United States
Securities and Exchange Commission
Washington, D.C. 20549
FORM 10-Q
|x| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For Quarterly period ended: June 30, 2005
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from_______________ to________________
Commission File Number 001-05558
Katy Industries, Inc.
(Exact name of registrant as specified in its charter)
Delaware 75-1277589
(State of Incorporation) (I.R.S. Employer Identification No.)
765 Straits Turnpike, Suite 2000, Middlebury, Connecticut 06762
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (203)598-0397
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes |X| No |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes |_| No |X|
Indicate the number of shares outstanding of each of the issuer's classes
of common stock as of the latest practicable date.
Class Outstanding at August 15, 2005
Common Stock, $1 Par Value 7,951,377
1
KATY INDUSTRIES, INC.
FORM 10-Q
June 30, 2005
INDEX
Page
----
PART I FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets
June 30, 2005 and December 31, 2004 (unaudited) 3
Condensed Consolidated Statements of Operations
Three Months and Six Months Ended
June 30, 2005 and 2004 (unaudited) 5
Condensed Consolidated Statements of Cash Flows 6
Six Months Ended June 30, 2005 and 2004 (unaudited)
Notes to Condensed Consolidated Financial Statements (unaudited) 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 24
Item 3. Quantitative and Qualitative Disclosures about Market Risk 40
Item 4. Controls and Procedures 41
PART II OTHER INFORMATION
Item 1. Legal Proceedings 42
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 42
Item 4. Submission of Matters to a Vote of Security Holders 42
Item 5. Other Information 43
Item 6. Exhibits 43
Signatures 44
Certifications 45
2
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
KATY INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Amounts in Thousands)
(Unaudited)
ASSETS
June 30, December 31,
2005 2004
---- ----
CURRENT ASSETS:
Cash and cash equivalents $ 4,063 $ 8,525
Accounts receivable, net 56,981 66,689
Inventories, net 58,548 65,674
Other current assets 4,493 4,233
--------- ------------
Total current assets 124,085 145,121
--------- ------------
OTHER ASSETS:
Goodwill 2,239 2,239
Intangibles, net 7,239 7,428
Other 9,298 9,946
--------- ------------
Total other assets 18,776 19,613
--------- ------------
PROPERTY AND EQUIPMENT
Land and improvements 1,789 1,897
Buildings and improvements 13,805 13,537
Machinery and equipment 135,265 132,825
--------- ------------
150,859 148,259
Less - Accumulated depreciation (95,088) (88,529)
--------- ------------
Property and equipment, net 55,771 59,730
--------- ------------
Total assets $ 198,632 $ 224,464
========= ============
See Notes to Condensed Consolidated Financial Statements.
3
KATY INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Amounts in Thousands, Except Share Data)
(Unaudited)
LIABILITIES AND STOCKHOLDERS' EQUITY
June 30, December 31,
2005 2004
---- ----
CURRENT LIABILITIES:
Accounts payable $ 32,650 $ 39,079
Accrued compensation 4,592 5,269
Accrued expenses 36,376 39,939
Current maturities of long-term debt 2,857 2,857
Revolving credit agreement 39,547 40,166
--------- ------------
Total current liabilities 116,022 127,310
--------- ------------
LONG-TERM DEBT, less current maturities 13,572 15,714
OTHER LIABILITIES 10,616 12,855
--------- ------------
Total liabilities 140,210 155,879
--------- ------------
COMMITMENTS AND CONTINGENCIES (Note 8) -- --
--------- ------------
STOCKHOLDERS' EQUITY
15% Convertible Preferred Stock, $100 par value, authorized
1,200,000 shares, issued and outstanding 1,131,551 shares,
liquidation value $113,155 108,256 108,256
Common stock, $1 par value, authorized 35,000,000 shares,
issued 9,822,204 shares 9,822 9,822
Additional paid-in capital 27,016 25,111
Accumulated other comprehensive income 3,120 4,564
Accumulated deficit (67,952) (57,258)
Treasury stock, at cost, 1,870,827 and 1,876,827 shares, respectively (21,840) (21,910)
--------- ------------
Total stockholders' equity 58,422 68,585
--------- ------------
Total liabilities and stockholders' equity $ 198,632 $ 224,464
========= ============
See Notes to Condensed Consolidated Financial Statements.
4
KATY INDUSTRIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS AND SIX MONTHS ENDED JUNE 30, 2005 AND 2004
(Thousands of Dollars, Except Share and Per Share Data)
(Unaudited)
Three Months Six Months
Ended June 30, Ended June 30,
2005 2004 2005 2004
---- ---- ---- ----
Net sales $ 98,210 $ 100,522 $ 193,723 $ 200,417
Cost of goods sold 86,424 87,261 172,414 170,526
---------- ---------- ---------- ----------
Gross profit 11,786 13,261 21,309 29,891
Selling, general and administrative expenses 13,885 14,240 26,239 28,988
Stock option expense 1,953 -- 1,953 --
Severance, restructuring and related charges (income) 940 (109) 1,313 1,789
Gain on sale of assets (166) (549) (166) (549)
---------- ---------- ---------- ----------
Operating loss (4,826) (321) (8,030) (337)
Interest expense (1,392) (997) (2,656) (1,797)
Other, net 38 144 (10) (231)
---------- ---------- ---------- ----------
Loss before (benefit) provision for income taxes (6,180) (1,174) (10,696) (2,365)
(Benefit) provision for income taxes (134) 109 (2) 699
---------- ---------- ---------- ----------
Net loss (6,046) (1,283) (10,694) (3,064)
Payment-in-kind dividends on convertible preferred stock -- (3,462) -- (6,924)
---------- ---------- ---------- ----------
Net loss attributable to common stockholders $ (6,046) $ (4,745) $ (10,694) $ (9,988)
========== ========== ========== ==========
Loss per share of common stock - Basic and diluted:
Net loss attributable to common stockholders $ (0.76) $ (0.60) $ (1.35) $ (1.27)
========== ========== ========== ==========
Weighted average common shares outstanding (thousands):
Basic and diluted 7,948 7,870 7,947 7,877
========== ========== ========== ==========
See Notes to Condensed Consolidated Financial Statements.
5
KATY INDUSTRIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 2005 AND 2004
(Thousands of Dollars)
(Unaudited)
2005 2004
---- ----
Cash flows from operating activities:
Net loss $(10,694) $ (3,064)
Depreciation and amortization 5,869 7,709
Amortization of debt issuance costs 557 535
Stock option expense 1,953 --
Gain on sale of assets (166) (549)
-------- --------
(2,481) 4,631
-------- --------
Changes in operating assets and liabilities:
Accounts receivable 8,983 4,175
Inventories 6,552 (14,704)
Other assets (341) (3,274)
Accounts payable (5,922) (7,870)
Accrued expenses (4,086) (3,071)
Other, net (2,217) (1,959)
-------- --------
2,969 (26,703)
-------- --------
Net cash provided by (used in) operating activities 488 (22,072)
-------- --------
Cash flows from investing activities:
Capital expenditures (2,954) (5,704)
Collections of note receivable from sale of subsidiary 106 --
Proceeds from sale of assets 600 5,533
-------- --------
Net cash used in investing activities (2,248) (171)
-------- --------
Cash flows from financing activities:
Net (repayments) borrowings on revolving loans (410) 7,022
Proceeds of term loans -- 18,152
Repayments of term loans (2,142) (2,529)
Direct costs associated with debt facilities (135) (1,296)
Repurchases of common stock -- (75)
-------- --------
Net cash (used in) provided by financing activities (2,687) 21,274
-------- --------
Effect of exchange rate changes on cash and cash equivalents (15) (95)
Net decrease in cash and cash equivalents (4,462) (1,064)
Cash and cash equivalents, beginning of period 8,525 6,748
-------- --------
Cash and cash equivalents, end of period $ 4,063 $ 5,684
======== ========
See Notes to Condensed Consolidated Financial Statements
6
KATY INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2005
(1) Significant Accounting Policies
Consolidation Policy and Basis of Presentation
The condensed consolidated financial statements include the accounts of
Katy Industries, Inc. and subsidiaries in which it has a greater than 50%
interest, collectively "Katy" or the Company. All significant intercompany
accounts, profits and transactions have been eliminated in consolidation.
Investments in affiliates that are not majority owned and where the Company
exercises significant influence are reported using the equity method. The
condensed consolidated financial statements at June 30, 2005 and December 31,
2004 and for the three and six month periods ended June 30, 2005 and June 30,
2004 are unaudited and reflect all adjustments which are, in the opinion of
management, necessary for a fair presentation of the financial condition and
results of operations of the Company. Interim results may not be indicative of
results to be realized for the entire year. The condensed consolidated financial
statements should be read in conjunction with the consolidated financial
statements and notes thereto, together with management's discussion and analysis
of financial condition and results of operations, contained in the Company's
Annual Report on Form 10-K for the year ended December 31, 2004.
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 (amounts in thousands):
June 30, December 31,
2005 2004
---- ----
Raw materials $ 19,805 $ 23,220
Work in process 1,854 1,826
Finished goods 41,570 45,299
Inventory reserves (4,681) (4,671)
------------ ------------
$ 58,548 $ 65,674
============ ============
At June 30, 2005 and December 31, 2004, approximately 35% and 39%,
respectively, of Katy's inventories were accounted for using the last-in,
first-out ("LIFO") method of costing, while the remaining inventories were
accounted for using the first-in, first-out ("FIFO") method. Current cost, as
determined using the FIFO method, exceeded LIFO cost by $5.0 million and $4.7
million at June 30, 2005 and December 31, 2004, respectively.
Property, Plant and Equipment
Property and equipment are stated at cost and depreciated over their
estimated useful lives: buildings (10-40 years) generally using the
straight-line method; machinery and equipment (3-20 years) using straight-line
or composite methods; tooling (5 years) using the straight-line method; and
leasehold improvements using the straight-line method over the remaining lease
period or useful life, if shorter. Costs for repair and maintenance of machinery
and equipment are expensed as incurred, unless the result significantly
increases the useful life or functionality of the asset, in which case
capitalization is considered. Depreciation expense from continuing operations
was $2.8 million and $3.5 million and $5.5 million and $6.9 million for the
three and six month periods ended June 30, 2005 and 2004, respectively.
Katy adopted Statement of Financial Accounting Standards ("SFAS") No. 143,
Accounting for Asset Retirement Obligations, on January 1, 2003. SFAS No. 143
requires that an asset retirement obligation associated with the retirement of a
tangible long-lived asset be recognized as a liability in the period in which it
is incurred or becomes determinable, with
7
an associated increase in the carrying amount of the related long-term asset.
The cost of the tangible asset, including the initially recognized asset
retirement cost, is depreciated over the useful life of the asset. In accordance
with SFAS No. 143, the Company has recorded as of June 30, 2005 an asset of $0.4
million and related liability of $1.0 million for retirement obligations
associated with returning certain leased properties to the respective lessors
upon the termination of the lease arrangements. A summary of the changes in
asset retirement obligation since December 31, 2004 is included in the table
below (amounts in thousands):
SFAS No. 143 Obligation at December 31, 2004 $ 1,237
Accretion expense 23
Changes in estimates, including timing (22)
Payments (250)
-------
SFAS No. 143 Obligation at June 30, 2005 $ 988
=======
Stock Options and Other Stock Awards
The Company follows the provisions of Accounting Principles Board ("APB")
Opinion No. 25, Accounting for Stock Issued to Employees, regarding accounting
for stock options and other stock awards. APB Opinion No. 25 dictates a
measurement date concept in the determination of compensation expense related to
stock awards including stock options, restricted stock, and stock appreciation
rights. The Company's outstanding stock options historically have had
established measurement dates and therefore, fixed plan accounting was applied,
generally resulting in no compensation expense for these stock option awards. In
March 2004, the Company's Board of Directors approved the vesting of all
previously outstanding and unvested stock options. The Company did not recognize
any compensation expense upon this vesting of options because, based on the
information available at that time, the Company did not have an expectation that
the holders of the previously unvested options would terminate their employment
with the Company prior to the original vesting period. In the second quarter of
2005, our former President and Chief Executive Officer retired from the Company.
Upon this event, the Company recognized $2.0 million of compensation expense
related to his 1,050,000 options using the intrinsic method of accounting under
APB 25, because he would not have otherwise vested in these options but for the
March 2004 accelerated vesting. Upon his retirement, our former President and
Chief Executive Officer immediately forfeited 750,000 options while 300,000
options remain unexercised. 6,000 options were granted during the three and six
months ended both June 30, 2005 and 2004.
The Company has also issued stock appreciation rights and restricted stock
awards which are accounted for as variable stock compensation awards and
compensation expense or income has been recorded for these awards. Compensation
expense recorded relative to stock awards was $22.1 thousand and $9.0 thousand
for both the three and six month periods ended June 30, 2005 and 2004,
respectively. Compensation income recorded associated with the vesting of stock
appreciation rights was $0.2 million and $0.1 million for the three month
periods ended June 30, 2005 and 2004, respectively. Compensation income recorded
associated with the vesting of stock appreciation rights was $0.8 million and
$0.2 million for the six month periods ended June 30, 2005 and 2004,
respectively. No compensation expense was recorded relative to restricted stock
awards during the three and six months ended June 30, 2005 and 2004,
respectively. Compensation expense or income for stock awards and stock
appreciation rights is recorded in selling, general and administrative expenses
in the Condensed Consolidated Statements of Operations.
SFAS No. 123, Accounting for Stock-Based Compensation, changes the method
for recognition of expense related to option grants to employees. Under SFAS No.
123, compensation cost would be recorded based upon the fair value of each
option at the date of grant using an option-pricing model that takes into
account as of the grant date the exercise price and expected life of the option,
the current price of the underlying stock and its expected volatility, expected
dividends on the stock and the risk-free interest rate for the expected term of
the option. The fair value of each option grant is estimated on the date of
grant using a Black-Scholes option-pricing model with an expected life of five
to ten years for all grants. Had compensation cost been determined based on the
fair value method of SFAS No. 123, the Company's net loss and loss per share
would have been adjusted to the pro forma amounts indicated below (amounts in
thousands, except per share data).
