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United States
Securities and Exchange Commission
Washington, D.C. 20549
FORM 10-K
|X| Annual Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the fiscal year ended: December 31, 2002
OR
|_| Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
Commission file number 1-5558
Katy Industries, Inc.
(Exact name of registrant as specified in its charter)
Delaware 75-1277589
(State of Incorporation) (IRS Employer Identification Number)
765 Straits Turnpike, Suite 2000, Middlebury, CT 06762
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (203) 598-0397
Securities registered pursuant to Section 12(b) of the Act:
(Title of each class) (Name of each exchange on which registered)
Common Stock, $1.00 par value New York Stock Exchange
Common Stock Purchase Rights
Securities registered pursuant to Section 12(g) of the Act: None
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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |X|
Indicate by check mark whether the Registrant is an accelerated filer
(as defined in Exchange Act Rule 12b-2)
YES |_| NO |X|
The aggregate market value of the voting common stock held by
non-affiliates of the registrant* (based upon its closing transaction price on
the New York Stock Exchange Composite Tape on June 28, 2002), as of April 14,
2003 was $26,347,835. On that date 8,362,427 shares of common stock, $1.00 par
value, were outstanding, the only class of the registrant's common stock.
5,217,393 shares of common stock were held by non-affiliates of the registrant.
* Calculated by excluding all shares held by executive officers and
directors of the registrant without conceding that all such persons are
"affiliates" of the registrant for purposes of federal securities laws.
DOCUMENTS INCORPORATED BY REFERENCE
Proxy Statement for the 2003 annual meeting - Part III.
Exhibit index appears on page 88. Report consists of 92 pages.
PART I
Item 1. BUSINESS
Katy Industries, Inc. (Katy or the Company) was organized as a Delaware
corporation in 1967. We carry on our business through two principal operating
groups: Maintenance Products and Electrical/Electronics. We also have a minority
interest in a seafood harvesting company. Each majority-owned company operates
within a broad framework of policies and corporate goals. Katy's corporate
management is responsible for overall planning, financial management,
acquisitions, dispositions, and other related administrative and corporate
matters.
Recapitalization
On June 28, 2001, we completed a recapitalization of the Company. Katy
reached a definitive agreement on June 2, 2001 with KKTY Holding Company, LLC.
(KKTY), an affiliate of Kohlberg Investors IV, L.P. (Kohlberg), regarding the
recapitalization. On June 28, 2001, our stockholders approved proposals to
effectuate the recapitalization at their annual meeting, including
classification of the board of directors into two classes with staggered terms.
Under the terms of the recapitalization, directors designated by KKTY represent
a majority of our Board of Directors. Pursuant to the shareholder vote at the
annual meeting, four of the elected directors are considered Class I directors,
and were elected for an initial term of one year. These directors include C.
Michael Jacobi, President and CEO, and three directors who were not designated
by KKTY. The Class I directors elected at the 2002 stockholders' meeting, and
their successors, will serve two year terms. Five of the elected directors are
considered Class II directors, and will serve terms of two years. All of the
Class II directors are designees of KKTY.
Under the terms of the recapitalization, KKTY purchased 700,000 shares of
newly issued preferred stock, $100 par value per share (Convertible Preferred
Stock), which is convertible into 11,666,666 common shares, for an aggregate
purchase price of $70.0 million. More information regarding the Convertible
Preferred Stock can be found in Note 10 to the Consolidated Financial Statements
of Katy included in Part II, Item 8. The recapitalization allowed us to retire
obligations we had under our former revolving credit agreement which was agented
by Bank of America (Bank of America Credit Agreement). In connection with the
recapitalization, we entered into a new credit agreement, agented by Bankers
Trust Company, a subsidiary of Deutsche Bank (Deutsche Bank Credit Agreement) to
finance the future operations of Katy. More information regarding the Deutsche
Bank Credit Agreement can be found in Note 9 to the Consolidated Financial
Statements of Katy included in Part II, Item 8, and in the Liquidity and Capital
Resources section of Management's Discussion and Analysis of Financial Condition
and Results of Operations, included in Part II, Item 7. Our debt obligations
under the Deutsche Bank Credit Agreement were refinanced on February 3, 2003,
under a new credit agreement agented by Fleet Capital (Fleet Credit Agreement).
Also in connection with the recapitalization, we entered into an agreement
with the holder of the preferred interest in our Contico International, L.L.C.
(Contico) subsidiary to redeem early approximately half of such interest at a
discount, plus accrued distributions thereon, which had a stated value prior to
the recapitalization of $32.9 million. See Note 13 to the Consolidated Financial
Statements of Katy included in Part II, Item 8. We utilized approximately $10.2
million of the proceeds from the issuance of the Convertible Preferred Stock for
this purpose. The difference between the amount paid on redemption and the
stated value of preferred interest redeemed ($6.6 million, plus the tax effect
of $0.1 million) was recognized as an increase to Additional Paid-in Capital on
the Consolidated Statements of Stockholders' Equity. This gain is also reflected
in the Consolidated Statement of Operations as a reduction in net loss
attributable to common shareholders. Following is a summary of the sources and
uses of funds from, and in connection with, the recapitalization:
(Thousands of Dollars)
Sources:
Sale of Convertible Preferred Stock $ 70,000
Borrowings under the Deutsche Bank Credit Agreement 93,211
--------
$163,211
========
Uses:
Paydown of principal obligations under the Bank of
America Credit Agreement $144,300
Payment of accrued interest under the Bank of America
Credit Agreement 624
Purchase of one-half of preferred interest of Contico
at a discount 9,900
Payment of accrued distributions on one-half of preferred
interest of Contico 322
Certain costs associated with the recapitalization
8,065
--------
$163,211
========
2
In connection with the Fleet Credit Agreement completed in February 2003,
the remainder of the preferred interest in Contico (carrying value of $16.4
million at December 31, 2002) was redeemed early at a similar 40% discount. More
information regarding this redemption can be found in Note 24 to the
Consolidated Financial Statements of Katy included in Part II, Item 8.
Operations
Selected operating data for each operating group can be found in
Management's Discussion and Analysis of Financial Condition and Results of
Operations included in Part II, Item 7. Information regarding foreign and
domestic operations and export sales can be found in Note 18 to the Consolidated
Financial Statements of Katy included in Part II, Item 8. Set forth below is
information about our operating groups and investments and about our business in
general.
We are restructuring many of our operations in order to maintain a low
cost structure, which is essential for us to be competitive in the markets we
serve. These restructuring efforts include consolidation of facilities,
headcount reductions, and evaluation of sourcing strategies to determine the
lowest cost method for obtaining finished product. Costs associated with these
efforts include expenses for recording liabilities for non-cancelable leases at
facilities that are abandoned, severance and other employee termination costs,
costs to move inventory and equipment, consultant costs for sourcing strategy
evaluation, and other exit costs that may be incurred not only with
consolidation of facilities, but potentially the complete shut down of certain
manufacturing operations. We have incurred significant costs in this respect
during 2002 ($19.2 million) and 2001 ($13.4 million), and to a lesser extent in
2000 ($2.7 million). It should be noted that $8.3 million of the costs incurred
during 2001 related mainly to severance and other employee termination costs and
other non-recurring costs associated with the closure of the former corporate
office and a significant changeover in management. We expect to incur additional
costs in 2003 and 2004, although the remaining costs in total are expected to be
significantly lower than those recognized in 2002 and 2001.
Maintenance Products Group
The Maintenance Products group's principal business is the manufacturing,
distribution and sale of sanitary maintenance supplies, professional cleaning
products, consumer products, abrasives and stains. Total revenues during 2002
were $314.6 million, and operating loss was ($19.9) million. The operating loss
included $20.8 million of impairments of long-lived assets, and $13.6 million of
severance, restructuring and related charges. The group accounted for 68% of the
Company's sales from continuing operations in 2002. Duckback Products, Inc. is
the only business in this group that is subject to significant seasonal sales
trends. The maintenance Products group sells product to both commercial and
consumer end-users. The business units in this group are:
Contico International, L.L.C. (Contico) Contico is headquartered in St.
Louis, Missouri. Contico's U.S. operations consist of three primary business
units. The Janitorial/Sanitation (Jan San) business is a plastics manufacturer
and a distributor of products for the commercial sanitary maintenance and food
service markets. Examples of Contico Jan San products are trash receptacles,
bucket/wringer combo units for mops, wet floor signs, janitorial carts, food
storage bins, and other products designed for commercial cleaning and food
service. The Consumer/Retail (Consumer) business is a plastics and metals
manufacturer of consumer and automotive storage products, sold primarily through
major home improvement and mass market retail outlets. Examples of Contico
Consumer products are metal and plastic storage boxes designed for pickup
trucks, garage shelving, drawer storage units, and clear plastic and heavy duty
storage bins. The Container business is a plastics manufacturer of products for
commercial and industrial use, including storage drums and pails. Contico also
has operations in the United Kingdom. Contico Manufacturing, Ltd. is a
distributor of primarily plastic products for the commercial and sanitary
maintenance markets in the UK. Contico Europe Holdings is a plastics
manufacturer of consumer storage products, sold primarily to major retail
outlets in the UK. Consumer products are sold under the Contico(R) brand name
and Jan San products are sold under the Continental(R) and Contico(R) brand
names. Contico also has operations in southern California and Winters, Texas.
Glit/Disco, Inc. (Disco) Disco, headquartered in McDonough, Georgia, is a
manufacturer and distributor of filtration, cleaning and specialty products sold
to the restaurant/food service industry. Examples of Disco products include
fryer filters, grill bricks, and other food service items.
Duckback Products, Inc. (Duckback) Duckback, headquartered in Chico,
California, is a manufacturer of high quality exterior transparent stains,
coatings and water repellents. These products are sold primarily under the trade
names Superdeck(R), Mason's Select(R) and Supershade(R). Superdeck products are
primarily protective deck stains for use on wood, while Mason's Select products
are protective stains for use on concrete patios, driveways, and other similar
surfaces. Duckback's revenues and operating income are subject to seasonal
trends, with higher sales late in the first quarter and early in the second
quarter, in anticipation of warm weather outdoor work, and lower sales levels in
the fourth quarter.
