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 the quarterly period ended: March 31, 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 April 30, 2005
Common Stock, $1 Par Value 7,945,377
KATY INDUSTRIES, INC.
FORM 10-Q
March 31, 2005
INDEX
Page
----
PART I FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets
March 31, 2005 and December 31, 2004 (unaudited) 2,3
Condensed Consolidated Statements of Operations
Three Months Ended March 31, 2005 and 2004 (unaudited) 4
Condensed Consolidated Statements of Cash Flows
Three Months Ended March 31, 2005 and 2004 (unaudited) 5
Notes to Condensed Consolidated Financial Statements (unaudited) 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 20
Item 3. Quantitative and Qualitative Disclosures about Market Risk 31
Item 4. Controls and Procedures 31
PART II OTHER INFORMATION
Item 1. Legal Proceedings 32
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 32
Item 5. Other Information 32
Item 6. Exhibits 32
Signatures 33
Certifications 34-37
- 1 -
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
KATY INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Amounts in Thousands)
(Unaudited)
ASSETS
March 31, December 31,
2005 2004
--------- ------------
CURRENT ASSETS:
Cash and cash equivalents $ 7,099 $ 8,525
Accounts receivable, net 50,288 66,689
Inventories, net 61,900 65,674
Other current assets 5,287 4,233
--------- ---------
Total current assets 124,574 145,121
--------- ---------
OTHER ASSETS:
Goodwill 2,239 2,239
Intangibles, net 7,352 7,428
Other 9,581 9,946
--------- ---------
Total other assets 19,172 19,613
--------- ---------
PROPERTY AND EQUIPMENT
Land and improvements 1,867 1,897
Buildings and improvements 14,016 13,537
Machinery and equipment 132,841 132,825
--------- ---------
148,724 148,259
Less - Accumulated depreciation (90,763) (88,529)
--------- ---------
Property and equipment, net 57,961 59,730
--------- ---------
Total assets $ 201,707 $ 224,464
========= =========
See Notes to Condensed Consolidated Financial Statements.
- 2 -
KATY INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Amounts in Thousands, Except Share Data)
(Unaudited)
LIABILITIES AND STOCKHOLDERS' EQUITY
March 31, December 31,
2005 2004
--------- ------------
CURRENT LIABILITIES
Accounts payable $ 27,070 $ 39,079
Accrued compensation 5,088 5,269
Accrued expenses 37,102 39,939
Current maturities of long-term debt 2,857 2,857
Revolving credit agreement 39,646 40,166
--------- ---------
Total current liabilities 111,763 127,310
--------- ---------
LONG-TERM DEBT, less current maturities 14,286 15,714
OTHER LIABILITIES 12,120 12,855
--------- ---------
Total liabilities 138,169 155,879
--------- ----------
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 25,111 25,111
Accumulated other comprehensive income 4,165 4,564
Accumulated deficit (61,906) (57,258)
Treasury stock, at cost, 1,876,827 ahares (21,910) (21,910)
Total stockholders'equity --------- ----------
Total liabilities and stockholders' equity 63,538 68,585
--------- ---------
$ 201,707 $ 224,464
========= ===========
See Notes to Condensed Consolidated Financial Statements.
- 3 -
KATY INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 2005 AND 2004
(Amounts in Thousands, Except Per Share Data)
(Unaudited)
2005 2004
-------- --------
Net sales $ 95,513 $ 99,895
Cost of goods sold 85,990 83,265
-------- --------
Gross profit 9,523 16,630
Selling, general and administrative expenses 12,354 14,748
Severance, restructuring and related charges 373 1,898
-------- --------
Operating loss (3,204) (16)
Interest expense (1,264) (800)
Other, net (48) (375)
-------- --------
Loss before provision for income taxes (4,516) (1,191)
Provision for income taxes 132 590
-------- --------
Net loss (4,648) (1,781)
Payment-in-kind of dividends on convertible preferred
stock -- (3,462)
-------- --------
Net loss attributable to common stockholders $ (4,648) $ (5,243)
======== ========
Loss per share of common stock - Basic and diluted $ (0.59) $ (0.67)
======== ========
Weighted average common shares outstanding (thousands):
Basic and diluted 7,945 7,881
======== ========
See Notes to Condensed Consolidated Financial Statements.
- 4 -
KATY INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2005 and 2004
(Amounts in Thousands)
(Unaudited)
2005 2004
-------- --------
Cash flows from operating activities:
Net Loss $ (4,648) $ (1,781)
Depreciation and amortization 2,847 3,802
Amortization of debt issuance costs 276 264
-------- --------
(1,525) 2,285
-------- --------
Changes in operating assets and liabilities:
Accounts receivable 16,164 5,956
Inventories 3,627 (13,188)
Other assets (756) (2,514)
Accounts payable (11,839) (6,243)
Accrued expenses (2,964) (1,923)
Other, net (738) (91)
-------- --------
3,494 (18,003)
-------- --------
-------- --------
Net cash provided by (used in) in operating activities 1,969 (15,718)
-------- --------
Cash flows from investing activities:
Capital expenditures (1,403) (2,415)
Collections of note receivable from sale of subsidiary 71 --
Proceeds from sale of assets -- 3,673
-------- --------
Net cash (used in) provided by investing activities (1,332) 1,258
-------- --------
Cash flows from financing activities:
Net (repayments) borrowings on revolving loans (466) 13,906
Repayments of term loans (1,429) (1,815)
Direct costs associated with debt facilities (138) (209)
-------- --------
Net cash (used in) provided by financing activities (2,033) 11,882
-------- --------
Effect of exchange rate changes on cash and cash equivalents (30) (174)
-------- --------
Net decrease in cash and cash equivalents (1,426) (2,752)
Cash and cash equivalents, beginning of period 8,525 6,748
-------- --------
Cash and cash equivalents, end of period $ 7,099 $ 3,996
======== ========
See Notes to Condensed Consolidated Financial Statements.
