diff --git a/demos/blocklyfactory/factory.css b/demos/blocklyfactory/factory.css
index 5a6600eeb..dad8922c3 100644
--- a/demos/blocklyfactory/factory.css
+++ b/demos/blocklyfactory/factory.css
@@ -430,8 +430,9 @@ td {
   padding-right: 20px;
 }
 
-.test {
-  border: 1px solid black;
+.disabled {
+  background-color: white;
+  opacity: 0.5;
 }
 
 #toolbox_div {
@@ -466,17 +467,6 @@ td {
   margin-top: 2%;
 }
 
-#disable_div {
-  background-color: white;
-  height: 100%;
-  left: 0;
-  opacity: .5;
-  position: absolute;
-  top: 0;
-  width: 100%;
-  z-index: -1;  /* Start behind workspace */
-}
-
 /* Rules for Closure popup color picker */
 .goog-palette {
   outline: none;
diff --git a/demos/blocklyfactory/factory_utils.js b/demos/blocklyfactory/factory_utils.js
index f8ce4c861..89e421663 100644
--- a/demos/blocklyfactory/factory_utils.js
+++ b/demos/blocklyfactory/factory_utils.js
@@ -913,3 +913,40 @@ FactoryUtils.sameBlockXml = function(blockXml1, blockXml2) {
   return blockXmlText1 == blockXmlText2;
 };
 