8
Three Months Six Months
Ended June 30, Ended June 30,
2005 2004 2005 2004
---- ---- ---- ----
Net loss attributable to common stockholders, as reported $ (6,046) $ (4,745) $(10,694) $ (9,988)
Add: Stock-based employee compensation expense
included in reported net income, with no related tax
tax effects 1,953 -- 1,953 --
Deduct: Total stock-based employee
compensation expense determined under fair
value based method for all awards, with no
related tax effects (14) (15) (14) (1,855)
-------- -------- -------- --------
Pro forma net loss $ (4,107) $ (4,760) $ (8,755) $(11,843)
======== ======== ======== ========
Loss per share
Basic and diluted - as reported $ (0.76) $ (0.60) $ (1.35) $ (1.27)
Basic and diluted - pro forma $ (0.52) $ (0.60) $ (1.10) $ (1.50)
In December 2004, the Financial Accounting Standards Board ("FASB") issued
Statement No. 123 (revised 2004), Share-Based Payment ("SFAS 123R"), which is a
revision of SFAS No. 123. SFAS 123R supersedes APB Opinion No. 25, and amends
FASB Statement No. 95, Statement of Cash Flows. The approach to quantifying
stock-based compensation expense in SFAS 123R is similar to SFAS No. 123.
However, the revised statement requires all share-based payments to employees,
including grants of employee stock options, to be recognized as an expense in
the Consolidated Statements of Operations based on their fair values as they are
earned by the employees under the vesting terms. Pro forma disclosure of
stock-based compensation expense, as is the Company's practice under SFAS No.
123, will not be permitted after 2005, since SFAS 123R must be adopted no later
than the first interim or annual period beginning after December 15, 2005. The
Company expects to follow the "modified prospective" method of adoption of SFAS
123R in the first quarter of 2006, whereby earnings for prior periods will not
be restated as though stock based compensation had been expensed, rather than
the "modified retrospective" method of adoption which would entail restatements
of previously published earnings. The Company is currently evaluating the effect
of SFAS 123R on the Company, which will be dependent in large part upon future
equity-based grants.
Reclassifications
Certain amounts from prior periods have been reclassified to conform to
the current period presentation.
(2) New Accounting Pronouncements
On December 8, 2003, the Medicare Prescription Drug, Improvement and
Modernization Act of 2003 (the "Act") became law in the U.S. The Act introduces
a prescription drug benefit under Medicare, as well as a federal subsidy to
sponsors of retiree health care benefit plans that provide retiree benefits in
certain circumstances. FASB Staff Position (FSP) 106-2, Accounting and
Disclosure Requirements Related to the Medicare Prescription Drug, Improvement
and Modernization Act of 2003 ("FSP 106-2"), issued in May 2004, requires
measures of the accumulated postretirement benefit obligation ("APBO") and net
periodic postretirement benefit cost ("NPPBC") to reflect the effects of the
Act. FSP 106-2 became effective for the Company in the third quarter of fiscal
2004; however Katy had chosen to defer adoption until its next measurement date,
subject to the final provisions of the Act. While the Company expects that it
may be entitled to the federal subsidy for certain of its plans, the effect of
the Act on the Company's accumulated postretirement benefit obligations is not
material.
9
In November 2004, the FASB issued SFAS No. 151, Inventory Costs, an
amendment of ARB No. 43, Chapter 4 (SFAS 151). SFAS 151 clarifies the accounting
for abnormal amounts of idle facility expense, freight, handling costs and
spoilage. In addition, SFAS 151 requires that allocation of fixed production
overhead to the costs of conversion be based on the normal capacity of the
production facilities. The provisions of SFAS 151 are effective for inventory
costs incurred during fiscal years beginning after June 15, 2005. The Company
expects the adoption of SFAS 151 will not have a material impact on its results
of operations and financial position.
In December 2004, the FASB issued FSP No. 109-1, Application of FASB
Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on
Qualified Production Activities Provided by the American Jobs Creation Act of
2004. The American Jobs Creation Act of 2004 includes a tax deduction of up to
9% of the lesser of qualified production activities income, as defined, or
taxable income, after the deduction for the utilization of any net operating
loss carryforwards. The FSP clarified that this deduction should be accounted
for as a special tax deduction in accordance with SFAS No. 109. The Company
expects that due to its net operating loss carryforwards and its full domestic
valuation allowance, the new deduction will have no impact on income tax expense
for fiscal years 2005 and 2006.
In December 2004, the FASB issued FSP No. 109-2, Accounting and Disclosure
Guidance for the Foreign Earnings Repatriation Provision within the American
Jobs Creation Act of 2004. The Company has completed its review of the
Repatriation Provision and has concluded that it will not benefit from the Act
due to the Company's current tax position. As a result, the Repatriation
Provision did not have any impact on income tax expense during fiscal 2004.
(3) Intangible Assets
Following is detailed information regarding Katy's intangible assets
(amounts in thousands):
June 30, December 31,
2005 2004
---- ----
Customer lists $ 10,946 $ 10,976
Tradenames 6,620 6,577
Patents 3,070 2,932
------------ ------------
Subtotal 20,636 20,485
Accumulated amortization (13,397) (13,057)
------------ ------------
Intangible assets, net $ 7,239 $ 7,428
============ ============
All of Katy's intangible assets are definite long-lived intangibles. Katy
recorded amortization expense on intangible assets of $0.1 million and $0.4
million for the three-month periods ended June 30, 2005 and 2004, respectively,
and $0.3 million and $0.8 million for the six-month periods ended June 30, 2005
and 2004, respectively. Estimated aggregate future amortization expense related
to intangible assets is as follows (amounts in thousands):
2005 $ 321
2006 670
2007 675
2008 665
2009 653
(4) Savannah Energy Systems Company Partnership
On April 29, 2002, Savannah Energy Systems Company ("SESCO"), an indirect
wholly owned subsidiary of Katy, entered into a partnership agreement with
Montenay Power Corporation and its affiliates ("Montenay") that turned over the
operational control of SESCO's waste-to-energy facility to the partnership. The
Company caused SESCO to enter into this agreement as a result of evaluations of
SESCO's business. First, Katy concluded that SESCO was not a core component of
10
the Company's long-term business strategy. Moreover, Katy did not feel it had
the management expertise to deal with certain risks and uncertainties presented
by the operation of SESCO's business, given that SESCO was the Company's only
waste-to-energy facility. Katy had explored options for divesting SESCO for a
number of years, and management felt that this transaction offered a reasonable
strategy to exit this business.
The partnership, with Montenay's leadership, assumed SESCO's position in
various contracts relating to the facility's operation. Under the partnership
agreement, SESCO contributed its assets and liabilities (except for its
liability under the loan agreement with the Resource Recovery Development
Authority (the "Authority") of the City of Savannah and the related receivable
under the service agreement with the Authority) to the partnership. While SESCO
has a 99% interest as a limited partner, Montenay has the day to day
responsibility for administration, operations, financing and other matters of
the partnership, and accordingly, the partnership will not be consolidated. Katy
agreed to pay Montenay $6.6 million over the span of seven years under a note
payable as part of the partnership and related agreements. Certain amounts may
be due to SESCO upon expiration of the service agreement in 2008; also, Montenay
may purchase SESCO's interest in the partnership at that time. Katy has not
recorded any amounts receivable or other assets relating to amounts that may be
received at the time the service agreement expires, given their uncertainty.
The Company made a payment of $1.1 million in June 2005 on the remaining
portion of the $6.6 million note. The table below schedules the remaining
payments as of June 30, 2005 which are reflected in accrued expenses and other
liabilities in the Condensed Consolidated Balance Sheet (amounts in thousands):
2006 $ 1,100
2007 1,100
2008 550
------------
$ 2,750
============
In the first quarter of 2002, the Company recognized a charge of $6.0
million consisting of 1) the discounted value of the $6.6 million note, 2) the
carrying value of certain assets contributed to the partnership, consisting
primarily of machinery spare parts, and 3) costs to close the transaction. It
should be noted that all of SESCO's long-lived assets were reduced to a zero
value at March 31, 2002, so no additional impairment was required. On a going
forward basis, Katy would expect that income statement activity associated with
its involvement in the partnership will not be material, and Katy's Condensed
Consolidated Balance Sheet will carry the liability mentioned above.
In 1984, the Authority issued $55.0 million of Industrial Revenue Bonds
and lent the proceeds to SESCO under the loan agreement for the acquisition and
construction of the waste-to-energy facility that has now been transferred to
the partnership. The funds required to repay the loan agreement come from the
monthly disposal fee paid by the Authority under the service agreement for
certain waste disposal services, a component of which is for debt service. To
induce the required parties to consent to the SESCO partnership transaction,
SESCO retained its liability under the loan agreement. In connection with that
liability, SESCO also retained its right to receive the debt service component
of the monthly disposal fee.
Based on an opinion from outside legal counsel, SESCO has a legally
enforceable right to offset amounts it owes to the Authority under the loan
agreement against amounts that are owed from the Authority under the service
agreement. At June 30, 2005, this amount was $23.7 million. Accordingly, the
amounts owed to and due from SESCO have been netted for financial reporting
purposes and are not shown on the Condensed Consolidated Balance Sheets.
In addition to SESCO retaining its liabilities under the loan agreement,
to induce the required parties to consent to the partnership transaction, Katy
also continues to guarantee the obligations of the partnership under the service
agreement. The partnership is liable for liquidated damages under the service
agreement if it fails to accept the minimum amount of waste or to meet other
performance standards under the service agreement. The liquidated damages, an
off balance sheet risk for Katy, are equal to the amount of the Industrial
Revenue Bonds outstanding, less $4.0 million maintained in a debt service
reserve trust. Management does not expect non-performance by the other parties.
Additionally, Montenay has agreed to indemnify Katy for any breach of the
service agreement by the partnership.
11
Following are scheduled principal repayments on the loan agreement (and
the Industrial Revenue Bonds) as of June 30, 2005 (amounts in thousands):
2005 $ 8,370
2006 15,300
------------
Total $ 23,670
============
(5) Indebtedness
On April 20, 2004, the Company completed a refinancing of its outstanding
indebtedness (the "Refinancing") and entered into a new agreement with Bank of
America Business Capital (formerly Fleet Capital Corporation) (the "Bank of
America Credit Agreement"). Like the previous credit agreement with Fleet
Capital Corporation, the Bank of America Credit Agreement is a $110 million
facility with a $20 million term loan ("Term Loan") and a $90 million revolving
credit facility ("Revolving Credit Facility") with essentially the same terms as
the previous credit agreement. The Bank of America Credit Agreement is an
asset-based lending agreement and involves a syndicate of four banks, all of
which participated in the syndicate from the previous credit agreement. In
addition, the Bank of America Credit Agreement contains credit sub-facilities in
Canada and the United Kingdom which allows the Company to borrow funds locally
in these countries and provide a natural hedge against currency fluctuations.
Under the Bank of America Credit Agreement, the Term Loan has a final
maturity date of April 20, 2009 with quarterly payments of $0.7 million. The
Term Loan is collateralized by the Company's property, plant and equipment. The
Revolving Credit Facility also has an expiration date of April 20, 2009 and its
borrowing base is determined by eligible inventory and accounts receivable.
Unused borrowing availability on the Revolving Credit Facility was $22.6 million
at June 30, 2005. All extensions of credit under the Bank of America Credit
Agreement are collateralized by a first priority security interest in and lien
upon the capital stock of each material domestic subsidiary (65% of the capital
stock of each material foreign subsidiary), and all present and future assets
and properties of Katy. Customary restrictions apply under the Bank of America
Credit Agreement.
Until September 30, 2004, interest accrued on Revolving Credit Facility
borrowings at 175 basis points over applicable LIBOR rates and at 200 basis
points over LIBOR for borrowings under the Term Loan. In accordance with the
Bank of America Credit Agreement, margins (i.e. the interest rate spread above
LIBOR) increased by 25 basis points in the fourth quarter of 2004 and an
additional 25 basis points in the first quarter of 2005 based on our leverage
ratio (as defined in the Bank of America Credit Agreement) as of September 30
and December 31, 2004, respectively. Margins increased another 50 basis points
upon the effective date of the Third Amendment (see below). Additionally,
margins on the Term Loan will drop 25 basis points if the balance of the Term
Loan is reduced below $10.0 million. Interest accrues at higher margins on prime
rates for swing loans, the amounts of which were nominal at June 30, 2005.
Long-term debt consists of the following (amounts in thousands):
June 30, December 31,
2005 2004
------------ ------------
Term loan payable under the Bank of America Credit Agreement, interest
based on LIBOR and Prime Rates (6.375% - 7.5%), due through 2009 $ 16,429 $ 18,571
Revolving loans payable under the Bank of America Credit Agreement,
interest based on LIBOR and Prime Rates (6% - 7.25%) 39,547 40,166
------------ ------------
Total debt 55,976 58,737
Less revolving loans, classified as current (see below) (39,547) (40,166)
Less current maturities (2,857) (2,857)
------------ ------------
Long-term debt $ 13,572 $ 15,714
============ ============
12
Aggregate remaining scheduled maturities of the Term Loan as of June 30,
2005 are as follows (amounts in thousands):
2005 $ 715
2006 2,857
2007 2,857
2008 2,857
2009 7,143
The Revolving Credit Facility under the Bank of America Credit Agreement
requires lockbox agreements which provide for all receipts to be swept daily to
reduce borrowings outstanding. These agreements, combined with the existence of
a material adverse effect ("MAE") clause in the Bank of America Credit
Agreement, cause the Revolving Credit Facility to be classified as a current
liability per guidance in Emerging Issues Task Force Issue No. 95--22, Balance
Sheet Classification of Borrowings Outstanding under Revolving Credit Agreements
that Include Both a Subjective Acceleration Clause and a Lock-Box Arrangement.
The Company does not expect to repay, or be required to repay, within one year,
the balance of the Revolving Credit Facility classified as a current liability.
The MAE clause, which is a typical requirement in commercial credit agreements,
allows the lenders to require the loan to become due if they determine there has
been a material adverse effect on the Company's operations, business,
properties, assets, liabilities, condition or prospects. The classification of
the Revolving Credit Facility as a current liability was a result only of the
combination of 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 April 20, 2009. The lender has not notified Katy of
any indication of a MAE at June 30, 2005, and to management's knowledge, the
Company was not in violation of any provision of the Bank of America Credit
Agreement, as amended, at June 30, 2005.
