Filed by Bowne Pure Compliance
Table of Contents

 
 
United States
Securities and Exchange Commission
Washington, D.C. 20549
FORM 10-K/A
Amendment No. 1
     
þ   Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the fiscal year ended: December 31, 2006
OR
     
o   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
(State or other jurisdiction of
incorporation or organization)
  75-1277589
(IRS Employer Identification No.)
2461 South Clark Street, Suite 630, Arlington, Virginia 22202
(Address of Principal Executive Offices)               (Zip Code)
Registrant’s telephone number, including area code: (703) 236-4300
Securities registered pursuant to Section 12(b) of the Act:
     
(Title of each class)
Common Stock, $1.00 par value
Common Stock Purchase Rights
  (Name of each exchange on which registered)
New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
YES o     NO þ
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
YES o     NO þ
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 þ     NO o
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. þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o   Accelerated filer o   Non-accelerated filer þ
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). YES o NO þ
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 30, 2006), as of June 30, 2006 was $11,223,415. As of February 28, 2007, 7,951,177 shares of common stock, $1.00 par value, were outstanding, the only class of the registrant’s common stock.
* 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 2007 annual meeting — Part III.
 
 

 

 


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EXPLANATORY NOTE
Restatement of Consolidated Financial Statements
We are filing this Amended Annual Report on Form 10-K/A (“Amended Filing”) to our Annual Report on Form 10-K for the fiscal year ended December 31, 2006 (“Original Filing”) to amend and restate our consolidated financial statements and the related disclosures for the fiscal years ended 2006 and 2005, as discussed in Note 2. The Original Filing was filed with the Securities and Exchange Commission (“SEC”) on March 16, 2007.
On August 6, 2007, the Audit Committee of the Board of Directors, or the Audit Committee, of Katy Industries, Inc. (the “Company”), in consultation with management, concluded that our following previously issued financial statements should no longer be relied upon and should be restated based on identified errors: 1) the consolidated financial statements as of December 31, 2006 and 2005 and for the years then ended contained in the Company’s Annual Report on Form 10-K; and 2) the consolidated financial statements for the quarters ending March 31, 2006 and 2007, June 30, 2006, and September 30, 2006 contained in the Company’s corresponding Form 10-Qs. The unaudited quarterly financial information included in the Company’s Annual Report on Form 10-K as of December 31, 2006 has been updated in this Annual Report on Form 10-K, and the unaudited quarterly financial information included in the Company’s Quarterly Reports on Form 10-Q as of March 31, 2006, June 30, 2006 and September 30, 2006 will be updated as the Company files its corresponding Quarterly Reports for 2007.
In the second quarter of 2007, management of the Company noted discrepancies in its physical raw material inventory levels and the corresponding perpetual inventory records. These discrepancies led the Company to initiate an internal investigation which resulted in the identification of errors in the physical inventory count of raw material used for valuation purposes at the Company’s wholly-owned subsidiary, Continental Commercial Products, LLC (“CCP”). The Company has concluded these errors are isolated to fiscal 2005, fiscal 2006 and the three months ended March 31, 2007.
When management became aware of the issues referenced above, the Company, including the Audit Committee, initiated an investigation of the matter. Management has discussed the investigation, the resolution of the problems and the strengthening of internal controls with the Audit Committee.
Based on the results of the investigation, management and the Audit Committee determined that (a) the errors were caused by intentional acts of a CCP employee who improperly accounted for physical quantities raw material inventory and who has since been dismissed; (b) the scope of the errors were contained in fiscal 2005, fiscal 2006 and the three months ended March 31, 2007; and (c) the errors were concentrated in the area discussed above.
Impact of Error on Previously filed Financial Statements
The impact of the raw material inventory error on loss from continuing operations and net loss is approximately ($0.2) million and ($0.6) million for the years ended December 31, 2005 and 2006, respectively. The impact of the raw material inventory error on loss from continuing operations and net loss is approximately ($0.2) million for the three months ended March 31, 2006, ($0.2) million and ($0.4) million for the three and six months ended June 30, 2006, ($0.2) million and ($0.6) million for the three and nine months ended September 30, 2006, and $0.1 million for the three months ended March 31, 2007. In addition, as part of the restatement, the Company has recorded additional items, certain of which were previously identified and determined to be immaterial. The impact of these additional items on net loss is approximately ($0.4) million and $0.2 million for the years ended December 31, 2005 and 2006, respectively, which is allocated entirely to loss from continuing operations.
Internal Control Considerations
In connection with the Company’s evaluation of the restatement described above, management has concluded that the restatement is the result of previously unidentified material weaknesses in the Company’s internal control over financial reporting, as discussed in Item 9A. A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim consolidated financial statements will not be prevented or detected. Management has also determined that the Company’s disclosure controls and procedures were ineffective as of December 31, 2005 and 2006, March 31, 2006 and 2007, June 30, 2006, and September 30, 2006.
These control deficiencies resulted in the restatement of the Company’s consolidated financial statements for December 31, 2005 and 2006, March 31, 2006 and 2007, June 30, 2006, and September 30, 2006. Additionally, these control deficiencies could result in further misstatements to the Company’s financial statements, which could result in a material misstatement to the annual or interim consolidated financial statements that would not be prevented or detected. Accordingly, management determined that these control deficiencies represented material weaknesses in internal control over financial reporting.

 

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We have not amended any of our other previously filed annual reports on Form 10-K for the periods affected by the restatement other than this Amended Filing. For this reason, the consolidated financial statements and related financial information contained in such previously filed reports should no longer be relied upon. All of the information in this Amended Filing does not reflect events occurring after the Original Filing.
For the convenience of the reader, this Amended Filing sets forth the Original Filing in its entirety, as modified and superseded where necessary to reflect the restatement. The following items have been amended principally as a result of, and to reflect, the restatement, and no other information in the Original Filing is amended hereby as a result of the restatement:
Part I — Item 1: Business;
Part I — Item 1A: Risk Factors;
Part II — Item 6: Selected Financial Data;
Part II — Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations;
Part III — Item 8: Financial Statements and Supplementary Data;
Part III — Item 9A: Controls and Procedures; and
Part IV — Item 15: Exhibits, Financial Statements and Schedules.
In accordance with applicable SEC rules, this amended Annual Report on Form 10-K/A includes current dated certifications from our Chief Executive Officer and Chief Financial Officer.
The remaining items contained within this Amended Filing consist of all other Items originally contained in the Form 10-K and are included for the convenience of the reader. The sections of the Form 10-K which were not amended are unchanged and continue in full force and effect as originally filed. This Amended Filing speaks of the date of the original filing on the Form 10-K and has not been updated to reflect events occurring subsequent to the original filing date.

 

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 Exhibit 21
 Exhibit 23
 Exhibit 31.1
 Exhibit 31.2
 Exhibit 32.1
 Exhibit 32.2

 

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PART I
Item 1. BUSINESS
Katy Industries, Inc. (“Katy” or the “Company”) was organized as a Delaware corporation in 1967 and has an even longer history of successful operations, with some of its predecessor companies having been established for as long as 75 years. We are organized into two operating groups, Maintenance Products and Electrical Products, and a corporate group. Each majority-owned company in the two groups operates within a broad framework of policies and corporate goals. Katy’s corporate group 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 following an agreement dated June 2, 2001 with KKTY Holding Company, L.L.C. (“KKTY”), an affiliate of Kohlberg Investors IV, L.P. (“Kohlberg”) (“the Recapitalization”). Under the terms of the Recapitalization, KKTY purchased 700,000 shares of newly issued preferred stock, $100 par value per share (the “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 12 to the Consolidated Financial Statements of Katy included in Part II, Item 8. The Recapitalization allowed us to retire obligations we had under the then-current revolving credit agreement. Since the Recapitalization, the Company’s management has been focused on various restructuring and cost reduction initiatives. Currently, the Company’s focus has shifted to sustaining revenue growth and managing raw material costs. Our future cost reductions, if any, will continue to come from process improvements (such as Lean Manufacturing and Six Sigma), value engineering products, improved sourcing/purchasing and lean administration.
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 17 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 have restructured 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 and other exit costs that may be incurred not only with consolidation of facilities, but potentially the complete shut down of certain manufacturing and distribution operations. We have incurred significant costs in this respect, approximately $47 million since the beginning of 2001. As our post-Recapitalization restructuring plan approaches completion, we expect to incur additional costs of approximately $1.1 million in 2007, mostly related to the consolidation of the Washington, Georgia facility into the Wrens, Georgia facility. Additional details regarding severance, restructuring and related charges can be found in Note 19 to the Consolidated Financial Statements of Katy included in Part II, Item 8.
Maintenance Products Group
The Maintenance Products Group’s principal business is the manufacturing and distribution of commercial cleaning products as well as consumer home products. Commercial cleaning products are sold primarily to janitorial/sanitary and foodservice distributors that supply end users such as restaurants, hotels, healthcare facilities and schools. Consumer home products are primarily sold through major home improvement and mass market retail outlets. Total revenues and operating income for the Maintenance Products Group during 2006 were $208.4 million and $5.6 million, respectively. The group accounted for 53% of the Company’s revenues in 2006. Total assets for the group were $95.1 million at December 31, 2006. The business units in this group are:
Continental Commercial Products, LLC (“CCP”) is the successor entity to Contico International, L.L.C. (“Contico”) and includes as divisions all the former business units of Contico (Continental, Contico, and Container), as well as the following business units: Disco, Glit and Wilen. CCP is headquartered in Bridgeton, Missouri near St. Louis, has additional operations in California and Georgia, and was created mainly for the purpose of simplifying our business transactions and improving our customer relationships by allowing customers to order products from any CCP division on one purchase order.

 

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The Continental business unit is a plastics manufacturer and a distributor of products for the commercial janitorial/sanitary maintenance and food service markets. Continental products include commercial waste receptacles, buckets, mop wringers, janitorial carts, and other products designed for commercial cleaning and food service. Continental products are sold under the following brand names: Continental®, Kleen Aire™, Huskee™, SuperKan™, KingKan®, Unibody®, and Tilt-N-Wheel™.
The Contico business unit is a plastics manufacturer and distributor of home storage products, sold primarily through major home improvement and mass market retail outlets. Contico products include plastic home storage units such as domestic storage containers, shelving and hard plastic gun cases and are sold under the following brand names: Contico® and Tuffbin®.
The Container business unit is a plastics manufacturer and distributor of industrial storage drums and pails for commercial and industrial use. Products are sold under the Contico® brand name.
The Disco business unit is a manufacturer and distributor of filtration, cleaning and specialty products sold to the restaurant/food service industry. Disco products include fryer filters, oil stabilizing powder, grill cleaning implements and other food service items and are sold under the Disco® name as well as BriteSorb®, and the Brillo® line of cleaning products. BriteSorb® is a registered trademark used under license from PQ Corporation, and Brillo® is a registered trademark used under license from Church & Dwight Company.
The Glit business unit is a manufacturer and distributor of non-woven abrasive products for commercial and industrial use and also supplies materials to various original equipment manufacturers (the “OEMs”). The Glit unit’s products include floor maintenance pads, hand pads, scouring pads, specialty abrasives for cleaning and finishing and roof ventilation products. Products are sold primarily in the commercial sanitary maintenance, food service and construction markets. Glit products are sold under the following brand names: Glit®, Glit Kleenfast®, Glit/Microtron®, Fiber Naturals®, Big Boss II®, Blue Ice®, Brillo®, BAB-O®, Old Dutch® and Twister™ brand names. Brillo® is a registered trademark used under license from Church & Dwight Company, Old Dutch® is a registered trademark used under license from Dial Brands, Inc., and BAB-O® is a registered trademark used under license from Fitzpatrick Bros., Inc. Twister™ is a trademark of HTC Industries, Inc.
This unit’s primary manufacturing facilities are in Wrens, Georgia, and Washington, Georgia. The Washington facility is expected to close during 2007 and its operations consolidated into the Wrens facility.
The Wilen business unit is a manufacturer and distributor of professional cleaning products that include mops, brooms, brushes, and plastic cleaning accessories. Wilen products are sold primarily through commercial sanitary maintenance and food service markets, with some products sold through consumer retail outlets. Products are sold under the following brand names: Wax-o-matic™, Wilen® and Rototech®.
The Maintenance Products Group also has operations in Canada and the United Kingdom (the “U.K.”).
The CCP Canada business unit, headquartered in Etobicoke, Ontario, Canada, is a distributor of primarily plastic products for the commercial and sanitary maintenance markets in Canada.
The Gemtex business unit is headquartered in Etobicoke, Ontario, Canada, and is a manufacturer and distributor of resin fiber disks and other coated abrasives for the OEMs, automotive, industrial, and home improvement markets. The most prominent brand name under which the product is sold is Trim-Kut®.
The Contico Manufacturing, Ltd. (“CML”) business unit is a distributor of a wide range of cleaning equipment, storage solutions and washroom dispensers for the commercial and sanitary maintenance and food service markets primarily in the U.K.
Electrical Products Group
The Electrical Products Group’s principal business is the design and distribution of consumer electrical corded products. Products are sold principally to national home improvement and mass merchant retailers, who in-turn sell to consumer end-users. Total revenues and operating income for the Electrical Products Group during 2006 were $187.7 million and $8.7 million, respectively. The group accounted for 47% of the Company’s revenues in 2006. Total assets for the group were $74.0 million at December 31, 2006. Woods Industries, Inc. (“Woods US”) and Woods Industries (Canada), Inc. (“Woods Canada”) are both subject to seasonal sales trends in connection with the holiday shopping season, with stronger sales and profits realized in the third and early fourth quarters. The business units in this group are:

 

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The Woods US business unit is headquartered in Indianapolis, Indiana, and distributes consumer electrical corded products and electrical accessories. Examples of Woods US products are outdoor and indoor extension cords, work lights, surge protectors, and power strips. Woods US products are sold under the following brand names: Woods®, Yellow Jacket®, Tradesman®, SurgeHawk®, and AC/Delco®. AC/Delco® is a registered trademark of The General Motors Corporation. These products are sold primarily through national home improvement and mass merchant retail outlets in the United States. Woods US’ products are sourced primarily from Asia.
The Woods Canada business unit is headquartered in Toronto, Ontario, Canada, and distributes consumer electrical corded products and electrical accessories. In addition to the products listed above for Woods US, Woods Canada’s primary product offerings include garden lighting and timers. Woods Canada products are sold under the following brand names: MoonRays®, Intercept®, and Pro Power®. These products are sold primarily through major home improvement and mass merchant retail outlets in Canada. Woods Canada’s products are sourced primarily from Asia.
See Licenses, Patents and Trademarks below for further discussion regarding the trademarks used by Katy companies.
Other Operations
Katy’s other operations include a 45% equity investment in a shrimp farming operation, Sahlman Holding Company, Inc. (“Sahlman”), and a 100% interest in Savannah Energy Systems Company (“SESCO”), the limited partner in a waste-to-energy facility.
Sahlman, which owns shrimp farming operations in Nicaragua, has a number of competitors, some of which are larger and have greater financial resources. Katy’s interest in Sahlman is an equity investment. During 2006, the Company did not recognize any equity in income from the Sahlman investment. Katy concluded that $2.2 million continues to be a reasonable estimate of the value of its investment in Sahlman. See Note 6 to the Consolidated Financial Statements of Katy included in Part II, Item 8.
In 2006, the Company sold 100% of its partnership interest in Montenay Savannah Limited Partnership, which was held by SESCO in Savannah, Georgia. The general partner of the partnership is an affiliate of Montenay Power Corporation (“Montenay”). In 2006, Montenay purchased the Company’s limited partnership interest for $0.1 million and a reduction of approximately $0.6 million in the face amount due to Montenay as agreed upon in the original partnership agreement. In addition, Montenay removed the Company as the performance guarantor under the service agreement. As a result of the above transaction, the Company recorded a gain of $0.4 million within continuing operations during the year ended December 31, 2006 given the reduction in the face amount due to Montenay as agreed upon in the original partnership interest purchase agreement. In addition, the Company recorded a gain on the sale of the partnership interest of approximately $0.1 million as reflected within continuing operations. See Note 8 to the Consolidated Financial Statements of Katy included in Part II, Item 8.
Discontinued Operations
In 2006, we identified and sold certain business units that we considered non-core to the future operations of the Company. The Metal Truck Box business unit, a manufacturer and distributor of aluminum and steel automotive storage products located in Winters, Texas was sold on June 2, 2006 for net proceeds of $3.6 million, including a note receivable of $1.2 million. A loss of $50 thousand was recognized in 2006 as a result of the Metal Truck Box sale. The Metal Truck Box business unit was formerly part of the Maintenance Products Group.
Also, in 2006, we sold the Contico Europe Limited (“CEL”) business unit, a manufacturer and distributor of plastic consumer storage and home products sold primarily to major retail outlets in the U.K. The business unit was sold on November 27, 2006 for net proceeds of $3.0 million. A loss (net of tax) of $5.4 million was recognized in 2006. CEL was formerly part of the Maintenance Products Group.
Customers
We have several large customers in the mass merchant/discount/home improvement retail markets. Two customers, Lowe’s Companies, Inc. (“Lowe’s”) and Wal-Mart Stores, Inc. (“Wal-Mart”), accounted for approximately 16% and 14%, respectively, of consolidated net sales. Sales to Lowe’s are made by the Woods US and Contico business units. Sales to Wal-Mart are made by the Woods US, Contico, Glit, Woods Canada, Wilen, and Continental business units. A significant loss of business from either of these customers could have a material adverse impact on our business, results of operations or prospects.

 

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Backlog
Maintenance Products:
Our aggregate backlog position for the Maintenance Products Group was $3.1 million and $5.5 million as of December 31, 2006 and 2005 respectively. The orders placed in 2006 are believed to be firm, and based on historical experience, substantially all orders are expected to be shipped during 2007.
Electrical Products:
Our aggregate backlog position for the Electrical Products Group was $17.6 million and $8.6 million as of December 31, 2006 and 2005, respectively. The orders placed in 2006 are believed to be firm, and based on historical experience, substantially all orders are expected to be shipped during 2007. The increase in 2006 primarily relates to the timing of a major customer’s ordering levels.
Markets and Competition
Maintenance Products:
We market a variety of commercial cleaning products and supplies to the commercial janitorial/sanitary maintenance and foodservice markets. Sales and marketing of these products is handled through a combination of direct sales personnel, manufacturers’ sales representatives, and wholesale distributors.
The commercial distribution channels for our commercial cleaning products are highly fragmented, resulting in a large number of small customers, mainly distributors of janitorial cleaning products. The markets for these commercial products are highly competitive. Competition is based primarily on price and the ability to provide superior customer service in the form of complete and 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 product line area of the Maintenance Products Group. We believe that we have established long standing relationships with our major customers based on quality products and service, and our ability to offer a complete line of products. While each product line is marketed under a different brand name, they are sold as complementary products, with customers able to access all products through a single purchase order. We also continue to strive to be a low cost provider in this industry; however, our ability to remain a low cost provider in the industry is highly dependent on the price of our raw materials, primarily resin (see discussion below). Being a low cost producer is also dependent upon our ability to reduce and subsequently control our cost structure, which has benefited from our nearly completed restructuring efforts.
We market branded plastic home storage units, and to a lesser extent, abrasive products and mops and brooms, to mass merchant and discount club retailers in the U.S. Sales and marketing of these products is generally handled by direct sales personnel and external representative groups. The consumer distribution channels for these products, especially the in-home products, are highly concentrated, with several large mass merchant retailers representing a very significant portion of the customer base. We compete with a limited number of large companies that offer a broad array of products and many small companies with niche offerings. With few consumer storage products enjoying patent protection, the primary basis for competition is price. Therefore, efficient manufacturing and distribution capability is critical to success. Ultimately, 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. We continue to pursue new markets for our products. Our ability to remain a low cost provider in the industry is highly dependent on the price of our raw materials, primarily resin (see discussion below). Being a low cost producer is also dependent upon our ability to reduce and subsequently control our cost structure, which has benefited from our nearly completed restructuring efforts. Our restructuring efforts have and will include consolidation of facilities and headcount reductions.
We also market certain of our products to the construction trade, and resin fiber disks and other abrasive disks to the OEM trade.
Electrical Products:
We market branded electrical 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, mass merchant, hardware and electronic and office supply markets, and smaller regional concerns serving a similar customer base.

 

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Electrical products sold by the Company are generally used by consumers and include such items as outdoor and indoor extension cords, work lights, surge protectors, power strips, garden lighting 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 the number of suburban homes and the consumer demand for appliances, computers, home entertainment equipment, and other electronic equipment.
The markets for our electrical products are highly competitive. Competition is based primarily on price and the ability to provide a high level of customer service in the form of inventory management, high fill rates and short lead times. Other competitive factors include brand recognition, a broad product offering, 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. Woods US and Woods Canada source all of their products almost entirely from international suppliers.
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 Products 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 Continental and Contico business units (and some others to a lesser extent) use polyethylene, polypropylene and other thermoplastic resins as raw materials in a substantial portion of their plastic products. Prices of plastic resins, such as polyethylene and polypropylene increased steadily from the latter half of 2002 through 2005 with prices in 2006 being relatively stable. Management has observed that the prices of plastic resins are driven to an extent by prices for crude oil and natural gas, in addition to other factors specific to the supply and demand of the resins themselves. We are equally exposed to price changes for copper at our Woods US and Woods Canada business units. Prices for copper began to increase in early 2003 and continued through 2006 until stabilizing at the end of 2006. Prices for corrugated packaging material and other raw materials have also accelerated over the past few years. We have not employed an active hedging program related to our commodity price risk, but are employing other strategies for managing this risk, including contracting for a certain percentage of resin needs through supply agreements and opportunistic spot purchases. We were able to reduce the impact of some of these increases through supply contracts, opportunistic buying, vendor negotiations and other measures. In addition, some price increases were implemented when possible. In a climate of rising raw material costs (and especially in the last three years), we experience difficulty in raising prices to shift these higher costs to our consumer customers for our plastic and electrical products. Our future earnings may be negatively impacted to the extent further increases in costs for raw materials cannot be recovered or offset through higher selling prices. We cannot predict the direction our raw material prices will take during 2007 and beyond.
Employees
As of December 31, 2006, we employed 1,172 people, of which 304 were members of various unions. Our labor relations are generally satisfactory and there have been no strikes in recent years. In January 2007, one of our expiring union contracts was renewed for a term of three years, covering approximately 77 employees. The next union contract set to expire, covering approximately 227 employees, will expire in December, 2007. Our operations can be impacted by labor relations issues involving other entities in our supply chain.
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 capital expenditures of $0.2 million for environmental matters during 2007, in accordance with terms agreed upon with the United States Environmental Protection Agency and various state environmental agencies. See Note 18 to the Consolidated Financial Statements in Part II, Item 8.
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, trademarks and licensing arrangements in the marketing of certain products. Examples of key licensed and protected trademarks include Yellow Jacket®, Woods®, Tradesman®, and AC/Delco® (Woods US); Contico®; Continental®; Glit®, Microtron®, Brillo®, and Kleenfast® (Glit); Wilen™; and Trim-Kut® (Gemtex). The business units most reliant upon patented products and technology are CCP, Woods US, Woods Canada 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.

 

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Available Information
We file annual, quarterly, and current reports, proxy statements, and other documents with the Securities and Exchange Commission (the “SEC”) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The public may read and copy any materials that the Company files with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at (800) SEC-0330. Also, the SEC maintains an Internet website that contains reports, proxy and information statements, and other information regarding issuers, including Katy, that file electronically with the SEC. The public can obtain documents that we file with the SEC at http://www.sec.gov.
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 well as Section 16 reports on Forms 3, 4 and 5, as soon as reasonably practicable after such reports are 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.
Item 1A. RISK FACTORS
In addition to other information and risk disclosures contained in this Form 10-K, the risk factors discussed in this section should be considered in evaluating our business. We work to manage and mitigate risks proactively. Nevertheless, the following risk factors, some of which may be beyond our control, could materially impact our result of operations or cause future results to materially differ from current expectations. Please also see “Cautionary Statement Pursuant to Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995.”
Our inability to achieve product price increases, especially as they relate to potentially higher raw material costs, may negatively impact our earnings.
Costs for certain raw materials used in our operations, including copper products, remain at unprecedented high levels. In addition, prices for thermoplastic resin have demonstrated volatility over the past few years. Increasing costs for raw material supplies will increase our production costs and harm our margins and results of operations if we are unable to pass the higher production costs on to our customers in the form of price increases. Further, if we are unable to obtain adequate supplies of raw materials in a timely manner, our operations could be interrupted.
The loss of a significant customer or the financial weakness of a significant customer could negatively impact our results of operations.
We have several large customers in the mass merchant/discount/home improvement retail markets. Two customers accounted for approximately 30% of consolidated net sales. While no other customer accounted for more than 10% of our total net sales in 2006, we do have other significant customers. The loss of any of these customers, or a significant reduction in our sales to any of such customers, could adversely affect our sales and results of operations. In addition, if any of such customers became insolvent or otherwise failed to pay its debts, it could have an adverse affect on our results of operations.
Increases in the cost of, or in some cases continuation of, the current price levels of plastic resins, copper, and other raw materials may negatively impact our earnings.
Our reliance on foreign suppliers and commodity markets to secure raw materials used in our products exposes us to volatility in the prices and availability of raw materials. In some instances, we depend upon a single source of supply or participate in commodity markets that may be subject to allocations by suppliers. A disruption in deliveries from our suppliers, price increases, or decreased availability of raw materials or commodities, could have an adverse effect on our ability to meet our commitments to customers or increase our operating costs. We believe that our supply management practices are based on an appropriate balancing of the foreseeable risks and the costs of alternative practices. Nonetheless, price increases or the unavailability of some raw materials, should they occur, may have an adverse effect on our results of operations or financial condition.

 

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The Company’s success depends on its ability to continuously improve productivity and streamline operations, principally by reducing its manufacturing overhead.
We have restructured 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. The Company needs to continuously improve its manufacturing efficiencies by the use of Lean Manufacturing and other methods in order to reduce its overhead structure. In addition, we will need to develop efficiencies within sourcing/purchasing as well as administration. We run the risk that these programs may not be completed substantially as planned, may be more costly to implement than expected or may not have the positive profit enhancing impact anticipated.
Disruption of our information technology and communications systems or our failure to adequately maintain our information technology and communications systems could have a material adverse effect on our business and operations.
We extensively utilize computer and communications systems to operate our business and manage our internal operations including demand and supply planning and inventory control. Any interruption of this service from power loss, telecommunications failure, failure of our computer system or other interruption caused by weather, natural disasters or any similar event could disrupt our operations and result in lost sales. In addition, hackers and computer viruses have disrupted operations at many major companies. We may be vulnerable to similar acts of sabotage, which could have a material adverse effect on our business and operations.
We rely on our management information systems to operate our business and to track our operating results. Our management information systems will require modification and refinement as we grow and our business needs change. If we experience a significant system failure or if we are unable to modify our management information systems to respond to changes in our business needs, our ability to properly run our business could be adversely affected.
Our inability to execute our acquisition integration and consolidation of facilities plans could adversely affect our business and results of operations.
We had sought to grow through strategic acquisitions. In addition, we have consolidated several manufacturing, distribution and office facilities. The success of these acquisitions and consolidations will depend on our ability to integrate assets and personnel, apply our internal controls processes to these businesses, and cooperate with our strategic partners. We may encounter difficulties in integrating business units with our operations, and in managing strategic investments. Furthermore, we may not realize the degree, or timing, of benefits we anticipate when we first enter into these organizational changes. Any of the foregoing could adversely affect our business and results of operations.
Fluctuations in the price, quality and availability of certain portions of our finished goods due to greater reliance on third parties could negatively impact our results of operations.
Because we are dependent on outside suppliers for a certain portion of our finished goods, we must obtain sufficient quantities of quality finished goods from our suppliers at acceptable prices and in a timely manner. We have no long-term supply contracts with our key suppliers. Unfavorable fluctuations in the price, quality and availability of these products could negatively affect our ability to meet demands of our customers and could result in a decrease in our sales and earnings.
Labor issues, including union activities that require an increase in production costs or lead to a strike, thus impairing production and decreasing sales. We are also subject to labor relations issues at entities involved in our supply chain, including both suppliers and those entities involved in transportation and shipping.
Katy’s relationships with its union employees could deteriorate. At December 31, 2006, the Company employed approximately 1,172 persons in its various businesses of which approximately 26% were subject to collective bargaining or similar arrangements. The next union contract set to expire, covering approximately 227 employees, will expire in December, 2007. If Katy’s union employees were to engage in a strike, work stoppage or other slowdown, the Company could experience a significant disruption of its operations or higher ongoing labor costs.
Our future performance is influenced by our ability to remain competitive.
As discussed in “Business — Competition”, we operate in markets that are highly competitive and face substantial competition in each of our product lines from numerous competitors. The Company’s competitive position in the markets in which it participates is, in part, subject to external factors. For example, supply and demand for certain of the Company’s products is driven by end-use markets and worldwide capacities which, in turn, impact demand for and pricing of the Company’s products. Many of the Company’s direct competitors are part of large multi-national companies and may have more resources than the Company. Any increase in competition may result in lost market share or reduced prices, which could result in reduced gross profit margins. This may impair the ability to grow or even to maintain current levels of revenues and earnings. If we are not as cost efficient as our competitors, or if our competitors are otherwise able to offer lower prices, we may lose customers or be forced to reduce prices, which could negatively impact our financial results.

