10-Q 1 ksform_10q2q05.txt SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE --- SECURITIES EXCHANGE ACT OF 1934 For the quarterly period June 30, 2005 ------------- Commission file number 1-3919 ------ Keystone Consolidated Industries, Inc. -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Delaware 37-0364250 ------------------------------- ------------------ (State or other jurisdiction of I.R.S. Employer incorporation or organization) Identification No.) 5430 LBJ Freeway, Suite 1740, Three Lincoln Centre, Dallas, TX 75240-2697 -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (972) 458-0028 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. Yes No X --- --- Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes No X --- --- Indicate by a check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes No X --- --- Number of shares of common stock outstanding at March 31, 2006: 10,000,000 KEYSTONE CONSOLIDATED INDUSTRIES, INC. AND SUBSIDIARIES (DEBTOR-IN-POSSESSION) INDEX ------- Page number PART I. FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Balance Sheets - December 31, 2004; and June 30, 2005 (Unaudited) 3-4 Consolidated Statements of Operations - Three months and six months ended June 30, 2004 and 2005 (Unaudited) 5 Consolidated Statements of Cash Flows - Six months ended June 30, 2004 and 2005 (Unaudited) 6 Consolidated Statement of Stockholders' Equity (Deficit) - Six months ended June 30, 2005 (Unaudited) 7 Notes to Consolidated Financial Statements (Unaudited) 8-26 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 27-39 Item 4. Controls and Procedures 40-41 PART II. OTHER INFORMATION Item 1. Legal Proceedings 42 Item 6. Exhibits 42 KEYSTONE CONSOLIDATED INDUSTRIES, INC. AND SUBSIDIARIES (DEBTOR-IN-POSSESSION) CONSOLIDATED BALANCE SHEETS (In thousands) (Unaudited)
December 31, June 30, ASSETS 2004 2005 ------------ ----------- (Restated) Current assets: Notes and accounts receivable $ 26,729 $ 36,587 Inventories 53,017 50,286 Restricted investments 5,373 5,407 Prepaid expenses and other 2,017 2,080 -------- -------- Total current assets 87,136 94,360 -------- -------- Property, plant and equipment 369,036 371,913 Less accumulated depreciation 275,003 281,412 -------- -------- Net property, plant and equipment 94,033 90,501 -------- -------- Other assets: Restricted investments 5,965 6,226 Prepaid pension cost 133,443 139,892 Deferred financing costs 1,226 894 Goodwill 752 752 Other 727 614 -------- -------- Total other assets 142,113 148,378 -------- -------- $323,282 $333,239 ======== ========
KEYSTONE CONSOLIDATED INDUSTRIES, INC. AND SUBSIDIARIES (DEBTOR-IN-POSSESSION) CONSOLIDATED BALANCE SHEETS (CONTINUED) (In thousands) (Unaudited)
December 31, June 30, LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) 2004 2005 ------------ ----------- (Restated) Current liabilities not subject to compromise: Notes payable and current maturities of long-term debt $ 51,640 $ 65,837 Accounts payable 3,801 887 Accounts payable to affiliates 821 1,042 Other accrued liabilities 18,964 18,450 -------- -------- Total current liabilities not subject to compromise 75,226 86,216 -------- -------- Noncurrent liabilities not subject to compromise: Long-term debt 14,345 13,659 Accrued OPEB cost 13,478 19,239 Other 988 118 -------- -------- Total noncurrent liabilities not subject to compromise 28,811 33,016 -------- -------- Liabilities subject to compromise 212,346 212,043 -------- -------- Redeemable Series A preferred stock 2,112 2,112 -------- -------- Stockholders' equity (deficit): Common stock 10,798 10,798 Additional paid-in capital 41,225 41,225 Accumulated deficit (47,224) (52,159) Treasury stock, at cost (12) (12) -------- -------- Total stockholders' equity (deficit) 4,787 (148) -------- -------- $323,282 $333,239 ======== ========
Commitments and contingencies (Notes 11 and 12). See accompanying notes to consolidated financial statements. KEYSTONE CONSOLIDATED INDUSTRIES, INC. AND SUBSIDIARIES (DEBTOR-IN-POSSESSION) CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data) (Unaudited)
Three months ended Six months ended June 30, June 30, ------------------ ----------------- 2004 2005 2004 2005 ------ ------ ------ ------ Net sales $101,827 $ 88,992 $169,004 $178,529 Cost of goods sold 83,118 87,034 151,728 171,516 -------- -------- -------- -------- Gross margin 18,709 1,958 17,276 7,013 -------- -------- -------- -------- Selling expense 1,451 1,582 2,709 3,017 General and administrative expense 2,718 2,706 5,424 5,410 Defined benefit pension credit (1,500) (3,224) (3,000) (6,449) -------- -------- -------- -------- 2,669 1,064 5,133 1,978 -------- -------- -------- -------- Operating income 16,040 894 12,143 5,035 -------- -------- -------- -------- General corporate income (expense): Corporate expense (632) (895) (1,505) (2,191) Interest expense (961) (919) (2,025) (1,776) Interest income 22 47 32 82 Other income (expense), net (96) 16 17 104 -------- -------- -------- -------- (1,667) (1,751) (3,481) (3,781) -------- -------- -------- -------- Income (loss) before income taxes and reorganization costs 14,373 (857) 8,662 1,254 Reorganization costs 3,092 2,687 5,019 5,981 -------- -------- -------- -------- Income (loss) before income taxes 11,281 (3,544) 3,643 (4,727) Provision for income taxes 288 115 288 208 -------- -------- -------- -------- Net income (loss) 10,993 (3,659) 3,355 (4,935) Dividends on preferred stock - - 1,223 - -------- -------- -------- -------- Net income (loss) available for common shares $ 10,993 $ (3,659) $ 2,132 $ (4,935) ======== ======== ======== ======== Basic income (loss) per share available for common shares $ 1.09 $(.36) $ .21 $ (.49) ======== ======== ======== ======== Basic shares outstanding 10,068 10,068 10,068 10,068 ======== ======== ======== ======== Diluted income (loss) per share available for common shares $ .39 $ (.36) $ .12 $ (.49) ======== ======== ======== ======== Diluted shares outstanding 28,043 10,068 28,043 10,068 ======== ======== ======== ========
See accompanying notes to consolidated financial statements. KEYSTONE CONSOLIDATED INDUSTRIES, INC. AND SUBSIDIARIES (DEBTOR-IN-POSSESSION) CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) (Unaudited)
Six months ended June 30, ---------------------- 2004 2005 ---- ---- Cash flows from operating activities: Net income (loss) $ 3,355 $ (4,935) Depreciation and amortization 7,955 7,889 Amortization of deferred financing costs 567 347 Non-cash defined benefit pension credit (3,000) (6,449) Non-cash OPEB expense 8,850 5,762 Reorganization costs accrued 5,019 5,981 Reorganization costs paid (1,930) (5,176) Other, net 48 116 Change in assets and liabilities: Notes and accounts receivable (21,265) (9,948) Inventories (15,492) 2,731 Accounts payable 9,101 (2,693) Other, net 4,546 (2,518) -------- -------- Net cash used by operating activities (2,246) (8,893) -------- -------- Cash flows from investing activities: Capital expenditures (685) (4,551) Collection of notes receivable 75 75 Restricted investments (7,677) (296) Other, net 62 168 -------- -------- Net cash used by investing activities (8,225) (4,604) -------- -------- Cash flows from financing activities: Revolving credit facilities, net (3,635) 14,784 Other notes payable and long-term debt: Additions 15,819 47 Principal payments (1,188) (1,319) Deferred financing costs paid (525) (15) -------- -------- Net cash provided by financing activities 10,471 13,497 -------- -------- Net change in cash and cash equivalents - - Cash and cash equivalents, beginning of period - - -------- -------- Cash and cash equivalents, end of period $ - $ - ======== ======== Supplemental disclosures: Cash paid for: Interest, net of amount capitalized $ 1,112 $ 1,440 Income taxes, net - 673
See accompanying notes to consolidated financial statements. KEYSTONE CONSOLIDATED INDUSTRIES, INC. AND SUBSIDIARIES (DEBTOR-IN-POSSESSION) CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT) Six months ended June 30, 2005 (In thousands) (Unaudited)
Additional Common paid-in Accumulated Treasury stock capital deficit stock Total ------- ----------- ----------- --------- ------ Balance - December 31, 2004 $10,798 $41,225 $(47,224) $(12) $4,787 Net loss - - (4,935) - (4,935) ------- ------- -------- ---- ------ Balance - June 30, 2005 $10,798 $41,225 $(52,159) $(12) $ (148) ======= ======= ======== ==== ======
See accompanying notes to consolidated financial statements. KEYSTONE CONSOLIDATED INDUSTRIES, INC. AND SUBSIDIARIES (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Note 1 - Restatement, organization and basis of presentation: Restatement. In connection with finalizing the preparation of the Company's consolidated financial statements for the year ended December 31, 2005, the Company determined that cash overdrafts, which currently are financed by borrowings under the Company's revolving credit facility, and cash receipts which would be applied against the revolving credit facility, were improperly classified as part of accounts payable. Under accounting principles generally accepted in the United States of America ("GAAP"), such cash overdrafts should have been classified as part of the current portion of long-term debt. In addition, the relative changes in such cash overdrafts were improperly included in the determination of cash flows from operating activities, while under GAAP changes in such cash overdrafts should have been included in the determination of cash flows from financing activities. Accordingly, the Company has restated its consolidated balance sheet at December 31, 2004, as contained in this Form 10-Q, to reflect this correction. The $2.7 million adjustment to the 2004 balance sheet is a result of $3.8 million of cash receipts net of $1.1 million of cash overdrafts. The following table shows (i) selected consolidated financial statements data as of December 31, 2004, as previously reported, (ii) adjustments to such consolidated financial statement data to reflect the effect of this restatement and (iii) such consolidated financial statement data, as restated. KEYSTONE CONSOLIDATED INDUSTRIES, INC. SELECTED CONSOLIDATED BALANCE SHEET DATA December 31, 2004 (In thousands)
December 31, 2004 ------------------------------------------------- Previously Reported Adjustments As restated ---------- ----------- ----------- Selected balance sheet items: Notes payable and current maturities of long-term debt $ 54,336 $ (2,696) $ 51,640 ======== ======== ======== Accounts payable $ 1,105 $ 2,696 $ 3,801 ======== ======== ======== Total current liabilities $ 75,226 $ - $ 75,226 ======== ======== ======== Organization and basis of presentation.