The Company determined that due to declining profitability in the fourth
quarter of 2004, potentially lower profitability in the first half of 2005 and
the timing of certain restructuring payments, it would not meet its Fixed Charge
Coverage Ratio (as defined in the Bank of America Credit Agreement) and could
potentially exceed its maximum Consolidated Leverage Ratio (also as defined in
the Bank of America Credit Agreement) as of the end of the first, second and
third quarters of 2005. In anticipation of not achieving the minimum Fixed
Charge Coverage Ratio or exceeding the maximum Consolidated Leverage Ratio, the
Company obtained an amendment to the Bank of America Credit Agreement (the
"Second Amendment"). The Second Amendment applied only to the first three
quarters of 2005 and the covenants would have returned to their original levels
for the fourth quarter of 2005. Specifically, the Second Amendment eliminated
the Fixed Charge Coverage Ratio, increased the maximum Consolidated Leverage
Ratio, established a Minimum Consolidated EBITDA (on a latest twelve months
basis) for each of the periods and also established a Minimum Availability (the
eligible collateral base less outstanding borrowings and letters of credit) on
each day within the nine-month period.
Subsequent to the Second Amendment's effective date, the Company
determined that it would likely not meet its amended financial covenants. On
April 13, 2005, the Company obtained a further amendment to the Bank of America
Credit Agreement (the "Third Amendment"). The Third Amendment eliminates the
maximum Consolidated Leverage Ratio and the Minimum Consolidated EBITDA as
established by the Second Amendment and adjusts the Minimum Availability such
that our eligible collateral must exceed the sum of the Company's outstanding
borrowings and letters of credit under the Revolving Credit Facility by at least
$5 million from the effective date of the Third Amendment through September 29,
2005 and by at least $7.5 million from September 30, 2005 until the date the
Company delivers its financial statements for the first quarter of 2006 to its
lenders. Subsequent to the delivery of the financial statements for the first
quarter of 2006 the Third Amendment reestablishes the minimum Fixed Charge
Coverage Ratio as originally set forth in the Bank of America Credit Agreement.
The Third Amendment also reduces the maximum allowable capital expenditures for
2005 from $15 million to $10 million, and increases the interest rate margins on
all of the Company's outstanding borrowings and letters of credit to the largest
margins set forth in the Bank of America Credit Agreement. Effective April 13,
2005, interest accrues on the Revolving Credit Facility and Term Loan borrowings
at 275 and 300 basis points over LIBOR, respectively. Interest rate margins will
return to levels set forth in the Bank of America Credit Agreement subsequent to
the delivery of the Company's financial statements for the first quarter of 2006
to its lenders.
If the Company is unable to comply with the terms of the amended
covenants, it may be required to obtain further amendments and pursue increased
liquidity through additional debt financing and/or the sale of assets. The
Company believes that given its strong working capital base, additional
liquidity could be obtained through additional debt financing, if
13
necessary. However, there is no guarantee that such financing could be obtained.
In addition, the Company is continually evaluating alternatives relating to the
sale of excess assets and divestitures of certain of its business units. Asset
sales and business divestitures present opportunities to provide additional
liquidity by de-leveraging our financial position.
Letters of credit totaling $9.1 million were outstanding at June 30, 2005,
which reduced the unused borrowing availability under the Revolving Credit
Facility.
All of the debt under the Bank of America Credit Agreement is re-priced to
current rates at frequent intervals. Therefore, its fair value approximates its
carrying value at June 30, 2005.
Katy incurred additional debt issuance costs in 2004 associated with the
Bank of America Credit Agreement. Additionally, at the time of the inception of
the Bank of America Credit Agreement, Katy had approximately $4.0 million of
unamortized debt issuance costs associated with the previous credit agreement.
The remainder of the previously capitalized costs, along with the capitalized
costs incurred in connection with the Bank of America Credit Agreement, will be
amortized over the life of the Bank of America Credit Agreement through April
2009. Future quarterly amortization expense is expected to be approximately $0.3
million. During the six months ended June 30, 2004, Katy incurred fees and
expenses of $0.4 million (reported in Other, net on the Condensed Consolidated
Statements of Operations) associated with a financing which the Company chose
not to pursue.
(6) Retirement Benefit Plans
Several of the Company's subsidiaries have pension plans covering
substantially all of their employees. These plans are noncontributory, defined
benefit pension plans. The benefits to be paid under these plans are generally
based on employees' retirement age and years of service. The companies' funding
policies, subject to the minimum funding requirement of employee benefit and tax
laws, are to contribute such amounts as determined on an actuarial basis to
provide the plans with assets sufficient to meet the benefit obligations. Plan
assets consist primarily of fixed income investments, corporate equities and
government securities. The Company also provides certain health care and life
insurance benefits for some of its retired employees. The post-retirement health
plans are unfunded. Katy uses an annual measurement date of December 31 for the
majority of its pension and other postretirement benefit plans for all years
presented. Information regarding the Company's net periodic benefit cost for
pension and other postretirement benefit plans for the three and six months
ended June 30, 2005 and 2004, is as follows (amounts in thousands):
Pension Benefits
-------------------------------------
Three Months Six Months
Ended June 30, Ended June 30,
2005 2004 2005 2004
------ ------ ------ ------
Components of net periodic benefit cost:
Service cost $ 2 $ 1 $ 4 $ 2
Interest cost 24 32 47 64
Expected return on plan assets (26) (32) (52) (65)
Amortization of net gain 19 17 39 34
------ ------ ------ ------
Net periodic benefit cost $ 19 $ 18 $ 38 $ 35
====== ====== ====== ======
14
Other Benefits
-------------------------------------
Three Months Six Months
Ended June 30, Ended June 30,
2005 2004 2005 2004
------ ------ ------ ------
Components of net periodic benefit cost:
Service cost $ -- $ 7 $ -- $ 14
Interest cost 48 40 95 80
Amortization of prior service cost 15 15 30 30
Amortization of net gain 15 -- 30 --
------ ------ ------ ------
Net periodic benefit cost $ 78 $ 62 $ 155 $ 124
====== ====== ====== ======
There are no required contributions to the pension plans for 2005 and Katy
did not make any contributions during the first and second quarters of 2005.
(7) Income Taxes
As of June 30, 2005 and December 31, 2004, the Company had deferred tax
assets, net of deferred tax liabilities, of approximately $61.3 million.
Domestic net operating loss (NOL) carry forwards comprised $28.9 million of the
deferred tax assets. Katy's history of operating losses in many of its taxing
jurisdictions provides significant negative evidence with respect to the
Company's ability to generate future taxable income, a requirement in order to
recognize deferred tax assets on the Condensed Consolidated Balance Sheets. For
this reason, the Company was unable to conclude at June 30, 2005 and December
31, 2004 that NOLs and other deferred tax assets in the United States and
certain unprofitable foreign jurisdictions would be utilized in the future. As a
result, valuation allowances for these entities were recorded as of such dates
for the full amount of deferred tax assets, net of the amount of deferred tax
liabilities.
The benefit for income taxes for the three and six months ended June 30,
2005 reflects a foreign income tax benefit net of a current expense for state
income taxes. The provision for income taxes for the three and six months ended
June 30, 2004 reflects a foreign income tax provision offset by a current
benefit for state income taxes. In both 2005 and 2004, tax benefits were not
recorded in the U.S. (for federal and most state income taxes) and for certain
foreign jurisdictions on pre-tax net losses. As a result of accumulated
operating losses in those jurisdictions, the Company has concluded that it was
more likely than not that such benefits would not be realized.
(8) Commitments and Contingencies
General Environmental Claims
15
The Company and certain of its current and former direct and indirect
corporate predecessors, subsidiaries and divisions are involved in remedial
activities at certain present and former locations and have been identified by
the United States Environmental Protection Agency ("EPA"), state environmental
agencies and private parties as potentially responsible parties ("PRPs") at a
number of hazardous waste disposal sites under the Comprehensive Environmental
Response, Compensation and Liability Act ("Superfund") or equivalent state laws
and, as such, may be liable for the cost of cleanup and other remedial
activities at these sites. Responsibility for cleanup and other remedial
activities at a Superfund site is typically shared among PRPs based on an
allocation formula. Under the federal Superfund statute, parties could be held
jointly and severally liable, thus subjecting them to potential individual
liability for the entire cost of cleanup at the site. Based on its estimate of
allocation of liability among PRPs, the probability that other PRPs, many of
whom are large, solvent, public companies, will fully pay the costs apportioned
to them, currently available information concerning the scope of contamination,
estimated remediation costs, estimated legal fees and other factors, the Company
has recorded and accrued for environmental liabilities in amounts that it deems
reasonable and believes that any liability with respect to these matters in
excess of the accruals will not be material. The ultimate costs will depend on a
number of factors and the amount currently accrued represents management's best
current estimate of the total costs to be incurred. The Company expects this
amount to be substantially paid over the next one to four years.
W.J. Smith Wood Preserving Company ("W.J. Smith")
The W. J. Smith matter originated in the 1980s when the United States and
the State of Texas, through the Texas Water Commission, initiated environmental
enforcement actions against W.J. Smith alleging that certain conditions on the
W.J. Smith property (the "Property") violated environmental laws. In order to
resolve the enforcement actions, W.J. Smith engaged in a series of cleanup
activities on the Property and implemented a groundwater monitoring program.
In 1993, the EPA initiated a proceeding under Section 7003 of the Resource
Conservation and Recovery Act ("RCRA") against W.J. Smith and Katy. The
proceeding sought certain actions at the site and at 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. W. J. Smith and Katy have completed the cleanup activities
required by the Order.
Since 1990, the Company has spent in excess of $7.0 million undertaking
cleanup and compliance activities in connection with this matter. While ultimate
liability with respect to this matter is not easy to determine, the Company has
recorded and accrued amounts that it deems reasonable for prospective
liabilities with respect to this matter and believes that any additional
liability with respect to this matter in excess of the accrual will not be
material.
In addition to the administrative claim specifically identified above, a
purported class action lawsuit was filed by 20 individuals in federal court in
the Marshall Division of the Eastern District of Texas, on behalf of "landowners
and persons who reside and/or work in" an identified geographical area
surrounding the W.J. Smith Wood Preserving facility in Denison, Texas. The
lawsuit purported to allege claims under state law for negligence, trespass,
nuisance and assault and battery. It sought damages for personal injury and
property damage, as well as punitive damages. The named defendants were Union
Pacific Corporation, Union Pacific Railroad Company, Katy Industries and W.J.
Smith Wood Preserving Company, Inc. On June 10, 2002, Katy and W.J. Smith filed
a motion to dismiss the case for lack of federal jurisdiction, or in the
alternative, to transfer the case to the Sherman Division. In response,
plaintiffs filed a motion for leave to amend the complaint to add a federal
claim under the RCRA. On July 30, 2002, the court dismissed plaintiffs' lawsuit
in its entirety.
On July 31, 2002, plaintiffs filed a new lawsuit against the same
defendants, again in the Marshall Division of the Eastern District of Texas,
alleging property damage class action claims under the federal Comprehensive
Environmental Response Compensation & Liability Act ("CERCLA"), as well as state
common law theories. The Company deposed all of the proposed class
representatives and on October 31, 2003, filed a motion for summary judgment on
the grounds that the court lacked jurisdiction and that Plaintiffs' claims are
barred by the applicable statute of limitations. Plaintiffs filed a motion for
class certification on the property damage claims on that date as well. By
Memorandum Opinion and Order dated June 8, 2004, the Court granted the Company's
Motion for Summary Judgment on the federal jurisdictional claim and dismissed
the case. The Company has not been notified of an appeal and the time for
appealing the decision has passed.
Asbestos Claims
16
A. The Company has recently been named as a defendant in seven lawsuits
filed in state court in Alabama by a total of approximately 62 individual
plaintiffs. There are over 100 defendants named in each case. In all seven
cases, the Plaintiffs claim that they were exposed to asbestos in the course of
their employment at a former U.S. Steel plant in Alabama and, as a result,
contracted mesothelioma, asbestosis, lung cancer or other illness. They claim
that they were exposed to asbestos in products in the plant which were
manufactured by each defendant. In five of the cases, Plaintiffs also assert
wrongful death claims. The Company will vigorously defend the claims against it
in these matters. The liability of the Company cannot be determined at this
time.
B. Sterling Fluid Systems (USA) has tendered over 1,800 cases pending in
Michigan, New Jersey, Illinois, Nevada, Mississippi, Wyoming, Louisiana,
Georgia, Massachusetts and California to the Company for defense and
indemnification. With respect to one case, Sterling has demanded that Katy
indemnify it for a $200,000 settlement. Sterling bases its tender of the
complaints on the provisions contained in a 1993 Purchase Agreement between the
parties whereby Sterling purchased the LaBour Pump business and other assets
from the Company. Sterling has not filed a lawsuit against Katy in connection
with these matters.
The tendered complaints all purport to state claims against Sterling and
its subsidiaries. The Company and its current subsidiaries are not named as
defendants. The plaintiffs in the cases also allege that they were exposed to
asbestos and products containing asbestos in the course of their employment.
Each complaint names as defendants many manufacturers of products containing
asbestos, apparently because plaintiffs came into contact with a variety of
different products in the course of their employment. Plaintiffs' claim that
LaBour Pump and/or Sterling may have manufactured some of those products.
With respect to many of the tendered complaints, including the one settled
by Sterling for $200,000, the Company has taken the position that Sterling has
waived its right to indemnity by failing to timely request it as required under
the 1993 Purchase Agreement. With respect to the balance of the tendered
complaints, the Company has elected not to assume the defense of Sterling in
these matters.
C. LaBour Pump Company, a former subsidiary of the Company, has been named
as a defendant in over 290 similar cases in New Jersey. These cases have also
been tendered by Sterling. The Company has elected to defend these cases, many
of which have been dismissed or settled for nominal sums.
While the ultimate liability of the Company related to the asbestos
matters above cannot be determined at this time, the Company has recorded and
accrued amounts that it deems reasonable for prospective liabilities with
respect to this matter.
Non-Environmental Litigation - Banco del Atlantico, S.A.