+/*
+ * Checks if a block has a variable field. Blocks with variable fields cannot
+ * be shadow blocks.
+ *
+ * @param {Blockly.Block} block The block to check if a variable field exists.
+ * @return {boolean} True if the block has a variable field, false otherwise.
+ */
+FactoryUtils.hasVariableField = function(block) {
+  if (!block) {
+    return false;
+  }
+  for (var i = 0, input; input = block.inputList[i]; i++) {
+    for (var j = 0, field; field = input.fieldRow[j]; j++) {
+      if (field.name == 'VAR') {
+        return true;
+      }
+    }
+  }
+  return false;
+};
+
+/**
+ * Checks if a block is a procedures block. If procedures block names are
+ * ever updated or expanded, this function should be updated as well (no
+ * other known markers for procedure blocks beyond name).
+ *
+ * @param {Blockly.Block} block The block to check.
+ * @return {boolean} True if hte block is a procedure block, false otherwise.
+ */
+FactoryUtils.isProcedureBlock = function(block) {
+  return block &&
+      (block.type == 'procedures_defnoreturn' ||
+      block.type == 'procedures_defreturn' ||
+      block.type == 'procedures_callnoreturn' ||
+      block.type == 'procedures_callreturn' ||
+      block.type == 'procedures_ifreturn');
+};
diff --git a/demos/blocklyfactory/index.html b/demos/blocklyfactory/index.html
index 641ec2e16..8a5e8fd23 100644
--- a/demos/blocklyfactory/index.html
+++ b/demos/blocklyfactory/index.html
@@ -180,7 +180,6 @@
       </table>
       <section id="toolbox_section">
         <div id="toolbox_blocks"></div>
-        <div id='disable_div'></div>
       </section>
       <aside id="toolbox_div">
         <p id="categoryHeader">Your categories will appear here</p>
diff --git a/demos/blocklyfactory/workspacefactory/wfactory_controller.js b/demos/blocklyfactory/workspacefactory/wfactory_controller.js
index d3fb168be..e663981c9 100644
--- a/demos/blocklyfactory/workspacefactory/wfactory_controller.js
+++ b/demos/blocklyfactory/workspacefactory/wfactory_controller.js
@@ -98,11 +98,76 @@ WorkspaceFactoryController.MODE_PRELOAD = 'preload';
  * before), and then creates a tab and switches to it.
  */
 WorkspaceFactoryController.prototype.addCategory = function() {
-  // Check if it's the first category added.
+  this.allowToTransferFlyoutBlocksToCategory();
+
+  // After possibly creating a category, check again if it's the first category.
   var isFirstCategory = !this.model.hasElements();
+  // Get name from user.
+  name = this.promptForNewCategoryName('Enter the name of your new category: ');
+  if (!name) {  //Exit if cancelled.
+    return;
+  }
+  // Create category.
+  this.createCategory(name);
+  // Switch to category.
+  this.switchElement(this.model.getCategoryIdByName(name));
+
+   // Allow the user to use the default options for injecting the workspace
+  // when there are categories if adding the first category.
+  if (isFirstCategory) {
+    this.allowToSetDefaultOptions();
+  }
+  // Update preview.
+  this.updatePreview();
+};
+
+/**
+ * Helper method for addCategory. Adds a category to the view given a name, ID,
+ * and a boolean for if it's the first category created. Assumes the category
+ * has already been created in the model. Does not switch to category.
+ *
+ * @param {!string} name Name of category being added.
+ * @param {!string} id The ID of the category being added.
+ */
+WorkspaceFactoryController.prototype.createCategory = function(name) {
+  // Create empty category
+  var category = new ListElement(ListElement.TYPE_CATEGORY, name);
+  this.model.addElementToList(category);
+  // Create new category.
+  var tab = this.view.addCategoryRow(name, category.id);
+  this.addClickToSwitch(tab, category.id);
+};
+
+/**
+ * Given a tab and a ID to be associated to that tab, adds a listener to
+ * that tab so that when the user clicks on the tab, it switches to the
+ * element associated with that ID.
+ *
+ * @param {!Element} tab The DOM element to add the listener to.
+ * @param {!string} id The ID of the element to switch to when tab is clicked.
+ */
+WorkspaceFactoryController.prototype.addClickToSwitch = function(tab, id) {
+  var self = this;
+  var clickFunction = function(id) {  // Keep this in scope for switchElement
+    return function() {
+      self.switchElement(id);
+    };
+  };
+  this.view.bindClick(tab, clickFunction(id));
+};
+
+/**
+ * Allows the user to transfer blocks in their flyout to a new category if
+ * the user is creating their first category and their workspace is not
+ * empty. Should be called whenever it is possible to switch from single flyout
+ * to categories (not including importing).
+ */
+WorkspaceFactoryController.prototype.allowToTransferFlyoutBlocksToCategory =
+    function() {
   // Give the option to save blocks if their workspace is not empty and they
   // are creating their first category.
-  if (isFirstCategory && this.toolboxWorkspace.getAllBlocks().length > 0) {
+  if (!this.model.hasElements() &&
+        this.toolboxWorkspace.getAllBlocks().length > 0) {
     var confirmCreate = confirm('Do you want to save your work in another '
         + 'category? If you don\'t, the blocks in your workspace will be ' +
         'deleted.');
@@ -127,64 +192,6 @@ WorkspaceFactoryController.prototype.addCategory = function() {
       this.updatePreview();
     }
   }
-
-  // After possibly creating a category, check again if it's the first category.
-  isFirstCategory = !this.model.hasElements();
-  // Get name from user.
-  name = this.promptForNewCategoryName('Enter the name of your new category: ');
-  if (!name) {  //Exit if cancelled.
-    return;
-  }
-  // Create category.
-  this.createCategory(name, isFirstCategory);
-  // Switch to category.
-  this.switchElement(this.model.getCategoryIdByName(name));
-
-   // Allow the user to use the default options for injecting the workspace
-  // when there are categories if adding the first category.
-  if (isFirstCategory) {
-    this.allowToSetDefaultOptions();
-  }
-  // Update preview.
-  this.updatePreview();
-};
-
-/**
- * Helper method for addCategory. Adds a category to the view given a name, ID,
- * and a boolean for if it's the first category created. Assumes the category
- * has already been created in the model. Does not switch to category.
- *
- * @param {!string} name Name of category being added.
- * @param {!string} id The ID of the category being added.
- * @param {boolean} isFirstCategory True if it's the first category created,
- * false otherwise.
- */
-WorkspaceFactoryController.prototype.createCategory = function(name,
-    isFirstCategory) {
-  // Create empty category
-  var category = new ListElement(ListElement.TYPE_CATEGORY, name);
-  this.model.addElementToList(category);
-  // Create new category.
-  var tab = this.view.addCategoryRow(name, category.id, isFirstCategory);
-  this.addClickToSwitch(tab, category.id);
-};
-
-/**
- * Given a tab and a ID to be associated to that tab, adds a listener to
- * that tab so that when the user clicks on the tab, it switches to the
- * element associated with that ID.
- *
- * @param {!Element} tab The DOM element to add the listener to.
- * @param {!string} id The ID of the element to switch to when tab is clicked.
- */
-WorkspaceFactoryController.prototype.addClickToSwitch = function(tab, id) {
-  var self = this;
-  var clickFunction = function(id) {  // Keep this in scope for switchElement
-    return function() {
-      self.switchElement(id);
-    };
-  };
-  this.view.bindClick(tab, clickFunction(id));
 };
 