The consolidated balance sheet of Keystone Consolidated Industries, Inc. ("Keystone" or the "Company") at December 31, 2004 has been condensed from the Company's audited consolidated financial statements at that date included in the Company's 2005 Form 10-K. The consolidated balance sheet at June 30, 2005 and the consolidated statements of operations and cash flows for the interim periods ended June 30, 2004 and 2005, and the consolidated statement of common stockholders' deficit for the interim period ended June 30, 2005, have each been prepared by the Company, without audit, in accordance with GAAP. In the opinion of management, all adjustments, consisting only of normal recurring adjustments necessary to present fairly the consolidated financial position, results of operations and cash flows, have been made. However, it should be understood that accounting measurements at interim dates may be less precise than at year end. The results of operations for the interim periods are not necessarily indicative of the operating results for a full year or of future operations. Certain information normally included in financial statements prepared in accordance with GAAP has been condensed or omitted, and certain prior year amounts have been reclassified to conform to the current year presentation. The accompanying consolidated financial statements should be read in conjunction with the consolidated financial statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 2005 (the "Annual Report"). At June 30, 2005, Contran Corporation ("Contran") and other entities related to Mr. Harold C. Simmons, beneficially owned approximately 50% of the outstanding common stock of the Company. Substantially all of Contran's outstanding voting stock is held by trusts established for the benefit of certain children and grandchildren of Mr. Simmons, of which Mr. Simmons is sole trustee, or is held by Mr. Simmons or persons or other entities related to Mr. Simmons. Keystone may be deemed to be controlled by Contran and Mr. Simmons. At June 30, 2005, Contran also owned 54,956 shares of the 71,899 shares of the Company's outstanding Redeemable Series A Preferred Stock. Each share of Series A Preferred Stock is convertible, at the option of the holder, into 250 shares of the Company's common stock (equivalent to a $4.00 per share exchange rate). The accompanying financial statements have been prepared under the assumption the Company will continue to operate on a going concern basis, which contemplates continuity of operations, realization of assets and liquidation of liabilities in the ordinary course of business and do not reflect adjustments that might result if Keystone is unable to continue as a going concern. However, on February 26, 2004, Keystone and five of its direct and indirect subsidiaries filed for voluntary protection under Chapter 11 of the Federal Bankruptcy Code. Keystone and its subsidiaries filed their petitions in the U.S. Bankruptcy Court for the Eastern District of Wisconsin in Milwaukee (the "Court"). Keystone's amended plan of reorganization was accepted by the impacted constitutencies and confirmed by the Court on August 10, 2005. The Company emerged from bankruptcy protection on August 31, 2005. See Note 2. Under Chapter 11 proceedings, actions by creditors to collect claims in existence at the filing date ("Pre-petition Claims") are stayed, absent specific authorization by the Court to pay such claims, while the Company continues to manage the business as a debtor-in-possession. Keystone received approval from the Court to pay certain of its Pre-petition Claims including employee wages and certain employee benefits. Note 2 - Bankruptcy On February 26, 2004, Keystone and five of its direct and indirect subsidiaries filed for voluntary protection under Chapter 11 of the Federal Bankruptcy Code. Keystone and its subsidiaries filed their petitions in the U.S. Bankruptcy Court for the Eastern District of Wisconsin in Milwaukee. The Company is managing its business as a debtor-in possession subject to approval by the Court. Keystone attributed the need to reorganize to weaknesses in product selling prices over the last several years, unprecedented increases in ferrous scrap costs, Keystone's primary raw material, and significant liquidity needs to service retiree medical costs. These problems substantially limited Keystone's liquidity and undermined its ability to obtain sufficient debt or equity capital to operate as a going concern. Under Chapter 11 proceedings, actions by creditors to collect Pre-petition Claims in existence at the filing date are stayed, absent specific authorization from the Court to pay such claims while the Company manages the business as a debtor-in-possession. Keystone filed a plan of reorganization on October 4, 2004 and amended that plan on May 26, 2005, June 21, 2005 and June 27, 2005. Keystone's amended plan of reorganization was accepted by the impacted constituencies and confirmed by the Court on August 10, 2005. The Company emerged from bankruptcy protection on August 31, 2005. Significant provisions of Keystone's amended plan of reorganization included, among other things: o Assumption of the previously negotiated amendment to the collective bargaining agreement with the Independent Steel Workers Alliance (the "ISWA"), Keystone's largest labor union that related primarily to greater employee participation in healthcare costs; o Assumption of the previously negotiated agreements reached with certain retiree groups that will provide relief by permanently reducing healthcare related payments to these retiree groups from pre-petition levels; o The Company's obligations due to pre-petition secured lenders other than its Debtor-In-Possession lenders were reinstated in full against reorganized Keystone; o All shares of Keystone's common and preferred stock outstanding at the petition date (February 26, 2004) were cancelled; o Pre-petition unsecured creditors with allowed claims against Keystone will receive, on a pro rata basis, in the aggregate, $5.2 million in cash, a $4.8 million secured promissory note and 49% of the new common stock of reorganized Keystone; o Certain operating assets and existing operations of Sherman Wire Company ("Sherman Wire"), one of Keystone's pre-petition wholly-owned subsidiaries, will be sold at fair market value (fair market value and book value both approximate $2.0 million) to Keystone, which will then be used to form and operate a newly created wholly-owned subsidiary of reorganized Keystone named Keystone Wire Products Inc.; o Sherman Wire was also reorganized and the proceeds of the operating asset sale to Keystone and other funds will be distributed, on a pro rata basis, to Sherman Wire's pre-petition unsecured creditors as their claims are finally adjudicated; o Sherman Wire's pre-petition wholly-owned non-operating subsidiaries, J.L. Prescott Company, and DeSoto Environmental Management, Inc. as well as Sherman Wire of Caldwell, Inc., a wholly-owned subsidiary of Keystone, will ultimately be liquidated and the pre-petition unsecured creditors with allowed claims against these entities will receive their pro-rata share of the respective entity's net liquidation proceeds; o Pre-petition unsecured creditors with allowed claims against FV Steel & Wire Company, another one of Keystone's wholly-owned subsidiaries, will receive cash in an amount equal to their allowed claims; o One of Keystone's Debtor-In-Possession lenders, EWP Financial, LLC (an affiliate of Contran) converted $5 million of its DIP credit facility, certain of its pre-petition unsecured claims and all of its administrative claims against Keystone into 51% of the new common stock of reorganized Keystone; and o The Board of Directors of reorganized Keystone now consists of seven individuals, two each of which were designated by Contran and the Official Committee of Unsecured Creditors (the "OCUC"), respectively. The remaining three directors qualify as independent directors (two of the independent directors were appointed by Contran with the OCUC's consent and one was appointed by the OCUC with Contran's consent). In addition, Keystone has obtained a five-year $80 million secured credit facility from Wachovia Capital Finance (Central). Proceeds from this credit facility were used to extinguish Keystone's existing Debtor-In-Possession ("DIP") credit facilities and to provide working capital for reorganized Keystone. Proceeds from this credit facility were used to extinguish Keystone's existing DIP credit facilities, the EWP Term Loan, the EWP Revolver and to provide working capital for reorganized Keystone. The facility includes a term loan in the amount of up to $25.0 million, subject to a borrowing base calculation based on the market value of the Company's real property and equipment. To the extent there is sufficient borrowing base, the term loan portion of this credit facility can be reloaded in the amount of $10.0 million. The portion of the credit facility in excess of the term loan balance is available to the Company as a revolving credit facility subject to a borrowing base calculation based on eligible receivables and inventory balances. Interest rates on the credit facility range from the prime rate to the prime rate plus .5% depending on Keystone's excess availability, as defined in the credit agreement. The facility also provides for a LIBOR interest rate option. Under the terms of the credit facility, the Company is required to annually pay down the term loan portion of the facility in the amount of 25% of excess cash flow, as defined in the agreement, subject to a $2.0 million annual and a $5.0 million aggregate limit. The facility also includes performance covenants related to minimum levels of cash flow and fixed charge coverage ratio. Keystone paid the lender approximately $400,000 of diligence, commitment and closing fees in connection with this facility. At June 30, 2005, the net assets of the one subsidiary of Keystone which was not party to the bankruptcy proceeding, included in the Company's consolidated net assets, was approximately $16.8 million, consisting of current assets of $25.4 million, noncurrent assets (primarily net property and equipment) of $5.9 million, current liabilities of $11.0 million and noncurrent liabilities (primarily long-term debt) of $3.5 million. Note 3 - Business Segment Information: The Company's operating segments are organized along its manufacturing facilities and include three reportable segments: (i) Keystone Steel and Wire ("KSW") which manufacturers and sells wire rod, wire and wire products for agricultural, industrial, construction, commercial, original equipment manufacturers and retail consumer markets, (ii) Engineered Wire Products ("EWP") which manufacturers and sells welded wire reinforcement in both roll and sheet form that is utilized in concrete construction products including pipe, pre-cast boxes and applications for use in roadways, buildings and bridges and (iii) Sherman Wire ("Sherman") which manufacturers and sells wire and wire products for agricultural, industrial, construction, commercial, original equipment manufacturers and retail consumer markets. Business Segment Principal entities Location ---------------- ------------------ -------- Keystone Steel & Wire Keystone Steel & Wire Peoria, Illinois Engineered Wire Products Engineered Wire Products Upper Sandusky, Ohio Sherman Sherman Wire Sherman, Texas
GAAP Adjustments, Corporate Items Segment and KSW EWP Sherman Total Eliminations Total --- --- ------- ------- ------------ ----- (In thousands) Three months ended June 30, 2004: Third party net sales $ 84,203 $15,949 $ 1,651 $101,803 $ 24 $101,827 Intercompany sales 18,982 - 2,787 21,769 (21,769) - -------- ------- ------- -------- -------- -------- $103,185 $15,949 $ 4,438 $123,572 $(21,745) $101,827 ======== ======= ======= ======== ======== ======== Operating income $ 10,295 $ 3,333 $ 14 $ 13,642 $ 2,398 $ 16,040 ======== ======= ======= ======== ======== ======== Three months ended June 30, 2005: Third party net sales $ 70,021 $17,755 $ 1,216 $ 88,992 $ - $ 88,992 Intercompany sales 11,866 - 2,897 14,763 (14,763) - -------- ------- ------- -------- -------- -------- $ 81,887 $17,755 $ 4,113 $103,755 $(14,763) $ 88,992 ======== ======= ======= ======== ======== ======== Operating income (loss) $(9,119) $ 2,992 $ (381) $ (6,508) $ 7,402 $ 894 ======== ======= ======= ======== ======== ======== Six months ended June 30, 2004: Third party net sales $139,431 $27,039 $ 2,490 $168,960 $ 44 $169,004 Intercompany sales 24,380 - 5,007 29,387 (29,387) - -------- ------- ------- -------- -------- -------- $163,811 $27,039 $ 7,497 $198,347 $(29,343) $169,004 ======== ======= ======= ======== ======== ======== Operating income (loss) $ 3,307 $ 4,601 $ (561) $ 7,347 $ 4,796 $ 12,143 ======== ======= ======= ======== ======== ======== Six months ended June 30, 2005: Third party net sales $145,895 $29,806 $ 2,828 $178,529 $ - $178,529 Intercompany sales 25,186 - 6,338 31,524 (31,524) - -------- ------- ------- -------- -------- -------- $171,081 $29,806 $ 9,166 $210,053 $(31,524) $178,529 ======== ======= ======= ======== ======== ======== Operating income (loss) $(10,571) $ 4,631 $ (550) $ (6,490) $ 11,525 $ 5,035 ======== ======= ======= ======== ======== ========
In the above tables, GAAP adjustments relate to operating profit (loss), Corporate items relate to depreciation and amortization, segment assets and capital expenditures and eliminations relate to net sales. GAAP adjustments are principally (i) the difference between the defined benefit pension expense or credit and OPEB expense allocated to the segments and the actual expense or credit included in the determination of operating profit or loss, (ii) the elimination of intercompany profit or loss on ending inventory balances and (iii) LIFO inventory reserve adjustments.
Three months ended Six months ended June 30, June 30, ------------------ ----------------- 2004 2005 2004 2005 ------ ------ ------ ------ Operating income $ 16,040 $ 894 $ 12,143 $ 5,035 General corporate items: Interest income 22 47 32 82 Other income (expense) (96) 16 17 104 Corporate expense (632) (895) (1,505) (2,191) Interest expense (961) (919) (2,025) (1,776) -------- -------- -------- -------- Income (loss) before income taxes and reorganization costs $ 14,373 $ (857) $ 8,662 $ 1,254 ======== ======== ======== ========
Note 4 - Inventories:
December 31, June 30, 2004 2005 ------------ ---------- (In thousands) Steel and wire products: Raw materials $15,142 $13,315 Work in process 21,305 16,694 Finished goods 28,941 27,703 Supplies 14,844 16,510 ------- ------- 80,232 74,222 Less LIFO reserve 27,215 23,936 ------- ------- $53,017 $50,286 ======= =======
Note 5 - Notes payable and long-term debt:
December 31, June 30, 2004 2005 ------------ ---------- (Restated) (In thousands) DIP facilities: Congress $15,108 $26,649 EWP 5,000 5,000 EWP revolving credit facility 1,989 4,631 8% Notes 28,116 28,116 Term loans: County 10,000 10,000 EWP 5,513 4,838 Other 259 262 ------- ------- 65,985 79,496 Less current maturities 51,640 65,837 ------- ------- $14,345 $13,659 ======= =======
The indenture governing Keystone's 8% Notes provides the holders of such Notes with the right to accelerate the maturity of the Notes in the event of a default by Keystone resulting in an acceleration of the maturity of any of the Company's other secured debt. As such, the 8% Notes were classified as a current liability at December 31, 2004 and June 30, 2005. The Company has determined there is insufficient collateral to cover the interest portion of scheduled payments on its pre-petition unsecured debt. As such, the Company discontinued accruing interest on its unsecured 6% Notes and unsecured 9 5/8% Notes as of February 26, 2004, the filing date. Contractual interest on those obligations during the second quarter and first six months of 2005 was approximately $313,000 and $624,000, respectively. Note 6 - Series A preferred stock: The Company discontinued accruing dividends on its Series A Preferred Stock upon filing for Chapter 11 on February 26, 2004. All of the Company's Series A Preferred Stock was cancelled in connection with Keystone's emergence from Chapter 11 on August 31, 2005. See Note 2. Note 7 - Income taxes: Summarized below are (i) the differences between the provision for income taxes and the amounts that would be expected by applying the U.S. federal statutory income tax rate of 35% and (ii) the components of the comprehensive provision for income taxes.
