SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
- --- SECURITIES EXCHANGE ACT OF 1934
For the quarterly period June 30, 2005
-------------
Commission file number 1-3919
------
Keystone Consolidated Industries, Inc.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 37-0364250
- ------------------------------- ------------------
(State or other jurisdiction of I.R.S. Employer
incorporation or organization) Identification No.)
5430 LBJ Freeway, Suite 1740, Three Lincoln Centre, Dallas, TX 75240-2697
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (972) 458-0028
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months, and (2) has been subject to such filing
requirements for the past 90 days.
Yes No X
--- ---
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes No X
--- ---
Indicate by a check mark whether the Registrant is a shell company (as defined
in Rule 12b-2 of the Exchange Act). Yes No X
--- ---
Number of shares of common stock outstanding at March 31, 2006: 10,000,000
KEYSTONE CONSOLIDATED INDUSTRIES, INC.
AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION)
INDEX
-------
Page
number
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets - December 31, 2004;
and June 30, 2005 (Unaudited) 3-4
Consolidated Statements of Operations - Three months
and six months ended June 30, 2004 and 2005 (Unaudited) 5
Consolidated Statements of Cash Flows - Six months
ended June 30, 2004 and 2005 (Unaudited) 6
Consolidated Statement of Stockholders' Equity
(Deficit) - Six months ended June 30, 2005 (Unaudited) 7
Notes to Consolidated Financial Statements (Unaudited) 8-26
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 27-39
Item 4. Controls and Procedures 40-41
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 42
Item 6. Exhibits 42
KEYSTONE CONSOLIDATED INDUSTRIES, INC.
AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION)
CONSOLIDATED BALANCE SHEETS
(In thousands)
(Unaudited)
December 31, June 30,
ASSETS 2004 2005
------------ -----------
(Restated)
Current assets:
Notes and accounts receivable $ 26,729 $ 36,587
Inventories 53,017 50,286
Restricted investments 5,373 5,407
Prepaid expenses and other 2,017 2,080
-------- --------
Total current assets 87,136 94,360
-------- --------
Property, plant and equipment 369,036 371,913
Less accumulated depreciation 275,003 281,412
-------- --------
Net property, plant and equipment 94,033 90,501
-------- --------
Other assets:
Restricted investments 5,965 6,226
Prepaid pension cost 133,443 139,892
Deferred financing costs 1,226 894
Goodwill 752 752
Other 727 614
-------- --------
Total other assets 142,113 148,378
-------- --------
$323,282 $333,239
======== ========
KEYSTONE CONSOLIDATED INDUSTRIES, INC.
AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION)
CONSOLIDATED BALANCE SHEETS (CONTINUED)
(In thousands)
(Unaudited)
December 31, June 30,
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) 2004 2005
------------ -----------
(Restated)
Current liabilities not subject to compromise:
Notes payable and current maturities of
long-term debt $ 51,640 $ 65,837
Accounts payable 3,801 887
Accounts payable to affiliates 821 1,042
Other accrued liabilities 18,964 18,450
-------- --------
Total current liabilities not subject
to compromise 75,226 86,216
-------- --------
Noncurrent liabilities not subject to compromise:
Long-term debt 14,345 13,659
Accrued OPEB cost 13,478 19,239
Other 988 118
-------- --------
Total noncurrent liabilities not subject
to compromise 28,811 33,016
-------- --------
Liabilities subject to compromise 212,346 212,043
-------- --------
Redeemable Series A preferred stock 2,112 2,112
-------- --------
Stockholders' equity (deficit):
Common stock 10,798 10,798
Additional paid-in capital 41,225 41,225
Accumulated deficit (47,224) (52,159)
Treasury stock, at cost (12) (12)
-------- --------
Total stockholders' equity (deficit) 4,787 (148)
-------- --------
$323,282 $333,239
======== ========
Commitments and contingencies (Notes 11 and 12).
See accompanying notes to consolidated financial statements.
KEYSTONE CONSOLIDATED INDUSTRIES, INC.
AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION)
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)
Three months ended Six months ended
June 30, June 30,
------------------ -----------------
2004 2005 2004 2005
------ ------ ------ ------
Net sales $101,827 $ 88,992 $169,004 $178,529
Cost of goods sold 83,118 87,034 151,728 171,516
-------- -------- -------- --------
Gross margin 18,709 1,958 17,276 7,013
-------- -------- -------- --------
Selling expense 1,451 1,582 2,709 3,017
General and administrative
expense 2,718 2,706 5,424 5,410
Defined benefit pension credit (1,500) (3,224) (3,000) (6,449)
-------- -------- -------- --------
2,669 1,064 5,133 1,978
-------- -------- -------- --------
Operating income 16,040 894 12,143 5,035
-------- -------- -------- --------
General corporate income
(expense):
Corporate expense (632) (895) (1,505) (2,191)
Interest expense (961) (919) (2,025) (1,776)
Interest income 22 47 32 82
Other income (expense), net (96) 16 17 104
-------- -------- -------- --------
(1,667) (1,751) (3,481) (3,781)
-------- -------- -------- --------
Income (loss) before
income taxes and
reorganization costs 14,373 (857) 8,662 1,254
Reorganization costs 3,092 2,687 5,019 5,981
-------- -------- -------- --------
Income (loss) before income
taxes 11,281 (3,544) 3,643 (4,727)
Provision for income taxes 288 115 288 208
-------- -------- -------- --------
Net income (loss) 10,993 (3,659) 3,355 (4,935)
Dividends on preferred stock - - 1,223 -
-------- -------- -------- --------
Net income (loss) available
for common shares $ 10,993 $ (3,659) $ 2,132 $ (4,935)
======== ======== ======== ========
Basic income (loss) per share
available for common shares $ 1.09 $(.36) $ .21 $ (.49)
======== ======== ======== ========
Basic shares outstanding 10,068 10,068 10,068 10,068
======== ======== ======== ========
Diluted income (loss) per share
available for common shares $ .39 $ (.36) $ .12 $ (.49)
======== ======== ======== ========
Diluted shares outstanding 28,043 10,068 28,043 10,068
======== ======== ======== ========
See accompanying notes to consolidated financial statements.
KEYSTONE CONSOLIDATED INDUSTRIES, INC.
AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Six months ended
June 30,
----------------------
2004 2005
---- ----
Cash flows from operating activities:
Net income (loss) $ 3,355 $ (4,935)
Depreciation and amortization 7,955 7,889
Amortization of deferred financing costs 567 347
Non-cash defined benefit pension credit (3,000) (6,449)
Non-cash OPEB expense 8,850 5,762
Reorganization costs accrued 5,019 5,981
Reorganization costs paid (1,930) (5,176)
Other, net 48 116
Change in assets and liabilities:
Notes and accounts receivable (21,265) (9,948)
Inventories (15,492) 2,731
Accounts payable 9,101 (2,693)
Other, net 4,546 (2,518)
-------- --------
Net cash used by operating activities (2,246) (8,893)
-------- --------
Cash flows from investing activities:
Capital expenditures (685) (4,551)
Collection of notes receivable 75 75
Restricted investments (7,677) (296)
Other, net 62 168
-------- --------
Net cash used by investing activities (8,225) (4,604)
-------- --------
Cash flows from financing activities:
Revolving credit facilities, net (3,635) 14,784
Other notes payable and long-term debt:
Additions 15,819 47
Principal payments (1,188) (1,319)
Deferred financing costs paid (525) (15)
-------- --------
Net cash provided by financing activities 10,471 13,497
-------- --------
Net change in cash and cash equivalents - -
Cash and cash equivalents, beginning of period - -
-------- --------
Cash and cash equivalents, end of period $ - $ -
======== ========
Supplemental disclosures:
Cash paid for:
Interest, net of amount capitalized $ 1,112 $ 1,440
Income taxes, net - 673
See accompanying notes to consolidated financial statements.
KEYSTONE CONSOLIDATED INDUSTRIES, INC.
AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION)
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
Six months ended June 30, 2005
(In thousands)
(Unaudited)
Additional
Common paid-in Accumulated Treasury
stock capital deficit stock Total
------- ----------- ----------- --------- ------
Balance - December 31, 2004 $10,798 $41,225 $(47,224) $(12) $4,787
Net loss - - (4,935) - (4,935)
------- ------- -------- ---- ------
Balance - June 30, 2005 $10,798 $41,225 $(52,159) $(12) $ (148)
======= ======= ======== ==== ======
See accompanying notes to consolidated financial statements.
KEYSTONE CONSOLIDATED INDUSTRIES, INC.
AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1 - Restatement, organization and basis of presentation:
Restatement.
In connection with finalizing the preparation of the Company's consolidated
financial statements for the year ended December 31, 2005, the Company
determined that cash overdrafts, which currently are financed by borrowings
under the Company's revolving credit facility, and cash receipts which would be
applied against the revolving credit facility, were improperly classified as
part of accounts payable. Under accounting principles generally accepted in the
United States of America ("GAAP"), such cash overdrafts should have been
classified as part of the current portion of long-term debt. In addition, the
relative changes in such cash overdrafts were improperly included in the
determination of cash flows from operating activities, while under GAAP changes
in such cash overdrafts should have been included in the determination of cash
flows from financing activities.
Accordingly, the Company has restated its consolidated balance sheet at
December 31, 2004, as contained in this Form 10-Q, to reflect this correction.
The $2.7 million adjustment to the 2004 balance sheet is a result of $3.8
million of cash receipts net of $1.1 million of cash overdrafts.
The following table shows (i) selected consolidated financial statements
data as of December 31, 2004, as previously reported, (ii) adjustments to such
consolidated financial statement data to reflect the effect of this restatement
and (iii) such consolidated financial statement data, as restated.
KEYSTONE CONSOLIDATED INDUSTRIES, INC.
SELECTED CONSOLIDATED BALANCE SHEET DATA
December 31, 2004
(In thousands)
December 31, 2004
-------------------------------------------------
Previously
Reported Adjustments As restated
---------- ----------- -----------
Selected balance sheet items:
Notes payable and current maturities
of long-term debt $ 54,336 $ (2,696) $ 51,640
======== ======== ========
Accounts payable $ 1,105 $ 2,696 $ 3,801
======== ======== ========
Total current liabilities $ 75,226 $ - $ 75,226
======== ======== ========
Organization and basis of presentation.
The consolidated balance sheet of Keystone Consolidated Industries, Inc.
("Keystone" or the "Company") at December 31, 2004 has been condensed from the
Company's audited consolidated financial statements at that date included in the
Company's 2005 Form 10-K. The consolidated balance sheet at June 30, 2005 and
the consolidated statements of operations and cash flows for the interim periods
ended June 30, 2004 and 2005, and the consolidated statement of common
stockholders' deficit for the interim period ended June 30, 2005, have each been
prepared by the Company, without audit, in accordance with GAAP. In the opinion
of management, all adjustments, consisting only of normal recurring adjustments
necessary to present fairly the consolidated financial position, results of
operations and cash flows, have been made. However, it should be understood that
accounting measurements at interim dates may be less precise than at year end.
The results of operations for the interim periods are not necessarily indicative
of the operating results for a full year or of future operations.
Certain information normally included in financial statements prepared in
accordance with GAAP has been condensed or omitted, and certain prior year
amounts have been reclassified to conform to the current year presentation. The
accompanying consolidated financial statements should be read in conjunction
with the consolidated financial statements included in the Company's Annual
Report on Form 10-K for the year ended December 31, 2005 (the "Annual Report").
At June 30, 2005, Contran Corporation ("Contran") and other entities
related to Mr. Harold C. Simmons, beneficially owned approximately 50% of the
outstanding common stock of the Company. Substantially all of Contran's
outstanding voting stock is held by trusts established for the benefit of
certain children and grandchildren of Mr. Simmons, of which Mr. Simmons is sole
trustee, or is held by Mr. Simmons or persons or other entities related to Mr.
Simmons. Keystone may be deemed to be controlled by Contran and Mr. Simmons. At
June 30, 2005, Contran also owned 54,956 shares of the 71,899 shares of the
Company's outstanding Redeemable Series A Preferred Stock. Each share of Series
A Preferred Stock is convertible, at the option of the holder, into 250 shares
of the Company's common stock (equivalent to a $4.00 per share exchange rate).
The accompanying financial statements have been prepared under the
assumption the Company will continue to operate on a going concern basis, which
contemplates continuity of operations, realization of assets and liquidation of
liabilities in the ordinary course of business and do not reflect adjustments
that might result if Keystone is unable to continue as a going concern. However,
on February 26, 2004, Keystone and five of its direct and indirect subsidiaries
filed for voluntary protection under Chapter 11 of the Federal Bankruptcy Code.
Keystone and its subsidiaries filed their petitions in the U.S. Bankruptcy Court
for the Eastern District of Wisconsin in Milwaukee (the "Court"). Keystone's
amended plan of reorganization was accepted by the impacted constitutencies and
confirmed by the Court on August 10, 2005. The Company emerged from bankruptcy
protection on August 31, 2005. See Note 2.
Under Chapter 11 proceedings, actions by creditors to collect claims in
existence at the filing date ("Pre-petition Claims") are stayed, absent specific
authorization by the Court to pay such claims, while the Company continues to
manage the business as a debtor-in-possession. Keystone received approval from
the Court to pay certain of its Pre-petition Claims including employee wages and
certain employee benefits.
Note 2 - Bankruptcy
On February 26, 2004, Keystone and five of its direct and indirect
subsidiaries filed for voluntary protection under Chapter 11 of the Federal
Bankruptcy Code. Keystone and its subsidiaries filed their petitions in the U.S.