 

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We may not be able to protect our intellectual property rights adequately.
Part of our success depends upon our ability to use and protect proprietary technology and other intellectual property, which generally covers various aspects in the design and manufacture of our products and processes. We own and use tradenames and trademarks worldwide. We rely upon a combination of trade secrets, confidentiality policies, nondisclosure and other contractual arrangements and patent, copyright and trademark laws to protect our intellectual property rights. The steps we take in this regard may not be adequate to prevent or deter challenges, reverse engineering or infringement or other violation of our intellectual property, and we may not be able to detect unauthorized use or take appropriate and timely steps to enforce our intellectual property rights to the same extent as the laws of the United States.
We have a high amount of debt, and the cost of servicing that debt could adversely affect our ability to take actions or our liquidity or financial condition.
We have a high amount of debt for which we are required to make interest and principal payments. As of December 31, 2006, we had $56.9 million of debt. Subject to the limits contained in some of the agreements governing our outstanding debt, we may incur additional debt in the future.
Our level of debt places significant demands on our cash resources, which could: make it more difficult for us to satisfy our outstanding debt obligations; require us to dedicate a substantial portion of our cash for payments on our debt, reducing the amount of our cash flow available for working capital, capital expenditures, acquisitions, and other general corporate purposes; limit our flexibility in planning for, or reacting to, changes in the industries in which we compete; place us at a competitive disadvantage compared to our competitors, some of which have lower debt service obligations and greater financial resources than we do; limit our ability to borrow additional funds; or increase our vulnerability to general adverse economic and industry conditions.
If we are unable to generate sufficient cash flow to service our debt and fund our operating costs, our liquidity may be adversely affected.
Our inability to meet covenants associated with the Company’s Amended and Restated Loan with Bank of America, N.A. (the “Bank of America Credit Agreement”) could result in acceleration of all or a substantial portion of our debt.
Our outstanding debt generally contains various restrictive covenants. These covenants include, among others, provisions restricting our ability to: incur additional debt; make certain distributions, investments and other restricted payments; limit the ability of restricted subsidiaries to make payments to us; enter into transactions with affiliates; create certain liens; sell assets and if sold, use of proceeds; and consolidate, merge or sell all or substantially all of our assets.
Our secured debt also contains other customary covenants, including, among others, provisions: relating to the maintenance of the property securing the debt, and restricting our ability to pledge assets or create other liens.
In addition, certain covenants in our bank facilities require us and our subsidiaries to maintain certain financial ratios. Any of the covenants described in this risk factor may restrict our operations and our ability to pursue potentially advantageous business opportunities. Our failure to comply with these covenants could also result in an event of default that, if not cured or waived, could result in the acceleration of all or a substantial portion of our debt. We have not been able to meet certain affirmative covenants in our Bank of America Credit Agreement, which has resulted in eight amendments temporarily relieving us from these obligations. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Bank of America Credit Agreement” for further discussion of these amendments.
If we cannot meet the New York Stock Exchange (“NYSE”) continued listing requirement, the NYSE may delist our common stock, which could negatively affect the price of the common stock and your ability to sell the common stock.
In the future, we may not be able to meet the continued listing requirements of the NYSE, and NYSE rules, which require, among other things, market capitalization or stockholders’ equity of at least $75.0 million level over 30 consecutive trading days. The Company’s shareholders’ equity was less than $75.0 million as of March 15, 2007.

 

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On October 11, 2005, we announced that we received notification from the NYSE that the Company was not in compliance with the NYSE’s continued listing standards. The Company’s plan to demonstrate how the Company intends to comply with the continued listing standards within 18 months of its receipt was accepted by the NYSE.
If we are unable to satisfy the NYSE criteria for continued listing, our common stock would be subject to delisting. Trading, if any, of our common stock would thereafter be conducted on another exchange or quotation system. As a consequence of any such delisting, a stockholder would likely find it more difficult to dispose of, or to obtain accurate quotations as to the prices of our common stock.
If our internal controls over financial reporting are found not to be effective or if we make disclosure of existing or potential significant deficiencies or material weaknesses in those controls, Investors could lose confidence in our financial reports, and our stock price may be adversely affected.
Beginning with our Annual Report for the year ending December 31, 2007, Section 404 of the Sarbanes-Oxley Act of 2002 requires us to include an internal control report with our Annual Report on Form 10-K. That report must include management’s assessment of the effectiveness of our internal control over financial reporting as of the end of the fiscal year. Additionally, our independent registered public accounting firm will be required to issue a report on management’s assessment of our internal control over financial reporting and a report on their evaluation of the operating effectiveness of our internal control over financial reporting beginning with our Annual Report for the year ending December 31, 2008.
We continue to evaluate our existing internal control over financial reporting against the standards adopted by the Public Company Accounting Oversight Board, or PCAOB. During the course of our ongoing evaluation of the internal controls, we may identify areas requiring improvement, and may have to design enhanced processes and controls to address issues identified through this review. Despite the existence of material weaknesses or significant deficiencies in our internal control over financial reporting, we may fail to identify them. Remedying any deficiencies, significant deficiencies or material weaknesses that we or our independent registered public accounting firm may identify, may require us to incur significant costs and expend significant time and management resources. Further, any of the measures we implement to remedy any such deficiencies may not effectively mitigate or remedy such deficiencies.
Any failure to remedy the deficiencies identified by management, any failure to implement required new or improved controls and the discovery of unidentified deficiencies could harm our operating results, cause us to fail to meet our reporting obligations, subject us to increased risk of errors and fraud related to our financial statements or result in material misstatements in, and untimely filing of, our financial statements. The existence of a material weakness could also cause a restatement of future presented financial statements. Investors could lose confidence in our financial reports, and our stock price may be adversely affected, if our internal controls over financial reporting are found not to be effective by management or by an independent registered public accounting firm or if we make disclosure of existing or potential significant deficiencies or material weaknesses in those controls.
Changes in significant laws and government regulations affecting environmental compliance and income taxes.
Katy is subject to many environmental and safety regulations with respect to its operating facilities that may result in unanticipated costs or liabilities. Most of the Company’s facilities are subject to extensive laws, regulations, rules and ordinances relating to the protection of the environment, including those governing the discharge of pollutants in the air and water and the generation, management and disposal of hazardous substances and wastes or other materials. Katy may incur substantial costs, including fines, damages and criminal penalties or civil sanctions, or experience interruptions in its operations for actual or alleged violations or compliance requirements arising under environmental laws. The Company’s operations could result in violations under environmental laws, including spills or other releases of hazardous substances to the environment. Given the nature of Katy’s business, violations of environmental laws may result in restrictions imposed on its operating activities or substantial fines, penalties, damages or other costs, including as a result of private litigation. In addition, the Company may incur significant expenditures to comply with existing or future environmental laws. Costs relating to environmental matters will be subject to evolving regulatory requirements and will depend on the timing of promulgation and enforcement of specific standards that impose requirements on Katy’s operations. Costs beyond those currently anticipated may be required under existing and future environmental laws.
At any point in time, many tax years are subject to audit by various taxing jurisdictions. The results of these audits and negotiations with tax authorities may affect tax positions taken. Additionally, our effective tax rate in a given financial statement period may be materially impacted by changes in the geographic mix or level of earnings.

 

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We are subject to litigation that could adversely affect our operating results.
From time to time we may be a party to lawsuits and regulatory actions relating to our business. Due to the inherent uncertainties of litigation and regulatory proceedings, we cannot accurately predict the ultimate outcome of any such proceedings. An unfavorable outcome could have a material adverse impact on our business, financial condition and results of operations. In addition, regardless of the outcome of any litigation or regulatory proceedings, such proceedings could result in substantial costs and may require that we devote substantial resources to defend the Company. Further, changes in government regulations both in the United States and in the foreign countries in which we operate could have adverse effects on our business and subject us to additional regulatory actions. The Company is currently a party to various lawsuits. See “Legal Proceedings.”
Because we translate foreign currency from international sales into U.S. dollars and are required to make foreign currency payments, we may incur losses due to fluctuations in foreign currency exchange rates.
We are exposed to fluctuations in the Euro, British pound, Canadian dollar and various Asian currencies such as the Chinese Renminbi. We recognize foreign currency gains or losses arising from our operations in the period incurred. As a result, currency fluctuations between the U.S. dollar and the currencies in which we do business will cause foreign currency translation gains and losses, which may cause fluctuations in our future operating results. We do not currently engage in foreign exchange hedging transactions to manage our foreign currency exposure.
Item 1B. UNRESOLVED STAFF COMMENTS
Not applicable.

 

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Item 2. PROPERTIES
As of December 31, 2006, our total building floor area owned or leased was 2,679,000 square feet, of which 185,000 square feet were owned and 2,494,000 square feet were leased. The following table shows a summary by location of our principal facilities including the nature of the facility and the related business unit.
         
Location   Facility   Business Unit
 
       
UNITED STATES
       
California
       
Norwalk
  Manufacturing, Distribution   Continental, Contico, Container
Chino
  Distribution   Continental, Contico, Glit, Wilen, Disco
 
       
Georgia
       
Atlanta
  Manufacturing, Distribution   Wilen
McDonough
  Manufacturing, Distribution   Glit, Wilen, Disco
Wrens*
  Manufacturing, Distribution   Glit
Washington**
  Manufacturing   Glit
 
       
Indiana
       
Carmel
  Manufacturing   Woods US
Indianapolis
  Office, Distribution   Woods US
 
       
Missouri
       
Bridgeton
  Office, Manufacturing, Distribution   Continental, Contico
Hazelwood
  Manufacturing   Continental, Contico
 
       
Virginia
       
Arlington
  Corporate Headquarters   Corporate
 
       
CANADA
       
Ontario
       
Toronto
  Office, Manufacturing, Distribution   Gemtex
Toronto
  Office, Distribution   Woods Canada, CCP Canada
 
       
CHINA
       
Shenzhen
  Office   Woods US
 
       
UNITED KINGDOM
       
Cornwall
       
Redruth***
  Office, Distribution   CML
Berkshire
       
Slough
  Office   CML
*  
Facility is owned.
 
**  
During 2007, we expect to consolidate all of our abrasives operations in Washington, Georgia into our Wrens, Georgia (“Wrens”) facility.
 
***  
Facility was sold in January, 2007; however, we will lease a portion of the facility.
We believe that our current facilities have been adequately maintained, generally are in good condition, and are suitable and adequate to meet our needs in our existing markets for the foreseeable future.
Item 3. LEGAL PROCEEDINGS
Information regarding legal proceedings is included in Note 18 to the Consolidated Financial Statements in Part II, Item 8 and is incorporated by reference herein.
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 2006.

 

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PART II
Item 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
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.
                 
Period   High   Low
 
               
2006
               
First Quarter
  $ 3.75     $ 2.80  
Second Quarter
    3.61       2.24  
Third Quarter
    3.23       1.85  
Fourth Quarter
    3.40       2.51  
 
               
2005
               
First Quarter
  $ 5.41     $ 3.80  
Second Quarter
    3.98       2.35  
Third Quarter
    3.70       2.25  
Fourth Quarter
    3.50       1.80  
As of February 28, 2007, there were 567 holders of record of our common stock, in addition to approximately 1,173 holders in street name, and there were 7,951,177 shares of common stock outstanding.
Dividend Policy
Dividends are paid at the discretion of the Board of Directors. Since the Board of Directors suspended quarterly dividends on March 30, 2001 in order to preserve cash for operations, the Company has not declared or paid any cash dividends on its common stock. In addition, the Bank of America Credit Agreement prohibits the Company from paying dividends on its securities, other than dividends paid solely in securities. The Company currently intends to retain its future earnings, if any, to fund the development and growth of its business and, therefore, does not anticipate paying any dividends, either in cash or securities, in the foreseeable future. Any future decision concerning the payment of dividends on the Company’s common stock will be subject to its obligations under the Bank of America Credit Agreement and will depend upon the results of operations, financial condition and capital expenditure plans of the Company, as well as such other factors as the Board of Directors, in its sole discretion, may consider relevant. For a discussion of our Bank of America Credit Agreement, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations”.
Equity Compensation Plan Information
Information regarding securities authorized for issuance under the Company’s equity compensation plans as of December 31, 2006 is set forth in Item 12, “Security Ownership of Certain Beneficial Owners and Management.”

 

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Share Repurchase Plan
On April 20, 2003, the Company announced a plan to repurchase up to $5.0 million in shares of its common stock. In 2004, 12,000 shares of common stock were repurchased on the open market for approximately $0.1 million, while in 2003, 482,800 shares of common stock were repurchased on the open market for approximately $2.5 million. We suspended further repurchases under the plan on May 10, 2004. On December 5, 2005, the Company announced the resumption of the above plan to repurchase $1.0 million in shares of its common stock. In 2005, 3,200 shares of common stock were repurchased on the open market for $7.5 thousand. In 2006, 40,800 shares of common stock, of which 4,900 shares were completed in the fourth quarter, were repurchased on the open market for $0.1 million. The following table sets forth the repurchases made under this program:
                                 
                    Total Number     Maximum  
                    of Shares     Number of  
                    Purchased as     Shares That  
                    Part of     May Yet Be  
                    Publicly     Purchased  
    Total Number             Announced     Under the  
    of Shares     Average Price     Plans or     Plans or  
Period   Purchased     Paid per Share     Programs     Programs  
 
                               
2005
    3,200     $ 2.35       3,200       333,333  
2006
    40,800     $ 2.71       40,800          
 
                           
 
                               
Total
    44,000     $ 2.68       44,000          
 
                           
The Company’s share repurchase program is conducted under authorizations made from time to time by the Company’s Board of Directors. The shares reported in the table are covered by Board authorizations to repurchase shares of common stock, as follows: 333,333 shares announced on December 5, 2005. This authorization does not have an expiration date.
Performance Graph
The following information in this Item 5 of this Annual Report on Form 10-K is not deemed to be “soliciting material” or to be “filed” with the SEC or subject to Regulation 14A or 14C under the Securities Exchange Act of 1934 or to the liabilities of Section 18 of the Securities Exchange Act of 1934, and will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent we specifically incorporate it by reference into such a filing.

 

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The graph below compares the yearly percentage change in the cumulative total stockholder return on the shares of Katy common stock with the cumulative total returns of the Russell 2000 Index, the Dow Jones US Industrial Diversified Index and the S&P Smallcap 600 Industrial Conglomerates Index for the fiscal years ending December 31, 2001 through 2006. The calculations in the graph below assume $100 was invested on December 31, 2001 in Katy’s common stock and each index, and also assume reinvestment of dividends.
(PERFORMANCE GRAPH)
                                                 
    12/01   12/02   12/03   12/04   12/05   12/06
Katy Industries, Inc.
    100.00       100.58       166.96       151.46       90.64       78.36  
Russell 2000
    100.00       79.52       117.09       138.55       144.86       171.47  
Dow Jones US Diversified Industrials
    100.00       64.93       87.84       104.69       101.95       111.68  
S & P SmallCap Industrial Conglomerates
    100.00       59.47       80.21       95.65       92.02       99.94  

 

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Item 6. SELECTED FINANCIAL DATA
                                         
    Years Ended December 31,  
    As Restated, see Note 2                    
    2006     2005     2004     2003     2002  
    (Amounts in Thousands, except per share data and percentages)  
 
                                       
Net sales
  $ 396,166     $ 423,390     $ 416,681     $ 398,249     $ 403,599  
 
                             
 
                                       
Loss from continuing operations [a]
  $ (4,789 )   $ (11,619 )   $ (36,528 )   $ (17,255 )   $ (55,149 )
Discontinued operations [b]
    (6,834 )     (2,178 )     407       7,891       914  
Cumulative effect of a change in accounting principle [b] [c]
    (756 )                       (2,514 )
 
                             
Net loss
    (12,379 )     (13,797 )     (36,121 )     (9,364 )     (56,749 )
Gain on early redemption of preferred interest of subsidiary [d]
                      6,560        
Payment-in-kind of dividends on convertible preferred stock [e]
                (14,749 )     (12,811 )     (11,136 )
 
                             
Net loss attributable to common stockholders
  $ (12,379 )   $ (13,797 )   $ (50,870 )   $ (15,615 )   $ (67,885 )
 
                             
 
                                       
(Loss) earnings per share of common stock — Basic and diluted:
                                       
Loss from continuing operations attributable to common stockholders
  $ (0.60 )   $ (1.47 )   $ (6.50 )   $ (2.86 )   $ (7.92 )
Discontinued operations
    (0.86 )     (0.27 )     0.05       0.96       0.11  
Cumulative effect of a change in accounting principle
    (0.09 )                       (0.30 )
 
                             
Net loss attributable to common stockholders
  $ (1.55 )   $ (1.74 )   $ (6.45 )   $ (1.90 )   $ (8.11 )
 
                             
 
                                       
Total assets
  $ 182,694     $ 212,094     $ 224,464     $ 241,708     $ 275,977  
Total liabilities
    140,662       157,390       155,879       139,416       157,405  
Preferred interest in subsidiary
                            16,400  
Stockholders’ equity
    42,032       54,704       68,585       102,292       102,172  
Long-term debt, including current maturities
    56,871       57,660       58,737       39,663       45,451  
Impairments of long-lived assets [f]
          2,112       30,056       11,525       21,204  
Severance, restructuring and related charges [f]
    (112 )     1,090       3,505       8,132       19,155  
Depreciation and amortization [f]
    8,640       8,968       12,145       18,877       17,732  
Capital expenditures [f]
    4,614       8,925       10,782       11,062       8,714  
Working capital [g]
    48,610       48,132       59,855       43,439       35,206  
Ratio of debt to capitalization
    57.5 %     51.3 %     46.1 %     27.9 %     27.7 %
 
                                       
Weighted average common shares outstanding — Basic and diluted
    7,966,742       7,948,749       7,883,265       8,214,712       8,370,815  
Number of employees
    1,172       1,544       1,793       1,808       2,261  
Cash dividends declared per common share
  $     $     $     $     $  
[a]  
Includes distributions on preferred securities in 2003 and 2002.
 
[b]  
Presented net of tax.
 
[c]  
In 2006, this amount is stock compensation expense recorded with the adoption of Statement of Financial Accounting Standards (“SFAS”) No. 123R, Share-Based Payment. In 2002, this amount is a transitional impairment of goodwill recorded with the adoption of SFAS No. 142, Goodwill and Other Intangible Assets.
 
[d]  
Represents the gain recognized on a redemption of a preferred interest of our CCP subsidiary.
 
[e]  
Represents a 15% payment-in-kind dividend on our Convertible Preferred Stock. See Note 12 to the Consolidated Financial Statements in Part II, Item 8.
 
[f]  
From continuing operations only.
 
[g]  
Defined as current assets minus current liabilities, exclusive of deferred tax assets and liabilities and debt classified as current.

 

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Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Restatement of Prior Financial Information
As a result of accounting errors in the raw material inventory records, management and the Company’s Audit Committee determined on August 6, 2007 that the Company’s consolidated financial statements for fiscal 2005 and 2006 should no longer be relied upon. The Company’s decision to restate its consolidated financial statements is based on facts obtained by management and the results of an internal investigation of the physical raw material inventory counting process at CCP. These procedures resulted in the identification of an intentional overstatement of raw material inventory when completing the physical inventory. At the time of the physical inventories, the Company did not have sufficient controls in place to ensure that the accurate physical raw material inventory on hand was properly accounted for and reported in the proper period.
In addition, as part of the restatement, the Company has recorded additional items, certain of which were previously identified and determined to be immaterial. The impact of these additional items on net loss is approximately ($0.4) million and $0.2 million for the years ended December 31, 2005 and 2006, respectively, which is allocated entirely to loss from continuing operations.
Refer to Note 2 of the Consolidated Financial Statements for additional discussion related to the effects of the restatement.
COMPANY OVERVIEW
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 Products. The group labeled as Other consists of Sahlman and SESCO. Two businesses formerly included in the Maintenance Products Group, Metal Truck Box and CEL, have been classified as Discontinued Operations for the periods prior to their sale. These business units were sold in 2006.
Since the Recapitalization, the Company’s management has been focused on various restructuring and cost reduction initiatives. Currently, the Company’s focus has shifted to sustaining revenue growth and managing raw material costs. Our future cost reductions, if any, will continue to come from process improvements (such as Lean Manufacturing and Six Sigma), value engineering products, improved sourcing/purchasing and lean administration.
End-user demand for our Maintenance and Electrical products is relatively stable and recurring. Demand for products in our markets is strong and supported by the necessity of the products to users, creating a steady and predictable market. In the core janitorial/sanitary and foodservice segments, sanitary and health standards create a steady flow of ongoing demand. The consumable or short-life nature of most of the products used for cleaning applications (primarily floor pads, hand pads, and mops, brooms and brushes) means that they are replaced frequently, creating further demand stability. However, we continue to see a trend of “just in time” inventory being maintained by our customers. This has resulted in smaller, more frequent orders coming from our distribution base. The unstable resin market has created a need to increase prices to commercial customers, and to date, they have been accepted. But, commercial customers now believe resin prices are coming down and future increases may be difficult to implement. In addition, many of our Electrical products can be characterized as “value” items that are frequently lost or discarded, with subsequent replacement ensuring continuing and stable demand. This is particularly the case with electrical cords, which consistently experience strong sales ahead of the holiday season.
Certain of the markets in which we compete are expected to experience steady growth over the next several years. Our core commercial cleaning product markets are expected to grow at rates approximating gross domestic product (“GDP”), driven by increasing sanitary standards as a result of heightened health concerns. The consumer plastics market as a whole is relatively mature, with its growth characteristics linked to household expenditures. Demand is driven by the increasing acquisition of material possessions by North American households and the desire of consumers to store those possessions in an attractive and orderly manner. Demand for consumer plastic storage products is closely linked to “value” items and the ability to pass resin increases has been a significant challenge. End-users are sensitive to the price/value relationship more than brand-name and are seeking alternative solutions when the price/value relationship does not meet their expectations.
We estimate that the North American market for cords and work lights will grow at above-GDP growth rates, driven by the growing number of suburban homes (particularly those with outdoor spaces) and the growth in the use of outdoor appliances. The market for surge protectors and multiple outlet products is also expected to grow at above-GDP growth rates driven by the continued use in consumer purchasers of appliances, computers, home entertainment equipment, and other electronic equipment, as well as the growing public awareness of the need to protect these products from power surges.
Key elements in achieving profitability in the Maintenance Products Group include 1) maintaining a low cost structure, from a production, distribution and administrative standpoint, 2) providing outstanding customer service and 3) containing raw material costs (especially plastic resins) or raising prices to shift these higher costs to our customers for our plastic products. In addition to continually striving to reduce our cost structure, we are seeking to offset pricing challenges by developing new 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. Retention of customers, or more specifically, product lines with those customers, is also very important in the mass merchant retail area, given the vast size of these national accounts. Since the fourth quarter of 2003, we centralized our customer service and administrative functions for CCP divisions Continental, Glit, Wilen, and Disco in one location, allowing customers to order products from any CCP commercial unit on one purchase order. We believe that operating these business units 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. We believe that this may increase customer loyalty, help in attracting new customers and lead to increased top line sales in future years.

 

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Key elements in achieving profitability in the Electrical Products Group are in many ways similar to those mentioned for our Maintenance Products Group. The achievement and maintenance of a low cost structure is critical given the significant level of foreign competition, primarily from Asia and Latin America. For this reason, Woods US and Woods Canada, respectively, executed a fully outsourced strategy for their consumer electrical 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. Woods US and Woods Canada are both subject to seasonal sales trends in connection with the holiday shopping season, with stronger sales and profits realized in the third and fourth quarters. Retention of customers is critical in the Electrical Products Group, given the size of national accounts.
See “Outlook for 2007” in this section for discussion of recent developments related to the Maintenance Products Group and the Electrical Products Group.
                                                 
    Years Ended December 31,  
    As Restated, see Note 2        
    2006     2005     2004  
    (Amounts in Millions, except per share data and percentages)  
    $     % to Sales     $     % to Sales     $     % to Sales  
Net sales
  $ 396.2       100.0     $ 423.4       100.0     $ 416.7       100.0  
Cost of goods sold
    345.5       87.2       372.9       88.0       361.7       86.8  
 
                                   
Gross profit
    50.7       12.8       50.5       12.0       55.0       13.2  
Selling, general and administrative expenses
    46.5       (11.7 )     52.7       (12.5 )     52.7       (12.6 )
Impairments of long-lived assets
                2.1       (0.5 )     30.0       (7.2 )
Severance, restructuring and related charges
    (0.1 )     0.0       1.1       (0.3 )     3.5       (0.9 )
Loss (gain) on sale of assets
    0.5       (0.1 )     (0.3 )     0.1       (0.3 )     0.1  
 
                                   
Operating income (loss)
    3.8       1.0       (5.1 )     (1.2 )     (30.9 )     (7.4 )
 
                                   
Equity in income of equity method investment
                  0.6                        
Gain on SESCO joint venture transaction
    0.6                                      
Interest expense
    (7.1 )             (5.7 )             (4.0 )        
Other, net
    0.2               0.2               (1.0 )        
 
                                         
Loss from continuing operations before provision for income taxes
    (2.5 )             (10.0 )             (35.9 )        
Provision for income taxes from continuing operations
    (2.3 )             (1.6 )             (0.6 )        
 
                                         
Loss from continuing operations
    (4.8 )             (11.6 )             (36.5 )        
(Loss) income from operations of discontinued businesses (net of tax)
    (1.4 )             (2.2 )             1.2          
Loss on sale of discontinued businesses (net of tax)
    (5.4 )                           (0.8 )        
 
                                         
Loss before cumulative effect of a change in accounting principle
    (11.6 )             (13.8 )             (36.1 )        
Cumulative effect of a change in accounting principle (net of tax)
    (0.8 )                                    
 
                                         
Net loss
    (12.4 )             (13.8 )             (36.1 )        
Payment-in-kind of dividends on convertible preferred stock
                                (14.8 )        
 
                                         
Net loss attributable to common stockholders
  $ (12.4 )           $ (13.8 )           $ (50.9 )        
 
                                         
Loss per share of common stock — Basic and diluted
                                               
Loss from continuing operations
  $ (0.60 )           $ (1.47 )           $ (4.63 )        
Payment-in-kind of dividends on convertible preferred stock
                                (1.88 )        
 
                                         
Loss from continuing operations attributable to common stockholders
    (0.60 )             (1.47 )             (6.50 )        
Discontinued operations (net of tax)
    (0.86 )             (0.27 )             0.05          
Cumulative effect of a change in accounting principle
    (0.09 )                                    
 
                                         
Net loss attributable to common stockholders
  $ (1.55 )           $ (1.74 )           $ (6.45 )        
 
                                         

 

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RESULTS OF OPERATIONS
2006 COMPARED TO 2005
Overview
Our consolidated net sales in 2006 decreased $27.2 million, or 6.4%, from 2005. Lower net sales resulted from a lower volume of 17.0% offset by higher pricing of 9.6% and favorable currency translation of 1.0%. Gross margins were 12.8% in the year ended December 31, 2006, an increase of 0.8 percentage point from the year ended December 31, 2005. Margins were positively impacted by improved operating performance at our Glit business offset by higher material costs, a portion of which could not be passed on through as price increases within our Electrical Group. Selling, general and administrative expenses (“SG&A”) as a percentage of sales were 11.7% in 2006 which is lower than 12.5% in 2005. In 2006, operating income was $3.8 million compared to an operating loss of ($5.1) million in 2005. The improvement was principally due to increased gross margins, lower selling, general and administrative expenses, along with the reduction of charges associated with impairment of long-lived assets and severance, restructuring and other charges of $3.3 million.
Overall, we reported a net loss attributable to common shareholders of ($12.4) million [($1.55) per share] for the year ended December 31, 2006, versus a net loss attributable to common shareholders of ($13.8) million [($1.74) per share] in the same period of 2005. In 2006, we reported a net loss from discontinued businesses of ($6.8) million [($0.86) per share] versus a net loss from discontinued businesses of ($2.2) million [($0.27) per share] in 2005. We also reported a cumulative effect of change in accounting principle of ($0.8) million [($0.09 per share)] related to the adoption of FAS 123R, Shared Based Payments, effective January 1, 2007.
Net Sales
Maintenance Products Group
Net sales from the Maintenance Products Group decreased from $216.1 million during the year ended December 31, 2005 to $208.4 million during the year ended December 31, 2006, a decrease of 3.5%. Overall, this decline was primarily due to lower volume of 8.3% offset by higher pricing of 4.6% and favorable currency translation of 0.2%. Sales volume for the Contico business unit in the U.S., which sells primarily to mass merchant customers, was significantly lower due to our decision to exit certain unprofitable business lines. We also experienced volume declines in our Glit business unit in the U.S. primarily due to activity with a major customer being adversely impacted from the overall slowdown in the building industry and the lower number of major hurricanes in 2006.
Higher pricing resulted from the implementation of selling price increases across the Maintenance Products Group, which took effect throughout the last half of 2005 and throughout 2006. The implementation of price increases was in response to the accelerating cost of our primary raw materials, packaging materials, utilities and freight.
Electrical Products Group
The Electrical Products Group’s sales decreased from $207.3 million for the year ended December 31, 2005 to $187.7 million for the year ended December 31, 2006, a decrease of 9.4%. Sales decreased as a result of a reduction in volume of 26.0% offset by higher pricing of 15.0%, and favorable currency translation of 1.6%.
Volume in 2006 at Woods US was adversely impacted by the absence of 2005 sales with one of its major customers which did not repeat in 2006. In addition, the current year was adversely impacted by the loss of certain product lines with
certain customers along with a milder hurricane season in the United States. Sales at Woods Canada were favorably impacted by a stronger Canadian dollar versus the U.S. dollar in 2006 versus 2005.
Multiple selling price increases were implemented throughout 2006 to offset the rising cost of copper and PVC. We have continued to implement price increases; however, there can be no assurance that such increases will be accepted.

 

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Operating Income
                                                 
    As Restated, see Note 2        
    2006     2005     Change  
    $     % Margin     $     % Margin     $     % Margin  
Maintenance Products Group
  $ 5.7       2.7     $ (6.4 )     (3.0 )   $ 12.1       5.7  
Electrical Products Group
    8.7       4.6       17.4       8.4       (8.7 )     (3.8 )
Unallocated corporate expense
    (10.2 )             (13.2 )             3.0          
 
                                         
 
    4.2       1.0       (2.2 )     (0.5 )     6.4       1.5  
Impairments of long-lived assets
                  (2.1 )             2.1          
Severance, restructuring and related charges
    0.1               (1.1 )             1.2          
(Loss) gain on sale of assets
    (0.5 )             0.3               (0.8 )        
 
                                         
Operating income (loss)
  $ 3.8       1.0     $ (5.1 )     (1.2 )   $ 8.9       2.2  
 
                                         
Maintenance Products Group
The Maintenance Products Group’s operating income increased from an operating loss of ($6.4) million (-3.0% of net sales) during the year ended December 31, 2005 to operating income of $5.7 million (2.7% of net sales) for the year ended December 31, 2006. The improvement was primarily attributable to production efficiencies gained at our Glit business as well as higher pricing levels in 2006 as well as positive impact from the liquidation of last-in, first-out inventory. In 2005, lower volumes and higher raw material costs adversely impacted our business units which sell plastic products. SG&A expenses as a percentage of net sales in 2006 were slightly lower versus 2005 due to mostly cost containment measures.
Electrical Products Group
The Electrical Products Group’s operating income decreased from $17.4 million (8.4% of net sales) for the year ended December 31, 2005 to $8.7 million (4.6% of net sales) for the year ended December 31, 2006. Operating margins have been negatively impacted, primarily during the last half of 2006, from the accelerated change in material costs and the inability to recover these costs from the customer. In addition, the reduced volume levels from 2005 have impacted operating income. SG&A as a percentage of net sales in 2006 was comparable to 2005 levels.
Corporate
Corporate operating expenses decreased from $13.2 million in 2005 to $10.2 million in 2006 principally due to compensation cost associated with the acceleration of vesting of stock options in 2005 and favorable self-insured costs performance in 2006.
Impairments of Long-lived Assets
During 2006, we did not recognize any impairment in our businesses. During the fourth quarter of 2005, we recognized an impairment loss of $2.1 million related to the Glit business unit of our Maintenance Products Group (see discussion of impairment in Note 5 of the Consolidated Financial Statements in Part II, Item 8) including $1.6 million related to goodwill, $0.2 million related to a tradename intangible, $0.2 million related to a customer list intangible, and $0.1 million related to patents. Our Glit business unit sustained a lower than expected profitability level throughout the last half of 2005 which resulted from increased costs due to operational disruptions at our Wrens, Georgia facility. The operational disruptions were the result of both the integration of other manufacturing operations into the facility as well as a fire in the fourth quarter of 2004. Not only did the facility have increased costs, the disruptions triggered the loss or reduction of customer activity. As a result, an impairment analysis was completed on the business unit and its long-lived assets. In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142, Goodwill and Intangible Assets, we (with the assistance of an independent third party valuation firm) performed an analysis of discounted future cash flows which indicated that the book value of the Glit unit was greater than the fair value of the business. In addition, as a result of the goodwill analysis, we also assessed whether there had been an impairment of the long-lived assets in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. The Company concluded that the book value of tradename, customer list and patents associated with the Glit business units exceeded the fair value and impairment had occurred.

