revolving
credit facility. We are commencing discussions with our lender banks to complete
a refinancing transaction of this sort.
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.
$7.9 million has been spent on capital projects thus far in 2002. 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
October 25, 2002, based on eligible accounts receivable and inventory, exceeded
our outstanding borrowings by approximately $13.7 million.
We have announced or committed to several restructuring plans involving
our operations. During the second and third quarters, respectively, we announced
plans to consolidate the Contico business' Warson and Earth City facilities into
the Bridgeton facility. All of these facilities are located in the St. Louis,
Missouri area. The move from our Warson facility is expected to require
approximately $0.5 million of incremental cash, approximately half of which had
been spent at September 30, 2002, the other half of which will be spent by year
end. The move from our Earth City facility will require approximately $1.9
million of incremental cash, $1.6 million in the form of capital expenditures,
mainly for material handling equipment, and $0.3 million to move inventory and
equipment. This cash will be spent in 2003. The large expense charges recorded
during the second and third quarters related to these facilities were mainly to
accrue non-cancelable lease payments for these facilities (i.e., non-incremental
cash).
- 23 -
During October 2002, we also announced the planned closure of four Woods
Industries manufacturing facilities in Indiana, necessitated by our decision to
fully outsource our supply of electrical consumer corded products to lower cost
sources. Woods already sources approximately half of its finished goods from
vendors. We expect to report a restructuring charge during the fourth quarter of
2002 related to these closures. While outsourcing of the Woods products is a
cost-saving measure, Woods expects to maintain higher inventory levels,
especially during mid-2003, as a result of this move.
We are considering other restructuring alternatives as well, most of which
center around consolidation of operations into fewer facilities. Certain of
these projects under consideration could require more significant levels of
incremental cash for both capital expenditures and moving and relocation costs.
Expected capital needs for these projects, if finalized, may reach $3.6 million,
which would be spent mainly in early 2003. Incremental cash for expenses for
these potential projects could reach approximately $1.5 million in each of 2003
and 2004, for a total of $3.0 million.
These restructuring projects in general require the approval of the
lenders that are party to our credit agreement. We are confident in our ability
to gain these approvals, and in our ability to work with our lenders to ensure
our loans are structured in such a way (such as new term loans) as to allow for
the available cash to fund these projects into 2003 and 2004.
We are continually evaluating alternatives relating to divestitures of
certain of our businesses (in addition to the Hamilton divestiture described
above). Divestitures present opportunities to de-leverage our financial position
and free up cash for further investments in core activities.
Based on our current capital levels and its assumptions about future
operating results, we believe that we will have sufficient resources to fund
existing operating plans. However, if actual results differ materially from
current assumptions, we may not have sufficient capital resources and may have
to modify existing operating plans and/or seek additional capital resources. If
we engage in efforts to obtain additional capital, we can make no assurances
that these efforts will be successful or that the terms of such funding would be
beneficial to the common stockholders.
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 the
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 September 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 Power Corporation has agreed to indemnify Katy for any
breach of the service agreement by the joint venture.
- 24 -
SEVERANCE, RESTRUCTURING AND OTHER UNUSUAL CHARGES
During the third quarter of 2002, we recorded $9.5 million of severance,
restructuring and other charges. During the third quarter, we committed to a
plan to abandon Contico's Earth City distribution facility, and to consolidate
its operations into the Bridgeton, MO facility (both facilities are in the St.
Louis, Missouri area). As a result, a $7.1 million charge was recorded to accrue
a liability for non-cancelable lease payments associated with the Earth City
facility. Also during the third quarter, the Contico business recorded a $1.4
million charge related to rent and other facility costs associated with its
Warson Road facility (also in the St. Louis area), whose operations are also
being consolidated into Bridgeton. A charge of $1.8 million was recorded in the
second quarter of 2002 for the Warson Road facility, and the additional amount
of $1.4 million was recorded after consideration of the market for sub-leasing
and to accrue costs to refurbish the facility. The Contico business recorded
related charges of $0.2 million incurred in moving inventory and equipment from
Warson to Bridgeton, and $0.2 million in severance costs. The Corporate group
recorded a $0.1 million charge for non-cancelable lease payments related to the
former corporate headquarters. Also in the third quarter of 2002, a charge of
$0.5 million was recorded for payments to consultants working with us on
sourcing and other manufacturing and production efficiency initiatives.