Bankruptcy Court for the Eastern District of Wisconsin in Milwaukee. The Company
is managing its business as a debtor-in possession subject to approval by the
Court. Keystone attributed the need to reorganize to weaknesses in product
selling prices over the last several years, unprecedented increases in ferrous
scrap costs, Keystone's primary raw material, and significant liquidity needs to
service retiree medical costs. These problems substantially limited Keystone's
liquidity and undermined its ability to obtain sufficient debt or equity capital
to operate as a going concern.
Under Chapter 11 proceedings, actions by creditors to collect Pre-petition
Claims in existence at the filing date are stayed, absent specific authorization
from the Court to pay such claims while the Company manages the business as a
debtor-in-possession.
Keystone filed a plan of reorganization on October 4, 2004 and amended that
plan on May 26, 2005, June 21, 2005 and June 27, 2005. Keystone's amended plan
of reorganization was accepted by the impacted constituencies and confirmed by
the Court on August 10, 2005. The Company emerged from bankruptcy protection on
August 31, 2005. Significant provisions of Keystone's amended plan of
reorganization included, among other things:
o Assumption of the previously negotiated amendment to the collective
bargaining agreement with the Independent Steel Workers Alliance (the
"ISWA"), Keystone's largest labor union that related primarily to greater
employee participation in healthcare costs;
o Assumption of the previously negotiated agreements reached with certain
retiree groups that will provide relief by permanently reducing healthcare
related payments to these retiree groups from pre-petition levels;
o The Company's obligations due to pre-petition secured lenders other than
its Debtor-In-Possession lenders were reinstated in full against
reorganized Keystone;
o All shares of Keystone's common and preferred stock outstanding at the
petition date (February 26, 2004) were cancelled;
o Pre-petition unsecured creditors with allowed claims against Keystone will
receive, on a pro rata basis, in the aggregate, $5.2 million in cash, a
$4.8 million secured promissory note and 49% of the new common stock of
reorganized Keystone;
o Certain operating assets and existing operations of Sherman Wire Company
("Sherman Wire"), one of Keystone's pre-petition wholly-owned subsidiaries,
will be sold at fair market value (fair market value and book value both
approximate $2.0 million) to Keystone, which will then be used to form and
operate a newly created wholly-owned subsidiary of reorganized Keystone
named Keystone Wire Products Inc.;
o Sherman Wire was also reorganized and the proceeds of the operating asset
sale to Keystone and other funds will be distributed, on a pro rata basis,
to Sherman Wire's pre-petition unsecured creditors as their claims are
finally adjudicated;
o Sherman Wire's pre-petition wholly-owned non-operating subsidiaries, J.L.
Prescott Company, and DeSoto Environmental Management, Inc. as well as
Sherman Wire of Caldwell, Inc., a wholly-owned subsidiary of Keystone, will
ultimately be liquidated and the pre-petition unsecured creditors with
allowed claims against these entities will receive their pro-rata share of
the respective entity's net liquidation proceeds;
o Pre-petition unsecured creditors with allowed claims against FV Steel &
Wire Company, another one of Keystone's wholly-owned subsidiaries, will
receive cash in an amount equal to their allowed claims;
o One of Keystone's Debtor-In-Possession lenders, EWP Financial, LLC (an
affiliate of Contran) converted $5 million of its DIP credit facility,
certain of its pre-petition unsecured claims and all of its administrative
claims against Keystone into 51% of the new common stock of reorganized
Keystone; and
o The Board of Directors of reorganized Keystone now consists of seven
individuals, two each of which were designated by Contran and the Official
Committee of Unsecured Creditors (the "OCUC"), respectively. The remaining
three directors qualify as independent directors (two of the independent
directors were appointed by Contran with the OCUC's consent and one was
appointed by the OCUC with Contran's consent).
In addition, Keystone has obtained a five-year $80 million secured credit
facility from Wachovia Capital Finance (Central). Proceeds from this credit
facility were used to extinguish Keystone's existing Debtor-In-Possession
("DIP") credit facilities and to provide working capital for reorganized
Keystone. Proceeds from this credit facility were used to extinguish Keystone's
existing DIP credit facilities, the EWP Term Loan, the EWP Revolver and to
provide working capital for reorganized Keystone. The facility includes a term
loan in the amount of up to $25.0 million, subject to a borrowing base
calculation based on the market value of the Company's real property and
equipment. To the extent there is sufficient borrowing base, the term loan
portion of this credit facility can be reloaded in the amount of $10.0 million.
The portion of the credit facility in excess of the term loan balance is
available to the Company as a revolving credit facility subject to a borrowing
base calculation based on eligible receivables and inventory balances. Interest
rates on the credit facility range from the prime rate to the prime rate plus
..5% depending on Keystone's excess availability, as defined in the credit
agreement. The facility also provides for a LIBOR interest rate option. Under
the terms of the credit facility, the Company is required to annually pay down
the term loan portion of the facility in the amount of 25% of excess cash flow,
as defined in the agreement, subject to a $2.0 million annual and a $5.0 million
aggregate limit. The facility also includes performance covenants related to
minimum levels of cash flow and fixed charge coverage ratio. Keystone paid the
lender approximately $400,000 of diligence, commitment and closing fees in
connection with this facility.
At June 30, 2005, the net assets of the one subsidiary of Keystone which
was not party to the bankruptcy proceeding, included in the Company's
consolidated net assets, was approximately $16.8 million, consisting of current
assets of $25.4 million, noncurrent assets (primarily net property and
equipment) of $5.9 million, current liabilities of $11.0 million and noncurrent
liabilities (primarily long-term debt) of $3.5 million.
Note 3 - Business Segment Information:
The Company's operating segments are organized along its manufacturing
facilities and include three reportable segments: (i) Keystone Steel and Wire
("KSW") which manufacturers and sells wire rod, wire and wire products for
agricultural, industrial, construction, commercial, original equipment
manufacturers and retail consumer markets, (ii) Engineered Wire Products ("EWP")
which manufacturers and sells welded wire reinforcement in both roll and sheet
form that is utilized in concrete construction products including pipe, pre-cast
boxes and applications for use in roadways, buildings and bridges and (iii)
Sherman Wire ("Sherman") which manufacturers and sells wire and wire products
for agricultural, industrial, construction, commercial, original equipment
manufacturers and retail consumer markets.
Business Segment Principal entities Location
- ---------------- ------------------ --------
Keystone Steel & Wire Keystone Steel & Wire Peoria, Illinois
Engineered Wire Products Engineered Wire Products Upper Sandusky, Ohio
Sherman Sherman Wire Sherman, Texas
GAAP
Adjustments,
Corporate
Items
Segment and
KSW EWP Sherman Total Eliminations Total
--- --- ------- ------- ------------ -----
(In thousands)
Three months ended June 30, 2004:
Third party net sales $ 84,203 $15,949 $ 1,651 $101,803 $ 24 $101,827
Intercompany sales 18,982 - 2,787 21,769 (21,769) -
-------- ------- ------- -------- -------- --------
$103,185 $15,949 $ 4,438 $123,572 $(21,745) $101,827
======== ======= ======= ======== ======== ========
Operating income $ 10,295 $ 3,333 $ 14 $ 13,642 $ 2,398 $ 16,040
======== ======= ======= ======== ======== ========
Three months ended June 30, 2005:
Third party net sales $ 70,021 $17,755 $ 1,216 $ 88,992 $ - $ 88,992
Intercompany sales 11,866 - 2,897 14,763 (14,763) -
-------- ------- ------- -------- -------- --------
$ 81,887 $17,755 $ 4,113 $103,755 $(14,763) $ 88,992
======== ======= ======= ======== ======== ========
Operating income (loss) $(9,119) $ 2,992 $ (381) $ (6,508) $ 7,402 $ 894
======== ======= ======= ======== ======== ========
Six months ended June 30, 2004:
Third party net sales $139,431 $27,039 $ 2,490 $168,960 $ 44 $169,004
Intercompany sales 24,380 - 5,007 29,387 (29,387) -
-------- ------- ------- -------- -------- --------
$163,811 $27,039 $ 7,497 $198,347 $(29,343) $169,004
======== ======= ======= ======== ======== ========
Operating income (loss) $ 3,307 $ 4,601 $ (561) $ 7,347 $ 4,796 $ 12,143
======== ======= ======= ======== ======== ========
Six months ended June 30, 2005:
Third party net sales $145,895 $29,806 $ 2,828 $178,529 $ - $178,529
Intercompany sales 25,186 - 6,338 31,524 (31,524) -
-------- ------- ------- -------- -------- --------
$171,081 $29,806 $ 9,166 $210,053 $(31,524) $178,529
======== ======= ======= ======== ======== ========
Operating income (loss) $(10,571) $ 4,631 $ (550) $ (6,490) $ 11,525 $ 5,035
======== ======= ======= ======== ======== ========
In the above tables, GAAP adjustments relate to operating profit (loss),
Corporate items relate to depreciation and amortization, segment assets and
capital expenditures and eliminations relate to net sales. GAAP adjustments are
principally (i) the difference between the defined benefit pension expense or
credit and OPEB expense allocated to the segments and the actual expense or
credit included in the determination of operating profit or loss, (ii) the
elimination of intercompany profit or loss on ending inventory balances and
(iii) LIFO inventory reserve adjustments.
Three months ended Six months ended
June 30, June 30,
------------------ -----------------
2004 2005 2004 2005
------ ------ ------ ------
Operating income $ 16,040 $ 894 $ 12,143 $ 5,035
General corporate items:
Interest income 22 47 32 82
Other income (expense) (96) 16 17 104
Corporate expense (632) (895) (1,505) (2,191)
Interest expense (961) (919) (2,025) (1,776)
-------- -------- -------- --------
Income (loss) before income
taxes and reorganization costs $ 14,373 $ (857) $ 8,662 $ 1,254
======== ======== ======== ========
Note 4 - Inventories:
December 31, June 30,
2004 2005
------------ ----------
(In thousands)
Steel and wire products:
Raw materials $15,142 $13,315
Work in process 21,305 16,694
Finished goods 28,941 27,703
Supplies 14,844 16,510
------- -------
80,232 74,222
Less LIFO reserve 27,215 23,936
------- -------
$53,017 $50,286
======= =======
Note 5 - Notes payable and long-term debt:
December 31, June 30,
2004 2005
------------ ----------
(Restated)
(In thousands)
DIP facilities:
Congress $15,108 $26,649
EWP 5,000 5,000
EWP revolving credit facility 1,989 4,631
8% Notes 28,116 28,116
Term loans:
County 10,000 10,000
EWP 5,513 4,838
Other 259 262
------- -------
65,985 79,496
Less current maturities 51,640 65,837
------- -------
$14,345 $13,659
======= =======
The indenture governing Keystone's 8% Notes provides the holders of such
Notes with the right to accelerate the maturity of the Notes in the event of a
default by Keystone resulting in an acceleration of the maturity of any of the
Company's other secured debt. As such, the 8% Notes were classified as a current
liability at December 31, 2004 and June 30, 2005.
The Company has determined there is insufficient collateral to cover the
interest portion of scheduled payments on its pre-petition unsecured debt. As
such, the Company discontinued accruing interest on its unsecured 6% Notes and
unsecured 9 5/8% Notes as of February 26, 2004, the filing date. Contractual
interest on those obligations during the second quarter and first six months of
2005 was approximately $313,000 and $624,000, respectively.
Note 6 - Series A preferred stock:
The Company discontinued accruing dividends on its Series A Preferred Stock
upon filing for Chapter 11 on February 26, 2004.
All of the Company's Series A Preferred Stock was cancelled in connection
with Keystone's emergence from Chapter 11 on August 31, 2005. See Note 2.
Note 7 - Income taxes:
Summarized below are (i) the differences between the provision for income
taxes and the amounts that would be expected by applying the U.S. federal
statutory income tax rate of 35% and (ii) the components of the comprehensive
provision for income taxes.
Six months ended
June 30,
--------------------
2004 2005
---- ----
(In thousands)
Expected tax provision (benefit),
at statutory rate $ 1,275 $(1,654)
U. S. state income taxes, net 237 102
Deferred tax asset valuation allowance (2,998) (56)
Capitalize reorganization costs 1,756 1,804
Other, net 18 12
------- -------
Provision for income taxes $ 288 $ 208
======= =======
Comprehensive provision for income taxes:
Currently payable:
U.S. federal $ 191 $ 86
U.S. state 97 122
------- -------
Net currently payable 288 208
Deferred income taxes, net - -
------- -------
$ 288 $ 208
======= =======
The Company's emergence from Chapter 11 on August 31, 2005 did not result
in an ownership change within the meaning of Section 382 of the Internal Revenue
Code.
At June 30, 2005, considering all factors believed to be relevant,
including the Company's recent operating results, its expected future near-term
productivity rates; cost of raw materials, electricity, labor and employee
benefits, environmental remediation, and retiree medical coverage; interest
rates; product mix; sales volumes and selling prices; and the fact that accrued
OPEB expenses will become deductible over an extended period of time and require
the Company to generate significant amounts of future taxable income, the
Company believes its gross deferred tax assets do not currently meet the
"more-likely-than-not" realizability test. As such, at December 31, 2004, the
Company had provided a deferred tax asset valuation allowance of approximately
$30.3 million. As a result of the deferred tax asset valuation allowance, the
Company does not anticipate recognizing tax expense associated with its expected
pre-tax income during 2005 will be appropriate. Accordingly, during the first
six months of 2005, the Company decreased the deferred tax asset valuation
allowance by approximately $56,000. Keystone will continue to review the
recoverability of its deferred tax assets, and based on such periodic reviews,
Keystone could recognize a change in the valuation allowance related to its
deferred tax assets in the future.
