On December 8, 2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the Act) became law in the U.S. The act introduces a prescription drug benefit under Medicare, as well as a federal subsidy to sponsors of retiree health care benefit plans that provides retiree benefits in certain circumstances. FASB Staff Position (FSP) 106-2, Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003, issued in May 2004, requires measures of the accumulated postretirement benefit obligation (APBO) and net periodic postretirement benefit cost (NPPBC) to reflect the effects of the Act. FSP 106-2 is effective for the Company in the third quarter of fiscal 2004. Currently, APBO, which is reflected in the other liabilities section of the accompanying Condensed Consolidated Balance Sheet, and NPPBC, which is reflected in the accompanying Condensed Consolidated Statement of Operations, do not reflect the effects, if any, of the Act.

 

 

 

 

(13) Share Repurchase Program

    On May 10, 2004, the Company suspended its $5.0 million share repurchase program after announcing the resumption of the plan on April 20, 2004. The Company had previously suspended the program in November 2003. In 2004, 12,000 shares of common stock were repurchased on the open market for approximately $75 thousand under this plan, while in 2003, 482,800 shares of common stock were repurchased on the open market for approximately $2.5 million.

Company Overview

[b] Excludes discontinued operations.

Maintenance Products Group

The Maintenance Products Group’s performance declined during the second quarter of 2004 due to an overall decrease in net sales for the quarter (mostly due to volume) along with higher raw material costs which were only partially offset by lower depreciation from levels that were atypically high in 2003.  This was the result of the revision of the estimated useful lives of certain manufacturing assets, specifically molds and tooling equipment used in the manufacture of plastic products, from seven to five years, effective January 1, 2003.  This change in estimate was made following significant impairments to these types of assets recorded during 2002. Operating results were also favorably impacted by cost reduction initiatives including the consolidation of our facilities in the St. Louis area.

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Net sales

Net sales from the Maintenance Products Group decreased from $72.3 million during the three months ended June 30, 2003 to $69.7 million during the three months ended June 30, 2004, a decrease of 4%. Overall, this decline was due to lower volumes of 5%, partially offset by the favorable impact of exchange rates of 1%. We experienced volume declines in our Consumer business unit in the U.S., which sells primarily to mass market retail customers, primarily due to the loss of certain product lines with major outlet customers. Sales of abrasives products were lower due to shipping and production inefficiencies caused by the consolidation of two abrasives facilities into the Wrens, Georgia facility and were partially offset by stronger sales of roofing products to the construction industry. The Jan/San and Consumer businesses in the U.K. benefited from favorable exchange rates.

Since the fourth quarter of 2003, we centralized our customer service and administrative functions for CCP divisions Jan/San, Glit/Microtron (abrasives), Wilen (mops, brooms and brushes) and Disco (filters and grillbricks) in one location, allowing customers to order products from any CCP division on one purchase order. The customer service and administrative functions for the Loren business unit will be added during 2004. We believe that operating these businesses as a cohesive unit will improve customer service in that our customers’ purchasing processes will be simplified, as will follow up on order status, billing, collection and other related functions. This should also increase customer loyalty, help in attracting new customers and lead to increased top line sales in future years.

Operating loss

The group’s operating deficit improved by $0.1 million from $1.5 million in the second quarter of 2003 to $1.4 million in 2004, an improvement of 2%. The operating deficit for both periods was impacted by costs for severance, restructuring and related charges, while the 2003 period also included impairments of fixed assets.  Excluding those charges, operating income decreased by $2.9 million from income of $1.5 million during the three months ended June 30, 2003 to a $1.4 million deficit for the same period in 2004. The decrease in operating income was attributable mostly to lower volumes and margins for our abrasives business resulting from shipping and production inefficiencies caused by the consolidation of two abrasives facilities into the Wrens, Georgia facility. In addition, raw material costs were higher in the second quarter of 2004 versus the second quarter of 2003 and were not fully recoverable through higher selling prices. Operating results were positively impacted by lower depreciation levels that were atypically high in 2003 related to the revision of the estimated useful lives of certain manufacturing assets and benefits realized from the implementation of cost reduction strategies.