Six months ended June 30, -------------------- 2004 2005 ---- ---- (In thousands) Expected tax provision (benefit), at statutory rate $ 1,275 $(1,654) U. S. state income taxes, net 237 102 Deferred tax asset valuation allowance (2,998) (56) Capitalize reorganization costs 1,756 1,804 Other, net 18 12 ------- ------- Provision for income taxes $ 288 $ 208 ======= ======= Comprehensive provision for income taxes: Currently payable: U.S. federal $ 191 $ 86 U.S. state 97 122 ------- ------- Net currently payable 288 208 Deferred income taxes, net - - ------- ------- $ 288 $ 208 ======= =======
The Company's emergence from Chapter 11 on August 31, 2005 did not result in an ownership change within the meaning of Section 382 of the Internal Revenue Code. At June 30, 2005, considering all factors believed to be relevant, including the Company's recent operating results, its expected future near-term productivity rates; cost of raw materials, electricity, labor and employee benefits, environmental remediation, and retiree medical coverage; interest rates; product mix; sales volumes and selling prices; and the fact that accrued OPEB expenses will become deductible over an extended period of time and require the Company to generate significant amounts of future taxable income, the Company believes its gross deferred tax assets do not currently meet the "more-likely-than-not" realizability test. As such, at December 31, 2004, the Company had provided a deferred tax asset valuation allowance of approximately $30.3 million. As a result of the deferred tax asset valuation allowance, the Company does not anticipate recognizing tax expense associated with its expected pre-tax income during 2005 will be appropriate. Accordingly, during the first six months of 2005, the Company decreased the deferred tax asset valuation allowance by approximately $56,000. Keystone will continue to review the recoverability of its deferred tax assets, and based on such periodic reviews, Keystone could recognize a change in the valuation allowance related to its deferred tax assets in the future.
Note 8 - Other accrued liabilities: December 31, June 30, 2004 2005 ------------ ---------- (In thousands) Current: Employee benefits $12,019 $ 9,434 Reorganization costs 2,883 3,688 Self insurance 1,064 1,689 Income taxes 1,405 1,036 Legal and professional 358 1,011 Other 1,235 1,592 ------- ------- $18,964 $18,450 ======= ======= Noncurrent: Workers compensation payments $ 988 $ 118 ======= =======
Note 9 - Liabilities subject to compromise
December 31, June 30, 2004 2005 ------------ ---------- (In thousands) Accrued OPEB cost $123,425 $123,425 Environmental 19,432 19,386 6% Notes 16,031 16,031 Accrued preferred stock dividends 11,846 11,846 Accounts payable 10,776 10,776 Deferred vendor payments 10,518 10,518 9 5/8% Notes 6,150 6,150 Self insurance 4,549 4,549 Accounts payable to affiliates 3,027 3,027 Workers compensation 1,847 1,847 Accrued and deferred interest 1,237 1,237 Legal and professional 726 547 Disposition of former facilities 665 665 Other 2,117 2,039 -------- -------- $212,346 $212,043 ======= =======
Note 10 - Employee benefit plans: Defined benefit plans. The components of net periodic defined benefit pension credit are presented in the table below.
Three months ended Six months ended June 30, June 30, ------------------ ----------------- 2004 2005 2004 2005 ------ ------ ------ ------ (In thousands) Service cost $ 875 $ 938 $ 1,750 $ 1,875 Interest cost 5,439 5,434 10,878 10,868 Expected return on plan assets (9,373) (10,733) (18,747) (21,467) Amortization of unrecognized: Prior service cost 221 221 441 441 Actuarial losses 1,338 915 2,678 1,834 -------- -------- -------- -------- $ (1,500) $ (3,225) $ (3,000) $(6,449) ======== ======== ======== ========
Postretirement benfits other than pensions ("OPEB"). The components of net periodic OPEB cost are presented in the table below.
Three months ended Six months ended June 30, June 30, ------------------ ----------------- 2004 2005 2004 2005 ------ ------ ------ ------ (In thousands) Service cost $ 725 $ 740 $ 1,450 $ 1,480 Interest cost 3,496 3,026 6,991 6,052 Amortization of unrecognized: Prior service cost (86) (86) (172) (172) Prior service cost due to plan amendment (625) (710) (1,250) (1,420) Actuarial losses 1,015 1,397 2,031 2,794 Settlement loss 1,250 - 2,500 - -------- -------- -------- -------- $ 5,775 $ 4,367 $ 11,550 $ 8,734 ======== ======== ======== ========
During 2004, the Company entered into an agreement (the "1114 Agreement") with certain retiree groups that substantially reduced the post retirement ("OPEB") benefits that will be paid to these retiree groups in the future. Prior to confirmation of Keystone's definitive plan of reorganization, the Court could have rescinded the 1114 Agreement and therefore the 1114 Agreement was not definitive until it was confirmed by the Court in connection with Keystone's emergence from Chapter 11 on August 31, 2005. As such, and in accordance with GAAP, the Company has continued to record OPEB expense through August 31, 2005 at the estimated level as if Keystone had not entered into the 1114 Agreement. Keystone estimates OPEB expense for the first eight months of 2005 will approximate $11.6 million. However, at the time of the Company's emergence from Chapter 11 on August 31, 2005, and concurrent confirmation of the 1114 Agreement GAAP then requires the effect of the substantially reduced future OPEB benefits agreed to as part of the 1114 Agreement be accounted for as a plan amendment, the benefit of which is amortized into income over future periods. Accordingly, Keystone estimates that it will record an OPEB credit of approximately $2.7 million for the last four months of 2005, resulting in an $8.9 million expense for the year 2005. Employer Contributions. Keystone previously disclosed in its financial statements for the year ended December 31, 2004, that it expected not to be required to contribute to its defined benefit pension plan in 2005. As of June 30, 2005, Keystone had not made any contributions to its defined benefit pension plan during 2005. The Company also previously disclosed in its financial statements for the year ended December 31, 2004, that it expected to contribute approximately $8.3 million to its post retirement benefit plans in 2005. As of June 30, 2005, Keystone had contributed $3.0 million to these plans during 2005. Note 11 - Environmental matters: As a result of the Chapter 11 filings on February 26, 2004, litigation relating to prepetition claims against the filing companies, including Keystone and Sherman Wire, has been stayed. Keystone has been named as a defendant, potentially responsible party ("PRP"), or both, pursuant to the Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA") or similar state laws in approximately 25 governmental and private actions associated with environmental matters, including waste disposal sites and facilities currently or previously owned, operated or used by Keystone, certain of which are on the United States Environmental Protection Agency's (the "U.S. EPA") Superfund National Priorities List or similar state lists. These proceedings seek cleanup costs, damages for personal injury or property damage and/or damages for injury to natural resources. Certain of these proceedings involve claims for substantial amounts. Although Keystone may be jointly and severally liable for such costs, in most cases, it is only one of a number of PRPs who may also be jointly and severally liable. On a quarterly basis, Keystone evaluates the potential range of its liability at sites where it has been named as a PRP or defendant by analyzing and estimating the range of reasonably possible costs to Keystone. Such costs include, among other things, expenditures for remedial investigations, monitoring, managing, studies, certain legal fees, clean-up, removal and remediation. Keystone believes it has provided adequate accruals ($19.5 million at June 30, 2005, substantially all of which is reflected in liabilities subject to compromise on the Company's June 30, 2005 balance sheet) for these matters at 13 sites for which Keystone believes its liability is probable and reasonably estimable, but Keystone's ultimate liability may be affected by a number of factors, including the imposition of more stringent standards or requirements under environmental laws or regulations, new developments or changes in remedial alternatives and costs, the allocation of such costs among PRPs, the solvency of other PRPs or a determination that Keystone is potentially responsible for the release of hazardous substances at other sites, any of which could result in expenditures in excess of amounts currently estimated by Keystone to be required for such matters. With respect to other PRPs and the fact that the Company may be jointly and severally liable for the total remediation cost at certain sites, the Company could ultimately be liable for amounts in excess of its accruals due to, among other things, reallocation of costs among PRPs or the insolvency of one or more PRPs. In addition, the actual timeframe for payments by Keystone for these matters may be substantially in the future. Keystone believes it is not possible to estimate the range of costs for seven sites. For these sites, generally the investigation is in the early stages, and it is either unknown as to whether or not the Company actually had any association with the site, or if the Company had association with the site, the nature of its responsibility, if any, for the contamination at the site and the extent of contamination. The timing on when information would become available to the Company to allow the Company to estimate a range of loss is unknown and dependent on events outside the control of the Company, such as when the party alleging liability provides information to the Company. The upper end of the range of reasonably possible costs to Keystone for sites for which it is possible to estimate costs (17 sites) is approximately $21.4 million. Keystone's estimates of such liabilities have not been discounted to present value, and other than certain previously-reported settlements with respect to certain of Keystone's former insurance carriers, Keystone has not recognized any material insurance recoveries. No assurance can be given that actual costs will not exceed accrued amounts or the upper end of the range for sites for which estimates have been made, and no assurance can be given that costs will not be incurred with respect to the eight sites as to which no estimate of liability can presently be made because the respective investigations are in early stages. The extent of CERCLA liability cannot be determined until the Remedial Investigation/Feasibility Study ("RI/FS") is complete, the U.S. EPA issues a Record of Decision ("ROD") and costs are allocated among PRPs. The extent of liability under analogous state cleanup statutes and for common law equivalents is subject to similar uncertainties. The exact time frame over which the Company makes payments with respect to its accrued environmental costs is unknown and is dependent upon, among other things, the timing of the actual remediation process which in part depends on factors outside the control of the Company. At each balance sheet date, the Company makes an estimate of the amount of its accrued environmental costs which will be paid out over the subsequent 12 months, and the Company classifies such amount as a current liability. The remainder of the accrued environmental costs are classified as a noncurrent liability. More detailed descriptions of certain legal proceedings relating to environmental matters are set forth below. A summary of activity in the Company's environmental accruals for the six months ended June 30, 2005 is as follows:
Six months ended June 30, ------------------ (In thousands) Balance at December 31, 2004 $19,432 Expense - Payments (45) Reclassification 71 ------- Balance at June 30, 2005 $19,458 =======
Substantially all of the Company's $19.5 million recorded environmental accrual at June 30, 2005 is included in liabilities subject to compromise on the Company's balance sheet. Approximately $10.4 million of the recorded environmental liability relates to sites that are owned by Keystone. Significantly all of the remainder of the recorded $19.5 million environmental liability relates to sites involving Sherman Wire or one of its predecessors. Sherman Wire's environmental liabilities continue to be negotiated and adjudicated subsequent to Keystone's emergence from Chapter 11 on August 31, 2005. The Company is currently involved in the closure of inactive waste disposal units at its Peoria facility pursuant to a closure plan approved by the Illinois Environmental Protection Agency ("IEPA") in September 1992. The original closure plan provides for the in-place treatment of seven hazardous waste surface impoundments and two waste piles to be disposed of as special wastes. The Company recorded an estimated liability for remediation of the impoundments and waste piles based on a six-phase remediation plan. The Company adjusts the recorded liability for each Phase as actual remediation costs become known. During 1995, the Company began remediation of Phases II and III and completed these Phases, as well as Phase IV during 1996. During 1998 and 1999 the Company did not have any significant remediation efforts relative to Phases V and VI. During 2000, Keystone began preliminary efforts relative to Phase V. Pursuant to agreements with the IEPA and Illinois Attorney General's office, the Company is depositing $75,000 per quarter into a trust fund. The Company must continue these quarterly deposits and cannot withdraw funds from the trust fund until the fund balance exceeds the sum of the estimated remaining remediation costs plus $2 million. At December 31, 2004 and June 30, 2005, the trust fund had a balance of $5.7 million and $6.0 million, respectively, which amounts are included in other noncurrent assets because the Company does not expect to have access to any of these funds until after 2005. In February 2000, Keystone received a notice from the