 

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Severance, Restructuring and Related Charges
Operating results for the year ended December 31, 2006 include a reduction of the non-cancelable lease liability for our Hazelwood, Missouri facility. This reduction in the liability was offset by costs associated with the restructuring of the Glit business ($0.3 million) and costs associated with the relocation of corporate headquarters ($0.2 million). Operating results for the Company during the year ended December 31, 2005 were negatively impacted by severance, restructuring and related charges of $1.1 million. Charges in 2005 related to the restructuring of the Glit business ($0.7 million), costs associated with the relocation of corporate headquarters ($0.2 million) and costs associated with various restructuring activities ($0.2 million). Refer to further discussion on severance and restructuring charges on Page 31 and Note 19 to the Consolidated Financial Statements in Part II, Item 8.
Other
In 2005, the Company recognized $0.6 million in equity income from the Sahlman investment compared to no income or loss being recognized in 2006. Interest expense increased by $1.4 million in 2006 versus 2005 primarily as a result of higher average borrowings as well as higher interest rates.
On June 27, 2006, the Company and Montenay amended the partnership interest purchase agreement in order to allow the Company to completely exit from the SESCO operations and related obligations. In addition, Montenay became the guarantor under the loan obligation for the IRBs. Montenay purchased the Company’s limited partnership interest for $0.1 million and a reduction of approximately $0.6 million in the face amount due to Montenay as agreed upon in the original partnership agreement. In addition, Montenay removed the Company as the performance guarantor under the service agreement. As a result of the above transaction, the Company recorded a gain of $0.4 million within continuing operations during the year ended December 31, 2006 given the reduction in the face amount due to Montenay as agreed upon in the original partnership interest purchase agreement. In addition, the Company recorded a gain on the sale of the partnership interest of approximately $0.1 million as reflected within continuing operations.
The provision for income taxes for 2006 and 2005 reflects current expense for state and foreign income taxes. The increase in the provision for income taxes reflects the improved operating performance for certain foreign businesses. In both 2006 and 2005, tax benefits were not recorded in the U.S. (for federal and certain state income taxes) and for certain foreign subsidiaries on pre-tax losses as valuation allowances were recorded related to deferred tax assets created as a result of operating losses in the United States and in certain foreign jurisdictions.
Loss from operations of discontinued businesses includes activity from the U.K. consumer plastics business plus the Metal Truck Box business unit, which were all sold in 2006. For the year ended December 31, 2006, we sold these business units for a loss of $5.4 million. In 2006, the Company incurred a loss from operations of discontinued businesses of $1.4 million compared to a loss from operations of discontinued businesses of $2.2 million for 2005.
Effective January 1, 2006, the Company adopted SFAS No. 123R, Share-Based Payments. As a result, a cumulative effect of this adoption of $0.8 million was recognized associated with the fair value of all vested stock appreciation rights (“SARs”).
2005 COMPARED TO 2004
Overview
Our consolidated net sales in 2005 increased $6.7 million, or 1.6%, from 2004. Higher net sales resulted from higher pricing of 4.6%, favorable currency translation of 0.8% offset by lower volume of 3.8%. Gross margins were 12.0% in the year ended December 31, 2005, a decrease of 1.2 percentage points from the year ended December 31, 2004. Margins were negatively impacted by higher material costs, a portion of which could not be passed on through price increases, and higher operating costs in our Glit business. SG&A as a percentage of sales were 12.5% in 2005 which is slightly lower than 12.6% in 2004. The operating loss decreased by $25.8 million to $5.1 million, principally due to the reduction of charges associated with impairment of long-lived assets and severance, restructuring and other charges of $30.3 million. However, these reductions were offset by lower gross margins as discussed above.
Overall, we reported a net loss attributable to common shareholders of ($13.8) million [($1.74) per share] for the year ended December 31, 2005, versus a net loss attributable to common shareholders of ($50.9) million [($6.45) per share] in the same period of 2004. In 2005, we reported net loss from discontinued businesses of ($2.2) million [($0.27) per share] versus net income from discontinued businesses of $0.4 million [$0.05 per share] in 2004. During the year ended December 31, 2004, we recorded the impact of paid-in-kind dividends earned on our convertible preferred stock of ($14.8) million [($1.88) per share].

 

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Net Sales
Maintenance Products Group
Net sales from the Maintenance Products Group decreased from $237.9 million during the year ended December 31, 2004 to $216.1 million during the year ended December 31, 2005, a decrease of 9.2%. Overall, this decline was primarily due to lower volume of 13.3% offset by higher pricing of 3.9% and favorable currency translation of 0.2%. Sales volume for the Contico business unit in the U.S., which sells primarily to mass merchant customers, was significantly lower due to our decision to exit certain unprofitable business lines. We also experienced volume declines in our Glit business unit in the U.S. due to certain operational disruptions including inefficiencies caused by the consolidation of two additional Glit facilities into the Wrens, Georgia facility as well as a fire in Wrens, Georgia early in the fourth quarter of 2004. These decreases in Glit sales were partially offset by stronger sales of roofing products to the construction industry.
Higher pricing resulted from the implementation of selling price increases across the Maintenance Products Group, which took effect throughout 2005. The implementation of price increases was in response to the accelerating cost of our primary raw materials, packaging materials, utilities and freight starting in 2004 and continuing in 2005.
Electrical Products Group
The Electrical Products Group’s sales improved from $178.8 million for the year ended December 31, 2004 to $207.3 million for the year ended December 31, 2005, an increase of 16.0%. Sales improved as a result of an increase in volume of 8.9%, higher pricing of 5.4%, and favorable currency translation of 1.7%.
Volume at Woods US benefited principally from increased promotional activity at one of its largest mass merchant retailers in the first quarter of 2005, increases in store growth at some of our large mass merchant retailers, hurricane related orders, and the timing of purchases by customers switching to direct import (direct import sales represent merchandise shipped directly from our suppliers to our customers). Woods Canada experienced a volume increase due to an increased demand at its largest customer (a national mass merchant retailer in Canada). Sales at Woods Canada were also favorably impacted by a stronger Canadian dollar versus the U.S. dollar in 2005 versus 2004. Multiple selling price increases were implemented throughout 2005 at Woods US (and to a lesser extent at Woods Canada) to offset the rising cost of copper and PVC.
Operating Income
                                                 
    As Restated, see Note 2              
    2005     2004     Change  
    $     % Margin     $     % Margin     $     % Margin  
Maintenance Products Group
  $ (6.4 )     (3.0 )   $ (4.1 )     (1.7 )   $ (2.3 )     (1.3 )
Electrical Products Group
    17.4       8.4       16.8       9.4       0.6       (1.0 )
Unallocated corporate expense
    (13.2 )             (10.4 )             (2.8 )        
 
                                         
 
    (2.2 )     (0.5 )     2.3       0.6       (4.5 )     (1.1 )
Impairments of long-lived assets
    (2.1 )             (30.0 )             27.9          
Severance, restructuring and related charges
    (1.1 )             (3.5 )             2.4          
Gain on sale of assets
    0.3               0.3                        
 
                                         
Operating loss
  $ (5.1 )     (1.2 )   $ (30.9 )     (7.4 )   $ 25.8       6.2  
 
                                         
Maintenance Products Group
The Maintenance Products Group’s operating loss increased from ($4.1) million (-1.7% of net sales) during the year ended December 31, 2004 to an operating loss of ($6.4) million (-3.0% of net sales) for the year ended December 31, 2005. The change was primarily attributable to lower volumes in the Contico and Glit units. In addition, higher raw material costs in 2005 versus 2004 were substantially recovered through higher selling prices. We continued to experience declines in the profitability of our Glit business resulting from increased costs which were principally due to certain operational disruptions at our Wrens Georgia facility. SG&A expenses were lower in 2005 versus 2004, but as a percentage of net sales, SG&A expenses have remained essentially unchanged.

 

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Electrical Products Group
The Electrical Products Group’s operating income increased from $16.8 million (9.4% of net sales) for the year ended December 31, 2004 to $17.4 million (8.4% of net sales) for the year ended December 31, 2005, an increase of 4%. The increase in operating income was due to the strong volume increases at the Woods US business unit during the fourth quarter of 2005. Operating income as a percentage of net sales decreased due to a higher mix of direct import sales.
Corporate
Corporate operating expenses increased from $10.4 million in 2004 to $13.2 million in 2005 primarily due to non-cash stock compensation expense related to the former chief executive officer of $2.0 million and higher insurance costs of $0.5 million offset by a credit recognized on SARs of $0.8 million attributable to the lower stock price.
Impairments of Long-lived Assets
During the fourth quarter of 2005, we recognized an impairment loss of $2.1 million related to the Glit business unit of our Maintenance Products Group (see discussion of impairment in Note 5 of the Consolidated Financial Statements in Part II, Item 8) including $1.6 million related to goodwill, $0.2 million related to a tradename intangible, $0.2 million related to a customer list intangible, and $0.1 million related to patents. During the fourth quarter of 2004, we recognized an impairment loss of $29.9 million related to the US Plastics business units of our Maintenance Products Group (see discussion of impairment in Note 5 to the Consolidated Financial Statements in Part II, Item 8) including $8.0 million related to goodwill, $8.4 million related to machinery and equipment, $10.9 million related to a customer list intangible, and $2.6 million related to a trademark. In the fourth quarter of 2004, the profitability of the Contico business unit declined sharply as we were unable to pass along sufficient selling price increases to combat the accelerating cost of resin (a key raw material used in all of the US Plastics units). We believe that our future earnings and cash flow could be negatively impacted to the extent further increases in resin and other raw material costs cannot be offset or recovered through higher selling prices. The Company concluded that the book value of equipment, a customer list intangible and trademark associated with the US Plastics business unit significantly exceeded the fair value and impairment had occurred. Also in 2004, we recorded impairment charges of $0.1 million related to certain assets at the Woods US business unit of our Electrical Products Group.
Severance, Restructuring and Related Charges
Operating results for the Company during the years ended December 31, 2005 and 2004 were negatively impacted by severance, restructuring and related charges of $1.1 million and $3.5 million, respectively. Charges in 2005 related to the restructuring of the Glit business ($0.7 million), costs associated with the relocation of corporate headquarters ($0.2 million) and costs associated with various restructuring activities ($0.2 million). Refer to further discussion on severance and restructuring charges on Page 31 and Note 19 to the Consolidated Financial Statements in Part II, Item 8.
Charges in 2004 related to adjustments to previously established non-cancelable lease liabilities for abandoned facilities ($0.9 million); a non-cancelable lease accrual and severance as a result of the shutdown of manufacturing and severance at Woods Canada ($0.9 million); the restructuring of the Glit business ($0.8 million); costs for the movement of inventory and equipment in connection with the consolidation of St. Louis, Missouri manufacturing and distribution facilities ($0.3 million); the shutdown and relocation of a procurement office in Asia ($0.3 million); costs incurred for the consolidation of administrative functions for CCP ($0.2 million); and expenses for the closure of CCP Canada’s facility and the subsequent consolidation into the Woods Canada facility ($0.1 million).
Other
In 2005, the Company recognized $0.6 million in equity income from the Sahlman investment compared to no equity income being recognized in 2004.
Interest expense increased by $1.8 million in 2005 versus 2004, primarily as a result of higher average borrowing as well as higher interest rates and increased margins over LIBOR pursuant to the Bank of America Credit Agreement. Other, net for the year ended December 31, 2004 included the net write-off of amounts related to divested business ($0.9 million) and the write-off of fees and expenses ($0.5 million) associated with a financing which the Company chose not to pursue.
The provision for income taxes for 2005 and 2004 reflects current expense for state and foreign income taxes offset by changes in certain tax reserves and foreign deferred tax assets.
Loss from operations of discontinued businesses includes activity from the United Kingdom consumer plastics business plus the Metal Truck Box business unit, which were all sold in 2006. For the year ended December 31, 2005, the Company incurred a loss from operations of discontinued businesses of $2.2 million compared to income from operations of discontinued businesses of $1.2 million for 2004. In 2004, the loss on sale of discontinued businesses includes impairment charges associated with the Metal Truck Box business of $0.8 million.

 

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LIQUIDITY AND CAPITAL RESOURCES
We require funding for working capital needs and capital expenditures. We believe that our cash flow from operations and the use of available borrowings under the Bank of America Credit Agreement (as defined below) provide sufficient liquidity for our operations going forward. As of December 31, 2006, we had cash and cash equivalents of $7.4 million versus cash and cash equivalents of $8.4 million at December 31, 2005. Also as of December 31, 2006, we had outstanding borrowings of $56.9 million [58% of total capitalization], under the Bank of America Credit Agreement with unused borrowing availability on the Revolving Credit Facility of $13.7 million. As of December 31, 2005, we had outstanding borrowings of $57.7 million [51% of total capitalization] with unused borrowing availability of $13.9 million. We provided cash flow from operations of $1.8 million during the year ended December 31, 2006 versus the $6.6 million provided by operations during the year ended December 31, 2005. Cash flow from operations was lower in 2006 than 2005 as a result of the level of accounts payable reduction in late 2006.
We have a number of obligations and commitments, which are listed on the schedule later in this section entitled “Contractual and Commercial Obligations.” We have considered all of these obligations and commitments in structuring our capital resources to ensure that they can be met. See the notes accompanying the table in that section for further discussions of those items. We believe that given our strong working capital base, additional liquidity could be obtained through additional debt financing, if necessary. However, there is no guarantee that such financing could be obtained. In addition, we are continually evaluating alternatives relating to the sale of excess assets and divestitures of certain of our business units. Asset sales and business divestitures present opportunities to provide additional liquidity by de-leveraging our financial position.
Bank of America Credit Agreement
On April 20, 2004, we completed a refinancing of our outstanding indebtedness (the “Refinancing”) and entered into a new agreement with Bank of America Business Capital (formerly Fleet Capital Corporation) (the “Bank of America Credit Agreement”). Like the previous credit agreement with Fleet Capital Corporation, the Bank of America Credit Agreement was a $110.0 million facility with a $20.0 million term loan (“Term Loan”) and a $90.0 million revolving credit facility (“Revolving Credit Facility”) with essentially the same terms as the previous credit agreement. The Bank of America Credit Agreement is an asset-based lending agreement and involves a syndicate of four banks, all of which participated in the syndicate from the previous credit agreement. The Bank of America Credit Agreement, and the additional borrowing ability under the Revolving Credit Facility obtained by incurring new term debt, resulted in three important benefits related to our long-term strategy: (1) additional borrowing capacity to invest in capital expenditures and/or acquisitions key to our strategic direction, (2) increased working capital flexibility to build inventory when necessary to accommodate lower cost outsourced finished goods inventory and (3) the ability to borrow locally in Canada and in the UK and provide a natural hedge against currency fluctuations.
The $20.0 million Term Loan proceeds were applied as follow: $1.8 million to the rollover of existing term debt; $16.7 million to reduce the Revolving Credit Facility; and $1.5 million to cover costs associated with the Bank of America Credit Agreement.
The Revolving Credit Facility has an expiration date of April 20, 2009 and its borrowing base is determined by eligible inventory and accounts receivable. All extensions of credit under the Bank of America Credit Agreement are collateralized by a first priority security interest in and lien upon the capital stock of each material domestic subsidiary (65% of the capital stock of certain foreign subsidiaries), and all of our present and future assets and properties. The Term Loan, as amended, also has a final maturity date of April 20, 2009 with quarterly payments of $0.4 million beginning April 1, 2007. A final payment of $10.0 million is scheduled to be paid in April 2009. The term loan is collateralized by our property, plant and equipment.
Our borrowing base under the Bank of America Credit Agreement is reduced by the outstanding amount of standby and commercial letters of credit. Vendors, financial institutions and other parties with whom we conduct business may require letters of credit in the future that either (1) do not exist today or (2) would be at higher amounts than those that exist today. Currently, our largest letters of credit relate to our casualty insurance programs. At December 31, 2006, total outstanding letters of credit were $7.9 million.
Primarily due to declining profitability and the timing of certain restructuring payments, the Company amended the Bank of America Credit Agreement seven times from April 20, 2004, the date of the Refinancing, through December 31, 2006. The amendments adjusted certain financial covenants such that the fixed charge coverage ratio and consolidated leverage ratio were eliminated and the minimum availability (eligible collateral base less outstanding borrowings and letters of credit) was set such that our eligible collateral must exceed the sum of our outstanding borrowings and letters of credit under the Revolving Credit Facility by at least $5.0 million to $7.5 million, at various points during that time period. In addition, the Company was limited on maximum allowable capital expenditures for $12.0 million and $10.0 million for 2006 and 2005, respectively.

 

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Until September 30, 2004, interest accrued on the Revolving Credit Facility borrowings at 175 basis points over applicable LIBOR rate and at 200 basis points over LIBOR for borrowings under the Term Loan. In accordance with the Bank of America Credit Agreement, our margins (i.e. the interest rate spread above LIBOR) increased by 25 basis points in the fourth quarter of 2004 based upon certain leverage measurements. Margins increased an additional 25 basis points in the first quarter of 2005. Effective since April 2005, interest rate margins have been set at the largest margins set forth in the Bank of Credit Agreement, 275 basis points over applicable LIBOR rate and at 300 basis points over LIBOR for borrowings under the Term Loan. In accordance with the Bank of America Credit Agreement, margins on the term borrowings will drop 25 basis points if the balance of the Term Loan is reduced below $10.0 million. Interest accrues at higher margins on prime rates for swing loans, the amounts of which were nominal at December 31, 2006 and 2005.
As a result of the Seventh Amendment, the Company’s debt covenants, as of December 31, 2006 and thereafter, under the Bank of America Credit Agreement were to be as follows:
Fixed Charge Coverage Ratio — The Company is required to maintain a Fixed Charge Coverage Ratio (as defined in the Bank of America Credit Agreement) of 1.1:1, beginning December 31, 2006.
Capital Expenditures — For the year ended December 31, 2007, the Company is not to exceed $15.0 million in capital expenditures.
Leverage Ratio — As noted above, interest rate margins are currently set at the largest margins set forth in the Bank of America Credit Agreement. Following the first quarter of 2007, the Leverage Ratio will be utilized to determine the interest rate margin over the applicable LIBOR rate. No maximum Consolidated Leverage Ratio requirement is present.
We were in compliance with the above financial covenants in the Bank of America Credit Agreement, as amended above, at December 31, 2006.
While the Company was in compliance with the covenants of the Bank of America Credit Agreement as of December 31, 2006, it obtained, on March 8, 2007, the Eighth Amendment. The Eighth Amendment eliminates the Fixed Charge Coverage Ratio for the remaining life of the debt agreement and requires the Company to maintain a minimum level of availability such that its eligible collateral must exceed the sum of its outstanding borrowings and letters of credit by at least $5.0 million from the effective date of the Eighth Amendment through September 29, 2007 and by $7.5 million through December 31, 2007. Thereafter, the Company is required to maintain a minimum level of availability of $5.0 million for the first three quarters of the year and $7.5 million for the fourth quarter. In addition, we reduced our Revolving Credit Facility from $90.0 million to $80.0 million.
If we are unable to comply with the terms of the amended covenants, we could seek to obtain further amendments and pursue increased liquidity through additional debt financing and/or the sale of assets (see discussion above). However, the Company believes that we will be able to comply with all covenants, as amended, throughout 2007.
We incurred additional debt issuance costs in 2004 associated with the Bank of America Credit Agreement. Additionally, at the time of the inception of the Bank of America Credit Agreement, we had approximately $4.0 million of unamortized debt issuance costs associated with the previous credit agreement. The remainder of the previously capitalized costs, along with the capitalized costs from the Bank of America Credit Agreement, will be amortized over the life of the Bank of America Credit Agreement through April 2009. Also, during the first quarter of 2004, we incurred fees and expenses of $0.5 million associated with a financing which we chose not to pursue. The Company had the amortization of debt issuance costs of $1.2 million, $1.1 million and $1.1 million in 2006, 2005 and 2004, respectively. In addition, the Company incurred $0.3 million and $0.2 million associated with amending the Bank of America Credit Agreement, as discussed above, in 2006 and 2005, respectively.
The revolving credit facility under the Bank of America Credit Agreement requires lockbox agreements which provide for all receipts to be swept daily to reduce borrowings outstanding. These agreements, combined with the existence of a material adverse effect (“MAE”) clause in the Bank of America Credit Agreement, caused the revolving credit facility to be classified as a current liability, per guidance in the Emerging Issues Task Force Issue No. 95-22, Balance Sheet Classification of Borrowings Outstanding under Revolving Credit Agreements that Include Both a Subjective Acceleration Clause and a Lock-Box Arrangement. We do not expect to repay, or be required to repay, within one year, the balance of the revolving credit facility classified as a current liability. The MAE clause, which is a fairly typical requirement in commercial credit agreements, allows the lenders to require the loan to become due if they determine there has been a material adverse effect on our operations, business, properties, assets, liabilities, condition, or prospects. The classification of the revolving credit facility as a current liability is a result only of the combination of the lockbox agreements and MAE clause. The Bank of America Credit Agreement does not expire or have a maturity date within one year, but rather has a final expiration date of April 20, 2009. The lender had not notified us of any indication of a MAE at December 31, 2006, and we were not in default of any provision of the Bank of America Credit Agreement at December 31, 2006.

 

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Contractual Obligations
We have contractual obligations associated with our debt, operating lease agreements, severance and restructuring, and other obligations. Our obligations as of December 31, 2006, are summarized below (amounts in thousands):
                                         
            Due in less     Due in 1-3     Due in 3-5     Due after 5  
Contractual Cash Obligations   Total     than 1 year     years     years     years  
Revolving credit facility [a]
  $ 43,879     $ 43,879     $     $     $  
Term loans
    12,992       1,125       11,867              
Interest on debt [b]
    10,128       4,500       5,628              
Operating leases [c]
    22,090       7,663       10,571       3,242       614  
Severance and restructuring [c]
    653       247       280       126        
SESCO payable to Montenay [d]
    400       400                    
Postretirement benefits [e]
    6,203       901       1,505       1,257       2,540  
 
                             
Total Contractual Obligations
  $ 96,345     $ 58,715     $ 29,851     $ 4,625     $ 3,154  
 
                             
                                         
            Due in less     Due in 1-3     Due in 3-5     Due after 5  
Other Commercial Commitments   Total     than 1 year     years     years     years  
Commercial letters of credit
  $ 762     $ 762     $     $     $  
Stand-by letters of credit
    7,121       7,121                    
 
                             
Total Commercial Commitments
  $ 7,883     $ 7,883     $     $     $  
 
                             
[a]  
As discussed in the Liquidity and Capital Resources section above and in Note 9 to the Consolidated Financial Statements in Part II, Item 8, the entire revolving credit facility under the Bank of America Revolving Credit Agreement is classified as a current liability on the Consolidated Balance Sheets as a result of the combination in the Bank of America Credit Agreement of (i) lockbox agreements on Katy’s depository bank accounts, and (ii) a subjective Material Adverse Effect (“MAE”) clause. The Revolving Credit Facility expires in April of 2009.
 
[b]  
Represents interest on the Revolving Credit Facility and Term Loan of the Bank of America Credit Agreement. Amounts assume interest accrues at the current rate in effect, including the effect of the impact of the increased margins through the end of the first quarter of 2007 pursuant to the Sixth Amendment. The amount also assumes the principal balance of the Revolving Credit Facility remains constant through its expiration date of April 20, 2009 and the principal balance of the Term Loan amortizes in accordance with the terms of the Bank of America Credit Agreement. Due to the variable nature of the Bank of America Credit Agreement, actual interest rates could differ from the assumptions above. In addition, actual borrowing levels could differ from the assumptions above due to liquidity needs.
 
[c]  
Future non-cancelable lease rentals are included in the line entitled “Operating leases,” which also includes obligations associated with restructuring activities. The Consolidated Balance Sheets at December 31, 2006 and 2005, includes $1.0 million and $3.0 million, respectively, in discounted liabilities associated with non-cancelable operating lease rentals, net of estimated sub-lease revenues, related to facilities that have been abandoned as a result of restructuring and consolidation activities.
 
[d]  
Amount owed to Montenay as a result of the SESCO partnership, discussed in Note 8 to the Consolidated Financial Statements in Part II, Item 8. This obligation is classified in the Consolidated Balance Sheets as an Accrued Expense in Current Liabilities.
 
[e]  
Benefits consisting of post-retirement medical obligations to retirees of former subsidiaries of Katy, as well as deferred compensation plan liabilities to former officers of the Company, discussed in Note 11 to the Consolidated Financial Statements in Part II, Item 8.
Off-balance Sheet Arrangements
See Note 8 to the Consolidated Financial Statements in Part II, Item 8 for a discussion of SESCO.

 

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Cash Flow
Liquidity was positively impacted during 2006 as a result of positive operating cash flow along with proceeds from the sale of discontinued businesses which offset funds used for capital expenditures and reduction of debt levels. We provided $1.8 million of operating cash compared to operating cash provided during 2005 of $6.6 million. During 2006, the Company reduced debt obligations by $1.0 million primarily due to the operating cash performance noted above as well as the proceeds from the sale of discontinued businesses offsetting our capital expenditures.
Operating Activities
Cash flow from operating activities before changes in operating assets and discontinued operations was $6.1 million in 2006 versus $1.9 million in 2005. While we reported a net loss in both periods, these amounts included many non-cash items such as depreciation and amortization, impairments of long-lived assets, the write-off and amortization of debt issuance costs, non-cash stock compensation expense associated with the former CEO, the gain or loss on the sale of assets and the equity income from our equity method investment. We used $7.1 million of cash related to operating assets and liabilities in 2006 compared to $4.0 million in cash being provided in 2005. Our operating cash flow was impacted in 2006 by reduction of accounts payable offset slightly by reduced accounts receivable and inventory levels of $5.6 million. By the end of 2006, we were turning our inventory at 6.2 times per year versus 6.4 times per year in 2005. Cash of $2.4 million and $2.3 million was used in 2006 and 2005, respectively, to satisfy severance, restructuring and related obligations.
Investing Activities
Capital expenditures from continuing operations totaled $4.6 million in 2006 as compared to $8.9 million in 2005 as spending for restructuring activities and new property and equipment continued to slow down as compared to the past few years. In 2006, we sold the United Kingdom consumer plastics business and the Metal Truck Box business unit for $5.4 million excluding a $1.2 million note receivable obtained as part of the Metal Truck Box transaction. In addition, the Company sold additional assets, including our SESCO partnership interest, in 2006 and 2005 for net proceeds of $0.4 million and $1.0 million, respectively. In 2005, we acquired substantially all of the assets and assumed certain liabilities of Washington International Non-Wovens, LLC. Anticipated capital expenditures are expected to be comparable in 2007 to prior year levels, mainly due to available capacity and amended bank covenants. On March 31, 2004, Woods Canada sold its manufacturing facility for net proceeds of $3.2 million and immediately entered into a sale/leaseback arrangement to allow that business unit to occupy this property as a distribution facility. On June 28, 2004, CCP sold its vacant metals facility in Santa Fe Springs, California for net proceeds of $1.9 million.
Financing Activities
Cash flows from financing activities in 2006 reflect the reduction of our debt obligations as cash provided by operations exceeded the requirements from investing activities. In 2005, cash flows from financing activities reflect the reduction of debt obligations. Overall, debt increased $1.0 million and $1.4 million in 2006 and 2005, respectively. Direct debt costs, primarily associated with the debt modifications and refinance transactions, totaled $0.3 million and $0.2 million in 2006 and 2005, respectively. During 2006 and 2005, the Company acquired 40,800 and 3,200 shares of common stock on the open market under the cost method for approximately $0.1 million and $7.5 thousand, respectively. During 2004, 12,000 shares of common stock were repurchased on the open market for approximately $0.1 million.
TRANSACTIONS WITH RELATED AND CERTAIN OTHER PARTIES
In connection with the Contico International, L.L.C. (now “CCP”) acquisition on January 8, 1999, we entered into building lease agreements with Newcastle Industries, Inc. (“Newcastle”). Lester Miller, the former owner of CCP, and a Katy director from 1999 to 2000, is the majority owner of Newcastle. Currently, the Hazelwood, Missouri facility is the only property leased directly from Newcastle. We believe that rental expense for these properties approximates market rates. Related party rental expense was approximately $0.5 million for each of the years ended December 31, 2006, 2005 and 2004.
Kohlberg & Co., L.L.C., an affiliate of Kohlberg Investors IV, L.P., whose affiliate holds all 1,131,551 shares of our Convertible Preferred Stock, provides ongoing management oversight and advisory services to Katy. We paid $0.5 million annually for such services in 2006, 2005 and 2004. We expect to pay $0.5 million annually in future years.

 

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SEVERANCE, RESTRUCTURING AND RELATED CHARGES
Over the past three years, the Company has initiated several cost reduction and facility consolidation initiatives, resulting in severance, restructuring and related charges. Key initiatives were the consolidation of the St. Louis manufacturing/distribution facilities, shutdown of both Woods U.S. and Woods Canada manufacturing as well as the consolidation of the Glit facilities. These initiatives resulted from the on-going strategic reassessment of our various businesses as well as the markets in which they operate.
A summary of charges by major initiative is as follows:
                         
    2006     2005     2004  
    (Amounts in Thousands)  
Consolidation of St. Louis manufacturing/distribution facilities
  $ (499 )   $ 39     $ 1,460  
Consolidation of Glit facilities
    299       724       791  
Corporate office relocation
    217       172        
Shutdown of Woods U.S. manufacturing
    (115 )           38  
Shutdown of Woods Canada manufacturing
    (14 )     134       841  
Consolidation of administrative functions for CCP
          21       215  
Other
                160  
 
                 
Total severance, restructuring and related costs
  $ (112 )   $ 1,090     $ 3,505  
 
                 
The impact of actions in connection with the above initiatives on the Company’s reportable segments (before tax) is as follows:
                 
    Total Expected     Total Provision  
    Cost     to Date  
 
               
Maintenance Products Group
  $ 21,993     $ 20,993  
Electrical Products Group
    12,776       12,776  
Corporate
    12,323       12,073  
 
           
 
  $ 47,092     $ 45,842  
 
           
A rollforward of all restructuring and related reserves since December 31, 2004 is as follows:
                                 
            One-time     Contract          
            Termination     Termination          
    Total     Benefits [a]     Costs [b]     Other [c]  
Restructuring and related liabilities at December 31, 2004
  $ 4,454     $ 807     $ 3,647     $  
Additions
    1,170       506       516       148  
Reductions
    (80 )     (19 )     (61 )      
Payments
    (2,252 )     (861 )     (1,243 )     (148 )
Currency translation and other
    127       (1 )     128        
 
                       
Restructuring and related liabilities at December 31, 2005
  $ 3,419     $ 432     $ 2,987     $  
Additions
    516       326             190  
Reductions
    (628 )     (19 )     (609 )      
Payments
    (2,354 )     (739 )     (1,425 )     (190 )
Currency translation
    8             8        
 
                       
Restructuring and related liabilities at December 31, 2006 [d]
  $ 961     $     $ 961     $  
 
                       
[a]  
Includes severance, benefits, and other employee-related costs associated with the employee terminations.
 