Note 8 - Other accrued liabilities:
December 31, June 30,
2004 2005
------------ ----------
(In thousands)
Current:
Employee benefits $12,019 $ 9,434
Reorganization costs 2,883 3,688
Self insurance 1,064 1,689
Income taxes 1,405 1,036
Legal and professional 358 1,011
Other 1,235 1,592
------- -------
$18,964 $18,450
======= =======
Noncurrent:
Workers compensation payments $ 988 $ 118
======= =======
Note 9 - Liabilities subject to compromise
December 31, June 30,
2004 2005
------------ ----------
(In thousands)
Accrued OPEB cost $123,425 $123,425
Environmental 19,432 19,386
6% Notes 16,031 16,031
Accrued preferred stock dividends 11,846 11,846
Accounts payable 10,776 10,776
Deferred vendor payments 10,518 10,518
9 5/8% Notes 6,150 6,150
Self insurance 4,549 4,549
Accounts payable to affiliates 3,027 3,027
Workers compensation 1,847 1,847
Accrued and deferred interest 1,237 1,237
Legal and professional 726 547
Disposition of former facilities 665 665
Other 2,117 2,039
-------- --------
$212,346 $212,043
======= =======
Note 10 - Employee benefit plans:
Defined benefit plans. The components of net periodic defined benefit
pension credit are presented in the table below.
Three months ended Six months ended
June 30, June 30,
------------------ -----------------
2004 2005 2004 2005
------ ------ ------ ------
(In thousands)
Service cost $ 875 $ 938 $ 1,750 $ 1,875
Interest cost 5,439 5,434 10,878 10,868
Expected return on plan assets (9,373) (10,733) (18,747) (21,467)
Amortization of unrecognized:
Prior service cost 221 221 441 441
Actuarial losses 1,338 915 2,678 1,834
-------- -------- -------- --------
$ (1,500) $ (3,225) $ (3,000) $(6,449)
======== ======== ======== ========
Postretirement benfits other than pensions ("OPEB"). The components of net
periodic OPEB cost are presented in the table below.
Three months ended Six months ended
June 30, June 30,
------------------ -----------------
2004 2005 2004 2005
------ ------ ------ ------
(In thousands)
Service cost $ 725 $ 740 $ 1,450 $ 1,480
Interest cost 3,496 3,026 6,991 6,052
Amortization of unrecognized:
Prior service cost (86) (86) (172) (172)
Prior service cost due to
plan amendment (625) (710) (1,250) (1,420)
Actuarial losses 1,015 1,397 2,031 2,794
Settlement loss 1,250 - 2,500 -
-------- -------- -------- --------
$ 5,775 $ 4,367 $ 11,550 $ 8,734
======== ======== ======== ========
During 2004, the Company entered into an agreement (the "1114 Agreement")
with certain retiree groups that substantially reduced the post retirement
("OPEB") benefits that will be paid to these retiree groups in the future. Prior
to confirmation of Keystone's definitive plan of reorganization, the Court could
have rescinded the 1114 Agreement and therefore the 1114 Agreement was not
definitive until it was confirmed by the Court in connection with Keystone's
emergence from Chapter 11 on August 31, 2005. As such, and in accordance with
GAAP, the Company has continued to record OPEB expense through August 31, 2005
at the estimated level as if Keystone had not entered into the 1114 Agreement.
Keystone estimates OPEB expense for the first eight months of 2005 will
approximate $11.6 million. However, at the time of the Company's emergence from
Chapter 11 on August 31, 2005, and concurrent confirmation of the 1114 Agreement
GAAP then requires the effect of the substantially reduced future OPEB benefits
agreed to as part of the 1114 Agreement be accounted for as a plan amendment,
the benefit of which is amortized into income over future periods. Accordingly,
Keystone estimates that it will record an OPEB credit of approximately $2.7
million for the last four months of 2005, resulting in an $8.9 million expense
for the year 2005.
Employer Contributions. Keystone previously disclosed in its financial
statements for the year ended December 31, 2004, that it expected not to be
required to contribute to its defined benefit pension plan in 2005. As of June
30, 2005, Keystone had not made any contributions to its defined benefit pension
plan during 2005. The Company also previously disclosed in its financial
statements for the year ended December 31, 2004, that it expected to contribute
approximately $8.3 million to its post retirement benefit plans in 2005. As of
June 30, 2005, Keystone had contributed $3.0 million to these plans during 2005.
Note 11 - Environmental matters:
As a result of the Chapter 11 filings on February 26, 2004, litigation
relating to prepetition claims against the filing companies, including Keystone
and Sherman Wire, has been stayed.
Keystone has been named as a defendant, potentially responsible party
("PRP"), or both, pursuant to the Comprehensive Environmental Response,
Compensation and Liability Act ("CERCLA") or similar state laws in approximately
25 governmental and private actions associated with environmental matters,
including waste disposal sites and facilities currently or previously owned,
operated or used by Keystone, certain of which are on the United States
Environmental Protection Agency's (the "U.S. EPA") Superfund National Priorities
List or similar state lists. These proceedings seek cleanup costs, damages for
personal injury or property damage and/or damages for injury to natural
resources. Certain of these proceedings involve claims for substantial amounts.
Although Keystone may be jointly and severally liable for such costs, in most
cases, it is only one of a number of PRPs who may also be jointly and severally
liable.
On a quarterly basis, Keystone evaluates the potential range of its
liability at sites where it has been named as a PRP or defendant by analyzing
and estimating the range of reasonably possible costs to Keystone. Such costs
include, among other things, expenditures for remedial investigations,
monitoring, managing, studies, certain legal fees, clean-up, removal and
remediation. Keystone believes it has provided adequate accruals ($19.5 million
at June 30, 2005, substantially all of which is reflected in liabilities subject
to compromise on the Company's June 30, 2005 balance sheet) for these matters at
13 sites for which Keystone believes its liability is probable and reasonably
estimable, but Keystone's ultimate liability may be affected by a number of
factors, including the imposition of more stringent standards or requirements
under environmental laws or regulations, new developments or changes in remedial
alternatives and costs, the allocation of such costs among PRPs, the solvency of
other PRPs or a determination that Keystone is potentially responsible for the
release of hazardous substances at other sites, any of which could result in
expenditures in excess of amounts currently estimated by Keystone to be required
for such matters. With respect to other PRPs and the fact that the Company may
be jointly and severally liable for the total remediation cost at certain sites,
the Company could ultimately be liable for amounts in excess of its accruals due
to, among other things, reallocation of costs among PRPs or the insolvency of
one or more PRPs. In addition, the actual timeframe for payments by Keystone for
these matters may be substantially in the future.
Keystone believes it is not possible to estimate the range of costs for
seven sites. For these sites, generally the investigation is in the early
stages, and it is either unknown as to whether or not the Company actually had
any association with the site, or if the Company had association with the site,
the nature of its responsibility, if any, for the contamination at the site and
the extent of contamination. The timing on when information would become
available to the Company to allow the Company to estimate a range of loss is
unknown and dependent on events outside the control of the Company, such as when
the party alleging liability provides information to the Company.
The upper end of the range of reasonably possible costs to Keystone for
sites for which it is possible to estimate costs (17 sites) is approximately
$21.4 million. Keystone's estimates of such liabilities have not been discounted
to present value, and other than certain previously-reported settlements with
respect to certain of Keystone's former insurance carriers, Keystone has not
recognized any material insurance recoveries. No assurance can be given that
actual costs will not exceed accrued amounts or the upper end of the range for
sites for which estimates have been made, and no assurance can be given that
costs will not be incurred with respect to the eight sites as to which no
estimate of liability can presently be made because the respective
investigations are in early stages. The extent of CERCLA liability cannot be
determined until the Remedial Investigation/Feasibility Study ("RI/FS") is
complete, the U.S. EPA issues a Record of Decision ("ROD") and costs are
allocated among PRPs. The extent of liability under analogous state cleanup
statutes and for common law equivalents is subject to similar uncertainties.
The exact time frame over which the Company makes payments with respect to
its accrued environmental costs is unknown and is dependent upon, among other
things, the timing of the actual remediation process which in part depends on
factors outside the control of the Company. At each balance sheet date, the
Company makes an estimate of the amount of its accrued environmental costs which
will be paid out over the subsequent 12 months, and the Company classifies such
amount as a current liability. The remainder of the accrued environmental costs
are classified as a noncurrent liability.
More detailed descriptions of certain legal proceedings relating to
environmental matters are set forth below. A summary of activity in the
Company's environmental accruals for the six months ended June 30, 2005 is as
follows:
Six months ended
June 30,
------------------
(In thousands)
Balance at December 31, 2004 $19,432
Expense -
Payments (45)
Reclassification 71
-------
Balance at June 30, 2005 $19,458
=======
Substantially all of the Company's $19.5 million recorded environmental
accrual at June 30, 2005 is included in liabilities subject to compromise on the
Company's balance sheet. Approximately $10.4 million of the recorded
environmental liability relates to sites that are owned by Keystone.
Significantly all of the remainder of the recorded $19.5 million environmental
liability relates to sites involving Sherman Wire or one of its predecessors.
Sherman Wire's environmental liabilities continue to be negotiated and
adjudicated subsequent to Keystone's emergence from Chapter 11 on August 31,
2005.
The Company is currently involved in the closure of inactive waste disposal
units at its Peoria facility pursuant to a closure plan approved by the Illinois
Environmental Protection Agency ("IEPA") in September 1992. The original closure
plan provides for the in-place treatment of seven hazardous waste surface
impoundments and two waste piles to be disposed of as special wastes. The
Company recorded an estimated liability for remediation of the impoundments and
waste piles based on a six-phase remediation plan. The Company adjusts the
recorded liability for each Phase as actual remediation costs become known.
During 1995, the Company began remediation of Phases II and III and completed
these Phases, as well as Phase IV during 1996. During 1998 and 1999 the Company
did not have any significant remediation efforts relative to Phases V and VI.
During 2000, Keystone began preliminary efforts relative to Phase V. Pursuant to
agreements with the IEPA and Illinois Attorney General's office, the Company is
depositing $75,000 per quarter into a trust fund. The Company must continue
these quarterly deposits and cannot withdraw funds from the trust fund until the
fund balance exceeds the sum of the estimated remaining remediation costs plus
$2 million. At December 31, 2004 and June 30, 2005, the trust fund had a balance
of $5.7 million and $6.0 million, respectively, which amounts are included in
other noncurrent assets because the Company does not expect to have access to
any of these funds until after 2005.
In February 2000, Keystone received a notice from the United States
Environmental Protection Agency ("U.S. EPA") giving formal notice of the U.S.
EPA's intent to issue a unilateral administrative order to Keystone pursuant to
section 3008(h) of the Resource Conservation and Recovery Act ("RCRA"). The
draft order enclosed with this notice would require Keystone to: (1) investigate
the nature and extent of hazardous constituents present at and released from
five alleged solid waste management units at the Peoria facility; (2)
investigate hazardous constituent releases from "any other past or present
locations at the Peoria facility where past waste treatment, storage or disposal
may pose an unacceptable risk to human health and the environment"; (3) complete
by June 30, 2001 an "environmental indicators report" demonstrating the
containment of hazardous substances that could pose a risk to "human receptors"
and further demonstrating that Keystone "has stabilized the migration of
contaminated groundwater at or from the facility;" (4) submit by January 30,
2002 proposed "final corrective measures necessary to protect human health and
the environment from all current and future unacceptable risks of releases of
hazardous waste or hazardous constituents at or from the Peoria facility; and
(5) complete by June 30, 2001 the closure of the sites discussed in the
preceding paragraph now undergoing RCRA closure under the supervision of the
IEPA. Keystone has complied with deadlines in the draft order. During the fourth
quarter of 2000, Keystone entered into a modified Administrative Order on
Consent, which may require the Company to conduct cleanup activities at certain
solid waste management units at its Peoria facility depending on the results of
soil and groundwater sampling and risk assessment to be conducted by Keystone
during future periods pursuant to the order.
In March 2000, the Illinois Attorney General (the "IAG") filed and served a
seven-count complaint against Keystone for alleged violations of the Illinois
Environmental Protection Act, 415 ILCS 5/31, and regulations implementing RCRA
at Keystone's Peoria facility. The complaint alleges Keystone violated RCRA in
failing to prevent spills of an alleged hazardous waste on four separate
occasions during the period from June 1995 through January 1999. The complaint
also alleges the Company illegally "stored", "disposed of" and manifested the
same allegedly hazardous waste on some or all of those occasions. In addition,
the complaint alleges these hazardous waste spills resulted in groundwater
pollution in violation of the Illinois Environmental Protection Act. The
complaint further alleges Keystone improperly disposed of hazardous waste on two
occasions at a landfill not permitted to receive such wastes. The complaint
seeks the maximum statutory penalties allowed which ranges up to $50,000 for
each violation and additional amounts up to $25,000 for each day of violation.
Keystone has answered the complaint and proceedings in the case have been stayed
pending the outcome of settlement negotiations between Keystone and the IAG's
office.