 /**
@@ -562,7 +569,21 @@ WorkspaceFactoryController.prototype.loadCategory = function() {
     }
   } while (!this.isStandardCategoryName(name));
 
-  // Check if the user can create that standard category.
+  // Load category.
+  this.loadCategoryByName(name);
+};
+
+/**
+ * Loads a Standard Category by name and switches to it. Leverages
+ * StandardCategories. Returns if cannot load standard category.
+ *
+ * @param {string} name Name of the standard category to load.
+ */
+WorkspaceFactoryController.prototype.loadCategoryByName = function(name) {
+  // Check if the user can load that standard category.
+  if (!this.isStandardCategoryName(name)) {
+    return;
+  }
   if (this.model.hasVariables() && name.toLowerCase() == 'variables') {
     alert('A Variables category already exists. You cannot create multiple' +
         ' variables categories.');
@@ -580,6 +601,8 @@ WorkspaceFactoryController.prototype.loadCategory = function() {
         + '. Rename your category and try again.');
     return;
   }
+  // Allow user to transfer current flyout blocks to a category.
+  this.allowToTransferFlyoutBlocksToCategory();
 
   var isFirstCategory = !this.model.hasElements();
   // Copy the standard category in the model.
@@ -589,7 +612,7 @@ WorkspaceFactoryController.prototype.loadCategory = function() {
   this.model.addElementToList(copy);
 
   // Update the copy in the view.
-  var tab = this.view.addCategoryRow(copy.name, copy.id, isFirstCategory);
+  var tab = this.view.addCategoryRow(copy.name, copy.id);
   this.addClickToSwitch(tab, copy.id);
   // Color the category tab in the view.
   if (copy.color) {
@@ -633,11 +656,9 @@ WorkspaceFactoryController.prototype.isStandardCategoryName = function(name) {
  * the separator, and updates the preview.
  */
 WorkspaceFactoryController.prototype.addSeparator = function() {
-  // Don't allow the user to add a separator if a category has not been created.
-  if (!this.model.hasElements()) {
-    alert('Add a category before adding a separator.');
-    return;
-  }
+  // If adding the first element in the toolbox, allow the user to transfer
+  // their flyout blocks to a category.
+  this.allowToTransferFlyoutBlocksToCategory();
   // Create the separator in the model.
   var separator = new ListElement(ListElement.TYPE_SEPARATOR);
   this.model.addElementToList(separator);
@@ -881,7 +902,7 @@ WorkspaceFactoryController.prototype.addShadowForBlockAndChildren_ =
   this.view.markShadowBlock(block);
   this.model.addShadowBlock(block.id);
 
-  if (this.hasVariableField(block)) {
+  if (FactoryUtils.hasVariableField(block)) {
     block.setWarningText('Cannot make variable blocks shadow blocks.');
   }
 
@@ -892,26 +913,6 @@ WorkspaceFactoryController.prototype.addShadowForBlockAndChildren_ =
   }
 };
 