[b]  
Includes charges related to non-cancelable lease liabilities for abandoned facilities, net of estimated sub-lease revenue. Total maximum potential amount of lease loss, excluding any sublease rentals, is $1.8 million as of December 31, 2006. We have included $0.8 million as an offset for sublease rentals.
 
[c]  
Includes charges associated with moving inventory, machinery and equipment, consolidation of administrative and operational functions, and consultants working on sourcing and other manufacturing and production efficiency initiatives.
 
[d]  
Katy expects to substantially complete its restructuring program in 2006. The remaining severance, restructuring and related costs for these initiatives are expected to be approximately $0.3 million.

 

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Since 2001, the Company has been focused on a number of restructuring and cost reduction initiatives, resulting in severance, restructuring and related charges. With these changes, we anticipated cost savings from reduced headcount, higher utilized facilities and divested non-core operations. However, anticipated cost savings have been impacted from such factors as material price increases, competitive markets and inefficiencies incurred from consolidation of facilities. See Note 19 to the Consolidated Financial Statements in Part II, Item 8 for further discussion of severance, restructuring and related charges.
OUTLOOK FOR 2007
We experienced lower sales performance during 2006 from the Woods US retail electrical corded products business as well as lower volumes in our Contico and Glit business units. Price increases were passed along to our Woods US customers during 2006 as a result of the rise in copper prices in the last two years, however, pricing pressure is anticipated given current copper pricing in early 2007. We anticipate a further reduction in net sales from Woods US due to customers moving more of their purchases directly to Asian manufacturers. Given the relative stability of resin and other materials pricing for the short-term period, we anticipate pricing levels to be stable in 2007 for products within the Maintenance Products Group with sales growth being driven by volume improvement over 2006. However, in the Contico business, we face the continuing challenge of passing through price increases to offset these higher costs, and sales volumes have been and are likely to continue to be negatively impacted as a result of raising prices and our decision to exit certain unprofitable products.
We believe that the quality, shipping and production issues present at our Glit facilities in 2005 have been resolved in 2006 as the Glit business unit has improved its quality level and executed cost control in its current operations and in the consolidation of the Pineville, North Carolina operation into the Wrens, Georgia facility. We currently believe the consolidation of the Washington, Georgia facility into Wrens, Georgia will occur in 2007 and will result in improved profitability of our Glit business.
Cost of goods sold is subject to variability in the prices for certain raw materials, most significantly thermoplastic resins used in the manufacture of plastic products for the Continental and Contico businesses. Prices of plastic resins, such as polyethylene and polypropylene increased steadily from the latter half of 2002 through 2005 with prices in 2006 being relatively stable. Management has observed that the prices of plastic resins are driven to an extent by prices for crude oil and natural gas, in addition to other factors specific to the supply and demand of the resins themselves. We are equally exposed to price changes for copper at our Woods US and Woods Canada business units. Prices for copper increased in late 2003 and continued through 2006. Copper prices remain and expect to be volatile over the next few years. Prices for corrugated packaging material and other raw materials have also accelerated over the past few years. We have not employed an active hedging program related to our commodity price risk, but are employing other strategies for managing this risk, including contracting for a certain percentage of resin needs through supply agreements and opportunistic spot purchases. We have experienced cost increases in the prices of primary raw materials used in our products and inflation on other costs such as packaging materials, utilities and freight. In a climate of rising raw material costs (and especially in 2005), we experience difficulty in raising prices to shift these higher costs to our consumer customers for our plastic products. Our future earnings may be negatively impacted to the extent further increases in costs for raw materials cannot be recovered or offset through higher selling prices. We cannot predict the direction our raw material prices will take during 2007 and beyond.
Over the past few years, our management has been focused on a number of restructuring and cost reduction initiatives, including the consolidation of facilities, divestiture of non-core operations, selling general and administrative (“SG&A”) cost rationalization and organizational changes. In the future, we expect to benefit from various profit enhancing strategies such as process improvements (including Lean Manufacturing and Six Sigma), value engineering products, improved sourcing/purchasing and lean administration.
SG&A expenses were comparable as a percentage of sales in 2006 versus 2005 and should remain stable as a percentage of sales in 2007. We will continue to evaluate the possibility of further consolidation of administrative processes.
Interest rates rose in 2006 and we expect rates to stabilize in 2007. Ultimately, we cannot predict the future levels of interest rates. With the execution of the Seventh Amendment under the Bank of America Credit Agreement, the Company has the interest rate margins on all of our outstanding borrowings and letters of credit set at the largest margins set forth in the Bank of America Credit Agreement. Interest rate margins, subsequent to the delivery of our financial statements for 2006 to our lenders, will be adjusted based on the Company’s ratio of debt to earnings.

 

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Given our history of operating losses, along with guidance provided by the accounting literature covering accounting for income taxes, we are unable to conclude it is more likely than not that we will be able to generate future taxable income sufficient to realize the benefits of domestic deferred tax assets carried on our books. Therefore, except for our profitable foreign subsidiaries, a full valuation allowance on the net deferred tax asset position was recorded at December 31, 2006 and 2005, and we do not expect to record the benefit of any deferred tax assets that may be generated in 2007. We will continue to record current expense associated with foreign and state income taxes.
In 2006, our financial performance benefited from favorable currency translation as the Canadian dollar and British pound strengthened throughout the year against the U.S. dollar. While we cannot predict the ultimate direction of exchange rates, we do not expect to see the same favorable impact on our financial performance in 2007.
We expect our working capital levels to remain constant as a percentage of sales. However, inventory carrying values may be impacted by higher material costs. Cash flow will be used in 2007 for capital expenditures and payments due under our term loan as well as the settlement of previously established restructuring accruals. The majority of these accruals relate to non-cancelable lease obligations for abandoned facilities. These accruals do not create incremental cash obligations in that we are obligated to make the associated payments whether we occupy the facilities or not. The amount we will ultimately pay out under these accruals is dependent on our ability to successfully sublet all or a portion of the abandoned facilities.
While the Company was in compliance with the covenants of the Bank of America Credit Agreement as of December 31, 2006, it obtained, on March 8, 2007, the Eighth Amendment. The Eighth Amendment eliminates the Fixed Charge Coverage Ratio for the remaining life of the debt agreement and requires the Company to maintain a minimum level of availability such that its eligible collateral must exceed the sum of its outstanding borrowings and letters of credit by at least $5.0 million from the effective date of the Eighth Amendment through September 29, 2007 and by $7.5 million through December 31, 2007. Thereafter, the Company is required to maintain a minimum level of availability of $5.0 million for the first three quarters of the year and $7.5 million for the fourth quarter. In addition, we reduced our Revolving Credit Facility from $90.0 million to $80.0 million.
If we are unable to comply with the terms of the amended covenants, we could seek to obtain further amendments and pursue increased liquidity through additional debt financing and/or the sale of assets. We believe that given our strong working capital base, additional liquidity could be obtained through additional debt financing, if necessary. However, there is no guarantee that such financing could be obtained. The Company believes that we will be able to comply with all covenants, as amended, throughout 2007. In addition, we are continually evaluating alternatives relating to the sale of excess assets and divestitures of certain of our business units. Asset sales and business divestitures present opportunities to provide additional liquidity by de-leveraging our financial position.
Cautionary Statement Pursuant to Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995
This report and the information incorporated by reference in this report contain various “forward-looking statements” as defined in Section 27A of the Securities Act of 1933 and Section 21E of the Exchange Act of 1934, as amended. The forward-looking statements are based on the beliefs of our management, as well as assumptions made by, and information currently available to, our management. We have based these forward-looking statements on current expectations and projections about future events and trends affecting the financial condition of our business. These forward-looking statements are subject to risks and uncertainties that may lead to results that differ materially from those expressed in any forward-looking statement made by us or on our behalf, including, among other things:
   
Increases in the cost of, or in some cases continuation of, the current price levels of plastic resins, copper, paper board packaging, and other raw materials.
   
Our inability to reduce product costs, including manufacturing, sourcing, freight, and other product costs.
   
Greater reliance on third parties for our finished goods as we increase the portion of our manufacturing that is outsourced.
 
   
Our inability to reduce administrative costs through consolidation of functions and systems improvements.
 
   
Our inability to execute our systems integration plan.
 
   
Our inability to successfully integrate our operations as a result of the facility consolidations.
   
Our inability to achieve product price increases, especially as they relate to potentially higher raw material costs.

 

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The potential impact of losing lines of business at large mass merchant retailers in the discount and do-it-yourself markets.
 
   
Competition from foreign competitors.
 
   
The potential impact of rising interest rates on our LIBOR-based Bank of America Credit Agreement.
 
   
Our inability to meet covenants associated with the Bank of America Credit Agreement.
   
Our failure to identify, and promptly and effectively remediate, any material weaknesses or significant deficiencies in our internal control over financial reporting.
 
   
The potential impact of rising costs for insurance for properties and various forms of liabilities.
 
   
The potential impact of changes in foreign currency exchange rates related to our foreign operations.
   
Labor issues, including union activities that require an increase in production costs or lead to a strike, thus impairing production and decreasing sales. We are also subject to labor relations issues at entities involved in our supply chain, including both suppliers and those involved in transportation and shipping.
   
Changes in significant laws and government regulations affecting environmental compliance and income taxes.
Words and phrases such as “expects,” “estimates,” “will,” “intends,” “plans,” “believes,” “should,” “anticipates,” and the like are intended to identify forward-looking statements. The results referred to in forward-looking statements may differ materially from actual results because they involve estimates, assumptions and uncertainties. Forward-looking statements included herein are as of the date hereof and we undertake no obligation to revise or update such statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. All forward-looking statements should be viewed with caution.
CRITICAL ACCOUNTING POLICIES
Our significant accounting policies are more fully described in Note 3 to the Consolidated Financial Statements of Katy included in Part II, Item 8. Certain of our accounting policies as discussed below require the application of significant judgment by management in selecting the appropriate assumptions for calculating amounts to record in our financial statements. By their nature, these judgments are subject to an inherent degree of uncertainty.
Revenue Recognition — Revenue is recognized for all sales, including sales to distributors, at the time the products are shipped and title has transferred to the customer, provided that a purchase order has been received or a contract has been executed, there are no uncertainties regarding customer acceptances, the sales price is fixed and determinable and collection is deemed probable. The Company’s standard shipping terms are FOB shipping point. The Company records sales discounts, returns and allowances in accordance with EITF 01-09, Accounting for Consideration Given by a Vendor to a Customer. Sales discounts, returns and allowances, and cooperative advertising are included in net sales, and the provision for doubtful accounts is included in selling, general and administrative expenses. These provisions are estimated at the time of sale.
Stock-based Compensation — Effective January 1, 2006, the Company has adopted SFAS No. 123R, Share-Based Payment (“SFAS No. 123R”), using the modified prospective method. Under this method, compensation cost recognized during 2006 includes: a) compensation cost for all stock options granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with SFAS No. 123R amortized over the options’ vesting period; b) compensation cost for stock appreciation rights granted prior to, but vested as of January 1, 2006, based on the January 1, 2006 fair value estimated in accordance with SFAS No. 123R; and c) compensation cost for SARs granted prior to and vested as of December 31, 2006 based on the December 31, 2006 fair value estimated in accordance with SFAS No. 123R. Going forward into 2007 and thereafter, the Company will incur compensation expense associated with the fair value of stock options and SARs.

 

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Accounts Receivable — We perform ongoing credit evaluations of our customers and adjust credit limits based upon payment history and the customer’s current creditworthiness, as determined by our review of their current credit information. We continuously monitor collections and payment from our customers and maintain a provision for estimated credit losses based upon our historical experience and any specific customer collection issues that we have identified. While such credit losses have historically been within our expectations and the provision established, we cannot guarantee that we will continue to experience the same credit loss rates that we have in the past. Since our accounts receivable are concentrated in a relatively few number of large sized customers, especially our consumer/retail customers, a significant change in the liquidity or financial position of any one of these customers could have a material adverse impact on our ability to collect our accounts receivable and our future operating results.
Inventories — We value our inventory at the lower of the actual cost to purchase and/or manufacture the inventory or the current net realizable value of the inventory. We regularly review inventory quantities on hand and record a provision for excess and obsolete inventory based primarily on our estimated forecast of product demand and production requirements for the next twelve months. Our accounting policies state that operating divisions are to identify, at a minimum, those inventory items that are in excess of either one year’s historical or one year’s forecasted usage, and to use business judgment in determining which is the more appropriate metric. Those inventory items must then be evaluated on a lower of cost or market basis for realization. A significant increase in the demand for our products could result in a short-term increase in the cost of inventory purchases while a significant decrease in demand could result in an increase in the amount of excess inventory quantities on hand. Additionally, our estimates of future product demand may prove to be inaccurate, in which case we may have understated or overstated the provision required for excess and obsolete inventory. In the future, if our inventory is determined to be overvalued, we would be required to recognize such costs in our cost of goods sold at the time of such determination.
Therefore, although we make every effort to ensure the accuracy of our forecasts of future product demand, any significant unanticipated changes in demand or product developments could have a significant impact on the value of our inventory and our reported operating results. Our reserves for excess and obsolete inventory were $3.9 million and $4.5 million, respectively, as of December 31, 2006 and 2005.
Goodwill and Impairments of Long-Lived Assets — In connection with certain acquisitions, we recorded goodwill representing the cost of the acquisition in excess of the fair value of the net assets acquired. In accordance with SFAS No. 142, Goodwill and Intangible Assets, the fair value of each reporting unit that carries goodwill is determined annually, or as indicators of impairment are identified, and the fair value is compared to the carrying value of the reporting unit. If the fair value exceeds the carrying value, then no adjustment is necessary. If the carrying value of the reporting unit exceeds the fair value, appraisals are performed of long-lived assets and other adjustments are made to arrive at a revised fair value balance sheet. This revised fair value balance sheet (without goodwill) is compared to the fair value of the business previously determined, and a revised goodwill amount is reached. If the indicated goodwill amount meets or exceeds the current carrying value of goodwill, then no adjustment is required. However, if the result indicates a reduced level of goodwill, an impairment is recorded to state the goodwill at the revised level. Any future impairments of goodwill determined in accordance with SFAS No. 142 would be recorded as a component of income from continuing operations.
We review our long-lived assets for impairment in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, whenever triggering events indicate that an impairment may have occurred. We monitor our operations to look for triggering events that may cause us to perform an impairment analysis. These events include, among others, loss of product lines, poor operating performance and abandonment of facilities. We determine the lowest level at which cash flows are separately identifiable to perform the future cash flows tests, and apply the results to the assets related to those separately identifiable cash flows. In some cases, this may be at the individual asset level, but in other cases, it is more appropriate to perform this testing at a business unit level (especially when poor operating performance was the triggering event). For assets that are to be held and used, we compare undiscounted future cash flows associated with the asset (or asset group) and determine if the carrying value of the asset (asset group) will be recovered by those cash flows over the remaining useful life of the asset (or of the primary asset of an asset group). If the future undiscounted cash flows indicate that the carrying value of the asset (asset group) will not be recovered, then the asset is marked to fair value. For assets that are to be disposed of by sale or by a means other than by sale, the identified asset (or disposal group if a group of assets or entire business unit) is marked to fair value less costs to sell. In the case of the planned sale of a business unit, SFAS No. 144 indicates that disposal groups should be reported as discontinued operations on the consolidated financial statements if cash flows of the disposal group are separately identifiable. SFAS No. 144 has had an impact on the application of accounting for discontinued operations, making it in general much easier to classify a business unit (disposal group) held for sale as a discontinued operation. The rules covering discontinued operations prior to SFAS No. 144 generally required that an entire segment of a business be planned for disposal in order to classify it as a discontinued operation. We recorded impairments of long-lived assets during 2005 and 2004 in accordance with SFAS No. 144, which are discussed in Notes 4 and 5 to the Consolidated Financial Statements in Part II, Item 8.

 

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Deferred Income Taxes — We recognize deferred income tax assets and liabilities based on the differences between the financial statement carrying amounts and the tax bases of assets and liabilities. Deferred income tax assets also include federal, state and foreign net operating loss carry forwards, primarily due to the significant operating losses incurred during recent years, as well as various tax credits. We regularly review our deferred income tax assets for recoverability taking into consideration historical net income (losses), projected future income (losses) and the expected timing of the reversals of existing temporary differences. We establish a valuation allowance when it is more likely than not that these assets will not be recovered. As of December 31, 2006, we had a valuation allowance of $67.0 million. During the year ended December 31, 2006, we increased the valuation allowance by $2.2 million primarily to provide a full reserve against our net deferred tax asset position. Except for certain of our foreign subsidiaries, given the negative evidence provided by our history of operating losses, and considering guidance provided by SFAS No. 109, Accounting for Income Taxes, we were unable to conclude that it is more likely that not that our deferred tax assets would be recoverable through the generation of future taxable income. We will continue to evaluate our valuation allowance requirements based on future operating results and business acquisitions and dispositions, and we may adjust our deferred tax asset valuation allowance. Such changes in our deferred tax asset valuation allowance will be reflected in current operations through our income tax provision.
Workers’ Compensation and Product Liabilities — We make payments for workers’ compensation and product liability claims generally through the use of a third party claims administrator. We have purchased insurance coverage for large claims over our self-insured retention levels. Our workers’ compensation liabilities are developed using actuarial methods based upon historical data for payment patterns, cost trends, and other relevant factors. In order to consider a range of possible outcomes, we have based our estimates of liabilities in this area on several different sources of loss development factors, including those from the insurance industry, the manufacturing industry, and factors developed in-house. Our general approach is to identify a reasonable, logical conclusion, typically in the middle range of the possible outcomes. While we believe that our liabilities for workers’ compensation and product liability claims as of December 31, 2006 are adequate and that the judgment applied is appropriate, such estimated liabilities could differ materially from what will actually transpire in the future.
Environmental and Other Contingencies — We and certain of our current and former direct and indirect corporate predecessors, subsidiaries and divisions are involved in remedial activities at certain present and former locations and have been identified by the United States Environmental Protection Agency, state environmental agencies and private parties as potentially responsible parties (“PRPs”) at a number of hazardous waste disposal sites under the Comprehensive Environmental Response, Compensation and Liability Act (“Superfund”) or equivalent state laws and, as such, may be liable for the cost of cleanup and other remedial activities at these sites. Responsibility for cleanup and other remedial activities at a Superfund site is typically shared among PRPs based on an allocation formula. Under the federal Superfund statute, parties could be held jointly and severally liable, thus subjecting them to potential individual liability for the entire cost of cleanup at the site. Based on our estimate of allocation of liability among PRPs, the probability that other PRPs, many of whom are large, solvent, public companies, will fully pay the costs apportioned to them, currently available information concerning the scope of contamination, estimated remediation costs, estimated legal fees and other factors, we have recorded and accrued for environmental liabilities in amounts that we deem reasonable. The ultimate costs will depend on a number of factors and the amount currently accrued represents our best current estimate of the total costs to be incurred. We expect this amount to be substantially paid over the next one to four years. See Note 18 to the Consolidated Financial Statements in Part II, Item 8.
Severance, Restructuring and Related Charges — Since the Recapitalization in mid-2001, we have initiated several cost reduction and facility consolidation initiatives including, (1) the closure or consolidation of manufacturing, distribution and office facilities, (2) the centralization of business units, and (3) the outsourcing of our Electrical Products manufacturing to Asia. These initiatives have resulted in significant severance, restructuring and related charges. Included in these charges are one-time termination benefits including severance, benefits and other employee-related costs associated with employee terminations; contract termination costs mostly related to non-cancelable lease liabilities for abandoned facilities, net of sublease revenue; and other costs associated with the consolidation of administrative and operational functions and consultants working on sourcing and other manufacturing and production efficiency initiatives. Our current restructuring programs were substantially completed in 2006. In accordance with SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, we recognize costs (including costs for one-time termination benefits) associated with exit or disposal activities as they are incurred. However, charges related to non-cancelable leases require estimates of sublease income and adjustments to these liabilities are possible in the future depending on the accuracy of the sublease assumptions made.
NEW ACCOUNTING PRONOUNCEMENTS
See Note 3 of the Notes to the Consolidated Financial Statements in Part II, Item 8 for a discussion of new accounting pronouncements and the potential impact to the Company’s consolidated results of operations and financial position.

 

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Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk
Our exposure to market risk associated with changes in interest rates relates primarily to our debt obligations. Accordingly, effective August 17, 2005, we entered into a two-year interest rate swap agreement on a notional amount of $25.0 million in the first year and $15.0 million in the second year. The fixed interest rate under the swap at December 31, 2006 and over the life of the agreement is 4.49%. Our interest obligations on outstanding debt at December 31, 2006 were indexed from short-term LIBOR. As a result of the current rising interest rate environment and the increase in the interest rate margins on our borrowings as a result of the amendments to the Bank of America Credit Agreement, our exposures to interest rate risks on the non-capped debt could be material to our financial position or results of operations. See Note 9 to the Consolidated Financial Statements in Part II, Item 8.
The following table presents as of December 31, 2006, our financial instruments, rates of interest and indications of fair value:
                                                                 
Expected Maturity Dates  
(Amounts in Thousands)  
 
ASSETS                                                
    2007     2008     2009     2010     2011     Thereafter     Total     Fair Value  
 
                                               
Temporary cash investments
                                                           
Fixed rate
  $     $     $     $     $     $     $     $  
Average interest rate
                                               
 
                                                               
INDEBTEDNESS
                                                               
 
                                                               
Fixed rate debt
  $     $     $     $     $     $     $     $  
Average interest rate
                                               
Variable rate debt
  $ 1,125     $ 1,500     $ 54,246     $     $     $     $ 56,871     $ 56,871  
Average interest rate
    8.38 %     8.38 %     8.18 %                              
Foreign Exchange Risk
We are exposed to fluctuations in the Euro, British pound, Canadian dollar and various Asian currencies such as the Chinese Renminbi. Some of our subsidiaries make significant U.S. dollar purchases from Asian suppliers, particularly in China, Taiwan and the Philippines. An adverse change in foreign currency exchange rates of Asian countries could result in an increase in the cost of purchases. We do not currently hedge foreign currency transaction or translation exposures. Our net investment in foreign subsidiaries translated into U.S. dollars at December 31, 2006 is $23.1 million. A 10% change in foreign currency exchange rates would amount to $2.3 million change in our net investment in foreign subsidiaries at December 31, 2006.
Commodity Price Risk
We have not employed an active hedging program related to our commodity price risk, but are employing other strategies for managing this risk, including contracting for a certain percentage of resin needs through supply agreements and opportunistic spot purchases. See Part I — Item 1 - Raw Materials and Part II — Item 7 — Outlook for 2007 for a further discussion of our raw materials.

 

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Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of Katy Industries, Inc.:
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, stockholders’ equity and cash flows present fairly, in all material respects, the financial position of Katy Industries, Inc. and its subsidiaries at December 31, 2006 and 2005, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2006 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
As discussed in Note 11 to the consolidated financial statements, the Company changed the manner in which it accounts for pensions and post-retirement plans in fiscal 2006.
As discussed in Note 13 to the consolidated financial statements, the Company changed the manner in which it accounts for share-based compensation in fiscal 2006.
As discussed in Note 2 to the consolidated financial statements, the Company has restated its 2006 and 2005 consolidated financial statements.
/s/ PricewaterhouseCoopers LLP
St. Louis, Missouri
March 16, 2007, except for the restatement discussed in Note 2 to the consolidated financial statements, as to which the date is August 17, 2007.

 

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KATY INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 2006 and 2005
(Amounts in Thousands)
ASSETS
                 
    As Restated, see Note 2  
    2006     2005  
CURRENT ASSETS:
               
 
               
Cash and cash equivalents
  $ 7,392     $ 8,421  
Trade accounts receivable, net of allowances of $2,213 and $2,445
    55,014       63,612  
Inventories, net
    54,980       62,593  
Other current assets
    2,991       3,600  
Asset held for sale
    4,483        
 
           
 
               
Total current assets
    124,860       138,226  
 
           
 
               
OTHER ASSETS:
               
 
               
Goodwill
    665       665  
Intangibles, net
    6,435       6,946  
Other
    8,990       8,260  
 
           
 
               
Total other assets
    16,090       15,871  
 
           
 
               
PROPERTY AND EQUIPMENT
               
Land and improvements
    336       1,732  
Buildings and improvements
    9,669       14,011  
Machinery and equipment
    119,703       140,514  
 
           
 
               
 
    129,708       156,257  
Less — Accumulated depreciation
    (87,964 )     (98,260 )
 
           
 
               
Property and equipment, net
    41,744       57,997  
 
           
 
               
Total assets
  $ 182,694     $ 212,094  
 
           
See Notes to Consolidated Financial Statements.

 

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KATY INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 2006 and 2005
(Amounts in Thousands, Except Share Data)
LIABILITIES AND STOCKHOLDERS’ EQUITY
                 
    As Restated, see Note 2  
    2006     2005  
CURRENT LIABILITIES:
               
 
               
Accounts payable
  $ 33,684     $ 47,449  
Accrued compensation
    3,518       4,071  
Accrued expenses
    38,187       37,713  
Current maturities, long-term debt
    1,125       2,857  
Revolving credit agreement
    43,879       41,946  
 
           
 
               
Total current liabilities
    120,393       134,036  
 
           
 
               
LONG-TERM DEBT, less current maturities
    11,867       12,857  
 
               
OTHER LIABILITIES
    8,402       10,497  
 
           
 
               
Total liabilities
    140,662       157,390  
 
           
 
               
COMMITMENTS AND CONTINGENCIES (Notes 18 and 21)
           
 
           
 
               
STOCKHOLDERS’ EQUITY
               
15% Convertible preferred stock, $100 par value, authorized 1,200,000 shares, issued and outstanding 1,131,551 shares, liquidation value $113,155
    108,256       108,256  
Common stock, $1 par value; authorized 35,000,000 shares; issued 9,822,304 shares
    9,822       9,822  
Additional paid-in capital
    27,120       27,067  
Accumulated other comprehensive income
    2,242       3,158  
Accumulated deficit
    (83,434 )     (71,055 )
Treasury stock, at cost, 1,869,827 shares and 1,874,027 shares, respectively
    (21,974 )     (22,544 )
 
           
 
               
Total stockholders’ equity
    42,032       54,704  
 
           
 
               
Total liabilities and stockholders’ equity
  $ 182,694     $ 212,094  
 
           
See Notes to Consolidated Financial Statements.

 

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KATY INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2006, 2005 and 2004
(Amounts in Thousands, Except Per Share Data)
                         
    As Restated, see Note 2        
    2006     2005     2004  
 
                       
Net sales
  $ 396,166     $ 423,390     $ 416,681  
Cost of goods sold
    345,469       372,921       361,660  
 
                 
Gross profit
    50,697       50,469       55,021  
Selling, general and administrative expenses
    46,556       52,749       52,668  
Impairments of goodwill
          1,574       7,976  
Impairments of other long-lived assets
          538       22,080  
Severance, restructuring and related charges
    (112 )     1,090       3,505  
Loss (gain) on sale of assets
    467       (377 )     (288 )
 
                 
Operating income (loss)
    3,786       (5,105 )     (30,920 )
Equity in income of equity method investment
          600        
Gain on SESCO joint venture transaction
    563              
Interest expense
    (7,114 )     (5,713 )     (3,968 )
Other, net
    302       207       (998 )
 
                 
Loss from continuing operations before provision for income taxes
    (2,463 )     (10,011 )     (35,886 )
Provision for income taxes from continuing operations
    (2,326 )     (1,608 )     (642 )
 
                 
Loss from continuing operations
    (4,789 )     (11,619 )     (36,528 )
(Loss) income from operations of discontinued businesses (net of tax)
    (1,429 )     (2,178 )     1,182  
Loss on sale of discontinued businesses (net of tax)
    (5,405 )           (775 )
 
                 
Loss before cumulative effect of a change in accounting principle
    (11,623 )     (13,797 )     (36,121 )
Cumulative effect of a change in accounting principle (net of tax)
    (756 )            
 
                 
Net loss
    (12,379 )     (13,797 )     (36,121 )
Payment-in-kind of dividends on convertible preferred stock
                (14,749 )
 
                 
Net loss attributable to common stockholders
  $ (12,379 )   $ (13,797 )   $ (50,870 )
 
                 
Loss per share of common stock — Basic and diluted
                       
Loss from continuing operations attributable to common stockholders
  $ (0.60 )   $ (1.47 )   $ (6.50 )
Discontinued operations (net of tax)
    (0.86 )     (0.27 )     0.05  
Cumulative effect of a change in accounting principle
    (0.09 )            
 
                 
Net loss attributable to common stockholders
  $ (1.55 )   $ (1.74 )   $ (6.45 )
 
                 
See Notes to Consolidated Financial Statements.