United States Environmental Protection Agency ("U.S. EPA") giving formal notice of the U.S. EPA's intent to issue a unilateral administrative order to Keystone pursuant to section 3008(h) of the Resource Conservation and Recovery Act ("RCRA"). The draft order enclosed with this notice would require Keystone to: (1) investigate the nature and extent of hazardous constituents present at and released from five alleged solid waste management units at the Peoria facility; (2) investigate hazardous constituent releases from "any other past or present locations at the Peoria facility where past waste treatment, storage or disposal may pose an unacceptable risk to human health and the environment"; (3) complete by June 30, 2001 an "environmental indicators report" demonstrating the containment of hazardous substances that could pose a risk to "human receptors" and further demonstrating that Keystone "has stabilized the migration of contaminated groundwater at or from the facility;" (4) submit by January 30, 2002 proposed "final corrective measures necessary to protect human health and the environment from all current and future unacceptable risks of releases of hazardous waste or hazardous constituents at or from the Peoria facility; and (5) complete by June 30, 2001 the closure of the sites discussed in the preceding paragraph now undergoing RCRA closure under the supervision of the IEPA. Keystone has complied with deadlines in the draft order. During the fourth quarter of 2000, Keystone entered into a modified Administrative Order on Consent, which may require the Company to conduct cleanup activities at certain solid waste management units at its Peoria facility depending on the results of soil and groundwater sampling and risk assessment to be conducted by Keystone during future periods pursuant to the order. In March 2000, the Illinois Attorney General (the "IAG") filed and served a seven-count complaint against Keystone for alleged violations of the Illinois Environmental Protection Act, 415 ILCS 5/31, and regulations implementing RCRA at Keystone's Peoria facility. The complaint alleges Keystone violated RCRA in failing to prevent spills of an alleged hazardous waste on four separate occasions during the period from June 1995 through January 1999. The complaint also alleges the Company illegally "stored", "disposed of" and manifested the same allegedly hazardous waste on some or all of those occasions. In addition, the complaint alleges these hazardous waste spills resulted in groundwater pollution in violation of the Illinois Environmental Protection Act. The complaint further alleges Keystone improperly disposed of hazardous waste on two occasions at a landfill not permitted to receive such wastes. The complaint seeks the maximum statutory penalties allowed which ranges up to $50,000 for each violation and additional amounts up to $25,000 for each day of violation. Keystone has answered the complaint and proceedings in the case have been stayed pending the outcome of settlement negotiations between Keystone and the IAG's office. In June 2000, the IAG filed a Complaint For Injunction And Civil Penalties against Keystone. The complaint alleges the Company's Peoria facility violated its National Pollutant Discharge Elimination System ("NPDES") permit limits for ammonia and zinc discharges from the facility's wastewater treatment facility into the Illinois River. The complaint alleges specific violations of the 30-day average ammonia limit in the NPDES permit for three months in 1996, 11 months in 1997, 12 months in 1998, 11 months in 1999 and the first two months of 2000. The complaint further alleges two violations of the daily maximum limit for zinc in October and December of 1999. In February 2004, the Company reached a settlement agreement with the IEPA which provided for Keystone to make a $75,000 penalty payment to the IEPA, and to implement certain corrective actions to prevent a recurrence of the NPDES violations. The Company did not pay the $75,000 penalty because the enforcement action was stayed by Keystone's Chapter 11 filing. The Company reached a settlement agreement with the IEPA in 2005 to satisfy the penalty obligation through a RCRA trust fund controlled by the IEPA. In December 2005, the Company received a Notice of Violation from the U.S. EPA regarding air permit issues at its Peoria, Illinois facility. The U.S. EPA alleges Keystone failed to perform stack testing and conduct a review of best available emission control technology in connection with the implementation of plant construction modifications made pursuant to a 2001 air permit issued under the Clean Air Act and the Illinois Environmental Protection Act. During January 2006, the Company and the U.S. EPA reached a preliminary agreement on a plan for addressing the U.S. EPA's concerns without referring the matter for any enforcement action. "Superfund" sites The Company is subject to federal and state "Superfund" legislation that imposes cleanup and remediation responsibility upon present and former owners and operators of, and persons that generated hazardous substances deposited upon, sites determined by state or federal regulators to contain hazardous substances. Keystone has been notified by U.S. EPA that the Company is a potentially responsible party ("PRP") under the federal "Superfund" legislation for the alleged release or threat of release of hazardous substances into the environment at eight sites. These situations involve cleanup of landfills and disposal facilities which allegedly received hazardous substances generated by discontinued operations of the Company. Although Keystone believes its comprehensive general liability insurance policies provide indemnification for certain costs the Company incurs at the "Superfund" sites discussed below, it has only recorded receivables for the estimated insurance recoveries at three of those sites. During 2002, 2003 and the first six months of 2005, the Company received approximately $43,000, $32,000 and $71,000, respectively, from certain of its insurers in exchange for releasing such insurers from coverage for certain years of environmental related liabilities. Such amounts are included in Keystone's self insurance accruals. Keystone did not receive any such insurance recoveries during 2004. In July 1991, the United States filed an action against a former division of the Company and four other PRPs in the United States District Court for the Northern District of Illinois (Civil Action No. 91C4482) seeking to recover investigation and remediation costs incurred by U.S. EPA at the Byron Salvage Yard, located in Byron, Illinois. In April 1992, Keystone filed a third-party complaint in this civil action against 15 additional parties seeking contribution in the event the Company is held liable for any response costs at the Byron site. Neither the Company nor the other designated PRPs are performing any investigation of the nature and extent of the contamination. In December 1996, Keystone, U.S. EPA and the Department of Justice entered into the Fifth Partial Consent Decree to settle Keystone's liability for EPA response costs incurred at the site through April 1994 for a payment of $690,000. Under the agreement Keystone is precluded from recovering any portion of the $690,000 settlement payment from other parties to the lawsuit. In January 1997, Keystone paid the $690,000 settlement. Keystone will remain potentially liable for EPA response costs incurred after April 30, 1994, and natural resource damage claims, if any, that may be asserted in the future. Keystone recovered a portion of the $690,000 payment from its insurer. In March 1997, U.S. EPA issued a Proposed Remedial Action Plan ("PRAP") recommending that a limited excavation of contaminated soils be performed at an estimated cost of $63,000, that a soil cover be placed over the site, an on-site groundwater pump and treat system be installed and operated for an estimated period of 15 years, and that both on-site and off-site groundwater monitoring be conducted for an indefinite period. U.S. EPA's cost estimate for the recommended plan is $5.1 million. U.S. EPA's estimate of the highest cost alternatives evaluated but not recommended in the PRAP is approximately $6 million. The Company filed public comments on May 1, 1997, objecting to the PRAP. In March 1999, Keystone and other PRP's received a Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA") special notice letter notifying them for the first time of a September 1998 Record of Decision ("ROD") and requesting a commitment on or before May 19, 1999 to perform soils work required by that ROD that was estimated to cost approximately $300,000. In addition, the special notice letter also requested the PRPs to reimburse U.S. EPA for costs incurred at the site since May 1994 in the amount of $1.1 million, as well as for all future costs the U.S. EPA will incur at the site in overseeing the implementation of the selected soils remedy and any future groundwater remedy. Keystone refused to agree to the U.S. EPA's past and future cost demand. In August 1999, U.S. EPA issued a groundwater PRAP with an estimated present value cost of $3 million. Keystone filed public comments opposing the PRAP in September 1999. In October 2002, Keystone and the other remaining PRPs entered into a second Consent Decree with the U.S. EPA, in order to resolve their liability for performance of the U.S. EPA's September 1998 ROD for a soils remedy at the site, for the performance of the U.S. EPA's December 1999 ROD for remedial action regarding the groundwater component of Operable Unit No. 4 at the site, for payment of U.S. EPA's site costs incurred since May 1994 as well as future U.S. EPA oversight costs, and for the transfer of certain funds that may be made available to the PRPs as a result of a consent decree reached between U.S. EPA and another site PRP. Under the terms of the second Consent Decree, and the PRP Agreement was executed to implement the PRPs' performance under that decree, Keystone is required to pay approximately $700,000 (of which approximately $600,000 has already been paid into a PRP Group trust fund), and would remain liable for 18.57% of future U.S. EPA oversight costs as well as a similar share of any unanticipated cost increases in the soils remedial action work. (Under the agreements, the City of Byron, Illinois, would assume responsibility for any cost overruns associated with the municipal water supply components of the groundwater contamination remedy.) The U.S. EPA served the PRP Group in February 2003 with its first oversight cost claim under the second Consent Decree, in the amount of $186,000 for the period from March 1, 2000 to November 25, 2002. Keystone's share of that claim is approximately $35,000. The U.S. EPA has also requested changes to the groundwater monitoring program at the site that may require future increases in the PRP Group's groundwater monitoring reserves. In September 2002, the IAG served a demand letter on Keystone and 3 other PRP's seeking recovery of approximately $1.3 million in state cleanup costs incurred at the Byron Salvage Yard site. The PRP's are currently negotiating with the IAG in an attempt to settle this claim. The four PRP's named in the demand letter are also attempting to include other site PRP's in the negotiations. It remains possible that these negotiations could fail and that Keystone's ultimate liability for the Byron Salvage Yard site could increase in a subsequent settlement agreement or as a result of litigation. In September 1991, the Company along with 53 other PRPs, executed a consent decree to undertake the immediate removal of hazardous wastes and initiate a Remedial Investigation/Feasibility Study ("RI/FS") of the Interstate Pollution Control site located in Rockford, Illinois. The Company's percentage allocation within the group of PRPs agreeing to fund this project is currently 2.14%. However, the Company's ultimate allocation, and the ultimate costs of the RI/FS and any remedial action, are subject to change depending, for example, upon: the number and financial condition of the other participating PRPs, field conditions and sampling results, results of the risk assessment and feasibility study, additional regulatory requirements, and the success of a contribution action seeking to compel additional parties to contribute to the costs of the RI/FS and any remedial action. The RI/FS began in 1993, was completed in 1997 and approved by IEPA in 1998. In the summer of 1999, IEPA selected a capping and soil vapor extraction remedy estimated by the PRP group to have a present value cost of approximately $2.5 million. IEPA may also demand reimbursement of future oversight costs. The three largest PRPs at the site are negotiating a consent order with IEPA for the performance of the site remedy. Keystone expects to participate with the larger PRPs in the performance of that remedy based on its RI/FS allocation percentage. In August 1987, Keystone was notified by U.S. EPA that it is a PRP responsible for the alleged hazardous substance contamination of a site previously owned by the Company in Cortland, New York. Four other PRPs participated in the RI/FS and a contribution action is pending against eleven additional viable companies which contributed wastes to the site. Following completion of the RI/FS, U.S. EPA published in November 1997, a PRAP for the site that recommends the excavation and disposal of contaminated soil, installation of an impervious cap over a portion of the site, placement of a surface cover over the remainder of the site and semi-annual groundwater monitoring until drinking water standards are met by natural attenuation. U.S. EPA estimates the costs of this recommended plan to be $3.1 million. The highest cost remedy evaluated by U.S. EPA but not recommended in the PRAP is estimated by U.S. EPA to have a cost of $19.8 million. In September 1998, Keystone and four other PRPs who had funded the prior remedial actions and RI/FS signed a proposed Consent Decree with U.S. EPA calling for them to be "nonperforming parties" for the implementation of a March 1998 Record of Decision. Under