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 September 30, 2006
------------------
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
---------------------
Whether the Registrant (1) has filed all reports required to be filed by Section
13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12
months (or for such shorter period that the Registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days. Yes X No
--- ---
Whether the Registrant is a large accelerated filer, an accelerated filer or a
non-accelerated filer (as defined in Rule 12b-2 of the Act). Large accelerated
filer Accelerated filer Non-accelerated filer X .
--- --- ---
Whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act).
Yes No X .
--- ---
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes X No .
--- ---
Number of shares of common stock outstanding at November 14, 2006: 10,000,000
[GRAPHIC OMITTED]
[GRAPHIC OMITTED]
- - 3 -
[GRAPHIC OMITTED]
KEYSTONE CONSOLIDATED INDUSTRIES, INC.
AND SUBSIDIARIES
INDEX
Page
number
------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets -
December 31, 2005;
September 30, 2006 (unaudited) 3
Condensed Consolidated Statements of Operations -
Three months and nine months ended
September 30, 2005 and 2006 (unaudited) 5
Condensed Consolidated Statements of Cash Flows -
Nine months ended September 30, 2005 and 2006 (unaudited) 6
Condensed Consolidated Statement of Stockholders' Equity -
Nine months ended September 30, 2006 (unaudited) 7
Notes to Condensed Consolidated Financial Statements
(unaudited) 8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 22
Item 3. Quantitative and Qualitative Disclosures About Market Risk 35
Item 4. Controls and Procedures 35
PART II. OTHER INFORMATION
Item 1. Legal Proceedings. 36
Item 1A. Risk Factors. 36
Item 6. Exhibits. 36
Items 2, 3, 4 and 5 of Part II are omitted because there is no information to
report.
KEYSTONE CONSOLIDATED INDUSTRIES, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
December 31, September 30,
ASSETS 2005 2006
----------- ----------
(unaudited)
Current assets:
Accounts receivable, net $ 46,199 $ 51,261
Inventories, net 69,691 65,270
Restricted investments 1,040 1,054
Deferred income taxes - 15,417
Prepaid expenses and other 2,760 3,125
--------- ---------
Total current assets 119,690 136,127
--------- ---------
Property, plant and equipment:
Land 1,193 1,193
Buildings and improvements 54,189 55,043
Machinery and equipment 310,446 299,082
Construction in progress 3,949 9,387
--------- ---------
369,777 364,705
Less accumulated depreciation 283,004 280,783
--------- ---------
Net property, plant and equipment 86,773 83,922
--------- ---------
Other assets:
Restricted investments 4,758 6,016
Prepaid pension cost 145,152 181,639
Deferred financing costs 902 722
Goodwill 752 752
Other 337 541
--------- ---------
Total other assets 151,901 189,670
--------- ---------
Total assets $ 358,364 $ 409,719
========= =========
- 3 -
KEYSTONE CONSOLIDATED INDUSTRIES, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (CONTINUED)
(In thousands)
LIABILITIES AND STOCKHOLDERS' EQUITY
December 31, September 30,
2005 2006
----------- -----------
(unaudited)
Current liabilities:
Notes payable and current maturities of
long-term debt $ 41,640 $ 54,691
Accounts payable 9,797 11,836
Accrued OPEB cost 4,256 4,256
Other accrued liabilities 27,624 24,949
--------- ---------
Total current liabilities 83,317 95,732
--------- ---------
Noncurrent liabilities:
Long-term debt 58,255 34,054
Accrued OPEB cost 133,208 123,988
Deferred income taxes - 24,789
Other 5,577 5,806
--------- ---------
Total noncurrent liabilities 197,040 188,637
--------- ---------
Liabilities subject to compromise 10,476 13,966
--------- ---------
Stockholders' equity:
Common stock 100 100
Additional paid-in capital 75,423 75,423
Retained earnings (accumulated deficit) (7,992) 35,861
--------- ---------
Total stockholders' equity 67,531 111,384
--------- ---------
Total liabilities and stockholders'
equity $ 358,364 $ 409,719
========= =========
Commitments and contingencies (Notes 10 and 11).
See accompanying Notes to Condensed Consolidated Financial Statements.
- 4 -
KEYSTONE CONSOLIDATED INDUSTRIES, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
Three months ended Nine months ended
September 30, September 30,
------------------------ ------------------------
2005 2006 2005 2006
-------- -------- -------- --------
(unaudited) (unaudited)
Net sales $ 84,770 $105,212 $263,299 $353,422
Cost of goods sold 75,854 96,017 247,370 319,914
-------- -------- -------- --------
Gross margin 8,916 9,195 15,929 33,508
-------- -------- -------- --------
Selling expense 1,630 1,665 4,647 5,113
General and administrative
expense 3,050 2,645 8,460 8,243
Defined benefit pension credit (3,226) (12,161) (9,675) (36,487)
-------- -------- -------- --------
Total operating costs 1,454 (7,851) 3,432 (23,131)
-------- -------- -------- --------
Operating income 7,462 17,046 12,497 56,639
-------- -------- -------- --------
Nonoperating income (expense):
Corporate income (expense) (566) (209) (2,757) 1,273
Interest expense (1,040) (1,189) (2,816) (3,728)
Interest income 138 67 220 159
Other income (expense), net 167 (361) 271 (94)
-------- -------- -------- --------
Total nonoperating expense (1,301) (1,692) (5,082) (2,390)
-------- -------- -------- --------
Income before income taxes and
reorganization items 6,161 15,354 7,415 54,249
-------- -------- -------- --------
Reorganization items:
Reorganization costs (4,342) (270) (10,323) (606)
Gain on cancellation of debt 32,349 - 32,349 -
-------- -------- -------- --------
Total reorganization items 28,007 (270) 22,026 (606)
-------- -------- -------- --------
Income before income
taxes 34,168 15,084 29,441 53,643
Provision for income taxes 64 5,990 272 9,790
-------- -------- -------- --------
Net income $ 34,104 $ 9,094 $ 29,169 $ 43,853
======== ======== ======== ========
Basic income per share $ 3.61 $ 0.91 $ 3.11 $ 4.39
======== ======== ======== ========
Basic shares outstanding 10,046 10,000 10,061 10,000
======== ======== ======== ========
Diluted income per share $ 1.64 $ 0.91 $ 1.20 $ 4.39
======== ======== ======== ========
Diluted shares outstanding 22,029 10,000 26,039 10,000
======== ======== ======== ========
See accompanying Notes to Condensed Consolidated Financial Statements.
- 5 -
KEYSTONE CONSOLIDATED INDUSTRIES, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine months ended September 30, 2005 and 2006
(In thousands)
2005 2006
------ ------
(unaudited)
Cash flows from operating activities:
Net income $ 29,169 $ 43,853
Depreciation and amortization 11,775 11,354
Amortization of deferred financing costs 604 203
Deferred income taxes - 9,372
Non-cash defined benefit pension credit (9,675) (36,487)
OPEB expense (credit) 10,956 (6,300)
OPEB payments (4,139) (2,920)
Reorganization costs accrued 10,322 606
Reorganization costs paid (7,639) (3,484)
Impairment of long-lived assets - 529
Gain on cancellation of debt (32,349) -
Other, net 19 725
Change in assets and liabilities:
Accounts receivable (15,541) (5,292)
Inventories (7,437) 4,421
Accounts payable 720 1,982
Other, net (5,126) 3,502
-------- --------
Net cash provided by (used in) operating
activities (18,341) 22,064
-------- --------
Cash flows from investing activities:
Capital expenditures (6,057) (9,645)
Restricted investments, net (415) (1,272)
Other, net 1,336 27
-------- --------
Net cash used in investing activities (5,136) (10,890)
-------- --------
Cash flows from financing activities:
Revolving credit facilities, net 17,451 (7,309)
Other notes payable and long-term debt:
Additions 22,553 468
Principal payments (16,004) (4,310)
Deferred financing costs paid (523) (23)
-------- --------
Net cash provided by (used in)
financing activities 23,477 (11,174)
-------- --------
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 $ 2,255 $ 3,115
Income taxes, net 680 365
Common stock issued in exchange for extinguishment
of certain pre-petition unsecured and DIP claims 21,400 -
Note issued in exchange for extinguishment of
certain pre-petition unsecured claims 4,800 -
See accompanying Notes to Condensed Consolidated Financial Statements.
- 6 -
KEYSTONE CONSOLIDATED INDUSTRIES, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
Nine months ended September 30, 2006
(In thousands)
Retained
Additional earnings
Common paid-in (accumulated
stock capital deficit) Total
------- --------- ------------ -----
(unaudited)
Balance - December 31, 2005 $100 $75,423 $ (7,992) $ 67,531
Net income - - 43,853 43,853
---- ------- -------- --------
Balance - September 30, 2006 $100 $75,423 $ 35,861 $111,384
==== ======= ======== ========
See accompanying Notes to Condensed Consolidated Financial Statements.