- 5 -
KATY INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 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 March 31, 2005 and December 31,
2004 and for the three month periods ended March 31, 2005 and March 31, 2004 are
unaudited and reflect all adjustments (consisting only of normal recurring
adjustments) which are, in the opinion of management, necessary for a fair
presentation of the financial condition and results of operations of the
Company. Interim 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):
March 31, December 31,
2005 2004
--------- ------------
Raw materials $ 23,665 $ 23,220
Work in process 2,223 1,826
Finished goods 40,242 45,299
Inventory reserves (4,230) (4,671)
-------- --------
$ 61,900 $ 65,674
======== ========
At March 31, 2005 and December 31, 2004, approximately 38% 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 $6.0 million and $4.7
million at March 31, 2005 and December 31, 2004, respectively.
Property 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 was $2.7 million and $3.4
million in the three-month periods ending March 31, 2005 and 2004, respectively.
Katy adopted SFAS No. 143, Accounting for Asset Retirement Obligations, on
January 1, 2003 (SFAS No. 143). 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 an associated increase in the
- 6 -
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 March 31, 2005 an asset of $0.9 million and related liability of
$1.2 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 12
Changes in estimates, including timing (22)
-------
SFAS No. 143 Obligation at March 31, 2005 $ 1,227
=======
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 ("APB No. 25"),
regarding accounting for stock options and other stock awards. APB No. 25
dictates a measurement date concept in the determination of compensation expense
related to stock awards including stock options, restricted stock, and stock
appreciation rights. Katy's outstanding stock options all have established
measurement dates and therefore, fixed plan accounting is applied, generally
resulting in no compensation expense for stock option awards. However, the
Company has issued stock appreciation rights and restricted stock awards which
are accounted for as variable stock compensation awards and compensation expense
or income has been recorded for these awards. No compensation expense was
recorded relative to restricted stock awards during the three months ended March
31, 2005 and 2004, respectively. Compensation (income) expense recorded
associated with the vesting of stock appreciation rights was $(0.6) million and
$20.0 thousand for the three month periods ended March 31, 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 ("SFAS No. 123)
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. No options were granted during the three months
ended March 31, 2005 and 2004, respectively.
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).
Three Months
Ended March 31,
2005 2004
------- -------
Net loss attributable to common stockholders, as reported $(4,648) $(5,243)
Deduct: Total stock-based employee compensation expense determined
under fair value based method for all awards, net of related tax effects -- (1,840)
------- -------
Pro forma net loss $(4,648) $(7,083)
======= =======
Loss per share:
Basic and diluted - as reported $ (0.59) $ (0.67)
Basic and diluted - pro forma $ (0.59) $ (0.90)
- 7 -
In December 2004, the FASB issued Statement No. 123 (revised 2004),
Share-Based Payment (SFAS 123R), which is a revision of SFAS No. 123. SFAS 123R
supersedes APB 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 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 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 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
this Statement on the Company, which will be dependent in large part upon future
equity-based grants.
(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 is 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, management has
estimated that the effect of the Act on the Company's accumulated postretirement
benefit obligations will not be material.
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.
- 8 -
(3) Intangible Assets
Following is detailed information regarding Katy's intangible assets
(amounts in thousands):
March 31, December 31,
2005 2004
--------- ------------
Customer lists $ 10,968 $ 10,976
Tradenames 6,574 6,577
Patents 3,037 2,932
-------- --------
Subtotal 20,579 20,485
Accumulated amortization (13,227) (13,057)
-------- --------
Intangible assets, net $ 7,352 $ 7,428
======== ========
All of Katy's intangible assets are definite long-lived intangibles. Katy
recorded amortization expense on intangible assets of $0.2 million and $0.4
million in the three-month periods ending March 31, 2005 and 2004, respectively.
Estimated aggregate future amortization expense related to intangible assets is
as follows (amounts in thousands):
2005 $508
2006 658
2007 653
2008 647
2009 635
(4) SESCO Partnership
On April 29, 2002, 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 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 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.
- 9 -
The Company made a payment of $1.0 million in July 2004 on the $6.6 million
note. The table below schedules the remaining payments as of March 31, 2005
which are reflected in accrued expenses and other liabilities in the
Consolidated Balance Sheet (amounts in thousands):
2005 $1,050
2006 1,100
2007 1,100
2008 550
------
$3,800
======
In the first quarter of 2002, the Company recognized a charge of $6.0
million consisting of 1) the discounted value of the $6.6 million note, 2) the
carrying value of certain assets contributed to the partnership, consisting
primarily of machinery spare parts, and 3) costs to close the transaction. It
should be noted that all of SESCO's long-lived assets were reduced to a zero
value at March 31, 2002, so no additional impairment was required. On a going
forward basis, Katy would expect that income statement activity associated with
its involvement in the partnership will not be material, and Katy's Consolidated
Balance Sheet will carry the liability mentioned above.