3
Glit/Microtron Abrasives (Glit/Microtron) Glit/Microtron is headquartered
in Wrens, Georgia, and has an additional manufacturing facility in Pineville,
North Carolina. Glit/Microtron manufactures non-woven floor maintenance pads,
abrasive hand pads, scouring pads and specialty abrasive products for cleaning
and finishing. Glit/Microtron sells certain abrasive products under the Brillo
brand name (under license) through commercial channels. Products are sold
primarily through commercial sanitary maintenance and food service markets, with
some products sold through consumer/retail outlets.
Gemtex, Ltd. (Gemtex) Gemtex, headquartered in Etobicoke, Ontario, Canada,
is a manufacturer and distributor of resin fiber disks and other coated
abrasives for the original equipment manufacturers (OEM), automotive,
industrial, and home improvement markets.
Loren Products (Loren) Loren, headquartered in Lawrence, Massachusetts, is
a manufacturer and distributor of abrasive products and roof ventilation
products for the sanitary maintenance and construction industries.
Wilen Products, Inc. (Wilen) Wilen, headquartered in Atlanta, Georgia, is
a manufacturer and distributor of professional cleaning products, including
mops, brooms, brushes, and plastic cleaning accessories. Wilen's products are
sold primarily through commercial sanitary maintenance and food service markets,
with some products sold through consumer/retail outlets.
Electrical/Electronics Group
The Electrical/Electronics group's principal business is the
manufacturing, distribution, and sale of consumer electric corded products,
electrical and electronic accessories, and electronic components. Revenues in
2002 were $144.2 million and operating income was $2.9 million. Operating income
in 2002 included $0.4 million of impairments of long-lived assets, and $5.2
million of severance, restructuring and related charges. The group accounted for
32% of the Company's consolidated sales in 2002. Both Woods Industries, Inc. and
Woods Industries (Canada), Inc. are subject to seasonal sales trends, with
higher sales in the third and early fourth quarters in connection with the
holiday shopping season. The Electrical/Electronics group sells product to
consumer end-users. On March 6, 2003, we announced that we are exploring the
sale of the Woods and Woods Canada businesses. However, there can be no
assurance that a sale of the Woods and Woods Canada businesses can be completed.
The business units in this group are:
Woods Industries, Inc. (Woods) Woods, headquartered in Carmel, Indiana,
distributes consumer electric corded products, supplies and
electrical/electronics accessories. Examples of Woods products are outdoor and
indoor extension cords, cord reels, surge protectors, power strips, and work
lights. Products are sold under brand names including Woods(R), Yellow
Jacket(R), Tradesman(R), and AC/Delco(R). These products are sold primarily
through major home improvement and mass market retail outlets. Woods' products
are sourced primarily from Asia.
Woods Industries (Canada), Inc. (Woods Canada) Woods Canada, headquartered
in Toronto, Ontario, Canada, manufactures and distributes consumer electric
corded products, supplies and electrical/electronics accessories. In addition to
products listed above for Woods, Woods Canada primary product offerings include
garden lighting and timers. Products are sold under brand names including
Noma(R) and Woods(R). These products are sold primarily through major home
improvement and mass market retail outlets in Canada. Certain of Woods Canada's
products are manufactured in Canada, while the remainder is sourced from Asia.
Other Operations
The businesses in this group include a 43% equity investment in a shrimp
harvesting and farming operation, and a waste-to-energy facility.
Sahlman Holding Company, Inc. (Sahlman) Sahlman harvests shrimp off the
coast of South and Central America and owns shrimp farming operations in
Nicaragua. Sahlman has a number of competitors, some of which are larger and
have greater financial resources. Katy's interest in this company is an equity
investment.
Savannah Energy Systems Company (SESCO). SESCO operated a waste-to-energy
facility in Savannah, Georgia. On March 15, 2002, we signed agreements with a
third party that turned over operation of the facility to a partnership managed
by an affiliate of Montenay Power Corporation. See Note 8 to Consolidated
Financial Statements of Katy included in Part II, Item 8.
4
Discontinued Operations
We have identified certain operations that we consider non-core to the
future operations of the Company. Hamilton Precision Metals L.P. (Hamilton), a
reroller of precision metal foils and strips located in Lancaster, Pennsylvania,
was sold in October 2002 for gross proceeds of $13.9 million. Hamilton was
formerly part of the Electrical/Electronics group. Prior to its sale, Hamilton
generated $10.4 million of net sales and $1.6 million of operating income.
GC/Waldom Electronics, Inc. (GC/Waldom), described below, was still owned by
Katy at December 31, 2002, but was considered held for sale, and was
subsequently sold on April 2, 2003 for gross proceeds of $8.3 million. GC/Waldom
is headquartered in Rockford, Illinois. During 2002, GC/Waldom generated $22.5
million in net sales, and incurred a net operating loss of ($6.3) million. We do
not expect to report a significant gain or loss on the sale of GC/Waldom.
GC/Waldom is a leading value-added distributor of high quality, brand name
electrical and electronic parts, components and accessories. In addition, the
company produces a full line of home entertainment component parts and service
technician products. GC/Waldom distributes primarily to the electronic,
automotive and communication industries. A significant portion of GC/Waldom's
products is sourced from Asia. GC/Waldom was formerly a part of the
Electrical/Electronics group, but has been classified in discontinued operations
as the business was held for sale at December 31, 2002, and has met the other
criteria established by Statement of Financial Accounting Standards (SFAS) No.
144, Accounting for the Impairment or Disposal of Long-Lived Assets.
Customers
We have several large customers in the mass merchant/discount/home
improvement retail markets. One customer accounted for 17% of consolidated net
sales. Sales to this particular customer are made by Contico, Woods and
Glit/Microtron. A significant loss of business at this retail outlet could have
an adverse impact on our results.
Backlog
Maintenance Products:
Our aggregate backlog position for the Maintenance Products group was $8.1
million and $11.9 million as of December 31, 2002 and 2001, respectively. The
orders placed in 2002 are firm and are expected to be shipped during 2003.
Electrical/Electronics:
Our aggregate backlog position for the Electrical/Electronics group was
$3.6 million and $3.0 million as of December 31, 2002 and 2001, respectively.
The orders placed in 2002 are firm and are expected to be shipped during 2003.
Markets and Competition
Maintenance Products:
We market a variety of professional cleaning products to the commercial
janitorial/sanitation markets. Sales and marketing of these products is handled
through a combination of direct sales personnel, manufacturers' sales
representatives, and wholesale distributors. Cleaning products sold by the
Company include 1) plastic items, such as trash receptacles, buckets, carts, and
signs, 2) abrasive products, including floor cleaning and polishing pads, and
hand scouring pads, 3) mops, brooms, and brushes, and 4) items for the food
service industry, including filters, grill cleaning supplies, and food storage
containers.
The commercial distribution channels for these products are highly
fragmented, resulting in a large number of small customers, mainly distributors
of janitorial cleaning products. The markets for our maintenance products are
highly competitive. Competition is based primarily on price and the ability to
provide superior customer service in the form of complete on-time product
delivery. Other competitive factors include brand recognition and product
design, quality and performance. We compete for market share with a number of
different competitors, depending upon the specific product. In large part, our
competition is unique in each area of 1) plastics, 2) abrasives, and 3) mops,
brooms and brushes. We believe that we have established long standing
relationships with our major customers based on quality products and service,
while continuing to strive to be a low cost provider in this industry. Our
ability to remain a low cost provider in the industry is highly dependent on the
price of our raw materials, primarily resin. Resin prices are influenced to a
certain degree by market prices for natural gas and crude oil, as well as supply
and demand factors within the plastics manufacturing industry. Being a low cost
producer is also dependent upon our ability to reduce and subsequently control
our cost structure, which is further dependent upon our ongoing restructuring
efforts.
We market branded consumer in-home and automotive storage, protective
sealant stains, and to a lesser extent, abrasive products and mops and brooms,
to consumer/retail outlets in the U.S. The consumer distribution channels for
these products, especially the in-home and automotive storage, are highly
concentrated, with several large "mass-market" retailers
5
representing a very significant portion of the customer base. However, the
Company continues to develop new markets for its products, including sporting
goods. Distribution channels for protective sealant stains are primarily through
paint distribution channels, with products ultimately being sold in
specialty/high-end paint stores and hardware stores. Sales and marketing of
these products is generally handled by direct sales personnel. Our ability to
remain competitive in these consumer markets is dependent upon our position as a
low cost producer, and also upon our development of new and innovative products.
Being a low cost producer is also dependent upon our ability to reduce and
subsequently control our cost structure, which is further dependent upon our
ongoing restructuring efforts. Our restructuring efforts include consolidation
of facilities and headcount reductions.
Less significant amounts (based on net sales dollars) are sold to
different markets, such as roofing ventilation products to the construction
trade, and resin fiber disks and other abrasive disks to the OEM trade.
Electrical/Electronics:
We market branded electrical and electronics products primarily in North
America through a combination of direct sales personnel and manufacturers' sales
representatives. Our primary customer base consists of major national retail
chains that service the home improvement, hardware, mass merchant, discount and
automotive markets, and smaller regional concerns serving a similar customer
base.
Electrical and electronic products sold by the Company are generally used
by consumers and include such items as extension cords, work lights, surge
suppressors, power taps and strips, and outdoor lights and timers. We have
entered into license agreements pursuant to which we market certain of our
products using certain other companies' proprietary brand names. Overall demand
for our products is highly correlated with consumer demand, the performance of
the general economy and, to a lesser extent, home construction and resale
activity.
The markets for our electrical and electronic products are highly
competitive. Competition is based primarily on price and the ability to provide
superior customer service in the form of complete on-time product delivery.
Other competitive factors include brand recognition, product design, quality and
performance. Foreign competitors, especially from Asia, provide an increasing
level of competition. Our ability to remain competitive in these markets is
dependent upon continued efforts to remain a low-cost provider of these
products.