- 7 -
KEYSTONE CONSOLIDATED INDUSTRIES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(unaudited)
Note 1 - Organization and basis of presentation:
The unaudited Condensed Consolidated Financial Statements contained in this
Quarterly Report have been prepared on the same basis as the audited
Consolidated Financial Statements in our Annual Report on Form 10-K for the year
ended December 31, 2005 that we filed with the Securities and Exchange
Commission ("SEC") on March 31, 2006 (the "2005 Annual Report"). In our opinion,
we have made all necessary adjustments (which include only normal recurring
adjustments) in order to state fairly, in all material respects, our
consolidated financial position, results of operations and cash flows as of the
dates and for the periods presented. Certain reclassifications have been made to
conform the prior year's Consolidated Financial Statements to the current year's
classifications. We have condensed the Consolidated Balance Sheet at December
31, 2005 contained in this Quarterly Report as compared to our audited
Consolidated Financial Statements at that date, and we have omitted certain
information and footnote disclosures (including those related to the
Consolidated Balance Sheet at December 31, 2005) normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America ("GAAP"). Our results of operations for the
interim periods ended September 30, 2006 may not be indicative of our operating
results for the full year. The Condensed Consolidated Financial Statements
contained in this Quarterly Report should be read in conjunction with our 2005
Consolidated Financial Statements contained in our 2005 Annual Report.
Contran Corporation beneficially owns 51.1% of our outstanding common stock
at September 30, 2006. Substantially all of Contran's outstanding voting stock
is held by trusts established for the benefit of certain children and
grandchildren of Harold C. Simmons (for which Mr. Simmons is the sole trustee)
or is held directly by Mr. Simmons or other persons or companies related to Mr.
Simmons. Consequently, Mr. Simmons may be deemed to control Contran and us.
Unless otherwise indicated, references in this report to "we", "us" or
"our" refer to Keystone Consolidated Industries, Inc. and its subsidiaries,
taken as a whole.
Note 2 - Bankruptcy:
On February 26, 2004, we and five of our direct and indirect subsidiaries
filed for voluntary protection under Chapter 11 of the Federal Bankruptcy Code.
We attributed the need to reorganize to weaknesses in product selling prices
over the preceding several years, unprecedented increases in ferrous scrap
costs, our primary raw material, and significant liquidity needs to service
retiree medical costs. These problems substantially limited our liquidity and
undermined our ability to obtain sufficient debt or equity capital to operate as
a going concern.
We emerged from bankruptcy protection on August 31, 2005. Significant
provisions of our plan of reorganization included greater employee participation
in healthcare costs and a permanent reduction in healthcare related payments to
retirees. Before the bankruptcy can be completely closed, all claims must be
adjudicated. As of September 30, 2006, only two significant claims had not been
adjudicated: (i) an environmental claim against Sherman Wire Company ("SWC"),
one of our pre-petition wholly-owned subsidiaries, and (ii) an employment
related claim against Keystone.
- 8 -
Upon emergence from Chapter 11, certain operating assets and existing
operations of SWC were sold at fair market value (fair market value and book
value both approximated $2.0 million) to us, which were then used to form and
operate a newly created wholly-owned subsidiary of ours named Keystone Wire
Products Inc. ("KWP"). SWC was also reorganized and the proceeds of the
operating assets sold to us, liquidation of SWC's remaining real estate assets
(book value approximates $1.6 million), and other funds (including $4.0 million
of proceeds from a settlement agreement with a former insurer received in the
second quarter of 2006, as discussed in Notes 6 and 11) will be distributed, on
a pro rata basis, to SWC's pre-petition unsecured creditors when all claims have
been finally adjudicated. The total amount that will ultimately be distributed
to SWC's pre-petition unsecured creditors will be limited to the lesser of (i)
the total of the claims granted by the U.S. Bankruptcy Court for the Eastern
District of Wisconsin in Milwaukee (the "Court") and (ii) the total funds
available to be distributed. Because all of the claims of SWC's pre-petition
unsecured creditors have not yet been finally adjudicated, all of SWC's
liabilities are still classified as liabilities subject to compromise on our
September 30, 2006 Condensed Consolidated Balance Sheet.
Note 3 - Business Segment Information:
Our operating segments are organized along our manufacturing facilities
and include three reportable segments:
o Keystone Steel and Wire ("KSW"), located in Peoria, Illinois,
manufactures and sells wire rod, coiled rebar, industrial wire, nails
and wire products for agricultural, industrial, construction,
commercial, original equipment manufacturers and retail consumer
markets,
o Engineered Wire Products ("EWP"), located in Upper Sandusky, Ohio,
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
o Keystone Wire Products, located in Sherman, Texas, manufactures and
sells industrial wire and wire products for agricultural, industrial,
construction, commercial, original equipment manufacturers and retail
consumer markets.
In connection with our emergence from Chapter 11 on August 31, 2005,
certain operating assets and existing operations of SWC ("Sherman") were sold at
fair market value to us. We then used these assets to form and operate KWP. As
such, operating results of this segment prior to our emergence from Chapter 11
were operating results of Sherman. Operating results of this segment after our
emergence from Chapter 11, were operating results of KWP. In accordance with our
plan of reorganization, the remaining assets of SWC will eventually be
liquidated.
During the third quarter of 2006, we decided to relocate KWP's industrial
wire manufacturing process to KSW and to discontinue the production of nails at
KSW. KWP will continue to manufacture and distribute fabricated wire products,
and KSW may sell nails manufactured by third parties. Certain of KWP's
industrial wire production equipment will be transferred to KSW, which we expect
will be completed during the fourth quarter of 2006. We do not expect the cost
to relocate this equipment to KSW will be significant. We are currently
negotiating the sale of KWP's remaining industrial wire production equipment,
which we expect will also be completed during the fourth quarter of 2006. We
plan to phase out our nail production at KSW over the next six months, after
which we plan to sell our nail production equipment. During the third quarter of
2006, we recorded an aggregate impairment charge of $529,000 (included in cost
of goods sold) to write down the carrying value of the industrial wire and nail
production equipment to be sold to its estimated fair value of $630,000. Because
we expect to complete the sale of the industrial wire production equipment that
is not being transferred to KSW during the fourth quarter of 2006, the carrying
value of these assets is included in other current assets on our September 30,
2006 Condensed Consolidated Balance Sheet. The carrying value of the industrial
wire production equipment that is being transferred to KSW, as well as the nail
production equipment which we will continue to use for the next six months,
continue to be included in machinery and equipment on our September 30, 2006
Condensed Consolidated Balance Sheet. The sales and operating income (loss) of
our nail operations is not material to our operating results.
- 9 -
Three months ended Nine months ended
September 30, September 30,
-------------------- ------------------
2005 2006 2005 2006
---- ---- ---- ----
(In thousands)
Net sales:
KSW $ 76,455 $ 98,990 $247,536 $335,475
EWP 17,986 16,496 47,792 47,229
Sherman/KWP 4,079 3,838 13,245 13,643
Elimination of intersegment sales:
KSW (11,644) (11,747) (36,830) (33,651)
EWP - - - -
Sherman/KWP (2,106) (2,365) (8,444) (9,274)
-------- -------- -------- --------
Total net sales $ 84,770 $105,212 $263,299 $353,422
======== ======== ======== ========
Operating income (loss):
KSW $ (489) $ 1,852 $(11,060) $ 10,505
EWP 2,453 3,554 7,084 7,973
Sherman/KWP (264) (445) (814) (411)
Allocation differences(1) 5,762 12,085 17,287 38,572
-------- -------- -------- --------
Total operating income 7,462 17,046 12,497 56,639
Nonoperating income (expense):
Corporate income (expense) (566) (209) (2,757) 1,273
Interest expense (1,040) (1,189) (2,816) (3,728)
Interest income 138 67 220 159
Other income (loss), net 167 (361) 271 (94)
-------- -------- -------- --------
Income before income taxes
and reorganization items $ 6,161 $ 15,354 $ 7,415 $ 54,249
======== ======== ======== ========
(1)Allocation differences are (i) the difference between the defined
benefit pension credit and postretirement benefit expense or credit allocated to
the operating 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.
- 10 -
Note 4 - Inventories, net:
December 31, September 30,
2005 2006
----------- -----------
(In thousands)
Raw materials $ 10,914 $ 16,198
Work in process 29,550 26,619
Finished goods 28,018 19,501
Supplies 16,421 18,714
-------- --------
Inventory at FIFO 84,903 81,032
Less LIFO reserve 15,212 15,762
-------- --------
Total $ 69,691 $ 65,270
======== ========
Note 5 - Other accrued liabilities:
December 31, September 30,
2005 2006
----------- -----------
(In thousands)
Current:
Employee benefits $12,085 $12,992
Income taxes 939 633
Self insurance 4,455 4,158
Environmental 3,000 898
Pre-petition unsecured creditor settlement 1,061 1,061
Legal and professional 247 271
Reorganization costs 3,057 179
Other 2,780 4,757
------- -------
Total $27,624 $24,949
======= =======
Noncurrent:
Environmental $ 3,921 $ 3,921
Workers compensation payments 1,595 1,833
Other 61 52
------- -------
Total $ 5,577 $ 5,806
======= =======
Note 6 - Liabilities subject to compromise:
December 31, September 30,
2005 2006
----------- -----------
(In thousands)
Environmental $ 8,491 $ 8,461
Accounts payable 850 789
Disposition of former facilities 684 417
Legal and professional 244 92
Other 207 4,207
------- -------
Total $10,476 $13,966
======= =======
- 11 -
During the second quarter of 2006, SWC received $4.0 million from a former
insurer under a Court approved settlement agreement. Under the terms of that
settlement agreement, the insurer withdrew certain claims it had filed against
SWC in SWC's bankruptcy proceedings, in exchange for which SWC released that
insurer from their liability to insure SWC for environmental coverage. SWC
currently anticipates a significant portion of the ultimate payment of its
pre-petition unsecured liabilities discussed in Note 2 will be funded with this
$4.0 million. The settlement agreement limits SWC's use of the proceeds to
payment of SWC's pre-petition unsecured claims, which we have classified as
noncurrent liabilities at September 30, 2006. Accordingly, we have classified
the $4.0 million we received as a noncurrent asset included in restricted
investments. Because of the restriction, we have also classified the $4.0
million as a liability subject to compromise on our September 30, 2006 Condensed
Consolidated Financial Statements.