17
Banco del Atlantico, S.A. v. Woods Industries, Inc., et al. Civil Action
No. L-96-139 (U.S. District Court, Southern District of Texas). In December
1996, Banco del Atlantico ("plaintiff"), a bank located in Mexico, filed a
lawsuit in Texas against Woods Industries, Inc. ("Woods"), a subsidiary of Katy,
and against certain past and/or then present officers, directors and former
owners of Woods (collectively, "defendants"). The plaintiff alleges that the
defendants participated in violations of the Racketeer Influenced and Corrupt
Organizations Act ("RICO") involving, among other things, allegedly fraudulently
obtained loans from Mexican banks (including the plaintiff) and "money
laundering" of the proceeds of the illegal enterprise. The plaintiff alleges
that it made loans to a Mexican corporation controlled by certain past officers
and directors of Woods based upon fraudulent representations and guarantees. The
plaintiff also alleges violations of the Indiana RICO and Crime Victims Act,
common law fraud and conspiracy, fraudulent transfer claims, and seeks recovery
upon certain alleged guarantees purportedly executed by Woods Wire Products,
Inc., a predecessor company from which Woods purchased certain assets in 1993
(prior to Woods's ownership by Katy, which began in December 1996). The primary
legal theories under which the plaintiff seeks to hold Woods liable for its
alleged damages are respondeat superior, conspiracy, successor liability, or a
combination of the three.
After several years of procedural disputes, this lawsuit has become more
active recently. In 2003, by order of the Southern District of Texas court, the
case was transferred to the Southern District of Indiana on the ground that
Indiana has a closer relationship to this case than Texas. The case is currently
pending in the Southern District of Indiana. In December 2003, the plaintiff
filed an Amended Complaint. There have been various motions to dismiss filed by
the defendants. These motions have been denied by the court or have become
mooted by subsequent filings by the plaintiff.
In September 2004, the plaintiff and HSBC Mexico, S.A. (collectively,
"plaintiffs"), an additional alleged owner of the Amended Complaint's claims
against the defendants, filed a Second Amended Complaint, which includes new
allegations and seeks additional relief from the defendants. The Second Amended
Complaint also adds new defendants (none of which is affiliated with the
Company) and claims, although the fundamental nature of the lawsuit, described
above, remains the same.
The defendants filed motions to dismiss the Second Amended Complaint on
November 8, 2004. These motions sought dismissal of plaintiffs' Second Amended
Complaint on grounds of, among other things, forum non conveniens and failure to
state a claim. The plaintiffs have responded to defendants' motions and the
defendants have replied. A new Case Management Plan has also been entered in the
case, which ties further case deadlines, including the date for close of
discovery and trial of this action, to the court's "last ruling" on the pending
motions to dismiss. Discovery is continuing.
On June 15, 2005, the court denied defendants' renewed motion to dismiss
for forum non conveniens. The defendants' other motions to dismiss remain
pending before the court.
The plaintiffs' Second Amended Complaint claims damages in excess of $24
million and is requesting that damages be trebled under Indiana and federal
RICO, and/or the Indiana Crime Victims Act. The Second Amended Complaint also
requests that the court void certain transactions and asset sales as purported
"fraudulent transfers," including the 1993 Woods Wire Products, Inc. - Woods
asset sale, and seeks other relief. Because various jurisdictional and
substantive issues have not yet been fully adjudicated, 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 also have recourse against
the former owners 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. Woods may
also have indemnity claims against the former officers and directors. In
addition, there is a dispute with the former owners of Woods regarding the final
disposition of amounts withheld from the purchase price, which may be subject to
further adjustment as a result of the claims by the plaintiff. The extent or
limit of any such adjustment cannot be predicted at this time.
While the ultimate liability of the Company related to this matter cannot
be determined at this time, the Company has recorded and accrued amounts that it
deems reasonable for prospective liabilities with respect to this matter.
Other Claims
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
18
years from the date of the injury to reach a final outcome on certain claims.
With respect to the product liability and workers' compensation claims, Katy has
provided for its share of expected losses beyond the applicable insurance
coverage, including those incurred but not reported to the Company or its
insurance providers, which are developed using actuarial techniques. Such
accruals are developed using currently available claim information, and
represent management's best estimates. The ultimate cost of any individual claim
can vary based upon, among other factors, the nature of the injury, the duration
of the disability period, the length of the claim period, the jurisdiction of
the claim and the nature of the final outcome.
Although management believes that the actions specified above in this
section individually and in the aggregate are not likely to have outcomes that
will have a material adverse effect on the Company's financial position, results
of operations or cash flow, further costs could be significant and will be
recorded as a charge to operations when, and if, current information dictates a
change in management's estimates.
(9) Industry Segment Information
The Company is organized into two operating segments: Maintenance Products
and Electrical Products. The activities of the Maintenance Products Group
include the manufacture and distribution of a variety of commercial cleaning
supplies and consumer home and automotive storage products. The Electrical
Products Group is a distributor of consumer electrical corded products. The
following table sets forth information by segment (amounts in thousands):
19
Three months ended June 30, Six months ended June
2005 2004 2005 2004
---- ---- ---- ----
Maintenance Products Group
Net external sales $ 63,869 $ 69,736 $ 125,342 $ 140,226
Operating (loss) income (450) (810) (4,528) $ 1,596
Operating (deficit) margin (0.7%) (1.2%) (3.6%) 1.1%
Depreciation and amortization 2,637 3,554 5,126 7,001
Capital expenditures 1,507 3,132 2,803 5,498
Electrical Products Group
Net external sales $ 34,341 $ 30,786 $ 68,381 $ 60,191
Operating income 1,150 2,513 4,063 4,550
Operating margin 3.3% 8.2% 5.9% 7.6%
Depreciation and amortization 349 281 703 584
Capital expenditures 44 156 151 204
Total
Net external sales - Operating segments $ 98,210 $ 100,522 $ 193,723 $ 200,417
------------------------- -------------------------
Total $ 98,210 $ 100,522 $ 193,723 $ 200,417
========================= =========================
Operating income (loss) - Operating segments $ 700 $ 1,703 $ (465) $ 6,146
- Unallocated corporate (2,633) (2,133) (4,299) (4,694)
- Stock option expense (1,953) -- (1,953) --
- Severance, restructuring,
and related charges (income) (940) 109 (1,313) (1,789)
------------------------- -------------------------
Total $ (4,826) $ (321) $ (8,030) $ (337)
========================= =========================
Depreciation and amortization - Operating segments $ 2,986 $ 3,835 $ 5,829 $ 7,585
- Unallocated corporate 36 72 40 124
------------------------- -------------------------
Total $ 3,022 $ 3,907 $ 5,869 $ 7,709
========================= =========================
Capital expenditures - Operating segments $ 1,551 $ 3,288 $ 2,954 $ 5,702
- Unallocated corporate -- 1 -- 2
------------------------- -------------------------
Total $ 1,551 $ 3,289 $ 2,954 $ 5,704
========================= =========================
June 30, December 31,
2005 2004
---- ----
Total assets - Maintenance Products Group $ 136,420 $ 154,635
- Electrical Products Group 54,210 57,698
- Other [a] 1,618 1,624
- Unallocated corporate 6,384 10,507
-------------------------
Total $ 198,632 $ 224,464
=========================
[a] The amount shown as "Other" represents an equity investment in a shrimp
harvesting and farming operation.
20
(10) Severance, Restructuring and Related Charges
The Company has initiated several cost reduction and facility
consolidation initiatives since its recapitalization in mid-2001, resulting in
severance, restructuring and related charges over the past three years. A
summary of severance, restructuring and related charges (income) (by major
initiative) for the three and six months ended June 30, 2005 and 2004,
respectively, is as follows (amounts in thousands):
Three Months Ended June 30, Six Months Ended June 30,
2005 2004 2005 2004
-------- -------- -------- --------
Consolidation of abrasives facilities $ 809 $ 317 $ 924 $ 663
Consolidation of St. Louis manufacturing/distribution facilities (33) (279) 48 (102)
Consolidation of administrative functions for CCP -- 32 21 172
Shutdown of Woods Canada manufacturing -- (60) (19) 1,042
Other 164 (119) 339 14
-------- -------- -------- --------
Total severance, restructuring and related (income) costs $ 940 $ (109) $ 1,313 $ 1,789
======== ======== ======== ========
Consolidation of abrasives facilities - In 2002, the Company initiated a
plan to consolidate the manufacturing facilities of its abrasives business in
order to implement a more competitive cost structure. The Lawrence,
Massachusetts, facility ceased production in the second quarter of 2005, while
the Pineville, North Carolina, facility is expected to close in early 2006. Each
of these operations will be consolidated into the newly expanded Wrens, Georgia
facility. Costs incurred in the six months ended June 30, 2005 related to
severance associated with the Lawrence facility ($0.3 million), idle facility
costs ($0.2 million), costs for demolition and repair of the Loren facility
($0.1 million) and various other consolidation related costs ($0.3 million).
Costs incurred in the six months ended June 30, 2004 related to the closure of
the Pineville facility ($0.3 million), severance for expected terminations at
the Lawrence facility ($0.2 million) and expenses for the preparation of the
Wrens facility ($0.1 million).
Consolidation of St. Louis manufacturing/distribution facilities -
Starting in 2001, the Company developed a plan to consolidate the manufacturing
and distribution of the four CCP facilities in the St. Louis area. Charges in
2005 were for miscellaneous costs for the termination of the Warson Road
facility lease and the movement of equipment from Hazelwood to Bridgeton, offset
by a credit related to the non-cancelable lease adjustment at the Hazelwood
facility. In the first half of 2004, a credit of $0.4 million was recorded to
reverse a non-cancelable lease accrual based on a change in usage of leased
facility (Hazelwood, Missouri) that was previously impaired and was offset by
costs of $0.2 million related primarily to the movement of equipment between
facilities.
Consolidation of administrative functions for CCP - Katy has incurred
various costs in 2005 and 2004 for the integration of back office and
administrative functions into St. Louis, Missouri from the various operating
divisions within the Maintenance Products Group. For the three and six months
ended June 30, 2005, all costs related to an accrual for idle space at our
Textiles facility in Atlanta. For the three and six months ended June 30, 2004,
costs were incurred for system conversions and the consolidation of
administrative personnel.
Shutdown of Woods Canada manufacturing - In December 2003, Woods Canada
closed its manufacturing facility in Toronto, Ontario, after a decision was made
to source all of its products from Asia. In the first half of 2004, Woods Canada
incurred a charge of $1.0 million for a non-cancelable lease accrual associated
with a sale/leaseback transaction and idle capacity as a result of the shutdown
of manufacturing. Also in the first half of 2004, Woods Canada recorded less
than $0.1 million for additional severance.
Other - Charges in the first six months of 2005 related to severance
associated with the reduction in workforce principally due to the exit of
certain product lines in the Consumer Plastics business units in the U.S. ($0.2
million) and the U.K. ($0.1 million). Costs in the first half of 2004 relate
primarily to the closure of CCP's facility in Canada
21
and the subsequent consolidation into the Woods Canada facility, and the closure
of CCP's metals facility in Santa Fe Springs, California.
The table below details activity in restructuring reserves since December
31, 2004 (amounts in thousands):
One-time Contract
Termination Termination
Total Benefits [a] Costs [b] Other [c]
-------- ------------ ------------ ---------
Restructuring liabilities at December 31, 2004 $ 4,454 $ 807 $ 3,647 $ --
Additions 1,378 684 241 453
Reductions (65) (19) (46) --
Payments (1,773) (829) (580) (364)
Currency translation and other 95 (1) 96 --
-------- ------------ ------------ --------
Restructuring liabilities at June 30, 2005 $ 4,089 $ 642 $ 3,358 $ 89
======== ============ ============ ========
[a] Includes severance, benefits, and other employee-related costs associated
with the employee terminations.
[b] Includes charges related to non-cancelable lease liabilities for abandoned
facilities, net of potential sub-lease revenue.
[c] Includes charges associated with moving inventory, machinery and
equipment, and the consolidation of administrative and operational
functions.
Katy expects to substantially complete its restructuring program in 2005.
The remaining severance, restructuring and related charges for these initiatives
are expected to be less than $1.0 million. Payments associated with
non-cancelable lease liabilities for abandoned facilities are scheduled to end
in 2011.
The table below details activity in restructuring and related reserves by
operating segment since December 31, 2004 (amounts in thousands):
Maintenance Electrical
Products Products
Total Group Group
-------- ------------ ------------
Restructuring liabilities at December 31, 2004 4,454 $ 3,385 $ 1,069
Additions 1,378 1,378 --
Reductions (65) (46) (19)
Payments (1,773) (1,559) (214)
Currency translation and other 95 -- 95
-------- ------------ ------------
Restructuring liabilities at June 30, 2005 $ 4,089 $ 3,158 $ 931
======== ============ ============
The table below summarizes the future obligations for severance,
restructuring and other related charges by operating segment detailed above
(amounts in thousands):
22
Maintenance Electrical
Products Products
Total Group Group
-------- ------------ ------------
2005 $ 1,286 $ 1,054 $ 232
2006 1,132 835 297
2007 446 275 171
2008 412 231 181
2009 289 243 46
Thereafter 524 524 --
-------- ------------ ------------
Total Payments $ 4,089 $ 3,162 $ 927
======== ============ ============
23
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
Three Months Ended June 30, 2005 versus Three Months Ended June 30, 2004
2005 2004
------------------------ ------------------------
(Amounts in Millions, Except Per Share Data)
---------- ---------- ---------- ----------
$ % to Sales $ % to Sales
---------- ---------- ---------- ----------
Net sales $ 98.2 100.0 $ 100.5 100.0
Cost of goods sold 86.4 88.0 87.3 86.8
---------- ---------- ---------- ----------
Gross profit 11.8 12.0 13.3 13.2
Selling, general and administrative expenses 13.9 14.1 14.2 14.2
Stock option expense 2.0 2.0 -- --
Severance, restructuring and related charges (income) 0.9 1.0 (0.1) (0.1)
Gain on sale of assets (0.2) (0.2) (0.5) (0.5)
---------- ---------- ---------- ----------
Operating loss (4.8) (4.9) (0.3) (0.3)
========== ==========
Interest expense (1.4) (1.0)
Other, net -- 0.1
---------- ----------
Loss before (benefit) provision for income taxes (6.2) (1.2)
(Benefit) provision for income taxes (0.1) 0.1
---------- ----------
Net loss (6.0) (1.3)
Payment-in-kind dividends on convertible preferred stock -- (3.5)
---------- ----------
Net loss attributable to common stockholders $ (6.0) $ (4.7)
========== ==========
Loss per share of common stock - basic and diluted:
Net loss $ (0.76) $ (0.16)
Payment-in-kind dividends on convertible preferred stock -- (0.44)
---------- ----------
Net loss attributable to common stockholders $ (0.76) $ (0.60)
========== ==========
Overview
Our consolidated net sales for the three month period ended June 30, 2005
decreased $2.3 million compared to the three month period ended June 30, 2004.
