Note 1. SIGNIFICANT ACCOUNTING POLICIES

9 Months Ended

Sep. 30, 2011

Significant Accounting Policies [Text Block]

Note 1.  SIGNIFICANT ACCOUNTING POLICIES

Consolidation Policy and Basis of Presentation – The condensed consolidated financial statements include the accounts of Katy Industries, Inc. and subsidiaries in which it has a greater than 50% voting interest or significant influence, collectively “Katy” or the “Company”.  All significant intercompany accounts, profits and transactions have been eliminated in consolidation.  The Condensed Consolidated Balance Sheet at September 30, 2011 and the related Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2011 and October 1, 2010 and Cash Flows for the nine months ended September 30, 2011 and October 1, 2010 have been prepared without audit, pursuant to the rules and regulations of the Securities and Exchange Commission, and reflect all adjustments (consisting only of normal recurring adjustments) which are, in the opinion of management, necessary for a fair presentation of the financial condition, results of operations and cash flows of the Company for the interim periods.  Interim results may not be indicative of results to be realized for the entire year.  The condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto, together with management’s discussion and analysis of financial condition and results of operations, contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.  The Condensed Consolidated Balance Sheet as of December 31, 2010 was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States (“GAAP”).

Fiscal Year – The Company operates and reports using a 4-4-5 fiscal year which always ends on December 31.  As a result, December and January do not typically consist of five and four weeks, respectively.  The three and nine months ended September 30, 2011 consisted of 63 shipping days and 190 shipping days, respectively, and the three and nine months ended October 1, 2010 consisted of 63 shipping days and 191 shipping days, respectively.

Use of Estimates and Reclassifications – The preparation of financial statements in conformity with GAAP 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.

Certain reclassifications on the Condensed Consolidated Balance Sheets and Condensed Consolidated Statements of Cash Flows were made to the 2010 amounts in order to conform to the 2011 presentation.

Inventories – The components of inventories are as follows (amounts in thousands):

	September 30,			December 31,
	2011			2010
Raw materials	$	7,485		$	7,845
Finished goods		13,524			12,226
Inventory reserves		(1,165	)		(1,250	)
LIFO reserve		(4,679	)		(3,812	)
	$	15,165		$	15,009

At September 30, 2011 and December 31, 2010, approximately 57% and 56%, 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 $4.7 million and $3.8 million at September 30, 2011 and December 31, 2010, respectively.

Share-Based Payment – Compensation cost recognized during the three and nine months ended September 30, 2011 and October 1, 2010 includes: a) compensation cost for all stock options based on the grant date fair value amortized over the options’ vesting period and b) compensation cost for outstanding stock appreciation rights (“SARs”) as of September 30, 2011 and October 1, 2010 based on the September 30, 2011 and October 1, 2010 fair value, respectively.  The Company re-measures the fair value of SARs each reporting period until the award is settled and compensation expense is recognized each reporting period for changes in fair value and vesting.

Compensation (income) expense is included in selling, general and administrative expense in the Condensed Consolidated Statements of Operations.  The components of compensation (income) expense are as follows (amounts in thousands):

	Three Months Ended						Nine Months Ended
	September 30,			October 1,			September 30,			October 1,
	2011			2010			2011			2010
Stock option (income) expense	$	-		$	42		$	(274	)	$	173
Stock appreciation right income		(23	)		(177	)		(336	)		(283	)
	$	(23	)	$	(135	)	$	(610	)	$	(110	)

For the nine months ended September 30, 2011, stock option income resulted from the reversal of compensation expense recognized on the cancellation of unvested stock options previously held by the Company’s Chief Executive Officer, the Company’s Chief Financial Officer and the Company’s former Vice President-Operations.

The fair value of stock options is estimated at the date of grant using a Black-Scholes option pricing model.  As the Company does not have sufficient historical exercise data to provide a basis for estimating the expected term, the Company uses the simplified method for estimating the expected term by averaging the minimum and maximum lives expected for each award.  In addition, the Company estimated volatility by considering its historical stock volatility over a term comparable to the remaining expected life of each award.  The risk-free interest rate is the current yield available on U.S. treasury issues with a remaining term equal 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.  There were no stock options granted during the three and nine months ended September 30, 2011 and October 1, 2010.

The fair value of SARs, a liability award, was estimated at September 30, 2011 and October 1, 2010 using a Black-Scholes option pricing model.  The Company estimated the expected term by averaging the minimum and maximum lives expected for each award.  In addition, the Company estimated volatility by considering its historical stock volatility over a term comparable to the remaining expected life of each award.  The risk-free interest rate is the current yield available on U.S. treasury issues with a remaining term equal 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 assumptions for expected term, volatility and risk-free rate are presented in the table below:

	September 30,	October 1,
	2011	2010
Expected term (years)	1.2 - 5.0	0.1 - 6.0
Volatility	187.4% - 246.2%	139.5% - 207.8%
Risk-free interest rate	0.2% - 1.0%	0.2% - 1.6%

Comprehensive (Loss) Income – The components of comprehensive (loss) income are as follows (amounts in thousands):

	Three Months Ended						Nine Months Ended
	September 30,			October 1,			September 30,			October 1,
	2011			2010			2011			2010
Net loss	$	(1,132	)	$	(1,585	)	$	(3,689	)	$	(2,238	)
Foreign currency translation (gains) losses		(94	)		(7	)		98			53
Comprehensive loss	$	(1,226	)	$	(1,592	)	$	(3,591	)	$	(2,185	)

The components of accumulated other comprehensive (loss) income are foreign currency translation adjustments and pension and other postretirement benefits adjustments.  The balance of foreign currency translation adjustments was $0.6 million and $0.7 million at September 30, 2011 and December 31, 2010, respectively.  The balance of pension and other postretirement benefits adjustments was $0.7 million at each of September 30, 2011 and December 31, 2010.

Segment Reporting – Operating segments are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief decision maker or group in deciding how to allocate resources and in assessing performance.  The Company’s chief decision maker reviews the results of operations and requests for capital expenditures based on one industry segment: manufacturing, importing and distributing commercial cleaning and storage products.  The Company’s entire revenue is generated through this segment.