Raw Materials
Our operations have not experienced significant difficulties in obtaining
raw materials, fuels, parts or supplies for their activities during the most
recent fiscal year, but no prediction can be made as to possible future supply
problems or production disruptions resulting from possible shortages. Our
Electrical/Electronics businesses are highly dependent upon products sourced
from Asia, and therefore remain vulnerable to potential disruptions in that
supply chain. We are also subject to uncertainties involving labor relations
issues at entities involved in our supply chain, both at suppliers and in the
transportation and shipping area. Our Contico subsidiary (and some others to a
lesser extent) uses polyethylene, polypropylene and other thermoplastic resins
as raw materials in a substantial portion of its plastic products. Prices of
plastic resins, such as polyethylene and polypropylene, have increased during
the early months of 2003. 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 cannot predict the longevity of the current price increase, or if
resin prices may increase further or be reduced through the rest of 2003. We are
also exposed to price changes for copper (used by Woods and Woods Canada),
corrugated packaging material and other raw materials. Copper prices have also
increased in recent months. We have not employed an active hedging program
related to our commodity price risk, but are employing other strategies for
mitigating the risk. In a climate of rising raw material costs, we experience
difficulty in raising prices to shift these higher costs to our customers. Our
future earnings may be negatively impacted to the extent increased costs for raw
materials cannot be recovered or offset.
Employees
As of December 31, 2002, we employed 2,261 people. Approximately 585 of
these employees were members of various unions. Our labor relations are
generally satisfactory and there have been no strikes in recent years. Our
operations can be impacted by labor relations issues involving other entities in
our supply chain.
6
Regulatory and Environmental Matters
We do not anticipate that federal, state or local environmental laws or
regulations will have a material adverse effect on our consolidated operations
or financial position. We anticipate making additional expenditures for
environmental matters during 2003, in accordance with terms agreed upon with the
United States Environmental Protection Agency and various state environmental
agencies. See Environmental and Other Contingencies in Part II, Item 7.
Licenses, Patents and Trademarks
The success of our products historically has not depended largely on
patent, trademark and license protection, but rather on the quality of our
products, proprietary technology, contract performance, customer service and the
technical competence and innovative ability of our personnel to develop and
introduce salable products. However, we do rely to a certain extent on patent
protection, trade marks and licensing arrangements in the marketing of certain
products. Examples of key licensed and protected trade marks include Yellow
Jacket(R), Woods(R), Tradesman(R), AC/Delco(TM) (Woods); Noma(R) (Woods Canada);
Contico(R) and Continental(R) (Contico); Glit(R), Microtron(R), Brillo(TM), and
Kleenfast(R) (Glit/Microtron); Wilen(R); Trim-Kut(R) (Gemtex); and Superdeck(R),
and Mason's Select(R) (Duckback). Divisions most reliant upon patented products
and technology are Contico, Woods, and Gemtex. Further, we are renewing our
emphasis on new product development, which will increase our reliance on patent
and trademark protection across all business units.
Available Information
We maintain a website at http://www.katyindustries.com. We make available,
free of charge through our website, our annual reports on Form 10-K, quarterly
reports on Form 10-Q, current reports on Form 8-K, and, if applicable, all
amendments to these reports, as soon as reasonably practicable after such
reports are electronically filed or furnished to the SEC. The information on our
website is not, and shall not be deemed to be, a part of this report or
incorporated into any other filings we make with the SEC.
7
Item 2. PROPERTIES
As of December 31, 2002, our total building floor area owned or leased was
4,570,000 square feet, of which 1,038,000 square feet were owned and 3,532,000
square feet were leased. The following table shows by industry segment a summary
of the size (in square feet) and character of the various facilities included in
the above totals together with the location of the principal facilities.
Industry Segment Owned Leased Total
- ---------------- ------ ------ ------
(In thousands of square feet)
Maintenance Products - primarily
plant and office facilities with principal
facilities located in Chico, Norwalk and
Santa Fe Springs, California; Wrens, Thomson,
McDonough and Atlanta, Georgia; Bridgeton,
St. Louis, Earth City and
Hazelwood, Missouri;
Pineville, North Carolina; Buffalo, New York;
Lawrence, Massachusetts; Winters, Texas;
Etobicoke and Mississauga, Ontario, Canada; and
Redruth, Cornwall, England 561 2,995 3,556
Electrical/Electronics - primarily plant and
office facilities with principal facilities
located in Carmel and Indianapolis, Indiana,
Toronto, Ontario, Canada,
and Taipei, Taiwan 477 532 1,009
Corporate - office facility in Middlebury, Connecticut 5 5
During 2002, we consolidated a majority of our Warson Road facility in St.
Louis, Missouri into our Bridgeton, Missouri building. We have abandoned 40% of
the Earth City, Missouri facility at December 31, 2002, and plan to abandon the
remaining 60% during 2003, consolidating these operations into the Bridgeton,
Missouri facility. At December 31, 2002, we also owned a building occupied by
GC/Waldom Electronics, Inc. (GC/Waldom). The building contains 176,000 square
feet. GC/Waldom is classified as a discontinued operation at December 31, 2002.
We believe that our current facilities meet our needs in our existing markets
for the foreseeable future.
8
Item 3. LEGAL PROCEEDINGS
Except as set forth below, no cases or legal proceedings are pending
against Katy, other than ordinary routine litigation incidental to Katy and our
businesses and other non-material cases and proceedings.
1. Environmental Claims - Administrative Order on Consent - W.J. Smith Wood
Preserving Company (W.J. Smith) and Katy Industries, Inc., U.S. EPA Docket No.
RCRA-VI-7003-93-02 and Texas Water Commission Administrative Enforcement Action.
The W. J. Smith case 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. Following these
enforcement actions, W.J. Smith engaged in a series of cleanup activities on the
Property and implemented a groundwater monitoring program.
In 1993, the Texas Water Commission referred the matter to the United
States Environmental Protection Agency (EPA), which initiated a proceeding under
Section 7003 of the Resource Conservation and Recovery Act (RCRA) against W.J.
Smith and Katy. The proceeding sought certain actions at the site and 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
the EPA agreed to resolve the proceeding through an Administrative Order on
Consent under Section 7003 of RCRA. W.J. Smith and Katy completed cleanup
activities required by the Order. W.J. Smith is currently implementing an RCRA
facility investigation of the site and an investigation of certain off-site
areas pursuant to the request of the EPA.
While ultimate liability with respect to this matter is not easily
determinable, we have recorded and accrued amounts that we deem reasonable and
probable for prospective costs with respect to this matter and we believe that
any additional costs with respect to this matter in excess of the accrual will
not be material.
In addition to the 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 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. 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 of the Eastern
District of Texas. In response, plaintiffs filed a motion for leave to amend the
complaint to add a federal claim under RCRA. On July 30, 2002, the court
dismissed plaintiffs' lawsuit in its entirety.
On July 31, 2002, plaintiffs filed a new lawsuit against the same
defendants, again in the Marshall Division of the Eastern District of Texas,
alleging class claims under the federal Comprehensive Environmental Liability
and Compensation Act (CERCLA) and state law negligence, trespass, nuisance,
assault and battery and unjust enrichment theories. Katy and W.J. Smith have
filed a motion to dismiss the lawsuit or, in the alternative, to transfer venue
to the Sherman Division. In response, plaintiffs filed a motion for leave to
amend the complaint. The court granted plaintiffs' motion to amend and denied
Katy and W. J. Smith's motion to dismiss or transfer venue. Plaintiff's counsel
has informed legal counsel for the Company that he is no longer seeking
class-wide relief for personal injury claims. Plaintiff's counsel has therefore
prepared and circulated a draft amended complaint clarifying that this lawsuit
is not a personal injury class action. A determination of ultimate liability
with respect to this matter is not estimable at this time.
General Environmental Claims
Katy and certain of our current and former direct and indirect corporate
predecessors, subsidiaries and divisions have been identified by EPA, state
environmental agencies and private parties as potentially responsible parties at
a number of waste disposal sites under CERCLA or equivalent state laws, and, as
such, may be liable for the costs of cleanup and other remedial activities at
these sites. The costs involved in these matters are, by nature, difficult to
estimate and subject to substantial change as litigation or negotiations with
the United States, states and other parties proceed. While ultimate liability
with respect to these matters is not easily determinable, we have recorded and
accrued amounts that we deem reasonable and probable for prospective costs and
we believe that any costs with respect to such matters in excess of the accruals
will not be material.
9
2. Banco del Atlantico, S.A. v. Woods Industries, Inc., et al., Civil Action No.
L-96-139 (U.S. District Court, Southern District of Texas).
In December 1996, Banco del Atlantico, a bank located in Mexico, filed a
lawsuit against Woods, a subsidiary of Katy, and against certain past and
then-present officers and directors and former owners of Woods, alleging that
the defendants participated in a violation of the Racketeer Influenced and
Corrupt Organizations (RICO) Act involving allegedly fraudulently obtained loans
from Mexican banks, including the plaintiff, and "money laundering" of the
proceeds of the illegal enterprise. All of the foregoing is alleged to have
occurred prior to Katy's purchase of Woods. The plaintiff also alleged that it
made loans to an entity controlled by certain past officers and directors of
Woods based upon fraudulent representations. The plaintiff seeks to hold Woods
liable for its alleged damages directly, and under principles of respondeat
superior and successor liability. The plaintiff is claiming damages in excess of
$24.0 million and is requesting treble damages under RICO. Because certain
threshold procedural and jurisdictional issues have not yet been fully
adjudicated in this litigation, it is not possible at this time for the Company
to reasonably determine an outcome or accurately estimate the range of potential
exposure. Katy may have recourse against the former owner of Woods and others
for, among other things, violations of covenants, representations and warranties
under the purchase agreement through which Katy acquired Woods, and under state,
federal and common law. In addition, the purchase price under the purchase
agreement may be subject to adjustment as a result of the claims made by Banco
del Atlantico or other issues related to the litigation. The extent or limit of
any such adjustment cannot be predicted at this time. An adverse judgment in
this matter could have a material impact on Katy's liquidity and financial
position if the Company were not able to exercise recourse against the former
owner of Woods.
3. General
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.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of the security holders during
the fourth quarter of 2002.
10
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock is traded on the New York Stock Exchange (NYSE). The
following table sets forth high and low sales prices for the common stock in
composite transactions as reported on the NYSE composite tape for the prior two
years and cash dividends declared during the respective periods.
Dividends
Period High Low Declared
------ ---- --- --------
2002
First Quarter $6.75 $3.40 $.000
Second Quarter 6.28 4.85 .000
Third Quarter 4.99 2.90 .000
Fourth Quarter 3.70 2.50 .000
2001
First Quarter $8.00 $5.60 $.000
Second Quarter 7.35 4.05 .000
Third Quarter 4.80 2.95 .000
Fourth Quarter 3.55 3.00 .000
Dividends are paid at the discretion of the Board of Directors. On March
30, 2001, our Board of Directors decided to suspend quarterly dividends in order
to preserve cash for operations. Additionally, under the restrictions related to
our Fleet Credit Agreement, the payment of dividends has been suspended through
the term of that agreement.