Operating results for the group during the three months ended June 30, 2004 and 2003 included severance, restructuring and related charges of $0.1 million and $1.1 million, respectively. Charges in the second quarter of 2004 related to the restructuring of the abrasives business ($0.3 million); the movement of inventory and equipment in connection with the consolidation of St. Louis manufacturing and distribution facilities ($0.1 million); and costs incurred for the consolidation of administrative functions for CCP and equipment removal and occupancy costs for the Santa Fe Springs, California metals facility ($0.1 million) offset by a credit of $0.4 million to reverse a non-cancelable lease accrual based on a change in usage of a previously impaired leased facility (Hazelwood, Missouri). During the second quarter of 2003, costs were incurred in connection with the consolidation of St. Louis manufacturing and distribution facilities ($0.5 million); the restructuring of the abrasives business ($0.3 million); severance for terminated employees at the Santa Fe Springs, California metals facility ($0.2 million); and severance costs for the elimination of certain employees in the Maintenance Products Group ($0.1 million). During the three months ended June 30, 2003, the group also recorded impairments of long-lived assets of $1.8 million associated primarily with injection molding machines at the Hazelwood, Missouri manufacturing facility.

Total assets for the group increased primarily as a result of increased inventory due to early purchasing of certain raw materials in advance of anticipated cost increases, higher raw material prices and to a lesser extent, higher accounts receivable.

 

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Electrical Products Group

The Electrical Products Group continued its strong performance into the second quarter of 2004, driven primarily by higher volumes at Woods versus the second quarter of 2003, and secondarily, by higher margins over the prior year resulting from Woods Canada’s decision to source substantially all of its products from Asia.

Net sales

The Electrical Product Group’s sales improved from $29.2 million in the second quarter of 2003 to $30.8 million in the second quarter of 2004, an increase of 6%. Higher pricing of 7% and favorable currency translation of 1% were partially offset by lower volumes of 2% in the overall group. Higher selling prices were implemented in the first and second quarters of 2004 to offset the rising cost of copper, but were offset slightly by pricing declines due to increasing levels of direct import sales (sales from our vendors directly to our customers, which generally provide lower gross margins) at Woods Canada. Sales at Woods Canada were also impacted by a stronger Canadian dollar versus the U.S. dollar in the second quarter of 2004. Woods Canada experienced volume declines due to the loss of certain lines of business at certain customers and to a lesser extent the timing of sales between 2003 and 2004, which were partially offset by improved sales performance at Woods during the three months ended June 30, 2004. Woods benefited from new store and same store growth for its two largest customers, both national mass market retailers.

Operating income

The group’s operating income increased from $0.8 million for the three months ended June 30, 2003 to $2.7 million for the three months ended June 30, 2004, an increase of 228%. Operating income in the second quarter of 2003 and 2004 was impacted by severance, restructuring and related costs (income), which are discussed further below. Excluding these costs (income), operating income increased from $1.0 million for the second quarter of 2003 to $2.5 million for the same period in 2004, an increase of 142%. The strong volume increases at Woods as well as improved gross margins contributed to the higher profitability of the Electrical Products Group. Margins were positively impacted in the second quarter of 2004 by the closure of the Woods Canada manufacturing facility in December 2003 and the completion of a fully outsourced product strategy. Higher selling prices were mostly offset by an increase in raw materials (principally copper).

Operating results in the first three months of 2004 and 2003 included severance, restructuring and related charges (income) of ($0.2) million and $0.2 million, respectively. In the second quarter of 2004, the group recorded credits to reverse a non-cancelable lease accrual based on a change in usage of leased facility that was previously impaired at Woods ($0.1 million) and to reverse a portion of a severance accrual at Woods Canada related to the December 2003 shutdown of their manufacturing facility ($0.1 million). Costs in the second quarter of 2003 were primarily for fees paid to a consultant for initiatives related primarily to sourcing products for the Woods and Woods Canada businesses ($0.1 million) and severance related to the December 2002 Woods manufacturing facility shutdown.

Total assets for the group decreased $0.8 million as lower accounts receivable balances due to seasonally lower sales at the end of the second quarter of 2004 versus the end of 2003 and lower fixed assets (primarily due to the sale of the Woods Canada manufacturing facility) were partially offset by higher inventory levels resulting from the early purchasing of products in advance of anticipated supplier price increases, higher material costs (due to the increase in copper prices) and a planned build in connection with closure of the Woods Canada manufacturing facility.