In June 2000, the IAG filed a Complaint For Injunction And Civil Penalties
against Keystone. The complaint alleges the Company's Peoria facility violated
its National Pollutant Discharge Elimination System ("NPDES") permit limits for
ammonia and zinc discharges from the facility's wastewater treatment facility
into the Illinois River. The complaint alleges specific violations of the 30-day
average ammonia limit in the NPDES permit for three months in 1996, 11 months in
1997, 12 months in 1998, 11 months in 1999 and the first two months of 2000. The
complaint further alleges two violations of the daily maximum limit for zinc in
October and December of 1999. In February 2004, the Company reached a settlement
agreement with the IEPA which provided for Keystone to make a $75,000 penalty
payment to the IEPA, and to implement certain corrective actions to prevent a
recurrence of the NPDES violations. The Company did not pay the $75,000 penalty
because the enforcement action was stayed by Keystone's Chapter 11 filing. The
Company reached a settlement agreement with the IEPA in 2005 to satisfy the
penalty obligation through a RCRA trust fund controlled by the IEPA.
In December 2005, the Company received a Notice of Violation from the U.S.
EPA regarding air permit issues at its Peoria, Illinois facility. The U.S. EPA
alleges Keystone failed to perform stack testing and conduct a review of best
available emission control technology in connection with the implementation of
plant construction modifications made pursuant to a 2001 air permit issued under
the Clean Air Act and the Illinois Environmental Protection Act. During January
2006, the Company and the U.S. EPA reached a preliminary agreement on a plan for
addressing the U.S. EPA's concerns without referring the matter for any
enforcement action.
"Superfund" sites
The Company is subject to federal and state "Superfund" legislation that
imposes cleanup and remediation responsibility upon present and former owners
and operators of, and persons that generated hazardous substances deposited
upon, sites determined by state or federal regulators to contain hazardous
substances. Keystone has been notified by U.S. EPA that the Company is a
potentially responsible party ("PRP") under the federal "Superfund" legislation
for the alleged release or threat of release of hazardous substances into the
environment at eight sites. These situations involve cleanup of landfills and
disposal facilities which allegedly received hazardous substances generated by
discontinued operations of the Company. Although Keystone believes its
comprehensive general liability insurance policies provide indemnification for
certain costs the Company incurs at the "Superfund" sites discussed below, it
has only recorded receivables for the estimated insurance recoveries at three of
those sites. During 2002, 2003 and the first six months of 2005, the Company
received approximately $43,000, $32,000 and $71,000, respectively, from certain
of its insurers in exchange for releasing such insurers from coverage for
certain years of environmental related liabilities. Such amounts are included in
Keystone's self insurance accruals. Keystone did not receive any such insurance
recoveries during 2004.
In July 1991, the United States filed an action against a former division
of the Company and four other PRPs in the United States District Court for the
Northern District of Illinois (Civil Action No. 91C4482) seeking to recover
investigation and remediation costs incurred by U.S. EPA at the Byron Salvage
Yard, located in Byron, Illinois. In April 1992, Keystone filed a third-party
complaint in this civil action against 15 additional parties seeking
contribution in the event the Company is held liable for any response costs at
the Byron site. Neither the Company nor the other designated PRPs are performing
any investigation of the nature and extent of the contamination. In December
1996, Keystone, U.S. EPA and the Department of Justice entered into the Fifth
Partial Consent Decree to settle Keystone's liability for EPA response costs
incurred at the site through April 1994 for a payment of $690,000. Under the
agreement Keystone is precluded from recovering any portion of the $690,000
settlement payment from other parties to the lawsuit. In January 1997, Keystone
paid the $690,000 settlement. Keystone will remain potentially liable for EPA
response costs incurred after April 30, 1994, and natural resource damage
claims, if any, that may be asserted in the future. Keystone recovered a portion
of the $690,000 payment from its insurer. In March 1997, U.S. EPA issued a
Proposed Remedial Action Plan ("PRAP") recommending that a limited excavation of
contaminated soils be performed at an estimated cost of $63,000, that a soil
cover be placed over the site, an on-site groundwater pump and treat system be
installed and operated for an estimated period of 15 years, and that both
on-site and off-site groundwater monitoring be conducted for an indefinite
period. U.S. EPA's cost estimate for the recommended plan is $5.1 million. U.S.
EPA's estimate of the highest cost alternatives evaluated but not recommended in
the PRAP is approximately $6 million. The Company filed public comments on May
1, 1997, objecting to the PRAP. In March 1999, Keystone and other PRP's received
a Comprehensive Environmental Response, Compensation and Liability Act
("CERCLA") special notice letter notifying them for the first time of a
September 1998 Record of Decision ("ROD") and requesting a commitment on or
before May 19, 1999 to perform soils work required by that ROD that was
estimated to cost approximately $300,000. In addition, the special notice letter
also requested the PRPs to reimburse U.S. EPA for costs incurred at the site
since May 1994 in the amount of $1.1 million, as well as for all future costs
the U.S. EPA will incur at the site in overseeing the implementation of the
selected soils remedy and any future groundwater remedy. Keystone refused to
agree to the U.S. EPA's past and future cost demand. In August 1999, U.S. EPA
issued a groundwater PRAP with an estimated present value cost of $3 million.
Keystone filed public comments opposing the PRAP in September 1999. In October
2002, Keystone and the other remaining PRPs entered into a second Consent Decree
with the U.S. EPA, in order to resolve their liability for performance of the
U.S. EPA's September 1998 ROD for a soils remedy at the site, for the
performance of the U.S. EPA's December 1999 ROD for remedial action regarding
the groundwater component of Operable Unit No. 4 at the site, for payment of
U.S. EPA's site costs incurred since May 1994 as well as future U.S. EPA
oversight costs, and for the transfer of certain funds that may be made
available to the PRPs as a result of a consent decree reached between U.S. EPA
and another site PRP. Under the terms of the second Consent Decree, and the PRP
Agreement was executed to implement the PRPs' performance under that decree,
Keystone is required to pay approximately $700,000 (of which approximately
$600,000 has already been paid into a PRP Group trust fund), and would remain
liable for 18.57% of future U.S. EPA oversight costs as well as a similar share
of any unanticipated cost increases in the soils remedial action work. (Under
the agreements, the City of Byron, Illinois, would assume responsibility for any
cost overruns associated with the municipal water supply components of the
groundwater contamination remedy.) The U.S. EPA served the PRP Group in February
2003 with its first oversight cost claim under the second Consent Decree, in the
amount of $186,000 for the period from March 1, 2000 to November 25, 2002.
Keystone's share of that claim is approximately $35,000. The U.S. EPA has also
requested changes to the groundwater monitoring program at the site that may
require future increases in the PRP Group's groundwater monitoring reserves. In
September 2002, the IAG served a demand letter on Keystone and 3 other PRP's
seeking recovery of approximately $1.3 million in state cleanup costs incurred
at the Byron Salvage Yard site. The PRP's are currently negotiating with the IAG
in an attempt to settle this claim. The four PRP's named in the demand letter
are also attempting to include other site PRP's in the negotiations. It remains
possible that these negotiations could fail and that Keystone's ultimate
liability for the Byron Salvage Yard site could increase in a subsequent
settlement agreement or as a result of litigation.
In September 1991, the Company along with 53 other PRPs, executed a consent
decree to undertake the immediate removal of hazardous wastes and initiate a
Remedial Investigation/Feasibility Study ("RI/FS") of the Interstate Pollution
Control site located in Rockford, Illinois. The Company's percentage allocation
within the group of PRPs agreeing to fund this project is currently 2.14%.
However, the Company's ultimate allocation, and the ultimate costs of the RI/FS
and any remedial action, are subject to change depending, for example, upon: the
number and financial condition of the other participating PRPs, field conditions
and sampling results, results of the risk assessment and feasibility study,
additional regulatory requirements, and the success of a contribution action
seeking to compel additional parties to contribute to the costs of the RI/FS and
any remedial action. The RI/FS began in 1993, was completed in 1997 and approved
by IEPA in 1998. In the summer of 1999, IEPA selected a capping and soil vapor
extraction remedy estimated by the PRP group to have a present value cost of
approximately $2.5 million. IEPA may also demand reimbursement of future
oversight costs. The three largest PRPs at the site are negotiating a consent
order with IEPA for the performance of the site remedy. Keystone expects to
participate with the larger PRPs in the performance of that remedy based on its
RI/FS allocation percentage.
In August 1987, Keystone was notified by U.S. EPA that it is a PRP
responsible for the alleged hazardous substance contamination of a site
previously owned by the Company in Cortland, New York. Four other PRPs
participated in the RI/FS and a contribution action is pending against eleven
additional viable companies which contributed wastes to the site. Following
completion of the RI/FS, U.S. EPA published in November 1997, a PRAP for the
site that recommends the excavation and disposal of contaminated soil,
installation of an impervious cap over a portion of the site, placement of a
surface cover over the remainder of the site and semi-annual groundwater
monitoring until drinking water standards are met by natural attenuation. U.S.
EPA estimates the costs of this recommended plan to be $3.1 million. The highest
cost remedy evaluated by U.S. EPA but not recommended in the PRAP is estimated
by U.S. EPA to have a cost of $19.8 million. In September 1998, Keystone and
four other PRPs who had funded the prior remedial actions and RI/FS signed a
proposed Consent Decree with U.S. EPA calling for them to be "nonperforming
parties" for the implementation of a March 1998 Record of Decision. Under this
Consent Decree, Keystone could be responsible for an unspecified share of U.S.
EPA's future costs in the event that changes to the existing ROD are required.
Prior to its acquisition by Keystone, DeSoto, Inc. ("DeSoto") was notified
by U.S. EPA that it is one of approximately 50 PRPs at the Chemical Recyclers,
Inc. site in Wylie, Texas. In January 1999, DeSoto changed its name to Sherman.
Under a consent order with the U.S. EPA, the PRP group has performed a removal
action and an investigation of soil and groundwater contamination. Such
investigation revealed certain environmental contamination. It is anticipated
U.S. EPA will order further remedial action, the exact extent of which is not
currently known. Sherman is paying on a non-binding interim basis, approximately
10% of the costs for this site. Remediation costs, at Sherman Wire's present
allocation level, are estimated at a range of from $1.5 million to $4 million.
In 1984, U.S. EPA filed suit against DeSoto by amending a complaint against
Midwest Solvent Recovery, Inc. et al ("Midco"). DeSoto was a defendant based
upon alleged shipments to an industrial waste recycling storage and disposal
operation site located in Gary, Indiana. The amended complaint sought relief
under CERCLA to force the defendants to clean up the site, pay non-compliance
penalties and reimburse the government for past clean up costs. In June 1992,
DeSoto settled its portion of the case by entering into a partial consent
decree, and all but one of the eight remaining primary defendants and 93 third
party defendants entered into a main consent decree. Under the terms of the
partial consent decree, DeSoto agreed to pay its pro rata share (13.47%) of all
costs under the main consent decree. In addition to certain amounts included in
the trust fund discussed below, Sherman Wire also has certain funds available in
other trust funds due it under the partial consent decree. These credits can be
used by Sherman Wire (with certain limitations) to fund its future liabilities
under the partial consent decree.
In 1995, DeSoto was notified by the Texas Natural Resource Conservation
Commission ("TNRCC") that there were certain deficiencies in prior reports to
TNRCC relative to one of its non-operating facilities located in Gainesville,
Texas. During 1999, Sherman Wire entered into TNRCC's Voluntary Cleanup Program.
Remediation costs are presently estimated to be between $1.2 million and $2
million. Investigation activities are on-going including additional soil and
groundwater sampling.
In December 1991, DeSoto and approximately 600 other PRPs were named in a
complaint alleging DeSoto and the PRPs generated wastes that were disposed of at
a Pennsauken, New Jersey municipal landfill. The plaintiffs in the complaint
were ordered by the court to show in what manner the defendants were connected
to the site. The plaintiffs provided an alleged nexus indicating garbage and
construction materials from DeSoto's former Pennsauken facility were disposed of
at the site and such waste allegedly contained hazardous material to which
DeSoto objected. The claim was dismissed without prejudice in August 1993. In
1996, DeSoto received an amended complaint containing the same allegations. This
matter is in discovery stage at June 30, 2005. Sherman Wire has denied any
liability with regard to this matter and expects to vigorously defend the
action.
Sherman Wire has received notification from the TNRCC stating that DeSoto
is a PRP at the Material Recovery Enterprises Site near Ovalo, Texas, with
approximately 3% of the total liability. The matter has been tendered to the
Valspar Corporation ("Valspar") pursuant to a 1990 agreement whereby Valspar
purchased certain assets of DeSoto. Valspar has been handling the matter under
reservation of rights. At the request of Valspar, Sherman Wire has signed a
participation agreement which would require Sherman Wire to pay no less than 3%
of the remediation costs. Valspar continues to pay for legal fees in this matter
and has reimbursed Sherman Wire for all assessments.
In November 2003, Sherman Wire received a General Notice of Potential
Liability from the U.S. EPA advising them that the U.S. EPA believe Sherman Wire
is a PRP at the Lake Calumet Cluster Site in Chicago, Illinois. The U.S. EPA
advises the 200 acre site consists of areas of both ground water and surface
water contamination located in a remnant wetland area. The U.S. EPA's effort at
this site is part of a larger effort undertaken along with the State of
Illinois, the City of Chicago, the U.S. Army Corps of Engineers, and the U.S.
Department of Energy to cleanup contamination in the Lake Calumet basin. The
U.S. EPA alleges the original wetland area has been partially filed by various
waste handling and disposal activities which started as early as the 1940's.