 

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KATY INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2006, 2005 and 2004
(Amounts in Thousands, Except Share Data)
                                                                                 
                                            Accumulated                              
    Convertible     Common             Other                              
    Preferred Stock     Stock     Additional     Compre-                     Compre-     Total  
    Number of     Par     Number of     Par     Paid-in     hensive     Accumulated     Treasury     hensive     Stockholders’  
    Shares     Value     Shares     Value     Capital     Income     Deficit     Stock     Loss     Equity  
Balance, January 1, 2004
    925,750     $ 93,507       9,822,204     $ 9,822     $ 40,441     $ 2,387     $ (21,137 )   $ (22,728 )           $ 102,292  
Net loss
                                        (36,121 )         $ (36,121 )     (36,121 )
Foreign currency translation adjustment
                                  2,065                   2,065       2,065  
Pension minimum liability adjustment
                                  112                   112       112  
 
                                                                             
Comprehensive loss
                                                                  $ (33,944 )        
 
                                                                             
Purchase of treasury stock
                                              (75 )             (75 )
Issuance of convertible preferred stock related to PIK dividends accrued
    205,801                                                          
Payment in kind dividends accrued
          14,749                   (14,749 )                                
Stock option exercise
                            (571 )                 875               304  
Other
                            (10 )                 18               8  
 
                                                             
Balance, December 31, 2004
    1,131,551     $ 108,256       9,822,204     $ 9,822     $ 25,111     $ 4,564     $ (57,258 )   $ (21,910 )           $ 68,585  
Net loss, As Restated, see Note 2
                                        (13,797 )         $ (13,797 )     (13,797 )
Foreign currency translation adjustment
                                  (1,352 )                 (1,352 )     (1,352 )
Pension minimum liability adjustment
                                  (109 )                 (109 )     (109 )
Interest rate swap
                                  55                   55       55  
 
                                                                             
Comprehensive loss, As Restated, see Note 2
                                                                  $ (15,203 )        
 
                                                                             
Purchase of treasury stock
                                              (7 )             (7 )
Stock compensation, As Restated, see Note 2
                            2,004                                 2,004  
Other
                            (48 )                 (627 )             (675 )
 
                                                             
Balance, December 31, 2005, As Restated, see Note 2
    1,131,551     $ 108,256       9,822,204     $ 9,822     $ 27,067     $ 3,158     $ (71,055 )   $ (22,544 )           $ 54,704  
Net loss, As Restated, see Note 2
                                        (12,379 )         $ (12,379 )     (12,379 )
Foreign currency translation adjustment
                                  686                   686       686  
Interest rate swap
                                  22                   22       22  
 
                                                                             
Comprehensive loss, As Restated, see Note 2
                                                                  $ (11,671 )        
 
                                                                             
Adoption of SFAS 158
                                  (1,624 )                         (1,624 )
Purchase of treasury stock
                                              (111 )             (111 )
Stock option exercise
                            (378 )                 525               147  
Stock compensation
                            587                                 587  
Other
                100             (156 )                 156                
 
                                                             
Balance, December 31, 2006, As Restated, see Note 2
    1,131,551     $ 108,256       9,822,304     $ 9,822     $ 27,120     $ 2,242     $ (83,434 )   $ (21,974 )           $ 42,032  
 
                                                             
See Notes to Consolidated Financial Statements.

 

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KATY INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2006, 2005 and 2004
(Amounts in Thousands)
                         
    As Restated, see Note 2        
    2006     2005     2004  
Cash flows from operating activities:
                       
Net loss
  $ (12,379 )   $ (13,797 )   $ (36,121 )
Loss (income) from discontinued operations
    6,834       2,178       (407 )
 
                 
Loss from continuing operations
    (5,545 )     (11,619 )     (36,528 )
Cumulative effect of a change in accounting principle
    756              
Depreciation and amortization
    8,640       8,968       12,145  
Impairments of goodwill
          1,574       7,976  
Impairments of other long-lived assets
          538       22,080  
Write-off and amortization of debt issuance costs
    1,178       1,122       1,076  
Stock option expense
    587       2,004        
Loss (gain) on sale of assets
    467       (377 )     (288 )
Equity in income of equity method investment
          (600 )      
Deferred income taxes
    14       240       (1,228 )
 
                 
    6,097       1,850       5,233  
 
                 
Changes in operating assets and liabilities:
                       
Accounts receivable
    2,743       (16 )     (215 )
Inventories
    2,830       2,260       (8,649 )
Other assets
    600       (1,045 )     307  
Accounts payable
    (8,000 )     7,503       200  
Accrued expenses
    (78 )     (3,952 )     (1,595 )
Other, net
    (5,206 )     (804 )     (3,508 )
 
                 
 
    (7,111 )     3,946       (13,460 )
 
                 
 
                       
Net cash (used in) provided by continuing operations
    (1,014 )     5,796       (8,227 )
Net cash provided by discontinued operations
    2,837       766       256  
 
                 
Net cash provided by (used in) operating activities
    1,823       6,562       (7,971 )
 
                 
 
                       
Cash flows from investing activities:
                       
Capital expenditures of continuing operations
    (4,614 )     (8,925 )     (10,782 )
Acquisition of subsidiary, net of cash acquired
          (1,115 )      
Proceeds from sale of assets, net
    367       981       5,778  
 
                 
 
                       
Net cash used in continuing operations
    (4,247 )     (9,059 )     (5,004 )
Net cash provided by (used in) discontinued operations
    5,292       (335 )     (3,051 )
 
                 
Net cash provided by (used in) investing activities
    1,045       (9,394 )     (8,055 )
 
                 
 
                       
Cash flows from financing activities:
                       
Net borrowings of revolving loans
    1,761       1,450       4,037  
(Decrease) increase in book overdraft
    (2,322 )     4,028        
Proceeds of term loans
    1,364             18,152  
Repayments of term loans
    (4,086 )     (2,857 )     (3,244 )
Direct costs associated with debt facilities
    (312 )     (151 )     (1,485 )
Repurchases of common stock
    (111 )     (7 )     (75 )
Proceeds from the exercise of stock options
    147             304  
 
                 
Net cash (used in) provided by financing activities
    (3,559 )     2,463       17,689  
 
                 
 
                       
Effect of exchange rate changes on cash and cash equivalents
    (338 )     265       114  
 
                 
Net (decrease) increase in cash and cash equivalents
    (1,029 )     (104 )     1,777  
Cash and cash equivalents, beginning of period
    8,421       8,525       6,748  
 
                 
Cash and cash equivalents, end of period
  $ 7,392     $ 8,421     $ 8,525  
 
                 
 
                       
Supplemental disclosure of non-cash investing activities:
                       
Note receivable from sale of discontinued operations
  $ 1,200     $     $  
 
                 
See Notes to Consolidated Financial Statements.

 

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KATY INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2006 and 2005
(Amounts in Thousands, Except Per Share Data)
Note 1. ORGANIZATION OF THE BUSINESS
The Company is organized into two operating segments: the Maintenance Products Group and the Electrical Products Group. The activities of the Maintenance Products Group include the manufacture and distribution of a variety of commercial cleaning supplies and consumer home storage products. The Electrical Products Group is a distributor of consumer electrical corded products. Principal geographic markets are in the United States, Canada, and Europe and include the sanitary maintenance, foodservice, mass merchant retail and home improvement markets.
Note 2. RESTATEMENT OF PRIOR FINANCIAL INFORMATION
Restatement — As a result of accounting errors in the raw material inventory records, management and the Company’s Audit Committee determined on August 6, 2007 that the Company’s consolidated financial statements for fiscal 2005 and 2006 should no longer be relied upon. The Company’s decision to restate its consolidated financial statements is based on facts obtained by management and the results of an internal investigation of the physical raw material inventory counting process at CCP. These procedures resulted in the identification of an intentional overstatement of raw material inventory when completing the physical inventory. At the time of the physical inventories, the Company did not have sufficient controls in place to ensure that the accurate physical raw material inventory on hand was properly accounted for and reported in the proper period.
(A) Impact of error on previously filed financial statements — The impact of the raw material inventory error on loss from continuing operations and net loss is approximately ($0.2) million and ($0.6) million for the years ended December 31, 2005 and 2006, respectively.
Other Out-of-Period Adjustments and Revisions — Due to the adjustments discussed above that required a restatement of our previously filed consolidated financial statements, we are also correcting these out-of-period adjustments and revisions by recording them in the proper periods.
The out-of-period adjustments and revisions in the table include the following as referenced:
(B) Accelerated vesting of stock options — The Company recorded non-cash compensation expense in 2005 of approximately $0.1 million related to stock options which would not have otherwise vested but for an accelerated vesting as further described in Note 12.
(C) Deferred compensation — In conjunction with a retirement compensation program as further described in Note 11, the Company made an adjustment for approximately $0.4 million in 2005 associated with the accounting for related compensation expense. The Company had originally recorded the out-of-period adjustment in 2006; therefore, the Company reduced compensation expense by the corresponding amount in 2006.
(D) Inventory reserves — The Company recorded an adjustment of approximately $0.1 million to increase inventory reserves and cost of goods sold in 2006 associated with our lower of cost or market evaluation.
(E) Revision of SESCO as a continuing operation — For all years presented, the Company previously inappropriately reported the results from the Savannah Energy Systems Company Partnership operation as discontinued operations, as described further in Note 8. As a result, the Company revised in 2006 $0.4 million from loss from operations of discontinued businesses and $0.1 million from loss on sale of discontinued businesses. Accordingly, the Company recorded in 2006 within continuing operations a $0.6 million gain on SESCO joint venture transaction offset by $0.1 million in interest expense. For 2005, the Company revised $0.1 million from loss from operations of discontinued businesses to interest expense within continuing operations.
All affected amounts described in these Notes to Consolidated Financial Statements have been restated. As a result of this restatement, the Company’s fiscal 2005 and 2006 financial results are adjusted as follows:

 

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Consolidated Balance Sheets
(Amounts in thousands)
                                 
    December 31, 2006     December 31, 2005  
    Previously             Previously        
Assets   reported     Restated     reported     Restated  
 
                       
 
                               
CURRENT ASSETS:
                               
Cash and cash equivalents
  $ 7,392     $ 7,392     $ 8,421     $ 8,421  
Trade accounts receivable, net
    55,014       55,014       63,612       63,612  
Inventories, net (A)(D)
    55,960       54,980       62,799       62,593  
Other current assets
    2,991       2,991       3,600       3,600  
Asset held for sale
    4,483       4,483              
 
                       
Total current assets
    125,840       124,860       138,432       138,226  
 
                       
OTHER ASSETS:
                               
Goodwill
    665       665       665       665  
Intangibles, net
    6,435       6,435       6,946       6,946  
Other (C)
    8,990       8,990       8,643       8,260  
 
                       
Total other assets
    16,090       16,090       16,254       15,871  
 
                       
Property and equipment, net
    41,744       41,744       57,997       57,997  
 
                       
Total assets
  $ 183,674     $ 182,694     $ 212,683     $ 212,094  
 
                       
 
                               
Liabilities and Stockholders’ Equity
                               
 
                               
CURRENT LIABILITIES:
                               
Accounts payable
  $ 33,684       33,684     $ 47,449       47,449  
Accrued compensation
    3,518       3,518       4,071       4,071  
Accrued expenses
    38,187       38,187       37,713       37,713  
Current maturities, long-term debt
    1,125       1,125       2,857       2,857  
Revolving credit agreement
    43,879       43,879       41,946       41,946  
 
                       
Total current liabilities
    120,393       120,393       134,036       134,036  
 
                       
LONG-TERM DEBT, less current maturities
    11,867       11,867       12,857       12,857  
OTHER LIABILITIES
    8,402       8,402       10,497       10,497  
 
                       
Total liabilities
    140,662       140,662       157,390       157,390  
 
                       
COMMITMENTS AND CONTINGENCIES (Notes 18 and 21)
                       
 
                       
STOCKHOLDERS’ EQUITY
                               
15% Convertible preferred stock, $100 par value, authorized 1,200,000 shares, issued and outstanding 1,131,551 shares, liquidation value $113,155
    108,256       108,256       108,256       108,256  
Common stock, $1 par value; authorized 35,000,000 shares; issued 9,822,304 shares
    9,822       9,822       9,822       9,822  
Additional paid-in capital (B)
    27,069       27,120       27,016       27,067  
Accumulated other comprehensive income
    2,242       2,242       3,158       3,158  
Accumulated deficit
    (82,403 )     (83,434 )     (70,415 )     (71,055 )
Treasury stock, at cost
    (21,974 )     (21,974 )     (22,544 )     (22,544 )
 
                       
Total stockholders’ equity
    43,012       42,032       55,293       54,704  
 
                       
Total liabilities and stockholders’ equity
  $ 183,674     $ 182,694     $ 212,683     $ 212,094  
 
                       

 

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Consolidated Statements of Operations
(Amounts in thousands, except per share data)
                                 
    For the years ended  
    December 31, 2006     December 31, 2005  
    Previously             Previously        
    reported     Restated     reported     Restated  
Net sales
  $ 396,166       396,166     $ 423,390       423,390  
Cost of goods sold (A)(D)
    344,695       345,469       372,715       372,921  
 
                       
Gross profit
    51,471       50,697       50,675       50,469  
Selling, general and administrative expenses (B)(C)
    46,939       46,556       52,315       52,749  
Impairments of goodwill
                1,574       1,574  
Impairments of other long-lived assets
                538       538  
Severance, restructuring and related charges
    (112 )     (112 )     1,090       1,090  
Loss (gain) on sale of assets
    467       467       (377 )     (377 )
 
                       
Operating income (loss)
    4,177       3,786       (4,465 )     (5,105 )
Equity in income of equity method investment
                600       600  
Gain on SESCO joint venture transaction (E)
          563              
Interest expense (E)
    (7,037 )     (7,114 )     (5,570 )     (5,713 )
Other, net
    302       302       207       207  
 
                       
Loss from continuing operations before provision for income taxes
    (2,558 )     (2,463 )     (9,228 )     (10,011 )
Provision for income taxes from continuing operations
    (2,326 )     (2,326 )     (1,608 )     (1,608 )
 
                       
Loss from continuing operations
    (4,884 )     (4,789 )     (10,836 )     (11,619 )
(Loss) income from operations of discontinued businesses (net of tax) (E)
    (1,043 )     (1,429 )     (2,321 )     (2,178 )
Loss on sale of discontinued businesses (net of tax) (E)
    (5,305 )     (5,405 )            
 
                       
Loss before cumulative effect of a change in accounting principle
    (11,232 )     (11,623 )     (13,157 )     (13,797 )
Cumulative effect of a change in accounting principle (net of tax)
    (756 )     (756 )            
 
                       
Net loss
    (11,988 )     (12,379 )     (13,157 )     (13,797 )
Payment-in-kind of dividends on convertible preferred stock
                       
 
                       
Net loss attributable to common stockholders
  $ (11,988 )   $ (12,379 )   $ (13,157 )   $ (13,797 )
 
                       
Loss per share of common stock — Basic and diluted
                               
Loss from continuing operations attributable to common stockholders
  $ (0.61 )   $ (0.60 )   $ (1.37 )   $ (1.47 )
Discontinued operations (net of tax)
    (0.80 )     (0.86 )     (0.29 )     (0.27 )
Cumulative effect of a change in accounting principle
    (0.09 )     (0.09 )            
 
                       
Net loss attributable to common stockholders
  $ (1.50 )   $ (1.55 )   $ (1.66 )   $ (1.74 )
 
                       

 

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Consolidated Statements of Cash Flows
(Amounts in thousands)
                                 
    For the years ended  
    December 31, 2006     December 31, 2005  
    Previously             Previously        
    reported     Restated     reported     Restated  
Cash flows from operating activities:
                               
Net loss
  $ (11,988 )   $ (12,379 )   $ (13,157 )   $ (13,797 )
Loss (income) from discontinued operations (E)
    6,348       6,834       2,321       2,178  
 
                       
Loss from continuing operations
    (5,640 )     (5,545 )     (10,836 )     (11,619 )
Cumulative effect of a change in accounting principle
    756       756              
Depreciation and amortization
    8,640       8,640       8,968       8,968  
Impairments of goodwill
                1,574       1,574  
Impairments of other long-lived assets
                538       538  
Write-off and amortization of debt issuance costs
    1,178       1,178       1,122       1,122  
Stock option expense (B)
    587       587       1,953       2,004  
Loss (gain) on sale of assets
    467       467       (377 )     (377 )
Equity in income of equity method investment
                (600 )     (600 )
Deferred income taxes
    14       14       240       240  
 
                       
 
    6,002       6,097       2,582       1,850  
 
                       
Changes in operating assets and liabilities:
                               
Accounts receivable
    2,743       2,743       (16 )     (16 )
Inventories (A)(D)
    2,056       2,830       2,054       2,260  
Other assets
    600       600       (1,045 )     (1,045 )
Accounts payable
    (8,000 )     (8,000 )     7,503       7,503  
Accrued expenses (E)
    622       (78 )     (3,047 )     (3,952 )
Other, net (C)(E)
    (3,237 )     (5,206 )     (1,187 )     (804 )
 
                       
 
    (5,216 )     (7,111 )     4,262       3,946  
 
                       
 
                               
Net cash (used in) provided by continuing operations
    786       (1,014 )     6,844       5,796  
Net cash provided by discontinued operations (E)
    1,037       2,837       (282 )     766  
 
                       
Net cash provided by (used in) operating activities
    1,823       1,823       6,562       6,562  
 
                       
                         
Cash flows from investing activities:
                               
Capital expenditures of continuing operations
    (4,614 )     (4,614 )     (8,925 )     (8,925 )
Acquisition of subsidiary, net of cash acquired
                (1,115 )     (1,115 )
Proceeds from sale of assets, net (E)
    267       367       981       981  
 
                       
 
                               
Net cash used in continuing operations
    (4,347 )     (4,247 )     (9,059 )     (9,059 )
Net cash provided by (used in) discontinued operations (E)
    5,392       5,292       (335 )     (335 )
 
                       
Net cash provided by (used in) investing activities
    1,045       1,045       (9,394 )     (9,394 )
 
                       
Cash flows from financing activities:
                               
Net borrowings on revolving loans
    1,761       1,761       1,450       1,450  
(Decrease) increase in book overdraft
    (2,322 )     (2,322 )     4,028       4,028  
Proceeds of term loans
    1,364       1,364              
Repayments of term loans
    (4,086 )     (4,086 )     (2,857 )     (2,857 )
Direct costs associated with debt facilities
    (312 )     (312 )     (151 )     (151 )
Repurchases of common stock
    (111 )     (111 )     (7 )     (7 )
Proceeds from the exercise of stock options
    147       147              
 
                       
Net cash (used in) provided by financing activities
    (3,559 )     (3,559 )     2,463       2,463  
 
                       
Effect of exchange rate changes on cash and cash equivalents
    (338 )     (338 )     265       265  
 
                       
Net (decrease) increase in cash and cash equivalents
    (1,029 )     (1,029 )     (104 )     (104 )
Cash and cash equivalents, beginning of period
    8,421       8,421       8,525       8,525  
 
                       
Cash and cash equivalents, end of period
  $ 7,392     $ 7,392     $ 8,421     $ 8,421  
 
                       
 
                               
Supplemental disclosure of non-cash investing activities:
                               
Note receivable from sale of discontinued operations
  $ 1,200     $ 1,200     $     $  
 
                       

 

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The comprehensive loss of approximately $12.9 million and $14.6 million for the years ended December 31, 2006 and 2005, respectively as previously reported was restated to a comprehensive loss of $11.7 million and $15.2 million, respectively. The change resulted from changes within our net loss attributable to common stockholders. Refer to Note 21 for restated unaudited quarterly results of operations.
Financial statement footnotes affected by this restatement are as follows:
  3.  
Significant Accounting Policies;
 
  7.  
Discontinued Operations;
 
  8.  
Savannah Energy Systems Company Partnership;
 
  10.  
Earnings Per Share;
 
  14.  
Income Taxes;
 
  17.  
Industry Segments and Geographic Information; and
 
  21.  
Quarterly Results of Operations (Unaudited).
Note 3. SIGNIFICANT ACCOUNTING POLICIES
Consolidation Policy — The consolidated financial statements include the accounts of Katy Industries, Inc. and subsidiaries in which it has a greater than 50% voting interest or significant influence, collectively “Katy” or the “Company”. All significant intercompany accounts, profits and transactions have been eliminated in consolidation. Investments in affiliates, which do not meet the criteria of a variable interest entity and are not majority owned or where the Company exercises significant influence, are reported using the equity method.
As part of the continuous evaluation of its operations, Katy has acquired and disposed of certain of its operating units in recent years. Those which affected the Consolidated Financial Statements for the year ended December 31, 2006 are discussed in Note 6.
At December 31, 2006, the Company owns 30,000 shares of common stock, a 45% interest, in Sahlman Holding Company, Inc. (“Sahlman”) that is accounted for under the equity method. The Company does not have significant influence over the operation. Sahlman is engaged in the business of shrimp farming in Nicaragua. As of December 31, 2006 and 2005, the investment balance was $2.2 million.
Use of Estimates — The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Revenue Recognition — Revenue is recognized for all sales, including sales to agents and distributors, at the time the products are shipped and title has transferred to the customer, provided that a purchase order has been received or a contract has been executed, there are no uncertainties regarding customer acceptances, the sales price is fixed and determinable and collectibility is deemed probable. The Company’s standard shipping terms are FOB shipping point. The Company records sales discounts, returns and allowances in accordance with Emerging Issues Task Force (“EITF”) Issue No. 01-09, Accounting for Consideration Given by a Vendor to a Customer. Sales discounts, returns and allowances, and cooperative advertising are included in net sales, and the provision for doubtful accounts is included in selling, general and administrative expenses. These provisions are estimated at the time of sale.
Cash and Cash Equivalents — Cash equivalents consist of highly liquid investments with original maturities of three months or less.
Advertising Costs — Advertising costs are expensed as incurred. Advertising costs within continuing operations expensed in 2006, 2005 and 2004 were $3.1 million, $3.3 million and $3.4 million, respectively.
Accounts Receivable and Allowance for Doubtful Accounts — Trade accounts receivable are recorded at the invoiced amount and do not bear interest. The allowance for doubtful accounts is the Company’s best estimate of the amount of probable credit losses in its existing accounts receivable. The Company determines the allowance based on its historical write-off experience. The Company reviews its allowance for doubtful accounts quarterly, which includes a review of past due balances over 90 days and over a specified amount for collectibility. All other balances are reviewed on a pooled basis by market distribution channels. Account balances are charged off against the allowance when the Company determines it is probable the receivable will not be recovered. The Company does not have any off-balance-sheet credit exposure related to its customers. Charges within continuing operations to expense for probable credit losses and allowances were $3.1 million, $3.3 million and $3.1 million in 2006, 2005 and 2004, respectively.

 

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Inventories — Inventories are stated at the lower of cost or market value, and reserves are established for excess and obsolete inventory in order to ensure proper valuation of inventories. Cost includes materials, labor and overhead. At December 31, 2006 and 2005, approximately 23% and 39%, respectively, of Katy’s inventories were accounted for using the last-in, first-out (“LIFO”) method of costing, while the remaining inventories were accounted for using the first-in, first-out (“FIFO”) method. Current cost, as determined using the FIFO method, exceeded LIFO cost by $3.7 million and $6.6 million at December 31, 2006 and 2005, respectively. The reduction in the LIFO reserve primarily resulted from the reduction in quantity levels as well as the sales of the Metal Truck Box and United Kingdom consumer plastics business units. The components of inventories are:
                 
    As Restated, see Note 2  
    December 31,  
    2006     2005  
    (Amounts in Thousands)  
 
               
Raw materials
  $ 14,777     $ 22,997  
Work in process
    613       1,766  
Finished goods
    47,230       48,949  
Inventory reserves
    (3,905 )     (4,548 )
LIFO reserve
    (3,735 )     (6,571 )
 
           
 
  $ 54,980     $ 62,593  
 
           
In November 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 151, Inventory Costs, an amendment of ARB No. 43, Chapter 4 (“SFAS No. 151”). SFAS No. 151 clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs and spoilage. In addition, SFAS No. 151 requires that allocation of fixed production overhead to the costs of conversion be based on the normal capacity of the production facilities. The provisions of SFAS No. 151 are effective for inventory costs incurred during fiscal years beginning after June 15, 2005. Effective January 1, 2006, the Company adopted SFAS No. 151 which did not have a material impact on the results of operations and financial position.
Goodwill — In connection with certain acquisitions, the Company recorded goodwill representing the cost of the acquisition in excess of the fair value of the net assets acquired. Beginning in 2002, goodwill is not amortized in accordance with SFAS No. 142, Goodwill and Intangible Assets (“SFAS No. 142”). The fair value of each reporting unit that carries goodwill is determined annually, or as indicators of impairment are identified, and the fair value is compared to the carrying value of the reporting unit. If the fair value exceeds the carrying value, then no adjustment is necessary. If the carrying value of the reporting unit exceeds the fair value, appraisals are performed of long-lived assets and other adjustments are made to arrive at a revised fair value balance sheet. This revised fair value balance sheet (without goodwill) is compared to the fair value of the business previously determined, and a revised goodwill amount is reached. If the indicated goodwill amount meets or exceeds the current carrying value of goodwill, then no adjustment is required. However, if the result indicates a reduced level of goodwill, an impairment is recorded to state the goodwill at the revised level. Any impairments of goodwill determined in accordance with SFAS No. 142 are recorded as a component of income from continuing operations. See Note 4.
Property and Equipment — Property and equipment are stated at cost and depreciated over their estimated useful lives: buildings (10-40 years) generally using the straight-line method; machinery and equipment (3-20 years) using straight-line or composite methods; tooling (5 years) using the straight-line method; and leasehold improvements using the straight-line method over the remaining lease period or useful life, if shorter. Costs for repair and maintenance of machinery and equipment are expensed as incurred, unless the result significantly increases the useful life or functionality of the asset, in which case capitalization is considered. Depreciation expense from continuing operations for 2006, 2005 and 2004 was $8.0 million, $8.3 million, and $10.4 million, respectively.

 

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Katy adopted SFAS No. 143, Accounting for Asset Retirement Obligations (“SFAS No. 143”), on January 1, 2003. SFAS No. 143 requires that an asset retirement obligation associated with the retirement of a tangible long-lived asset be recognized as a liability in the period in which it is incurred or becomes determinable, with an associated increase in the carrying amount of the related long-term asset. The cost of the tangible asset, including the initially recognized asset retirement cost, is depreciated over the useful life of the asset. In accordance with SFAS No. 143, the Company has recorded as of December 31, 2006 an asset of $0.4 million and related liability of $1.1 million for retirement obligations associated with returning certain leased properties to the respective lessors upon the termination of the lease arrangements. A summary of the changes in asset retirement obligation since December 31, 2004 is included in the table below (amounts in thousands):
         
SFAS No. 143 Obligation at December 31, 2004
  $ 1,237  
Accretion expense
    49  
Additions
    330  
Changes in estimates, including timing
    32  
Payments
    (580 )
 
     
SFAS No. 143 Obligation at December 31, 2005
  $ 1,068  
Accretion expense
    49  
 
     
SFAS No. 143 Obligation at December 31, 2006
  $ 1,117  
 
     
Impairment of Long-lived Assets — Long-lived assets, other than goodwill which is discussed above, are reviewed for impairment if events or circumstances indicate the carrying amount of these assets may not be recoverable through future undiscounted cash flows. If this review indicates that the carrying value of these assets will not be recoverable, based on future undiscounted net cash flows from the use or disposition of the asset, the carrying value is reduced to fair value. See Note 5.
Income Taxes — Income taxes are accounted for using a balance sheet approach known as the liability method. The liability method accounts for deferred income taxes by applying the statutory tax rates in effect at the date of the balance sheet to the differences between the book basis and tax basis of the assets and liabilities. The Company records a valuation allowance when it is more likely than not that some portion or all of the deferred income tax asset will not be realizable. See Note 14.
Foreign Currency Translation — The results of the Company’s foreign subsidiaries are translated to U.S. dollars using the current-rate method. Assets and liabilities are translated at the year end spot exchange rate, revenue and expenses at average exchange rates and equity transactions at historical exchange rates. Exchange differences arising on translation are recorded as a component of accumulated other comprehensive income (loss). Katy recorded gains on foreign exchange transactions (included in other, net in the Consolidated Statements of Operations) of $0.2 million, $2.0 thousand, and $0.3 million, in 2006, 2005 and 2004, respectively.
Fair Value of Financial Instruments — Where the fair values of Katy’s financial instrument assets and liabilities differ from their carrying value or Katy is unable to establish the fair value without incurring excessive costs, appropriate disclosures have been given in the Notes to the Consolidated Financial Statements. All other financial instrument assets and liabilities not specifically addressed are believed to be carried at their fair value in the accompanying Consolidated Balance Sheets.
Stock Options and Other Stock Awards — Prior to January 1, 2006, the Company accounted for stock options and other stock awards under the provisions of Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees (“APB No. 25”), as allowed by SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS No. 123”), as amended by SFAS No. 148, Accounting for Stock-Based Compensation — Transition and Disclosure (“SFAS No. 148”). APB No. 25 dictated a measurement date concept in the determination of compensation expense related to stock awards including stock options, restricted stock, and stock appreciation rights (“SARs”).
Katy’s outstanding stock options all had established measurement dates and therefore, fixed plan accounting was applied, generally resulting in no compensation expense for stock option awards. However, the Company issued stock appreciation rights, stock awards and restricted stock awards which were accounted for as variable stock compensation awards for which compensation income (expense) was recorded. Compensation income associated with stock appreciation rights was $0.9 million and $0.1 million in 2005 and 2004, respectively. Compensation expense relative to stock awards was $22.1 thousand and $8.9 thousand in 2005 and 2004, respectively. No compensation expense relative to restricted stock awards was recognized in 2005 or 2004. Compensation income (expense) for stock awards and stock appreciation rights is recorded in selling, general and administrative expenses in the Consolidated Statements of Operations.

 

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Effective January 1, 2006, the Company has adopted SFAS No. 123R, Share-Based Payment (“SFAS No. 123R”), using the modified prospective method. Under this method, compensation cost recognized during 2006 includes: a) compensation cost for all stock options granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with SFAS No. 123R amortized over the options’ vesting period; b) compensation cost for stock appreciation rights granted prior to, but vested as of January 1, 2006, based on the January 1, 2006 fair value estimated in accordance with SFAS No. 123R; and c) compensation cost for stock appreciation rights granted prior to and vested as of December 31, 2006 based on the December 31, 2006 fair value estimated in accordance with SFAS No. 123R.
The following table shows total compensation expense (see Note 12 for descriptions of Stock Incentive Plans) included in the Consolidated Statements of Operations for the year ended December 31, 2006:
         
    Year Ended  
    December 31, 2006  
 
       
Selling, general and administrative expense
  $ 398  
Cumulative effect of a change in accounting principle
    756  
 
     
 
  $ 1,154  
 
     
The cumulative effect of a change in accounting principle reflects the compensation cost for stock appreciation rights granted prior to, but vested as of January 1, 2006, based on the January 1, 2006 fair value. Prior to the effective date, no compensation cost was accrued associated with SARs as all of these stock awards were out of the money. Pro forma results for the prior period have not been restated. As a result of adopting SFAS No. 123R on January 1, 2006, the Company’s net loss for the year ended December 31, 2006 is approximately $1.2 million higher than had it continued to account for stock-based employee compensation under APB No. 25. Basic and diluted net loss per share for the year ended December 31, 2006 would have been $1.36 had the Company not adopted SFAS No. 123R (which is a non-GAAP measurement), compared to reported basic and diluted net loss per share of $1.50. The adoption of SFAS No. 123R had approximately $0.6 million positive impact on cash flows from operations with the recognition of a liability for the outstanding and vested stock appreciation rights. The adoption of SFAS No. 123R had no impact on cash flows from financing.
The fair value for stock options was estimated at the date of grant using a Black-Scholes option pricing model. The Company used the simplified method, as allowed by Staff Accounting Bulletin (“SAB”) No. 107, Share-Based Payment, for estimating the expected term equal to the average between the minimum and maximum lives expected for each award, ranging from 5.30 years to 6.50 years. In addition, the Company estimated volatility, ranging from 53.8% to 57.6%, by considering its historical stock volatility over a term comparable to the remaining expected life of each award. The risk-free interest rate, ranging from 3.98% to 4.48%, was the current yield available on U.S. treasury rates with issues with a remaining term equal in term to each award. The Company estimates forfeitures using historical results. Its estimates of forfeitures will be adjusted over the requisite service period based on the extent to which actual forfeitures differ, or are expected to differ, from their estimate.
The fair value for stock appreciation rights, a liability award, was estimated at the effective date of SFAS No. 123R and December 31, 2006 using a Black-Scholes option pricing model. The Company estimated the expected term equal to the average between the minimum and maximum lives expected for each award, ranging from 0.4 years to 5.5 years. In addition, the Company estimated volatility, ranging from 52.6% to 70.3%, by considering its historical stock volatility over a term comparable to the remaining expected life of each award. The risk-free interest rate, ranging from 4.69% to 5.10%, was the current yield available on U.S. treasury rates with issues with a remaining term equal in term of each award. The Company estimates forfeitures using historical results. Its estimates of forfeitures will be adjusted over the requisite service period based on the extent to which actual forfeitures differ, or are expected to differ, from their estimate.