 

 

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		Six Months
		Ended June 30,
		2004			2003
Net sales			100.0	%		100.0	%
Cost of goods sold			85.1	%		85.3	%
Gross profit			14.9	%		14.7	%
Selling, general and administrative expenses			(14.5	%)		(15.7	%)
Severance, restructuring and related charges			(0.9	%)		(1.0	%)
Impairments of long-lived assets			0.0	%		(0.9	%)
Operating loss			(0.4	%)		(3.0	%)
Equity in loss of equity method investment			0.0	%		(0.1	%)
Gain on sale of assets			0.3	%		0.4	%
Interest expense			(0.9	%)		(1.9	%)
Other, net			(0.1	%)		0.2	%
Loss before provision for income taxes			(1.2	%)		(4.3	%)
Provision for income taxes			(0.3	%)		0.0	%
Loss from continuing operations before distributions on preferred
interest of subsidiary			(1.5	%)		(4.3	%)
Distributions on preferred interest of subsidiary (net of tax)			0.0	%		(0.1	%)
Loss from continuing operations			(1.5	%)		(4.4	%)
Income from operations of discontinued businesses (net of tax)			0.0	%		0.8	%
Loss on sale of discontinued business			0.0	%		(0.1	%)
Net loss			(1.5	%)		(3.7	%)
Gain on early redemption of preferred interest of subsidiary			0.0	%		3.4	%
Payment in kind dividends on convertible preferred stock			(3.5	%)		(3.1	%)
Net loss attributable to common stockholders			(5.0	%)		(3.4	%)

Company Overview

    Overall, net sales for the Company in the first half of 2004 increased $8.5 million, or 4%, from the first half of 2003. Higher net sales resulted from a volume increase of 2% and favorable currency translation of 2%. Gross margins were 14.9% in the six months ended December 31, 2004 an increase of 0.2 percentage points from the same period of 2003. The favorable impact of restructuring, cost containment and lower depreciation was offset partially by higher raw material costs and incremental operating costs incurred due the consolidation of the abrasives facilities. Selling, general and administrative expenses (SG&A) as a percentage of sales declined from 15.7% in the first half of 2003 to 14.5% in the first half of 2004. This decrease can be primarily attributed to maintaining these costs despite the increase in net sales. The operating deficit was reduced $4.8 million to $0.9 million, mostly as a result of improved sales, lower SG&A, lower impairments, and lower severance, restructuring and related charges. Excluding these charges, the Company experienced operating profit of $0.9 million during the six months ended June 30, 2004 versus an operating deficit of $1.9 million during the six months ended June 30, 2003. To provide additional transparency about measures of the Company’s performance, we supplement the reporting of our financial information under generally accepted accounting principles (GAAP) with non-GAAP information on operating income (loss) excluding severance, restructuring and related charges and impairments of long-lived assets. We believe the use of this measure is a better indicator of the underlying operating performance of the Company’s businesses and allows us to make meaningful comparisons of different operating periods.

    Interest expense decreased by $1.8 million in the first half of 2004 versus the same period of 2003, primarily due to the write-off of unamortized debt costs of $1.2 million in the first quarter of 2003 resulting from a February 2003 refinancing. Excluding the write-off, interest expense decreased by $0.6 million, due mainly to lower average borrowings during the first six months of 2004, principally as a result of applying the proceeds from the sale of non-core businesses in 2003 to repay debt. Other, net for the six months ended June 30, 2004 included the write-off of fees and expenses of $0.4 million associated with a financing which the Company chose not to pursue, offset by the write-off of net liabilities related to previously divested businesses of $0.1 million. Other, net for the six months ended June 30, 2003 consisted of the write-off of net liabilities related to previously divested businesses of $0.3 million.

The Bank of America Credit Agreement allows us to more efficiently leverage our entire asset base, and to create more borrowing capacity under our new Revolving Credit Facility. 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 $24.9 million at June 30, 2004. The Term Loan also has a final maturity date of April 20, 2009 with quarterly payments of $0.7 million. A final payment of $6.4 million is scheduled to be paid in April 2009. The term loan is collateralized by the Company’s 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 June 30, 2004, total outstanding letters of credit were $8.8 million.

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. Customary financial covenants and restrictions apply under the Bank of America Credit Agreement. Until September 30, 2004, interest accrues on the 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. Subsequent to September 30, 2004 in accordance with the Bank of America Credit Agreement, our margins (i.e. the interest rate spread above LIBOR) could increase depending upon certain leverage measurements. Also in accordance with the Bank of America Credit Agreement, margins on the term borrowings will drop an additional 25 basis points if the balance of the Term Loan is reduced below $10.0 million. Interest accrues at higher margins on prime rates for swing loans, the amounts of which were nominal at June 30, 2004.