Incineration of hazardous waste including paints, thinners, varnishes,
chlorinated solvents, styrene, ink, adhesives, and antifreeze occurred on the
site from 1977 until 1982. In addition, several landfills operated in and near
the site from 1967 into the 1990s. Approximately 1,600 ruptured drums have been
discovered buried on the site. The U.S. EPA has undertaken or overseen various
response actions at the site to mitigate remaining above ground contamination in
the site vicinity. The U.S. EPA advises these activities have led to the
formation of an extensive ground water contamination plume and contamination in
the remaining wetland. The origin of the contamination cannot be associated with
any single prior activity. The ground water is in direct contact with the
wetland waters, and the same contaminants of concern, certain of which are known
to bioaccumulate, and their concentrations are above human health and
environmental standards. Sherman did not respond to the November 2003 Notice,
however, Sherman notified their insurance carriers and asked them to indemnify
and defend Sherman with respect to the Notice. At present, no carrier has agreed
to either indemnify or defend. In addition, in November, 2003, Sherman Wire
requested the U.S. EPA to provide any documentation that allegedly connects
Sherman Wire to the site. Subsequently, the U.S. EPA produced documents that may
show that Sherman Wire wastes were sent to the site. It is not possible at this
time to determine if Sherman Wire has any future liability with respect to this
site.
In addition to the sites discussed above, Sherman Wire is allegedly
involved at various other sites and in related toxic tort lawsuits which it does
not currently expect to incur significant liability.
Sherman Wire has access to a trust fund relative to another environmental
site for any expenses or liabilities it incurs relative to environmental claims
at that site. The trust fund is included in restricted investments on the
balance sheet. At December 31, 2004 and June 30, 2005, the balance in this trust
fund was approximately $248,000 and $251,000, respectively.
Note 12 - Other commitments and contingencies:
Current litigation
As a result of the Chapter 11 filings on February 26, 2004, litigation
relating to prepetition claims against the filing companies, including Keystone
and Sherman has been stayed. These liabilities that relate to Sherman continue
to be negotiated and adjudicated subsequent to Keystone's emergence from Chapter
11 on August 31, 2005.
In July 2001, Sherman Wire received a letter from a law firm advising them
that Sears Roebuck & Co. ("Sears") had been named as a defendant in a lead paint
personal injury case. Sears claimed contractual indemnity against Sherman and
demanded that Sherman defend and indemnify Sears with regard to any losses or
damages Sears may sustain in the case. Sears was named as an additional insured
on insurance policies, in which DeSoto, the manufacturer of the paint, was the
named insured. Additional demands were made by Sears in 2002 with regard to
additional lead paint cases. DeSoto's insurance carriers were notified of the
action and asked to indemnify Sherman with respect to the complaint. Sherman
Wire has not indemnified Sears and is unaware if the insurors have agreed to
indemnify Sears.
In May 2002, the Company was notified by an insurance company of a
declaratory complaint filed in Cook County Illinois by Sears against the
insurance company and a second insurance company (collectively the "Insurance
Companies") relative to a certain lead paint personal injury litigation against
Sears. It is the Company's understanding that the declaratory complaint has
since been amended to include all lead paint cases where Sears has been named as
a defendant as a result of paint sold by Sears that was manufactured by DeSoto
(now Sherman Wire). Sears was allegedly named as an additional insured on
insurance policies issued by the Insurance Companies, in which DeSoto, the
manufacturer of the paint, was the named insured. Sears has demanded
indemnification from the Insurance Companies. One of the Insurance Companies has
demanded indemnification and defense from Sherman Wire. Sherman Wire believes
the request for indemnification is invalid. However, such Insurance Company has
refused to accept Sherman Wire's response and has demanded that Sherman Wire
participate in mediation in accordance with the terms of a prior settlement
agreement. Sherman Wire may be sued by the Insurance Companies and, as a result,
could be held responsible for all costs incurred by the Insurance Companies in
defending Sears and paying for any claims against Sears as well as for the cost
of any litigation against Sherman Wire. The total amount of these lead paint
litigation related costs and claims could be significant. However, the Company
does not have a liability recorded with respect to these matters because the
liability that may result, if any, cannot be reasonably estimated at this time.
The Company is also engaged in various legal proceedings incidental to its
normal business activities. In the opinion of the Company, none of such
proceedings is material in relation to the Company's consolidated financial
position, results of operations or liquidity.
Note 13 - Earnings per share:
Net income (loss) per share is based upon the weighted average number of
common shares and dilutive securities. A reconciliation of the numerators and
denominators used in the calculations of basic and diluted earnings per share
computations of income (loss) is presented below. The effect of the assumed
conversion of the Series A Convertible Preferred Stock was antidilutive in the
three months ended June 30, 2005 and both of the six month periods ended June
30, 2004 and 2005. Keystone stock options were omitted from the calculation
because they were antidilutive in all periods presented.
Three months ended Six months ended
June 30, June 30,
------------------ -----------------
2004 2005 2004 2005
------ ------ ------ ------
(In thousands)
Numerator:
Net income (loss) $ 10,993 $ (3,659) $ 3,355 $ (4,935)
Less Series A Preferred Stock
dividends - - 1,223 -
-------- -------- -------- -------
Basic net income (loss) 10,993 (3,659) 2,132 (4,935)
Series A Preferred Stock dividends - - 1,223 -
-------- -------- -------- --------
Diluted net income (loss) $ 10,993 $ (3,659) $ 3,355 $ (4,935)
======== ======== ======== ========
Denominator:
Average common shares outstanding 10,068 10,068 10,068 10,068
Dilutive effect of Series A
Preferred Stock 17,975 - 17,975 -
-------- -------- -------- -------
Diluted shares 28,043 10,068 28,043 10,068
======== ======== ======== ========
Note 14 - Accounting principles not yet adopted:
Inventory costs. The Company will adopt SFAS No. 151, "Inventory Costs, an
amendment of ARB No. 43, Chapter 4," for inventory costs incurred on or after
January 1, 2006. SFAS No. 151 requires that the allocation of fixed production
overhead costs to inventory shall be based on normal capacity. Normal capacity
is not defined as a fixed amount; rather, normal capacity refers to a range of
production levels expected to be achieved over a number of periods under normal
circumstances, taking into account the loss of capacity resulting from planned
maintenance shutdowns. The amount of fixed overhead allocated to each unit of
production is not increased as a consequence of idle plant or production levels
below the low end of normal capacity, but instead a portion of fixed overhead
costs are charged to expense as incurred. Alternatively, in periods of
production above the high end of normal capacity, the amount of fixed overhead
costs allocated to each unit of production is decreased so that inventories are
not measured above cost. SFAS No. 151 also clarifies existing GAAP to require
that abnormal freight and wasted materials (spoilage) are to be expensed as
incurred. The Company believes its production cost accounting already complies
with the requirements of SFAS No. 151, and the Company does not expect adoption
of SFAS No. 151 will have a material effect on its consolidated financial
statements.
Stock options. Based on guidance issued by the U.S. Securities and Exchange
Commission, the Company will adopt SFAS No. 123R, "Share-Based Payment," as of
January 1, 2006. SFAS No. 123R, among other things, eliminates the alternative
in existing GAAP to use the intrinsic value method of accounting for stock-based
employee compensation under APBO No. 25. Upon adoption of SFAS No. 123R, the
Company will generally be required to recognize the cost of employee services
received in exchange for an award of equity instruments based on the grant-date
fair value of the award, with the cost recognized over the period during which
an employee is required to provide services in exchange for the award
(generally, if the vesting period of the award). No compensation cost will be
recognized in the aggregate for equity instruments for which the employee does
not render the requisite service (generally, the instrument is forfeited before
it has vested). The grant-date fair value will be estimated using option-pricing
models (e.g. Black-Scholes or a lattice model). Under the transition
alternatives permitted under SFAS No. 123R, the Company will apply the new
standard to all new awards granted on or after January 1, 2006, and to all
awards existing as of December 31, 2005 which are subsequently modified,
repurchased or cancelled. Additionally, as of January 1, 2006, the Company will
be required to recognize compensation cost for the portion of any non-vested
award existing as of December 31, 2005 over the remaining vesting period.
Because the Company is not expected to grant any options prior to January 1,
2006 and because the number of non-vested awards as of December 31, 2005 with
respect to options previously granted by the Company is not expected to be
material, the effect of adopting SFAS No. 123R is not expected to be significant
in so far as it relates to existing stock options. Should the Company, however,
grant a significant number of options in the future, the effect on the Company's
consolidated financial statements could be material.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
Bankruptcy:
On February 26, 2004, Keystone and five of its direct and indirect
subsidiaries filed for voluntary protection under Chapter 11 of the Federal
Bankruptcy Code. Keystone and its subsidiaries filed their petitions in the U.S.
Bankruptcy Court for the Eastern District of Wisconsin in Milwaukee. The Company
is managing its business as a debtor-in possession subject to approval by the
Court. Keystone attributed the need to reorganize to weaknesses in product
selling prices over the last several years, unprecedented increases in ferrous
scrap costs, Keystone's primary raw material, and significant liquidity needs to
service employee and retiree medical costs. These problems substantially limited
Keystone's liquidity and undermined its ability to obtain sufficient debt or
equity capital to operate as a going concern.
Under Chapter 11 proceedings, actions by creditors to collect Pre-petition
Claims are stayed, absent specific authorization from the Court to pay such
claims while the Company manages the business as a debtor-in-possession.
Keystone received approval from the Court to pay certain of its pre-petition
liabilities, including employee wages and certain employee benefits.
Keystone filed a plan of reorganization on October 4, 2004 and amended that
plan on May 26, 2005, June 21, 2005 and June 27, 2005. Keystone's amended plan
of reorganization was accepted by the impacted constituencies and confirmed by
the Court on August 10, 2005. The Company emerged from bankruptcy protection on
August 31, 2005. Significant provisions of Keystone's amended plan of
reorganization included, among other things:
o Assumption of the previously negotiated amendment to the collective
bargaining agreement with the Independent Steel Workers Alliance (the
"ISWA"), Keystone's largest labor union;
o Assumption of the previously negotiated agreements reached with certain
retiree groups that will provide relief by permanently reducing healthcare
related payments to these retiree groups from pre-petition levels;
o The Company's obligations due to pre-petition secured lenders other than
its Debtor-In-Possession lenders were reinstated in full against
reorganized Keystone;
o All shares of Keystone's common and preferred stock outstanding at the
petition date (February 26, 2004) were cancelled;
o Pre-petition unsecured creditors with allowed claims against Keystone will
receive, on a pro rata basis, in the aggregate, $5.2 million in cash, a
$4.8 million secured promissory note and 49% of the new common stock of
reorganized Keystone;
o Certain operating assets and existing operations of Sherman Wire will be
sold at fair market value to Keystone, which will then be used to form and
operate a newly created wholly-owned subsidiary of reorganized Keystone
named Keystone Wire Products Inc.;
o Sherman Wire was also reorganized and the proceeds of the operating asset
sale to Keystone and other funds will be distributed, on a pro rata basis,
to Sherman Wire's pre-petition unsecured creditors as their claims are
finally adjudicated;
o Sherman Wire's pre-petition wholly-owned non-operating subsidiaries, J.L.
Prescott Company, and DeSoto Environmental Management, Inc. as well as
Sherman Wire of Caldwell, Inc., a wholly-owned subsidiary of Keystone, will
ultimately be liquidated and the pre-petition unsecured creditors with
allowed claims against these entities will receive their pro-rata share of
the respective entity's net liquidation proceeds;
o Pre-petition unsecured creditors with allowed claims against FV Steel &
Wire Company, another one of Keystone's wholly-owned subsidiaries, will
receive cash in an amount equal to their allowed claims;
o One of Keystone's Debtor-In-Possession lenders, EWP Financial, LLC (an
affiliate of Contran Corporation ("Contran"), Keystone's largest
pre-petition shareholder) converted $5 million of its DIP credit facility,
certain of its pre-petition unsecured claims and all of its administrative
claims against Keystone into 51% of the new common stock of reorganized
Keystone; and
o The Board of Directors of reorganized Keystone now consists of seven
individuals, two each of which were designated by Contran and the Official
Committee of Unsecured Creditors (the "OCUC"), respectively. The remaining
three directors qualify as independent directors (two of the independent
directors were appointed by Contran with the OCUC's consent and one was
appointed by the OCUC with Contran's consent).
In addition, Keystone has obtained an $80 million secured credit facility
from Wachovia Capital Finance (Central). Proceeds from this credit facility were
used to extinguish Keystone's existing Debtor-In-Possession credit facilities
and to provide working capital for reorganized Keystone. See Note 2 to the
Consolidated Financial Statements.
Summary
As discussed in Note 1 to the Consolidated Financial Statements, Keystone
restated its 2003 and 2004 consolidated balance sheets and statements of cash
flows to properly classify certain cash overdrafts.
The Company reported a net loss of $3.7 million in the second quarter of
2005 as compared to net income of $11.0 million in the second quarter of 2004
and during the first six months of 2005, the Company reported a net loss of $4.9
million as compared to net income of $3.4 million during the first six months of
2004. The primary reasons for the decline in net income from both of the 2004
periods to the respective periods in 2005 were due to the net effects of (i)
significantly higher costs for ferrous scrap partially offset by higher per-ton
product selling prices, (ii) substantially lower shipment volumes during both of
the 2005 periods as compared to the 2004 periods, (iii) a higher defined benefit
pension credit in the 2005 periods, and (iv) lower retiree medical costs.