As of April 1, 2003, there were approximately 596 holders of record of our
common stock, in addition to approximately 1,353 holders in street name, and
there were 8,362,177 shares of Common Stock outstanding.
Sale of Unregistered Securities
On June 28, 2001, we sold 700,000 shares of preferred stock, $100
par value per share, to KKTY Holding Company, L.L.C. (KKTY) for a total purchase
price of $70,000,000. These shares were sold to KKTY based on exemption from
registration under Section 4(2) of the Securities Act of 1933 since the stock
was not sold in a public offering. The preferred stock is convertible into
11,666,666 shares of our common stock at the option of KKTY at any time after
the earlier of 1) June 28, 2006, 2) board approval of a merger, consolidation or
other business combination involving a change in control of Katy, or a sale of
all or substantially all of the assets or liquidation of Katy, or 3) a contested
election for directors of the Company nominated by KKTY. The preferred shares 1)
are non-voting (with limited exceptions), 2) are non-redeemable, except in
whole, but not in part, at the Company's option (as approved by the Class I
directors) at any time after June 30, 2021, 3) are entitled to receive
cumulative payment in kind (PIK) dividends through December 31, 2004, at a rate
of 15% percent, 4) have no preemptive rights with respect to any other
securities or instruments issued by the Company, and 5) have registration rights
with respect to any common shares issued upon conversion.
As discussed above, the preferred shares are entitled to a 15% PIK
dividend (that is, dividends in the form of additional shares of preferred
stock), compounded annually, which started accruing on August 1, 2001, and are
payable on the first day in August in each of 2002, 2003, 2004, and on December
31, 2004. No dividends will accrue or be payable after December 31, 2004. As a
result, KKTY received an additional 105,000 shares of convertible preferred
stock on August 1, 2002. If KKTY continues to hold the preferred stock through
December 31, 2004, it will receive, including the 105,000 shares already
received, a total of 431,555 shares of preferred stock through PIK dividends,
which would be convertible into an additional 7,192,598 shares of common stock.
11
Item 6. SELECTED FINANCIAL DATA
Years Ended December 31,
------------------------
2002 2001 2000 1999 1998
----------- ----------- ----------- ------------ ----------
(Thousands of Dollars, except per share data and ratios)
Net sales $ 459,990 $ 460,176 $ 523,639 $ 526,809 $ 295,245
=========== =========== =========== ============ ==========
(Loss) income from continuing operations [a] $ (51,391) $ (62,867) $ (7,781) $ 10,845 $ 9,933
Discontinued operations [b] (2,844) 787 2,323 (390) 3,149
Extraordinary loss on early extinguishment of
debt [b] [e] -- (1,182) -- -- --
Cumulative effect of a change in accounting
principle [b] [f] (2,514) -- -- -- --
----------- ----------- ----------- ------------ ----------
Net (loss) income $ (56,749) $ (63,262) $ (5,458) $ 10,455 $ 13,082
=========== =========== =========== ============ ==========
(Loss) earnings per share - Basic:
(Loss) income from continuing operations (7.47) (7.23) (0.93) 1.29 1.20
Discontinued operations (0.34) 0.09 0.28 (0.04) 0.38
Extraordinary loss on early extinguishment of debt -- (0.14) -- -- --
Cumulative effect of a change in accounting principle (0.30) -- --
----------- ----------- ----------- ------------ ----------
(Loss) earnings per common share $ (8.11) $ (7.28) $ (0.65) $ 1.25 $ 1.58
=========== =========== =========== ============ ==========
(Loss) earnings per share - Diluted:
(Loss) income from continuing operations (7.47) (7.23) (0.93) 1.25 1.18
Discontinued operations (0.34) 0.09 0.28 (0.04) 0.37
Extraordinary loss on early extinguishment of debt -- (0.14) -- -- --
Cumulative effect of a change in accounting principle (0.30) -- --
----------- ----------- ----------- ------------ ----------
(Loss) earnings per common share $ (8.11) $ (7.28) $ (0.65) $ 1.21 $ 1.55
=========== =========== =========== ============ ==========
Total assets $ 275,977 $ 347,955 $ 446,723 $ 493,104 $ 294,131
Total liabilities 157,405 173,691 263,490 299,893 144,815
Preferred interest in subsidiary 16,400 16,400 32,900 32,900 --
Stockholders' equity 102,172 157,864 150,333 160,311 149,316
Long-term debt, excluding current portion -- 12,474 771 150,835 39,908
Current portion of long-term debt 700 14,619 133,067 67 72
Revolving credit agreement, classified current 44,751 57,000 -- -- --
Depreciation and amortization [c] 19,403 20,728 21,608 18,283 5,195
Capital expenditures 10,118 12,566 14,196 21,066 11,314
Working capital [d] 35,206 65,733 97,258 112,463 87,775
Free cash flow [g] 21,370 5,086 7,485 14,306 8,727
Ratio of debt to capitalization 27.7% 32.5% 42.2% 43.8% 21.1%
Weighted average common shares outstanding - Basic 8,370,815 8,393,210 8,403,701 8,366,178 8,289,915
Weighted average common shares outstanding -Diluted 8,370,815 8,393,210 8,403,701 10,015,238 8,443,591
Number of employees 2,261 2,922 3,509 3,834 2,472
Cash dividends declared per common share $ 0.00 $ 0.00 $ 0.30 $ 0.30 $ 0.30
[a] Includes distributions on preferred securities in 2002, 2001, 2000 and
1999.
[b] Presented net of tax.
[c] From continuing operations only.
[d] Defined as current assets minus current liabilities, exclusive of 1)
current balances of deferred tax assets and liabilities, and 2) current
classifications of debt.
[e] This amount represents the write-off of previously capitalized debt
issuance costs related to the credit agreement in effect at the time of
the Recapitalization, which occurred on June 28, 2001.
[f] This amount is a transitional impairment of goodwill recorded with the
adoption of SFAS No. 142, Goodwill and Other Intangible Assets.
[g] Free cash flow is defined as cash flow from operations less capital
expenditures and cash dividends paid. Below is a table detailing free cash
flow:
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
Cash flow from operations $ 31,488 $ 18,281 $ 24,201 $ 37,917 $ 22,533
Capital expenditures (10,118) (12,566) (14,196) (21,066) (11,314)
Cash dividends paid -- (629) (2,520) (2,508) (2,492)
-------- -------- -------- -------- --------
Free cash flow $ 21,370 $ 5,086 $ 7,485 $ 14,343 $ 8,727
======== ======== ======== ======== ========
12
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
For purposes of this discussion and analysis section, reference is made to
the table below and the Company's Consolidated Financial Statements included in
Part II, Item 8. We have two principal operating groups: Maintenance Products
and Electrical/Electronics. The segment labeled as other consists of a minority
equity investment in a seafood harvesting and farming company, as well as an
operation exited by Katy in May 2002 which operated a waste-to-energy facility.
Two businesses formerly included in the Electrical/Electronics group, GC/Waldom
and Hamilton, have been classified as Discontinued Operations. GC/Waldom was
held for sale at December 31, 2002 and was sold on April 2, 2003, and Hamilton
was sold in October 2002. Gross proceeds on the sale of GC/Waldom were $8.3
million. We do not expect to record a significant gain or loss in 2003 related
to the sale of GC/Waldom.
Key elements in achieving profitability in the Maintenance Products group
include 1) maintaining a low cost structure, both from a production and
administrative standpoint, and 2) providing outstanding customer service. Most
of our products in the Maintenance Products group do not rely upon strong brand
equity (the exception being Duckback's products), so achieving and maintaining a
position as a low cost producer is a necessity, given that our comparative price
point on many products is below those of our competitors. New product
development is especially important in the consumer/retail markets for
Maintenance Products, as new products or beneficial modifications of existing
products increase demand from our customers, provide novelty to the consumer,
and offer an opportunity for favorable pricing from customers in the national
mass market retail area. Retention of customers, or more specifically, product
lines with those customers, is also very important in the mass market retail
area, given the vast size of these national accounts. Prices for raw materials,
especially plastic resins, have a very significant impact on Contico, the
largest division within the Maintenance Products group.
Key elements in achieving profitability in the Electrical/Electronics
group are in many ways similar to those mentioned for our Maintenance Products
group. Achieving and maintaining a low cost structure is critical given the
significant level of foreign competition, primarily from Asia and Latin America.
For this reason, in December 2002, Woods ceased all U.S. manufacturing and
initiated a fully outsourced strategy for its consumer electrical corded
products. Customer service, specifically the ability to fill orders at a rate
designated by our customers, is very important to customer retention, given
seasonal sales pressures in the consumer electrical area. Retention of customers
is critical in the Electrical/Electronics group, given the size of national
accounts.
The table below and the narrative that follows summarize the key factors
in the year-to-year changes in operating results.
13
Years Ended December 31,
------------------------
2002 2001 2000
---- ---- ----
(Thousands of dollars)
Maintenance Products Group
Net external sales $ 314,571 $ 324,642 $362,922
Operating income (loss) (19,915) (39,699) 10,298
Operating margin (deficit) -6% -12% 3%
Impairments of long-lived assets 20,812 36,087 --
Severance, restructuring and related charges 13,629 3,489 1,177
Depreciation and amortization 17,769 19,926 20,238
Capital expenditures 9,306 10,060 11,737
Total assets 197,865 231,179 299,292
Electrical/Electronics Group
Net external sales $ 144,242 $ 130,949 $157,027
Operating income (loss) 2,874 (166) 4,511
Pretax margin (deficit) 2% 0% 3%
Impairments of long-lived assets 392 1,565 --
Severance, restructuring and related charges 5,239 1,552 385
Depreciation and amortization 1,484 220 810
Capital expenditures 601 301 723
Total assets 48,228 51,591 75,062
Total Company [a]
Net external sales [b] $ 459,990 $ 460,176 $523,639
Operating income (loss) [b] (35,028) (70,886) 4,662
Operating margin (deficit) [b] -8% -15% 1%
Severance, restructuring and related charges [b] 19,155 13,380 2,651
Impairments of long-lived assets [b] 21,204 47,469 --
Depreciation and amortization [b] 19,403 20,728 21,608
Capital expenditures [b] 10,065 11,064 13,215
Total assets [c] 275,977 347,955 446,723
[a] Included in "Total Company" are certain amounts in addition to those shown
for the Maintenance Products and Electrical/Electronics segments,
including amounts associated with 1) unallocated corporate expenses, 2)
our equity investment in a shrimp harvesting and farming operation, and 3)
our waste-to-energy facility (SESCO). See Note 18 to Consolidated
Financial Statements for detailed reconciliations of segment information
to the Consolidated Financial Statements.