We have incurred additional debt issuance costs in 2004 associated with the Bank of America Credit Agreement. Additionally, at the time of the inception of the New Fleet Credit Agreement, we had approximately $4.0 million of unamortized debt issuance costs associated with the previous credit agreement. The remainder of the previously capitalized costs, along with the capitalized costs from the Bank of America Credit Agreement will be amortized over the life of the Bank of America Credit Agreement through April 2009. Also, during the first quarter of 2004, we incurred fees and expenses of $0.4 million associated with a financing which the Company chose not to pursue.

 

The revolving credit facility under the Bank of America Credit Agreement requires lockbox agreements which provide for all receipts to be swept daily to reduce borrowings outstanding. These agreements, combined with the existence of a material adverse effect (MAE) clause in the Bank of America Credit Agreement, causes the revolving credit facility to be classified as a current liability (except as noted below), per guidance in the Emerging Issues Task Force (EITF) Issue No. 95-22, Balance Sheet Classification of Borrowings Outstanding under Revolving Credit Agreements that Include Both a Subjective Acceleration Clause and a Lock-Box Arrangement. We do not expect to repay, or be required to repay, within one year, the balance of the revolving credit facility classified as a current liability. The MAE clause, which is a fairly typical requirement in commercial credit agreements, allows the lenders to require the loan to become due if they determine there has been a material adverse effect on our operations, business, properties, assets, liabilities, condition or prospects. The classification of the revolving credit facility as a current liability (except as noted above) is a result only of the combination of the two aforementioned factors: the lockbox agreements and the MAE clause. The Bank of America Credit Agreement does not expire or have a maturity date within one year, but rather has a final expiration date of April 20, 2009. Also, we were in compliance with the applicable financial covenants of the Bank of America Credit Agreement at June 30, 2004. The lender had not notified us of any indication of a MAE at June 30, 2004, and we were not in default of any provision of the Bank of America Credit Agreement at June 30, 2004.

 

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The Bank of America Credit Agreement, and the additional borrowing ability under the Revolving Credit Facility obtained by incurring new term debt, results in three important benefits related to our long-term strategy: 1) additional borrowing capacity to invest in capital expenditures and/or acquisitions key to our strategic direction, 2) increased working capital flexibility to build inventory when necessary to accommodate lower cost outsourced finished goods inventory and 3) the ability to borrow locally in Canada and the United Kingdom and provide a natural hedge against currency fluctuations.

On May 10, 2004, we suspended our $5.0 million share repurchase program after announcing the resumption of the plan on April 20, 2004.  We had previously suspended the program in November 2003. In 2004, 12,000 shares of common stock were repurchased on the open market for approximately $75 thousand under this plan, while in 2003, 482,800 shares of common stock were repurchased on the open market for approximately $2.5 million.

Funding for capital expenditures and working capital needs is expected to be accomplished through the use of available borrowings under the Bank of America Credit Agreement. Anticipated capital expenditures are expected to be slightly higher in 2004 than in 2003, mainly due to additional investments planned for the development of new products. Restructuring and consolidation activities are important to reducing our cost structure to a competitive level. We believe that our operations and the Bank of America Credit Agreement provide sufficient liquidity for our operations going forward.

We have a number of obligations and commitments, which are listed on the schedule later in this section entitled “Contractual Cash Obligations” and “Other Commercial Commitments.” We have considered all of these obligations and commitments in structuring our capital resources to ensure that they can be met. See the notes accompanying the table in that section for further discussions of those items.

We are continually evaluating alternatives relating to divestitures of certain of our businesses. Divestitures present opportunities to de-leverage our financial position and free up cash for further investments in core activities. In addition to the sale of the GC/Waldom and Duckback businesses in 2003 for aggregate proceeds of $23.6 million, we sold additional assets in 2003 and the first six months of 2004 for net proceeds of $2.8 million and $5.5 million, respectively. The largest of these was the March 31, 2004 sale of the Woods Canada manufacturing facility in Toronto, Ontario for net proceeds of $3.2 million, all of which was used to repay our outstanding debt obligations. Contemporaneously with the sale, Woods Canada entered into a five-year lease with the buyer to continue the distribution of their products from that facility. In addition, we sold our vacant metals facility in Santa Fe Springs, California on June 28, 2004 for net proceeds of $1.9 million.