OVERALL RESULTS OF OPERATIONS:
Keystone believes it is a leading manufacturer of steel fabricated wire
products, nails, industrial wire and wire rod for the agricultural, industrial,
construction, original equipment manufacturer and retail consumer markets and
believes it is one of the largest manufacturers of fabricated wire products in
the United States. Historically, the Company has experienced greater sales and
profits during the first half of the year due to the seasonality of sales in
principal wire products markets, including the agricultural and construction
markets. Keystone is also engaged in the operation of a ferrous scrap recycling
facility. The operations of this ferrous scrap recycling facility were
insignificant when compared to the consolidated operations of the Company. As
such, the results of its operations are not separately addressed in the
discussion that follows.
As provided by the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995, the Company cautions that statements in this
Quarterly Report on Form 10-Q relating to matters that are not historical facts
including, but not limited to, statements found in this "Management's Discussion
And Analysis Of Financial Condition And Results Of Operations," are
forward-looking statements that represent management's beliefs and assumptions
based on currently available information. Forward-looking statements can be
identified by the use of words such as "believes", "intends", "may", "should",
"could", "anticipates," "expected" or comparable terminology, or by discussions
of strategies or trends. Although Keystone believes the expectations reflected
in such forward-looking statements are reasonable, it cannot give any assurances
that these expectations will prove to be correct. Such statements by their
nature involve substantial risks and uncertainties that could significantly
impact expected results, and actual future results could differ materially from
those described in such forward-looking statements. While it is not possible to
identify all factors, Keystone continues to face many risks and uncertainties.
Among the factors that could cause actual future results to differ materially
are the risks and uncertainties discussed in this Quarterly Report and those
described from time to time in the Company's other filings with the Securities
and Exchange Commission including, but not limited to;
o Future supply and demand for the Company's products (including cyclicality
thereof),
o Customer inventory levels,
o Changes in raw material and other operating costs (such as ferrous scrap
and energy)
o The possibility of labor disruptions,
o General global economic and political conditions,
o Competitive products and substitute products,
o Customer and competitor strategies,
o The impact of pricing and production decisions,
o The possibility of labor disruptions,
o Environmental matters (such as those requiring emission and discharge
standards for existing and new facilities),
o Government regulations and possible changes therein,
o Significant increases in the cost of providing medical coverage to
employees and retirees,
o The ultimate resolution of pending litigation,
o International trade policies of the United States and certain foreign
countries,
o Operating interruptions (including, but not limited to, labor disputes,
fires, explosions, unscheduled or unplanned downtime and transportation
interruptions),
o The ability of the Company to renew or refinance credit facilities,
o Any possible future litigation, and
o Other risks and uncertainties as discussed in this Quarterly Report and the
Annual Report, including, without limitation, the section referenced above.
Should one or more of these risks materialize (or the consequences of such
a development worsen), or should the underlying assumptions prove incorrect,
actual results could differ materially from those forecasted or expected.
Keystone disclaims any intention or obligation to update or revise any
forward-looking statement whether as a result of new information, future events
or otherwise.
The following table sets forth Keystone's steel and wire production,
ferrous scrap costs, sales volume and pricing data for the periods indicated.
Three months ended Six months ended
June 30, June 30,
------------------ -----------------
2004 2005 2004 2005
------ ------ ------ ------
(Tons in thousands)
Production volume (tons):
Billets 167 95 286 236
Wire rod 150 98 267 232
Average per-ton ferrous
scrap purchase cost $189 $ 228 $183 $ 242
Sales volume(tons):
Fabricated wire products 58 48 108 94
Nails 11 3 21 8
Industrial wire 27 15 44 31
Wire rod 34 45 63 88
Billets 10 3 14 5
---- ------ ---- ------
140 114 250 226
==== ====== ==== ======
Per-ton selling prices:
Fabricated wire products $945 $1,021 $857 $1,038
Nails $800 $ 810 $727 $ 791
Industrial wire $697 $ 758 $649 $ 763
Wire rod $516 $ 543 $470 $ 555
Billets $197 $ 355 $166 $ 313
All steel and wire products $726 $ 773 $673 $ 785
The following table sets forth the components of the Company's net sales
for the periods indicated.
Three months ended Six months ended
June 30, June 30,
------------------ -----------------
2004 2005 2004 2005
------ ------ ------ ------
(In millions)
Fabricated wire products $ 54.3 $48.8 $ 92.4 $ 96.8
Nails 8.7 2.7 15.1 6.5
Industrial wire 18.7 11.2 28.9 23.6
Wire rod 17.7 24.7 29.7 49.0
Billets 2.0 1.1 2.3 1.7
Other .4 .5 .6 .9
---- ------ ---- ------
$101.8 $89.0 $169.0 $178.5
==== ====== ==== ======
The following table sets forth selected operating data of the Company as a
percentage of net sales for the periods indicated.
Three months ended Six months ended
June 30, June 30,
------------------ -----------------
2004 2005 2004 2005
------ ------ ------ ------
Net sales 100.0 % 100.0 % 100.0 % 100.0 %
Cost of goods sold 81.6 97.8 89.8 96.1
----- ----- ----- -----
Gross margin 18.4 % 2.2 % 10.2 % 3.9 %
===== ===== ===== =====
Selling expense 1.4 % 1.8% 1.6 % 1.7 %
General and administrative expense 2.7 % 3.0 % 3.2 % 3.0 %
Defined benefit pension credit (1.5)% (3.6)% (1.8)% (3.6)%
Corporate expense .6 % 1.0 % .9 % 1.2 %
Reorganization costs 3.0 % 3.0 % 3.0 % 3.4 %
Income (loss) before income taxes 11.1 % (4.0)% 2.2 % (2.6)%
Income tax provision .3 .1 .2 .2
----- ----- ----- -----
Net income (loss) 10.8% (4.1)% 2.0 % (2.8)%
===== ===== ===== =====
Discussion of operating results
Net sales during the second quarter of 2005 declined $12.8 million, or
12.6% from the second quarter of 2004 due primarily to a 26,000 ton decline in
shipment volume partially offset by a 6.5% increase in per-ton product selling
prices. Despite the decline in net sales during the second quarter of 2005, net
sales during the first six months of 2005 increased $9.5 million, or 5.6% from
the first six months of 2004 as significantly higher per-ton product selling
prices more than offset a 24,000 ton decline in shipment volume. As a result of
lower shipment volumes in all product lines except wire rod during the 2005
periods as compared to the 2004 periods, Keystone's product mix in the 2005
periods consisted of a lower percentage of fabricated wire products, nails and
industrial wire than during the respective 2004 periods. Keystone was able to
supplement these lower shipment volumes of fabricated wire products, nails and
industrial wire during the 2005 periods with increased shipments of wire rod.
However, the Company typically realizes a lower gross margin on sales of wire
rod than it does on its other products. The 6.5% increase ($47 per ton) in
overall per-ton product selling prices during the second quarter of 2005
favorably impacted net sales in that period by approximately $5.4 million while
the 16.6% increase ($112 per ton) in overall per-ton product selling prices
during the first six months of 2005 favorably impacted net sales in that period
by approximately $25.3 million.
During both the second quarter and first six months of 2005, Keystone
realized increased per-ton selling prices in all product lines over those of the
same periods during 2004. During the second quarter of 2005, fabricated wire
products per-ton selling prices increased by 8.0%, nails increased 1.3%,
industrial wire increased 8.8%, wire rod increased 5.2% and the per-ton selling
prices of billets during the second quarter of 2005 increased 80.2% as compared
to the second quarter of 2004. During the first six months of 2005, fabricated
wire products per-ton selling prices increased by 21.1%, nails increased 8.8%,
industrial wire increased 17.6%, wire rod increased 18.1% and the per-ton
selling prices of billets during the first six months of 2005 increased 88.6% as
compared to the first six months of 2004. During both the second quarter and
first six months of 2005, shipment volumes declined as compared to the same
periods during 2004 in all product lines except wire rod. During the second
quarter of 2005, fabricated wire products shipment volume declined 17.2%, nails
declined 72.7%, industrial wire declined 44.4% and billet shipments declined
70.0% while wire rod shipment volume in the second quarter of 2005 increased
32.4% from the 2004 second quarter levels. During the first six months of 2005,
fabricated wire products shipment volume declined 13.0%, nails declined 61.9%,
industrial wire declined 29.5% and billet shipments declined 64.3% while wire
rod shipment volume in the first six months of 2005 increased 39.7% from the
first six months of 2004 levels. The Company believes the lower shipment volume
in the 2005 periods of both its fabricated wire products and industrial wire
were due to high inventory levels at Keystone's customers. In addition, Keystone
believes the late winter and inclement weather during the spring also adversely
impacted fabricated wire product shipments. The Company also believes the lower
shipment volume of nails during the 2005 periods was due primarily to a Company
initiative that began during the last quarter of 2003 to discontinue sales to
its less profitable customers. Throughout 2004, the Company implemented several
price increases primarily as a reaction to rapidly increasing ferrous scrap
costs, Keystone's primary raw material. As a result of these efforts, during the
both the second quarter and first six months of 2005, the Company was able to
realize increases in the per-ton product selling prices of all of its product
lines as compared to per-ton selling prices during the respective periods during
2004.
Billet production during the 2005 second quarter declined by 72,000 tons to
95,000 tons from 167,000 tons during the second quarter of 2004. Wire rod
production during the second quarter of 2005 declined by 52,000 tons to 98,000
tons from 150,000 tons during the second quarter of 2004. Billet production
during the first six months of 2005 declined by 50,000 tons to 236,000 tons from
286,000 tons during the first six months of 2004. Wire rod production during the
first six months of 2005 declined by 35,000 tons to 232,000 tons from 267,000
tons during the first six months of 2004. The lower billet and wire rod
production during the 2005 periods was due primarily to Keystone limiting
production schedules during the 2005 periods as a result of the lower market
demand.
Despite the lower shipment volume during both the second quarter and first
six month periods of 2005, cost of goods sold during the 2005 second quarter
increased by 4.7% to $87.0 million from $83.1 million during the 2004 second
quarter and during the first six months of 2005, cost of goods sold increased by
13.0% to $171.5 million from $151.7 million during the first six months of 2004.
As a result, the cost of goods sold percentage increased from 81.6% in the 2004
second quarter to 97.8% of net sales in the second quarter of 2005 and increased
from 89.8% during the first six months of 2004 to 96.1% during the first six
months of 2005. This increase in the cost of goods sold percentage was due
primarily to significantly higher costs for ferrous scrap in the 2005 periods as
well as higher costs for natural gas and electrical power at the Company's
Peoria, Illinois facility partially offset by the increased product per-ton
selling prices and lower retiree medical costs in the 2005 periods. Keystone's
per-ton ferrous scrap costs increased 20.6% during the 2005 second quarter as
compared to the 2004 second quarter and 32.2% during the first six months of
2005 as compared to the same period in 2004. During the 2005 second quarter, the
Company purchased 112,000 tons of ferrous scrap at an average price of $228
per-ton as compared to 2004 second quarter purchases of 180,000 tons at an
average price of $189 per ton. During the first six months of 2005, the Company
purchased 264,000 tons of ferrous scrap at an average price of $242 per-ton as
compared to purchases in the first six months of 2004 of 319,000 tons at an
average price of $183 per ton. This increase in per-ton ferrous scrap costs
adversely impacted gross profit during the 2005 second quarter by approximately
$4.4 million and by $15.6 million during the first six months of 2005. The cost
of natural gas and electrical power at the Company's Peoria facility in both the
2005 second quarter and the first six months of 2005 was higher than the
respective periods during 2004. These higher costs adversely impacted cost of
goods sold by approximately $382,000 and $661,000, respectively, in the second
quarter of 2005 and by approximately $953,000 and $671,000, respectively, in the
first six months of 2005.
As a result of the above items, the gross margin of $18.7 million in the
2004 second quarter declined to a gross margin of $2.0 million in the 2005 first
quarter and the gross margin of $17.3 million during the first six months of
2004 declined to $7.0 million during the first six months of 2005. As a result,
the gross margin percentage in the second quarter of 2004 of 18.4% declined to
2.2% in the 2005 second quarter and the gross margin percentage in the first six
months of 2004 of 10.2% declined to 3.9% in the first six months of 2005.
Selling expense during the 2005 second quarter of $1.6 million approximated
the 2004 second quarter selling expense of $1.5 million, whereas selling expense
during the first six months of 2004 increased from $2.7 million to $3.0 million
during the first six months of 2005 due primarily to increased advertising
expenses.
General and administrative expense of $2.7 million in the 2005 second
quarter was relatively unchanged from the 2004 level whereas general and
administrative expense during the first six months of 2005 of $5.4 million
approximated general and administrative expense in the first six months of 2004.
During the second quarter and first six months of 2005, Keystone recorded a
defined benefit pension credit of $3.2 million and $6.4 million, respectively,
as compared to recording a defined benefit pension credit in the same periods
during 2004 of $1.5 million and $3.0 million, respectively. The increased
pension credit during the 2005 periods was a result of a $52 million increase in
plan assets from the end of 2003 to the end of 2004. In addition, Keystone was
not required to make any cash contributions for defined benefit pension plan
fundings during either 2005 or 2004. The Company currently anticipates during
2005 it will record a defined benefit pension credit of $11.7 million and that
no plan fundings will be required during 2005. However, future variances from
assumed actuarial rates, including the rate of return on pension plan assets,
may result in increases or decreases in pension expense or credit and future
funding requirements.