[b] Excludes discontinued operations.
[c] Includes discontinued operations.
2002 Compared to 2001
Maintenance Products Group
The Maintenance Products group had a mixed year in 2002. Operating income,
excluding severance, restructuring, and impairment charges, was up over 2001, as
the various cost reduction programs put into place over the last two years have
begun to impact results. While the improvement in profitability was a positive
step, significant improvement over 2001 was expected since 2001 was an
especially weak year in the Maintenance Products group. Sales volumes were down
overall from 2001, with the largest decrease in the Contico Consumer products
business.
Sales from the Maintenance Products group decreased from $324.6 million in
2001 to $314.6 million in 2002, a decrease of 3%. The largest sales decrease
occurred within the consumer business, which sells primarily to mass market
retail customers. While certain product lines with retail customers remained
stable, the revenue declines were caused by the loss of certain product lines,
as well as selected price erosion with retail customers through allowance,
rebate, and other pricing programs. In addition to continually striving to
reduce our cost structure, we are seeking to offset these challenges by
developing new products for the retail markets. The development of new products
is essential to remaining competitive and to maintaining strong relationships
with large national mass market retail customers. Sales in the Maintenance
Products divisions serving commercial markets (primarily janitorial/sanitation)
were essentially flat versus 2001. Glit/Microtron's abrasives business saw a
significant increase in sales from 2001, with sales increasing year over year
for seven of their top ten customers. Glit/Microtron's sales increases included
increases with several key, sizable, janitorial/sanitation distributors.
Glit/Microtron
14
also grew its business with a large national retail chain, for which
Glit/Microtron supplies their full stock of floor cleaning abrasive pads for
internal use at their stores nationwide. Sales were also higher in the
international markets of Katy's janitorial/sanitation businesses, primarily in
the U.K. and Canada. These positive sales trends were offset by lower sales at
Contico's janitorial/sanitation business (Continental) and at Wilen (mops,
brooms and brushes). We believe that these negative sales comparisons are in
part due to the downturn in the travel (hotels, airports), restaurant, and
hospitality sectors of the economy, to which many of our maintenance products
are sold. Other factors resulting from the worsening overall economic
environment are higher vacancy rates in office buildings, distribution
facilities, and other commercial facilities where professional cleaning products
are used. The Maintenance Products group also made positive steps in 2002 toward
managing the various janitorial/sanitation supply divisions as one group,
consolidating more of the customer service and administrative functions of these
divisions in St. Louis, Missouri. By the end of 2003, we expect to have
centralized customer service and administrative functions for Continental,
Glit/Microtron, Wilen and Disco in place, allowing customers to order products
from any division on one purchase order. We believe that operating these
businesses as a cohesive unit will improve customer service in that our
customers' purchasing processes will be simplified, as will follow up on order
status, billing, collection and other related functions. This should increase
customer loyalty, help in attracting new customers and lead to increased top
line sales in future years.
The group's operating loss improved by $19.8 million from ($39.7) million
in 2001 to ($19.9) million in 2002, an improvement of 50%. The operating loss
was primarily a result of costs for severance, restructuring and related costs,
and asset impairments, which are discussed further below. Excluding those items,
operating income improved by $14.7 million from ($0.1) million in 2001 to $14.6
million in 2002. The improvement in income was primarily driven by
Glit/Microtron, Contico and Wilen. Glit/Microtron's operating income improvement
was driven by strong sales volume and cost reductions in numerous areas,
including raw materials, freight, and headcount. Contico's operating income
improved mainly due to cost reductions implemented on a continuing basis
throughout 2001 and 2002 producing results. The Wilen business deteriorated
during 2000 and 2001 due to operational problems that were largely remedied in
2002. In addition, significant new business was gained in early 2003 from a
large national mass market retail store chain, who will use Wilen mops for their
in-store floor care needs, providing meaningful levels of new sales to use
capacity existing at the Wilen plant. During 2001, the Maintenance Products
group recorded significant valuation reserve adjustments associated with
inventory and receivables, totaling $3.5 million. Operating income improved by
$1.8 million as a result of the cessation of goodwill amortization per the
adoption of SFAS No. 142, Goodwill and Other Intangible Assets.
Operating results in 2002 were negatively impacted by several unusual
charges. The group incurred severance and restructuring charges of $13.6
million. The largest of these charges was the establishment of $10.8 million of
liabilities for non-cancelable lease payments at abandoned Contico facilities,
the operations of which have been or will be consolidated into Contico's
largest, most modern plant in Bridgeton, Missouri. The establishment of these
liabilities involves estimates of future sub-lease income. We generally assumed
that there will be no sub-lease income on these facilities until January 2004,
at which time a portion of the facility costs are expected to be recovered.
Adjustments to these liabilities are possible in the future depending upon the
accuracy of sub-lease assumptions made. Charges of $0.5 million were incurred in
2002 related to the movement of equipment and inventory from an abandoned
facility, and severance payments of $0.1 million were made to employees impacted
by this move. The Maintenance Products group incurred approximately $0.8 million
in consulting fees associated with outsourcing strategies, relating mainly to
the Wilen business. While current plans call for Wilen to continue in a
manufacturing capacity, the outsourcing project resulted in improved prices from
some new vendors on products that had already been outsourced. The group
incurred $0.4 million of severance costs related to various headcount
reductions, primarily at the executive level of operating divisions. The
Maintenance Products group also incurred $0.5 million associated with
transitioning administrative and accounting functions of Wilen and
Glit/Microtron to St. Louis, Missouri, where those functions are now performed
by Contico.
The Maintenance Products group recognized impairment charges on certain
long-lived assets totaling $20.8 million in 2002. Certain Contico property,
plant and equipment, primarily molds and tooling assets, were impaired by $15.3
million, and a customer list intangible was impaired by $3.6 million. The
majority of these impairments were associated with assets used in the Contico
Consumer business, and were the result of analyses indicating insufficient
future cash flows to cover the carrying values of the assets. It was determined
that portions of the carrying values of certain assets would not be recovered by
future cash flows over the remaining useful life of the assets. Given the unique
nature of molds for specific products, the fair values, if any, are often less
than historical cost, resulting in impairments. The Wilen business unit recorded
asset impairments of $1.9 million, resulting from management decisions on the
future use of certain manufacturing assets in the Atlanta, Georgia plant.
Operating results in 2001 for the Maintenance Products group were also
negatively impacted by several unusual charges. We recorded an impairment charge
of $33.0 million at Wilen because consistently poor operating performance led us
to conclude that the carrying values of certain long-lived assets were not
recoverable through future cash flows. In addition to the impairment at Wilen,
an additional $3.1 million of impairment charges were taken, related primarily
to management decisions regarding the discontinuance of certain property, plant
and equipment. Additional items that negatively impacted operating results
during 2001 include severance and restructuring charges of $3.5 million,
primarily at Contico and Wilen.
15
Identifiable assets for the group decreased primarily as a result of the
impairments noted above, and due to the fact that normal depreciation expense
exceeded capital expenditures for the group.
Electrical/Electronics Group
The Electrical/Electronics group had a positive year in 2002, driven
primarily by improved sales volume over 2001, and secondarily, by higher margins
over the prior year. In addition, during 2002 a major restructuring occurred at
the Woods business. After significant study and research into different sourcing
alternatives, we decided that Woods would source all of its products from Asia.
In December 2002, Woods shut down all U.S. manufacturing facilities, which were
in suburban Indianapolis and in southern Indiana. As a result of these plant
closures, 361 employees were terminated. The following charges were recorded
related to the shut down: severance and other closure costs of $2.4 million,
asset impairments of $0.4 million, and write-offs of excess raw material
inventory on hand at the time of the shut down of $0.9 million.
The Electrical/Electronics group's sales increased from $130.9 million in
2001 to $144.2 million in 2002, an increase of 10%. Higher sales volumes to the
two largest customers of Woods, both national mass market retailers, drove the
sales increase. Sales to these two customers combined were up $13.2 million, or
21%, from 2001. Higher volumes of direct import merchandise, which are shipped
directly from our suppliers to our customers, such as extension cords and power
strips, drove the higher sales to one of these customers. The strong
relationships with these large customers have provided a solid foundation for
growth in the Woods business. Woods Canada also experienced a significant sales
increase to its largest customer, also a large mass market retailer, to whom
sales were higher by 21%. A portion of the sales growth at Woods from 2001 to
2002 was due to a significant increase in purchases from a large customer, and
some portion of the sales may not occur again in 2003.
The group's operating income increased from ($0.2) million in 2001 to $2.9
million in 2002. Operating income was reduced by costs for severance,
restructuring and related costs, and asset impairments, which are discussed
further below. Excluding these costs, operating income increased from $3.0
million in 2001 to $8.5 million in 2002, an increase of 183%. Higher sales
volumes aided in maintaining margins, and ongoing cost control has allowed Woods
and Woods Canada to reduce product and variable costs. During 2002, Woods
incurred a loss of $0.9 million related to obsolete raw material and packaging
inventory on hand which could not be utilized following the shutdown of the U.S.
manufacturing facilities (see next paragraph). Significant factors impacting
2001 results include lower of cost or market inventory valuation adjustments
totaling $4.3 million, the largest of which related to the exit of certain
licensed branded product lines by Woods in the first quarter of 2001. Woods had
entered into several proprietary licensed branding agreements with several
companies well known in the electronics and computer industries, but efforts to
market the products proved unsuccessful. Woods also incurred a litigation loss
reserve of $0.5 million. Woods also wrote off a related $0.1 million amount of
prepaid maintenance related to software licenses (see next paragraph). Selling,
general and administrative (SG&A) expenses were negatively impacted in 2002
versus 2001, as a result of the existence in 2001 of amortization of negative
goodwill (an income item) of $1.7 million.