 

OFF-BALANCE SHEET ARRANGEMENTS

Contractual Obligations and Commercial Obligations

Katy’s obligations as of June 30, 2004 are summarized below:

(In thousands of dollars)

 

 

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Contractual Cash Obligations		Total			Due in less than 1 year			Due in 1-3 years			Due in 4-5 years			Due after  5 years
Revolving credit facility [a]		$	43,022		$	-		$	-		$	43,022		$	-
Term loans			19,286			2,857			5,714			5,714			5,001
Operating leases [b]			29,135			8,859			12,203			6,547			1,526
Severance and restructuring [b]			2,891			1,598			897			341			55
SESCO payable to Montenay [c]			3,800			1,050			2,200			550			-
Total Contractual Obligations		$	98,134		$	14,364		$	21,014		$	56,174		$	6,582
Other Commercial Commitments			Total			Due in less than 1 year			Due in 1-3 years			Due in 4-5 years			Due after 5 years
Commercial letters of credit		$	503		$	503		$	-		$	-		$	-
Stand-by letters of credit			8,300			8,300			-			-			-
Guarantees [d]			30,435			6,765			23,670			-			-
Total Commercial Commitments		$	39,238		$	15,568		$	23,670		$	-		$	-

 

 

[a] As discussed in the Liquidity and Capital Resources section above, a portion of the Bank of America Revolving Credit Facility is classified as a current liability on the Condensed Consolidated Balance Sheets as a result of the combination in the Bank of America Credit Agreement of 1) lockbox agreements on Katy’s depository bank accounts and 2) a subjective Material Adverse Effect (MAE) clause. The Revolving Credit Facility expires in April of 2009.

 

[b] These obligations represent liabilities associated with restructuring activities, other than liabilities for non-cancelable lease rentals. Future non-cancelable lease rentals are included in the line entitled “Operating leases.” Our Condensed Consolidated Balance Sheet at June 30, 2004 includes $5.9 million 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.

 

[c] Amount owed to Montenay as a result of the SESCO partnership. $1.1 million of this obligation is classified in the Condensed Consolidated Balance Sheets as an Accrued Expense in Current Liabilities, while the remainder is included in Other Liabilities, recorded on a discounted basis.

 

[d] SESCO, an indirect wholly-owned subsidiary of Katy, is party to a partnership that operates a waste-to-energy facility and has certain contractual obligations, for which Katy provides guarantees. If the partnership is not able to perform its obligations under the contracts, under certain circumstances SESCO and Katy could be subject to damages equal to the amount of Industrial Revenue Bonds outstanding (which financed construction of the facility) of $30.4 million less amounts held by the partnership in debt service reserve funds. Katy and SESCO do not anticipate non-performance by parties to the contracts. See Note 5 to the Condensed Consolidated Financial Statements in Part I, Item 1.

 

 

SEVERANCE, RESTRUCTURING AND RELATED CHARGES   

 

    See Note 12 to the Condensed Consolidated Financial Statements in Part I, Item 1 for a discussion of severance, restructuring and related charges.

 

 

OUTLOOK FOR 2004       

   We continue to anticipate only a modest improvement in 2004 from the general economic conditions and business environment that existed in 2003. However, we have seen recent improvement in the restaurant, travel and hotel markets to which we sell products. We have also seen a strong first half sales performance from the Woods and Woods Canada retail electrical corded products business, and we expect to see that performance continue into the second half of the year. We have a significant concentration of customers in the mass-market retail, discount and do-it-yourself market channels. Our ability to maintain and increase our sales levels depends in part on our ability to retain and improve relationships with these customers. In addition, while we face uncertainty with respect to the replacement of NOMA®-branded sales as Woods Canada has lost the right to use the NOMA® trademark effective July 1, 2004, we believe, based on performance through the end of the second quarter, that we will be able to replace these sales in 2004. We also face the continuing challenge of recovering or offsetting cost increases for raw materials.   

 