In 1984, the Authority issued $55.0 million of Industrial Revenue Bonds
and lent the proceeds to SESCO under the loan agreement for the acquisition and
construction of the waste-to-energy facility that has now been transferred to
the partnership. The funds required to repay the loan agreement come from the
monthly disposal fee paid by the Authority under the service agreement for
certain waste disposal services, a component of which is for debt service. To
induce the required parties to consent to the SESCO partnership transaction,
SESCO retained its liability under the loan agreement. In connection with that
liability, SESCO also retained its right to receive the debt service component
of the monthly disposal fee.
Based on an opinion from outside legal counsel, SESCO has a legally
enforceable right to offset amounts it owes to the Authority under the loan
agreement against amounts that are owed from the Authority under the service
agreement. At March 31, 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 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.
Following are scheduled principal repayments on the loan agreement (and
the Industrial Revenue Bonds) (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
- 10 -
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 will allow 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 $18.3 million
at March 31, 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 based upon
certain leverage measurements. Margins increased 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 December 31, 2004 and increased another 50
basis points upon the effective date of the Third Amendment (see below).
Additionally, margins on the Term Loan will drop an additional 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 March 31, 2005.
Long-term debt consists of the following (amounts in thousands):
March 31, December 31,
2005 2004
--------- ------------
Term loan payable under Bank of America Credit Agreement, interest based
on LIBOR and Prime Rates (5.38% - 6.50%), due through 2009 $ 17,143 $ 18,571
Revolving loans payable under the Bank of America Credit Agreement,
interest based on LIBOR and Prime Rates (5.13% - 6.25%) 39,646 40,166
-------- --------
Total debt 56,789 58,737
Less revolving loans, classified as current (see below) (39,646) (40,166)
Less current maturities (2,857) (2,857)
-------- --------
Long-term debt $ 14,286 $ 15,714
======== ========
Aggregate remaining scheduled maturities of the Term Loan as of March 31,
2005 are as follows (amounts in thousands):
2005 $1,429
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
- 11 -
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 March 31, 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 March 31, 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 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 $8.6 million were outstanding at March 31,
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 March 31, 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 first quarter of 2004, Katy incurred fees and expenses of
$0.4 million (reported in Other, net on the Condensed Consolidated Statement of
Operations) associated with a financing which the Company chose not to pursue.
- 12 -
(6) Retirement Benefit Plans
Several 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 as of March 31, 2005 is as follows (amounts
in thousands):
Pension Benefits Other Benefits
--------------------- --------------------
March 31, March 31, March 31, March 31,
2005 2004 2005 2004
--------- --------- --------- ---------
Components of net periodic benefit cost:
Service cost $ 2 $ 1 $ -- $ 7
Interest cost 23 32 47 40
Expected return on plan assets (26) (33) -- --
Amortization of prior service cost -- -- 15 15
Amortization of net gain 20 17 15 --
---- ---- ---- ----
Net periodic benefit cost $ 19 $ 17 $ 77 $ 62
==== ==== ==== ====
There are no required contributions to the pension plans for 2005 and Katy did
not make any contributions during the first quarter of 2005.
(7) Income Taxes
As of March 31, 2005 and December 31, 2004, the Company had deferred tax
assets, net of deferred tax liabilities, of $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 March 31, 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 provision for income taxes for the three months ended March 31, 2005
and 2004 reflects current expense for state and foreign income taxes. Tax
benefits were not recorded on the pre-tax net loss for the first quarter of 2005
as valuation allowances were recorded related to deferred tax assets created as
a result of operating losses in the United States and certain foreign
jurisdictions.
- 13 -
(8) Commitments and Contingencies
General Environmental Claims
The Company and certain of its current and former direct and indirect
corporate predecessors, subsidiaries and divisions are involved in remedial
activities at certain present and former locations and have been identified by
the United States Environmental Protection Agency, state environmental agencies
and private parties as potentially responsible parties (PRPs) at a number of
hazardous waste disposal sites under the Comprehensive Environmental Response,
Compensation and Liability Act (Superfund) or equivalent state laws and, as
such, may be liable for the cost of cleanup and other remedial activities at
these sites. Responsibility for cleanup and other remedial activities at a
Superfund site is typically shared among PRPs based on an allocation formula.
Under the federal Superfund statute, parties could be held jointly and severally
liable, thus subjecting them to potential individual liability for the entire
cost of cleanup at the site. Based on its estimate of allocation of liability
among PRPs, the probability that other PRPs, many of whom are large, solvent,
public companies, will fully pay the costs apportioned to them, currently
available information concerning the scope of contamination, estimated
remediation costs, estimated legal fees and other factors, the Company has
recorded and accrued for environmental liabilities in amounts that it deems
reasonable. 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 paid over the next
several years.
W.J. Smith Wood Preserving Company ("W.J. Smith")
The most significant environmental matter in which the Company is
currently involved relates to the W.J. Smith site. 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 United States Environmental Protection Agency (EPA) initiated
a proceeding under Section 7003 of the Resource Conservation and Recovery Act
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 USEPA 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.
In addition to the administrative claim specifically identified above, a
purported class action lawsuit was filed by twenty 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 Resource Conservation and Recovery Act. 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 lacks 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.
- 14 -
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 the WJ Smith 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.
Asbestos Claims
A. The Company has recently been named as a defendant in four lawsuits filed in
state court in Alabama by a total of approximately 24 individual plaintiffs.