Operating results in 2002 were negatively impacted by a number of
restructuring-related charges. The Electrical/Electronics group incurred
consulting fees of $2.8 million associated with product outsourcing strategies.
In December 2002, as mentioned above, Woods incurred charges related to the shut
down of all U.S. manufacturing operations of $2.4 million for severance and
other exit costs, and $0.4 million of impaired assets that will not be utilized
following the shut down of Woods' facilities. The group also incurred several
unusual charges in 2001. Woods incurred $1.5 million of severance and other exit
costs in early 2001 associated with the closure of several satellite
manufacturing facilities in southern Indiana. Asset impairments of $0.7 million
were recorded, related primarily to previously capitalized software licenses
that were not being used.
We believe that restructuring steps executed in 2002 related to the Woods
business will allow that business to remain competitive within its markets. The
fully outsourced product strategy has reduced headcount at the Woods division by
361 employees effective in mid-December 2002.
We are continually evaluating alternatives relating to divestitures of
certain of our businesses. Divestitures present opportunities to de-leverage our
financial position and free up cash for further investments in core activities.
On March 6, 2003, we announced that we are exploring the sale of the Woods and
Woods Canada businesses. However, there can be no assurance that a sale of the
Woods and Woods Canada business can be completed.
Other
Sales from other operations decreased by $3.4 million, or 74%, as a result
of the SESCO waste-to-energy operation being turned over to a third party in
April 2002, compared to a full year's sales in 2001. Operating income from other
16
operations in 2002 was driven by an unusual charge of $6.0 million, relating to
an obligation created by Katy to the third party who took over operation of the
SESCO facility. Amounts will be paid in roughly equal installments through 2007.
See Note 8 to the Consolidated Financial Statements for Katy in Part II, Item 8,
for a discussion of the SESCO partnership transaction. Operating income in 2001
was impacted primarily by the $9.8 million impairment of all of the long-lived
assets of the SESCO operation. The assets were written down in anticipation of a
cash flow-negative transaction that would be necessary for Katy to exit the
SESCO business.
Discontinued Operations
Two business units are reported as discontinued operations for all periods
presented: Hamilton Precisions Metals, L.P. (Hamilton) and GC/Waldom
Electronics, Inc. (GC/Waldom). Hamilton generated $1.5 million of operating
income in 2002 (prior to its sale on October 31, 2002), versus operating income
of $3.5 million in 2001. Hamilton's business was affected by general economic
conditions and lower capital spending within the markets Hamilton serves.
GC/Waldom incurred a $6.3 million operating loss in 2002, versus a $2.5 million
operating loss in 2001. Nearly the entire operating loss of GC/Waldom in 2002 is
the result of asset valuation adjustments in anticipation of a sale of the
business unit in early 2003.
Corporate
During 2001, the Corporate group incurred $8.3 million of severance and
restructuring charges and $3.0 million of costs associated with completing the
recapitalization. The majority of the severance and restructuring charges relate
to payments made in connection with management transition. Included in this
amount is approximately $1.0 million of charges that relate to outside
consultants working with Katy to modify operating and financial strategies, and
$0.7 million of non-cancelable rent and other exit costs associated with the
premature termination of our leased office facility in Englewood, Colorado. The
largest portions of the $3.0 million of costs associated with the
recapitalization were non-capitalizable legal fees and investment banker fees,
board and committee fees and other internal incremental costs.
Identifiable assets at corporate decreased due to two primary items. Cash
was lower by $3.0 million due to more efficient management of borrowed funds at
the end of 2002 versus 2001 and net deferred tax assets were lower by $10.5
million as a result of additional valuation allowance adjustments in 2002.
Interest was lower by $3.6 million, or 25%, in 2002 compared to 2001,
primarily due to significant reductions in outstanding debt balances due to 1)
the infusion of equity capital with the recapitalization on June 28, 2001, and
2) reductions in debt as a result of working capital reductions in the last half
of 2001. Our effective tax rate in 2002 was (21%), indicating that $8.6 million
of tax provision was recorded on a $41.1 million pretax loss. A net tax
provision was recorded on the loss rather than a net tax benefit because we
determined that a greater valuation allowance was required on our net deferred
tax asset position. See "Deferred Income Taxes" in "Critical Accounting
Policies" and Note 15 to the Consolidated Financial Statements in Part II, Item
8., for further discussion of income tax accounting. The effective tax rate in
2001, while resulting in book benefit on a pretax book loss, was only 25%, due
to a significant increase in valuation allowances on net operating loss deferred
tax assets. We also recorded a $2.5 million, net of tax, transitional goodwill
impairment as a result of the adoption of SFAS No. 142, which is shown on the
Consolidated Statements of Operations as a cumulative effect of a change in
accounting principle. See Note 4 to the Consolidated Financial Statements in
Part II, Item 8. for a further discussion of goodwill impairments.
2001 Compared to 2000
Maintenance Products Group
Sales in the Maintenance Products group decreased from $362.9 million in
2000 to $324.6 million in 2001, a decrease of 11%. Sales decreased in 2001 at
Contico and Wilen, and to a lesser extent at Duckback, Gemtex and Disco. Sales
increased at Glit/Microtron and Loren. The group experienced weakness in both
the retail and institutional sectors to which it sells. Retailers' efforts to
reduce inventories, especially in early 2001, led to softer sales for Contico
and Duckback, and a slower economy contributed to softer sales in the
janitorial/sanitation markets.
The group's operating income decreased from $10.3 million in 2000 to
($39.7) million in 2001, a decrease of 485%. Operating income was reduced by
costs for severance, restructuring and related costs, and asset impairments,
which are discussed further below. Excluding the impact of these items,
operating income for the group declined from $11.5 million in 2000 to ($0.1)
million in 2001. SG&A expenses as a percentage of sales improved at Contico,
Glit/Microtron, Loren and Disco, offset by higher percentages of SG&A expenses
at Wilen, Duckback and Gemtex. The overall improvement in SG&A expenses
(excluding the unusual items) was offset by reduced gross margins at all
businesses, led by Contico. Decreased volumes and the inability to reduce
overhead accordingly was the main cause of the margin decreases. Offsetting
these factors were prices paid for various resins, a key raw material for
plastic products produced by Contico, which were lower in 2001 than in 2000,
especially for polypropylene. The lower prices for resins taken alone accounted
for approximately $4.7 million in lower cost of
17
goods sold during 2001 versus 2000. The Maintenance Products group recorded
valuation reserve adjustments for inventory and receivables of $3.5 million
during 2001, contributing to the lower operating results. 2000 results included
a $0.7 million increase (expense) to the LIFO inventory reserve at Contico and
an inventory write down at Wilen of $0.9 million
Operating results in 2001 were negatively impacted by unusual items of
$39.6 million. We recorded an impairment charge of $33.0 million at Wilen
because consistently poor operating performance led us to conclude that the
carrying values of certain long-lived assets were not recoverable through future
cash flows. In addition to the impairment at Wilen, an additional $3.1 million
of impairment charges were taken, related primarily to management decisions
regarding the discontinuance of certain property, plant and equipment.
Additional items that negatively impacted operating results during 2001 include
severance and restructuring charges of $3.5 million, primarily at Contico and
Wilen. Operating results in 2000 were negatively impacted by $1.2 million in
severance and restructuring charges
Identifiable assets for the group decreased by $68.2 million from $299.3
million in 2000 to $231.1 million in 2001, a decrease of 23%. The decrease was
due in part to the $33.0 million write-off of long-lived assets in the mop,
broom and brush business. An inventory reduction effort on a company-wide basis
resulted in lower working capital levels at each division in 2001. Depreciation
expense in excess of capital expenditures also contributed to the decline.
Electrical/Electronics Group
The Electrical/Electronics group's sales decreased from $157.0 million in
2000 to $130.9 million in 2001, a decrease of 17%. Sales volumes were lower in
2001 at both Woods and Woods Canada. We sold Thorsen Tools during the second
quarter of 2001, which accounted for $7.3 million of the sales decrease. The
sales decreases were primarily attributable to slower economic conditions during
2001, especially as those conditions caused retailers to reduce inventory levels
during the early portion of 2001.
The group's operating income decreased from $4.5 million in 2000 to ($0.2)
million in 2001, a decrease of 104%. Operating income was reduced by costs for
severance, restructuring and related costs, and asset impairments, which are
discussed further below. Operating results excluding these unusual items
decreased from $4.9 million in 2000 to $3.0 million in 2001, a decrease of 40%.
Positive factors included significant reductions in SG&A expenses at Woods and
Woods Canada in 2001 as compared to 2000. Negative factors in 2001 included $4.3
million of inventory lower of cost or market adjustments, the largest occurring
at Woods relating to exiting licensed branded product lines ($3.3 million).
Negative factors impacting operating income in 2000 included a charge of $0.8
million for costs associated with a product recall.
Operating results in 2001 were reduced by unusual items of $3.2 million,
including severance and restructuring charges of $1.6 million and related
impairments of long-lived assets of $1.6 million. Unusual items impacted
operating results in 2000 as well, including a $0.4 million severance charge at
Woods.
Identifiable assets for the group decreased from $67.3 million in 2000 to
$50.6 million in 2001, a decrease of 25%. Lower working capital levels at Woods
and Woods Canada drove this decrease. These reductions were the result of
aggressive efforts to reduce inventories, as well as lower levels of capital
expenditures. Also, assets of Thorsen Tools, which were sold during 2001,
accounted for approximately $6.9 million of the reduction.
Other
Sales from other operations increased modestly as a result of higher sales
at the SESCO waste-to-energy facility.
Operating income from other operations decreased $8.9 million, primarily
as a result of a $9.8 million impairment of our investment in SESCO's
waste-to-energy facility and related property, plant and equipment. Excluding
the effect of the write-off, operating income increased $0.9 million at the
SESCO waste-to-energy facility.
Identifiable assets for our other operations decreased $9.5 million in
connection with the write-off of Katy's investment in the SESCO waste-to-energy
facility.