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    We expect increases in raw material costs to impact gross margins. Further, the consolidation of our abrasives facilities has been delayed. We anticipate these developments to be partially off set by the benefits of various profit enhancing strategies implemented since the recapitalization of the Company in June 2001. These strategies include outsourcing previously manufactured products, as well as locating new vendors for products already sourced outside of our facilities. We have significantly reduced headcount, and continue to monitor whether we can further consolidate any of our facilities. 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 Jan/San and consumer plastic businesses. Prices of plastic resins, such as polyethylene and polypropylene, increased steadily from the latter half of 2002 through the middle of 2003, then fell slightly in the second half of the year, and have increased again during the first half of 2004. 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 expect resin prices to remain high during the second half of 2004. We are also exposed to price changes for copper (a primary material in many of the products sold by Woods and Woods Canada), aluminum and steel (primary materials in production of truck boxes), corrugated packaging material and other raw materials. Prices for aluminum and steel have increased throughout 2004, while prices for copper increased in the early part of 2004 and have now stabilized. We have not employed an active hedging program related to our commodity price risk, but are employing other strategies for managing this risk, including contracting for a certain percentage of resin needs through supply agreements and opportunistic spot purchases. In a climate of rising raw material costs, we experience difficulty in raising prices to share these higher costs to our customers. However, price increases were passed along to our Woods’ customers during 2004 as a result of the rise in copper prices in late 2003 and early 2004 and we are implementing price increases on certain plastic products.

 

    Depreciation expense was higher during 2003 as a result of the reduction in depreciable lives for certain CCP manufacturing assets, specifically molds and tooling equipment used in the manufacture of plastic products, from seven to five years, effective January 1, 2003. This change in estimate was made following significant impairments to these types of assets recorded during 2002. The amount of incremental depreciation expense during 2003 as a result of this reduction in depreciable lives was $5.4 million. However, many of these assets became fully depreciated during 2003 since the CCP acquisition occurred in early 1999. Therefore, depreciation expense related to these assets is expected to reduce again in 2004 and subsequent years. Our total depreciation expense in 2004 and subsequent years will also depend on changes in the level of depreciable assets.    

 

    Selling, general and administrative expenses have declined this year as a percentage of sales and should remain stable or drop as a percentage of sales from 2003 levels in the second half of 2004. Cost reduction efforts are ongoing throughout the Company. We expect to maintain modest headcount and rental costs for our corporate office. We have completed the process of transferring most back-office functions of our Wilen (mops, brooms and brushes) and Glit/Microtron (abrasives) businesses from Georgia to Bridgeton, Missouri, the headquarters of CCP. We have now completed the process of transferring the back-office functions of our Disco (filters and miscellaneous food service items) business in McDonough, Georgia to Bridgeton, Missouri. We will consolidate administrative processes at our Loren business unit during the second half of 2004 and will continue to evaluate the possibility of further consolidation of administrative processes.    

 

    We are nearing completion of several restructuring plans involving our operations. During 2002 and 2003, we announced plans to consolidate the Warson Road and Earth City facilities as well as a portion of the Hazelwood facility into the Bridgeton facility. All of these facilities are located in the St. Louis, Missouri area. The moves from the Warson Road, Hazelwood and Earth City facilities are now complete. Hazelwood will continue to operate on a satellite basis to support our Bridgeton facility. Certain molding machines have been and may continue to be transferred to the Bridgeton facility and excess machinery will be sold. The significant charges recorded during 2002 and 2003 related to these facilities were mainly to accrue non-cancelable lease payments for these facilities. These accruals do not create incremental cash obligations in that we are obligated to make the associated payments whether we occupy the facilities or not. The amount we will ultimately pay out under these accruals is dependent on our ability to successfully sublet all or a portion of the abandoned facilities. We expect the Jan/San and consumer plastics business units to continue to benefit from lower overhead costs in 2004 as a result of these consolidations. In 2002, the Company initiated a plan to consolidate the manufacturing facilities of its abrasives business in order to implement a more competitive cost structure.  We expect that the Lawrence, Massachusetts and the Pineville, North Carolina facilities will be closed by the end of 2004 and those operations will be consolidated into the newly expanded Wrens, Georgia facility. Charges have been recorded in 2003 and 2004 principally for the closure of facilities, expansion of the Wrens facility and severance for terminated employees.

 

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Our integration cost reduction efforts, integration of back office functions and simplifications of our business transactions are all dependent on executing a system integration plan. This plan involves the migration of data across information technology platforms and implementation of new software and hardware. The domestic systems integration plan was substantially completed in October 2003, while the international systems integration plan will be completed by the end of 2004.   

 

    The labor agreement with our largest union expires in late December. Historically, the parties have been successful in negotiating new agreements. While we remain optimistic regarding these upcoming negotiations, we also recognize there are some issues of potential dispute, primarily economic in nature. Accordingly, we will be taking appropriate actions to ensure that our ability to service our customers is not impeded during this time frame.