this Consent Decree, Keystone could be responsible for an unspecified share of U.S. EPA's future costs in the event that changes to the existing ROD are required. Prior to its acquisition by Keystone, DeSoto, Inc. ("DeSoto") was notified by U.S. EPA that it is one of approximately 50 PRPs at the Chemical Recyclers, Inc. site in Wylie, Texas. In January 1999, DeSoto changed its name to Sherman. Under a consent order with the U.S. EPA, the PRP group has performed a removal action and an investigation of soil and groundwater contamination. Such investigation revealed certain environmental contamination. It is anticipated U.S. EPA will order further remedial action, the exact extent of which is not currently known. Sherman is paying on a non-binding interim basis, approximately 10% of the costs for this site. Remediation costs, at Sherman Wire's present allocation level, are estimated at a range of from $1.5 million to $4 million. In 1984, U.S. EPA filed suit against DeSoto by amending a complaint against Midwest Solvent Recovery, Inc. et al ("Midco"). DeSoto was a defendant based upon alleged shipments to an industrial waste recycling storage and disposal operation site located in Gary, Indiana. The amended complaint sought relief under CERCLA to force the defendants to clean up the site, pay non-compliance penalties and reimburse the government for past clean up costs. In June 1992, DeSoto settled its portion of the case by entering into a partial consent decree, and all but one of the eight remaining primary defendants and 93 third party defendants entered into a main consent decree. Under the terms of the partial consent decree, DeSoto agreed to pay its pro rata share (13.47%) of all costs under the main consent decree. In addition to certain amounts included in the trust fund discussed below, Sherman Wire also has certain funds available in other trust funds due it under the partial consent decree. These credits can be used by Sherman Wire (with certain limitations) to fund its future liabilities under the partial consent decree. In 1995, DeSoto was notified by the Texas Natural Resource Conservation Commission ("TNRCC") that there were certain deficiencies in prior reports to TNRCC relative to one of its non-operating facilities located in Gainesville, Texas. During 1999, Sherman Wire entered into TNRCC's Voluntary Cleanup Program. Remediation costs are presently estimated to be between $1.2 million and $2 million. Investigation activities are on-going including additional soil and groundwater sampling. In December 1991, DeSoto and approximately 600 other PRPs were named in a complaint alleging DeSoto and the PRPs generated wastes that were disposed of at a Pennsauken, New Jersey municipal landfill. The plaintiffs in the complaint were ordered by the court to show in what manner the defendants were connected to the site. The plaintiffs provided an alleged nexus indicating garbage and construction materials from DeSoto's former Pennsauken facility were disposed of at the site and such waste allegedly contained hazardous material to which DeSoto objected. The claim was dismissed without prejudice in August 1993. In 1996, DeSoto received an amended complaint containing the same allegations. This matter is in discovery stage at June 30, 2005. Sherman Wire has denied any liability with regard to this matter and expects to vigorously defend the action. Sherman Wire has received notification from the TNRCC stating that DeSoto is a PRP at the Material Recovery Enterprises Site near Ovalo, Texas, with approximately 3% of the total liability. The matter has been tendered to the Valspar Corporation ("Valspar") pursuant to a 1990 agreement whereby Valspar purchased certain assets of DeSoto. Valspar has been handling the matter under reservation of rights. At the request of Valspar, Sherman Wire has signed a participation agreement which would require Sherman Wire to pay no less than 3% of the remediation costs. Valspar continues to pay for legal fees in this matter and has reimbursed Sherman Wire for all assessments. In November 2003, Sherman Wire received a General Notice of Potential Liability from the U.S. EPA advising them that the U.S. EPA believe Sherman Wire is a PRP at the Lake Calumet Cluster Site in Chicago, Illinois. The U.S. EPA advises the 200 acre site consists of areas of both ground water and surface water contamination located in a remnant wetland area. The U.S. EPA's effort at this site is part of a larger effort undertaken along with the State of Illinois, the City of Chicago, the U.S. Army Corps of Engineers, and the U.S. Department of Energy to cleanup contamination in the Lake Calumet basin. The U.S. EPA alleges the original wetland area has been partially filed by various waste handling and disposal activities which started as early as the 1940's. Incineration of hazardous waste including paints, thinners, varnishes, chlorinated solvents, styrene, ink, adhesives, and antifreeze occurred on the site from 1977 until 1982. In addition, several landfills operated in and near the site from 1967 into the 1990s. Approximately 1,600 ruptured drums have been discovered buried on the site. The U.S. EPA has undertaken or overseen various response actions at the site to mitigate remaining above ground contamination in the site vicinity. The U.S. EPA advises these activities have led to the formation of an extensive ground water contamination plume and contamination in the remaining wetland. The origin of the contamination cannot be associated with any single prior activity. The ground water is in direct contact with the wetland waters, and the same contaminants of concern, certain of which are known to bioaccumulate, and their concentrations are above human health and environmental standards. Sherman did not respond to the November 2003 Notice, however, Sherman notified their insurance carriers and asked them to indemnify and defend Sherman with respect to the Notice. At present, no carrier has agreed to either indemnify or defend. In addition, in November, 2003, Sherman Wire requested the U.S. EPA to provide any documentation that allegedly connects Sherman Wire to the site. Subsequently, the U.S. EPA produced documents that may show that Sherman Wire wastes were sent to the site. It is not possible at this time to determine if Sherman Wire has any future liability with respect to this site. In addition to the sites discussed above, Sherman Wire is allegedly involved at various other sites and in related toxic tort lawsuits which it does not currently expect to incur significant liability. Sherman Wire has access to a trust fund relative to another environmental site for any expenses or liabilities it incurs relative to environmental claims at that site. The trust fund is included in restricted investments on the balance sheet. At December 31, 2004 and June 30, 2005, the balance in this trust fund was approximately $248,000 and $251,000, respectively. Note 12 - Other commitments and contingencies: Current litigation As a result of the Chapter 11 filings on February 26, 2004, litigation relating to prepetition claims against the filing companies, including Keystone and Sherman has been stayed. These liabilities that relate to Sherman continue to be negotiated and adjudicated subsequent to Keystone's emergence from Chapter 11 on August 31, 2005. In July 2001, Sherman Wire received a letter from a law firm advising them that Sears Roebuck & Co. ("Sears") had been named as a defendant in a lead paint personal injury case. Sears claimed contractual indemnity against Sherman and demanded that Sherman defend and indemnify Sears with regard to any losses or damages Sears may sustain in the case. Sears was named as an additional insured on insurance policies, in which DeSoto, the manufacturer of the paint, was the named insured. Additional demands were made by Sears in 2002 with regard to additional lead paint cases. DeSoto's insurance carriers were notified of the action and asked to indemnify Sherman with respect to the complaint. Sherman Wire has not indemnified Sears and is unaware if the insurors have agreed to indemnify Sears. In May 2002, the Company was notified by an insurance company of a declaratory complaint filed in Cook County Illinois by Sears against the insurance company and a second insurance company (collectively the "Insurance Companies") relative to a certain lead paint personal injury litigation against Sears. It is the Company's understanding that the declaratory complaint has since been amended to include all lead paint cases where Sears has been named as a defendant as a result of paint sold by Sears that was manufactured by DeSoto (now Sherman Wire). Sears was allegedly named as an additional insured on insurance policies issued by the Insurance Companies, in which DeSoto, the manufacturer of the paint, was the named insured. Sears has demanded indemnification from the Insurance Companies. One of the Insurance Companies has demanded indemnification and defense from Sherman Wire. Sherman Wire believes the request for indemnification is invalid. However, such Insurance Company has refused to accept Sherman Wire's response and has demanded that Sherman Wire participate in mediation in accordance with the terms of a prior settlement agreement. Sherman Wire may be sued by the Insurance Companies and, as a result, could be held responsible for all costs incurred by the Insurance Companies in defending Sears and paying for any claims against Sears as well as for the cost of any litigation against Sherman Wire. The total amount of these lead paint litigation related costs and claims could be significant. However, the Company does not have a liability recorded with respect to these matters because the liability that may result, if any, cannot be reasonably estimated at this time. The Company is also engaged in various legal proceedings incidental to its normal business activities. In the opinion of the Company, none of such proceedings is material in relation to the Company's consolidated financial position, results of operations or liquidity. Note 13 - Earnings per share: Net income (loss) per share is based upon the weighted average number of common shares and dilutive securities. A reconciliation of the numerators and denominators used in the calculations of basic and diluted earnings per share computations of income (loss) is presented below. The effect of the assumed conversion of the Series A Convertible Preferred Stock was antidilutive in the three months ended June 30, 2005 and both of the six month periods ended June 30, 2004 and 2005. Keystone stock options were omitted from the calculation because they were antidilutive in all periods presented.
Three months ended Six months ended June 30, June 30, ------------------ ----------------- 2004 2005 2004 2005 ------ ------ ------ ------ (In thousands) Numerator: Net income (loss) $ 10,993 $ (3,659) $ 3,355 $ (4,935) Less Series A Preferred Stock dividends - - 1,223 - -------- -------- -------- ------- Basic net income (loss) 10,993 (3,659) 2,132 (4,935) Series A Preferred Stock dividends - - 1,223 - -------- -------- -------- -------- Diluted net income (loss) $ 10,993 $ (3,659) $ 3,355 $ (4,935) ======== ======== ======== ======== Denominator: Average common shares outstanding 10,068 10,068 10,068 10,068 Dilutive effect of Series A Preferred Stock 17,975 - 17,975 - -------- -------- -------- ------- Diluted shares 28,043 10,068 28,043 10,068 ======== ======== ======== ========
Note 14 - Accounting principles not yet adopted: Inventory costs. The Company will adopt SFAS No. 151, "Inventory Costs, an amendment of ARB No. 43, Chapter 4," for inventory costs incurred on or after January 1, 2006. SFAS No. 151 requires that the allocation of fixed production overhead costs to inventory shall be based on normal capacity. Normal capacity is not defined as a fixed amount; rather, normal capacity refers to a range of production levels expected to be achieved over a number of periods under normal circumstances, taking into account the loss of capacity resulting from planned maintenance shutdowns. The amount of fixed overhead allocated to each unit of production is not increased as a consequence of idle plant or production levels below the low end of normal capacity, but instead a portion of fixed overhead costs are charged to expense as incurred. Alternatively, in periods of production above the high end of normal capacity, the amount of fixed overhead costs allocated to each unit of production is decreased so that inventories are not measured above cost. SFAS No. 151 also clarifies existing GAAP to require that abnormal freight and wasted materials (spoilage) are to be expensed as incurred. The Company believes its production cost accounting already complies with the requirements of SFAS No. 151, and the Company does not expect adoption of SFAS No. 151 will have a material effect on its consolidated financial statements. Stock options. Based on guidance issued by the U.S. Securities and Exchange Commission, the Company will adopt SFAS No. 123R, "Share-Based Payment," as of January 1, 2006. SFAS No. 123R, among other things, eliminates the alternative in existing GAAP to use the intrinsic value method of accounting for stock-based employee compensation under APBO No. 25. Upon adoption of SFAS No. 123R, the Company will generally be required to recognize the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award, with the cost recognized over the period during which an employee is required to provide services in exchange for the award (generally, if the vesting period of the award). No compensation cost will be recognized in the aggregate for equity instruments for which the employee does not render the requisite service (generally, the instrument is forfeited before it has vested). The grant-date fair value will be estimated using option-pricing models (e.g. Black-Scholes or a lattice model). Under the transition alternatives permitted under SFAS No. 123R, the Company will apply the new standard to all new awards granted on or after January 1, 2006, and to all awards existing as of December 31, 2005 which are subsequently modified, repurchased or cancelled. Additionally, as of January 1, 2006, the Company will be required to recognize compensation cost for the portion of any non-vested award existing as of December 31, 2005 over the remaining vesting period. Because the Company is not expected to grant any options prior to January 1, 2006 and because the number of non-vested awards as of December 31, 2005 with respect to options previously granted by the Company is not expected to be material, the effect of adopting SFAS No. 123R is not expected to be significant in so far as it relates to existing stock options. Should the Company, however, grant a significant number of options in the future, the effect on the Company's consolidated financial statements could be material. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Bankruptcy: On February 26, 2004, Keystone and five of its direct and indirect subsidiaries filed for voluntary protection under Chapter 11 of the Federal Bankruptcy Code. Keystone and its subsidiaries filed their petitions in the U.S. Bankruptcy Court for the Eastern District of Wisconsin in Milwaukee. The Company is managing its business as a debtor-in possession subject to approval by the Court. Keystone attributed the need to reorganize to weaknesses in product selling prices over the last several years, unprecedented increases in ferrous scrap costs, Keystone's primary raw material, and significant liquidity needs to service employee and retiree medical costs. These problems substantially limited Keystone's liquidity and undermined its ability to obtain sufficient debt or equity capital to operate as a going concern. Under Chapter 11 proceedings, actions by creditors to collect Pre-petition Claims are stayed, absent specific authorization from the Court to pay such claims while the Company manages the business as a debtor-in-possession. Keystone received approval from the Court to pay certain of its pre-petition liabilities, including employee wages and certain employee benefits. Keystone filed a plan of reorganization on October 4, 2004 and amended that plan on May 26, 2005, June 21, 2005 and June 27, 2005. Keystone's amended plan of reorganization was accepted by the impacted constituencies and confirmed by the Court on August 10, 2005. The Company emerged from bankruptcy protection on August 31, 2005. Significant provisions of Keystone's amended plan of reorganization included, among other things: o Assumption of the previously negotiated amendment to the collective bargaining agreement with the Independent Steel Workers Alliance (the "ISWA"), Keystone's largest labor union; o Assumption of the previously negotiated agreements reached with certain retiree groups that will provide relief by permanently reducing healthcare related payments to these retiree groups from pre-petition levels; o The Company's obligations due to pre-petition secured lenders other than its Debtor-In-Possession lenders were reinstated in full against reorganized Keystone; o All shares of Keystone's common and preferred stock outstanding at the petition date (February 26, 2004) were cancelled; o Pre-petition unsecured creditors with allowed claims against Keystone will receive, on a pro rata basis, in the aggregate, $5.2 million in cash, a $4.8 million secured promissory note and 49% of the new common stock of reorganized Keystone; o Certain operating assets and existing operations of Sherman Wire will be sold at fair market value to Keystone, which will then be used to form and operate a newly created wholly-owned subsidiary of reorganized Keystone named Keystone Wire Products Inc.; o Sherman Wire was also reorganized and the proceeds of the operating asset sale to Keystone and other funds will be distributed, on a pro rata basis, to Sherman Wire's pre-petition unsecured creditors as their claims are finally adjudicated; o Sherman Wire's pre-petition wholly-owned non-operating subsidiaries, J.L. Prescott Company, and DeSoto Environmental Management, Inc. as well as Sherman Wire of Caldwell, Inc., a wholly-owned subsidiary of Keystone, will ultimately be liquidated and the pre-petition unsecured creditors with allowed claims against these entities will receive their pro-rata share of the respective entity's net liquidation proceeds; o Pre-petition unsecured creditors with allowed claims against FV Steel & Wire Company, another one of Keystone's wholly-owned subsidiaries, will receive cash in an amount equal to their allowed claims; o One of Keystone's Debtor-In-Possession lenders, EWP Financial, LLC (an affiliate of Contran Corporation ("Contran"), Keystone's largest pre-petition shareholder) converted $5 million of its DIP credit facility, certain of its pre-petition unsecured claims and all of its administrative claims against Keystone into 51% of the new common stock of reorganized Keystone; and o The Board of Directors of reorganized Keystone now consists of seven individuals, two each of which were designated by Contran and the Official Committee of Unsecured Creditors (the "OCUC"), respectively. The remaining three directors qualify as independent directors (two of the independent directors were appointed by Contran with the OCUC's consent and one was appointed by the OCUC with Contran's consent). In addition, Keystone has obtained an $80 million secured credit facility from Wachovia Capital Finance (Central). Proceeds from this credit facility were used to extinguish Keystone's existing Debtor-In-Possession credit facilities and to provide working capital for reorganized Keystone. See Note 2 to the Consolidated Financial Statements. Summary As discussed in Note 1 to the Consolidated Financial Statements, Keystone restated its 2003 and 2004 consolidated balance sheets and statements of cash flows to properly classify certain cash overdrafts. The Company reported a net loss of $3.7 million in the second quarter of 2005 as compared to net income of $11.0 million in the second quarter of 2004 and during the first six months of 2005, the Company reported a net loss of $4.9 million as compared to net income of $3.4 million during the first six months of 2004. The primary reasons for the decline in net income from both of the 2004 periods to the respective periods in 2005 were due to the net effects of (i) significantly higher costs for ferrous scrap partially offset by higher per-ton product selling prices, (ii) substantially lower shipment volumes during both of the 2005 periods as compared to the 2004 periods, (iii) a higher defined benefit pension credit in the 2005 periods, and (iv) lower retiree medical costs. OVERALL RESULTS OF OPERATIONS: Keystone believes it is a leading manufacturer of steel fabricated wire products, nails, industrial wire and wire rod for the agricultural, industrial, construction, original equipment manufacturer and retail consumer markets and believes it is one of the largest manufacturers of fabricated wire products in the United States. Historically, the Company has experienced greater sales and profits during the first half of the year due to the seasonality of sales in principal wire products markets, including the agricultural and construction markets. Keystone is also engaged in the operation of a ferrous scrap recycling facility. The operations of this ferrous scrap recycling facility were insignificant when compared to the consolidated operations of the Company. As such, the results of its operations are not separately addressed in the discussion that follows. As provided by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, the Company cautions that statements in this Quarterly Report on Form 10-Q relating to matters that are not historical facts including, but not limited to, statements found in this "Management's Discussion And Analysis Of Financial Condition And Results Of Operations," are forward-looking statements that represent management's beliefs and assumptions based on currently available information. Forward-looking statements can be identified by the use of words such as "believes", "intends", "may", "should", "could", "anticipates," "expected" or comparable terminology, or by discussions of strategies or trends. Although Keystone believes the expectations reflected in such forward-looking statements are reasonable, it cannot give any assurances that these expectations will prove to be correct. Such statements by their nature involve substantial risks and uncertainties that could significantly impact expected results, and actual future results could differ materially from those described in such forward-looking statements. While it is not possible to identify all factors, Keystone continues to face many risks and uncertainties. Among the factors that could cause actual future results to differ materially are the risks and uncertainties discussed in this Quarterly Report and those described from time to time in the Company's other filings with the Securities and Exchange Commission including, but not limited to; o Future supply and demand for the Company's products (including cyclicality thereof), o Customer inventory levels, o Changes in raw material and other operating costs (such as ferrous scrap and energy) o The possibility of labor disruptions, o General global economic and political conditions, o Competitive products and substitute products, o Customer and competitor strategies, o The impact of pricing and production decisions, o The possibility of labor disruptions, o Environmental matters (such as those requiring emission and discharge standards for existing and new facilities), o Government regulations and possible changes therein, o Significant increases in the cost of providing medical coverage to employees and retirees, o The ultimate resolution of pending litigation, o International trade policies of the United States and certain foreign countries, o Operating interruptions (including, but not limited to, labor disputes, fires, explosions, unscheduled or unplanned downtime and transportation interruptions), o The ability of the Company to renew or refinance credit facilities, o Any possible future litigation, and o Other risks and uncertainties as discussed in this Quarterly Report and the Annual Report, including, without limitation, the section referenced above. Should one or more of these risks materialize (or the consequences of such a development worsen), or should the underlying assumptions prove incorrect, actual results could differ materially from those forecasted or expected. Keystone disclaims any intention or obligation to update or revise any forward-looking statement whether as a result of new information, future events or otherwise. The following table sets forth Keystone's steel and wire production, ferrous scrap costs, sales volume and pricing data for the periods indicated.
Three months ended Six months ended June 30, June 30, ------------------ ----------------- 2004 2005 2004 2005 ------ ------ ------ ------ (Tons in thousands) Production volume (tons): Billets 167 95 286 236 Wire rod 150 98 267 232 Average per-ton ferrous scrap purchase cost $189 $ 228 $183 $ 242 Sales volume(tons): Fabricated wire products 58 48 108 94 Nails 11 3 21 8 Industrial wire 27 15 44 31 Wire rod 34 45 63 88 Billets 10 3 14 5 ---- ------ ---- ------ 140 114 250 226 ==== ====== ==== ====== Per-ton selling prices: Fabricated wire products $945 $1,021 $857 $1,038 Nails $800 $ 810 $727 $ 791 Industrial wire $697 $ 758 $649 $ 763 Wire rod $516 $ 543 $470 $ 555 Billets $197 $ 355 $166 $ 313 All steel and wire products $726 $ 773 $673 $ 785
The following table sets forth the components of the Company's net sales for the periods indicated.
Three months ended Six months ended June 30, June 30, ------------------ ----------------- 2004 2005 2004 2005 ------ ------ ------ ------ (In millions) Fabricated wire products $ 54.3 $48.8 $ 92.4 $ 96.8 Nails 8.7 2.7 15.1 6.5 Industrial wire 18.7 11.2 28.9 23.6 Wire rod 17.7 24.7 29.7 49.0 Billets 2.0 1.1 2.3 1.7 Other .4 .5 .6 .9 ---- ------ ---- ------ $101.8 $89.0 $169.0 $178.5 ==== ====== ==== ======
The following table sets forth selected operating data of the Company as a percentage of net sales for the periods indicated.
Three months ended Six months ended June 30, June 30, ------------------ ----------------- 2004 2005 2004 2005 ------ ------ ------ ------ Net sales 100.0 % 100.0 % 100.0 % 100.0 % Cost of goods sold 81.6 97.8 89.8 96.1 ----- ----- ----- ----- Gross margin 18.4 % 2.2 % 10.2 % 3.9 % ===== ===== ===== ===== Selling expense 1.4 % 1.8% 1.6 % 1.7 % General and administrative expense 2.7 % 3.0 % 3.2 % 3.0 % Defined benefit pension credit (1.5)% (3.6)% (1.8)% (3.6)% Corporate expense .6 % 1.0 % .9 % 1.2 % Reorganization costs 3.0 % 3.0 % 3.0 % 3.4 % Income (loss) before income taxes 11.1 % (4.0)% 2.2 % (2.6)% Income tax provision .3 .1 .2 .2 ----- ----- ----- ----- Net income (loss) 10.8% (4.1)% 2.0 % (2.8)% ===== ===== ===== =====