Note 7 - Notes payable and long-term debt:
December 31, September 30,
2005 2006
----------- -----------
(In thousands)
Wachovia revolving credit facility $36,174 $28,865
8% Notes 26,532 25,740
UC Note 4,997 5,465
Term loans:
Wachovia 21,980 18,538
County 10,000 10,000
Other 212 137
------- -------
Total debt 99,895 88,745
Less current maturities 41,640 54,691
------- -------
Total long-term debt $58,255 $34,054
======= =======
Note 8 - Employee benefit plans:
Defined benefit plans - The components of net periodic defined benefit
pension credit are presented in the table below.
Three months ended Nine months ended
September 30, September 30,
---------------------- ----------------------
2005 2006 2005 2006
---- ---- ---- ----
(In thousands)
Service cost $ 938 $ 959 $ 2,813 $ 2,877
Interest cost 5,432 5,106 16,300 15,318
Expected return on plan assets (10,732) (16,863) (32,216) (50,589)
Amortization of unrecognized:
Prior service cost 221 227 662 681
Actuarial losses 915 (1,590) 2,766 (4,774)
-------- -------- -------- --------
Total $ (3,226) $(12,161) $ (9,675) $(36,487)
======== ======== ======== ========
We do not expect to make cash contributions to our defined benefit pension
plans during 2006.
- 12 -
Postretirement benefits other than pensions - The components of net
periodic expense (credit) related to postretirement benefits other than pensions
are presented in the table below.
Three months ended Nine months ended
September 30, September 30,
--------------------- ------------------
2005 2006 2005 2006
---- ---- ---- ----
(In thousands)
Service cost $ 514 $ 63 $ 1,995 $ 189
Interest cost 2,196 495 8,248 1,485
Amortization of unrecognized:
Prior service cost (86) (84) (257) (252)
Prior service cost due to
plan amendments (1,915) (4,243) (3,335) (12,729)
Actuarial losses 1,512 1,669 4,305 5,007
------ ------- ------- -------
Total $2,221 $(2,100) $10,956 $(6,300)
====== ======= ======= =======
We currently anticipate contributing $4.3 million of cash to our
postretirement benefit plans during 2006.
Note 9 - Provision for income taxes:
Nine months ended
September 30,
----------------------
2005 2006
---- ----
(In thousands)
Expected tax provision, at statutory rate $10,304 $18,775
U. S. state income taxes, net 1,788 1,969
Deferred tax asset valuation allowance (15,714) (10,675)
Capitalized reorganization costs 3,613 133
Other, net 281 (412)
------- -------
Provision for income taxes $ 272 $ 9,790
======= =======
Comprehensive provision for income taxes:
Currently payable:
U.S. federal $ 80 $ 6
U.S. state 192 412
------- -------
Net currently payable 272 418
Deferred income taxes, net - 9,372
------- -------
$ 272 $ 9,790
======= =======
Our 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.
Prior to June 30, 2006, considering all factors believed to be relevant, we
believed our gross deferred tax assets did not meet the "more-likely-than-not"
realizability test. As such, we had provided a deferred tax asset valuation
allowance to offset our net deferred income tax asset (before valuation
allowance) of approximately $10.7 million at December 31, 2005. During the first
six months of 2006, we recorded taxable income in excess of our available net
operating loss carryforwards. As such, the valuation allowance related to those
deferred tax assets was completely reversed during the first six months of 2006.
After such reversal, we have a net deferred income tax liability. Due in part to
our continued profitability, we believe the realization of our remaining gross
deferred income tax assets (including an alternative minimum tax credit
carryforward) meet the "more-likely-than-not" realizability test.
- 13 -
Certain of our U.S. tax returns are currently being examined and tax
authorities could propose tax deficiencies. To date, the tax authorities have
not proposed any tax deficiencies. We believe the ultimate disposition of tax
examinations should not have a material adverse effect on our consolidated
financial position, results of operations or liquidity.
Note 10 - Environmental matters:
We have 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 14 governmental
and private actions associated with environmental matters, including waste
disposal sites and facilities currently or previously owned, operated or used by
us, 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 we may be jointly
and severally liable for such costs, in most cases, we are only one of a number
of PRPs who may also be jointly and severally liable.
On a quarterly basis, we evaluate the potential range of our liability at
sites where we have been named as a PRP or defendant by analyzing and estimating
the range of reasonably possible costs to us. Such costs include, among other
things, expenditures for remedial investigations, monitoring, managing, studies,
certain legal fees, clean-up, removal and remediation. 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 upper end of the range of reasonably possible costs to us for
sites for which it is possible to estimate costs (14 sites) is approximately
$14.0 million. Our estimate of such costs has not been discounted to present
value, and other than certain previously-reported settlements with respect to
certain of our former insurance carriers, we have not recognized any material
insurance recoveries. We have provided accruals ($13.3 million at September 30,
2006, $8.5 million of which is reflected in liabilities subject to compromise on
our September 30, 2006 balance sheet) for 10 sites which we believe our
liability is probable and reasonably estimable. However, our 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 we are
potentially responsible for the release of hazardous substances at other sites.
In addition, the actual timeframe for payments by us for these matters may be
substantially in the future. It is possible our actual costs will exceed the
amounts we have accrued or the upper end of the range for sites for which
estimates have been made.
The exact time frame over which we make payments with respect to our
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 our control. At each balance sheet date, we make an estimate of
the amount of our accrued environmental costs which will be paid out over the
subsequent 12 months, and we classify such amount as a current liability. The
remainder of the accrued environmental costs are classified as a noncurrent
liability.
- 14 -
More detailed descriptions of certain legal proceedings relating to
environmental matters are set forth below. A summary of activity in our
environmental accruals for the nine months ended September 30, 2006 is as
follows:
Nine months ended
September 30,
-----------------
(In thousands)
Balance at December 31, 2005 $ 15,412
Expense -
Payments (2,242)
Reclassification 110
---------
Balance at September 30, 2006 $ 13,280
=========
Amounts classified as:
Current accrued environmental cost $ 898
Noncurrent accrued environmental cost 3,921
Liabilities subject to compromise 8,461
---------
$ 13,280
=========
All of the recorded environmental liability included in liabilities subject
to compromise on our September 30, 2006 balance sheet relates to sites involving
SWC or one of its predecessors and consists of $7.6 million related to non-owned
sites and $826,000 related to an owned site. The pre-petition claims against SWC
continue to be stayed while one final environmental claim is adjudicated.
In general, as a result of our Chapter 11 reorganization and discharge, any
future government or third-party private actions against us arising from our
alleged pre-petition responsibility for hazardous contamination at environmental
sites that we do not own have been barred. Our Chapter 11 discharge does not
affect our liability for hazardous contamination of property that was owned by
us as of the petition date therefore, any associated clean up costs remains our
responsibility.
Sites no longer subject to compromise.
We are currently involved in the closure of inactive waste disposal units
at KSW pursuant to a closure plan approved by the Illinois Environmental
Protection Agency ("IEPA") in September 1992 ("the Closure Plan"). The original
closure plan provided for the in-place treatment of seven hazardous waste
surface impoundments and two waste piles to be disposed of as special wastes. We
recorded an estimated liability for remediation of the impoundments and waste
piles based on a six-phase remediation plan. We adjusted the recorded liability
for each Phase as actual remediation costs became known. Pursuant to agreements
with the IEPA and Illinois Attorney General's office ("IAG"), we are depositing
$75,000 per quarter into a trust fund. Prior to 2005, we were required to
continue these quarterly deposits and could not withdraw funds from the trust
fund until the fund balance exceeded the sum of the estimated remaining
remediation costs at KSW plus $2.0 million. During 2005, this agreement was
modified such that the IEPA and IAG now permit us to withdraw funds from the
trust fund as the KSW sites are remediated. However, the requirement for us to
make quarterly deposits of $75,000 into the trust fund remains until such time
as the sites are completely remediated in accordance with the Closure Plan.
During the first nine months of 2006, we paid approximately $2.1 million in
remediation costs for these sites and received approximately $2.8 million in
funds from the trust fund. At December 31, 2005 and September 30, 2006, the
trust fund had a balance of $4.5 million and $2.0 million, respectively, which
were included in other noncurrent assets. We believe we completed the
remediation required by the Closure Plan as it has been amended during the third
quarter of 2006. However, as of September 30, 2006, the IEPA has not approved
the work.
- 15 -
In February 2000, we received a notice from the U.S. EPA giving formal
notice of the U.S. EPA's intent to issue a unilateral administrative order to us
pursuant to section 3008(h) of the Resource Conservation and Recovery Act
("RCRA"). The draft order enclosed with this notice would require us to: (1)
investigate the nature and extent of hazardous constituents present at and
released from five alleged solid waste management units at KSW; (2) investigate
hazardous constituent releases from "any other past or present locations at KSW
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 we "have 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 our 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. We have complied with deadlines
in the draft order. During the fourth quarter of 2000, we entered into a
modified Administrative Order on Consent which may require us to conduct cleanup
activities at certain solid waste management units at KSW depending on the
results of soil and groundwater sampling and risk assessment to be conducted by
us during future periods pursuant to the order.