There are over 100 defendants named in each case. In all four 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 three 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 1,500 cases pending in
Michigan, New Jersey, Illinois, Nevada, Mississippi, Wyoming, Louisiana,
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 entered into by Sterling with one of its plaintiffs.
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 280 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.
In December 1996, Banco del Atlantico ("plaintiff"), a bank located in
Mexico, filed a lawsuit in Texas against 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.
- 15 -
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.
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 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.
- 16 -
(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):
Three months ended March 31,
2005 2004
--------- ---------
Maintenance Products Group
Net external sales $ 61,473 $ 70,490
Operating (loss) income (4,078) 2,406
Operating margin (6.6%) 3.4%
Depreciation and amortization 2,489 3,447
Capital expenditures 1,296 2,366
Electrical Products Group
Net external sales $ 34,040 $ 29,405
Operating income 2,913 2,037
Operating margin 8.6% 6.9%
Depreciation and amortization 354 303
Capital expenditures 107 48
Total
Net external sales - Operating segments $ 95,513 $ 99,895
--------- ---------
Total $ 95,513 $ 99,895
========= =========
Operating loss - Operating segments $ (1,165) $ 4,443
- Unallocated corporate (1,666) (2,561)
- Severance, restructuring and related charges (373) (1,898)
--------- ---------
Total $ (3,204) $ (16)
========= =========
Depreciation and amortization - Operating segments $ 2,843 $ 3,750
- Unallocated corporate 4 52
--------- ---------
Total $ 2,847 $ 3,802
========= =========
Capital expenditures - Operating segments $ 1,403 $ 2,414
- Unallocated corporate -- 1
--------- ---------
Total $ 1,403 $ 2,415
========= =========
March 31, December 31,
2005 2004
--------- ------------
Total assets - Maintenance Products Group $ 140,985 $ 154,635
- Electrical Products Group 49,498 57,698
- Other [a] 1,617 1,624
- Unallocated corporate 9,607 10,507
--------- ---------
Total $ 201,707 $ 224,464
========= =========
[a] Amounts shown as "Other" primarily represent items associated with an equity
investment in a shrimp harvesting and farming operation.
- 17 -
(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 (by major initiative)
for the three months ended March 31, 2005 and 2004, respectively, is as follows
(amounts in thousands):
Three Months Ended March 31,
2005 2004
------ ------
Consolidation of abrasives facilities $ 115 $ 346
Consolidation of St. Louis manufacturing/distribution facilities 81 177
Consolidation of administrative functions for CCP 21 140
Shutdown of Woods Canada manufacturing (19) 1,102
Other 175 133
------ ------
Total severance, restructuring and related charges $ 373 $1,898
====== ======
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. It is expected that the
Lawrence, Massachusetts and Pineville, North Carolina facilities will be closed
in 2005 and those operations consolidated into the newly expanded Wrens, Georgia
facility. Costs incurred in the three months ended March 31, 2005 related to
severance for expected terminations at the Lawrence facility. Costs incurred in
the three months ended March 31, 2004 related to 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 related to a non-cancelable lease adjustment at the Hazelwood facility,
miscellaneous costs for the termination of the Warson Road facility lease, and
the movement of equipment from Hazelwood to Bridgeton. In the first quarter of
2004, costs of $0.2 million were incurred related primarily to the movement of
inventory and equipment.
Consolidation of administrative functions for CCP - Katy has incurred
various costs in 2004 and 2005 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 months ended
March 31, 2005 costs related to an accrual for idle space at our Textiles
facility in Atlanta. For the three months ended March 31, 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 quarter of 2005, a credit
was recorded to finalize the severance paid in 2003 and 2004. In the first
quarter 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
quarter of 2004, Woods Canada recorded $0.1 million for additional severance.
Other - Charges in the first quarter 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 unit. Costs in the first
quarter of 2004 relate primarily to the closure of CCP's facility in Canada and
the subsequent consolidation into the Woods Canada facility, and the closure of
CCP's metals facility in Santa Fe Springs, California.
- 18 -
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 392 290 76 26
Reductions (19) (19) -- --
Payments (521) (183) (312) (26)
Foreign Exchange (4) (1) (3) --
------- ------- ------- -------
Restructuring liabilities at March 31, 2005 [d] $ 4,302 $ 894 $ 3,408 $ --
======= ======= ======= =======
[a] Includes severance, benefits, and other employee-related costs associated
with 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.
[d] Katy expects to substantially complete its restructuring program in 2005.