The decline in net sales of 2% was comprised of lower volumes [(7%)], higher
pricing [4%] and favorable currency translation [1%]. Gross margins were 12.0%
for the three month period ended June 30, 2005, a decrease of 1.2 percentage
points compared to the three month period ended June 30, 2004. Higher raw
material costs and incremental operating costs incurred due to the delayed
consolidation of the abrasives facilities were partially offset by selling price
increases. Selling, general and administrative expense (SG&A) as a percentage of
sales decreased from 14.2% for the second quarter of 2004 to 14.1% in the second
quarter of 2005, primarily due to cost containment in the Maintenance Products
Group partially offset by non-recurring corporate costs. The operating loss
increased by $4.5 million
24
to ($4.8) million, mostly due to lower sales volumes, lower gross margins ,
higher non-cash stock option expense and higher severance and restructuring
costs.
Overall, we reported a net loss attributable to common shareholders of
($6.0) million [($0.76) per share] for the three month period ended June 30,
2005, versus a net loss attributable to common shareholders of ($4.7) million
[($0.60) per share] in the same period of 2004. During the second quarter of
2004, we recorded the impact of payment-in-kind dividends earned on our
convertible preferred stock of ($3.5) million [($0.44) per share]. The
payment-in-kind dividends ended in December 2004.
Net Sales
Maintenance Products Group
Net sales from the Maintenance Products Group decreased from $69.7 million
during the three month period ended June 30, 2004 to $63.9 million during the
three month period ended June 30, 2005. Overall, this decline of 8% was
primarily due to lower volumes [(13%)] partially offset by higher pricing [5%].
Sales volume for the Consumer Plastics business units in the U.S. and the U.K.,
which sell primarily to mass merchant customers, was significantly lower due to
our decision to exit certain unprofitable product lines. In addition, volumes at
our U.K. Consumer Plastics business unit were negatively impacted by softening
demand due to a weak retail sector in the U.K. We also experienced volume
declines in our Abrasives business unit in the U.S. due to shipping and
production inefficiencies caused by the delayed consolidation of two abrasives
facilities into the Wrens, Georgia facility and a fire at our facility in Wrens
early in the fourth quarter of 2004 that disrupted production. The disruption to
our Abrasives operations has resulted in the loss of certain customers. These
decreases in Abrasives sales were partially offset by stronger sales of roofing
products to the construction industry. Sales volumes for our Container business
unit improved over last year principally due to available production capacity at
our Norwalk, California facility, which resulted from the exit of certain
product lines by the Consumer Plastics business.
Higher pricing resulted from the implementation of selling price increases
across the Maintenance Products Group, which took effect throughout the first
half of 2005, with the most significant increases in the domestic business
units. The implementation of price increases was in response to the accelerating
cost of our primary raw materials, packaging materials, utilities and freight
starting in 2004 and continuing into early 2005.
Electrical Products Group
The Electrical Products Group's sales improved from $30.8 million for the
three month period ended June 30, 2004 to $34.3 million for the three month
period ended June 30, 2005. The sales improvement of 12% was a primarily the
result of increased volume [7%], higher pricing [3%] and favorable currency
translation [2%]. Multiple selling price increases have been implemented since
the beginning of 2004 at Woods U.S. (and to a lesser extent at Woods Canada) to
offset the rising cost of copper and PVC. We continue to implement price
increases; however there can be no assurance that such increases will be
accepted. Woods Canada's pricing was negatively impacted by incremental program
costs in the second quarter of 2005 necessary to retain business with a
significant customer. Volume at Woods U.S. benefited principally from the timing
of orders, which shipped ahead of last year. Woods Canada experienced volume
increases primarily due to stronger sales of garden lighting, cords and multi
outlet/surge protector products. In addition, sales at Woods Canada were
favorably impacted by a stronger Canadian dollar versus the U.S. dollar in the
second quarter of 2005 as compared to the same period in 2004.
25
Operating Income
Three months ended June 30,
-------------------------------------
(Amounts in Millions)
Operating income (loss) 2005 2004 Change
----------------- ----------------- -----------------
% of % of % of
---- ---- ----
$ Sales $ Sales $ Sales
- ----- - ----- - -----
Maintenance Products Group $ (0.5) (0.7) $ (0.8) (1.2) $ 0.3 0.5
Electrical Products Group 1.2 3.3 2.5 8.2 (1.3) (4.9)
Unallocated corporate expense (2.6) (2.1) (0.5)
Stock option expense (2.0) -- (2.0)
Severance, restructuring and related income (charges) (0.9) 0.1 (1.0)
------ ------ ------
Operating loss $ (4.8) $ (0.3) $ (4.5)
====== ====== ======
Maintenance Products Group
The Maintenance Products Group's operating loss improved from $0.8 million
(-1.2% of net sales) during the three month period ended June 30, 2004 to an
operating loss of $0.5 million (-0.7% of net sales) for the three month period
ended June 30, 2005. The improvement was primarily attributable to SG&A cost
containment and the impact of higher selling prices which took effect in 2005
which outpaced the impact of higher raw material costs. Offsetting these items
was a decline in the profitability of our domestic Abrasives business resulting
from shipping and production inefficiencies caused by the delayed consolidation
of two facilities into the Wrens, Georgia facility and the fire at our facility
in Wrens in the fourth quarter of 2004 that disrupted production. In addition,
the Maintenance Products Group recorded a gain on the sale of assets during the
three months ended June 30, 2005 primarily related to the sale of excess
equipment at our U.S. plastic molding facilities, while the gain on the sale of
assets during the three months ended June 30, 2004 was for the sale of our
former metals facility in Santa Fe Springs, California.
Electrical Products Group
The Electrical Products Group's operating income decreased from $2.5
million (8.2% of net sales) for the three month period ended June 30, 2004 to
$1.2 million (3.3% of net sales) for the three month period ended June 30, 2005.
The decrease in profitability was principally the result of selling price
increases not quite keeping pace with the increasing costs of copper and PVC,
partially offset by stronger volumes. SG&A expenses were up proportionately with
the overall increase in sales.
Corporate
Corporate operating expenses increased from $2.1 million in the three
month period ended June 30, 2004 to $2.6 million in three month period ended
June 30, 2005 principally due to non-recurring severance costs and search fees
associated with the CEO transition in the second quarter of 2005.
Stock Option Expense
The non-cash stock option expense of $2.0 million during the three months
ended June 30, 2005 related to the March 2004 acceleration of vesting of options
that were held by our former CEO at that time. A substantial portion of these
options were forfeited by the former CEO upon his retirement, however. See Note
1 of the Notes to Condensed Consolidated Financial Statements.
Severance, Restructuring and Related Charges
Operating results for the Company during the three months ended June 30,
2005 and 2004 were impacted by severance, restructuring and related charges
(income) of $0.9 million and ($0.1) million, respectively. Charges in 2005
26
related to severance, facility closure costs and inventory and equipment moves
associated with the closure of one of our abrasives facilities ($0.8 million);
and severance associated with the reduction in workforce principally due to the
exit of certain product lines in the U.S. and U.K. Consumer Plastics business
units ($0.1 million).
Charges in the second quarter of 2004 related to the restructuring of the
abrasives business ($0.3 million); the movement of inventory and equipment in
connection with the consolidation of St. Louis manufacturing and distribution
facilities ($0.1 million), and costs incurred for the consolidation of
administrative functions for CCP and equipment removal and occupancy costs for
the Santa Fe Springs, California metals facility ($0.1 million), offset by
credits to reverse a non-cancelable lease accrual based on a change in usage of
a previously impaired leased facility (Hazelwood, Missouri) ($0.4 million); to
reverse a non-cancelable lease accrual based on a change in usage of leased
facility that was previously impaired at Woods U.S. ($0.1 million) and to
reverse a portion of a severance accrual at Woods Canada related to the December
2003 shutdown of their manufacturing facility ($0.1 million).
Other Items
Interest expense increased by $0.4 million in the second quarter of 2005
compared to the same period of 2004, primarily as a result of higher interest
rates in 2005 and increased margins over LIBOR pursuant to the Third Amendment
of our Bank of America Credit Agreement (see Note 5 of the Notes to Condensed
Consolidated Financial Statements).
The benefit for income taxes for the three months ended June 30, 2005
reflects a current expense for state income taxes and a foreign income tax
benefit. The provision for income taxes for the three months ended June 30, 2004
reflects a current benefit for state income taxes and a foreign income tax
provision. In both 2005 and 2004, tax benefits were not recorded in the U.S.
(for federal and state income taxes) and for certain foreign subsidiaries on
pre-tax net losses as a result of accumulated operating losses in the those
jurisdictions, as we concluded that it was more likely than not that such
benefits would not be realized. We recorded tax benefits for other foreign
subsidiaries as we concluded that it was more likely than not that such benefits
would be realized.
27
Six Months Ended June 30, 2005 versus Six Months Ended June 30, 2004
2005 2004
------------------------ ------------------------
(Amounts in Millions, Except Per Share Data)
---------- ---------- ---------- ----------
$ % to Sales $ % to Sales
---------- ---------- ---------- ----------
Net sales $ 193.7 100.0 $ 200.4 100.0
Cost of goods sold 172.4 89.0 170.5 85.1
---------- ---------- ---------- ----------
Gross profit 21.3 11.0 29.9 14.9
Selling, general and administrative expenses 26.2 13.5 29.0 14.5
Stock option expense 2.0 1.0 -- --
Severance, restructuring and related charges 1.3 0.7 1.8 0.9
Gain of sale of assets (0.2) (0.1) (0.5) (0.3)
---------- ---------- ---------- ----------
Operating loss (8.0) (4.1) (0.4) (0.2)
========== ==========
Interest expense (2.7) (1.8)
Other, net -- (0.2)
---------- ----------
Loss before provision for income taxes (10.7) (2.4)
Provision for income taxes -- 0.7
---------- ----------
Net loss (10.7) (3.1)
Payment-in-kind dividends on convertible preferred stock -- (6.9)
---------- ----------
Net loss attributable to common stockholders $ (10.7) $ (10.0)
========== ==========
Loss per share of common stock - basic and diluted:
Net loss $ (1.35) $ (0.39)
Payment-in-kind dividends on convertible preferred stock -- (0.88)
---------- ----------
Net loss attributable to common stockholders $ (1.35) $ (1.27)
========== ==========
Overview
Our consolidated net sales for the six month period ended June 30, 2005
decreased $6.7 million compared to the six month period ended June 30, 2004. The
decline in net sales of 3% was comprised of lower volumes [(9%)], offset by
higher pricing [5%] and favorable currency translation [1%]. Gross margins were
11.0% for the six month period ended June 30, 2005; a decrease of 3.9 percentage
points compared to the six month period ended June 30, 2004. Higher raw material
costs and incremental operating costs incurred due to the delayed consolidation
of the abrasives facilities were partially offset by selling price increases and
the favorable impact of restructuring and cost containment. Selling, general and
administrative expense (SG&A) as a percentage of sales declined from 14.5% for
the first six months of 2004 to 13.5% in the first six months of 2005, primarily
due to cost containment (mostly in the Electrical Products Group) offset by
non-recurring corporate expenses. The operating loss increased by $7.7 million
to ($8.0) million, mostly due to lower sales volumes, lower gross margins and
higher non-cash stock option expense.
Overall, we reported a net loss attributable to common shareholders of
($10.7) million [($1.35) per share] for the six month period ended June 30,
2005, versus a net loss attributable to common shareholders of ($10.0) million
[($1.27) per share] in the same period of 2004. During the first half of 2004,
we recorded the impact of payment-in-kind dividends
28
earned on our convertible preferred stock of ($6.9) million [($0.88) per share].
The payment-in-kind dividends ended in December 2004.
Net Sales
Maintenance Products Group
Net sales from the Maintenance Products Group decreased from $140.2
million during the six month period ended June 30, 2004 to $125.3 million during
the six month period ended June 30, 2005. Overall, this decline of 11% was
primarily due to lower volumes [(15%)] net of higher pricing [4%]. Sales volume
for the Consumer Plastics business units in the U.S. and the U.K., which sell
primarily to mass merchant customers, was significantly lower due to our
decision to exit certain unprofitable product lines. In addition, volumes at our
U.K Consumer Plastics business unit were negatively impacted by softening demand
due to a weak retail sector in the U.K. We also experienced volume declines in
our Abrasives business unit in the U.S. due to shipping and production
inefficiencies caused by the delayed consolidation of two abrasives facilities
into the Wrens, Georgia facility and a fire at our facility in Wrens in the
fourth quarter of 2004 that disrupted production. The disruption to our
Abrasives operations has resulted in the loss of certain customers. These
decreases in Abrasives sales were partially offset by stronger sales of roofing
products to the construction industry. Sales of Metal Truck Box products
declined in first half of 2005 versus the first half of 2004 primarily due to
lower demand from a major retail outlet customer, while sales of Textiles were
down slightly due to the loss of a customer. Sales volumes for our Container
business unit improved over last year principally due to available production
capacity at our Norwalk, California facility, which resulted from the exit of
certain product lines by the U.S. Consumer Plastics business.
Higher pricing resulted from the implementation of selling price increases
across the Maintenance Products Group, which took effect throughout the first
half of 2005, with the most significant increases in the domestic business
units. The implementation of price increases was in response to the accelerating
cost of our primary raw materials, packaging materials, utilities and freight
starting in 2004 and continuing into early 2005.
Electrical Products Group
The Electrical Products Group's sales improved from $60.2 million for the
six month period ended June 30, 2004 to $68.4 million for the six month period
ended June 30, 2005. The sales improvement of 14% was primarily the result of
higher pricing [8%], increased volume [4%] and favorable currency translation
[2%]. Multiple selling price increases were implemented since the beginning of
2004 at Woods U.S. (and to a lesser extent at Woods Canada) to offset the rising
cost of copper and PVC. We continue to implement price increases; however, there
can be no assurance that such increases will be accepted. Woods Canada's net
pricing was negatively impacted by incremental program costs necessary to retain
business with a significant customer. Volume at Woods U.S. benefited principally
from increased promotional activity at one of its largest mass merchant
retailers in the first quarter of 2005 and from the timing of orders, which
shipped ahead of last year. Sales at Woods Canada were favorably impacted by a
stronger Canadian dollar versus the U.S. dollar in the first half of 2005 as
compared to the same period in 2004.