In March 2000, the IAG filed and served a seven-count complaint against us
for alleged violations of the Illinois Environmental Protection Act, 415 ILCS
5/31, and regulations implementing RCRA at KSW. The complaint alleges that we
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 that we 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 that we 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.
We have answered the complaint and proceedings in the case have been stayed
pending the outcome of settlement negotiations between us and the IAG's office.
In December 2005, we received a Notice of Violation from the U.S. EPA
regarding air permit issues at KSW. The U.S. EPA alleges that we 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, we reached a
preliminary agreement with the U.S. EPA on a plan for addressing the U.S. EPA's
concerns without referring the matter for any enforcement action.
In addition, SWC is allegedly involved at various other sites and in
related toxic tort lawsuits which it does not currently expect to incur
significant liability.
SWC-related sites still subject to compromise at September 30, 2006.
The pre-petition claims against SWC continue to be stayed while one final
environmental claim is adjudicated.
Prior to SWC's 1996 acquisition of DeSoto, Inc. ("DeSoto"), 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, SWC entered
into TNRCC's Voluntary Cleanup Program. Remediation costs are presently
estimated to be between $826,000 and $2.0 million. Investigation activities are
on-going including additional soil and groundwater sampling.
- 16 -
SWC-related sites discharged in the Chapter 11 proceedings.
Prior to SWC's acquisition of DeSoto, DeSoto was notified by the U.S. EPA
that it is one of approximately 50 PRPs at the Chemical Recyclers, Inc. site in
Wylie, Texas. 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 the U.S. EPA will order further remedial action, the exact
extent of which is not currently known. Any further liability of SWC related to
this site was discharged in the Chapter 11 proceedings.
In 1984, the 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 above, SWC also has certain funds available in other
trust funds due it under the partial consent decree. These credits can be used
by SWC (with certain limitations) to fund its future liabilities under the
partial consent decree. The U.S. EPA was granted a $1.1 million claim in the
Chapter 11 proceedings. Any further liability of SWC related to this site was
discharged in the Chapter 11 proceedings.
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 a 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. The
plaintiffs were granted a $750,000 claim in the Chapter 11 proceedings. Any
further liability of SWC related to this site was discharged in the Chapter 11
proceedings.
SWC 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, SWC has signed a participation agreement
which would require SWC to pay no less than 3% of the remediation costs. Valspar
continues to pay for legal fees in this matter and has reimbursed SWC for all
assessments. The TNRCC was granted a $15,000 claim in the Chapter 11
proceedings. Any further liability of SWC related to this site was discharged in
the Chapter 11 proceedings.
- 17 -
Note 11 - Other commitments and contingencies:
Current litigation
We are engaged in various legal proceedings incidental to our normal
business activities. In our opinion, none of such proceedings is material in
relation to our consolidated financial position, results of operations or
liquidity.
Pre-petition claims against SWC continue to be stayed while one final
environmental claim is adjudicated.
Settled litigation
In July 2001, SWC 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 SWC and
demanded that SWC 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 (now SWC), 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 SWC with respect to the complaint.
In May 2002, SWC 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 certain lead paint personal injury litigation against Sears. It is our
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. Sears demanded
indemnification from the Insurance Companies. One of the Insurance Companies
demanded indemnification and defense from SWC.
On March 27, 2006, the Bankruptcy Court approved a settlement agreement
with one of DeSoto's former insurers, Allstate Insurance Company ("AIC") and
Northbrook Property and Casualty Insurance Company ("NP&CIC"), whereby SWC
entered into a policy buy-back arrangement with the insurers and the insurers
agree to withdraw their claims for retrospective premiums under the policies in
SWC's bankruptcy with prejudice after the Bankruptcy Court's order approving the
agreement becomes final and non-appealable (which occurred during the 2006
second quarter). As a result of this agreement, SWC received approximately $4.0
million from the insurers in exchange for a release of the insurers from the
policies. The $4.0 million may be used by SWC to satisfy its pre-petition
allowed unsecured claims, including environmental related claims against SWC in
its bankruptcy proceedings. Any portion of the $4.0 million not used to satisfy
SWC's allowed unsecured claims will revert back to the bankruptcy estate of SWC
and be distributed in accordance with its plan of reorganization. The settlement
agreement does not apply to any worker's compensation policies that AIC or
NP&CIC underwrote for SWC. The settlement agreement also does not apply to
Sears, but Sears is barred from bringing a claim against SWC's bankruptcy
estate. Sears filed a notice with the Bankruptcy Court indicating it is
consenting to the Allstate Settlement and withdrew its claims with prejudice
with respect to this matter.
- 18 -
Note 12 - Earnings per share:
Net income per share is based upon the weighted average number of common
shares and dilutive securities outstanding during the periods. Options to
purchase our common stock that were outstanding during the 2005 periods were
omitted from the calculation of diluted earnings per share because they were
anti-dilutive. A reconciliation of the numerators and denominators used in the
calculations of basic and diluted earnings per share computations of income is
presented below.
Three months ended Nine months ended
September 30, September 30,
----------------------- ---------------------
2005 2006 2005 2006
---- ---- ---- ----
(In thousands)
Numerator:
Net income $ 34,104 $ 9,094 $ 29,169 $ 43,853
Cancellation of Series A Preferred
Stock 2,112 - 2,112 -
Less Series A Preferred Stock
dividends - - - -
-------- -------- -------- --------
Basic net income 36,216 $ 9,094 31,281 43,853
Series A Preferred Stock dividends - - - -
-------- -------- -------- --------
Diluted net income $ 36,216 $ 9,094 $ 31,281 $ 43,853
======== ======== ======== ========
Denominator:
Average common shares outstanding 10,046 10,000 10,061 10,000
Dilutive effect of Series A
Preferred Stock 11,983 - 15,978 -
-------- -------- -------- --------
Diluted shares 22,029 10,000 26,039 10,000
======== ======== ======== ========
Note 13 - Recent Accounting Pronouncements:
Inventory costs. Statement of Financial Accounting Standards ("SFAS") No.
151, Inventory Costs, an amendment of ARB No. 43, Chapter 4, became effective
for us for inventory costs incurred on or after January 1, 2006. SFAS No. 151
requires that allocation of fixed production overhead costs to inventory be
based on normal capacity of the production facilities, as defined by SFAS No.
151. SFAS No. 151 also clarifies the accounting for abnormal amounts of idle
facility expense, freight handling costs and wasted material, requiring those
items be recognized as current-period charges. Our existing production cost
policies complied with the requirements of SFAS No. 151, therefore the adoption
of SFAS No. 151 did not affect our Consolidated Financial Statements.
Stock options. On January 1, 2006, SFAS No. 123R, Share-Based Payment,
became effective for us. SFAS No. 123R, among other things, requires the cost of
employee compensation paid with equity instruments to be measured based on the
grant-date fair value. That cost is then recognized over the vesting period.
Because we did not have any outstanding awards or options at January 1, 2006,
the adoption of SFAS No. 123R did not affect our Consolidated Financial
Statements. If we or our subsidiaries grant a significant number of equity
awards in the future, the amount of equity compensation expense in our
Consolidated Financial Statements could be material.
Uncertain tax positions. In the second quarter of 2006 the Financial
Accounting Standards Board ("FASB") issued FASB Interpretation No. ("FIN") 48,
Accounting for Uncertain Tax Positions, which will become effective for us on
January 1, 2007. FIN No. 48 clarifies when and how much of a benefit we can
recognize in our Consolidated Financial Statements for certain positions taken
in our income tax returns under SFAS No. 109, Accounting for Income Taxes, and
enhances the disclosure requirements for our income tax policies and reserves.
Among other things, FIN No. 48 will prohibit us from recognizing the benefit of
- 19 -
a tax position unless we believe it is more-likely-than-not our position will
prevail with the applicable tax authorities and limits the amount of the benefit
to the largest amount for which we believe the likelihood of realization is
greater than 50%. FIN No. 48 also requires companies to accrue penalties and
interest on the difference between tax positions taken on their tax returns and
the amount of benefit recognized for financial reporting purposes under the new
standard. Our current income tax accounting policies comply with this aspect of
the new standard. We will also be required to reclassify any reserves we have
for uncertain tax positions from deferred income tax liabilities, where they are
currently recognized, to a separate current or noncurrent liability, depending
on the nature of the tax position. We are currently evaluating the impact of FIN
No. 48 on our Consolidated Financial Statements, and we expect to finalize our
analysis in the fourth quarter of 2006.
Planned Major Maintenance Activities. In September, 2006 FASB issued FASB
Staff Position ("FSP") No. AUG AIR-1, Accounting for Planned Major Maintenance
Activities, which will become effective for us in January 2007, although early
adoption is permitted. Under FSP No. AUG AIR-1 accruing in advance for major
maintenance is no longer permitted. Companies that previously accrued in advance
for major maintenance activities will be required to retroactively restate their
financial statements to reflect a permitted method of expense for all periods
presented. In the past, we have accrued in advance during the year for our
planned major maintenance activities expected to be undertaken within that year.
We will retroactively restate our interim consolidated financial statements in
the fourth quarter of 2006 to reflect the direct expense method of accounting.