Corporate
During 2001, the Corporate group incurred $8.3 million of severance and
restructuring charges and $4.1 million of other unusual items. The majority of
the severance and restructuring charges relate to payments made in connection
with management transition. Included in this amount is approximately $1.0
million of charges that relate to outside consultants working with Katy to
modify operating and financial strategies, and $0.7 million of non-cancelable
rent and other exit costs associated with the premature termination of our
leased office facility in Englewood, Colorado. The largest portion of the other
unusual items were approximately $3.0 million of costs associated with the
recapitalization, including non-capitalizable legal
18
fees and investment banker fees, board and committee fees and other internal
incremental costs. Other unusual items included increases to claims and
environmental reserves of $0.7 million and other items totaling $0.3 million.
Corporate expenses in 2000 were negatively impacted by $0.6 million in unusual
items, including $0.9 million of severance and restructuring charges and $0.2
million of costs associated with the recapitalization, partially offset by
proceeds of $0.5 million related to a previously written-off investment.
Interest was lower by $3.6 million, or 25%, in 2001 compared to 2000,
primarily due to the reduction in bank debt caused by the recapitalization in
June of 2001. Bank debt was reduced by $51.1 million when the recapitalization
occurred. We incurred an extraordinary loss on early extinguishment of debt of
$1.2 million, net of tax, at the time of the recapitalization. This loss
represented the write-off of previously capitalized debt costs. The effective
income tax rate for continuing operations reduced from 35% in 2000 to 25% in
2001, resulting in lowered tax benefit from book losses in 2001. The lower tax
rate and benefit were the result of valuation allowance adjustments placed on
certain deferred tax assets, particularly federal net operating loss
carry-forwards.
19
LIQUIDITY AND CAPITAL RESOURCES
Liquidity was our strongest performance measure in 2002, with overall debt
decreasing by $38.6 million from $84.1 million at the end of 2001 to $45.5
million at the end of 2002. Cash decreased by $3.0 million from $7.8 million at
the end of 2001 to $4.8 million at the end of 2002. During 2002, we accomplished
the following:
o Generated operating cash flow of $31.5 million.
o Incurred capital expenditures from continuing operations of $10.1
million.
o Sold the Hamilton business for gross proceeds of $13.9 million.
o The three items listed above, along with strong working capital
management in 2001, allowed us to repay by October 2002 the entire
remaining balance of the $30 million term loan with Deutsche Bank,
which was obtained in June 2001 at the time of the recapitalization.
The term loan was scheduled to be paid ratably through June of
2006. At December 31, 2002, scheduled remaining maturities of term
debt per the repayment amortization schedule in the loan document
would have been $21 million.
In addition, during 2003, the following events occurred:
o In February 2003, we funded a new credit agreement, agented by Fleet
Capital (Fleet Credit Agreement), which replaced the credit
agreement entered into at the time of the recapitalization in June
of 2001 (Deutsche Bank Credit Agreement). The new $110 million
facility, which provides for $20 million of term debt and $90
million of revolving debt, involves a syndicate of banks, all of
whom had participated in the Deutsche Bank Credit Agreement. The
Fleet Credit Agreement is an asset-based lending agreement, and is
generally on similar terms to those found in the Deutsche Bank
Credit Agreement. The term of the agreement is through January 30,
2008.
o Sold the GC/Waldom business for gross proceeds of $8.3 million,
which allowed us to further reduce our debt obligations.
While book losses in 2002 were significant, large portions of these losses
were due to non-cash events such as impairments of assets ($21.2 million),
depreciation and amortization ($19.4 million), and the creation of liabilities
to be paid in future years, such as the SESCO obligation (see discussion
regarding Contractual Obligations below) ($5.0 million, discounted) and the
recording of liabilities for non-cancelable leases at several operating
locations ($10.9 million, discounted). Strong collections of receivables late in
2002, as well as management of accounts payable, resulted in working capital
improvement in 2002.
With the early pay down of the term loan in October 2002, we set out to
take out a new term loan, which is collateralized by real and personal property,
in order to most efficiently leverage our entire asset base, and to create more
borrowing room under our revolving credit arrangements, which are based on the
liquidation values of accounts receivable and inventories. We believe we have
accomplished these goals by entering into the Fleet Credit Agreement in February
of 2003. Below is a summary of the sources and uses associated with the funding
of the Fleet Credit Agreement:
(Thousands of Dollars)
Sources:
Term loan borrowings under the Fleet Credit Agreement 20,000
Revolving loan borrowings under the Fleet Credit Agreement 43,743
-------
$63,743
=======
Uses:
Payment of interest and principal under the Deutsche
Bank Credit Agreement 52,895
Purchase of outstanding preferred interest of Contico at a
discount 9,840
Payment of accrued distributions on outstanding preferred
interest of Contico 122
Certain costs associated with the Fleet Credit Agreement 886
-------
$63,743
=======
The Fleet Credit Agreement, which provides for a total borrowing facility
of $110.0 million, has a $20.0 million term loan portion with a final maturity
date of February 3, 2008 and quarterly repayments of $0.7 million, the first of
which will be made on April 1, 2003. A final payment of $5.7 million is
scheduled to be made in 2008. The term loan is based on orderly liquidation
values of the Company's property, plant and equipment. The remaining portion of
the Fleet Credit Agreement is a
20
$90.0 million revolving credit facility that also has an expiration date of
February 3, 2008. The borrowing base of the revolving credit facility is
determined by eligible inventory and accounts receivable.
Unused borrowing availability on the revolving credit facility was $27.8
million at February 21, 2003.
All extensions of credit under the Fleet Credit Agreement are
collateralized by a first priority perfected security interest in and lien upon
the capital stock of each material domestic subsidiary (65% of the capital stock
of each material foreign subsidiary), and all present and future assets and
properties of Katy. Customary financial covenants and restrictions apply under
the Fleet Credit Agreement. Until June 30, 2003, interest accrues on revolving
borrowings at 225 basis points over applicable LIBOR rates, and at 250 basis
points over LIBOR for term borrowings. Subsequent to June 30, 2003, margins are
determined on a pricing matrix which factors operating performance into the
pricing grid. Margins drop an additional 25 basis points in the most favorable
pricing grid from the pre-June 30 levels. Interest accrues at higher margins on
prime rates for swing loans.
Katy incurred $0.9 million in debt issuance costs associated with the
Fleet Credit Agreement. However, Katy expects to charge to expense during the
first quarter of 2003 approximately $1.2 million of previously capitalized debt
issuance costs from the Deutsche Bank Credit Agreement. While approximately $5.6
million of debt issuance costs were capitalized at the time of the inception of
the Fleet Credit Agreement, the $1.2 million represents an amount derived from
the pro rata reduction in borrowing capacity from the Duetsche Bank Credit
Agreement to the Fleet Credit Agreement. The remainder of the previously
capitalized costs, along with the newly capitalized costs from the Fleet Credit
Agreement will be amortized over the life of the Fleet Credit Agreement, through
January 2008.
With regard to the Deutsche Bank Credit Agreement, we were in compliance
with all covenants related to the agreement at December 31, 2002. Total debt was
28% of total capitalization at December 31, 2002. The revolving credit
facilities under the Deutsche Bank Credit Agreement required lockbox agreements
which provided 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 Deutsche Bank Credit Agreement, caused the Revolving
Credit Facility to be classified as a current liability, per guidance in the
Emerging Issues Task Force (EITF) 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. However, the Company
did 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 lender to require the loan to become due if it determines there has
been a material adverse effect on our operations, business, properties, assets,
liabilities, condition or prospects. The classification of the Revolving Credit
Facility as a current liability is a result only of the combination of the two
aforementioned factors: the lockbox agreements and the MAE clause. However, the
Revolving Credit Facility under the Deutsche Bank Credit Agreement did not
expire or have a maturity date within one year, but rather had a final
expiration date of June 28, 2006. Also, we were in compliance with the
applicable financial covenants at December 31, 2002. The lender had not notified
us of any indication of a MAE at December 31, 2002, and to our knowledge, we
were not in default of any provision of the Deutsche Bank Credit Agreement at
December 31, 2002.
The Fleet Credit Agreement also calls for similar lockbox arrangements,
and has language regarding material adverse changes. We anticipate that our
obligations under the revolving credit facility will continue to be classified
as current liabilities.
The Fleet Credit Agreement, and the additional borrowing ability on
revolving credit obtained by incurring new term debt, results in three important
benefits related to the long-term strategy of Katy: 1) allowed us to redeem
early at a discount a preferred interest obligation of Contico, 2) provides
borrowing power to invest in capital expenditures key to our strategic
direction, and 3) provides working capital flexibility to build inventory when
necessary to accommodate lower cost outsourced finished goods inventory. We feel
that our operations and the Fleet Credit Agreement provide sufficient liquidity
for our operations going forward.
As a result of the refinance with the new Fleet Credit Agreement, we were
able to redeem at a 40% discount the remaining preferred interest that the
former owner of Contico had held. This balance sheet liability, which had a
carrying value of $16.4 million at December 31, 2002, was redeemed for $9.8
million in February 2003. The gain on this redemption will be an addition to
stockholders' equity, and will favorably impact earnings per share. This will
result in a reduction of preferred cash distributions by approximately $1.3
million annually, which had accrued at an annual rate of 8%. After giving effect
to the interest cost incurred by the Company to fund the redemption, the net
decrease in financing cost for the Company will be approximately $1.0 million
annually.
Funding for capital expenditures and working capital needs is expected to
be accomplished through the use of available borrowings under the Fleet Credit
Agreement. Anticipated capital expenditures are expected to be higher in 2003
than in 2002 and 2001, mainly due to investments planned for the restructuring
of the abrasives businesses and the various Contico facilities. These
restructuring and consolidation activities are important to reducing our cost
structure to a competitive level.
21
Our borrowing base under the Fleet Credit Agreement is reduced by the
outstanding amount of standby and commercial letters of credit. Vendors,
financial institutions and other parties with whom Katy does 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. Our largest letters of
credit relate to our casualty insurance programs.
We have a number of obligations and commitments, which are listed on the
schedule later in this section entitled "Contractual Obligations and Commercial
Commitments." 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.
Businesses classified as discontinued operations were both sold by early
2003. Therefore, we will not have the benefit of the cash flow generated by
those businesses in the past. However, the proceeds of the sales of those
businesses were used to pay down debt, more than offsetting the negative
liquidity impact of losing their cash flow from operations.
We are continually evaluating alternatives relating to divestitures of
certain of our businesses. Divestitures present opportunities to de-leverage our
financial position and free up cash for further investments in core activities.