Discussion of operating results Net sales during the second quarter of 2005 declined $12.8 million, or 12.6% from the second quarter of 2004 due primarily to a 26,000 ton decline in shipment volume partially offset by a 6.5% increase in per-ton product selling prices. Despite the decline in net sales during the second quarter of 2005, net sales during the first six months of 2005 increased $9.5 million, or 5.6% from the first six months of 2004 as significantly higher per-ton product selling prices more than offset a 24,000 ton decline in shipment volume. As a result of lower shipment volumes in all product lines except wire rod during the 2005 periods as compared to the 2004 periods, Keystone's product mix in the 2005 periods consisted of a lower percentage of fabricated wire products, nails and industrial wire than during the respective 2004 periods. Keystone was able to supplement these lower shipment volumes of fabricated wire products, nails and industrial wire during the 2005 periods with increased shipments of wire rod. However, the Company typically realizes a lower gross margin on sales of wire rod than it does on its other products. The 6.5% increase ($47 per ton) in overall per-ton product selling prices during the second quarter of 2005 favorably impacted net sales in that period by approximately $5.4 million while the 16.6% increase ($112 per ton) in overall per-ton product selling prices during the first six months of 2005 favorably impacted net sales in that period by approximately $25.3 million. During both the second quarter and first six months of 2005, Keystone realized increased per-ton selling prices in all product lines over those of the same periods during 2004. During the second quarter of 2005, fabricated wire products per-ton selling prices increased by 8.0%, nails increased 1.3%, industrial wire increased 8.8%, wire rod increased 5.2% and the per-ton selling prices of billets during the second quarter of 2005 increased 80.2% as compared to the second quarter of 2004. During the first six months of 2005, fabricated wire products per-ton selling prices increased by 21.1%, nails increased 8.8%, industrial wire increased 17.6%, wire rod increased 18.1% and the per-ton selling prices of billets during the first six months of 2005 increased 88.6% as compared to the first six months of 2004. During both the second quarter and first six months of 2005, shipment volumes declined as compared to the same periods during 2004 in all product lines except wire rod. During the second quarter of 2005, fabricated wire products shipment volume declined 17.2%, nails declined 72.7%, industrial wire declined 44.4% and billet shipments declined 70.0% while wire rod shipment volume in the second quarter of 2005 increased 32.4% from the 2004 second quarter levels. During the first six months of 2005, fabricated wire products shipment volume declined 13.0%, nails declined 61.9%, industrial wire declined 29.5% and billet shipments declined 64.3% while wire rod shipment volume in the first six months of 2005 increased 39.7% from the first six months of 2004 levels. The Company believes the lower shipment volume in the 2005 periods of both its fabricated wire products and industrial wire were due to high inventory levels at Keystone's customers. In addition, Keystone believes the late winter and inclement weather during the spring also adversely impacted fabricated wire product shipments. The Company also believes the lower shipment volume of nails during the 2005 periods was due primarily to a Company initiative that began during the last quarter of 2003 to discontinue sales to its less profitable customers. Throughout 2004, the Company implemented several price increases primarily as a reaction to rapidly increasing ferrous scrap costs, Keystone's primary raw material. As a result of these efforts, during the both the second quarter and first six months of 2005, the Company was able to realize increases in the per-ton product selling prices of all of its product lines as compared to per-ton selling prices during the respective periods during 2004. Billet production during the 2005 second quarter declined by 72,000 tons to 95,000 tons from 167,000 tons during the second quarter of 2004. Wire rod production during the second quarter of 2005 declined by 52,000 tons to 98,000 tons from 150,000 tons during the second quarter of 2004. Billet production during the first six months of 2005 declined by 50,000 tons to 236,000 tons from 286,000 tons during the first six months of 2004. Wire rod production during the first six months of 2005 declined by 35,000 tons to 232,000 tons from 267,000 tons during the first six months of 2004. The lower billet and wire rod production during the 2005 periods was due primarily to Keystone limiting production schedules during the 2005 periods as a result of the lower market demand. Despite the lower shipment volume during both the second quarter and first six month periods of 2005, cost of goods sold during the 2005 second quarter increased by 4.7% to $87.0 million from $83.1 million during the 2004 second quarter and during the first six months of 2005, cost of goods sold increased by 13.0% to $171.5 million from $151.7 million during the first six months of 2004. As a result, the cost of goods sold percentage increased from 81.6% in the 2004 second quarter to 97.8% of net sales in the second quarter of 2005 and increased from 89.8% during the first six months of 2004 to 96.1% during the first six months of 2005. This increase in the cost of goods sold percentage was due primarily to significantly higher costs for ferrous scrap in the 2005 periods as well as higher costs for natural gas and electrical power at the Company's Peoria, Illinois facility partially offset by the increased product per-ton selling prices and lower retiree medical costs in the 2005 periods. Keystone's per-ton ferrous scrap costs increased 20.6% during the 2005 second quarter as compared to the 2004 second quarter and 32.2% during the first six months of 2005 as compared to the same period in 2004. During the 2005 second quarter, the Company purchased 112,000 tons of ferrous scrap at an average price of $228 per-ton as compared to 2004 second quarter purchases of 180,000 tons at an average price of $189 per ton. During the first six months of 2005, the Company purchased 264,000 tons of ferrous scrap at an average price of $242 per-ton as compared to purchases in the first six months of 2004 of 319,000 tons at an average price of $183 per ton. This increase in per-ton ferrous scrap costs adversely impacted gross profit during the 2005 second quarter by approximately $4.4 million and by $15.6 million during the first six months of 2005. The cost of natural gas and electrical power at the Company's Peoria facility in both the 2005 second quarter and the first six months of 2005 was higher than the respective periods during 2004. These higher costs adversely impacted cost of goods sold by approximately $382,000 and $661,000, respectively, in the second quarter of 2005 and by approximately $953,000 and $671,000, respectively, in the first six months of 2005. As a result of the above items, the gross margin of $18.7 million in the 2004 second quarter declined to a gross margin of $2.0 million in the 2005 first quarter and the gross margin of $17.3 million during the first six months of 2004 declined to $7.0 million during the first six months of 2005. As a result, the gross margin percentage in the second quarter of 2004 of 18.4% declined to 2.2% in the 2005 second quarter and the gross margin percentage in the first six months of 2004 of 10.2% declined to 3.9% in the first six months of 2005. Selling expense during the 2005 second quarter of $1.6 million approximated the 2004 second quarter selling expense of $1.5 million, whereas selling expense during the first six months of 2004 increased from $2.7 million to $3.0 million during the first six months of 2005 due primarily to increased advertising expenses. General and administrative expense of $2.7 million in the 2005 second quarter was relatively unchanged from the 2004 level whereas general and administrative expense during the first six months of 2005 of $5.4 million approximated general and administrative expense in the first six months of 2004. During the second quarter and first six months of 2005, Keystone recorded a defined benefit pension credit of $3.2 million and $6.4 million, respectively, as compared to recording a defined benefit pension credit in the same periods during 2004 of $1.5 million and $3.0 million, respectively. The increased pension credit during the 2005 periods was a result of a $52 million increase in plan assets from the end of 2003 to the end of 2004. In addition, Keystone was not required to make any cash contributions for defined benefit pension plan fundings during either 2005 or 2004. The Company currently anticipates during 2005 it will record a defined benefit pension credit of $11.7 million and that no plan fundings will be required during 2005. However, future variances from assumed actuarial rates, including the rate of return on pension plan assets, may result in increases or decreases in pension expense or credit and future funding requirements. During 2004, the Company entered into an agreement (the "1114 Agreement") with certain retiree groups that substantially reduced the post retirement ("OPEB") benefits that will be paid to these retiree groups in the future. Prior to confirmation of Keystone's definitive plan of reorganization, the Court could have rescinded the 1114 Agreement and therefore the 1114 Agreement was not definitive until it was confirmed by the Court in connection with Keystone's emergence from Chapter 11 on August 31, 2005. As such, and in accordance with GAAP, the Company has continued to record OPEB expense through August 31, 2005 at the estimated level as if Keystone had not entered into the 1114 Agreement, Keystone estimates OPEB expense for the first eight months of 2005 will approximate $11.5 million. However, at the time of the Company's emergence from Chapter 11 on August 31, 2005, and concurrent confirmation of the 1114 Agreement, GAAP then requires the effect of the substantially reduced OPEB benefits agreed to as part of the 1114 Agreement be accounted for as a plan amendment, the benefit of which is amortized into income over future periods. Accordingly, Keystone estimates that it will record an OPEB credit of approximately $2.7 million for the last four months of 2005, resulting in an $8.9 million expense for the year 2005. General corporate expenses during the 2005 second quarter were approximately $263,000 higher than general corporate expenses during the second quarter of 2004 due primarily to substantially higher state franchise taxes during the 2005 period. General corporate expenses during the first six months of 2005 were approximately $686,000 higher than general corporate expenses during the first six months of 2004 due primarily to higher legal and professional fees not related to the Company's Chapter 11 proceedings and reorganization efforts as well as substantially higher state franchise taxes during the 2005 period. Interest expense during the second quarter of 2005 was slightly lower than in the second quarter of 2004 due primarily to lower amortization of deferred financing costs in the 2005 second quarter partially offset by slightly higher interest rates and debt levels in the 2005 quarter. Interest expense during the first six months of 2005 was lower than in the first six months of 2004 due primarily to lower debt levels in 2005 partially offset by higher interest rates in 2005. The overall average interest rates were impacted by the fact the Company discontinued accruing interest on pre-petition unsecured debt upon filing for Chapter 11 on February 2, 2004. Average borrowings by the Company approximated $85.7 million during the second quarter of 2005 as compared to $81.3 million during the second quarter of 2004. Average borrowings by the Company approximated $81.1 million during the first six months of 2005 as compared to $103.0 million during the first six months of 2004. During the second quarter of 2005, the average interest rate on outstanding indebtedness was 3.6% per annum as compared 2.6% per annum during the 2004 second quarter. During the first six months of 2005, the average interest rate on outstanding indebtedness was 3.3% per annum as compared 3.2% per annum during the first six months of 2004. Keystone currently anticipates average interest rates and debt levels for the year 2005 will be higher than their respective levels during 2004. During the second quarters of 2005 and 2004, Keystone incurred $2.7 million and $3.1 million, respectively of legal and professional fees relative to its Chapter 11 proceedings and related reorganization activities. During the first six month periods of 2005 and 2004, Keystone incurred $6.0 million and $5.0 million, respectively of legal and professional fees relative to these same activities. The principal reasons for the difference between the U.S. federal statutory income tax rate and the Company's effective income tax rates are explained in Note 7 to the Consolidated Financial Statements. At June 30, 2005, the Company had recorded a deferred tax asset valuation allowance of $31.2 million resulting in no net deferred tax assets. Keystone periodically reviews the recoverability of its deferred tax assets to determine whether such assets meet the "more-likely-than-not" recognition criteria. The Company will continue to review the recoverability of its deferred tax assets, and based on such periodic reviews, Keystone could recognize a change in the recorded valuation allowance related to its deferred tax assets in the future. While the Company currently expects to report pre-tax income for financial reporting purposes during 2005, it does not believe it will have sufficient positive evidence to conclude that its net deferred income tax assets will meet the "more-likely-than-not" recognition criteria anytime during 2005. As a result of the deferred tax asset valuation allowance, the Company does not anticipate recognizing a tax provision associated with its expected pre-tax income during 2005 will be appropriate. As a result of the items discussed above, Keystone recorded a net loss during the second quarter of 2005 of $3.7 million as compared to net income of $11.0 million in the second quarter of 2004 and a net loss of $4.9 million during the first six months of 2005 as compared to net income of $3.4 million during the first six months of 2004. SEGMENT RESULTS OF OPERATIONS: The Company's operating segments are organized along its manufacturing facilities and include three reportable segments: (i) Keystone Steel and Wire ("KSW") which manufacturers and sells wire rod, wire and wire products for agricultural, industrial, construction, commercial, original equipment manufacturers and retail consumer markets, (ii) Engineered Wire Products ("EWP") which manufactures and sells welded wire reinforcement in both roll and sheet form that is utilized in concrete construction products including pipe, pre-cast boxes and applications for use in roadways, buildings and bridges and, (iii) Sherman Wire ("Sherman") which manufacturers and sells wire and wire products for agricultural, industrial, construction, commercial, original equipment manufacturers and retail consumer markets.