Adoption of the FSP will not have any impact on our previously reported net
income for any calendar year. Since we did accrue in advance during the year,
the adoption of the FSP will have the following effect on our previously
reported interim net income:
Increase (decrease) in net
-----------------------------
income
------
2005 2006
---- ----
Quarter Ended: (In thousands)
March 31 $ 424 $ 507
June 30 370 387
September 30 48 362
December 31 (842) na
-------- -------
Total $ - $ 1,256
======== ========
Quantifying Financial Statement Misstatement. In September, 2006 the SEC
issued Staff Accounting Bulletin ("SAB") No. 108 expressing their views
regarding the process of quantifying financial statement misstatements. The SAB
is effective for us no later than the fourth quarter of 2006. According to SAB
No. 108 both the "rollover" and "iron curtain" approaches must be considered
when evaluating a misstatement for materiality. We do not expect the adoption of
the SAB to have a material effect on our previously-reported consolidated
financial position or results of operations at the date of adoption.
Fair Value Measurements. In September, 2006 the FASB issued SFAS No. 157,
Fair Value Measurements, which will become effective for us on January 1, 2007.
SFAS No. 157 generally provides a consistent, single fair value definition and
measurement techniques for GAAP pronouncements. SFAS No. 157 also establishes a
fair value hierarchy for different measurement techniques based on the objective
nature of the inputs in various valuation methods. We will be required to ensure
all of our fair value measurements are in compliance with SFAS No. 157 on a
prospective basis beginning in the first quarter of 2007. In addition, we will
be required to expand our disclosures regarding the valuation methods and level
of inputs we utilize in the first quarter of 2007. The adoption of this standard
will not have a material effect on our Consolidated Financial Statements.
- 20 -
Pension and Other Postretirement Plans. In September, 2006 FASB issued SFAS
No. 158, Employers' Accounting for Defined Benefit Pension and Other
Postretirement Plans. SFAS No. 158 requires us to recognize an asset or
liability for the over or under funded status of each of our individual defined
benefit pension and postretirement benefit plans on our Consolidated Balance
Sheets. We will recognize through other comprehensive income prior unrecognized
gains and losses and prior service costs or credits, net of tax, as of December
31, 2006 that we currently amortize through net periodic benefit cost. All
future changes in the funded status of these plans will be recognized through
comprehensive income, net of tax (either net income or other comprehensive
income). We will also provide certain new discloses related to these plans. In
addition, this standard requires the measurement date of all plans to be
December 31, which is currently the measurement date of all our pension and
postretirement benefit plans. SFAS No. 158 does not change the existing
recognition and measurement requirements that determine the amount of periodic
benefit cost recognized in net income.
The asset and liability recognition and disclosure requirements of this
standard will become effective for us as of December 31, 2006 and must be
adopted prospectively. At December 31, 2005 our pension plans were over funded
by $309.0 million and we had a $145.2 million asset recognized on our
Consolidated Balance Sheet related to these plans. At December 31, 2005, our
postretirement benefit plans were under funded by $38.7 million and we had a
$137.5 million total liability recognized on our Consolidated Balance Sheet
related to these plans. We will not complete the 2006 assessment of the funded
status of our pension and postretirement benefit plans until after December 31,
2006, and our December 31, 2006 funded status will be based in part on certain
actuarial assumptions that we cannot yet determine and differences between the
actual and expected return on plan assets during the year. Therefore, we are not
able to determine the ultimate impact this standard will have on our
Consolidated Financial Statements. However, we believe the net effect of
adopting SFAS No. 158 will increase our stockholders' equity at December 31,
2006. The full disclosure of the funded status of our defined benefit pension
and postretirement benefit plans at December 31, 2005 can be found in Note 10 to
our 2005 Annual Report.
- 21 -
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
- --------------------------------------------------------------------------------
RESULTS OF OPERATIONS
Business Overview
We are a leading manufacturer of steel fabricated wire products, welded
wire reinforcement, nails, coiled rebar, industrial wire and wire rod for the
agricultural, industrial, construction, original equipment manufacturer and
retail consumer markets. Historically, we have 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. We are also engaged in the operation of a ferrous scrap recycling
facility. The operations of this ferrous scrap recycling facility were
insignificant when compared to our consolidated operations. As such, the results
of its operations are not separately addressed in the discussion that follows.
Our operating segments are organized by our manufacturing facilities and
include three reportable segments:
o Keystone Steel and Wire ("KSW"), located in Peoria, Illinois,
manufactures and sells wire rod, industrial wire, nails, coiled rebar
and fabricated wire products for agricultural, industrial,
construction, commercial, original equipment manufacturers and retail
consumer markets,
o Engineered Wire Products ("EWP"), located in Upper Sandusky, Ohio,
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
o Keystone Wire Products ("KWP"), located in Sherman, Texas,
manufactures and sells industrial wire and fabricated wire products
for agricultural, industrial, construction, commercial, original
equipment manufacturers and retail consumer markets.
In connection with our emergence from Chapter 11 on August 31, 2005,
certain operating assets and existing operations of SWC ("Sherman") were sold to
us at fair market value. We then used these assets to form and operate KWP. As
such, operating results of this segment prior to our emergence from Chapter 11
were operating results of Sherman. Operating results of this segment after our
emergence from Chapter 11, were operating results of KWP. In accordance with our
plan of reorganization, the remaining assets of SWC will eventually be
liquidated.
During the third quarter of 2006, we decided to relocate KWP's industrial
wire manufacturing process to KSW and to discontinue the production of nails at
KSW. KWP will continue to manufacture and distribute fabricated wire products,
and KSW may sell nails manufactured by third parties. Certain of KWP's
industrial wire production equipment will be transferred to KSW. During the
third quarter of 2006, we recorded an aggregate impairment charge of $529,000 to
write down the carrying value of the industrial wire and nail production
equipment to be sold to an estimated fair value of $630,000. The sales and
operating income (loss) of our nail operations is not material to our operating
results. See Note 3 to the Condensed Consolidated Financial Statements.
Our profitability is primarily dependent on sales volume, per-ton selling
prices, per-ton ferrous scrap cost, and energy costs. Additionally, because
pension and other postretirement benefits ("OPEB") expense or credits are
- 22 -
unrelated to the operating activities of our business, we measure our overall
performance using operating profit before pension and OPEB. Operating profit
before pension and OPEB credit or expense is a non-GAAP measure of profitability
and it shall not be considered in isolation or as a substitute for a measure
prepared in accordance with GAAP. A reconciliation of statement of operations
line items as reported to statement of operations line items adjusted for
pension and OPEB expense or credits is set forth in the following tables.
Three months ended September 30,
----------------------------------------------------------------------------------------------
(In thousands)
2005 2006
--------------------------------------------- --------------------------------------------
Operating Operating
Elimination Profit Elimination Profit
As of before As of before
Reported Pension/OPEB Pension/OPEB Reported Pension/OPEB Pension/OPEB
-------- ------------ ------------- -------- ------------ ------------
Net sales $84,770 $ - $84,770 $105,212 $ - $105,212
Cost of goods sold 75,854 (1,984) 73,870 96,017 1,450 97,467
------- ------- ------- -------- -------- --------
Gross margin 8,916 1,984 10,900 9,195 (1,450) 7,745
------- ------- ------- -------- -------- --------
Selling Expense 1,630 (1) 1,629 1,665 15 1,680
General and
administrative expense 3,050 10 3,060 2,645 29 2,674
Defined benefit pension
credit (3,226) 3,226 - (12,161) 12,161 -
------- ------- ------- -------- -------- --------
Total operating costs 1,454 3,235 4,689 (7,851) 12,205 4,354
------- ------- ------- -------- -------- --------
Operating income $ 7,462 $(1,251) $ 6,211 $ 17,046 $(13,655) $ 3,391
======= ======= ======= ======== ======== ========
Nine months ended September 30,
-----------------------------------------------------------------------------------------------
(In thousands)
2005 2006
--------------------------------------------- ---------------------------------------------
Operating Operating
Elimination Profit Elimination Profit
As of before As of before
Reported Pension/OPEB Pension/OPEB Reported Pension/OPEB Pension/OPEB
-------- ------------ ------------ -------- ------------ ------------
Net sales $263,299 $ - $263,299 $353,422 $ - $353,422
Cost of goods sold 247,370 (9,806) 237,564 319,914 4,351 324,265
-------- ------- -------- -------- --------- ---------
Gross margin 15,929 9,806 25,735 33,508 (4,351) 29,157
-------- ------- -------- -------- --------- --------
Selling Expense 4,647 (5) 4,642 5,113 44 5,157
General and
administrative expense 8,460 (25) 8,435 8,243 88 8,331
Defined benefit pension
credit (9,675) 9,675 - (36,487) 36,487 -
-------- ------- -------- -------- --------- --------
Total operating costs 3,432 9,645 13,077 (23,131) 36,619 13,488
-------- ------- -------- -------- --------- --------
Operating income $ 12,497 $ 161 $ 12,658 $ 56,639 $ (40,970) $ 15,669
======== ======= ======== ======== ========= ========
The decrease in operating profit before pension and OPEB from the third
quarter of 2005 to the third quarter of 2006 was primarily due to higher costs
for ferrous scrap partially offset by higher per-ton selling prices. The
increase in operating profit before pension and OPEB for the nine months ended
September 30, 2006 as compared to the same period in 2005 was due to the net
effects of increased shipment volumes and lower costs for ferrous scrap
partially offset by lower per-ton selling prices. As discussed in Note 2 to the
Condensed Consolidated Financial Statements, we were operating under the
protection of our Chapter 11 bankruptcy filing for the first eight months of
2005.