 

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The following table illustrates the effect on net loss and net loss per share had the Company applied the fair value recognition provisions of SFAS No. 123R to account for the Company’s employee stock option awards for the years ended December 31, 2005 and 2004 because these awards were not accounted for using the fair value recognition method during those periods. However, no impact was present on net loss as all stock option awards were vested prior to the time period presented. For purposes of pro forma disclosure, the estimated fair value of the stock awards, as prescribed by SFAS No. 123, is amortized to expense over the vesting period:
                 
    For the years ended  
    December 31,  
    2005     2004  
    As Restated,        
    see Note 2        
Net loss attributable to common stockholders, as reported
  $ (13,797 )   $ (50,870 )
Add: Stock-based employee compensation expense included in reported net loss, with no related tax effects
    2,004          
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects
    (293 )     (1,852 )
 
           
 
               
Pro forma net loss
  $ (12,086 )   $ (52,722 )
 
           
 
               
Earnings per share
               
Basic and diluted-as reported
  $ (1.74 )   $ (6.45 )
 
           
Basic and diluted-pro forma
  $ (1.52 )   $ (6.69 )
 
           
The historical pro forma impact of applying the fair value method prescribed by SFAS No. 123 is not representative of the impact that may be expected in the future due to changes resulting from additional grants and changes in assumptions such as volatility, interest rates, and the expected life used to estimate fair value of stock options and other stock awards. Note that the above pro forma disclosure was not presented for the year ended December 31, 2006 because all stock awards have been accounted for using the fair value recognition method under SFAS No. 123R for this period.
Derivative Financial Instruments — Effective August 17, 2005, the Company entered into an interest rate swap agreement designed to limit exposure to increasing interest rates on its floating rate indebtedness. The differential to be paid or received is recognized as an adjustment of interest expense related to the debt upon settlement. In connection with the Company’s adoption of SFAS No. 133, Accounting for Derivative Financial Instruments and Hedging Activities (“SFAS No. 133”), the Company is required to recognize all derivatives, such as interest rate swaps, on its balance sheet at fair value. As the derivative instrument held by the Company is classified as a hedge under SFAS No. 133, changes in the fair value of the derivative will be offset against the change in fair value of the hedged liability through earnings, or recognized in other comprehensive income until the hedged item is recognized in earnings. Hedge ineffectiveness associated with the swap will be reported by the Company in interest expense.
The agreement has an effective date of August 17, 2005 and a termination date of August 17, 2007 with a notional amount of $25.0 million in the first year declining to $15.0 million in the second year. The Company is hedging its variable LIBOR-based interest rate for a fixed interest rate of 4.49% for the term of the swap agreement to protect the Company from potential interest rate increases. The Company has designated its benchmark variable LIBOR-based interest rate on a portion of the Bank of America Credit Agreement as a hedged item under a cash flow hedge. In accordance with SFAS No. 133, the Company recorded an asset of $0.1 million on its balance sheet at December 31, 2006 and 2005, respectively, with changes in fair market value included in other comprehensive income.
The Company reported insignificant losses for 2006 and 2005 as a result of hedge ineffectiveness. Future changes in this swap arrangement, including termination of the agreement, may result in a reclassification of any gain or loss reported in other comprehensive income into earnings as an adjustment to interest expense.

 

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Details regarding the swap as of December 31, 2006 are as follows (amounts in thousands):
                                 
Notional Amount     Maturity   Rate Paid     Rate Received     Fair Value (2)  
$ 15,000    
August 17, 2007
    4.49 %   LIBOR (1)   $ 87  
     
 
                 
(1)  
LIBOR rate is determined on the 23rd of each month and continues up to and including the maturity date
 
(2)  
The fair value is the mark-to-market value.
New Accounting Pronouncements — In June 2006, the FASB issued FASB Interpretation (“FIN”) No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”), which describes a comprehensive model for the measurement, recognition, presentation and disclosure of uncertain tax positions in the financial statements. Under the interpretation, the financial statements will reflect expected future tax consequences of such positions presuming the tax authorities’ full knowledge of the position and all relevant facts, but without considering time values. For the Company, the provisions of FIN 48 are effective January 1, 2007. The Company continues to evaluate the impact of FIN 48 on its consolidated financial statements. At this time, the Company does not know what the impact will be upon adoption of this standard. However, it does not expect the impact to be significant.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS No. 157”). SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. This standard does not require any new fair value measurements but provides guidance in determining fair value measurements presently used in the preparation of financial statements. For the Company, SFAS No. 157 is effective January 1, 2008. The Company is assessing the impact this standard may have in its future financial statements.
Reclassifications — Certain amounts from prior years have been reclassified to conform to the 2006 financial statement presentation.
Note 4. GOODWILL AND INTANGIBLE ASSETS
Below is a summary of activity (all in the Maintenance Products Group) in the goodwill accounts since December 31, 2003 (amounts in thousands):
         
Goodwill at December 31, 2003
  $ 10,215  
Impairment charge
    (7,976 )
 
     
Goodwill at December 31, 2004
    2,239  
Impairment charge
    (1,574 )
 
     
Goodwill at December 31, 2005
    665  
Impairment charge
     
 
     
Goodwill at December 31, 2006
  $ 665  
 
     
See Note 5 for discussion of impairment of long-lived assets. Following is detailed information regarding Katy’s intangible assets (amounts in thousands):
                                                 
    December 31,     December 31,  
    2006     2005  
    Gross     Accumulated     Net Carrying     Gross     Accumulated     Net Carrying  
    Amount     Amortization     Amount     Amount     Amortization     Amount  
Patents
  $ 1,511     $ (1,065 )   $ 446     $ 1,409     $ (954 )   $ 455  
Customer lists
    10,454       (8,111 )     2,343       10,643       (7,997 )     2,646  
Tradenames
    5,612       (2,345 )     3,267       5,498       (2,075 )     3,423  
Other
    441       (62 )     379       441       (19 )     422  
 
                                   
Total
  $ 18,018     $ (11,583 )   $ 6,435     $ 17,991     $ (11,045 )   $ 6,946  
 
                                   

 

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All of Katy’s intangible assets are definite long-lived intangibles. Katy recorded amortization expense on intangible assets of $0.7 million, $0.7 million and $1.7 million in 2006, 2005 and 2004, respectively. Estimated aggregate future amortization expense related to intangible assets is as follows (amounts in thousands):
         
2007
  $ 645  
2008
    632  
2009
    597  
2010
    549  
2011
    508  
Thereafter
    3,504  
Note 5. IMPAIRMENTS OF LONG-LIVED ASSETS
Under SFAS No. 142, goodwill and other intangible assets are reviewed for impairment at least annually and if a triggering event were to occur in an interim period. The Company’s annual impairment test is performed in the fourth quarter. For the year ended December 31, 2006, no impairments were noted.
The Glit business unit, part of the Maintenance Products Group, had sustained a low profitability level throughout the last half of 2005 which resulted from increased costs during operational disruptions at our Wrens, Georgia facility. These operational disruptions were the result of the integration of other manufacturing operations into this facility and a fire at the facility in the fourth quarter of 2004. These disruptions triggered loss or reduction of customer activity. The first step of the impairment test resulted in the book value of the Glit business unit exceeding its fair value. The second step of the impairment testing showed that the goodwill of the Glit business unit had no fair value, and that the book value of the unit’s tradename, customer relationships and patent exceeded their implied fair value. As a result, impairment charges were recorded in 2005 for goodwill, tradename, customer relationships and patents of $1.6 million, $0.2 million, $0.2 million and $0.1 million, respectively. The valuation utilized a discounted cash-flow method and multiple analyses of historical results and 3% growth rate.
The Company operates three businesses in the United States that are engaged in the manufacture and distribution of plastics products: Continental, Contico and Container (collectively, “US Plastics”), part of the Maintenance Products Group. Since all of these business units essentially share long-lived assets, namely manufacturing equipment and certain intangibles, it is difficult to attribute separately identifiable cash flows emanating from each of the units. Therefore, in accordance with guidance provided in SFAS No. 142, SFAS No. 144, Accounting for the Impairments or Disposal of Long Lived Assets (“SFAS No. 144”), and EITF Topic D-101, Clarification of Reporting Unit Guidance in Paragraph 30 of FASB Statement No. 142, the Company determined that the appropriate level of testing for impairment under SFAS No. 142 and SFAS No. 144 was at the US Plastics combination of units.
In the fourth quarter of 2004, the profitability of the Contico business unit declined sharply as the Company was unable to pass along sufficient selling price increases to combat the accelerating cost of resin (a key raw material used in the US Plastics units). The Company believed that future earnings and cash flow could be negatively impacted to the extent further increases in resin and other raw material costs could not be offset or recovered through higher selling prices. In accordance with SFAS No. 142, the Company performed an analysis of discounted future cash flows which indicated that the book value of the US Plastics units was significantly greater than the fair value of those businesses. In addition, as a result of the goodwill analysis, the Company also assessed whether there had been an impairment of the long-lived assets in accordance with SFAS No. 144. The Company concluded that the book value of equipment, a customer list intangible and trademark associated with the US Plastics business unit significantly exceeded the fair value and impairment had occurred. Accordingly, the Company recognized an impairment loss and related charge of $29.9 million in 2004. The charges included $8.0 million related to goodwill, $8.4 million related to machinery and equipment, $10.9 million related to a customer list and $2.6 million related to the trademark. The valuation utilized a discounted cash flow method and multiple analyses of historical results and 3% growth rate. Also in 2004, the Company recorded impairment charges of $0.8 million related to property and equipment at its Metal Truck Box business unit, classified as a discontinued operation, and $0.1 million related to certain assets at the Woods US business unit.

 

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Note 6. EQUITY METHOD INVESTMENT
In 2005, the Company recorded $0.6 million in equity income from operations as a result of Sahlman’s improving financial performance. No adjustment was made in 2006 based on current and future operating results and financial position as well as an independent assessment of the investment’s fair value. At December 31, 2006 and 2005, its investment in Sahlman reflects a $2.2 million balance.
Sahlman was in the business of harvesting shrimp off the coast of South and Central America, and farming shrimp in Nicaragua, and its customers are primarily in the United States. Currently, Sahlman is only farming shrimp in Nicaragua. Sahlman experienced poor results of operations in 2002, primarily as a result of producers receiving very low prices for shrimp. Increased foreign competition, especially from Asia, has had a significant downward impact on shrimp prices in the United States. Upon review of Sahlman’s results for 2002 and through the second quarter of 2003, and after initial study of the status of the shrimp industry and markets in the United States, Katy evaluated the business further to determine if there had been a loss in the value of the investment that was other than temporary. Per ABP No. 18, The Equity Method for of Accounting for Investments in Common Stock, losses in the value of equity investments that are other than temporary should be recognized.
Katy estimated the fair value of the Sahlman business through a liquidation value analysis whereby all of Sahlman’s assets would be sold and all of its obligations would be settled. Katy evaluated the business by using various discounted cash flow analyses, estimating future free cash flows of the business with different assumptions regarding growth, and reducing the value of the business arrived at through this analysis by its outstanding debt. All values were then multiplied by 43%, Katy’s investment percentage. The answers derived by each of the three assumption models were then probability weighted. As a result, Katy concluded that $1.6 million was a reasonable estimate of the value of its investment in Sahlman as of December 31, 2004.
Note 7. DISCONTINUED OPERATIONS
Two of Katy’s operations have been classified as discontinued operations as of and for the years ended December 31, 2006, 2005 and 2004 in accordance with SFAS No. 144.
On June 2, 2006, the Company sold certain assets of the Metal Truck Box business unit within the Maintenance Products Group for gross proceeds of $3.6 million, including a $1.2 million note receivable. These proceeds were used to pay off related portions of the Term Loan and the Revolving Credit Facility. The Company recorded a loss of $50 thousand in 2006 in connection with this sale. Management and the board of directors determined that this business is not a core component to the Company’s long-term business strategy.
On November 27, 2006, the Company sold its United Kingdom consumer plastics business unit (excluding the related real estate holdings) for gross proceeds of approximately $3.0 million. These proceeds were used to pay off related portions of the Term Loan and the Revolving Credit Facility. The Company recorded a loss of $5.4 million in 2006 in connection with this sale. Management and the board of directors determined that this business is not a core component of the Company’s long-term business strategy. Refer to further discussion below related to asset held for sale classification.

 

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The Company did not separately identify the related assets and liabilities of the Metal Truck Box business unit and the United Kingdom consumer plastics business unit on the Consolidated Balance Sheets, except for the Asset Held for Sale. Following is a summary of the major asset and liability categories for these discontinued operations:
                 
    As Restated, see Note 2  
    December 31,  
    2006     2005  
 
               
Current assets:
               
Accounts receivable, net
  $ 83     $ 6,434  
Inventories, net
          5,746  
Other current assets
          583  
 
           
 
  $ 83     $ 12,763  
 
           
 
               
Non-current assets:
               
Intangibles, net
  $     $ 166  
Property and equipment, net
          12,145  
 
           
 
  $     $ 12,311  
 
           
 
               
Current liabilities:
               
Accounts payable
  $     $ 3,834  
Accrued compensation
          119  
Accrued expenses
    743       1,445  
 
           
 
  $ 743     $ 5,398  
 
           
On September 29, 2006, the Board of Directors of Katy approved management’s plan to sell the United Kingdom consumer plastics business unit. As a result, the net assets of this business unit were classified as an asset held for sale on the Consolidated Balance Sheets in accordance with SFAS No. 144 as of September 30, 2006. Accordingly, the carrying value of the business unit’s net assets was adjusted to the lower of its costs or its fair value less costs to sell, amounting to $8.7 million. Costs to sell included the incremental direct costs to complete the sale and represent costs such as broker commissions, legal and other closing costs. Costs to sell excluded future expected losses associated with the operations of the disposal group while held for sale. With the classification as an asset held for sale and its adjusted valuation, the Company incurred a $3.2 million impairment charge. Upon the sale of the United Kingdom consumer plastics business unit, excluding real estate holdings, in November, 2006, the Company incurred a total loss of $5.4 million, which includes the $3.2 million impairment charge taken during the third quarter of 2006.
As of December 31, 2006, the Company was in the process of selling the related real estate holdings of the United Kingdom consumer plastics business unit. As a result, the real estate holdings have been classified as an asset held for sale on the Consolidated Balance Sheets in accordance with SFAS No. 144. Accordingly, the carrying value of the business unit’s net assets was adjusted to the lower of its costs or its fair value less costs to sell, amounting to $4.5 million. Costs to sell include the incremental direct costs to complete the sale and represent costs such as broker commissions, legal and other closing costs. The transaction on the sale of the real estate holdings was completed on January 19, 2007 and resulted in a gain of approximately $1.9 million.
The historical operating results of the United Kingdom consumer plastics business unit and the Metal Truck Box business unit have been segregated as discontinued operations on the Consolidated Statements of Operations. Selected financial data for discontinued operations is summarized as follows (in thousands):
                         
    As Restated, see Note 2        
    2006     2005     2004  
Net sales
  $ 21,485     $ 31,807     $ 40,961  
 
                 
Pre-tax operating (loss) income
  $ (1,436 )   $ (2,357 )   $ 1,423  
 
                 
Pre-tax loss on sale of discontinued businesses
  $ (5,405 )   $     $ (775 )
 
                 

 

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Note 8. SAVANNAH ENERGY SYSTEMS COMPANY PARTNERSHIP
In 1984, SESCO, an indirect wholly owned subsidiary of Katy, entered into a series of contracts with the Resource Recovery Development Authority of the City of Savannah, Georgia (“the Authority”) to construct and operate a waste-to-energy facility. The facility would be owned and operated by SESCO solely for the purpose of processing and disposing of waste from the City of Savannah. In 1984, the Authority issued $55.0 million of Industrial Revenue Bonds (“the IRBs”) and lent the proceeds to SESCO under the loan agreement for the acquisition and construction of the waste-to-energy facility. The funds required to repay the loan agreement come from the monthly disposal fee paid by the Authority under the service agreement for certain waste disposal services, a component of which is for debt service. The debt service component of the monthly fee is paid into a trust, outside of the Company’s control, which is then utilized to make the scheduled debt payments on the IRBs. The Authority is unconditionally obligated to pay the monthly fee whether or not the facility is operating unless SESCO and Katy are insolvent and the facility is deemed incapable of handling the required amount of waste.
SESCO has a legally enforceable right to offset amounts it owes to the Authority under the loan agreement (scheduled principal repayments) against amounts that are owed from the Authority under the service agreement. At December 31, 2006, no amounts were outstanding as a result of the sale of the partnership interest discussed further below. At December 31, 2005, the outstanding amount was $15.3 million. Accordingly, the amounts owed to and due from SESCO have been netted for financial reporting purposes and are not shown on the Consolidated Balance Sheets in accordance with FIN No. 39, Offsetting of Amounts Related to Certain Contracts.
On April 29, 2002, SESCO entered into a partnership agreement with Montenay Power Corporation and its affiliates (“Montenay”) that turned over the control of SESCO’s waste-to-energy facility to Montenay Savannah Limited Partnership. The Company caused SESCO to enter into this agreement as a result of evaluations of SESCO’s business. First, Katy concluded that SESCO was not a core component of the Company’s long-term business strategy. Moreover, Katy did not feel it had the management expertise to deal with certain risks and uncertainties presented by the operation of SESCO’s business, given that SESCO was the Company’s only waste-to-energy facility. Katy had explored options for divesting SESCO for a number of years, and management felt that this transaction offered a reasonable strategy to exit this business.
The partnership, with Montenay’s leadership, assumed SESCO’s position in various contracts relating to the facility’s operation. Under the partnership agreement, SESCO contributed its assets and liabilities (except for its liability under the loan agreement with the Authority and the related receivable under the service agreement with the Authority) to the partnership. While SESCO had a 99% interest as a limited partner, profits and losses were allocated 1% to SESCO and 99% to Montenay. In addition, Montenay had the day to day responsibility for administration, operations, financing and other matters of the partnership. While the above partnership qualified as a variable interest entity, the Company was not the primary beneficiary as defined by FIN No. 46, Consolidation of Variable Interest Entities, and accordingly, the partnership was not consolidated. SESCO did not meet the criteria as the primary beneficiary as Montenay received 99% of all profits and losses, Montenay was required to finance the partnership, partners were not obligated to contribute additional capital, and Montenay had agreed to indemnify SESCO for any losses incurred due to a breach in the service agreement.
Katy agreed to pay Montenay $6.6 million over the span of seven years under a note payable in return for Montenay assuming the risks associated with the partnership and its operation of the waste-to-energy facility. In the first quarter of 2002, the Company recognized a charge of $6.0 million consisting of 1) the discounted value of the $6.6 million note, 2) the carrying value of certain assets contributed to the partnership, consisting primarily of machinery spare parts, and 3) costs to close the transaction. It should be noted that all of SESCO’s long-lived assets were reduced to a zero value in 2001, so no additional impairment was required. On a going forward basis, Katy expected that income statement activity associated with its involvement in the partnership would not be material, and Katy’s Consolidated Balance Sheets would carry the liability mentioned above.
Certain amounts may have been due to SESCO upon expiration of the service agreement in 2008; also, Montenay may have purchased SESCO’s interest in the partnership at that time. Katy did not record any amounts receivable or other assets relating to amounts that may have been received at the time the service agreement expired, given their uncertainty.
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. In addition to SESCO retaining its liabilities under the loan agreement, to induce the required parties to consent to the partnership transaction, Katy continued to guarantee the obligations of the partnership under the service agreement. The partnership was liable for liquidated damages under the service agreement if it failed to accept the minimum amount of waste or to meet other performance standards under the service agreement. Additionally, Montenay had agreed to indemnify Katy for any breach of the service agreement by the partnership.

 

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On June 27, 2006, the Company and Montenay amended the partnership interest purchase agreement in order to allow the Company to completely exit from the SESCO operations and related obligations. In addition, Montenay became the guarantor under the loan obligation for the IRBs. Montenay purchased the Company’s limited partnership interest for $0.1 million and a reduction of approximately $0.6 million in the face amount due to Montenay as agreed upon in the original partnership agreement. In addition, Montenay removed the Company as the performance guarantor under the service agreement. As a result of the above transaction, the Company recorded a gain of $0.4 million within operating income during the year ended December 31, 2006 given the reduction in the face amount due to Montenay as agreed upon in the original partnership interest purchase agreement. In addition, the Company recorded a gain on the sale of the partnership interest of approximately $0.1 million as reflected within operating income.
The final payment of $0.4 million due to Montenay as of December 31, 2006 is reflected in accrued expenses in the Consolidated Balance Sheets, and was paid in January 2007.
Note 9. INDEBTEDNESS
Long-term debt consists of the following:
                 
    December 31,  
    2006     2005  
    (Amounts in Thousands)  
Term loan payable under the Bank of America Credit Agreement, interest based on LIBOR and Prime Rates (8.38% - 9.50%), due through 2009
  $ 12,992     $ 15,714  
Revolving loans payable under the Bank of America Credit Agreement, interest based on LIBOR and Prime Rates (8.13% - 9.25%)
    43,879       41,946  
 
           
Total debt
    56,871       57,660  
Less revolving loans, classified as current (see below)
    (43,879 )     (41,946 )
Less current maturities
    (1,125 )     (2,857 )
 
           
Long-term debt
  $ 11,867     $ 12,857  
 
           
Aggregate remaining scheduled maturities of the Term Loan as of December 31, 2006 are as follows (in thousands):
         
2007
  $ 1,125  
2008
    1,500  
2009
    10,367  
On April 20, 2004, the Company completed a refinancing of its outstanding indebtedness (the “Refinancing”) and entered into a new agreement with Bank of America Business Capital (formerly Fleet Capital Corporation) (the “Bank of America Credit Agreement”). Like the previous credit agreement with Fleet Capital Corporation, the Bank of America Credit Agreement is a $110.0 million facility with a $20.0 million term loan (“Term Loan”) and a $90.0 million revolving credit facility (“Revolving Credit Facility”) with essentially the same terms as the previous credit agreement. The Bank of America Credit Agreement is an asset-based lending agreement and involves a syndicate of four banks, all of which participated in the syndicate from the previous credit agreement. The Bank of America Credit Agreement, and the additional borrowing ability under the Revolving Credit Facility obtained by incurring new term debt, results in three important benefits related to the Company’s long-term strategy: (1) additional borrowing capacity to invest in capital expenditures and/or acquisitions key to the Company’s strategic direction, (2) increased working capital flexibility to build inventory when necessary to accommodate lower cost outsourced finished goods inventory and (3) the ability to borrow locally in Canada and the United Kingdom and provide a natural hedge against currency fluctuations.
The funding of the Bank of America Credit Agreement was derived from term loan incremental borrowings of $18.2 million of which $16.7 million was utilized to reduce the Revolving Credit Facility and the remaining $1.5 million covering costs associated with the Bank of America Credit Agreement.
The Revolving Credit Facility has an expiration date of April 20, 2009 and its borrowing base is determined by eligible inventory and accounts receivable. Unused borrowing availability on the Revolving Credit Facility was $27.4 million at December 31, 2005. All extensions of credit under the Bank of America Credit Agreement are collateralized by a first priority security interest in and lien upon the capital stock of each material domestic subsidiary (65% of the capital stock of certain foreign subsidiaries), and all present and future assets and properties of the Company. The Term Loan also has a final maturity date of April 20, 2009 with quarterly payments of $0.4 million, as amended and beginning April 1, 2007. A final payment of $10.0 million is scheduled to be paid in April 2009. The Term Loan is collateralized by the Company’s property, plant and equipment.

 

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The Company’s borrowing base under the Bank of America Credit Agreement is reduced by the outstanding amount of standby and commercial letters of credit. Vendors, financial institutions and other parties with whom the Company conducts business may require letters of credit in the future that either (1) do not exist today or (2) would be at higher amounts than those that exist today. Currently, the Company’s largest letters of credit relate to its casualty insurance programs. At December 31, 2006, total outstanding letters of credit were $7.9 million.
Primarily due to declining profitability and the timing of certain restructuring payments, the Company amended the Bank of America Credit Agreement seven times from April 20, 2004, date of Refinancing, through December 31, 2006. The amendments adjusted certain financial covenants such that the fixed charge coverage ratio and consolidated leverage ratio were eliminated and the minimum availability (eligible collateral base less outstanding borrowings and letters of credit) was set such that the Company’s eligible collateral must exceed the sum of its outstanding borrowings and letters of credit under the Revolving Credit Facility by at least $5.0 million to $7.5 million, at various points during that time period. In addition, the Company was limited on maximum allowable capital expenditures for $12.0 million and $10.0 million for 2006 and 2005, respectively.
Until September 30, 2004, interest accrued on Revolving Credit Facility borrowings at 175 basis points over applicable LIBOR rates and at 200 basis points over LIBOR for borrowings under the Term Loan. In accordance with the Bank of America Credit Agreement, margins (i.e. the interest rate spread above LIBOR) increased to 25 basis points in the fourth quarter of 2004 based upon certain leverage measurements. Margins increased an additional 25 basis points in the first quarter of 2005. Effective since April 2005, interest rate margins have been set at the largest margins set forth in the Bank of America Credit Agreement, 275 basis points over applicable LIBOR rates for Revolving Credit Facility borrowings and 300 basis points over LIBOR for borrowings under the Term Loan. In accordance with the Bank of America Credit Agreement, margins on the Term Loan will drop 25 basis points if the balance of the Term Loan is reduced below $10.0 million. Interest accrues at higher margins on prime rates for swing loans, the amounts of which were nominal at December 31, 2006 and 2005.
Effective August 17, 2005, the Company entered into a two-year interest rate swap on a notional amount of $25.0 million in the first year and $15.0 million in the second year. The purpose of the swap was to limit the Company’s exposure to interest rate increases on a portion of the Revolving Credit Facility over the two-year term of the swap. The fixed interest rate under the swap at December 31, 2006 and over the life of the agreement is 4.49%.
As a result of the Seventh Amendment, the Company’s debt covenants, as of December 31, 2006 and thereafter, under the Bank of America Credit Agreement were to be as follows:
Fixed Charge Coverage Ratio — The Company is required to maintain a Fixed Charge Coverage Ratio (as defined in the Bank of America Credit Agreement) of 1.1:1, beginning December 31, 2006.
Capital Expenditures — For the year ended December 31, 2007, the Company is not to exceed $15.0 million in capital expenditures.
Leverage Ratio — As noted above, interest rate margins are currently set at the largest margins set forth in the Bank of America Credit Agreement. Following the first quarter of 2007, the Leverage Ratio will be utilized to determine the interest rate margin over the applicable LIBOR rate. No maximum Consolidated Leverage Ratio requirement is present.
The Company was in compliance with the above financial covenants in the Bank of America Credit Agreement, as amended above, at December 31, 2006.
While the Company was in compliance with the covenants of the Bank of America Credit Agreement as of December 31, 2006, it obtained, on March 8, 2007, the Eighth Amendment. The Eighth Amendment eliminates the Fixed Charge Coverage Ratio for the remaining life of the debt agreement and requires the Company to maintain a minimum level of availability such that its eligible collateral must exceed the sum of its outstanding borrowings and letters of credit by at least $5.0 million from the effective date of the Eighth Amendment through September 29, 2007 and by $7.5 million through December 2007. Thereafter, the Company is required to maintain a minimum level of availability of $5.0 million for the first three quarters of the year and $7.5 million for the fourth quarter. In addition, the Company reduced its Revolving Credit Facility from $90.0 million to $80.0 million.