29
Operating Income
Six months ended June 30,
----------------------------------
(Amounts in Millions)
Operating income (loss) 2005 2004 Change
----------------- ---------------- -----------------
% of % of % of
---- ---- ----
$ Sales $ Sales $ Sales
- ----- - ----- - -----
Maintenance Products Group $ (4.5) (3.6) $ 1.6 1.1 $ (6.1) (4.7)
Electrical Products Group 4.1 5.9 4.6 7.6 (0.5) (1.7)
Unallocated corporate expense (4.3) (4.7) 0.4
Stock option expense (2.0) -- (2.0)
Severance, restructuring and related charges (1.3) (1.8) 0.5
------ ------ ------
Operating loss $ (8.0) $ (0.3) $ (7.7)
====== ====== ======
Maintenance Products Group
The Maintenance Products Group's operating income decreased from $1.6
million (1.1% of net sales) during the six month period ended June 30, 2004 to
an operating loss of ($4.5) million (-3.6% of net sales) for the six month
period ended June 30, 2005. The decrease was primarily attributable to lower
volumes in the U.S. and U.K. Consumer Plastics and domestic Abrasives business
units. In addition, higher raw material costs in the first half of 2005 versus
the first half of 2004 were partially recovered through higher selling prices.
The impact of higher raw material costs had the most pronounced effect on the
gross margins of our business units which sell plastics products, although the
raw material costs appear to have stabilized and we were able to implement price
increases across most business units starting in the first quarter of 2005. In
addition, manufacturing throughput was low at our plastics molding facilities in
the U.S. and the U.K. in the first quarter as we reduced inventory and adjusted
our production levels in connection with our decision to exit certain
unprofitable lines of Consumer Plastics business. We continue to experience
declines in the profitability of our Abrasives business resulting from shipping
and production inefficiencies caused by the delayed consolidation of two
facilities into the Wrens, Georgia facility and the fire at our facility in
Wrens in the fourth quarter of 2004 that disrupted production. SG&A as a
percentage of net sales in the first half of 2005 was slightly lower versus the
first half of 2004 due mostly to cost containment measures. In addition, the
Maintenance Products Group recorded a gain on the sale of assets during the six
months ended June 30, 2005 primarily related to the sale of excess equipment at
our U.S. plastic molding facilities, while the gain on the sale of assets during
the six months ended June 30, 2004 was for the sale of our former metals
facility in Santa Fe Springs, California.
Electrical Products Group
The Electrical Products Group's operating income decreased from $4.6
million (7.6% of net sales) for the six month period ended June 30, 2004 to $4.1
million (5.9% of net sales) for the six month period ended June 30, 2005, a
decline of 11%. The lower profitability was principally the result of selling
price increases not quite keeping pace with the increasing costs of copper and
PVC, most notably in the second quarter. Lower gross margins were partially
offset by stronger volumes and lower SG&A which was primarily due to cost
containment initiatives.
Corporate
Corporate operating expenses decreased from $4.7 million in the six month
period ended June 30, 2004 to $4.3 million in the six month period ended June
30, 2005 principally due to lower bonus expense resulting from a decline in
operating performance and decreased expense for stock appreciation rights due to
a lower stock price offset by non-recurring severance costs and search fees
associated with the CEO transition in the second quarter of 2005.
Stock Option Expense
The non-cash stock option expense of $2.0 million during the six months
ended June 30, 2005 related to the March 2004 acceleration of vesting of options
that were held by our former CEO at that time. A substantial portion of these
options
30
were forfeited by the former CEO upon his retirement, however. See Note 1 of the
Notes to Condensed Consolidated Financial Statements.
Severance, Restructuring and Related Charges
Operating results for the Company during the six months ended June 30,
2005 and 2004 were negatively impacted by severance, restructuring and related
charges of $1.3 million and $1.8 million, respectively. Charges in 2005 related
to severance, facility closure costs and inventory and equipment moves
associated with the closure of one of our abrasives facilities ($0.9 million);
severance associated with the reduction in workforce principally due to the exit
of certain product lines in the U.S. and U.K. Consumer Plastics business units
($0.3 million) and charges aggregating to $0.1 million for miscellaneous costs
for the termination of the Warson Road facility lease and the movement of
inventory and equipment from Hazelwood to Bridgeton.
Charges in the first half of 2004 related to a non-cancelable lease
accrual associated with a sale/leaseback transaction and idle capacity as a
result of the shutdown of manufacturing at Woods Canada ($1.0 million); the
restructuring of the abrasives business ($0.7 million); costs incurred for the
consolidation of administrative functions for CCP ($0.2 million); costs for the
movement of inventory and equipment in connection with the consolidation of St.
Louis manufacturing and distribution facilities ($0.2 million); and expenses for
the closure of CCP's facility in Canada and the subsequent consolidation into
the Woods Canada facility ($0.1 million); partially offset by credits for
adjustments to non-cancelable leases based on changes in the usage of these
leased facilities ($0.4 million).
Other Items
Interest expense increased by $0.9 million in the first half of 2005
versus the same period of 2004, primarily as a result of higher interest rates
and increased margins over LIBOR pursuant to the Third Amendment of our Bank of
America Credit Agreement (see Note 5 of the Notes to Condensed Consolidated
Financial Statements). In addition, higher average borrowings in 2005
(principally due to increased working capital levels and poor financial
performance in the second half of 2004), contributed to the increase. Other, net
for the six months ended June 30, 2004 included the write-off of fees and
expenses of $0.4 million associated with a financing which the Company chose not
to pursue, offset by the write-off of net liabilities related to previously
divested businesses of $0.1 million.
The benefit for income taxes for the six months ended June 30, 2005
reflects a net foreign income tax benefit offset by a current expense for state
income taxes. The provision for income taxes for the six months ended June 30,
2004 reflects a current benefit for state income taxes and a foreign income tax
provision. In both 2005 and 2004, tax benefits were not recorded in the U.S.
(for federal and state income taxes) and for certain foreign subsidiaries on
pre-tax net losses as a result of accumulated operating losses in the those
jurisdictions, as we concluded that it was more likely than not that such
benefits would not be realized. We recorded tax benefits for other foreign
subsidiaries as we concluded that it was more likely than not that such benefits
would be realized.
LIQUIDITY AND CAPITAL RESOURCES
We require funding for working capital needs and capital expenditures. We
believe that our cash flow from operations and the use of available borrowings
under the Bank of America Credit Agreement (as defined below) provide sufficient
liquidity for our operations for the foreseeable future. As of June 30, 2005, we
had cash and cash equivalents of $4.1 million versus cash and cash equivalents
of $8.5 million at December 31, 2004. Also as of June 30, 2005, we had
outstanding borrowings of $56.0 million [49% of total capitalization], under the
Bank of America Credit Agreement with unused borrowing availability on the
Revolving Credit Facility of $22.6 million. As of December 31, 2004, we had
outstanding borrowings of $58.7 million [46% of total capitalization]. We
generated $0.5 million of cash flow from operations during the six months ended
June 30, 2005 versus the utilization of $22.1 million of cash flow from
operations during the six months ended June 30, 2004. The improvement in cash
flow from operations was primarily attributable to a reduction of inventory in
the first half of 2005 versus an inventory build in the first half of 2004 and
to a lesser extent, lower capital expenditures.
31
We expect liquidity to generally stabilize for the remainder of 2005, with
the exception of seasonal inventory builds in the third quarter offset by
increased receivable collections in the fourth quarter (both primarily related
to the Electrical Products Group). Other elements of working capital continue to
be closely managed. Capital expenditures are expected to be higher in the second
half of 2005 versus the first half of 2005, but overall are expected to be lower
than 2004. We have a number of obligations and commitments, which are listed on
the schedule later in this section entitled "Contractual and Commercial
Obligations." We have considered all of these obligations and commitments in
structuring our capital resources to ensure that they can be met. See the notes
accompanying the table in that section for further discussions of those items.
We believe that given our strong working capital base, additional liquidity
could be obtained through additional debt financing, if necessary. However,
there is no guarantee that such financing could be obtained. In addition, we are
continually evaluating alternatives relating to the sale of excess assets and
divestitures of certain of our business units. Asset sales and business
divestitures present opportunities to provide additional liquidity by
de-leveraging our financial position.
Bank of America Credit Agreement
On April 20, 2004, we completed a refinancing of our outstanding
indebtedness (the "Refinancing") and entered into a new agreement with Bank of
America Business Capital (formerly Fleet Capital Corporation) (the "Bank of
America Credit Agreement"). Like the previous credit agreement with Fleet
Capital Corporation, the Bank of America Credit Agreement is a $110 million
facility with a $20 million term loan ("Term Loan") and a $90 million revolving
credit facility ("Revolving Credit Facility") with essentially the same terms as
the previous credit agreement. The Bank of America Credit Agreement is an
asset-based lending agreement and involves a syndicate of four banks, all of
which participated in the syndicate from the previous credit agreement. The Bank
of America Credit Agreement, and the additional borrowing ability under the
Revolving Credit Facility obtained by incurring new term debt, results in three
important benefits related to our long-term strategy: (1) additional borrowing
capacity to invest in capital expenditures and/or acquisitions key to our
strategic direction, (2) increased working capital flexibility to build
inventory when necessary to accommodate lower cost outsourced finished goods
inventory and (3) the ability to borrow locally in Canada and the United Kingdom
and provide a natural hedge against currency fluctuations.
The Revolving Credit Facility has an expiration date of April 20, 2009 and
its borrowing base is determined by eligible inventory and accounts receivable.
The Term Loan also has a final maturity date of April 20, 2009 with quarterly
payments of $0.7 million. A final payment of $6.4 million is scheduled to be
paid in April 2009. The term loan is collateralized by our property, plant and
equipment. All extensions of credit under the Bank of America Credit Agreement
are collateralized by a first priority security interest in and lien upon the
capital stock of each material domestic subsidiary (65% of the capital stock of
each material foreign subsidiary), and all present and future assets and
properties of Katy. Customary restrictions apply under the Bank of America
Credit Agreement.
Our borrowing base under the Bank of America Credit Agreement is reduced
by the outstanding amount of standby and commercial letters of credit. Vendors,
financial institutions and other parties with whom we conduct business may
require letters of credit in the future that either (1) do not exist today or
(2) would be at higher amounts than those that exist today. Currently, our
largest letters of credit relate to our casualty insurance programs. At June 30,
2005, total outstanding letters of credit were $9.1 million.
Until September 30, 2004, interest accrued on Revolving Credit Facility
borrowings at 175 basis points over applicable LIBOR rates and at 200 basis
points over LIBOR for borrowings under the Term Loan. In accordance with the
Bank of America Credit Agreement, margins (i.e. the interest rate spread above
LIBOR) increased by 25 basis points in the fourth quarter of 2004 and an
additional 25 basis points in the first quarter of 2005 based on our leverage
ratio (as defined in the Bank of America Credit Agreement) as of September 30
and December 31, 2004, respectively. Margins increased another 50 basis points
upon the effective date of the Third Amendment (see below). Additionally,
margins on the Term Loan will drop 25 basis points if the balance of the Term
Loan is reduced below $10.0 million. Interest accrues at higher margins on prime
rates for swing loans, the amounts of which were nominal at June 30, 2005.
32
In the first half of 2005, we paid a fee of $0.1 million to our lenders in
connection with the Second Amendment to our credit agreement. We incurred
additional debt issuance costs in 2004 associated with the Bank of America
Credit Agreement. Additionally, at the time of the inception of the Bank of
America Credit Agreement, we had approximately $4.0 million of unamortized debt
issuance costs associated with the previous credit agreement. The remainder of
the previously capitalized costs, along with the capitalized costs from the Bank
of America Credit Agreement, will be amortized over the life of the Bank of
America Credit Agreement through April 2009. Also, during the first half of
2004, we incurred fees and expenses of $0.4 million associated with a financing
which we chose not to pursue.
The revolving credit facility under the Bank of America Credit Agreement
requires lockbox agreements which provide for all receipts to be swept daily to
reduce borrowings outstanding. These agreements, combined with the existence of
a material adverse effect ("MAE") clause in the Bank of America Credit
Agreement, caused the revolving credit facility to be classified as a current
liability (except as noted below), per guidance in the Emerging Issues Task
Force Issue No. 95-22 , Balance Sheet Classification of Borrowings Outstanding
under Revolving Credit Agreements that Include Both a Subjective Acceleration
Clause and a Lock-Box Arrangement. We do not expect to repay, or be required to
repay, within one year, the balance of the revolving credit facility classified
as a current liability. The MAE clause, which is a fairly typical requirement in
commercial credit agreements, allows the lenders to require the loan to become
due if they determine 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
(except as noted above) is a result only of the combination of the lockbox
agreements and the MAE clause. The Bank of America Credit Agreement does not
expire or have a maturity date within one year, but rather has a final
expiration date of April 20, 2009. The lender had not notified us of any
indication of a MAE at June 30, 2005, and, to management's knowledge, we were
not in default of any provision of the Bank of America Credit Agreement, as
amended at June 30, 2005.
We determined that due to declining profitability in the fourth quarter of
2004, potentially lower profitability in the first half of 2005 and the timing
of certain restructuring payments, we would not meet our Fixed Charge Coverage
Ratio (as defined in the Bank of America Credit Agreement) and could potentially
exceed our maximum Consolidated Leverage Ratio (also as defined in the Bank of
America Credit Agreement) as of the end of the first, second and third quarters
of 2005. In anticipation of not achieving the minimum Fixed Charge Coverage
Ratio or exceeding the maximum Consolidated Leverage Ratio, we obtained an
amendment to the Bank of America Credit Agreement (the "Second Amendment"). The
Second Amendment applied only to the first three quarters of 2005 and the
covenants would have returned to their original levels for the fourth quarter of
2005. Specifically, the Second Amendment eliminated the Fixed Charge Coverage
Ratio, increased the maximum Consolidated Leverage Ratio, established a Minimum
Consolidated EBITDA (on a latest twelve months basis) for each of the periods
and also established a Minimum Availability (the eligible collateral base less
outstanding borrowings and letters of credit) on each day within the nine-month
period.