-/**
- * Checks if a block has a variable field. Blocks with variable fields cannot
- * be shadow blocks.
- *
- * @param {Blockly.Block} block The block to check if a variable field exists.
- * @return {boolean} True if the block has a variable field, false otherwise.
- */
-WorkspaceFactoryController.prototype.hasVariableField = function(block) {
-  if (!block) {
-    return false;
-  }
-  for (var i = 0; i < block.inputList.length; i++) {
-    if (block.inputList[i].fieldRow.length > 0 &&
-        block.inputList[i].fieldRow[0].name == 'VAR') {
-      return true;
-    }
-  }
-  return false;
-};
-
 /**
  * If the currently selected block is a user-generated shadow block, this
  * function makes it a normal block again, removing it from the list of
@@ -956,6 +957,14 @@ WorkspaceFactoryController.prototype.convertShadowBlocks = function() {
   for (var i = 0, block; block = blocks[i]; i++) {
     if (block.isShadow()) {
       block.setShadow(false);
+      // Delete the shadow DOM attached to the block so that the shadow block
+      // does not respawn. Dependent on implementation details.
+      var parentConnection = block.outputConnection ?
+          block.outputConnection.targetConnection :
+          block.previousConnection.targetConnection;
+      if (parentConnection) {
+        parentConnection.setShadowDom(null);
+      }
       this.model.addShadowBlock(block.id);
       this.view.markShadowBlock(block);
     }
@@ -1231,3 +1240,21 @@ WorkspaceFactoryController.prototype.warnForUndefinedBlocks_ = function() {
     }
   }
 };
+
+/*
+ * Determines if a standard variable category is in the custom toolbox.
+ *
+ * @return {boolean} True if a variables category is in use, false otherwise.
+ */
+WorkspaceFactoryController.prototype.hasVariablesCategory = function() {
+  return this.model.hasVariables();
+};
+
+/**
+ * Determines if a standard procedures category is in the custom toolbox.
+ *
+ * @return {boolean} True if a procedures category is in use, false otherwise.
+ */
+WorkspaceFactoryController.prototype.hasProceduresCategory = function() {
+  return this.model.hasProcedures();
+};
diff --git a/demos/blocklyfactory/workspacefactory/wfactory_init.js b/demos/blocklyfactory/workspacefactory/wfactory_init.js
index 4e286da84..58209f0e0 100644
--- a/demos/blocklyfactory/workspacefactory/wfactory_init.js
+++ b/demos/blocklyfactory/workspacefactory/wfactory_init.js
@@ -27,6 +27,8 @@
  * @author Emma Dauterman (evd2014)
  */
 
+ goog.require('FactoryUtils');
+
 /**
  * Namespace for workspace factory initialization methods.
  * @namespace
@@ -443,7 +445,7 @@ WorkspaceFactoryInit.addWorkspaceFactoryEventListeners_ = function(controller) {
         // Enable block editing and remove warnings if the block is not a
         // variable user-generated shadow block.
         document.getElementById('button_editShadow').disabled = false;
-        if (!controller.hasVariableField(selected) &&
+        if (!FactoryUtils.hasVariableField(selected) &&
             controller.isDefinedBlock(selected)) {
           selected.setWarningText(null);
         }
@@ -459,7 +461,7 @@ WorkspaceFactoryInit.addWorkspaceFactoryEventListeners_ = function(controller) {
             // Warn if a non-shadow block is nested inside a shadow block.
             selected.setWarningText('Only shadow blocks can be nested inside '
                 + 'other shadow blocks.');
-          } else if (!controller.hasVariableField(selected)) {
+          } else if (!FactoryUtils.hasVariableField(selected)) {
             // Warn if a shadow block is invalid only if not replacing
             // warning for variables.
             selected.setWarningText('Shadow blocks must be nested inside other'
@@ -475,7 +477,7 @@ WorkspaceFactoryInit.addWorkspaceFactoryEventListeners_ = function(controller) {
 