 

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If the Company is unable to comply with the terms of the amended covenants, it could seek to obtain further amendments and pursue increased liquidity through additional debt financing and/or the sale of assets (see discussion above). However, the Company believes that it will be able to comply with all covenants, as amended, throughout 2007.
All of the debt under the Bank of America Credit Agreement is re-priced to current rates at frequent intervals. Therefore, its fair value approximates its carrying value at December 31, 2006. The Company incurred additional debt issuance costs in 2004 associated with the Bank of America Credit Agreement. Additionally, at the time of the inception of the Bank of America Credit Agreement, the Company had approximately $4.0 million of unamortized debt issuance costs associated with the previous credit agreement. The remainder of the previously capitalized costs, along with the capitalized costs from the Bank of America Credit Agreement, will be amortized over the life of the Bank of America Credit Agreement through April 2009. Also, during the first quarter of 2004, the Company incurred fees and expenses of $0.5 million associated with a financing which the Company chose not to pursue. The Company had amortization of debt issuance costs of $1.2 million, $1.1 million and $1.1 million in 2006, 2005 and 2004, respectively. In addition, the Company incurred $0.3 million and $0.2 million associated with amending the Bank of America Credit Agreement, as discussed above, in 2006 and 2005, respectively.
The Revolving Credit Facility under the Bank of America Credit Agreement requires lockbox agreements which provide for all receipts to be swept daily to reduce borrowings outstanding. These agreements, combined with the existence of a material adverse effect (“MAE”) clause in the Bank of America Credit Agreement, caused the Revolving Credit Facility to be classified as a current liability, per guidance in 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. The Company does not expect to repay, or be required to repay, within one year, the balance of the Revolving Credit Facility classified as a current liability. The MAE clause, which is a fairly typical requirement in commercial credit agreements, allows the lenders to require the loan to become due if they determine there has been a material adverse effect on the Company’s 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 lockbox agreements and the MAE clause. The Revolving Credit Facility does not expire or have a maturity date within one year, but rather has a final expiration date of April 20, 2009. The lender has not notified the Company of any indication of a MAE at December 31, 2006, and the Company was not in default of any provision of the Bank of America Credit Agreement at December 31, 2006.
Note 10. EARNINGS PER SHARE
The Company’s diluted earnings per share were calculated using the treasury stock method in accordance with SFAS No. 128, Earnings Per Share. The basic and diluted earnings per share (“EPS”) calculations are as follows:
                         
    As Restated, see Note 2        
For the Year Ended December 31,   2006     2005     2004  
 
                       
Basic and Diluted EPS:
                       
Loss from continuing operations
  $ (4,789 )   $ (11,619 )   $ (36,528 )
Payment-in-kind dividends on convertible preferred stock
                (14,749 )
 
                 
Loss from continuing operations attributable to common stockholders
    (4,789 )     (11,619 )     (51,277 )
Discontinued operations (net of tax)
    (6,834 )     (2,178 )     407  
Cumulative effect of a change in accounting principle
    (756 )            
 
                 
Net loss attributable to common stockholders
  $ (12,379 )   $ (13,797 )   $ (50,870 )
 
                 
 
                       
Weighted average shares — Basic and Diluted
    7,967       7,949       7,883  
 
                       
Per share amount:
                       
Loss from continuing operations attributable to common stockholders
  $ (0.60 )   $ (1.47 )   $ (6.50 )
Discontinued operations (net of tax)
    (0.86 )     (0.27 )     0.05  
Cumulative effect of a change in accounting principle
    (0.09 )            
 
                 
Net loss attributable to common stockholders
  $ (1.55 )   $ (1.74 )   $ (6.45 )
 
                 

 

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As of December 31, 2006, 2005 and 2004, 150,000, 920,000 and 1,530,000 options were in-the-money and 1,568,000, 936,350 and 195,650 options were out-of-the money, respectively. At December 31, 2006, 2005 and 2004, 1,131,551 convertible preferred shares were outstanding, which are in total convertible into 18,859,183 shares of Katy common stock. In-the-money options and convertible preferred shares were not included in the calculation of diluted earnings per share in any period presented because of their anti-dilutive impact as a result of the Company’s net loss position.
Note 11. RETIREMENT BENEFIT PLANS
Pension and Other Postretirement Plans
Certain subsidiaries have pension plans covering substantially all of their employees. These plans are noncontributory, defined benefit pension plans. The benefits to be paid under these plans are generally based on employees’ retirement age and years of service. The Company’s funding policies, subject to the minimum funding requirements of employee benefit and tax laws, are to contribute such amounts as determined on an actuarial basis to provide the plans with assets sufficient to meet the benefit obligations. Plan assets consist primarily of fixed income investments, corporate equities and government securities. The Company also provides certain health care and life insurance benefits for some of its retired employees. The postretirement health plans are unfunded. Katy uses an annual measurement date as of December 31 for the majority of its pension and other postretirement benefit plans for all years presented.
The Company adopted the provisions of SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106 and 132(R) (“SFAS No. 158”), effective December 31, 2006. SFAS No. 158 requires employers to recognize the overfunded or underfunded positions of defined benefit postretirement plans as an asset or liability in their balance sheets and to recognize as a component of other comprehensive income the gains or losses and prior services costs or credits that arise during the period but are not recognized as components of net periodic benefit cost. The following table presents the incremental effect of applying SFAS No. 158 on individual line items in the Company’s Consolidated Balance Sheets as of December 31, 2006:
                         
Incremental Effect of Applying SFAS No. 158 on Individual Line Items in Katy's  
Consolidated Balance Sheets as of December 31, 2006  
 
    Before             After  
    Application of             Application of  
    SFAS No. 158     Adjustments     SFAS No. 158  
Assets:
                       
Other non-current assets
  $ 136     $ (94 )   $ 42  
Deferred taxes
                 
Liabilities:
                       
Accrued expenses
          327       327  
Other liabilities
    2,585       1,203       3,788  
Stockholders’ Equity:
                       
Accumulated OCI
  $ (500 )   $ (1,624 )   $ (2,124 )

 

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The following table presents the funded status of the Company’s pension and postretirement benefit plans for the years ended December 31, 2006 and 2005:
                                 
    Pension Benefits     Other Benefits  
    2006     2005     2006     2005  
    (Amounts in Thousands)  
Change in benefit obligation:
                               
Benefit obligation at beginning of year
  $ 1,634     $ 1,544     $ 2,801     $ 3,171  
Service cost
    9       7              
Interest cost
    90       90       209       160  
Actuarial (gain) loss
    (43 )     123       1,093       (246 )
Benefits paid
    (151 )     (130 )     (272 )     (284 )
 
                       
Benefit obligation at end of year
  $ 1,539     $ 1,634     $ 3,831     $ 2,801  
 
                       
 
                               
Accumulated benefit obligation at end of year
  $ 1,539     $ 1,634                  
 
                           
 
                               
Change in plan assets:
                               
Fair value of plan assets at beginning of year
  $ 1,239     $ 1,306     $     $  
Actuarial return on plan assets
    106       63              
Employer contributions
    102             272       284  
Benefits paid
    (150 )     (130 )     (272 )     (284 )
 
                       
Fair value of plan assets at end of year
  $ 1,297     $ 1,239     $     $  
 
                       
 
                               
Funded status — deficiency
  $ 242     $ 395     $ 3,831     $ 2,801  
Unrecognized net actuarial loss
          (766 )           (633 )
Unrecognized prior service cost
                      (74 )
 
                       
Accrued (prepaid) benefit cost at end of year
  $ 242     $ (371 )   $ 3,831     $ 2,094  
 
                       
 
                               
Amount recognized in financial statements:
                               
Other non-current assets
  $ (42 )   $ (150 )   $     $  
Accrued expenses
          453       327        
Other liabilities
    284             3,504       2,094  
Accumulated other comprehensive income
          (674 )            
 
                       
Total
  $ 242     $ (371 )   $ 3,831     $ 2,094  
 
                       
 
                               
Amounts recognized in accumulated OCI consist of:
                               
Unrecognized net actuarial loss (gain)
  $ 604     $ (395 )   $ 285     $ (2,801 )
Unrecognized prior service cost
                1,235        
 
                       
Prepaid (accrued) benefit cost
  $ 604     $ (395 )   $ 1,520     $ (2,801 )
 
                       

 

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The following table presents the assumptions used to determine the Company’s benefit obligations at December 31, 2006 and 2005 along with sensitivity of the Company’s plans to potential changes in certain key assumptions:
                                 
    Pension Benefits     Other Benefits  
    2006     2005     2006     2005  
Assumptions as of December 31:
                               
Discount rates
    5.75 %     5.50 %     5.75 %     5.50 %
Assumed rates of compensation increases
    N/A       N/A       N/A       N/A  
Medical trend rate (initial)
    N/A       N/A       8.50 %     9.00 %
Medical trend rate (ultimate)
            N/A       5.00 %     5.00 %
Years to ultimate rate
            N/A       7       7  
 
                               
Impact of one-percent increase in health care trend rate:
                               
Increase in accumulated postretirement benefit obligation
                  $ 322     $ 391  
Increase in service cost and interest cost
                  $ 18     $ 25  
Impact of one-percent decrease in health care trend rate:
                               
Decrease in accumulated postretirement benefit obligation
                  $ 280     $ 315  
Decrease in service cost and interest cost
                  $ 16     $ 20  
The discount rate was based on several factors comparing Moody’s AA Corporate rate and actuarial-based yield curves. In determining the expected return on plan assets, the Company considers the relative weighting of plan assets, the historical performance of total plan assets and individual asset classes and economic and other indictors of future performance. In addition, the Company may consult with and consider the opinions of financial and other professionals in developing appropriate return benchmarks. Assets are rebalanced to the target asset allocation at least once per quarter. The allocation of pension plan assets is as follows:
                     
    Target   Percentage of
    Allocation   Plan Assets
Asset Category   2007   2006   2005
Equity Securities
  30 - 35%     45 %     35 %
Debt Securities
  60 - 65%     55 %     65 %
Real estate
  0%     0 %     0 %
Other
  0 - 3%     0 %     0 %
 
        100 %     100 %
The following table presents components of the net periodic benefit cost for the Company’s pension and postretirement benefit plans during 2006 and 2005:
                                 
    Pension Benefits     Other Benefits  
    2006     2005     2006     2005  
Components of net periodic benefit cost:
                               
Service cost
  $ 9     $ 7     $     $  
Interest cost
    90       90       209       160  
Expected return on plan assets
    (90 )     (101 )            
Amortization of prior service cost
                126       55  
Amortization of net gain
    59       52       16       39  
 
                       
Net periodic benefit cost
  $ 68     $ 48     $ 351     $ 254  
 
                       

 

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Required contributions to the pension plans for 2007 are $10 thousand and as a result, the Company will make contributions in 2007. The following table presents estimated future benefit payments:
                 
    Pension Benefits     Other Benefits  
2007
  $ 53     $ 337  
2008
    60       338  
2009
    71       336  
2010
    80       333  
2011
    83       327  
2012-2016
    454       1,474  
 
           
Total
  $ 801     $ 3,145  
 
           
The estimated amounts that will be amortized from accumulated other comprehensive income into net periodic benefit cost in 2007 are:
                 
    Pension Benefits     Other Benefits  
 
               
Actuarial loss
  $ 48     $ 6  
Prior service cost
          89  
 
           
Total
  $ 48     $ 95  
 
           
In addition to the plans described above, in 1993 the Company’s Board of Directors approved a retirement compensation program for certain officers and employees of the Company and a retirement compensation arrangement for the Company’s then Chairman and Chief Executive Officer. The Board approved a total of $3.5 million to fund such plans. Participants are allowed to defer 50% of their annual compensation as well as be eligible to participate in a profit sharing arrangement in which they vest over a five year period. In 2001, the Company limited participation to existing participants as well as discontinued any profit sharing arrangements. Participants can withdraw from the plan upon the latter of age 62 or termination from the Company.
The obligation created by this plan is partially funded. Assets are held in a rabbi trust invested in various mutual funds. Gains and/or losses are earned by the participant. For the unfunded portion of the obligation, interest is accrued at 4% each year. The Company had $1.6 million and $2.4 million recorded in accrued compensation and other liabilities at December 31, 2006 and 2005, respectively, for this obligation.
401(k) Plans
The Company offers its employees the opportunity to voluntarily participate in one of two 401(k) plans administered by the Company or one of its subsidiaries. On January 1, 2002, Katy consolidated certain of its 401(k) plans and reduced the number of plans within the Company from five to two. The Company makes matching and other contributions in accordance with the provisions of the plans and, under certain provisions, at the discretion of the Company. The Company made annual matching and other contributions for continuing operations of $0.5 million, $0.6 million and $0.6 million in 2006, 2005 and 2004, respectively.
Note 12. STOCKHOLDERS’ EQUITY
Convertible Preferred Stock
On June 28, 2001, Katy completed a recapitalization following an agreement on June 2, 2001 with KKTY Holding Company, LLC (“KKTY”), an affiliate of Kohlberg Investors IV, L.P. (“Kohlberg”) (the “Recapitalization”). 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. The Convertible Preferred shares were entitled to a 15% payment in kind (“PIK”) dividend (that is, dividends in the form of additional shares of Convertible Preferred Stock), compounded annually, which started accruing on August 1, 2001. PIK dividends were paid on August 1, 2002 (105,000 convertible preferred shares, equivalent to 1,750,000 common shares); August 1, 2003 (120,750 convertible preferred shares, equivalent to 2,012,500 common shares); August 1, 2004 (138,862.5 convertible preferred shares equivalent to 2,314,375 common shares); and on December 31, 2004 (66,938.5 convertible preferred shares, equivalent to 1,115,642 common shares). No dividends accrue or are payable after December 31, 2004. If converted, the 11,666,666 common shares, along with the 7,192,517 equivalent common shares from PIK dividends paid through December 31, 2004, would represent approximately 70% of the outstanding shares of common stock as of December 31, 2006, excluding outstanding options. The accruals of the PIK dividends were recorded as a charge to Additional Paid-in Capital due to the Company’s Accumulated Deficit position, and an increase to Convertible Preferred Stock. The dividends were recorded at fair value, reduced earnings available to common shareholders in the calculation of basic and diluted earnings per share, and are presented on the Consolidated Statements of Operations as an adjustment to arrive at net loss available to common shareholders.

 

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The Convertible Preferred Stock is convertible at the option of the holder 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 the Company, or a sale of all or substantially all of the assets or liquidation of the Company, 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 only by the Class I directors) at any time after June 30, 2021, 3) were entitled to receive cumulative PIK dividends through December 31, 2004, as mentioned above, 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 of the Convertible Preferred Stock. Upon a liquidation of Katy, the holders of the Convertible Preferred Stock would receive the greater of (i) an amount equal to the par value ($100 per share) of their Convertible Preferred Stock, or (ii) an amount that the holders of the Convertible Preferred Stock would have received if their shares of Convertible Preferred Stock were converted into common stock immediately prior to the distribution upon liquidation.
Share Repurchase
On April 20, 2003, the Company announced a plan to repurchase up to $5.0 million in shares of its common stock. In 2004, 12,000 shares of common stock were repurchased on the open market for approximately $0.1 million. The Company suspended further repurchases under the plan on May 10, 2004. On December 5, 2005, the Company announced the resumption of the plan. During 2006 and 2005, the Company purchased 40,800 and 3,200 shares of common stock, respectively, on the open market for $0.1 million and $7.5 thousand, respectively.
Rights Plan
In January 1995, the Board of Directors adopted a Stockholder Rights Agreement (“Rights Agreement”) and distributed one right for each outstanding share of the Company’s common stock (not otherwise exempted under the terms of the agreement). The rights entitle the stockholders to purchase, upon certain triggering events, shares of either the Company’s common stock or any acquiring company’s stock, at a reduced price. The rights are not and will not become exercisable unless certain change of control events or increases in certain parties’ percentage ownership occur. Consistent with the intent of the Rights Agreement, a shareholder who caused a triggering event would not be able to exercise his or her rights. If stockholders were to exercise rights, the effect would be to increase the percentage ownership stakes of those not causing the triggering event, while decreasing the percentage ownership stake of the party causing the triggering event. The Rights Agreement was amended on June 2, 2001 to clarify that the Recapitalization was not a triggering event under the Rights Agreement. The Rights Agreement expired in January 2005.
Note 13. STOCK INCENTIVE PLANS
Director Stock Grant
During 2006, the Company did not make any grants as this plan has expired. During 2005, the Company granted all independent, non-employee directors 2,000 shares of Company common stock as part of their compensation. During 2004, the Company granted these directors 500 shares of Company common stock as part of their compensation. The total grant to the directors for the years ended December 31, 2005 and 2004 was 6,000 and 1,500 shares, respectively.
Stock Options
At the 1995 Annual Meeting, the Company’s stockholders approved the Long-Term Incentive Plan (the “1995 Incentive Plan”) authorizing the issuance of up to 500,000 shares of Company common stock pursuant to the grant or exercise of stock options, including incentive stock options, nonqualified stock options, SARs, restricted stock, performance units or shares and other incentive awards to executives and certain key employees. The Compensation Committee of the Board of Directors administers the 1995 Incentive Plan and determines to whom awards may be granted, the type of award as well as the number of shares of Company common stock to be covered by each award, and the terms and conditions of such awards. The exercise price of stock options granted under the 1995 Incentive Plan cannot be less than 100 percent of the fair market value of such stock on the date of grant. In the event of a Change in Control of the Company, awards granted under the 1995 Incentive Plan are subject to substantially similar provisions to those described under the 1997 Incentive Plan. The definition of Change in Control of the Company under the 1995 Incentive Plan is substantially similar to the definition described under the 1997 Incentive Plan below.

 

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At the 1995 Annual Meeting, the Company’s stockholders approved the Non-Employee Directors Stock Option Plan (the “Directors Plan”) authorizing the issuance of up to 200,000 shares of Company common stock pursuant to the grant or exercise of nonqualified stock options to outside directors. The Board of Directors administers the Directors Plan. The exercise price of stock options granted under the Directors Plan is equal to the fair market value of the Company’s common stock on the date of grant. Stock options granted pursuant to the Directors Plan are immediately vested in full on the date of grant and generally expire 10 years after the date of grant. This plan has expired as of December 31, 2005 and no further grants will be made.
At the 1998 Annual Meeting, the Company’s stockholders approved the 1997 Long-Term Incentive Plan (the “1997 Incentive Plan”), authorizing the issuance of up to 875,000 shares of Company common stock pursuant to the grant or exercise of stock options, including incentive stock options, nonqualified stock options, SARs, restricted stock, performance units or shares and other incentive awards. The Compensation Committee of the Board of Directors administers the 1997 Incentive Plan and determines to whom awards may be granted, the type of award as well as the number of shares of Company common stock to be covered by each award, and the terms and conditions of such awards. The exercise price of stock options granted under the 1997 Incentive Plan cannot be less than 100 percent of the fair market value of such stock on the date of grant. The restricted stock grants in 1999 and 1998 referred to above were made under the 1997 Incentive Plan. Related to the 1997 Incentive Plan, the Company granted SARs as described below.
The 1997 Incentive Plan also provides that in the event of a Change in Control of the Company, as defined below, 1) any SARs and stock options outstanding as of the date of the Change in Control which are neither exercisable or vested will become fully exercisable and vested (the payment received upon the exercise of the SARs shall be equal to the excess of the fair market value of a share of the Company’s Common Stock on the date of exercise over the grant date price multiplied by the number of SARs exercised); 2) the restrictions applicable to restricted stock will lapse and such restricted stock will become free of all restrictions and fully vested; and 3) all performance units or shares will be considered to be fully earned and any other restrictions will lapse, and such performance units or shares will be settled in cash or stock, as applicable, within 30 days following the effective date of the Change in Control. For purposes of subsection 3), the payout of awards subject to performance goals will be a pro rata portion of all targeted award opportunities associated with such awards based on the number of complete and partial calendar months within the performance period which had elapsed as of the effective date of the Change in Control. The Compensation Committee will also have the authority, subject to the limitations set forth in the 1997 Incentive Plan, to make any modifications to awards as determined by the Compensation Committee to be appropriate before the effective date of the Change in Control.
For purposes of the 1997 Incentive Plan, “Change in Control” of the Company means, and shall be deemed to have occurred upon, any of the following events: 1) any person (other than those persons in control of the Company as of the effective date of the 1997 Incentive Plan, a trustee or other fiduciary holding securities under an employee benefit plan of the Company or a corporation owned directly or indirectly by the stockholders of the Company in substantially the same proportions as their ownership of stock of the Company) becomes the beneficial owner, directly or indirectly, of securities of the Company representing 30 percent or more of the combined voting power of the Company’s then outstanding securities; or 2) during any period of two consecutive years (not including any period prior to the effective date), the individuals who at the beginning of such period constitute the Board of Directors (and any new director, whose election by the Company’s stockholders was approved by a vote of at least two-thirds of the directors then still in office who either were directors at the beginning of the period or whose election or nomination for election was so approved), cease for any reason to constitute a majority thereof, or 3) the stockholders of the Company approve: (a) a plan of complete liquidation of the Company; or (b) an agreement for the sale or disposition of all or substantially all the Company’s assets; or (c) a merger, consolidation, or reorganization of the Company with or involving any other corporation, other than a merger, consolidation, or reorganization that would result in the voting securities of the Company outstanding immediately prior thereto continuing to represent at least 50 percent of the combined voting power of the voting securities of the Company (or such surviving entity) outstanding immediately after such merger, consolidation, or reorganization. The Company has determined that the Recapitalization did not result in such a Change in Control.

 

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In March 2004, the Company’s Board of Directors approved the vesting of all previously unvested stock options. The Company did not recognize any compensation expense upon this vesting of options because, based on the information available at that time, the Company did not have an expectation that the holders of the previously unvested options would terminate their employment with the Company prior to the original vesting period.
On June 28, 2001, the Company entered into an employment agreement with C. Michael Jacobi, its former President and Chief Executive Officer. To induce Mr. Jacobi to enter into the employment agreement, on June 28, 2001, the Compensation Committee of the Board of Directors approved the Katy Industries, Inc. 2001 Chief Executive Officer’s Plan. Under this plan, Mr. Jacobi was granted 978,572 stock options. Mr. Jacobi was also granted 71,428 stock options under the Company’s 1997 Incentive Plan. Upon Mr. Jacobi’s retirement in May 2005, all but 300,000 of these options were cancelled. All of the remaining options are under the 2001 Chief Executive Officer’s Plan. The Company recognized $2.0 million of non-cash compensation expense related to his 1,050,000 options using the intrinsic method of accounting under APB 25, because he would not have otherwise vested in these options but for the March 2004 accelerated vesting.
On September 4, 2001, the Company entered into an employment agreement with Amir Rosenthal, its Vice President, Chief Financial Officer, General Counsel and Secretary. To induce Mr. Rosenthal to enter into the employment agreement, on September 4, 2001, the Compensation Committee of the Board of Directors approved the Katy Industries, Inc. 2001 Chief Financial Officer’s Plan. Under this plan, Mr. Rosenthal was granted 123,077 stock options. Mr. Rosenthal was also granted 76,923 stock options under the Company’s 1995 Incentive Plan.
On June 1, 2005, the Company entered into an employment agreement with Anthony T. Castor III, its President and Chief Executive Officer. To induce Mr. Castor to enter into the employment agreement, on July 15, 2005, the Compensation Committee of the Board of Directors approved the Katy Industries, Inc. 2005 Chief Executive Officer’s Plan. Under this plan, Mr. Castor was granted 750,000 stock options. These options vest evenly over a three-year period.
The following table summarizes option activity under each of the 1997 Incentive Plan, 1995 Incentive Plan, the Chief Executive Officer’s Plan, the Chief Financial Officer’s Plan and the Directors Plan:
                                 
                    Weighted        
            Weighted     Average     Aggregate  
            Average     Remaining     Intrinsic  
            Exercise     Contractual     Value  
    Options     Price     Life     (in thousands)  
 
                               
Outstanding at December 31, 2003
    1,799,200     $ 4.92                  
 
                               
Granted
    6,000       5.91                  
Exercised
    (75,000 )     4.05                  
Cancelled
    (4,550 )     12.70                  
 
                             
 
                               
Outstanding at December 31, 2004
    1,725,650     $ 4.94                  
 
                               
Granted
    936,000       2.71                  
Expired
    (55,000 )     8.98                  
Cancelled
    (750,300 )     4.20                  
 
                             
 
                               
Outstanding at December 31, 2005
    1,856,350     $ 3.99                  
 
                               
Exercised
    (45,000 )     3.26                  
Expired
    (60,750 )     13.23                  
Cancelled
    (32,600 )     5.53                  
 
                             
 
                               
Outstanding at December 31, 2006
    1,718,000     $ 3.66     6.69 years   $ 48  
 
                             
 
                               
Vested and Exercisable at December 31, 2006
    1,098,000     $ 4.20     5.69 years   $ 16  
 
                             

 

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As of December 31, 2006, total unvested compensation expense associated with stock options amounted to $0.3 million, and is being amortized on a straight-line basis over the respective option’s vesting period. The weighted average period in which the above compensation cost will be recognized is 0.9 years as of December 31, 2006.
Stock Appreciation Rights
During 2002, a non-employee consultant was awarded 200,000 SARs under the 1997 Incentive Plan. As of December 31, 2006, these SARs were outstanding at an exercise price of $6.00.
On November 21, 2002, the Board of Directors approved the 2002 Stock Appreciation Rights Plan (the “2002 SAR Plan”), authorizing the issuance of up to 1,000,000 SARs. Vesting of the SARs occurs ratably over three years from the date of issue. The 2002 SAR Plan provides limitations on redemption by holders, specifying that no more than 50% of the cumulative number of vested SARs held by an employee could be exercised in any one calendar year. The SARs expire ten years from the date of issue. The Board approved grants on November 22, 2002, of 717,175 SARs to 60 individuals with an exercise price of $3.15, which equaled the market price of Katy’s stock on the grant date. In addition, 50,000 SARs were granted to four individuals during 2003 with exercise prices ranging from $3.01 through $5.05. In 2004, 275,000 SARs were granted to fifteen individuals with exercise prices ranging from $5.20 through $6.45. No SARs were granted in 2005. In 2006, 20,000 SARs were granted to one individual with an exercise price of $3.16. In addition in 2006, 2,000 SARs each were granted to three directors with a Stand-Alone Stock Appreciation Rights Agreement. These 6,000 SARs vest immediately and have an exercise price of $2.08. At December 31, 2006, Katy had 598,281 SARs outstanding at a weighted average exercise price of $4.18.
The 2002 SAR Plan also provides that in the event of a Change in Control of the Company, all outstanding SARs may become fully vested. In accordance with the 2002 SAR Plan, a “Change in Control” is deemed to have occurred upon any of the following events: 1) a sale of 100 percent of the Company’s outstanding capital stock, as may be outstanding from time to time; 2) a sale of all or substantially all of the Company’s operating subsidiaries or assets; or 3) a transaction or series of transactions in which any third party acquires an equity ownership in the Company greater than that held by KKTY Holding Company, L.L.C. and in which Kohlberg & Co., L.L.C. relinquishes its right to nominate a majority of the candidates for election to the Board of Directors.
The following table summarizes SARs activity under each of the 1997 Incentive Plan and the 2002 SAR Plan:
         
Non-Vested at December 31, 2005
    85,115  
 
       
Granted
    26,000  
Vested
    (55,998 )
Cancelled
    (1,683 )
 
     
 
       
Non-Vested at December 31, 2006
    53,434  
 
     
 
       
Total Outstanding at December 31, 2006
    798,281  
 
     
See Note 3 for a discussion of accounting for stock awards, and related fair value and pro forma earnings disclosures.
Note 14. INCOME TAXES
The provision for income taxes from continuing operations is based on the following pre-tax loss:
                         
    As Restated, see Note 2        
    2006     2005     2004  
    (Amounts in Thousands)  
 
                       
Domestic
  $ (7,409 )   $ (14,730 )   $ (39,125 )
Foreign
    4,946       4,719       3,239  
 
                 
Total
  $ (2,463 )   $ (10,011 )   $ (35,886 )
 
                 

 

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The provision for income taxes from continuing operations consists of the following:
                         
    2006     2005     2004  
    (Amounts in Thousands)  
Current tax provision (benefit):
                       
Federal
  $     $     $ (343 )
State
    110       100       (204 )
Foreign
    2,202       1,268       2,417  
 
                 
Total
  $ 2,312     $ 1,368     $ 1,870  
 
                 
 
                       
Deferred tax provision (benefit):
                       
Federal
  $     $     $  
State
                 
Foreign
    14       240       (1,228 )
 
                 
Total
  $ 14     $ 240     $ (1,228 )
 
                 
 
                       
Total provision from continuing operations
  $ 2,326     $ 1,608     $ 642  
 
                 
Actual income taxes reported from continuing operations are different than would have been computed by applying the federal statutory tax rate to income from continuing operations before income taxes. The reasons for this difference are as follows:
                         
    As Restated, see Note 2        
    2006     2005     2004  
    (Amounts in Thousands)  
 
                       
Benefit for income taxes at statutory rate
  $ (865 )   $ (3,504 )   $ (12,560 )
State income taxes, net of federal benefit
    72       65       (133 )
Foreign tax rate differential
    95       112       463  
Foreign tax credits
    (2,080 )     (1,266 )     (245 )
Utilization of foreign losses
    823       718        
Return to provision adjustments
    2,739       (166 )     (991 )
Dividend income from foreign subsidiary
    1,267       913        
Dividend gross-up
    698       494        
Stock option expense
          547        
Valuation allowance adjustments
    (310 )     3,712       14,325  
Permanent items
    (115 )     4       103  
Increase (reduction) of tax reserves
                (343 )
Other, net
    2       (21 )     23  
 
                 
Net provision for income taxes
  $ 2,326     $ 1,608     $ 642  
 
                 

 

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The significant components of the Company’s deferred income tax liabilities and assets are as follows:
                 
    As Restated, see Note 2  
    2006     2005  
    (Amounts in Thousands)  
Deferred tax liabilities
               
Waste-to-energy facility
  $ 160     $ (2,602 )
Inventory costs
    (1,072 )     (1,800 )
Unremitted foreign earnings
    (4,153 )     (4,428 )
 
           
 
  $ (5,065 )   $ (8,830 )
 
           
 
               
Deferred tax assets
               
Allowance for doubtful receivables
  $ 1,862     $ 972  
Accrued expenses and other items
    12,069       13,425  
Difference between book and tax basis of property
    12,859       16,149  
Operating loss carry-forwards — domestic
    35,326       35,026  
Operating loss carry-forwards — foreign
    94       45  
Tax credit carry forwards
    6,647       4,567  
Estimated foreign tax credit related to unremitted earnings
    4,153       4,428  
 
           
 
    73,010       74,612  
Less valuation allowance
    (66,971 )     (64,794 )
 
           
 
    6,039       9,818  
 
           
Net deferred income tax asset
  $ 974     $ 988  
 
           
At December 31, 2006, the Company had approximately $94.1 million of Federal net operating loss carry-forwards (“Federal NOLs”), which will expire in years 2020 through 2026 if not utilized prior to that time. Due to tax laws governing change in control events and their relation to the Recapitalization, approximately $20.4 million of the Federal NOLs are subject to certain limitations as to the amount that can be used to offset taxable income in any single year. The remainder of the Company’s domestic and foreign net operating loss carry-forwards relate to certain U.S. operating subsidiaries, and the Company’s Canadian operations, respectively, and can only be used to offset income from these operations. At December 31, 2006, the Company’s Canadian subsidiaries have Canadian net operating loss carry-forwards of approximately $0.1 million that expire in 2008. The tax credit carry-forwards relate to United States federal minimum tax credits of $1.2 million that have no expiration date, general business credits of $0.1 million that expire in years 2011 through 2022, and foreign tax credit carryovers of $5.2 million that expire in the years 2009 through 2016.
Valuation allowances are recorded when it is considered more likely than not that some portion or all of the deferred tax assets will not be realized. A history of operating losses incurred by the domestic and certain foreign subsidiaries provides significant negative evidence with respect to the Company’s ability to generate future taxable income, a requirement in order to recognize deferred tax assets. For this reason, the Company was unable to conclude that it was more likely that not that certain deferred tax assets would be utilized in the future. The valuation allowance relates to federal, state and foreign net operating loss carry-forwards, foreign and domestic tax credits, and certain other deferred tax assets to the extent they exceed deferred tax liabilities with the exception of deferred tax assets of certain foreign subsidiaries which are considered realizable.
Deduction for Qualified Domestic Production Activities
On October 22, 2004, the President signed the American Jobs Creation Act of 2004 (the “Act”). The Act provides a deduction for income from qualified domestic production activities, which will be phased in from 2005 through 2010. In return, the Act also provides for a two-year phase-out of the existing extra-territorial income exclusion (ETI) for foreign sales that was viewed to be inconsistent with international trade protocols by the European Union. The Company expects that due to its net operating loss carry forwards and its full valuation allowance the phase out of the ETI and the phase in of this new deduction to have no effect on its effective tax rate for fiscal year 2007.
Repatriation of Foreign Earnings
The American Jobs Creation Act of 2004 provides for a special one-time elective dividends received deduction on the repatriation of certain foreign earnings to a U.S. taxpayer (Repatriation Provision). The Company has completed its review of the Repatriation Provision and has concluded that it will not benefit from the Act because of the Company’s current tax position. As a result, the Repatriation Provision did not have any impact on income tax expense during fiscal 2006.