During the second quarter of 2002, we 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 us 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
Road facility 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, we 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 us on sourcing and other
manufacturing and production efficiency initiatives. Approximately $0.3 million
related to involuntary termination benefits for two management employees whose
positions were eliminated, and $0.1 million were costs associated with the
consolidation of administrative and operational functions.
During the third quarter of 2001, we 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. Additionally, $1.0 million of
costs were incurred related primarily to outside consultants working with us 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, 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. All of these costs had been paid out by September 30, 2002.
During the first quarter of 2001, Woods undertook a restructuring effort
that involved reductions in senior management headcount as well as facility
closings. We 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. All of these costs had been paid
out by September 30, 2002.
As of September 30, 2002, accruals for severance and other restructuring
costs totaled $13.8 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 restructuring restructuring September
31, 2001 accruals liabilities 30, 2002
--------------------------------------------------------
2002 $3,209 3,302 (4,580) 1,931
2003 265 5,493 (84) 5,674
2004 55 1,157 -- 1,212
2005 55 1,216 -- 1,271
2006 22 1,289 (22) 1,289
Thereafter -- 2,465 -- 2,465
------ ------- ------- -------
Total payments $3,606 $14,922 $(4,686) $13,842
====== ======= ======= =======
- 25 -
OUTLOOK FOR 2002
We anticipate a continuation of the difficult economic conditions and
business 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 and third quarters of
2002. We have also seen strong sales performance from the Woods and Woods Canada
retail electrical corded products business, which we expect to see continue
through the end of the year. 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 also 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.
We have announced or committed to several restructuring plans involving
our operations. During the second and third quarters of 2002, respectively, we
announced plans to consolidate the Contico business' Warson and Earth City
facilities into the Bridgeton facility. All of these facilities are located in
the St. Louis, Missouri area. The move from our Warson Road facility is expected
to require approximately $0.5 million of incremental cash, approximately half of
which had been spent at September 30, 2002, the other half of which will be
spent by year end. The move from our Earth City facility will require
approximately $1.9 million of incremental cash, $1.6 million in the form of
capital expenditures, mainly for material handling equipment, and $0.3 million
to move inventory and equipment. This cash will be spent in 2003. The large
expense charges recorded during the second and third quarters of 2002 related to
these facilities were mainly to accrue non-cancelable lease payments for these
facilities (i.e., non-incremental cash).
During October 2002, we also announced the planned closure of four Woods
Industries manufacturing facilities in Indiana, necessitated by our decision to
fully outsource our supply of electrical consumer corded products to lower cost
sources. Woods already sources approximately half of its finished goods from
vendors. We expect to record charges in the fourth quarter of 2002 related to
this action. While outsourcing of the Woods' products is a cost-saving measure,
Woods expects to maintain higher inventory levels, especially during mid-2003,
as a result of this move.
We are considering other restructuring alternatives as well, most of which
center around consolidation of operations into fewer facilities. Certain of
these projects under consideration could require more significant levels of
incremental cash for both capital expenditures and moving and relocation costs.
Expected capital needs for these projects, if finalized, may reach $3.6 million,
which would be spent mainly in early 2003. Incremental cash for expenses for
these potential projects could reach approximately $1.5 million in each of 2003
and 2004, for a total of $3.0 million.
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 Disco for
customers in the janitorial/sanitation markets. The new organization would allow
customers to order certain products from all of the companies 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
contribute to improving profitability over the long-term.
- 26 -
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.
While 2003 plans are in the development phase, we expect to see continued
improvement in operating cash flow as a result of cost reductions and other
initiatives. Sales in 2003 are expected to remain flat from 2002 levels.