Subsequent to the Second Amendment's effective date, we determined that we
would likely not meet our amended financial covenants. On April 13, 2005, we
obtained a further amendment to the Bank of America Credit Agreement (the "Third
Amendment"). The Third Amendment eliminated the maximum Consolidated Leverage
Ratio and the Minimum Consolidated EBITDA as established by the Second Amendment
and adjusted the Minimum Availability such that our eligible collateral must
exceed the sum of our outstanding borrowings and letters of credit under the
Revolving Credit Facility by at least $5 million from the effective date of the
Third Amendment through September 29, 2005 and by at least $7.5 million from
September 30, 2005 until the date we deliver our financial statements for the
first quarter of 2006 to our lenders. Subsequent to the delivery of the
financial statements for the first quarter of 2006, the Third Amendment
reestablished the minimum Fixed Charge Coverage Ratio as originally set forth in
the Bank of America Credit Agreement. The Third Amendment also reduced the
maximum allowable capital expenditures for 2005 from $15 million to $10 million,
and increased the interest rate margins on all of the Company's outstanding
borrowings and letters of credit to the largest margins set forth in the Bank of
America Credit Agreement. Effective April 13, 2005, interest accrues on the
Revolving Credit Facility and Term Loan borrowings at 275 and 300 basis points
over LIBOR, respectively. Interest rate margins will return to levels set forth
in the Bank of America Credit Agreement subsequent to the delivery of our
financial statements for the first quarter of 2006 to our lenders.
If we are unable to comply with the terms of the amended covenants, we may
be required to obtain further amendments and pursue increased liquidity through
additional debt financing and/or the sale of assets (see discussion above).
Contractual Obligations and Commercial Obligations
33
Katy's obligations as of June 30, 2005 are summarized below (amounts in
thousands):
Due in Due Due Due
less than in 1-3 in 3-5 after 5
Contractual Cash Obligations Total 1 year years years years
--------- --------- --------- --------- ---------
Revolving credit facility [a] $ 39,547 $ -- $ -- $ 39,547 $ --
Term loans 16,429 2,857 5,714 7,858 --
Interest on debt [b] 13,394 3,954 6,893 2,547 --
Operating leases [c] 27,403 7,478 11,415 5,289 3,221
Severance and restructuring [c] 2,697 1,369 700 373 255
SESCO payable to Montenay [d] 2,750 1,100 1,100 550 --
--------- --------- --------- --------- ---------
Total Contractual Obligations $ 102,220 $ 16,758 $ 25,822 $ 56,164 $ 3,476
========= ========= ========= ========= =========
Due in Due Due Due
less than in 1-3 in 3-5 after 5
Other Commercial Commitments Total 1 year years years years
--------- --------- --------- --------- ---------
Commercial letters of credit $ 596 $ 596 $ -- $ -- $ --
Stand-by letters of credit 8,506 8,506 -- -- --
Guarantees [e] 23,670 8,370 15,300 -- --
--------- --------- --------- --------- ---------
Total Commercial Commitments $ 32,772 $ 17,472 $ 15,300 $ -- $ --
========= ========= ========= ========= =========
[a] As discussed in the Liquidity and Capital Resources section above, the
entire revolving credit facility under the Bank of America Revolving Credit
Agreement is classified as a current liability on the Consolidated Statements of
Financial Position as a result of the combination in the Bank of America Credit
Agreement of (i) lockbox agreements on Katy's depository bank accounts, and (ii)
a subjective Material Adverse Effect (MAE) clause. The Revolving Credit Facility
expires in April of 2009.
[b] Represents interest on the Revolving Credit Facility and Term Loan of the
Bank of America Credit Agreement. Amounts assume interest accrues at the current
rate in effect, including the effect the impact of the increased margins through
the end of the first quarter of 2006 pursuant to the Third Amendment. Amount
also assumes the principal balance of the Revolving Credit Facility remains
constant through its expiration date of April 20, 2009 and the principal balance
of the Term Loan amortizes in accordance with the terms of the Bank of America
Credit Agreement. Due to the variable nature of the Bank of America Credit
Agreement, actual interest rates could differ from the assumptions above. In
addition, actual borrowing levels could differ from the assumptions above due to
liquidity needs.
[c] Future non-cancelable lease rentals are included in the line entitled
"Operating leases," which also includes obligations associated with
restructuring activities. The Condensed Consolidated Balance Sheet at June 30,
2005 and December 31, 2004, includes $3.4 million and $3.6 million,
respectively, in discounted liabilities associated with non-cancelable operating
lease rentals, net of estimated sub-lease revenues, related to facilities that
have been abandoned as a result of restructuring and consolidation activities.
[d] Amount owed to Montenay as a result of the SESCO partnership, discussed in
Note 4 to the Condensed Consolidated Financial Statements. $1.1 million of this
obligation is classified in the Condensed Consolidated Balance Sheets as an
Accrued Expense in Current Liabilities, while the remainder is included in Other
Liabilities, recorded on a discounted basis.
34
[e] As discussed in Note 4 to the Condensed Consolidated Financial Statements in
Part I, Item 1, SESCO, an indirect wholly-owned subsidiary of Katy, is party to
a partnership that operates a waste-to-energy facility, and has certain
contractual obligations, for which Katy provides certain guarantees. If the
partnership is not able to perform its obligations under the contracts, under
certain circumstances SESCO and Katy could be subject to damages equal to the
amount of Industrial Revenue Bonds outstanding (which financed construction of
the facility) less amounts held by the partnership in debt service reserve
funds. Katy and SESCO do not anticipate non-performance by parties to the
contracts.
Off-balance Sheet Arrangements
See Note 4 to the Condensed Consolidated Financial Statements in Part II,
Item 8 for a discussion of SESCO.
Cash Flow
Operating Activities
Cash flow used in operating activities before changes in operating assets
was $2.5 million in the first half of 2005 versus cash flow provided by
operating activities before changes in operating assets of $4.6 million in the
first half of 2004. While we had net losses in both periods, these amounts
included non-cash items such as depreciation, amortization and amortization of
debt issuance costs. We generated $3.0 million of cash related to operating
assets and liabilities during the six months ended June 30, 2005 versus cash
used related to operating assets and liabilities of $26.7 million during the six
months ended June 30, 2004. Our operating cash flow was favorably impacted in
the first half of 2005 by a decrease in inventory of $6.6 million, mostly in the
business units in the Maintenance Products Group which sell plastics products,
and by lower accounts receivable, principally resulting from a decrease in net
sales in the second quarter of 2005 versus the fourth quarter of 2004. Operating
cash flow during the first half of 2005 was negatively impacted by lower
accounts payable (as we limited our purchases from suppliers in connection with
the aforementioned reduction of inventory) and lower accruals due to the
settlement of previously recorded restructuring charges. Operating cash flow in
the first half of 2004 was negatively impacted by higher inventory and lower
payables and accruals. The inventory build was due to the early purchase of
certain materials in advance of scheduled supplier price increases, increased
material prices and planned builds in connection with facility closures.
Accounts payable were lower as a result of our decision to take advantage of
discount terms offered by certain vendors while accruals were impacted by the
settlement of previously recorded restructuring charges. During the first half
of 2005, we were turning our inventory at 5.2 times per year versus 4.5 times
per year during the first half of 2004. Cash of $1.8 million and $3.6 million
was used in the six months ended June 30, 2005 and 2004, respectively, to
satisfy severance, restructuring and related obligations. Severance,
restructuring and related charges are expected to substantially end in 2005,
however, cash payments will continue through 2011 to satisfy non-cancelable
lease obligations. See Note 10 of the Notes to Condensed Consolidated Financial
Statements.
Investing Activities
Capital expenditures totaled $3.0 million during the six months ended June
30, 2005 as compared to $5.7 million during the six months ended June 30, 2004.
Capital expenditures are anticipated to be higher in the second half of 2005
versus the first half of 2005, but overall are expected to be lower in 2005 than
in 2004. On March 31, 2004, Woods Canada sold its manufacturing facility for net
proceeds of $3.2 million and immediately entered into a sale/leaseback
arrangement to allow that business unit to occupy this property as a
distribution facility. On June 28, 2004, CCP sold its vacant metals facility in
Santa Fe Springs, California for net proceeds of $1.9 million.
Financing Activities
Overall, debt decreased $2.6 million during the six months ended June 30,
2005 versus an increase of $22.6 million during the six months ended June 30,
2004, primarily relating to the changes in working capital during those periods.
Direct debt costs totaling $0.1 million in the first half of 2005 primarily
represents a fee paid to our lenders in connection with the Second Amendment and
$1.3 million in the first half of 2004 relates to the April 20, 2004 refinancing
of the Bank of America Credit Agreement. On May 10, 2004, we suspended our $5.0
million share repurchase program after announcing the resumption of the plan on
April 20, 2004. We had previously suspended the program in November 2003. There
35
currently are no plans to resume the share repurchase program.
SEVERANCE, RESTRUCTURING AND RELATED CHARGES
See Note 10 to the Condensed Consolidated Financial Statements in Part I,
Item 1 for a discussion of severance, restructuring and related charges.
OUTLOOK FOR 2005
We continue to experience a strong sales performance during the first half
of 2005 from the Woods U.S. business unit, offset by lower volumes in our U.S.
and U.K. Consumer Plastics and domestic Abrasives business units. Price
increases were passed along to our Woods U.S. customers during 2004 and early
2005 as a result of the rise in copper prices since late 2003. We continue to
implement price increases; however there can be no assurance that such increases
will be accepted. We do anticipate modest volume growth from our Woods U.S.
unit. We also expect continued softness in the U.K., especially in the consumer
/retail sector. We have implemented price increases for the JanSan Plastics,
Container and Consumer Plastics business units and for our Metal Truck Box
business in response to the increase in raw material costs over the past few
years. However, in the U.S. and U.K. Consumer Plastics business, we face the
continuing challenge of passing through price increases to offset these higher
costs, and sales volumes have been and will continue to be negatively impacted
as a result of raising prices.
The continued shipping and production inefficiencies at our Abrasives
facilities have resulted in higher operating costs. The consolidation of one of
the two facilities into the Wrens, Georgia facility is nearly complete and while
we may experience higher operating costs in the near term, the consolidation
will ultimately result in improved profitability of our Abrasives business.
Early in the fourth quarter of 2004, we experienced a fire at the Wrens
facility. The fire damaged certain production equipment and affected the
operations of certain of our production lines. However, we have been able to
continue to operate the remainder of our production lines at this facility and
have obtained equipment allowing us to operate all product lines at this
facility. These disruptions to our Abrasives operations have also resulted in
the loss of certain customers, commencing in the second half of 2004. While we
expect to recover some of these lost sales in the current year, we may
experience additional lost sales in 2005. We believe that sales for the
Abrasives business unit in the second half of 2005 will be approximately equal
to the sales in the second half of 2004 and the first half of 2005.
Cost of goods sold is subject to variability in the prices for certain raw
materials, most significantly thermoplastic resins used in the manufacture of
plastic products for the JanSan Plastics, Consumer Plastics and Container
businesses. Prices of plastic resins, such as polyethylene and polypropylene
have increased steadily from the latter half of 2002 through the early months of
2005. Prices for resin decreased in the second quarter of 2005, but have
recently returned to historically high levels. Management has observed that the
prices of plastic resins are driven to an extent by prices for crude oil and
natural gas, in addition to other factors specific to the supply and demand of
the resins themselves. We are equally exposed to price changes for copper at our
Woods U.S. and Woods Canada business units. Prices for copper generally
increased from late 2003 and have continued through the present time. Prices for
copper appear to have stabilized in a historically high range in the second
quarter of 2005. Prices for aluminum (a raw material used in our Metal Truck Box
business), corrugated packaging material and other raw materials had also
increased through the first quarter of 2005. We have not employed an active
hedging program related to our commodity price risk, but are employing other
strategies for managing this risk, including contracting for a certain
percentage of resin needs through supply agreements and opportunistic spot
purchases. In 2004, we experienced $24 million of cost increases in our primary
raw materials, packaging materials, utilities and freight compared to 2003;
these extraordinary cost increases continued into the first quarter of 2005. In
2004, we passed on about $15 million of these higher costs through price
increases. We announced additional price increases in the first half of 2005
across almost all business units. We continue to implement price increases;
however there can be no assurance that such increases will be accepted. In a
climate of rising raw material costs (especially in 2004 and the first half of
2005), we experienced difficulty in raising prices to shift these higher costs
to our customers, particularly major home improvement and mass market retail
outlets. Our future earnings may be negatively impacted to the extent further
increases in costs for raw materials cannot be recovered or offset through
higher selling prices. We cannot predict the direction our raw material prices
will take during the latter half of 2005 and beyond.
36
Since the Recapitalization, our management has been focused on a number of
restructuring and cost reduction initiatives, including the consolidation of
facilities; divestiture of non-core operations; SG&A cost rationalization and
organizational changes. In the future, we expect to benefit from sales growth
opportunities across our various business units. We believe we can accomplish
this without having to add significant capital because our facilities are
currently under utilized.
As a percentage of sales, SG&A in the latter half of 2005 should remain in
line with the same period in 2004. SG&A has continually declined since 2001as a
percentage of sales. We expect to maintain modest headcount and rental costs for
our corporate office. We have completed the process of transferring back-office
functions of our Textiles (Wilen), Abrasives (Glit-Microtron and Loren) and
Filters and Grillbricks (Disco) business units from Georgia to Bridgeton,
Missouri, the headquarters of CCP. We will continue to evaluate the possibility
of further consolidation of administrative processes. Our cost reduction
efforts, integration of back office functions and simplifications of our
business transactions are all dependent on executing a system integration plan.
This plan involves the migration of data across information technology platforms
and implementation of new software and hardware. The domestic systems
integration plan was substantially completed in October 2003, while our
international systems integration plan is nearly complete.