The remaining severance, restructuring and related charges for these initiatives
are expected to be in the range of $1.0 million to $2.0 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 392 392 --
Reductions (19) -- (19)
Payments (521) (415) (106)
Foreign Exchange (4) -- (4)
------- ------- -------
Restructuring liabilities at March 31, 2005 $ 4,302 $ 3,362 $ 940
======= ======= =======
The table below summarizes the future payments for severance,
restructuring and other related charges by operating segment detailed above
(amounts in thousands):
Maintenance Electrical
Products Products
Total Group Group
------ ----------- ----------
2005 $1,996 $1,657 $ 339
2006 770 574 196
2007 428 249 179
2008 389 200 189
2009 248 211 37
Thereafter 471 471 --
------ ------ ------
Total Payments $4,302 $3,362 $ 940
====== ====== ======
- 19 -
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
Three Months Ended March 31, 2005 versus Three Months Ended March 31, 2004
2005 2004
-------------------- --------------------
(Amounts in Millions, Except Per Share Data)
------ ---------- ------ ----------
$ % to Sales $ % to Sales
------ ---------- ------ ----------
Net sales $ 95.5 100.0 $ 99.9 100.0
Cost of goods sold 86.0 90.0 83.3 83.4
------ ------ ------ ------
Gross profit 9.5 10.0 16.6 16.6
Selling, general and administrative expenses 12.3 12.9 14.7 14.8
Severance, restructuring and related charges 0.4 0.5 1.9 1.8
------ ------ ------ ------
Operating loss (3.2) (3.4) -- --
====== ======
Interest expense (1.3) (0.8)
Other, net -- (0.4)
------ ------
Loss before provision for income taxes (4.5) (1.2)
Provision for income taxes 0.1 0.6
------ ------
Net loss (4.6) (1.8)
Payment-in-kind dividends on convertible preferred stock -- (3.4)
------ ------
Net loss attributable to common stockholders (4.6) (5.2)
====== ======
Loss per share of common stock - basic and diluted:
Net loss $(0.59) $(0.23)
Payment-in-kind dividends on convertible preferred stock -- (0.44)
------ ------
Net loss attributable to common stockholders $(0.59) $(0.67)
====== ======
Overview
Our consolidated net sales for the three month period ending March 31,
2005 decreased $4.4 million compared to the three month period ending March 31,
2004. The decline in net sales of 4% was comprised of lower volumes [(11%)],
higher pricing [6%] and favorable currency translation [1%]. Gross margins were
10.0% for the three month period ending March 31, 2005 a decrease of 6.6
percentage points compared to the three month period ending March 31, 2004.
Higher raw material costs and incremental operating costs incurred due to the
delayed consolidation of the abrasives facilities were partially offset by the
favorable impact of restructuring, cost containment, and selling price
increases. Selling, general and administrative expense (SG&A) as a percentage of
sales declined from 14.8% for the first quarter of 2004 to 12.9% in the first
quarter of 2005, primarily due to cost containment in the Electrical Products
Group. The operating loss decreased by $3.2 million to $(3.2) million, mostly
due to lower sales volumes and lower gross margins.
Overall, we reported a net loss attributable to common shareholders of
($4.6) million [($0.59) per share] for the three month period ending March 31,
2005, versus a net loss attributable to common shareholders of ($5.2) million
[($0.67) per share] in the same period of 2004. During the first quarter of
2004, we recorded the impact of payment-in-kind dividends earned on our
convertible preferred stock of ($3.4) million [($0.44) per share]. The
payment-in-kind dividends ended in December 2004.
- 20 -
Net Sales
Maintenance Products Group
Net sales from the Maintenance Products Group decreased from $70.5 million
during the three month period ending March 31, 2004 to $61.5 million during the
three month period ending March 31, 2005. Overall, this decline of 13% was due
to lower volumes [(16%)] and higher pricing [3%]. Sales volume for the Consumer
Plastics business units in the US and the UK, which sell primarily to mass
merchant customers, was significantly lower due to our decision to exit certain
unprofitable lines of business. In addition, volumes at our UK Consumer Plastics
business unit were negatively impacted by softening demand due to a weakening
retail sector in the UK. 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 quarter of 2005 versus the first
quarter 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. On a positive note, 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, most of which took effect in the first
quarter of 2005. The implementation of price increases was in response to the
accelerating cost of our primary raw materials, packaging materials, utilities
and freight. In 2004, we experienced $24 million of these cost increases
compared to 2003. These cost increases have continued in the first quarter of
2005, and if sustained throughout 2005, would amount to an increase of over $50
million compared to 2003.
Electrical Products Group
The Electrical Products Group's sales improved from $29.4 million for the
three month period ending March 31, 2004 to $34.0 million for the three month
period ending March 31, 2005. The sales improvement of 16% was a result of a
higher pricing [13%], favorable currency translation [2%] and increased volume
[1%]. Multiple selling price increases were implemented since the beginning of
2004 at Woods US (and to a lesser extent at Woods Canada) to offset the rising
cost of copper and PVC. Volume at Woods US benefited principally from increased
promotional activity at one of its largest mass merchant retailers. Woods Canada
experienced a volume decline primarily due to the timing of sales. Garden
lighting sales were stronger in the first quarter of 2004 as corresponding
seasonal sales came in ahead of the first quarter of 2005. Sales at Woods Canada
were favorably impacted by a stronger Canadian dollar versus the U.S. dollar in
the first quarter of 2005 as compared to the same period in 2004.
Operating Income
Three months ended March 31,
(Amounts in Millions)
Operating income (loss) 2005 2004 Change
------------------ ------------------ ------------------
$ % Margin $ % Margin $ % Margin
----- -------- ----- -------- ----- --------
Maintenance Products Group $(4.1) (6.6) $ 2.4 3.4 $(6.5) (10.0)
Electrical Products Group 2.9 8.6 2.0 6.9 0.9 1.7
Unallocated corporate expense (1.6) (2.5) 0.9
Severance, restructuring and related charges (0.4) (1.9) 1.5
----- ----- -----
Operating loss $(3.2) $ -- $(3.2)
===== ===== =====
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Maintenance Products Group
The Maintenance Products Group's operating income decreased from $2.4
million (3.4% of net sales) during the three month period ending March 31, 2004
to an operating loss of $4.1 million (-6.6% of net sales) for the three month
period ending March 31, 2005. The decrease was primarily attributable to lower
volumes and higher raw material costs in the first quarter of 2005 versus the
first quarter of 2004 that were only partially recovered through higher selling
prices. The impact of accelerating raw material costs had the most pronounced
effect on the gross margins of our business units which sell plastics products.