 

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During 2006 and 2005, the Company made provision for U.S. federal and foreign withholding tax on approximately $8.3 million of its Canadian subsidiary earnings which we intend to repatriate. The Company provided no federal and foreign withholding tax on the undistributed earnings of its UK subsidiary as these earnings are intended to be re-invested indefinitely. It is not practicable to determine the amount of income tax liability that would result had such earnings actually been repatriated.
Note 15. LEASE OBLIGATIONS
The Company, a lessee, has entered into non-cancelable leases for manufacturing and data processing equipment and real property with lease terms of up to ten years. Future minimum lease payments as of December 31, 2006 are as follows:
         
2007
  $ 7,663  
2008
    7,239  
2009
    3,332  
2010
    2,732  
2011
    510  
Thereafter
    614  
 
     
Total minimum payments
  $ 22,090  
 
     
Liabilities totaling $1.0 million were recorded on the Consolidated Balance Sheets at December 31, 2006, related to leased facilities that have been fully or partially abandoned and available for sub-lease. These facilities were abandoned as cost saving measures as a result of efforts to restructure the Company’s operations. These liabilities are stated at fair value (i.e., discounted), and include estimates of sub-lease revenue. See Note 22 for further detail on accrued amounts in both current and long-term liabilities related to non-cancelable, abandoned, leased facilities.
Rental expense for 2006, 2005 and 2004 for operating leases from continuing operations was $8.4 million, $8.9 million, and $10.8 million, respectively. Also, $1.4 million and $1.3 million of rent was paid and charged against liabilities in 2006 and 2005, respectively, for non-cancelable leases at facilities abandoned as a result of restructuring initiatives. In 2004, the Company bought out the remaining obligation for its non-cancelable lease at the Warson Road facility for $2.3 million.
Note 16. RELATED PARTY TRANSACTIONS
In connection with the CCP (formerly Contico International, L.L.C.) acquisition on January 8, 1999, the Company entered into building lease agreements with Newcastle. Lester Miller, the former owner of CCP, and a Katy director from 1999 to 2000, is the majority owner of Newcastle. Since the acquisition of CCP, several additional properties utilized by CCP are leased directly from Lester Miller. Rental expense for these properties approximates historical market rates. Related party rental expense was approximately $0.5 million for each of the years ended December 31, 2006, 2005 and 2004.
Kohlberg, whose affiliate holds all 1,131,551 shares of our Convertible Preferred Stock, provides ongoing management oversight and advisory services to Katy. We paid $0.5 million annually for such services in 2006, 2005 and 2004, respectively, and expect to pay $0.5 million annually in future years. Such amounts are recorded in selling, general and administrative expenses in the Consolidated Statements of Operations.
Note 17. INDUSTRY SEGMENTS AND GEOGRAPHIC INFORMATION
The Company is organized into two operating segments: Maintenance Products and Electrical Products. The activities of the Maintenance Products Group include the manufacture and distribution of a variety of commercial cleaning supplies and consumer home products. The Electrical Products Group is a marketer and distributor of consumer electrical corded products. Principal geographic markets are in the United States, Canada, and Europe and include the sanitary maintenance, foodservice, mass merchant retail and home improvement markets. During 2006, Lowe’s Companies, Inc. (“Lowe’s”) and Wal-Mart Stores, Inc. (“Wal-Mart”) accounted for 16% and 14%, respectively, of consolidated net sales. Sales to Lowe’s are made by two separate business units (Woods US and Contico). Sales to Wal-Mart are made by six separate business units (Woods US, Contico, Glit, Woods Canada, Wilen, and Continental). A significant loss of business at either of these retail outlets could have a material adverse impact on the Company’s results.

 

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For all periods presented, information for the Maintenance Products Group excludes amounts related to the United Kingdom consumer plastics and Metal Truck Box business units as these units are classified as discontinued operations as discussed further in Note 7. The table below summarizes the key factors in the year-to-year changes in operating results:
                             
        Years Ended December 31,  
        2006     2005     2004  
        As Restated, see Note 2        
        (Amounts in thousands)  
Maintenance Products Group
                           
Net external sales
      $ 208,423     $ 216,068     $ 237,927  
Operating income (loss)
        5,637       (6,467 )     (4,115 )
Operating margin (deficit)
        2.7 %     (3.0 %)     (1.7 %)
Depreciation and amortization
    7,694       7,673       10,593  
Capital expenditures
        3,855       8,329       10,111  
Total assets
        95,119       107,806       124,458  
Electrical Products Group
                           
Net external sales
      $ 187,743     $ 207,322     $ 178,754  
Operating income
        8,710       17,385       16,809  
Operating margin
        4.6 %     8.4 %     9.4 %
Depreciation and amortization
    827       1,191       1,327  
Capital expenditures
        739       596       671  
Total assets
        74,025       66,744       57,698  
Net sales
  - Operating segments   $ 396,166     $ 423,390     $ 416,681  
 
                     
 
     Total   $ 396,166     $ 423,390     $ 416,681  
 
                     
Operating income (loss)
  - Operating segments   $ 14,347     $ 10,918     $ 12,694  
 
  - Unallocated corporate     (10,206 )     (13,198 )     (10,341 )
 
  - Impairments of long-lived assets           (2,112 )     (30,056 )
 
  - Severance, restructuring and related charges     112       (1,090 )     (3,505 )
 
  - (Loss) gain on sale of assets     (467 )     377       288  
 
                     
 
     Total   $ 3,786     $ (5,105 )   $ (30,920 )
 
                     
Depreciation and amortization
  - Operating segments   $ 8,521     $ 8,864     $ 11,920  
 
  - Unallocated corporate     119       104       225  
 
                     
 
     Total   $ 8,640     $ 8,968     $ 12,145  
 
                     
Capital expenditures
  - Operating segments   $ 4,594     $ 8,925     $ 10,782  
 
  - Unallocated corporate     20              
 
  - Discontinued operations     128       441       3,094  
 
                     
 
     Total   $ 4,742     $ 9,366     $ 13,876  
 
                     
Total assets
  - Operating segments   $ 169,144     $ 174,550     $ 182,156  
 
  - Other [a]     6,700       27,391       31,801  
 
  - Unallocated corporate     6,850       10,153       10,507  
 
                     
 
     Total   $ 182,694     $ 212,094     $ 224,464  
 
                     
[a]  
Amounts shown as “Other” represent items associated with Sahlman Holding Company, Inc., the Company’s equity method investment, and the assets of the United Kingdom consumer plastics and the Metal Truck Box business units.

 

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The Company operates businesses in the United States and foreign countries. The operations for 2006, 2005 and 2004 of businesses within major geographic areas are summarized as follows:
                                                 
    United                     Europe              
(Thousands of Dollars)   States     Canada     U.K.     (Excluding U.K.)     Other     Consolidated  
2006:
                                               
Sales to unaffiliated customers
  $ 316,313     $ 58,334     $ 14,289     $ 3,826     $ 3,404     $ 396,166  
Total assets, As Restated, see Note 2
  $ 145,512     $ 24,678     $ 12,264     $     $ 240     $ 182,694  
 
                                               
2005:
                                               
Sales to unaffiliated customers
  $ 347,894     $ 53,684     $ 14,185     $ 3,721     $ 3,906     $ 423,390  
Total assets, As Restated, see Note 2
  $ 161,044     $ 25,950     $ 24,881     $     $ 219     $ 212,094  
 
                                               
2004:
                                               
Sales to unaffiliated customers
  $ 346,346     $ 47,549     $ 14,167     $ 4,423     $ 4,196     $ 416,681  
Total assets
  $ 170,166     $ 23,513     $ 30,227     $ 558     $     $ 224,464  
Net sales for each geographic area include sales of products produced in that area and sold to unaffiliated customers, as reported in the Consolidated Statements of Operations.
Note 18. COMMITMENTS AND CONTINGENCIES
General Environmental Claims
The Company and certain of its current and former direct and indirect corporate predecessors, subsidiaries and divisions are involved in remedial activities at certain present and former locations and have been identified by the United States Environmental Protection Agency (“EPA”), state environmental agencies and private parties as potentially responsible parties (“PRPs”) at a number of hazardous waste disposal sites under the Comprehensive Environmental Response, Compensation and Liability Act (“Superfund”) or equivalent state laws and, as such, may be liable for the cost of cleanup and other remedial activities at these sites. Responsibility for cleanup and other remedial activities at a Superfund site is typically shared among PRPs based on an allocation formula. Under the federal Superfund statute, parties could be held jointly and severally liable, thus subjecting them to potential individual liability for the entire cost of cleanup at the site. Based on its estimate of allocation of liability among PRPs, the probability that other PRPs, many of whom are large, solvent, public companies, will fully pay the costs apportioned to them, currently available information concerning the scope of contamination, estimated remediation costs, estimated legal fees and other factors, the Company has recorded and accrued for environmental liabilities in amounts that it deems reasonable and believes that any liability with respect to these matters in excess of the accruals will not be material. The ultimate costs will depend on a number of factors and the amount currently accrued represents management’s best current estimate of the total costs to be incurred. The Company expects this amount to be substantially paid over the next five to ten years.
W.J. Smith Wood Preserving Company (“W.J. Smith”)
The W. J. Smith matter originated in the 1980s when the United States and the State of Texas, through the Texas Water Commission, initiated environmental enforcement actions against W.J. Smith alleging that certain conditions on the W.J. Smith property (the “Property”) violated environmental laws. In order to resolve the enforcement actions, W.J. Smith engaged in a series of cleanup activities on the Property and implemented a groundwater monitoring program.
In 1993, the EPA initiated a proceeding under Section 7003 of the Resource Conservation and Recovery Act (“RCRA”) against W.J. Smith and Katy. The proceeding sought certain actions at the site and at certain off-site areas, as well as development and implementation of additional cleanup activities to mitigate off-site releases. In December 1995, W.J. Smith, Katy and the EPA agreed to resolve the proceeding through an Administrative Order on Consent under Section 7003 of RCRA. While the Company has completed the cleanup activities required by the Administrative Order on Consent under Section 7003 of RCRA, the Company still has further obligations with respect to this matter in the areas of groundwater and land treatment unit monitoring and closure as well as ongoing site operation and maintenance costs.

 

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Since 1990, the Company has spent in excess of $7.0 million undertaking cleanup and compliance activities in connection with this matter. While ultimate liability with respect to this matter is not easy to determine, the Company has recorded and accrued amounts that it deems reasonable for prospective liabilities with respect to this matter.
Asbestos Claims
A. The Company has been named as a defendant in ten lawsuits filed in state court in Alabama by a total of approximately 324 individual plaintiffs. There are over 100 defendants named in each case. In all ten cases, the Plaintiffs claim that they were exposed to asbestos in the course of their employment at a former U.S. Steel plant in Alabama and, as a result, contracted mesothelioma, asbestosis, lung cancer or other illness. They claim that they were exposed to asbestos in products in the plant which were manufactured by each defendant. In eight of the cases, Plaintiffs also assert wrongful death claims. The Company will vigorously defend the claims against it in these matters. The liability of the Company cannot be determined at this time.
B. Sterling Fluid Systems (USA) has tendered over 2,082 cases pending in Michigan, New Jersey, New York, Illinois, Nevada, Mississippi, Wyoming, Louisiana, Georgia, Massachusetts and California to the Company for defense and indemnification. With respect to one case, Sterling has demanded that Katy indemnify it for a $200,000 settlement. Sterling bases its tender of the complaints on the provisions contained in a 1993 Purchase Agreement between the parties whereby Sterling purchased the LaBour Pump business and other assets from the Company. Sterling has not filed a lawsuit against Katy in connection with these matters.
The tendered complaints all purport to state claims against Sterling and its subsidiaries. The Company and its current subsidiaries are not named as defendants. The plaintiffs in the cases also allege that they were exposed to asbestos and products containing asbestos in the course of their employment. Each complaint names as defendants many manufacturers of products containing asbestos, apparently because plaintiffs came into contact with a variety of different products in the course of their employment. Plaintiffs’ claim that LaBour Pump and/or Sterling may have manufactured some of those products.
With respect to many of the tendered complaints, including the one settled by Sterling for $200,000, the Company has taken the position that Sterling has waived its right to indemnity by failing to timely request it as required under the 1993 Purchase Agreement. With respect to the balance of the tendered complaints, the Company has elected not to assume the defense of Sterling in these matters.
C. LaBour Pump Company, a former subsidiary of the Company, has been named as a defendant in over 361 similar cases in New Jersey. These cases have also been tendered by Sterling. The Company has elected to defend these cases, many of which have been dismissed or settled for nominal sums.
While the ultimate liability of the Company related to the asbestos matters above cannot be determined at this time, the Company has recorded and accrued amounts that it deems reasonable for prospective liabilities with respect to this matter.
Non-Environmental Litigation — Banco del Atlantico, S.A.
Banco del Atlantico, S.A. v. Woods Industries, Inc., et al. Civil Action No. L-96-139 (now 1:03-CV-1342-LJM-VSS, U.S. District Court, Southern District of Indiana). In December 1996, Banco del Atlantico (“plaintiff”), a bank located in Mexico, filed a lawsuit in Texas against Woods Industries, Inc., a subsidiary of Katy, and against certain past and/or then present officers, directors and owners of Woods (collectively, “defendants”). The plaintiff alleges that it was defrauded into making loans to a Mexican corporation controlled by certain past officers and directors of Woods based upon fraudulent representations and purported guarantees. Based on these allegations, and others, the plaintiff originally asserted claims for alleged violations of the federal Racketeer Influenced and Corrupt Organizations Act (“RICO”); “money laundering” of the proceeds of the illegal enterprise; the Indiana RICO and Crime Victims Act; common law fraud and conspiracy; and fraudulent transfer. As discussed below, certain of the plaintiff’s claims were dismissed with prejudice by the Court. The plaintiff also seeks recovery upon certain alleged guarantees purportedly executed by Woods Wire Products, Inc., a predecessor company from which Woods purchased certain assets in 1993 (prior to Woods’s ownership by Katy, which began in December 1996). The primary legal theories under which the plaintiff seeks to hold Woods liable for its alleged damages are respondeat superior, conspiracy, successor liability, or a combination of the three.
The case was transferred from Texas to the Southern District of Indiana in 2003. In September 2004, the plaintiff and HSBC Mexico, S.A. (collectively, “plaintiffs”), who intervened in the litigation as an additional alleged owner of the claims against the defendants, filed a Second Amended Complaint. The defendants filed motions to dismiss the Second Amended Complaint on November 8, 2004. These motions sought dismissal of plaintiffs’ Second Amended Complaint on grounds of, among other things, failure to state a claim and forum non conveniens.

 

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On August 11, 2005, the court granted significant aspects of Defendants’ motions to dismiss for failure to state a claim. Specifically, the Court dismissed with prejudice all of the federal and Indiana RICO claims asserted in the Second Amended Complaint against Woods. This ruling removes the treble damages exposure associated with the federal and Indiana RICO claims. Recently, the Court also denied the defendants’ renewed motion to dismiss for forum non conveniens. The sole claims now remaining against Woods are certain common law claims and claims under the Indiana Crime Victims Act.
The time set for discovery has concluded, and the appearing Defendants (including Woods) have moved for summary judgment on all remaining claims against them. Defendants have also moved under the Court’s rules for sanctions against Plaintiffs for their asserted failures to abide by the rules of discovery and produce certain documents and witnesses. These discovery sanction motions separately seek dismissal of all of Plaintiffs’ claims with prejudice. Plaintiffs have cross-moved for summary judgment in their favor on their claims under the alleged guarantees purportedly executed by old Woods Wire Products, Inc. (the company from which Woods purchased certain assets). Summary judgment briefing is expected to be complete by April 15, 2007, with a decision some time thereafter. A trial, if any is necessary, is not expected until late 2007 or 2008.
The plaintiffs seek damages in excess of $24.0 million, request that the Court void certain asset sales as purported “fraudulent transfers” (including the 1993 Woods Wire Products, Inc./Woods asset sale), and continue to claim that the Indiana Crime Victims Act entitles them to treble damages for some or all of their claims. Katy may have recourse against the former owners of Woods and others for, among other things, violations of covenants, representations and warranties under the purchase agreement through which Katy acquired Woods, and under state, federal and common law. Woods may also have indemnity claims against the former officers and directors. In addition, there is a dispute with the former owners of Woods regarding the final disposition of amounts withheld from the purchase price, which may be subject to further adjustment as a result of the claims by the plaintiff. The extent or limit of any such adjustment cannot be predicted at this time.
While the ultimate liability of the Company related to this matter cannot be determined at this time, the Company has recorded and accrued amounts that it deems reasonable for prospective liabilities with respect to this matter.
Other Claims
Katy also has a number of product liability and workers’ compensation claims pending against it and its subsidiaries. Many of these claims are proceeding through the litigation process and the final outcome will not be known until a settlement is reached with the claimant or the case is adjudicated. The Company estimates that it can take up to 10 years from the date of the injury to reach a final outcome on certain claims. With respect to the product liability and workers’ compensation claims, Katy has provided for its share of expected losses beyond the applicable insurance coverage, including those incurred but not reported to the Company or its insurance providers, which are developed using actuarial techniques. Such accruals are developed using currently available claim information, and represent management’s best estimates. The ultimate cost of any individual claim can vary based upon, among other factors, the nature of the injury, the duration of the disability period, the length of the claim period, the jurisdiction of the claim and the nature of the final outcome.
Although management believes that the actions specified above in this section individually and in the aggregate are not likely to have outcomes that will have a material adverse effect on the Company’s financial position, results of operations or cash flow, further costs could be significant and will be recorded as a charge to operations when, and if, current information dictates a change in management’s estimates.
Note 19. SEVERANCE, RESTRUCTURING AND RELATED CHARGES
Over the past three years, the Company has initiated several cost reduction and facility consolidation initiatives, resulting in severance, restructuring and related charges. Key initiatives were the consolidation of the St. Louis, Missouri manufacturing/distribution facilities, shutdown of both Woods U.S. and Woods Canada manufacturing as well as the consolidation of the Glit facilities. These initiatives resulted from the on-going strategic reassessment of our various businesses as well as the markets in which they operate.

 

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A summary of charges (reductions) by major initiative is as follows:
                         
    2006     2005     2004  
    (Amounts in Thousands)  
Consolidation of St. Louis manufacturing/distribution facilities
  $ (499 )   $ 39     $ 1,460  
Consolidation of Glit facilities
    299       724       791  
Corporate office relocation
    217       172        
Shutdown of Woods U.S. manufacturing
    (115 )           38  
Shutdown of Woods Canada manufacturing
    (14 )     134       841  
Consolidation of administrative functions for CCP
          21       215  
Other
                160  
 
                 
Total severance, restructuring and related costs
  $ (112 )   $ 1,090     $ 3,505  
 
                 
Consolidation of St. Louis manufacturing/distribution facilities — In 2002, the Company committed to a plan to consolidate the manufacturing and distribution of the four CCP facilities in the St. Louis, Missouri area. Management believed that in order to implement a more competitive cost structure and combat competitive pricing pressure, the excess capacity at the four plastic molding facilities in this area would need to be eliminated. This plan was expected to be completed by the end of 2003; however charges have been incurred past 2003 due to changes in assumptions in non-cancelable lease accruals. Charges in 2006 were for an adjustment to the non-cancelable lease accrual at the Hazelwood, Missouri facility due to the execution of a sublease on the property as well as an increased amount of usable manufacturing space currently required. Charges in 2005 and 2004 related to adjustments to previously established non-cancelable lease liabilities for abandoned facilities and costs for the movement of inventory and equipment. Management believes that no further charges will be incurred for this activity, except for potential adjustments to non-cancelable lease liabilities. Following is a rollforward of restructuring liabilities by type for the consolidation of St. Louis manufacturing/distribution facilities (amounts in thousands):
         
    Contract  
    Termination  
    Costs [b]  
Restructuring liabilities at December 31, 2004
  $ 2,402  
Additions
    100  
Reductions
    (61 )
Payments
    (596 )
 
     
Restructuring liabilities at December 31, 2005
  $ 1,845  
Additions
     
Reductions
    (499 )
Payments
    (881 )
 
     
Restructuring liabilities at December 31, 2006
  $ 465  
 
     
Consolidation of Glit facilities — In 2002, the Company approved a plan to consolidate the manufacturing facilities of its Glit business unit in order to implement a more competitive cost structure. It was anticipated that this activity would begin in early 2003 and be completed by the end of the second quarter of 2004. Due to numerous operational issues, including management turnover and a small fire at the Wrens, Georgia facility, the completion of this consolidation was delayed. In 2006, the Company completed the closure of the Pineville, North Carolina facility. Charges were incurred in 2006 associated with severance ($0.1 million) and costs for the movement of equipment ($0.2 million). In 2005, the Company completed the closure of the Lawrence, Massachusetts facility. Charges were incurred in 2005 associated with severance ($0.3 million), establishment of non-cancelable lease liability ($0.3 million) and other charges ($0.1 million). Charges were incurred in 2004 related to severance for expected terminations at the Lawrence facility ($0.4 million), the closure of the Pineville facility ($0.3 million) and expenses for the preparation of the Wrens facility ($0.1 million). Management believes that no further charges will be incurred for this activity. Following is a rollforward of restructuring liabilities by type for the consolidation of Glit facilities (amounts in thousands):

 

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            One-time     Contract          
            Termination     Termination          
    Total     Benefits [a]     Costs [b]     Other [c]  
Restructuring liabilities at December 31, 2004
  $ 983     $ 733     $ 250     $  
Additions
    724       313       263       148  
Payments
    (1,202 )     (791 )     (263 )     (148 )
 
                       
Restructuring liabilities at December 31, 2005
  $ 505     $ 255     $ 250     $  
Additions
    299       109             190  
Payments
    (799 )     (364 )     (245 )     (190 )
 
                       
Restructuring liabilities at December 31, 2006
  $ 5     $     $ 5     $  
 
                       
Corporate office relocation — In November 2005, the Company announced the closing of its corporate office in Middlebury, Connecticut, and the relocation of certain corporate functions to the CCP location in Bridgeton, Missouri, the outsourcing of other functions, and the move of the remaining functions to a new location in Arlington, Virginia. The amounts recorded in 2006 and 2005 primarily relate to severance for employees at the Middlebury office. Following is a rollforward of restructuring liabilities by type for the corporate office relocation (amounts in thousands):
         
    One-time  
    Termination  
    Benefits [a]  
Restructuring liabilities at December 31, 2004
  $  
Additions
    172  
Payments
    (15 )
 
     
Restructuring liabilities at December 31, 2005
  $ 157  
Additions
    217  
Payments
    (374 )
 
     
Restructuring liabilities at December 31, 2006
  $  
 
     
Shutdown of Woods U.S. manufacturing — During 2002, a major restructuring occurred at the Woods business unit. After significant study and research into different sourcing alternatives, Katy 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. In 2006, outstanding liabilities were removed as no additional restructuring activity was anticipated. All 2005 activity reflects payments on the non-cancelable lease accrual. During 2004, a charge of $0.3 million was recorded for the shutdown and relocation of a procurement office in Asia and was offset by a credit of $0.3 million to reverse a non-cancelable lease accrual based on a change in usage of a leased facility that was previously impaired. Following is a rollforward of restructuring liabilities by type for the shutdown of Woods U.S. manufacturing (amounts in thousands):
                         
            One-time     Contract  
            Termination     Termination  
    Total     Benefits [a]     Costs [b]  
Restructuring liabilities at December 31, 2004
  $ 261     $ 20     $ 241  
Additions
                 
Reductions
                 
Payments
    (176 )           (176 )
Currency translation and other
    110             110  
 
                 
Restructuring liabilities at December 31, 2005
  $ 195     $ 20     $ 175  
Additions
                 
Reductions
    (115 )     (19 )     (96 )
Payments
    (80 )     (1 )     (79 )
 
                 
Restructuring liabilities at December 31, 2006
  $     $     $  
 
                 

 

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Shutdown of Woods Canada manufacturing — In 2003, the Company approved a plan to shut down the manufacturing operation in Toronto, Ontario and source substantially all of its products from Asia. Management believed that this action was necessary in order to implement a more competitive cost structure to combat pricing pressure by producers in Asia. In connection with this shutdown, the Company also anticipated the sale and leaseback of this facility, which would provide additional liquidity. In December 2003, Woods Canada closed this manufacturing facility in Toronto, Ontario, but was unable to complete the sale/leaseback transaction at that time. Accordingly, the charge for the non-cancelable lease accrual was recorded in the first quarter of 2004, upon the completion of the sale/leaseback transaction. The idle capacity was a direct result of the elimination of the manufacturing function from this facility. A portion of the facility was available for sublease at the time the accrual was established. In 2005, a charge of $0.2 million was recorded for an adjustment to the non-cancelable lease accruals. In 2004, Woods Canada incurred a charge of $0.8 million for a non-cancelable lease accrual associated with a sale/leaseback transaction and idle capacity as a result of the shutdown of manufacturing. Also in 2004, Woods Canada recorded less than $0.1 million for additional severance. Management believes that no more costs will be incurred for this activity, except for potential adjustments to non-cancelable lease liabilities. Following is a rollforward of restructuring liabilities by type for the shutdown of Woods Canada manufacturing (amounts in thousands):
                         
            One-time     Contract  
            Termination     Termination  
    Total     Benefits [a]     Costs [b]  
Restructuring liabilities at December 31, 2004
  $ 808     $ 54     $ 754  
Additions
    153             153  
Reductions
    (19 )     (19 )      
Payments
    (242 )     (34 )     (208 )
Currency translation and other
    17       (1 )     18  
 
                 
Restructuring liabilities at December 31, 2005
  $ 717     $     $ 717  
Additions
                 
Reductions
    (14 )           (14 )
Payments
    (220 )           (220 )
Currency translation
    8             8  
 
                 
Restructuring liabilities at December 31, 2006
  $ 491     $     $ 491  
 
                 
Consolidation of administrative functions for CCP — In 2002, in order to streamline processes and eliminate duplicate functions, the Company initiated a plan to centralize certain administrative and back office functions into Bridgeton, Missouri from certain businesses within the Maintenance Products Group. This plan was anticipated to be completed in 2004 upon the transfer of functions from the Lawrence, Massachusetts facility (see Consolidation of Glit facilities above); however the closure was delayed and subsequently contributed to the delay in this plan until completion in 2005. Katy has incurred primarily severance costs over the past three years for this integration of back office and administrative functions. The most significant project is the centralization of the customer service functions for the Continental, Glit, Wilen, and Disco business units. Following is a rollforward of restructuring liabilities by type for the consolidation of administrative functions for CCP (amounts in thousands):
         
    One-time  
    Termination  
    Benefits [a]  
Restructuring liabilities at December 31, 2004
  $  
Additions
    21  
Payments
    (21 )
 
     
Restructuring liabilities at December 31, 2005
  $  
Additions
     
Payments
     
 
     
Restructuring liabilities at December 31, 2006
  $  
 
     
Other — During 2004, costs were incurred for the closure of CCP’s metals facility in Santa Fe Springs, California ($0.1 million) and for the closure of CCP’s facility in Canada and the subsequent consolidation into the Woods Canada facility ($0.1 million).

 

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A rollforward of all restructuring and related reserves since December 31, 2004 is as follows (amounts in thousands):
                                 
            One-time     Contract          
            Termination     Termination          
    Total     Benefits [a]     Costs [b]     Other [c]  
Restructuring and related liabilities at December 31, 2004
  $ 4,454     $ 807     $ 3,647     $  
Additions
    1,170       506       516       148  
Reductions
    (80 )     (19 )     (61 )      
Payments
    (2,252 )     (861 )     (1,243 )     (148 )
Currency translation and other
    127       (1 )     128        
 
                       
Restructuring and related liabilities at December 31, 2005
  $ 3,419     $ 432     $ 2,987     $  
Additions
    516       326             190  
Reductions
    (628 )     (19 )     (609 )      
Payments
    (2,354 )     (739 )     (1,425 )     (190 )
Currency translation
    8             8        
 
                       
Restructuring and related liabilities at December 31, 2006 [d]
  $ 961     $     $ 961     $  
 
                       
[a]  
Includes severance, benefits, and other employee-related costs associated with the employee terminations.
 
[b]  
Includes charges related to non-cancelable lease liabilities for abandoned facilities, net of potential sub-lease revenue. Total maximum potential amount of lease loss, excluding any sublease rentals, is $1.8 million as of December 31, 2006. The Company has included $0.8 million as an offset for sublease rentals.
 
[c]  
Includes charges associated with moving inventory, machinery and equipment, and consolidation of administrative and operational functions.
 
[d]  
Katy expects to substantially complete its restructuring program in 2007. The remaining severance, restructuring and related costs for these initiatives are expected to be approximately $0.3 million.
The table below details activity in restructuring and related reserves by operating segment since December 31, 2004 (amounts in thousands):
                                 
            Maintenance     Electrical        
            Products     Products        
    Total     Group     Group     Corporate  
Restructuring and related liabilities at December 31, 2004
  $ 4,454     $ 3,385     $ 1,069     $  
Additions
    1,170       845       153       172  
Reductions
    (80 )     (61 )     (19 )      
Payments
    (2,252 )     (1,819 )     (418 )     (15 )
Currency translation and other
    127             127        
 
                       
Restructuring and related liabilities at December 31, 2005
  $ 3,419     $ 2,350     $ 912     $ 157  
Additions
    516       299             217  
Reductions
    (628 )     (499 )     (129 )      
Payments
    (2,354 )     (1,680 )     (300 )     (374 )
Currency translation
    8             8        
 
                       
Restructuring and related liabilities at December 31, 2006
  $ 961     $ 470     $ 491     $  
 
                       

 

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The table below summarizes the future obligations for severance, restructuring and other related charges by operating segment detailed above (amounts in thousands):
                                 
            Maintenance     Electrical        
            Products     Products        
    Total     Group     Group     Corporate  
2007
  $ 419     $ 186     $ 233     $  
2008
    336       94       242        
2009
    75       59       16        
2010
    63       63              
2011
    68       68              
 
                       
Total Payments
  $ 961     $ 470     $ 491     $  
 
                       
Note 20. ACQUISITION
During the third quarter of 2005, CCP acquired substantially all of the assets and assumed certain liabilities of Washington International Non-Wovens, LLC (“WIN”), based in Washington, Georgia. The purchase price was approximately $1.7 million, including $0.6 million of ass