- 23 -
Our consolidated net sales, cost of goods sold, operating costs and
operating profit before pension and OPEB by segment are set forth in the
following tables.
Allocation
Sherman/ differences/
KSW EWP KWP eliminations(1) Total
--- --- ------- -------------- -----
(In thousands)
Three months ended September 30, 2005:
Net sales $ 76,455 $ 17,986 $ 4,079 $(13,750) $ 84,770
Cost of goods sold 66,038 14,274 4,145 (10,587) 73,870
-------- -------- ------- -------- --------
Gross margin 10,417 3,712 (66) (3,163) 10,900
Selling and
administrative expense 3,164 1,205 61 259 4,689
-------- -------- ------- -------- --------
Operating profit (loss) before
Pension/OPEB $ 7,253 $ 2,507 $ (127) $ (3,422) $ 6,211
======== ======== ======= ======== ========
Three months ended September 30, 2006:
Net sales $ 98,990 $ 16,496 $ 3,838 $(14,112) $105,212
Cost of goods sold 94,307 11,910 4,112 (12,862) 97,467
-------- -------- ------- -------- --------
Gross margin 4,683 4,586 (274) (1,250) 7,745
Selling and
administrative expense 3,166 994 164 30 4,354
-------- -------- ------- -------- --------
Operating profit (loss) before
Pension/OPEB $ 1,517 $ 3,592 $ (438) $ (1,280) $ 3,391
======== ======== ======= ======== ========
Nine months ended September 30, 2005:
Net sales $247,536 $ 47,792 $13,245 $(45,274) $263,299
Cost of goods sold 232,268 37,406 13,490 (45,600) 237,564
-------- -------- ------- -------- --------
Gross margin 15,268 10,386 (245) 326 25,735
Selling and
administrative expense 9,068 3,139 595 275 13,077
-------- -------- ------- -------- --------
Operating profit (loss) before
Pension/OPEB $ 6,200 $ 7,247 $ (840) $ 51 $ 12,658
======== ======== ======= ======== ========
Nine months ended September 30, 2006:
Net sales $335,475 $ 47,229 $13,643 $(42,925) $353,422
Cost of goods sold 316,685 36,043 13,538 (42,001) 324,265
-------- -------- ------- -------- --------
Gross margin 18,790 11,186 105 (924) 29,157
Selling and
administrative expense 9,851 3,100 492 45 13,488
-------- -------- ------- -------- --------
Operating profit (loss) before
Pension/OPEB $ 8,939 $ 8,086 $ (387) $ (969) $ 15,669
======== ======== ======= ======== ========
(1)Allocation differences are the elimination of intercompany profit or
loss on ending inventory balances and LIFO inventory reserve adjustments.
- 24 -
Our consolidated sales volume and per-ton selling prices for the third
quarter and first nine months of 2005 and 2006 are as follows:
Three months ended Nine months ended
September 30, September 30,
---------------------- ---------------------
2005 2006 2005 2006
---- ---- ---- ----
Sales volume (000 tons):
Fabricated wire products 19 24 79 90
Welded wire reinforcement 21 19 54 55
Nails 4 3 12 15
Industrial wire 19 20 50 59
Coiled rebar - (1) - (1)
Wire rod 61 85 149 291
Billets 5 5 11 32
---- ---- ---- ----
Total 129 156 355 542
==== ==== ==== ====
(1) - Less than 1,000 tons
Per-ton selling prices:
Fabricated wire products $1,065 $1,014 $1,099 $1,033
Welded wire reinforcement 860 880 888 865
Nails 718 714 768 706
Industrial wire 704 741 741 722
Coiled rebar - 589 - 559
Wire rod 470 523 520 500
Billets 277 307 295 357
All products 656 667 738 647
The higher shipment volume of fabricated wire products and wire rod during
the third quarter of 2006 as compared to the third quarter of 2005 was due to
increased market demand and competitor production problems. The higher shipment
volume of all products during the nine months ended September 30, 2006 as
compared to the same period in 2005 was due to increased market demand and
competitor production problems as well as an abnormally low shipment volume
during the first half of 2005, in part due to our customers' concerns about our
financial stability while we were operating under Chapter 11 protection. The
higher per-ton selling prices during the third quarter of 2006 as compared to
the third quarter of 2005 were due primarily to price increases implemented
during the third quarter of 2006. The lower overall per-ton selling prices
during the nine months ended September 30, 2006 as compared to the same period
in 2005, were due primarily to lower ferrous scrap costs, as the price we sell
our products is influenced in part by the market cost of ferrous scrap.
As a result of our strengthened financial position due to our emergence
from Chapter 11, we believe we have been able to recapture in 2006 a portion of
the market that we lost during the last two years. We believe a portion of this
market was lost due to customer concerns about our financial stability. As a
result, we expect 2006 shipment volumes to be higher than 2005 shipment volumes.
However, due to anticipated market pressures and lower projected ferrous scrap
costs, we believe 2006 overall per-ton selling prices will be lower than 2005
selling prices. Energy costs are expected to remain relatively flat in 2006.
Additionally, we anticipate a higher defined benefit pension credit and lower
postretirement benefit and reorganization costs in 2006. As a result, we expect
to report pre-tax income and positive cash flows from operating activities in
2006. In addition, as a result of the reversal of our deferred income tax
valuation allowance during the second quarter of 2006, we believe our provision
for income taxes during the remainder of 2006 will significantly exceed the
corresponding provision for income taxes in the same periods of the prior year.
We currently anticipate recording a provision for income taxes during the
remainder of the year that will approximate the statutory rate.
- 25 -
As previously stated, energy costs are a primary driver of our
profitability. Deregulation of electricity in Illinois (the location of our
largest manufacturing facility) will occur on January 1, 2007, as such, we
anticipate higher energy costs in 2007.
This report contains forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995. Statements in this Quarterly
Report on Form 10-Q that are not historical in nature are forward-looking and
are not statements of fact. Statements are found in this report including, but
not limited to, statements found in Item 2 - "Management's Discussion and
Analysis of Financial Condition and Results of Operations," are forward-looking
statements that represent our beliefs and assumptions based on currently
available information. In some cases you can identify these forward-looking
statements 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 we believe the expectations reflected in
forward-looking statements are reasonable, we do not know if these expectations
will be correct. Forward-looking statements by their nature involve substantial
risks and uncertainties that could significantly impact expected results. Actual
future results could differ materially from those predicted. While it is not
possible to identify all factors, we continue to face many risks and
uncertainties. Among the factors that could cause our actual future results to
differ materially from those described herein are the risks and uncertainties
discussed in this Quarterly Report and those described from time to time in our
other filings with the SEC including, but not limited to, the following:
o Future supply and demand for our 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 Our ability 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 2005 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. We
disclaim any intention or obligation to update or revise any forward-looking
statement whether as a result of new information, future events or otherwise.
- 26 -
Segment Operating Results:
The segment operating results presented exclude the effect of pension
and OPEB expense or credits.
Keystone Steel & Wire
Three months ended September 30,
------------------------------------
% of % of
2005 sales 2006 Sales
---- ----- ---- -----
($ in thousands)
Net sales $ 76,455 100.0% $98,990 100.0%
Cost of goods sold 66,038 86.4 94,307 95.3
-------- ------ ------- -----
Gross margin 10,417 13.6 4,683 4.7
-------- ------ ------- -----
Selling and administrative 3,164 4.1 3,166 3.2
-------- ------ ------- -----
Operating profit before
Pension and OPEB $ 7,253 9.5% $ 1,517 1.5%
======== ====== ======= =====
Nine months ended September 30,
------------------------------------
% of % of
2005 sales 2006 sales
---- ----- ---- -----
($ in thousands)
Net sales $247,536 100.0% $335,475 100.0%
Cost of goods sold 232,268 93.8 316,685 94.4
-------- ----- -------- -----
Gross margin 15,268 6.2 18,790 5.6
-------- ----- -------- -----
Selling and administrative 9,068 3.7 9,851 2.9
-------- ----- -------- -----
Operating profit before
Pension and OPEB $ 6,200 2.5% $ 8,939 2.7%
======== ===== ======== =====
- 27 -
The primary drivers of sales, cost of goods sold, and the resulting gross
margin are as follows:
Three months ended Nine months ended
September 30, September 30,
--------------------- ---------------------
2005 2006 2005 2006
---- ---- ---- ----
Sales volume(000 tons):
Fabricated wire products 19 24 79 90
Nails 4 4 12 15
Industrial wire 17 18 45 54
Coiled rebar - (1) - (1)
Wire rod 86 102 222 354
Billets 5 14 11 41
------ ------- ------ -------
Total sales 131 162 369 554
====== ======= ====== =======
(1) - Less than 1,000 tons
Per-ton selling prices:
Fabricated wire products $1,065 $ 1,014 $1,100 $ 1,033
Nails 718 714 768 706
Industrial wire 711 746 745 725
Coiled rebar - 589 - 559
Wire rod 463 515 510 493
Billets 277 376 295 369
All products 582 608 668 600
Average per-ton ferrous
scrap purchase cost $ 201 $ 216 $ 225 $ 211
Average electricity
cost per kilowatt hour $ 0.04 $ 0.04 $ 0.04 $ 0.04
Average natural gas
cost per therm $ 0.84 $ 0.68 $ 0.74 $ 0.80
KSW believes the higher shipment volume during the 2006 periods was due to
increased market demand and competitor production problems as well as an
abnormally low shipment volume during the first half of 2005, in part due to our
customers' concerns about our financial stability while we were operating under
Chapter 11 protection. The higher per-ton selling prices during the third
quarter of 2006 as compared to the third quarter of 2005 were due, in part, to
price increases implemented during the third quarter of 2006. The lower per-ton
selling prices during the nine months ended September 30, 2006 as compared to
the same period in 2005 were due primarily to significantly lower ferrous scrap
costs, as the price we sell our products is influenced in part by the market
cost of ferrous scrap.