In addition, manufacturing throughput was low at our plastics molding facilities
in the U.S. and the U.K. as we reduced inventory and adjusted our production
levels in connection with our decision to exit certain unprofitable lines of
Consumer Plastics business. We also experienced a decline 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
quarter of 2005, was essentially unchanged versus the first quarter of 2004.
Electrical Products Group
The Electrical Products Group's operating income increased from $2.0
million (6.9% of net sales) for the three month period ending March 31, 2004 to
$2.9 million (8.6% of net sales) for the three month period ending March 31,
2005, an increase of 43%. The increase in profitability was due to the strong
volume increases at the Woods US business unit as well as a decrease in SG&A
expenses on significantly higher sales. Lower SG&A was primarily due to cost
containment initiatives. Despite slightly higher volumes in the first quarter of
2005, gross margins declined slightly as a result of selling price increases not
quite keeping pace with the increasing costs of copper and PVC.
Corporate
Corporate operating expenses decreased from $2.5 million in the three
month period ending March 31, 2004 to $1.6 million in three month period ending
March 31, 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.
Severance, Restructuring and Related Charges
Operating results for the Company during the three months ended March 31,
2005 and 2004 were negatively impacted by severance, restructuring and related
charges of $0.4 million and $1.9 million, respectively. Charges in 2005 related
to severance associated with the reduction in workforce principally due to the
exit of certain product lines in the Consumer Plastics business unit ($0.2
million); severance associated with the planned closure of one our abrasives
facilities ($0.1 million); and charges aggregating to $0.1 million for a
non-cancelable lease adjustment at the Hazelwood facility, miscellaneous costs
for the termination of the Warson Road facility lease, and the movement of
equipment from Hazelwood to Bridgeton .
Charges in the first quarter of 2004 related to a non-cancelable lease
accrual associated with a sale/leaseback transaction and idle capacity ($1.0
million) and additional severance ($0.1 million) as a result of the shutdown of
manufacturing at Woods Canada; 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 ($0.2
million); costs incurred for the consolidation of administrative functions for
CCP ($0.1 million) and expenses for the closure of CCP's facility in Canada and
the subsequent consolidation into the Woods Canada facility ($0.1 million).
Other Items
Interest expense increased by $0.5 million in the first quarter of 2005
versus the same period of 2004, primarily as a result of higher interest rates
and higher average borrowings in 2005. The increased level of borrowings was
principally due to increased working capital levels and poor financial
performance in the second half of 2004. Other, net for the three months ended
March 31, 2004 included the write-off of fees and expenses of $0.4 million
associated with a financing which the Company chose not to pursue.
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The provision for income taxes for the three months ended March 31, 2005
and 2004 reflects current expense for state and foreign income taxes. Tax
benefits were not recorded on the pre-tax net loss for the first quarter of 2005
as valuation allowances were recorded related to deferred tax assets created as
a result of operating losses in the United States and certain foreign
jurisdictions.
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 going forward. As of March 31, 2005, we had cash
and cash equivalents of $7.1 million versus cash and cash equivalents of $8.5
million at December 31, 2004. Also as of March 31, 2005, we had outstanding
borrowings of $56.8 million [47% of total capitalization], under the Bank of
America Credit Agreement with unused borrowing availability on the Revolving
Credit Facility of $18.3 million. As of December 31, 2004, we had outstanding
borrowings of $58.7 million [46% of total capitalization]. We generated $2.0
million of cash flow from operations during the quarter ended March 31, 2005
versus the utilization of $15.7 million of cash flow from operations during the
quarter ended March 31, 2004. The improvement in cash flow from operations was
primarily attributable to a reduction of inventory in 2005 versus an inventory
build in 2004. We expect these trends to generally continue throughout 2005 as
inventory is being reduced (except for seasonal builds at the Woods US and Woods
Canada business units) and other elements of working capital are being managed.
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.
- 23 -
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 March
31, 2005, total outstanding letters of credit were $8.6 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 based upon
certain leverage measurements. Margins increased 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 December 31, 2004 and will increase another
50 basis points upon the effective date of the Third Amendment (see below).
Additionally, margins on the Term Loan will drop an additional 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 March 31, 2005.
In the first quarter 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 quarter 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 March 31, 2005, and we were not in default of any
provision of the Bank of America Credit Agreement, as amended at March 31, 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
- 24 -
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
Katy's obligations as of March 31, 2005 are summarized below (amounts in
thousands):
Due in less Due in Due in Due after
Contractual Cash Obligations Total than 1 year 1-3 years 3-5 years 5 years
-------- ----------- --------- --------- ---------
Revolving credit facility [a] $ 39,646 $ -- $ -- $ 39,646 $ --
Term loans 17,143 2,857 5,714 8,572 --
Interest on debt [b] 11,592 3,314 5,588 2,690 --
Operating leases [c] 27,313 7,824 10,640 5,313 3,536
Severance and restructuring [c] 2,713 1,337 682 351 343
SESCO payable to Montenay [d] 3,800 1,050 2,200 550 --
-------- -------- -------- -------- --------
Total Contractual Obligations $102,207 $ 16,382 $ 24,824 $ 57,122 $ 3,879
======== ======== ======== ======== ========
Due in less Due in Due in Due after
Other Commercial Commitments Total than 1 year 1-3 years 3-5 years 5 years
-------- ----------- --------- --------- ---------
Commercial letters of credit $ 511 $ 511 $ -- $ -- $ --
Stand-by letters of credit 8,116 8,116 -- -- --
Guarantees [e] 23,670 8,370 15,300 -- --
-------- -------- -------- -------- --------
Total Commercial Commitments $ 32,297 $ 16,997 $ 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 1) lockbox agreements on Katy's depository bank accounts and 2) 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.