During 2004, the Company entered into an agreement (the "1114 Agreement")
with certain retiree groups that substantially reduced the post retirement
("OPEB") benefits that will be paid to these retiree groups in the future. Prior
to confirmation of Keystone's definitive plan of reorganization, the Court could
have rescinded the 1114 Agreement and therefore the 1114 Agreement was not
definitive until it was confirmed by the Court in connection with Keystone's
emergence from Chapter 11 on August 31, 2005. As such, and in accordance with
GAAP, the Company has continued to record OPEB expense through August 31, 2005
at the estimated level as if Keystone had not entered into the 1114 Agreement,
Keystone estimates OPEB expense for the first eight months of 2005 will
approximate $11.5 million. However, at the time of the Company's emergence from
Chapter 11 on August 31, 2005, and concurrent confirmation of the 1114
Agreement, GAAP then requires the effect of the substantially reduced OPEB
benefits agreed to as part of the 1114 Agreement be accounted for as a plan
amendment, the benefit of which is amortized into income over future periods.
Accordingly, Keystone estimates that it will record an OPEB credit of
approximately $2.7 million for the last four months of 2005, resulting in an
$8.9 million expense for the year 2005.
General corporate expenses during the 2005 second quarter were
approximately $263,000 higher than general corporate expenses during the second
quarter of 2004 due primarily to substantially higher state franchise taxes
during the 2005 period. General corporate expenses during the first six months
of 2005 were approximately $686,000 higher than general corporate expenses
during the first six months of 2004 due primarily to higher legal and
professional fees not related to the Company's Chapter 11 proceedings and
reorganization efforts as well as substantially higher state franchise taxes
during the 2005 period.
Interest expense during the second quarter of 2005 was slightly lower than
in the second quarter of 2004 due primarily to lower amortization of deferred
financing costs in the 2005 second quarter partially offset by slightly higher
interest rates and debt levels in the 2005 quarter. Interest expense during the
first six months of 2005 was lower than in the first six months of 2004 due
primarily to lower debt levels in 2005 partially offset by higher interest rates
in 2005. The overall average interest rates were impacted by the fact the
Company discontinued accruing interest on pre-petition unsecured debt upon
filing for Chapter 11 on February 2, 2004. Average borrowings by the Company
approximated $85.7 million during the second quarter of 2005 as compared to
$81.3 million during the second quarter of 2004. Average borrowings by the
Company approximated $81.1 million during the first six months of 2005 as
compared to $103.0 million during the first six months of 2004. During the
second quarter of 2005, the average interest rate on outstanding indebtedness
was 3.6% per annum as compared 2.6% per annum during the 2004 second quarter.
During the first six months of 2005, the average interest rate on outstanding
indebtedness was 3.3% per annum as compared 3.2% per annum during the first six
months of 2004. Keystone currently anticipates average interest rates and debt
levels for the year 2005 will be higher than their respective levels during
2004.
During the second quarters of 2005 and 2004, Keystone incurred $2.7 million
and $3.1 million, respectively of legal and professional fees relative to its
Chapter 11 proceedings and related reorganization activities. During the first
six month periods of 2005 and 2004, Keystone incurred $6.0 million and $5.0
million, respectively of legal and professional fees relative to these same
activities.
The principal reasons for the difference between the U.S. federal statutory
income tax rate and the Company's effective income tax rates are explained in
Note 7 to the Consolidated Financial Statements. At June 30, 2005, the Company
had recorded a deferred tax asset valuation allowance of $31.2 million resulting
in no net deferred tax assets. Keystone periodically reviews the recoverability
of its deferred tax assets to determine whether such assets meet the
"more-likely-than-not" recognition criteria. The Company will continue to review
the recoverability of its deferred tax assets, and based on such periodic
reviews, Keystone could recognize a change in the recorded valuation allowance
related to its deferred tax assets in the future. While the Company currently
expects to report pre-tax income for financial reporting purposes during 2005,
it does not believe it will have sufficient positive evidence to conclude that
its net deferred income tax assets will meet the "more-likely-than-not"
recognition criteria anytime during 2005. As a result of the deferred tax asset
valuation allowance, the Company does not anticipate recognizing a tax provision
associated with its expected pre-tax income during 2005 will be appropriate.
As a result of the items discussed above, Keystone recorded a net loss
during the second quarter of 2005 of $3.7 million as compared to net income of
$11.0 million in the second quarter of 2004 and a net loss of $4.9 million
during the first six months of 2005 as compared to net income of $3.4 million
during the first six months of 2004.
SEGMENT RESULTS OF OPERATIONS:
The Company's operating segments are organized along its manufacturing
facilities and include three reportable segments: (i) Keystone Steel and Wire
("KSW") which manufacturers and sells wire rod, wire and wire products for
agricultural, industrial, construction, commercial, original equipment
manufacturers and retail consumer markets, (ii) Engineered Wire Products ("EWP")
which manufactures and sells welded wire reinforcement in both roll and sheet
form that is utilized in concrete construction products including pipe, pre-cast
boxes and applications for use in roadways, buildings and bridges and, (iii)
Sherman Wire ("Sherman") which manufacturers and sells wire and wire products
for agricultural, industrial, construction, commercial, original equipment
manufacturers and retail consumer markets.
Three months ended Six months ended
June 30, June 30,
------------------ -----------------
2004 2005 2004 2005
------ ------ ------ ------
(In thousands)
Revenues:
Keystone Steel and Wire $103,185 $ 81,887 $163,811 $171,081
Engineered Wire Products 15,949 17,755 27,039 29,806
Sherman 4,438 4,113 7,497 9,166
Elimination of intersegment
revenues (21,745) (14,763) (29,343) (31,524)
-------- -------- -------- --------
$101,827 $ 88,992 $169,004 $178,529
======== ======== ======== ========
Operating profit (loss):
Keystone Steel and Wire $ 10,295 $ (9,119) $ 3,307 $(10,571)
Engineered Wire Products 3,333 2,992 4,601 4,631
Sherman 14 (381) (561) (550)
GAAP adjustments and
eliminations 2,398 7,402 4,796 11,525
-------- -------- -------- --------
$ 16,040 $ 894 $ 12,143 $ 5,035
======== ======== ======== ========
GAAP adjustments and eliminations in the above table consisted primarily of
adjustments to reflect the difference between the defined benefit pension credit
and OPEB expense allocated to the segments and the actual expense or credit
included in the determination of operating profit or loss. GAAP adjustments and
eliminations included a defined benefit pension credit of $4.1 million and $2.4
million during the three months ended June 30, 2005 and 2004, respectively, and
$8.2 million and $4.8 million during the six months ended June 30, 2004 and
2005, respectively.
Keystone Steel & Wire
KSW's net sales in the 2005 second quarter declined by $21.3 million or
20.6% to $81.9 million from $103.2 million in the second quarter of 2004 due
primarily to lower shipment volumes partially offset by higher overall per-ton
product selling prices. KSW's net sales during the first six months of 2005
increased by $7.3 million or 4.4% to $171.1 million from $163.8 million during
the first six months of 2004 due primarily to higher overall per-ton product
selling prices partially offset by lower shipment volumes. KSW sold
approximately 43,000 less tons of products in the 2005 second quarter as
compared to the second quarter of 2004, although at selling prices $55 per-ton
higher than per-ton product selling prices in the 2004 second quarter. KSW sold
approximately 26,000 less tons of products in the first six months of 2005 as
compared to the first six months of 2004, although at selling prices $98 per-ton
higher than per-ton product selling prices in the same period during 2004. KSW
believes the lower shipment volume in the 2005 periods of both its fabricated
wire products and industrial wire were due to high inventory levels at KSW's
customers. In addition, KSW believes the late winter and inclement weather
during the spring also adversely impacted fabricated wire product shipments. KSW
also believes the lower shipment volume of nails during the 2005 periods was due
primarily to an initiative that began during the last quarter of 2003 to
discontinue sales to its less profitable customers. KSW was able to supplement
these lower shipment volumes of fabricated wire products, nails and industrial
wire during the 2005 periods with increased shipments of wire rod. However, KSW
typically realizes a lower gross margin on sales of wire rod than it does on its
other products. Throughout 2004, KSW implemented several price increases
primarily as a reaction to increasing ferrous scrap costs, KSW's primary raw
material. As a result of these efforts, during both the 2005 second quarter and
the first six months of 2005, KSW was able to realize increases in its per-ton
product selling prices over the same periods in 2004. During the 2004 second
quarter, approximately 18% of KSW's net sales were made to other Keystone
entities. During the 2005 second quarter and the first six months of both 2004
and 2005, approximately 15% of KSW's net sales were made to other Keystone
entities. Significantly all of the KSW sales to other Keystone entities were
sales of wire rod.
During the second quarter of 2005, KSW recorded an operating loss of $9.1
million as compared to recording operating income of $10.0 million in the 2004
second quarter. During the first six months of 2005, KSW recorded an operating
loss of $10.6 million as compared to recording operating income of $3.3 million
during the first six months of 2004. The primary reasons for the decreased
operating profit in the 2005 periods were the increased costs for ferrous scrap,
natural gas costs and electrical power partially offset by the higher per-ton
product selling prices and lower retiree medical costs in the 2005 periods.
Engineered Wire Products
EWP's net sales of $17.8 million during the second quarter of 2005 were
approximately $1.8 million or 11.3% higher than during the second quarter of
2004 due primarily to higher overall per-ton product selling prices and higher
shipment volume. During the first six months of 2005, EWP's net sales of $29.8
million were approximately $2.8 million or 10.2% higher than during the first
six months of 2004 also due primarily to higher overall per-ton product selling
prices and higher shipment volume. During the 2005 second quarter, EWP sold
1,100 more tons of products than during the second quarter of 2004 at per-ton
product selling prices approximately $46 per-ton higher than per-ton selling
prices in the 2004 second quarter. During the first six months of 2005, EWP sold
900 more tons of products than during the first six months of 2004 at per-ton
product selling prices approximately $88 per-ton higher than per-ton selling
prices in the same period in 2004. During 2004, EWP implemented several price
increases primarily as a reaction to rapidly increasing wire rod costs, EWP's
primary raw material. As a result of these efforts, during both the second
quarter and first six month periods of 2005, EWP was able to realize increases
in its per-ton product selling prices. EWP sources the majority of its wire rod
requirements from KSW.
As a result of increased cost for wire rod, partially offset by the higher
per-ton product selling prices during the second quarter of 2005, EWP recorded a
$341,000 decline in operating income from the same period in 2004 to $3.0
million. During the first six months of 2005, EWP's higher per-ton product
selling prices were offset by increased cost for wire rod and, as such, EWP's
operating income of $4.6 million was unchanged from the same period during 2004.
Sherman Wire
Sherman Wire's net sales of $4.1 million in the 2005 second quarter
approximated net sales during the second quarter of 2004 of $4.4 million as
increased per-ton product selling prices were offset by lower shipment volume.
However, during the first six months of 2005, Sherman Wire's net sales increased
22.3% to $9.2 million from $7.5 million during the first six months of 2004 due
to both increased per-ton product selling prices and increased shipment volume.
Tons shipped by Sherman Wire during the second quarter of 2005 declined by 900
tons from shipment levels during the second quarter of 2004. However, tons
shipped by Sherman Wire during the first six months of 2005 increased by 900
tons from shipment levels during the same period of 2004. Sherman Wire believes
its lower shipment volume during the 2005 second quarter was due to reduced
demand resulting from high inventory levels at Sherman Wire's customers as well
as the late winter and inclement weather during the spring adversely impacting
fabricated wire product shipments. Sherman Wire believes its higher shipment
volume during the first six months of 2005 was due to its limited production
schedules during the period preceding and immediately following Keystone's
Chapter 11 filing in 2004. Sherman Wire's overall per-ton product selling price
increased by approximately $104 per-ton during the 2005 second quarter as
compared to the per-ton product selling prices during the second quarter of
2004. Sherman Wire's overall per-ton product selling price increased by
approximately $88 per-ton during the first six months of 2005 as compared to the
per-ton product selling prices during the first six months of 2004. During 2004,
Sherman Wire implemented several price increases primarily as a reaction to
rapidly increasing wire rod costs, Sherman Wire's primary raw material. As a
result of these efforts, during both the second quarter and first six months of
2005, Sherman Wire was able to realize significant increases in its per-ton
product selling prices over the same periods during 2004. Sherman Wire sources
the majority of its wire rod requirements from KSW. During the second quarter of
2005 and 2004, approximately 63% and 70%, respectively, and during the first six
months of 2004 and 2005, approximately 67% and 69%, respectively, of Sherman
Wire's net sales were made to other Keystone entities, primarily KSW. The
majority of these sales were fabricated wire products.
During the second quarter of 2005, Sherman Wire recorded a $381,000
operating loss as compared to $14,000 of operating income in the 2004 second
quarter. During the first six months of 2005, Sherman Wire recorded a $550,000
operating loss as compared to a $561,000 operating loss during the first six
months of 2004. The primary reason for the decline in operating performance
during the 2005 second quarter was the increased costs for wire rod partially
offset by the higher overall per-ton product selling prices and lower retiree
medical costs.
Outlook for 2005
During 2005, rod imports have continued at high levels. These high import
levels combined with increased production from domestic mills has resulted in a
decline in per-ton sales prices of the Company's products. In addition, the late
winter and inclement weather during the spring and summer of 2005 has adversely
impacted sales. As a result, management believes these factors will result in
lower shipment volume in 2005 as compared to 2004. The Company's 2005
performance will also be adversely impacted by higher costs for ferrous scrap
and the cost of legal and professional fees associated with the Company's
bankruptcy and related restructuring efforts. However, the effects of the
Company's restructuring efforts in 2004 and 2005 will partially mitigate these
factors, as the Company expects to report a significant gain upon cancellation
of debt and other liabilities concurrent with its emergence from Chapter 11. As
a result, Keystone expects it will report net income for financial reporting
purposes although it expects to report negative cash flows from operating
activities in 2005. In addition, as a result of significant accumulated net
operating losses, the benefit of which has not been previously recognized for
financial reporting purposes as the Company does not currently believe meets the
"more-likely-than-not" recognition criteria, the Company does not expect to
record significant net tax expense associated with its pre-tax income during
2005.