On March 6, 2003, we announced that we are exploring the sale of the Woods and
Woods Canada businesses. However, there can be no assurance that a sale of the
Woods and Woods Canada business will be completed. On April 2, 2003, we
announced the sale of GC/Waldom with gross proceeds of $8.3 million, which were
used to reduce our debt obligations.. On February 3, 2003, we announced that we
sold a Woods manufacturing facility in Moorseville, Indiana. Gross proceeds were
$1.9 million, of which $0.7 million was used to repay a mortgage loan payable on
the property. The remainder of the proceeds reduced our debt obligations.
Non-GAAP Financial Measure - Earnings before Income Taxes, Depreciation and
Amortization (EBITDA)
Cash flow generation is integral to the success of our business, and
EBITDA is used on a routine basis as a measure of operating performance at Katy.
While it is a non-GAAP measure, EBITDA is used extensively on an internal basis,
acting as a primary metric for performance measurement related to incentive
compensation for management. EBITDA is also the prime measure of operating
results used by the lenders in our bank group when evaluating our performance.
While appreciating the importance of depreciation charges and the information
operating income provides regarding returns on assets, we actively monitor the
payback and return on capital projects by thorough review of projects prior to
their approval, ensuring that returns on those projects are specified in
operating budgets, and subsequent follow up on the return provided by those
projects. The items added back in the table below to arrive at an EBITDA amount
shown below should not be ignored or considered irrelevant in the analysis of
our performance. However, management routinely views operating results with
unusual items such as those below excluded, so that a reasonable profitability
answer can be derived that can be used as a reliable indicator for future
performance. We think it is useful for investors to understand EBITDA because it
provides a link between profitability and operating cash flow, and also allows
the investor to view performance in a manner similar to the method used by our
management. Below are reconciliations of net income, computed in accordance with
generally accepted accounting principles and displayed on the Consolidated
Statements of Operations (Total Company), with EBITDA, a measure we use on a
routine basis:
22
Twelve months ended
Excluding
December 31, Unusual Unusual
2002 Items Items % of sales
------------ --------- -----------------------
Net sales $ 459,990 $ 459,990
Cost of goods sold 381,846 -- 381,846
--------- --------- ---------------------
Gross profit 78,144 -- 78,144 17.1%
Selling, general & administrative expenses 66,803 -- 66,803 14.5%
Impairments of long-lived assets 21,204 (21,204)(a) --
Severance, restructuring & other costs 19,155 (19,155)(b) --
SESCO joint venture transaction 6,010 (6,010)(c) --
--------- --------- ---------------------
Operating (loss) income (35,028) 46,369 11,341 2.6%
Equity in income of unconsolidated investment 295 -- 295
Interest (6,046) -- (6,046)
Other, net (407) -- (407)
--------- --------- ---------------------
(Loss) income before provision for income taxes (41,186) 46,369 5,183 1.3%
Income taxes (8,612) 6,642 (d) (1,970)
--------- --------- ---------------------
(Loss) income before distributions on preferred interest in subsidiary (49,798) 53,011 3,213 0.8%
Distributions on preferred interest of subsidiary, net of tax (1,593) -- (1,593)
--------- --------- ---------------------
(Loss) income from continuing operations $ (51,391) $ 53,011 $ 1,620 0.4%
========= ========= =====================
Earnings before interest, taxes, depreciation and amortization (EBITDA) Pretax income $ 5,183
(excluding unusual items) Interest 6,046
Depreciation and
amortization 19,403
---------
EBITDA $ 30,632 6.8%
=========
Twelve months ended
Excluding
December 31, Unusual Unusual
2001 Items Items % of sales
------------ --------- ----------------------
Net sales $ 460,176 $ -- $ 460,176
Cost of goods sold 395,789 -- 395,789
--------- --------- ----------------------
Gross profit 64,387 -- 64,387 14.0%
Selling, general & administrative expenses 74,424 (2,973)(e) 71,451 15.5%
Impairments of long-lived assets 47,469 (47,469)(a) --
Severance, restructuring & other costs 13,380 (13,380)(b) --
SESCO joint venture transaction -- -- --
--------- --------- ----------------------
Operating (loss) income (70,886) 63,822 (7,064) -1.5%
Equity in income of unconsolidated investment 72 -- 72
Interest (10,822) -- (10,822)
Other, net (604) -- (604)
--------- --------- ----------------------
(Loss) income before provision for income taxes (82,240) 63,822 (18,418) -4.0%
Income taxes 20,647 (16,024)(d) 4,623
--------- --------- ----------------------
(Loss) income before distributions on preferred interest in subsidiary (61,593) 47,798 (13,795) -3.0%
Distributions on preferred interest of subsidiary, net of tax (1,274) -- (1,274)
--------- --------- ----------------------
(Loss) income from continuing operations $ (62,867) $ 47,798 $ (15,069) -3.3%
========= ========= ======================
Earnings before interest, taxes, depreciation and amortization (EBITDA) Pretax income $ (18,418)
(excluding unusual items) Interest 10,822
Depreciation and
amortization 20,728
---------
EBITDA $ 13,132 2.9%
=========
Items to reconcile to EBITDA are discussed in further detail in the
Results of Operations section of MD&A. Summaries of the items are presented
below:
23
a) Impairments of long-lived assets include carrying value adjustments
relating to property, plant and equipment, intangible assets, and
goodwill (except for goodwill write-offs recorded with the adoption
of SFAS No. 142, Goodwill and Intangible Assets).
b) Severance and restructuring costs include costs related to 1)
accruals for non-cancelable lease payments for rented facilities
that have been, or will be, abandoned as part of facilities
consolidation or other restructuring projects, 2) severance charges
for terminated employees, 3) consultant fees for outsourcing and
other restructuring projects, 4) costs to move inventory and
equipment between facilities related to consolidation projects.
c) SESCO transaction costs include the charge for the contracted amount
payable to the third party who has taken prime responsibility within
the partnership for the operations of SESCO, and the cost of certain
spare parts that were contributed to the partnership.
d) Adjustment to reflect a more normalized effective tax rate excluding
unusual items. e) Recapitalization costs include costs associated
with completing the recapitalization that for various reasons were
not charged against the proceeds of convertible preferred stock or
capitalized with debt issuance costs.
e) Recapitalization costs include costs associated with completing the
recapitalization that for various reasons were not charged against
the proceeds of convertible preferred stock or capitalized with debt
issuance costs.
EBITDA, excluding unusual items as shown above, increased by $17.5 million
from $13.1 million in 2001 to $30.6 million in 2002, an improvement of 133%.
Higher EBITDA was generated in both the Maintenance Products group and the
Electrical/Electronics group in 2002 versus 2001. The reasons for the
improvements in EBITDA for both segments are largely the same as those discussed
for operating income in the Results of Operations discussion above regarding
2002 versus 2001. EBITDA in 2001 was negatively impacted by valuation
adjustments of $6.9 million for excess and obsolete inventory.
EBITDA enhances the understanding of our liquidity and helps provide a
link between earnings and cash provided by operating activities in the
Consolidated Statements of Cash Flows in Part II, Item 8.Depreciation,
amortization, impairments of long-lived assets and increases to valuation
allowances on deferred tax assests are non-cash charges. Also, certain
severance, restructuring and related charges did not result in cash outflows in
2002, but created liabilities that will be settled in future years; most
significantly, those for non-cancelable lease liabilities associated with
facilities that have been (or will be) abandoned as a result of restructuring
and consolidation efforts. Included in severance, restructuring and related
charges in 2002 are costs of $11.8 million for the establishment of these types
of liabilities. The balance sheet liabilities for these types of costs increased
by $10.5 million from December 31, 2001 to December 31, 2002. This change is
reflected in the Consolidated Statements of Cash Flows in the line item which
shows the change in "Accrued expenses and other liabilities" as a positive
adjustment from net income to cash provided by operating activities in 2002. As
the non-cancelable lease payments are made in future years, they will negatively
impact operating cash flow through opposite changes in this line item. See also
the section entitled "Restructuring and Severance Charges" for a discussion of
charges and payments against restructuring reserves, and estimates of future
settlement of related liabilities.
OFF-BALANCE SHEET ARRANGEMENTS
On April 29, 2002, Katy and SESCO, an indirect wholly owned subsidiary,
entered into a partnership agreement with Montenay Power Corporation and its
affiliates (Montenay) that turned over the operation of SESCO's waste-to-energy
facility to Montenay. The Company entered into this agreement as a result of
evaluations of SESCO's business. First, we determined that SESCO was not a core
component of our long-term business strategy. Moreover, we did not feel the
Company 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. We 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 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)
to the partnership. While SESCO will maintain a 99% partnership interest as a
limited partner, Montenay will have most of the day to day responsibility 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. This note payable is
recorded as a liability on the Consolidated Balance Sheets included in Part II,
Item 8. Certain amounts may be due to SESCO upon expiration of the service
agreement in 2008; also, Montenay may purchase SESCO's interest in the
partnership at that time. Katy has not recorded any amounts receivable or other
assets relating to amounts that may be received at the time the service
agreement expires, given their uncertainty.
The Company recognized in the first quarter of 2002 a charge of $6.0
million, consisting of 1) the discounted value of the $6.6 million note, which
is payable over seven years, 2) the carrying value of certain assets contributed
to the 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 December 31, 2001, so no additional
impairment was required. Going forward, Katy does not expect any income
statement activity as a result of its involvement in the partnership, and Katy's
balance sheet will carry the liability mentioned above.
In 1984, the Authority issued $55.0 million of Industrial Revenue Bonds
and lent the proceeds to SESCO, under the loan agreement for the acquisition and
construction of the 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 to SESCO 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 December 31, 2002, this amount was $35.8 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 bonds
outstanding, less $4.0 million maintained in a debt service reserve trust. We do
not expect
24
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) (in thousands):
2003 5,385
2004 6,765
2005 8,370
2006 15,300
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Total $35,820
========
We also enter into operating lease agreements in the ordinary course of
business, and many of our facilities are leased. Contractual obligations
associated with these leases are listed in the table under the following section
entitled "Contractual Obligations and Commercial Obligations."
Contractual Obligations and Commercial Obligations
Katy's obligations are summarized below:
(In thousands of dollars)
Due in less Due in Due in Due after
Contractual Cash Obligations Total than 1 year 1-3 yea