- 25 -
[c] Future non-cancelable lease rentals are included in the line entitled
"Operating leases," which also includes obligations associated with
restructuring activities. The Consolidated Balance Sheet at March 31, 2005 and
December 31, 2004, includes $3.4 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 Consolidated Financial Statements. $1.1 million of this obligation
is classified in the Consolidated Balance Sheets as an Accrued Expense in
Current Liabilities, while the remainder is included in Other Liabilities,
recorded on a discounted basis.
[e] As discussed in Note 4 to the 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 Consolidated Financial Statements in Part II, Item 8 for
a discussion of SESCO.
Cash Flow
Liquidity was positively impacted during the first quarter of 2005 as a
result of higher operating cash flow and lower capital expenditures. We provided
$2.0 million of operating cash compared to operating cash used of $15.7 million
during the first quarter of 2004. Debt obligations at March 31, 2005 decreased
$1.9 million from December 31, 2004 primarily the result of lower working
capital.
Operating Activities
Cash flow used in operating activities before changes in operating assets
was $1.5 million in the first quarter of 2005 versus cash flow provided by
operating activities before changes in operating assets of $2.3 million in the
first quarter 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 $3.5 million of cash related to operating
assets and liabilities during the three months ended March 31, 2005 versus cash
used related to operating assets and liabilities of $18.0 million during the
three months ended March 31, 2004. Our operating cash flow was favorably
impacted in the first quarter of 2005 by a decrease in inventory of $3.6
million, mostly in the business units in the Maintenance Products Group which
sell plastics products. Operating cash flow in the first quarter of 2004 was
negatively impacted by an increase in inventory of $13.2 million principally due
to the early purchase of certain materials in advance of scheduled supplier
price increases and to a seasonal increase in the Electrical Products Group.
During the first quarter of 2005, we were turning our inventory at 5.5 times per
year versus 5.1 times per year during the first quarter of 2004. Operating cash
flow in the first quarter of 2005 was also favorably impacted by lower accounts
receivable, principally resulting from a decrease in net sales in the first
quarter of 2005 versus the fourth quarter of 2004. Cash of $0.5 million and $2.5
million was used in the three months ended March 31, 2005 and 2004,
respectively, to satisfy severance, restructuring and related obligations.
Restructuring and consolidation activities, which are expected to end in 2005,
are important to reducing our cost structure to a competitive level.
Investing Activities
Capital expenditures totaled $1.4 million during the three months ended
March 31, 2005 as compared to $2.4 million during the three months ended March
31, 2004. Anticipated capital expenditures are expected to be significantly
lower in 2005 than in 2004, mainly due to an equipment replacement program 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.
- 26 -
Financing Activities
Overall, debt decreased $1.9 million during three months ended March 31,
2005 versus an increase of $12.1 million during the three months ended March 31,
2004, primarily relating to the changes in inventory balances during those
periods. Direct debt costs totaling $0.1 million in the first quarter of 2005
represents a fee paid to our lenders in connection with the Second Amendment and
$0.2 million in the first quarter 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
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
quarter of 2005 from the Woods US business unit, offset by lower volumes in our
Consumer Plastics and Abrasives business units. Price increases were passed
along to our Woods US customers during 2004 and early 2005 as a result of the
rise in copper prices from late 2003 through early 2005. While we anticipate a
continued strong top line performance from Woods US, only modest volume growth
is expected. We also expect continued softness in the U.K., especially in the
consumer /retail sector. We continue to implement price increases for the JanSan
Plastics, Container and Consumer Plastics business units and for our Metal Truck
Box business in response to higher raw material costs. However, in the 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.
We expect that the continued shipping and production inefficiencies at our
Abrasives facilities will result in higher operating costs until the
consolidation of two facilities into the Wrens, Georgia facility is completed.
We currently believe this consolidation will occur in 2005 and when complete,
will result in improved profitability of our Abrasives business. The disruption
to our Abrasives operations has resulted in the loss of certain customers. While
we expect to recover some of these lost sales in the current year, we may
experience additional lost sales in 2005. 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 recently obtained equipment allowing
us to operate all product lines at this facility.
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. 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 US and Woods Canada business
units. Prices for copper generally increased from late 2003 through early 2005.
Prices for resin and copper appear to have stabilized in a historically high
range early in the second quarter of 2005. Prices for aluminum and steel (raw
materials used in our Metal Truck Box business), corrugated packaging material
and other raw materials have also increased over the past year. 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 have continued in the first quarter of
2005, and if sustained throughout 2005, would amount to an increase of over $50
million compared to 2003. In 2004, we passed on about $15 million of these
higher costs through price increases. We announced additional price increases in
the first quarter of 2005 and expect to announce even further price increases in
the second quarter. In a climate of rising raw material costs (especially in
2004 and early 2005), we experience difficulty in raising prices to shift these
higher costs to our customers for
- 27 -
our plastic products. 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 2005 and beyond.