In addition to the items presented in the table above, our profitability
has been adversely impacted by production interruptions due to operating issues
related to our rod mill reheat furnace in 2006. We plan to overhaul the reheat
furnace during the fourth quarter to avoid future production inefficiencies.
- 28 -
Engineered Wire Products
Three months ended September 30,
------------------------------------
% of % of
2005 sales 2006 sales
---- ----- ---- -----
($ in thousands)
Net sales $17,986 100.0% $16,496 100.0%
Cost of goods sold 14,274 79.4 11,910 72.2
------- ----- ------- -----
Gross margin 3,712 20.6 4,586 27.8
------- ----- ------- -----
Selling and administrative 1,205 6.7 994 6.0
------- ----- ------- -----
Operating profit before
Pension and OPEB $ 2,507 13.9% $ 3,592 21.8%
======= ===== ======= =====
Nine months ended September 30,
-----------------------------------
% of % of
2005 sales 2006 sales
---- ----- ---- -----
($ in thousands)
Net sales $47,792 100.0% $47,229 100.0%
Cost of goods sold 37,406 78.3 36,043 76.3
------- ------ ------- -----
Gross margin 10,386 21.7 11,186 23.7
------- ------ ------- -----
Selling and administrative 3,139 6.6 3,100 6.6
------- ------ ------- -----
Operating profit before
Pension and OPEB $ 7,247 15.1% $ 8,086 17.1%
======= ====== ======= =====
The primary drivers of sales, cost of goods sold, and the resulting gross
margin are as follows:
Three months ended Nine months ended
September 30, September 30,
-------------------- --------------------
2005 2006 2005 2006
---- ---- ---- ----
Sales volume (000 tons) -
Welded wire reinforcement 21 19 54 55
Per-ton selling prices -
Welded wire reinforcement $860 $880 $888 $865
Average per-ton wire rod
purchase cost $520 $515 $548 $501
EWP believes the lower shipment volume during the third quarter of 2006 as
compared to the third quarter of 2005 was due to a decline in the construction
of new homes which results in a decline of related infrastructure projects and
consequently, in a decrease in the sales of welded wire reinforcement. The
higher per-ton selling prices during the third quarter of 2006 as compared to
the third quarter of 2005 were due primarily to price increases implemented
during the third quarter of 2006. Selling and administrative expenses were lower
in the third quarter of 2006 as compared to the third quarter of 2005 primarily
due to a decline in 2006 personnel related costs.
The lower per-ton selling prices for the nine months ended September 30,
2006 as compared to the same period of 2005 were due primarily to significantly
lower cost for wire rod, EWP's primary raw material. EWP sources substantially
all of its wire rod requirements from KSW at prices that we believe approximate
market.
- 29 -
Sherman/KWP
Three months ended September 30,
-------------------------------------------------
% of % of
2005 sales 2006 sales
---- ----- ---- -----
($ in thousands)
Net sales $ 4,079 100.0% $3,838 100.0%
Cost of goods sold 4,145 101.6 4,112 107.1
------- ----- ------ -----
Gross margin (66) (1.6) (274) (7.1)
------- ----- ------ -----
Selling and administrative 61 1.5 164 4.3
-------- ----- ------ -----
Operating loss before
Pension and OPEB $ (127) (3.1)% $ (438) (11.4)%
======= ===== ====== =====
Nine months ended September 30,
-------------------------------------------------
% of % of
2005 sales 2006 sales
---- ----- ---- -----
($ in thousands)
Net sales $13,245 100.0% $ 13,643 100.0%
Cost of goods sold 13,490 101.8 13,538 99.2
------- ----- -------- -----
Gross margin (245) (1.8) 105 0.8
------- ----- -------- -----
Selling and administrative 595 4.5 492 3.6
------- ----- -------- -----
Operating loss before
Pension and OPEB $ (840) (6.3)% $ (387) (2.8)%
======= ====== ======== =====
The primary drivers of sales, cost of goods sold, and the resulting gross
margin are as follows:
Three months ended Nine months ended
September 30, September 30,
---------------------- ---------------------
2005 2006 2005 2006
---- ---- ---- ----
Sales volume(000 tons):
Fabricated wire products 2 3 8 9
Industrial wire 3 2 6 6
------ ------ ------ ------
Total sales 5 5 14 15
====== ====== ====== ======
Per-ton selling prices:
Fabricated wire products $ 944 $ 957 $ 1,013 $ 983
Industrial wire 667 692 708 687
Average per-ton wire rod
purchase cost $ 398 $ 459 $ 451 $ 443
The higher per-ton selling prices during the third quarter of 2006 as
compared to the third quarter of 2005 were due primarily to price increases
implemented during the third quarter of 2006. Cost of goods sold was higher in
the third quarter of 2006 as compared to the third quarter of 2005 due primarily
to the $172,000 impairment charge related to the industrial wire production
equipment that we plan to sell and an increase in the cost of wire rod, KWP's
primary raw material. KWP sources substantially all of its wire rod requirements
from KSW at prices that we believe approximate market.
The lower per-ton selling prices for the nine months ended September 30,
2006 as compared to the same period in 2005, were primarily due to significantly
lower cost for wire rod.
- 30 -
Pension and Postretirement Benefit Credits, Interest Expense, Provision for
Income Taxes, and General Corporate Items
During the third quarter and first nine months of 2006, we recorded a
defined benefit pension credit of $12.2 million and $36.5 million, respectively,
as compared to recording a defined benefit pension credit in the same periods
during 2005 of $3.2 million and $9.7 million, respectively. The increased
pension credit during the 2006 periods was a result of a $277 million increase
in plan assets from the end of 2004 to the end of 2005. We were not required to
make any cash contributions to the defined benefit pension plans during 2005 and
the first nine months of 2006. We currently expect to record a defined benefit
pension credit of $49.6 million during 2006 and that no plan contributions will
be required during the remainder of 2006. 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 the third quarter and first nine months of 2006, we recorded general
corporate expense of $209,000 and general corporate income of $1.3 million,
respectively, as compared to recording general corporate expense during the same
periods in 2005 of $566,000 and $2.8 million, respectively. The reduction in
general corporate expenses for the third quarter of 2006 as compared to the
third quarter of 2005 is primarily due to lower retiree medical costs partially
offset by increases in general insurance expense and consulting fees. The
reduction in general corporate expenses for the nine months ended September 30,
2006 as compared to the same period in 2005 is primarily due to lower retiree
medical costs, general insurance expense, and franchise taxes partially offset
by an increase in professional fees. As a result of the 1114 Agreement that was
entered into in connection with our emergence from Chapter 11 in August 2005,
postretirement benefit expense during periods subsequent to that date is
substantially less than in periods prior to that date. During the third quarter
and first nine months of 2006, we recorded a postretirement benefit credit of
approximately $2.1 million and $6.3 million, respectively, (of which $608,000
and $1.8 million, respectively, was included in general corporate expenses) as
compared to a $2.2 million and $11.0 million of postretirement benefit expense
recorded in the third quarter and first nine months of 2005, respectively, (of
which $235,000 and $1.2 million, respectively, was included in general corporate
expenses).
During the third quarter and first nine months of 2006, we incurred
$270,000 and $606,000, respectively, of legal and professional fees relative to
our Chapter 11 proceedings and the associated reorganization activities
including post-emergence activities related to closing the Chapter 11 cases and
liquidation of certain pre-petition subsidiaries. During the third quarter and
first nine months of 2005, we incurred $4.3 million and $10.3 million,
respectively, of legal and professional fees relative to these same activities.
- 31 -
Interest expense during the third quarter and first nine months of 2006 of
$1.2 million and $3.7 million, respectively, increased from interest expense
during the same periods in 2005 of $1.0 million and $2.8 million, respectively.
The primary drivers of interest expense are as follows:
Three months ended Nine months ended
September 30, September 30,
-------------------- --------------------
2005 2006 2005 2006
---- ---- ---- ----
($ in thousands)
Average debt balance $88,620 $87,046 $87,147 $93,436
Weighted average interest rate 4.2% 5.2% 4.0% 5.2%
The overall weighted average interest rates during the 2005 periods were
impacted by the fact that we discontinued accruing interest on pre-petition
unsecured debt upon filing for Chapter 11 on February 26, 2004.
A tabular reconciliation of the difference between the U.S. federal
statutory income tax rate and our effective income tax rates is included in Note
9 to the Condensed Consolidated Financial Statements. During 2005 and prior to
the second quarter of 2006, considering all factors believed to be relevant, we
believed our gross deferred tax assets did not meet the "more-likely-than-not"
realizability test. As such, we had provided a deferred tax asset valuation
allowance to offset our net deferred income tax asset (before valuation
allowance) of approximately $10.7 million at December 31, 2005. Primarily as a
result of the deferred tax asset valuation allowance, our provisions for income
taxes during those periods were not significant. However, during the first six
months of 2006, we recorded taxable income in excess of our available net
operating loss carryforwards. As such, the valuation allowance related to those
deferred tax assets was completely reversed during the first six months of 2006.