Continued pricing pressures will require us to consider further restructuring
alternatives to reduce our cost structure. These restructuring alternatives
include facilities consolidation and sourcing of products from vendors as
opposed to manufacturing.
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 Credit Agreement.
- Our inability to meet covenants associated with the Credit
Agreement.
- Our inability to work with our lenders to refinance the debt under
the Credit Agreement in a way that will allow us to pursue planned
restructuring and consolidation efforts involving our operations.
- 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.
- 27 -
- 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.
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.
ENVIRONMENTAL AND OTHER CONTINGENCIES
As set forth more fully in the Company's Form 10-K for the year ended
December 31, 2001, 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, we have
recorded and accrued for indicated environmental liabilities at amounts that we
deem reasonable and believe 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. We expect 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 claimants or the cases are
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, we have provided for our 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 us to reasonably determine an outcome or
accurately estimate the range of potential exposure. We 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. An adverse
judgment in this matter could have an adverse impact on Katy's liquidity and
financial position if the Company were not able to exercise recourse against the
former owner of Woods.
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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 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
nine months ended September 30, 2002 as a result of the adoption of the
non-amortization provisions was $1.4 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.
See Note 2 to the Condensed Consolidated Financial Statements for further
discussion of the final transition to SFAS No. 142.
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. See Notes 3
and 4 to the Condensed Consolidated Financial Statements for further discussion
of impairments and discontinued operations.
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. We are 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 statements of operations, tending to spread
the costs out as opposed to recognition of a large portion of the costs at the
time we commit to such restructuring and exit plans. We have decided that we
will not adopt the provisions of SFAS No. 146 prior to the required date.
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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Item 4. CONTROLS AND PROCEDURES
We maintain disclosure controls and procedures that are designed to ensure
that information required to be disclosed in our SEC filings is reported within
the time periods specified in the SEC's rules, and that such information is
accumulated and communicated to the management, including the Chief Executive
Officer and Chief Financial Officer, as appropriate, to allow timely decisions
regarding required disclosure. We also have investments in certain
unconsolidated entities. As we do not control or manage these entities, the
disclosure controls and procedures with respect to such entities are necessarily
more limited than those we maintain with respect to our consolidated
subsidiaries.
Within the 90 days prior to the filing date of this report, we carried out
an evaluation, under the supervision and with the participation of our
management, including the Chief Executive Officer and Chief Financial Officer,
of the effectiveness of the design and operation of our disclosure controls and
procedures pursuant to Rule 13a-14 under the Securities Exchange Act of 1934, as
amended. Based upon that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that our disclosure controls and procedures are
effective in timely alerting them to material information relating to Katy
(including its consolidated subsidiaries) required to be included in our
periodic SEC filings. There have been no significant changes in internal
controls or in other factors that could significantly affect these controls
subsequent to the date of their evaluation.
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PART II - OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
During the quarter for which this report is filed, there have been no
material developments in previously reported legal proceedings, and no other
cases or legal proceedings, other than ordinary routine litigation incidental to
the Company's business and other nonmaterial proceedings, brought against the
Company.
Item 5. OTHER INFORMATION
None.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibit
None.
(b) Reports on Form 8-K
None.
- 31 -
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, 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
- 32 -
CERTIFICATION PURSUANT TO
RULE 13A-14 OF THE SECURITIES EXCHANGE ACT OF 1934,
AS ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, C. Michael Jacobi, Chief Executive Officer of the company, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Katy Industries, Inc.
(the "registrant");
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in the
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 14, 2002 By: /s/ C. Michael Jacobi
-----------------------
C. Michael Jacobi
Chief Executive Officer
- 33 -
CERTIFICATION PURSUANT TO
RULE 13A-14 OF THE SECURITIES EXCHANGE ACT OF 1934,
AS ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Amir Rosenthal, Chief Financial Officer of the company, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Katy Industries, Inc.
(the "registrant");
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in the
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 14, 2002 By: /s/ Amir Rosenthal
-----------------------
Amir Rosenthal
Chief Financial Officer
- 34 -