LIQUIDITY AND CAPITAL RESOURCES:
The amount of available borrowings under Keystone's revolving credit and
primary DIP facilities is based on formula-determined amounts of trade
receivables and inventories, less the amount of outstanding letters of credit.
At June 30, 2005, unused credit available for borrowing under Keystone's DIP
facilities and EWP's $7 million revolving credit facility (the "EWP Revolver"),
were $21.9 million and $1.4 million, respectively. The Company's primary DIP
facility requires daily cash receipts be used to reduce outstanding borrowings,
which results in the Company maintaining zero cash balances when there are
balances outstanding under this credit facility. Accordingly, any outstanding
balances under the primary DIP facility are always classified as a current
liability regardless of the maturity date of the facility.
On August 31, 2005, in connection with its emergence from Chapter 11,
Keystone entered into a new five-year, $80.0 million secured credit facility.
Proceeds from this credit facility were used to extinguish Keystone's existing
DIP credit facilities, the EWP Term Loan, the EWP Revolver and to provide
working capital for reorganized Keystone. The facility includes a term loan in
the amount of up to $25.0 million, subject to a borrowing base calculation based
on the market value of the Company's real property and equipment. To the extent
there is sufficient borrowing base, the term loan portion of this credit
facility can be reloaded in the amount of $10.0 million. The portion of the
credit facility in excess of the term loan balance is available to the Company
as a revolving credit facility subject to a borrowing base calculation based on
eligible receivables and inventory balances. Interest rates on the credit
facility range from the prime rate to the prime rate plus .5% depending on
Keystone's excess availability, as defined in the credit agreement. The facility
also provides for a LIBOR interest rate option. Under the terms of the credit
facility, the Company is required to annually pay down the term loan portion of
the facility in the amount of 25% of excess cash flow, as defined in the
agreement, subject to a $2.0 million annual and a $5.0 million aggregate limit.
The facility also includes performance covenants related to minimum levels of
cash flow and fixed charge coverage ratio. Keystone paid the lender
approximately $400,000 of diligence, commitment and closing fees in connection
with this facility.
Despite an $8.3 million decline in earnings between the first six months of
2004 and the first six months of 2005, cash flow from operating activities in
the first six months of 2005 declined by only $6.7 million as Keystone used $2.2
million of cash in operations during the first six months of 2004 as compared to
using $8.9 million of cash in operations during the first six months of 2005.
This increase in cash used in operations was due primarily to the 2005 decline
in profitability partially offset by a smaller increase in accounts receivable
as well as a decline in inventory levels during the 2005 period as compared to a
substantial increase in inventory levels during the 2004 period. Because of the
seasonal nature of the Company's business, the 2005 changes in accounts
receivable and inventory levels was typical. The reason the 2004 changes in
these accounts was not consistent with 2005's changes was due to Keystone's
limited liquidity during the last half of 2003 and the first portion of 2004,
not allowing the Company to operate on a continuous basis. As such, production
levels declined and Keystone was forced to substantially reduce its normal
inventory levels over the last half of 2003 and the first two months of 2004 in
order to meet customer shipment demand. In addition, as the Company's liquidity
deteriorated throughout 2003 and the first two months of 2004, Keystone
liquidated as many of its accounts receivable as possible. As such, at the end
of 2003, the Company's accounts receivable and inventory balances were both at
abnormally low levels. Keystone's operations returned to normal levels during
2004.
During the first six months of 2005, Keystone made capital expenditures of
approximately $4.6 million primarily related to upgrades of production equipment
at its facility in Peoria, Illinois, as compared to $700,000 in the first six
months of 2004. Capital expenditures for 2005 are expected to be approximately
$7.0 million and are related primarily to upgrades of production equipment at
EWP. Such capital expenditures are expected to be funded using cash flows from
operations together with borrowing availability under Keystone's credit
facilities.
At June 30, 2005, the Company's financial statements reflected accrued
liabilities of $19.5 million (substantially all of which is included in
liabilities subject to compromise on the Company's balance sheet) for estimated
remediation costs for those environmental matters which Keystone believes are
probable and reasonably estimable. Although the Company has established an
accrual for estimated future required environmental remediation costs, there is
no assurance regarding the ultimate cost of remedial measures that might
eventually be required by environmental authorities or that additional
environmental hazards, requiring further remedial expenditures, might not be
asserted by such authorities or private parties. Accordingly, the costs of
remedial measures may exceed the amounts accrued. Keystone believes it is not
possible to estimate the range of costs for certain sites. The upper end of
range of reasonably possible costs to Keystone for sites for which the Company
believes it is possible to estimate costs is approximately $21.4 million. See
Notes 11 and 12 to the Consolidated Financial Statements for discussions of the
Company's environmental liabilities and current litigation.
Keystone is not expected to be required to make contributions to its
pension plan during 2005. Future variances from assumed actuarial rates,
including the rate of return on pension plan assets, may result in increases or
decreases to pension expense or credit and funding requirements in future
periods.
The Company periodically reviews the recoverability of its deferred tax
assets to determine whether such assets meet the "more-likely-than-not"
recognition criteria. At June 30, 2005, the Company expects that its long-term
profitability should ultimately be sufficient to enable it to realize full
benefit of its future tax deductions, in part due to the long-term nature of its
net operating loss carryforwards, which expire in 2023 and 2024. Although,
considering all factors believed to be relevant, including the Company's recent
operating results, its expected future near-term productivity rates; cost of raw
materials, electricity, labor and employee benefits, environmental remediation,
and retiree medical coverage; interest rates; product mix; sales volumes and
selling prices and the fact that accrued OPEB expenses will become deductible
over an extended period of time and require the Company to generate significant
amounts of future taxable income, the Company believes its gross deferred tax
assets do not currently meet the "more-likely-than-not" realizability test. As
such, the Company has provided a deferred tax asset valuation allowance of
approximately $31.2 million at June 30, 2005, or all of the Company's deferred
tax asset. Keystone will continue to review the recoverability of its deferred
tax assets, and based on such periodic reviews, the Company could change the
valuation allowance related to its deferred tax assets in the future. The
Company does not currently expect it will be appropriate to recognize a tax
provision associated with its expected pre-tax income during 2005.
Keystone incurs significant ongoing costs for plant and equipment and
substantial employee medical benefits for both current and retired employees. As
such, Keystone is vulnerable to business downturns and increases in costs, and
accordingly, routinely compares its liquidity requirements and capital needs
against its estimated future operating cash flows. In addition, Keystone
currently anticipates incurring legal and professional fees of approximately
$10.0 million during 2005 related to its reorganization efforts. Keystone is
also taking additional action towards improving its liquidity. Keystone has also
considered, and may in the future consider, the sale of certain divisions or
subsidiaries that are not necessary to achieve the Company's long-term business
objectives. However, there can be no assurance Keystone will be successful in
any of these or other efforts, or that if successful, they will provide
sufficient liquidity for the Company's operations during the next year.
ITEM 4. CONTROLS AND PROCEDURES
- --------------------------------
Evaluation of Disclosure Controls and Procedures. The Company maintains
disclosure controls and procedures. The term "disclosure controls and
procedures," as defined by Rule 13a-15(e) of the Securities and Exchange Act of
1934 as amended ("the Act"), means controls and other procedures that are
designed to ensure that information required to be disclosed in the reports that
the Company files or submits to the Securities and Exchange Commission ("SEC"),
is recorded, processed, summarized and reported, within the time periods
specified in the SEC's rules and forms. Disclosure controls and procedures
include, without limitation, controls and procedures designed to ensure that
information required to be disclosed by the Company in the reports that it files
or submits to the SEC under the Act is accumulated and communicated to the
Company's management, including its principal executive officer and its
principal financial officer, or persons performing similar functions, as
appropriate to allow timely decisions to be made regarding required disclosure.
Each of David L. Cheek, the Company's President and Chief Executive Officer, and
Bert E. Downing, Jr., the Company's Vice President, Chief Financial Officer,
Corporate Controller and Treasurer, have evaluated the Company's disclosure
controls and procedures as of June 30, 2005. Based upon their evaluation, and
solely as a result of the material weaknesses discussed below, these executive
officers have concluded the Company's disclosure controls and procedures were
not effective as of June 30, 2005.
Internal Control Over Financial Reporting. A material weakness is a control
deficiency, or a combination of control deficiencies, that results in more than
a remote likelihood that a material misstatement of the annual or interim
financial statements will not be prevented or detected. Management of the
Company has concluded that the following control deficiencies constitute
material weaknesses in the Company's internal control over financial reporting:
(1) As of June 30, 2005, the Company did not maintain effective controls over
the completeness and accuracy of net sales and related cost of goods sold.
Specifically, the Company did not have controls designed and in place to
detect sales made under the terms F.O.B. at the customer's location.
Additionally, the Company did not maintain effective controls over the
review and monitoring of the accuracy and completeness of net sales and
costs of goods sold. This control deficiency resulted in adjustments to net
sales and cost of goods sold in the third quarter of 2005.
(2) As of June 30, 2005, the Company did not maintain effective controls over
the presentation and classification of cash overdrafts. Specifically,
effective controls were not designed and in place to ensure that cash
overdrafts were properly classified as indebtedness in the Company's
consolidated balance sheet, and that changes in its cash overdrafts were
properly included in the determination of cash flows from financing
activities. This control deficiency resulted in the restatement of the
Company's 2003 and 2004 annual consolidated financial statements and audit
adjustments to both its 2004 interim consolidated financial statements and
its annual and interim 2005 consolidated financial statements affecting
accounts payable and the current portion of long-term debt.
Each of these two control deficiencies could result in a misstatement of
the aforementioned accounts that would result in a material misstatement to the
Company's annual or interim consolidated financial statements that would not be
prevented or detected.
Accordingly, management of the Company determined that each of these
control deficiencies constitutes a material weakness.
The Company currently expects that Section 404 of the Sarbanes-Oxley Act of
2002 will require the Company to annually include a management report on
internal control over financial reporting starting with the Company's Annual
Report on Form 10-K for the year ended December 31, 2007. The Company will have
to document, test and evaluate its internal control over financial reporting,
using a combination of internal and external resources. The process of
documenting, testing and evaluating the Company's internal control over
financial reporting under the applicable guidelines is expected to be complex
and time consuming, and available internal and external resources necessary to
assist the Company in the documentation and testing required to comply with
Section 404 could be limited. While the Company currently believes it will be
able to dedicate the appropriate resources, and that it will be able to fully
comply with Section 404 in its Annual Report on Form 10-K for the year ended
December 31, 2007 and be in a position to conclude that the Company's internal
control over financial reporting is effective as of December 31, 2007, because
the applicable requirements are complex and time consuming, and because
currently unforeseen events or circumstances beyond the Company's control could
arise, there can be no assurance that the Company will ultimately be able to
fully comply with Section 404 in its Annual Report on Form 10-K for the year
ended December 31, 2007 or whether it will be able to conclude that the
Company's internal control over financial reporting is effective as of December
31, 2007.
Remediation of Material Weakness. In order to remediate the first material
weakness discussed above, in March 2006, the Company modified its information
system to appropriately identify products shipped to its customers under
delivery terms of F.O.B. at the customer location. In addition, the Company
intends to institute a quarterly close procedure, to be implemented for the
first time for the quarter ending March 31, 2006, to review all sales within a
specified number of weeks prior to the end of the quarter to ensure the delivery
terms are consistent with revenue recognition in the quarter of shipment.
In order to remediate the second material weakness discussed above, in
March 2006 the Company revised the recurring reclassification journal entry used
in the preparation of its consolidated balance sheet to properly classify the
amount of any cash overdrafts as part of the current portion of long-term debt.
In addition, the Company intends to institute quarterly close procedures, to be
implemented for the first time for the quarter ending March 31, 2006, to ensure
(i) that an adequate review of the Company's balance sheet and statement of cash
flow consolidation occurs each quarter and (ii) the continued appropriateness of
the reclassification journal entry to classify bank overdrafts as part of the
current portion of long-term debt.
Changes in Internal Control Over Financial Reporting. There have been no
changes in the Company's internal control over financial reporting during the
quarter ended June 30, 2005 that has materially affected, or is reasonably
likely to materially affect, the Company's internal control over financial
reporting.
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings
Reference is made to disclosure provided under the caption "Current
litigation" in Note 12 to the Consolidated Financial Statements.
ITEM 6. Exhibits
(a) The Company has retained a signed original of any exhibit listed below that
contains signatures, and the Company will provide any such exhibit to the
Commission or its staff upon request. The following exhibit is included
herein:
31.1 Chief Executive Officer's Certification Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Chief Financial Officer's Certification Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Chief Executive and Chief Financial Officers' Certification Pursuant
to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Keystone Consolidated Industries, Inc.
--------------------------------------
(Registrant)
Date: March 31, 2006 By /s/Bert E. Downing, Jr.
-------------- -------------------------------
Bert E. Downing, Jr.
Vice President, Chief Financial
Officer, Corporate Controller
and Treasurer (Principal
Financial and Accounting
Officer)