After such reversal, we have a net deferred tax liability. Due in part to our
continued profitability, we believe the realization of our remaining deferred
tax assets (including an alternative minimum tax credit carryforward) meet the
"more-likely-than-not" realizability test. We currently expect to report pre-tax
income for financial reporting purposes for the remainder of 2006 and as a
result of the reversal of our deferred income tax valuation allowance during the
second quarter of 2006, we believe our provision for income taxes during the
remainder of 2006 will significantly exceed the corresponding provision for
income taxes in the same periods of the prior year. We currently anticipate
recording a provision for income taxes during the remainder of the year that
will approximate the statutory rate.
Recent Accounting Pronouncements
See Note 13 to the Condensed Consolidated Financial Statements.
LIQUIDITY AND CAPITAL RESOURCES
Working Capital
At September 30, 2006, we had working capital of $40.4 million, including
$25.8 million of notes payable and current maturities of long-term debt as well
as outstanding borrowings under our revolving credit facility of $28.9 million.
The amount of available borrowings under our revolving credit facility is based
on formula-determined amounts of trade receivables and inventories, less the
amount of outstanding letters of credit. At September 30, 2006, unused credit
available for borrowing under our revolving credit facility was $29.8 million.
The revolving credit facility requires daily cash receipts be used to reduce
outstanding borrowings, which results in us maintaining zero cash balances when
- 32 -
there are balances outstanding under this credit facility. Accordingly, any
outstanding balances under this facility are always classified as a current
liability regardless of the maturity date of the facility.
Our primary credit facility requires compliance with certain financial
covenants related to performance measures. We were in compliance with all
financial covenants at September 30, 2006.
Historical Cash Flows
During the first nine months of 2006, net cash provided by operations
totaled $22.1 million as compared to net cash used in operations of $18.3
million during the first nine months of 2005. The improvement in operating cash
flows during the first nine months of 2006 as compared to the first nine months
of 2005 was due primarily to:
o Higher earnings in 2006,
o Lower levels of reorganization costs in 2006,
o Relative changes in our accounts receivable balances primarily due to
an abnormally low accounts receivable balance at December 31, 2004 as
a result of decreased demand during the fourth quarter of 2004 and an
abnormally high accounts receivable balance at December 31, 2005 as a
result of increased demand during the third and fourth quarters of
2005,
o Relative changes in our inventory levels due to weaker than
anticipated sales during the 2005 period due in part to our customers'
concerns about our financial stability while we were operating under
Chapter 11 protection, and
o Relative changes in our liabilities due to an increase in taxes
payable during 2006, the $4.0 million liability related to the
insurance settlement during the second quarter of 2006, and a decrease
in liabilities during 2005 as a result of bankruptcy proceedings.
During the first nine months of 2006, we had capital expenditures of
approximately $9.6 million primarily related to upgrades of production equipment
at KSW and a plant expansion at EWP. Capital expenditures for 2006 are expected
to be approximately $23.0 million and are related primarily to the EWP plant
expansion. We expect to fund capital expenditures using cash flows from
operations and borrowing availability under our credit facilities.
As a result of increased profitability, we decreased our borrowings on our
revolving credit facilities by $7.3 million during the first nine months of 2006
as compared to increasing our borrowings on our revolving credit facilities
during the first nine months of 2005. During the first nine months of 2005, we
paid off $16.0 million of Debtor-In-Possession and other financing and obtained
a five-year $80.0 million secured credit facility from Wachovia Capital Finance
(Central) ("Wachovia"). The Wachovia credit 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 our real property and equipment. To the extent there is
sufficient borrowing base, the term loan portion of the Wachovia Facility can be
reloaded in the amount of $10.0 million. On August 31, 2005, we obtained $22.5
million related to the Wachovia term loan. During the first nine months of 2006,
we made principal payments of $4.3 million related to financing obtained upon
emergence from bankruptcy.
Environmental Obligations
At September 30, 2006, our financial statements reflected accrued
liabilities of $13.3 million ($8.5 million of which is included in liabilities
subject to compromise on our balance sheet) for estimated remediation costs for
those environmental matters which we believe are probable and reasonably
estimable. Although we have established an accrual for estimated future required
environmental remediation costs, we do not know 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. We believe it is not
possible to estimate the range of costs for certain sites. The upper end of the
range of reasonably possible costs to us for sites for which we believe it is
possible to estimate costs is approximately $14.0 million, including the $13.3
million currently accrued. See Notes 10 and 11 to the Condensed Consolidated
Financial Statements for discussions of our environmental liabilities and
current litigation.
- 33 -
Pension and Other Postretirement Obligations
We do not expect to make contributions to our defined benefit pension plans
during 2006. However, we anticipate $4.3 million of cash contributions to our
postretirement benefit plans. Future variances from assumed actuarial rates,
including the rate of return on plan assets, may result in increases or
decreases to pension and postretirement benefit expense or credit and funding
requirements in future periods.
Income Taxes
We currently expect to report pre-tax income for financial reporting
purposes for the remainder of 2006 and as a result of the utilization of our
available net operating loss carryforwards during the first six months of 2006,
we will be required to pay significantly higher cash income taxes in future
periods with positive taxable income amounts.
Liquidity Outlook
We incur significant ongoing costs for plant and equipment and substantial
employee benefits for both current and retired employees. As such, we are
vulnerable to business downturns and increases in costs, and accordingly,
routinely compare our liquidity requirements and capital needs against our
estimated future operating cash flows. We have significant cash commitments over
the next nine months including:
o Scheduled payment of the $10.0 million term loan from the County of
Peoria, Illinois,
o Scheduled principal payment of $8.3 million on our 8% Notes,
o Scheduled principal payments of $2.1 million on our UC Note,
o Scheduled monthly payments of $4.4 million on our Wachovia Term Loan,
and
o Approximately $8.0 million in capital expenditures related to the EWP
plant expansion.
We may attempt to renegotiate certain of these credit facilities, including
extending the dates of scheduled principal payments. We continue efforts to
recapture a portion of the market we lost during the last two years.
Additionally, in an effort to reduce costs, we decided in September of 2006 to
relocate KWP's industrial wire operations to KSW and to discontinue the
production of nails at KSW. We will continue to analyze the profitability of our
operations and make operating decisions accordingly. Overall, we believe our
cash flows from operating activities combined with availability under our credit
agreement will be sufficient to enable us to meet our cash flow needs for the
next twelve months including the cash requirements identified above.
- 34 -
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Reference is made to the 2005 Annual Report for a discussion of the market
risks associated with changes in interest rates that affect us. There have been
no material changes in such market risks since we filed the 2005 Annual Report.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures - We maintain a system of
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
we file or submit to the Securities and Exchange Commission (the "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 us in the reports that we file or submit to the SEC
under the Act is accumulated and communicated to our management, including our
principal executive officer and our 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, our President and
Chief Executive Officer, and Bert E. Downing, Jr., our Vice President, Chief
Financial Officer, Corporate Controller and Treasurer, have evaluated our
disclosure controls and procedures as of September 30, 2006. Based upon their
evaluation, these executive officers have concluded that our disclosure controls
and procedures were effective as of the date of such evaluation.
Internal Control Over Financial Reporting - We currently expect that
Section 404 of the Sarbanes-Oxley Act of 2002 will require us to annually
include a management report on internal control over financial reporting
starting with our Annual Report on Form 10-K for the year ended December 31,
2007. We will have to document, test and evaluate our internal control over
financial reporting, using a combination of internal and external resources. The
process of documenting, testing and evaluating our 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 us in the documentation and testing required to comply with Section 404
could be limited. While we currently believe we will be able to dedicate the
appropriate resources, and that we will be able to fully comply with Section 404
in our Annual Report on Form 10-K for the year ended December 31, 2007 and be in
a position to conclude that our 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 our control could arise, there can be no assurance that we
will ultimately be able to fully comply with Section 404 in our Annual Report on
Form 10-K for the year ended December 31, 2007 or whether we will be able to
conclude that our internal control over financial reporting is effective as of
December 31, 2007.
Changes in Internal Control Over Financial Reporting - There have been no
changes in our internal control over financial reporting during the quarter
ended September 30, 2006 that has materially affected, or is reasonably likely
to materially affect, our internal control over financial reporting.
- 35 -
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings.
Reference is made to disclosure provided under the caption "Current
litigation" in Note 11 to the Condensed Consolidated Financial Statements.
ITEM 1A. Risk Factors.
Reference is made to our 2005 Annual Report for a discussion of risk
factors related to our businesses. There have been no material changes in such
risk factors since we filed the 2005 Annual Report.
ITEM 6. Exhibits.
(a) We have retained a signed original of any exhibit listed below that
contains signatures, and we 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.
- 36 -
[GRAPHIC OMITTED]
S I G N A T U R E S
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: November 14, 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)
- 37 -
S I G N A T U R E S
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: November 14, 2006 By ___________________________________
Bert E. Downing, Jr.
Vice President, Chief Financial
Officer, Corporate Controller
and Treasurer
(Principal Financial and
Accounting Officer)
- 38 -