Interest rates rose in the second half of 2004 and we expect rates to
continue to rise in 2005. Until September 30, 2004, interest accrued on
Revolving Credit Facility borrowings at 175 basis points over applicable LIBOR
rates and at 200 basis points over LIBOR for borrowings under the Term Loan. In
accordance with the Bank of America Credit Agreement, margins (i.e. the interest
rate spread above LIBOR) increased by 25 basis points in the fourth quarter of
2004 and an additional 25 basis points in the first quarter of 2005 based on our
leverage ratio (as defined in the Bank of America Credit Agreement) as of
September 30, 2004 and December 31, 2004, respectively. Margins increased
another 50 basis points upon the effective date of the Third Amendment (see
below). Additionally, margins on the Term Loan will drop 25 basis points if the
balance of the Term Loan is reduced below $10.0 million
Given our history of operating losses, along with guidance provided by the
accounting literature covering accounting for income taxes, we are unable to
conclude it is more likely than not that we will be able to generate future
taxable income sufficient to realize the benefits of domestic deferred tax
assets and deferred tax assets of unprofitable foreign subsidiaries. Therefore,
except for our profitable foreign subsidiaries, a full valuation allowance on
the net deferred tax asset position was recorded at June 30, 2005 and December
31, 2004, and we do not expect to record the benefit of any deferred tax assets
that may be generated in 2005 from domestic and certain unprofitable foreign
jurisdictions. We will continue to record current expense associated with
foreign and state income taxes.
In 2004, our financial performance benefited from favorable currency
translation as the British Pound Sterling and the Canadian dollar strengthened
throughout the year against the U.S. dollar. In the first half of 2005, the
Canadian dollar appears to have stabilized against the U.S. dollar and the
British Pound Sterling has somewhat weakened against the U.S. dollar in the same
period. While we cannot predict the ultimate direction of exchange rates, we do
not expect to see the same favorable impact on our financial performance in
2005.
We expect our current working capital levels to remain constant except for
seasonal inventory builds during the third quarter of 2005, offset by increased
receivable collections in the fourth quarter of 2005 (both primarily in the
Electrical Products Group). Inventory carrying values may be impacted by higher
material costs. Cash flow will be used in 2005 for additional costs related to
the consolidation of the Abrasives facilities (which is expected to be
substantially completed in the third quarter) as well as the settlement of
previously established restructuring accruals. The majority of these accruals
relate to non-cancelable lease obligations for abandoned facilities. These
accruals do not create incremental cash obligations in that we are obligated to
make the associated payments whether we occupy the facilities or not. The amount
we will ultimately pay out under these accruals is dependent on our ability to
successfully sublet all or a portion of the abandoned facilities.
We determined that due to declining profitability in the fourth quarter of
2004, potentially lower profitability in the first half of 2005 and the timing
of certain restructuring payments, we would not meet our Fixed Charge Coverage
Ratio (as
37
defined in the Bank of America Credit Agreement) and could potentially exceed
our maximum Consolidated Leverage Ratio (also as defined in the Bank of America
Credit Agreement) as of the end of the first, second and third quarters of 2005.
In anticipation of not achieving the minimum Fixed Charge Coverage Ratio or
exceeding the maximum Consolidated Leverage Ratio, we obtained the Second
Amendment to the Bank of America Credit Agreement. The Second Amendment applied
only to the first three quarters of 2005 and the covenants would have returned
to their original levels for the fourth quarter of 2005. Specifically, the
Second Amendment eliminated the Fixed Charge Coverage Ratio, increased the
maximum Consolidated Leverage Ratio, established a Minimum Consolidated EBITDA
(on a latest twelve months basis) for each of the periods and also established a
Minimum Availability (the eligible collateral base less outstanding borrowings
and letters of credit) on each day within the nine-month period.
Subsequent to the Second Amendment's effective date, we determined that we
would likely not meet our amended financial covenants. On April 13, 2005, we
obtained the Third Amendment to the Bank of America Credit Agreement. The Third
Amendment eliminated the maximum Consolidated Leverage Ratio and the Minimum
Consolidated EBITDA as established by the Second Amendment and adjusted the
Minimum Availability such that our eligible collateral must exceed the sum of
our outstanding borrowings and letters of credit under the Revolving Credit
Facility by at least $5 million from the effective date of the Third Amendment
through September 29, 2005 and by at least $7.5 million from September 30, 2005
until the date we deliver our financial statements for the first quarter of 2006
to our lenders. Subsequent to the delivery of the financial statements for the
first quarter of 2006, the Third Amendment reestablished the minimum Fixed
Charge Coverage Ratio as originally set forth in the Bank of America Credit
Agreement. The Third Amendment also reduced the maximum allowable capital
expenditures for 2005 from $15 million to $10 million, and increased the
interest rate margins on all of the Company's outstanding borrowings and letters
of credit to the largest margins set forth in the Bank of America Credit
Agreement. Effective April 13, 2005, interest accrues on the Revolving Credit
Facility and Term Loan borrowings at 275 and 300 basis points over LIBOR,
respectively. Interest rate margins will return to levels set forth in the Bank
of America Credit Agreement subsequent to the delivery of our financial
statements for the first quarter of 2006 to our lenders. We expect to be in
compliance with the amended covenants in the Bank of America Credit Agreement
for the remainder of 2005.
If we are unable to comply with the terms of the amended covenants, we may
be required to obtain further amendments and pursue increased liquidity through
additional debt financing and/or the sale of assets. We believe that given our
strong working capital base, additional liquidity could be obtained through
additional debt financing, if necessary. However, there is no guarantee that
such financing could be obtained. In addition, we are continually evaluating
alternatives relating to the sale of excess assets and divestitures of certain
of our business units. Asset sales and business divestitures present
opportunities to provide additional liquidity by de-leveraging our financial
position.
38
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:
- 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 mass
merchant retailers in the discount and do-it-yourself markets.
- Competition from foreign competitors.
- Increases in the cost of, or in some cases continuation of, the
current price levels of plastic resins, copper, paper board
packaging, and other raw materials.
- Our inability to reduce product costs, including manufacturing,
sourcing, freight, and other product costs.
- Greater reliance on third parties for our finished goods as we
increase the portion of our manufacturing that is outsourced.
- 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.
- Our inability to reduce administrative costs through consolidation
of functions and systems improvements.
- Our inability to execute our systems integration plan.
- Our inability to successfully integrate our operations as a result
of the facility consolidations.
- Our inability to sub-lease rented facilities which have been
abandoned as a result of consolidation and restructuring
initiatives.
- The potential impact of rising costs for insurance for properties
and various forms of liabilities.
- The potential impact of rising interest rates on our LIBOR-based
Bank of America Credit Agreement.
- Our inability to meet covenants associated with the Bank of America
Credit Agreement.
- The potential impact of changes in foreign currency exchange rates
related to our foreign operations.
- Changes in significant laws and government regulations affecting
environmental compliance and income taxes.
39
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. These factors are not intended to
represent a complete list of all risks and uncertainties inherent in our
business and should be read in conjunction with the cautionary statements and
risks included in our other filings with the SEC, including, but not limited to,
our Annual Report on Form 10-K for the fiscal year ended December 31, 2004.
ENVIRONMENTAL AND OTHER CONTINGENCIES
See Note 8 to the Condensed Consolidated Financial Statements in Part I,
Item 1 for a discussion of environmental and other contingencies.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
See Note 2 to the Condensed Consolidated Financial Statements in Part I,
Item 1 for a discussion of recently issued accounting pronouncements.
CRITICAL ACCOUNTING POLICIES
We disclosed details regarding certain of our critical accounting policies
in the Management's Discussion and Analysis section of our 2004 Annual Report on
Form 10-K (Part II, Item 7). There have been no changes to policies as of June
30, 2005.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate
Risk Our exposure to market risk associated with changes in interest rates
relates primarily to our debt obligations. We currently do not use derivative
financial instruments relating to this exposure. Our interest obligations on
outstanding debt at June 30, 2005 were indexed from short-term LIBOR. As a
result of the current rising interest rate environment and the increase in the
interest rate margins on our borrowings as a result of the Third Amendment to
the Bank of America Credit Agreement, our exposures to interest rate risks could
be material to our financial position or results of operations.
Foreign Exchange
Risk We are exposed to fluctuations in the Euro, British pound, Canadian
dollar and Chinese Yuan Renminbi. Some of our subsidiaries make significant U.S.
dollar purchases from Asian suppliers, particularly in China. An adverse change
in foreign currency exchange rates of Asian countries could result in an
increase in the cost of purchases. We do not currently hedge foreign currency
transaction or translation exposures. In July, the Chinese Central Bank revalued
the Yuan Renminbi, breaking the link to the U.S. Dollar. We are currently unable
to determine the long-term effects of China's revaluation on the foreign
currency exchange rate with the U.S.
Commodity Price Risk
We have not employed an active hedging program related to our commodity
price risk, but are employing other strategies for managing this risk, including
contracting for a certain percentage of resin needs through supply agreements
and
40
opportunistic spot purchases. See Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - OUTLOOK FOR 2005, for further
discussion of our exposure to increasing raw material costs.
Item 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure 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 our 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.
Pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934, Katy
carried out an evaluation, under the supervision and with the participation of
our management, including the Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the design and operation of our disclosure
controls and procedures (pursuant to Rule 13a-15(e) under the Securities
Exchange Act of 1934, as amended) as of the end of the period of our report.
Based upon that evaluation, the Chief Executive Officer and Chief Financial
Officer concluded that our disclosure controls and procedures are effective to
ensure that information required to be disclosed by us in the reports that we
file or submit under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the SEC's rules and forms, and
that such information is accumulated and communicated to our management,
including our principal executive officer and primary financial officer, as
appropriate, to allow timely decisions regarding required disclosure.
(b) Change in Internal Controls
There have been no changes in Katy's internal control over financial
reporting during the quarter ended June 30, 2005 that has materially affected,
or is reasonably likely to materially affect Katy's internal control over
financial reporting.
41
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 were brought against
the company.
Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
On April 20, 2003, the Company announced a plan to spend up to $5.0
million to repurchase shares of its common stock. In 2004, 12,000 shares of
common stock were repurchased on the open market for approximately $75 thousand
under this plan, while in 2003, 482,800 shares of its common stock were
repurchased on the open market for approximately $2.6 million. The Company
suspended further purchases under the plan on May 10, 2004.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of Stockholders of Katy Industries, Inc. was held at
Katy Industries' Corporate Headquarters, 765 Straits Turnpike, Suite 2000,
Middlebury, Connecticut, at 10:00 AM, on May 26, 2005. Stockholders voted on
three proposals, summarized below with the accompanying number of votes in
favor, opposed, or abstained.
PROPOSAL No. 1: Election of Directors
CLASS II DIRECTORS:
Name Votes For Votes Withheld
---- --------- --------------
Christopher W. Anderson 6,722,877 783,808
William F. Andrews 6,718,604 788,081
Samuel P. Frieder 6,723,077 783,608
James A. Kohlberg 6,732,881 773,804
Christopher Lacovara 6,723,077 783,608
The required vote for directors was the affirmative vote of a plurality of the
votes cast at the annual meeting. As a result of the vote, each of the five
nominees for Class II directors was elected. The specified term of the Company's
Class I directors, Robert M. Baratta, Daniel B. Carroll, Wallace E. Carroll,
Jr., and Anthony T. Castor III, is through the Company's 2006 Annual Meeting.
PROPOSAL No. 2: To ratify the selection of PricewaterhouseCoopers LLP as the
independent public accountants of Katy for the fiscal year ended December 31,
2005.
Votes For Votes Against Votes Abstained
--------- ------------- ---------------
7,485,116 9,269 12,300
The required vote to ratify the appointment of PricewaterhouseCoopers LLP was
the majority of Katy's outstanding common stock present, in person or by proxy,
at the annual meeting. As a result of the vote, the selection of
PricewaterhouseCoopers LLP was ratified.
PROPOSAL No. 3: To consider and vote upon a stockholder proposal regarding
Katy's Stockholder Rights Agreement:
Votes For Votes Against Votes Abstained
--------- ------------- ---------------
2,728,694 3,385,058 9,392
The required vote for the approval of the stockholder proposal was the majority
of Katy's outstanding common stock present, in person or by proxy, at the annual
meeting. There were present in person or by proxy at the annual meeting
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7,506,685 shares of common stock, a majority of which was 3,753,343 shares. As a
result of the vote, the stockholder proposal was not approved.
Item 5. OTHER INFORMATION
Entry into Material Definitive Agreement
We incorporate by reference the disclosure contained in Item 5.02 of our
Current Report on Form 8-K filed with the SEC on May 31, 2005 and Item 5.02 of
our Current Report on Form 8-K/A filed with the SEC on August 15, 2005, whereby
we disclosed that effective June 1, 2005, we entered into an employment
agreement with Anthony T. Castor, III to serve as our President and Chief
Executive Officer, which provides for a base salary of $525,000 with a target
incentive bonus of 70% of his base salary. For 2005 only, one half of Mr.
Castor's target incentive bonus will be guaranteed. On July 15, 2005, pursuant
to his employment agreement, Mr. Castor was also granted 750,000 options to
purchase shares of our common stock with an exercise price of $2.75 per share,
which vest in three annual installments on the anniversary of the effective date
of his employment agreement and have a term of 10 years. Mr. Castor will be
entitled to additional options to purchase common stock equal to 5% of new
common shares issued in connection with a conversion of our 15% convertible
preferred stock to common stock by the holder. These additional options will
have an exercise price equal to the current market price of the common stock
price at the time the 15% convertible preferred stock is converted by the
holder. In addition, Mr. Castor is entitled to be covered by a company-matched
non-qualified savings plan.
On August 8, 2005, the Board of Directors approved the Katy Industries,
Inc. 2005 Chief Executive Officer's Plan in order to provide the grant of
750,000 options to Mr. Castor.
Item 6. EXHIBITS
10.1 Agreement effective as of June 1, 2005 between Anthony T. Castor III
and the Company, filed herewith.
10.2 Fourth Amendment to Amended and Restated Loan Agreement dated as of
June 8, 2005 with Fleet Capital Corporation, filed herewith.
10.3 Fifth Amendment to Amended and Restated Loan Agreement dated as of
August 4, 2005 with Fleet Capital Corporation, filed herewith.
10.4 Katy Industries, Inc. 2005 Chief Executive Officer's Plan, filed
herewith.
31.1 Certification of Chief Executive Officer pursuant to Securities
Exchange Act Rule 13a-14, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Securities
Exchange Act Rule 13a-14, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
43
Signatures
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
KATY INDUSTRIES, INC.
Registrant
DATE: August 15, 2005 By /s/ Anthony T. Castor III
-------------------------
Anthony T. Castor III
President and Chief Executive Officer
By /s/ Amir Rosenthal
------------------
Amir Rosenthal
Vice President, Chief Financial Officer,
General Counsel and Secretary
44