           // Remove possible 'invalid shadow block placement' warning.
           if (selected != null && controller.isDefinedBlock(selected) &&
-              (!controller.hasVariableField(selected) ||
+              (!FactoryUtils.hasVariableField(selected) ||
               !controller.isUserGenShadowBlock(selected.id))) {
             selected.setWarningText(null);
           }
@@ -495,6 +497,51 @@ WorkspaceFactoryInit.addWorkspaceFactoryEventListeners_ = function(controller) {
     // shadow blocks.
     if (e.type == Blockly.Events.CREATE) {
       controller.convertShadowBlocks();
+
+      // Let the user create a Variables or Functions category if they use
+      // blocks from either category.
+
+      // Get all children of a block and add them to childList.
+      var getAllChildren = function(block, childList) {
+        childList.push(block);
+        var children = block.getChildren();
+        for (var i = 0, child; child = children[i]; i++) {
+          getAllChildren(child, childList);
+        }
+      };
+
+      var newBaseBlock = controller.toolboxWorkspace.getBlockById(e.blockId);
+      var allNewBlocks = [];
+      getAllChildren(newBaseBlock, allNewBlocks);
+      var variableCreated = false;
+      var procedureCreated = false;
+
+      // Check if the newly created block or any of its children are variable
+      // or procedure blocks.
+      for (var i = 0, block; block = allNewBlocks[i]; i++) {
+        if (FactoryUtils.hasVariableField(block)) {
+          variableCreated = true;
+        } else if (FactoryUtils.isProcedureBlock(block)) {
+          procedureCreated = true;
+        }
+      }
+
+      // If any of the newly created blocks are variable or procedure blocks,
+      // prompt the user to create the corresponding standard category.
+      if (variableCreated && !controller.hasVariablesCategory()) {
+        if (confirm('Your new block has a variables field. To use this block '
+            + 'fully, you will need a Variables category. Do you want to add '
+            + 'a Variables category to your custom toolbox?')) {
+          controller.loadCategoryByName('variables');
+        }
+
+      } else if (procedureCreated && !controller.hasProceduresCategory()) {
+        if (confirm('Your new block is a function block. To use this block '
+            + 'fully, you will need a Functions category. Do you want to add '
+            + 'a Functions category to your custom toolbox?')) {
+          controller.loadCategoryByName('functions');
+        }
+      }
     }
   });
 };
diff --git a/demos/blocklyfactory/workspacefactory/wfactory_view.js b/demos/blocklyfactory/workspacefactory/wfactory_view.js
index 5f713960c..ae8d79dc5 100644
--- a/demos/blocklyfactory/workspacefactory/wfactory_view.js
+++ b/demos/blocklyfactory/workspacefactory/wfactory_view.js
@@ -28,6 +28,8 @@
  * @author Emma Dauterman (edauterman)
  */
 
+ goog.require('FactoryUtils');
+
  /**
   * Class for a WorkspaceFactoryView
   * @constructor
@@ -43,19 +45,18 @@ WorkspaceFactoryView = function() {
  *
  * @param {!string} name The name of the category being created
  * @param {!string} id ID of category being created
- * @param {boolean} firstCategory true if it's the first category, false
- * otherwise
  * @return {!Element} DOM element created for tab
  */
-WorkspaceFactoryView.prototype.addCategoryRow =
-    function(name, id, firstCategory) {
+WorkspaceFactoryView.prototype.addCategoryRow = function(name, id) {
   var table = document.getElementById('categoryTable');
+  var count = table.rows.length;
+
   // Delete help label and enable category buttons if it's the first category.
-  if (firstCategory) {
+  if (count == 0) {
     document.getElementById('categoryHeader').textContent = 'Your Categories:';
   }
+
   // Create tab.
-  var count = table.rows.length;
   var row = table.insertRow(count);
   var nextEntry = row.insertCell(0);
   // Configure tab.
@@ -253,9 +254,13 @@ WorkspaceFactoryView.prototype.setBorderColor = function(id, color) {
  * @param {!Element} The td DOM element representing the separator.
  */
 WorkspaceFactoryView.prototype.addSeparatorTab = function(id) {
-  // Create separator.
   var table = document.getElementById('categoryTable');
   var count = table.rows.length;
+
+  if (count == 0) {
+    document.getElementById('categoryHeader').textContent = 'Your Categories:';
+  }
+  // Create separator.
   var row = table.insertRow(count);
   var nextEntry = row.insertCell(0);
   // Configure separator.
@@ -275,7 +280,14 @@ WorkspaceFactoryView.prototype.addSeparatorTab = function(id) {
  * if it should be enabled.
  */
 WorkspaceFactoryView.prototype.disableWorkspace = function(disable) {
-  document.getElementById('disable_div').style.zIndex = disable ? 1 : -1;
+  if (disable) {
+    document.getElementById('toolbox_section').className = 'disabled';
+    document.getElementById('toolbox_blocks').style.pointerEvents = 'none';
+  } else {
+    document.getElementById('toolbox_section').className = '';
+    document.getElementById('toolbox_blocks').style.pointerEvents = 'auto';
+  }
+
 };
 
 /**
@@ -334,6 +346,10 @@ WorkspaceFactoryView.prototype.markShadowBlock = function(block) {
       block.setWarningText('Shadow blocks must be nested inside' +
           ' other blocks to be displayed.');
   }
+
+  if (FactoryUtils.hasVariableField(block)) {
+    block.setWarningText('Cannot make variable blocks shadow blocks.');
+  }
 };
 
 /**