 

We originally expected interest rates in 2004 to be slightly higher than 2003; however, rates in 2004 have been relatively comparable to last year. Ultimately, we cannot predict the future levels of interest rates. Until September 30, 2004, interest accrues on the Bank of America Credit Facility borrowings at 175 basis points over applicable LIBOR rates, and at 200 basis points over LIBOR for Term Loan borrowings. Subsequent to September 30, 2004 in accordance with the Bank of America Credit Agreement, our margins (i.e. the interest rate spread above LIBOR) could increase depending upon certain leverage measurements. Also margins on the term borrowings will drop an additional 25 basis points if the balance of the Term Loan is reduced below $10.0 million. 

 

Given our history of operating losses, along with guidance provided by the accounting literature covering accounting for income taxes, we are unable to conclude it is more likely than not that we will be able to generate future taxable income sufficient to realize the benefits of deferred tax assets carried on our books. Therefore, a full valuation allowance on the net deferred tax asset position was recorded at June 30, 2004 and December 31, 2003, and we do not expect to record the benefit of any deferred tax assets that may be generated in 2004. We will continue to record current expense associated with federal, foreign and state income taxes.    

 

We are continually evaluating alternatives that relate to divestitures of non-core businesses. Divestitures present opportunities to de-leverage our financial position and free up cash for further investments in core activities.

 

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.

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-Our inability to reduce administrative costs through consolidation of functions and systems improvements.

-Our inability to execute our systems integration plan.

 

-Our inability to successfully integrate our operations as a result of the facility consolidations.

-Our inability to sub-lease rented facilities which have been abandoned as a result of consolidation and restructuring initiatives.

-Our inability to achieve product price increases, especially as they relate to potentially higher raw material costs.

-The potential impact of losing lines of business at large retail outlets in the discount and do-it-yourself markets.

-Competition from foreign competitors.

-The potential impact of new distribution channels, such as e-commerce, negatively impacting us and our existing channels.

-The potential impact of rising interest rates on our LIBOR-based Bank of America Credit Agreement.

-Our inability to meet covenants associated with the Bank of America Credit Agreement.

-The potential impact of rising costs for insurance for properties and various forms of liabilities.

-The potential impact of changes in foreign currency exchange rates related to our foreign operations.

-Labor issues, including union activities that require an increase in production costs or lead to a strike, thus impairing production and decreasing sales. We are

 also subject to labor relations issues at entities involved in our supply chain, including both suppliers and those involved in transportation and shipping.

-Changes in significant laws and government regulations affecting environmental compliance and income taxes.

-Our inability to replace lost sales due the loss of the NOMA® -branded products at Woods Canada.

 

Words and phrases such as “expects,” “estimates,” “will,” “intends,” “plans,” “believes,” “anticipates” and the like are intended to identify forward-looking statements. The results referred to in forward-looking statements may differ materially from actual results because they involve estimates, assumptions and uncertainties. Forward-looking statements included herein are as of the date hereof and we undertake no obligation to revise or update such statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. All forward-looking statements should be viewed with caution.

 

ENVIRONMENTAL AND OTHER CONTINGENCIES

 

See Note 10 to the Condensed Consolidated Financial Statements in Part I, Item 1 for a discussion of environmental and other contingencies.

    

 

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RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS   

 

See Note 2 to the Condensed Consolidated Financial Statements in Part I, Item 1 for a discussion of recently issued accounting pronouncements.

 

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Interest Rate Risk

 

Our exposure to market risk associated with changes in interest rates relates primarily to our debt obligations. We currently do not use derivative financial instruments relating to this exposure. Our interest obligations on outstanding debt at June 30, 2004 were indexed from short-term LIBOR. We do not believe our exposures to interest rate risks are material to our financial position or results of operations.

 

Foreign Exchange Risk   

 

We are exposed to fluctuations in the Euro, British pound, Canadian dollar and Chinese Yuan. Some of our subsidiaries make significant U.S. dollar purchases from Asian suppliers, particularly in China. An adverse change in foreign currency exchange rates of Asian countries could result in an increase in the cost of purchases. We do not currently hedge foreign currency transaction or translation exposures.

 

Commodity Price Risk

 

We have not employed an active hedging program related to our commodity price risk, but are employing other strategies for managing this risk, including contracting for a certain percentage of resin needs through supply agreements and opportunistic spot purchases. See Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - OUTLOOK FOR 2004, for further discussion of our exposure to increasing raw material costs.

 

Item 4. CONTROLS AND PROCEDURES

 

(a)  Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our SEC filings is reported within the time periods specified in the SEC's rules, and that such information is accumulated and communicated to our management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. We have investments in certain unconsolidated entities. As we do not control or manage these entities, the disclosure controls and procedures with respect to such entities are necessarily more limited than those we maintain with respect to our consolidated subsidiaries.

Pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934, Katy carried out an evaluation, under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (pursuant to Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period of our report. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information relating to Katy (including its consolidated subsidiaries) required to be included in our periodic SEC filings.

 

(b)  Change in Internal Controls

 

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There have been no changes in Katy’s internal control over financial reporting during the quarter ended June 30, 2004 that has materially affected, or is reasonably likely to materially affect Katy’s internal control over financial reporting.

 

PART II - OTHER INFORMATION

Item 1. LEGAL PROCEEDINGS

During the quarter for which this report is filed, there have been no material developments in previously reported legal proceedings, and no other cases or legal proceedings, other than a) ordinary routine litigation incidental to the Company’s business and other nonmaterial proceedings, brought against the Company and b) updates to those matters specified in Note 10 to the Condensed Consolidated Financial Statements in Part I, Item 1. 

Item 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PROCEEDS OF EQUITY SECURITIES

 

		Total Number			Average			Total Number of Shares			Maximum Dollar Value
		of Shares			Price Paid			Purchased as Part of			that May Yet Be
Period		Purchased			per Share			Publicly Announced Plan			Purchased Under the Plan (1)
April 2004
(4/22/04 - 4/30/04)			10,200		$	6.25			493,000		$	2,416,134
May 2004
(5/4/04 - 5/7/04)			1,800		$	6.26			494,800		$	2,404,866
June 2004			-		$	-			-		$	-
Total			12,000		$	6.25			494,800		$	2,404,866

(1)  On April 20, 2003, the Company announced a plan to spend up to $5.0 million to repurchase shares of its common stock. During 2003, the Company repurchased 482,800 shares of its common stock on the open market for approximately $2.5 million. The Company suspended further purchases under the plan on May 10, 2004.

Item 4.   SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

The Annual Meeting of Stockholders of Katy Industries, Inc. was held at The Heritage - A Dolce Conference Resort, 522 Heritage Road, Southbury, Connecticut, at 10:00 AM, on May 27, 2004. Stockholders voted on two proposals, summarized below with the accompanying number of votes in favor, opposed, or abstained.

PROPOSAL No. 1: Election of Directors

CLASS II DIRECTORS:
Name	Votes For	Votes Withheld
Robert M. Baratta	6,982,461	159,791
Daniel B. Carroll	7,050,009	92,943
Wallace E. Carroll, Jr.	7,046,440	95,812
C. Michael Jacobi	6,982,061	160,191

    The required vote for directors was the affirmative vote of a plurality of the votes cast at the annual meeting. As a result of the vote, each of the four nominees for Class I directors was elected. The specified term of the Company’s Class II directors, Christopher Lacovara, James Kohlberg, William F. Andrews, Christopher Anderson and Samuel Frieder, is through the Company’s 2005 Annual Meeting.

PROPOSAL No. 2: To ratify the selection of PricewaterhouseCoopers LLP as the independent public accountants of Katy for the fiscal year ending December 31, 2004.

 

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Votes For	Votes Against	Votes Abstained
7,052,791	85,536	3,925

The required vote to ratify the appointment of PricewaterhouseCoopers LLP was the majority of Katy’s outstanding common stock present, in person or by proxy, at the annual meeting. As a result of the vote, the selection of PricewaterhouseCoopers LLP was ratified.

Item 6. EXHIBITS AND REPORTS ON FORM 8-K

(a)Exhibits

10.1 First Amendment to Amended and Restated Loan Agreement dated as of June 29, 2004 with Fleet Capital Corporation, filed herewith.

 

31.1 Certification of Chief Executive Officer pursuant to Securities Exchange Act Rule 13a-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

31.2 Certification of Chief Financial Officer pursuant to Securities Exchange Act Rule 13a-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

(b) Reports on Form 8-K

 

    -Form 8-K, Item 12 furnished May 5, 2004, including press release and schedules announcing results of operations for the first quarter of 2004 (not incorporated by reference).

 

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Signatures

Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

KATY INDUSTRIES, INC.

Registrant

DATE: August 16, 2004                                           By /s/ C. Michael Jacobi

                                C. Michael Jacobi

                                President and Chief Executive Officer

                                                                By /s/ Amir Rosenthal

                                Amir Rosenthal

                                Vice President, Chief Financial Officer,

                                General Counsel and Secretary

 

 

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