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 various profit
enhancing strategies such as process improvements (including Lean Manufacturing
and Six Sigma), value engineering products, improved sourcing/purchasing and
lean administration.
SG&A has continually declined as a percentage of sales and should remain
stable as a percentage of sales in 2005. 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 portion) and Filters and Grillbricks (Disco) business units from
Georgia to Bridgeton, Missouri, the headquarters of CCP. We expect to
consolidate administrative processes at our Loren portion of the Abrasives
business in 2005 and 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 we expect the
international systems integration plan to be completed during 2005.
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 based upon certain leverage measurements. Margins increased 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 December 31, 2004 and
will increase another 50 basis points upon the effective date of the Third
Amendment (see below). Additionally, margins on the Term Loan will drop an
additional 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 carried on our books. Therefore, except for our profitable foreign
subsidiaries, a full valuation allowance on the net deferred tax asset position
was recorded at March 31, 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. 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 working capital levels to remain constant or improve as a
percentage of sales as the liquidation of excess inventory in the first half of
2005 will be offset by seasonal builds in the Electrical Products Group in the
second and third quarters of 2005. 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 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 defined in the Bank of America Credit Agreement) and could potentially
exceed our maximum Consolidated Leverage Ratio
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(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.
Cautionary Statement Pursuant to Safe Harbor Provisions of the Private
Securities Litigation Reform Act of 1995
This report and the information incorporated by reference in this report
contain various "forward-looking statements" as defined in Section 27A of the
Securities Act of 1933 and Section 21E of the Exchange Act of 1934, as amended.
The forward-looking statements are based on the beliefs of our management, as
well as assumptions made by, and information currently available to, our
management. We have based these forward-looking statements on current
expectations and projections about future events and trends affecting the
financial condition of our business. These forward-looking statements are
subject to risks and uncertainties that may lead to results that differ
materially from those expressed in any forward-looking statement made by us or
on our behalf, including, among other things:
- Increases in the cost of, or in some cases continuation of, the
current price levels of plastic resins, copper, paper board
packaging, and other raw materials.
- Our inability to reduce product costs, including manufacturing,
sourcing, freight, and other product costs.
- Greater reliance on third parties for our finished goods as we
increase the portion of our manufacturing that is outsourced.
- Our inability to reduce administrative costs through consolidation
of functions and systems improvements.
- Our inability to execute our systems integration plan.
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- Our inability to successfully integrate our operations as a result
of the facility consolidations.
- Our inability to sub-lease rented facilities which have been
abandoned as a result of consolidation and restructuring
initiatives.
- Our inability to achieve product price increases, especially as they
relate to potentially higher raw material costs.
- The potential impact of losing lines of business at large mass
merchant retailers in the discount and do-it-yourself markets.
- Competition from foreign competitors.
- 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 rising costs for insurance for properties
and various forms of liabilities.
- The potential impact of changes in foreign currency exchange rates
related to our foreign operations.
- Labor issues, including union activities that require an increase in
production costs or lead to a strike, thus impairing production and
decreasing sales. We are also subject to labor relations issues at
entities involved in our supply chain, including both suppliers and
those involved in transportation and shipping.
- Changes in significant laws and government regulations affecting
environmental compliance and income taxes.
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 March
31, 2005.
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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 March 31, 2005 were indexed from short-term LIBOR and the
prime rate. 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.
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 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 the management, including the Chief Executive
Officer and Chief Financial Officer, as appropriate, to allow timely decisions
regarding required disclosure. We also have investments in certain
unconsolidated entities. As we do not control or manage these entities, the
disclosure controls and procedures with respect to such entities are necessarily
more limited than those we maintain with respect to our consolidated
subsidiaries.
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 in
timely alerting them to material information relating to Katy (including its
consolidated subsidiaries) required to be included in our periodic SEC filings.
(b) Change in Internal Controls
There have been no changes in Katy's internal control over financial
reporting during the quarter ended March 31, 2005 that has materially affected,
or is reasonable likely to materially affect Katy's internal control over
financial reporting.
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PART II - OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
During the quarter for which this report is filed, there have been no
material developments in previously reported legal proceedings, and no other
cases or legal proceedings, other than ordinary routine litigation incidental to
the Company's business and other nonmaterial proceedings, 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 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 5. OTHER INFORMATION
None.
Item 6. EXHIBITS
10.1 Second Amendment to Amended and Restated Loan Agreement dated as of
March 29, 2005 with Fleet Capital Corporation (incorporated by
reference to Exhibit 10.1 of the Company's Current Report on Form
8-K filed April 1, 2005)
10.2 Third Amendment to Amended and Restated Loan Agreement dated as of
April 13, 2005 with Fleet Capital Corporation (incorporated by
reference to Exhibit 10.17 of the Company's Annual Report on Form
10-K filed April 15, 2005)
31.1 CEO Certification pursuant to Securities Exchange Act Rule 13a-14,
as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
31.2 CFO Certification pursuant to Securities Exchange Act Rule 13a-14,
as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
32.1 CEO Certification required by 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 CFO Certification required by 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
- 32 -
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: May 9, 2005 By /s/ C. Michael Jacobi
---------------------------
C. Michael Jacobi
President and Chief Executive
Officer
By /s/ Amir Rosenthal
---------------------------
Amir Rosenthal
Vice President, Chief
Financial Officer, General
Counsel and Secretary
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