Three months ended Six months ended June 30, June 30, ------------------ ----------------- 2004 2005 2004 2005 ------ ------ ------ ------ (In thousands) Revenues: Keystone Steel and Wire $103,185 $ 81,887 $163,811 $171,081 Engineered Wire Products 15,949 17,755 27,039 29,806 Sherman 4,438 4,113 7,497 9,166 Elimination of intersegment revenues (21,745) (14,763) (29,343) (31,524) -------- -------- -------- -------- $101,827 $ 88,992 $169,004 $178,529 ======== ======== ======== ======== Operating profit (loss): Keystone Steel and Wire $ 10,295 $ (9,119) $ 3,307 $(10,571) Engineered Wire Products 3,333 2,992 4,601 4,631 Sherman 14 (381) (561) (550) GAAP adjustments and eliminations 2,398 7,402 4,796 11,525 -------- -------- -------- -------- $ 16,040 $ 894 $ 12,143 $ 5,035 ======== ======== ======== ========
GAAP adjustments and eliminations in the above table consisted primarily of adjustments to reflect the difference between the defined benefit pension credit and OPEB expense allocated to the segments and the actual expense or credit included in the determination of operating profit or loss. GAAP adjustments and eliminations included a defined benefit pension credit of $4.1 million and $2.4 million during the three months ended June 30, 2005 and 2004, respectively, and $8.2 million and $4.8 million during the six months ended June 30, 2004 and 2005, respectively. Keystone Steel & Wire KSW's net sales in the 2005 second quarter declined by $21.3 million or 20.6% to $81.9 million from $103.2 million in the second quarter of 2004 due primarily to lower shipment volumes partially offset by higher overall per-ton product selling prices. KSW's net sales during the first six months of 2005 increased by $7.3 million or 4.4% to $171.1 million from $163.8 million during the first six months of 2004 due primarily to higher overall per-ton product selling prices partially offset by lower shipment volumes. KSW sold approximately 43,000 less tons of products in the 2005 second quarter as compared to the second quarter of 2004, although at selling prices $55 per-ton higher than per-ton product selling prices in the 2004 second quarter. KSW sold approximately 26,000 less tons of products in the first six months of 2005 as compared to the first six months of 2004, although at selling prices $98 per-ton higher than per-ton product selling prices in the same period during 2004. KSW believes the lower shipment volume in the 2005 periods of both its fabricated wire products and industrial wire were due to high inventory levels at KSW's customers. In addition, KSW believes the late winter and inclement weather during the spring also adversely impacted fabricated wire product shipments. KSW also believes the lower shipment volume of nails during the 2005 periods was due primarily to an initiative that began during the last quarter of 2003 to discontinue sales to its less profitable customers. KSW was able to supplement these lower shipment volumes of fabricated wire products, nails and industrial wire during the 2005 periods with increased shipments of wire rod. However, KSW typically realizes a lower gross margin on sales of wire rod than it does on its other products. Throughout 2004, KSW implemented several price increases primarily as a reaction to increasing ferrous scrap costs, KSW's primary raw material. As a result of these efforts, during both the 2005 second quarter and the first six months of 2005, KSW was able to realize increases in its per-ton product selling prices over the same periods in 2004. During the 2004 second quarter, approximately 18% of KSW's net sales were made to other Keystone entities. During the 2005 second quarter and the first six months of both 2004 and 2005, approximately 15% of KSW's net sales were made to other Keystone entities. Significantly all of the KSW sales to other Keystone entities were sales of wire rod. During the second quarter of 2005, KSW recorded an operating loss of $9.1 million as compared to recording operating income of $10.0 million in the 2004 second quarter. During the first six months of 2005, KSW recorded an operating loss of $10.6 million as compared to recording operating income of $3.3 million during the first six months of 2004. The primary reasons for the decreased operating profit in the 2005 periods were the increased costs for ferrous scrap, natural gas costs and electrical power partially offset by the higher per-ton product selling prices and lower retiree medical costs in the 2005 periods. Engineered Wire Products EWP's net sales of $17.8 million during the second quarter of 2005 were approximately $1.8 million or 11.3% higher than during the second quarter of 2004 due primarily to higher overall per-ton product selling prices and higher shipment volume. During the first six months of 2005, EWP's net sales of $29.8 million were approximately $2.8 million or 10.2% higher than during the first six months of 2004 also due primarily to higher overall per-ton product selling prices and higher shipment volume. During the 2005 second quarter, EWP sold 1,100 more tons of products than during the second quarter of 2004 at per-ton product selling prices approximately $46 per-ton higher than per-ton selling prices in the 2004 second quarter. During the first six months of 2005, EWP sold 900 more tons of products than during the first six months of 2004 at per-ton product selling prices approximately $88 per-ton higher than per-ton selling prices in the same period in 2004. During 2004, EWP implemented several price increases primarily as a reaction to rapidly increasing wire rod costs, EWP's primary raw material. As a result of these efforts, during both the second quarter and first six month periods of 2005, EWP was able to realize increases in its per-ton product selling prices. EWP sources the majority of its wire rod requirements from KSW. As a result of increased cost for wire rod, partially offset by the higher per-ton product selling prices during the second quarter of 2005, EWP recorded a $341,000 decline in operating income from the same period in 2004 to $3.0 million. During the first six months of 2005, EWP's higher per-ton product selling prices were offset by increased cost for wire rod and, as such, EWP's operating income of $4.6 million was unchanged from the same period during 2004. Sherman Wire Sherman Wire's net sales of $4.1 million in the 2005 second quarter approximated net sales during the second quarter of 2004 of $4.4 million as increased per-ton product selling prices were offset by lower shipment volume. However, during the first six months of 2005, Sherman Wire's net sales increased 22.3% to $9.2 million from $7.5 million during the first six months of 2004 due to both increased per-ton product selling prices and increased shipment volume. Tons shipped by Sherman Wire during the second quarter of 2005 declined by 900 tons from shipment levels during the second quarter of 2004. However, tons shipped by Sherman Wire during the first six months of 2005 increased by 900 tons from shipment levels during the same period of 2004. Sherman Wire believes its lower shipment volume during the 2005 second quarter was due to reduced demand resulting from high inventory levels at Sherman Wire's customers as well as the late winter and inclement weather during the spring adversely impacting fabricated wire product shipments. Sherman Wire believes its higher shipment volume during the first six months of 2005 was due to its limited production schedules during the period preceding and immediately following Keystone's Chapter 11 filing in 2004. Sherman Wire's overall per-ton product selling price increased by approximately $104 per-ton during the 2005 second quarter as compared to the per-ton product selling prices during the second quarter of 2004. Sherman Wire's overall per-ton product selling price increased by approximately $88 per-ton during the first six months of 2005 as compared to the per-ton product selling prices during the first six months of 2004. During 2004, Sherman Wire implemented several price increases primarily as a reaction to rapidly increasing wire rod costs, Sherman Wire's primary raw material. As a result of these efforts, during both the second quarter and first six months of 2005, Sherman Wire was able to realize significant increases in its per-ton product selling prices over the same periods during 2004. Sherman Wire sources the majority of its wire rod requirements from KSW. During the second quarter of 2005 and 2004, approximately 63% and 70%, respectively, and during the first six months of 2004 and 2005, approximately 67% and 69%, respectively, of Sherman Wire's net sales were made to other Keystone entities, primarily KSW. The majority of these sales were fabricated wire products. During the second quarter of 2005, Sherman Wire recorded a $381,000 operating loss as compared to $14,000 of operating income in the 2004 second quarter. During the first six months of 2005, Sherman Wire recorded a $550,000 operating loss as compared to a $561,000 operating loss during the first six months of 2004. The primary reason for the decline in operating performance during the 2005 second quarter was the increased costs for wire rod partially offset by the higher overall per-ton product selling prices and lower retiree medical costs. Outlook for 2005 During 2005, rod imports have continued at high levels. These high import levels combined with increased production from domestic mills has resulted in a decline in per-ton sales prices of the Company's products. In addition, the late winter and inclement weather during the spring and summer of 2005 has adversely impacted sales. As a result, management believes these factors will result in lower shipment volume in 2005 as compared to 2004. The Company's 2005 performance will also be adversely impacted by higher costs for ferrous scrap and the cost of legal and professional fees associated with the Company's bankruptcy and related restructuring efforts. However, the effects of the Company's restructuring efforts in 2004 and 2005 will partially mitigate these factors, as the Company expects to report a significant gain upon cancellation of debt and other liabilities concurrent with its emergence from Chapter 11. As a result, Keystone expects it will report net income for financial reporting purposes although it expects to report negative cash flows from operating activities in 2005. In addition, as a result of significant accumulated net operating losses, the benefit of which has not been previously recognized for financial reporting purposes as the Company does not currently believe meets the "more-likely-than-not" recognition criteria, the Company does not expect to record significant net tax expense associated with its pre-tax income during 2005. LIQUIDITY AND CAPITAL RESOURCES: The amount of available borrowings under Keystone's revolving credit and primary DIP facilities is based on formula-determined amounts of trade receivables and inventories, less the amount of outstanding letters of credit. At June 30, 2005, unused credit available for borrowing under Keystone's DIP facilities and EWP's $7 million revolving credit facility (the "EWP Revolver"), were $21.9 million and $1.4 million, respectively. The Company's primary DIP facility requires daily cash receipts be used to reduce outstanding borrowings, which results in the Company maintaining zero cash balances when there are balances outstanding under this credit facility. Accordingly, any outstanding balances under the primary DIP facility are always classified as a current liability regardless of the maturity date of the facility. On August 31, 2005, in connection with its emergence from Chapter 11, Keystone entered into a new five-year, $80.0 million secured credit facility. Proceeds from this credit facility were used to extinguish Keystone's existing DIP credit facilities, the EWP Term Loan, the EWP Revolver and to provide working capital for reorganized Keystone. The facility includes a term loan in the amount of up to $25.0 million, subject to a borrowing base calculation based on the market value of the Company's real property and equipment. To the extent there is sufficient borrowing base, the term loan portion of this credit facility can be reloaded in the amount of $10.0 million. The portion of the credit facility in excess of the term loan balance is available to the Company as a revolving credit facility subject to a borrowing base calculation based on eligible receivables and inventory balances. Interest rates on the credit facility range from the prime rate to the prime rate plus .5% depending on Keystone's excess availability, as defined in the credit agreement. The facility also provides for a LIBOR interest rate option. Under the terms of the credit facility, the Company is required to annually pay down the term loan portion of the facility in the amount of 25% of excess cash flow, as defined in the agreement, subject to a $2.0 million annual and a $5.0 million aggregate limit. The facility also includes performance covenants related to minimum levels of cash flow and fixed charge coverage ratio. Keystone paid the lender approximately $400,000 of diligence, commitment and closing fees in connection with this facility. Despite an $8.3 million decline in earnings between the first six months of 2004 and the first six months of 2005, cash flow from operating activities in the first six months of 2005 declined by only $6.7 million as Keystone used $2.2 million of cash in operations during the first six months of 2004 as compared to using $8.9 million of cash in operations during the first six months of 2005. This increase in cash used in operations was due primarily to the 2005 decline in profitability partially offset by a smaller increase in accounts receivable as well as a decline in inventory levels during the 2005 period as compared to a substantial increase in inventory levels during the 2004 period. Because of the seasonal nature of the Company's business, the 2005 changes in accounts receivable and inventory levels was typical. The reason the 2004 changes in these accounts was not consistent with 2005's changes was due to Keystone's limited liquidity during the last half of 2003 and the first portion of 2004, not allowing the Company to operate on a continuous basis. As such, production levels declined and Keystone was forced to substantially reduce its normal inventory levels over the last half of 2003 and the first two months of 2004 in order to meet customer shipment demand. In addition, as the Company's liquidity deteriorated throughout 2003 and the first two months of 2004, Keystone liquidated as many of its accounts receivable as possible. As such, at the end of 2003, the Company's accounts receivable and inventory balances were both at abnormally low levels. Keystone's operations returned to normal levels during 2004. During the first six months of 2005, Keystone made capital expenditures of approximately $4.6 million primarily related to upgrades of production equipment at its facility in Peoria, Illinois, as compared to $700,000 in the first six months of 2004. Capital expenditures for 2005 are expected to be approximately $7.0 million and are related primarily to upgrades of production equipment at EWP. Such capital expenditures are expected to be funded using cash flows from operations together with borrowing availability under Keystone's credit facilities. At June 30, 2005, the Company's financial statements reflected accrued liabilities of $19.5 million (substantially all of which is included in liabilities subject to compromise on the Company's balance sheet) for estimated remediation costs for those environmental matters which Keystone believes are probable and reasonably estimable. Although the Company has established an accrual for estimated future required environmental remediation costs, there is no assurance regarding the ultimate cost of remedial measures that might eventually be required by environmental authorities or that additional environmental hazards, requiring further remedial expenditures, might not be asserted by such authorities or private parties. Accordingly, the costs of remedial measures may exceed the amounts accrued. Keystone believes it is not possible to estimate the range of costs for certain sites. The upper end of range of reasonably possible costs to Keystone for sites for which the Company believes it is possible to estimate costs is approximately $21.4 million. See Notes 11 and 12 to the Consolidated Financial Statements for discussions of the Company's environmental liabilities and current litigation. Keystone is not expected to be required to make contributions to its pension plan during 2005. Future variances from assumed actuarial rates, including the rate of return on pension plan assets, may result in increases or decreases to pension expense or credit and funding requirements in future periods. The Company periodically reviews the recoverability of its deferred tax assets to determine whether such assets meet the "more-likely-than-not" recognition criteria. At June 30, 2005, the Company expects that its long-term profitability should ultimately be sufficient to enable it to realize full benefit of its future tax deductions, in part due to the long-term nature of its net operating loss carryforwards, which expire in 2023 and 2024. Although, considering all factors believed to be relevant, including the Company's recent operating results, its expected future near-term productivity rates; cost of raw materials, electricity, labor and employee benefits, environmental remediation, and retiree medical coverage; interest rates; product mix; sales volumes and selling prices and the fact that accrued OPEB expenses will become deductible over an extended period of time and require the Company to generate significant amounts of future taxable income, the Company believes its gross deferred tax assets do not currently meet the "more-likely-than-not" realizability test. As such, the Company has provided a deferred tax asset valuation allowance of approximately $31.2 million at June 30, 2005, or all of the Company's deferred tax asset. Keystone will continue to review the recoverability of its deferred tax assets, and based on such periodic reviews, the Company could change the valuation allowance related to its deferred tax assets in the future. The Company does not currently expect it will be appropriate to recognize a tax provision associated with its expected pre-tax income during 2005. Keystone incurs significant ongoing costs for plant and equipment and substantial employee medical benefits for both current and retired employees. As such, Keystone is vulnerable to business downturns and increases in costs, and accordingly, routinely compares its liquidity requirements and capital needs against its estimated future operating cash flows. In addition, Keystone currently anticipates incurring legal and professional fees of approximately $10.0 million during 2005 related to its reorganization efforts. Keystone is also taking additional action towards improving its liquidity. Keystone has also considered, and may in the future consider, the sale of certain divisions or subsidiaries that are not necessary to achieve the Company's long-term business objectives. However, there can be no assurance Keystone will be successful in any of these or other efforts, or that if successful, they will provide sufficient liquidity for the Company's operations during the next year. ITEM 4. CONTROLS AND PROCEDURES -------------------------------- Evaluation of Disclosure Controls and Procedures. The Company maintains disclosure controls and procedures. The term "disclosure controls and procedures," as defined by Rule 13a-15(e) of the Securities and Exchange Act of 1934 as amended ("the Act"), means controls and other procedures that are designed to ensure that information required to be disclosed in the reports that the Company files or submits to the Securities and Exchange Commission ("SEC"), is recorded, processed, summarized and reported, within the time periods specified in the SEC's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Company in the reports that it files or submits to the SEC under the Act is accumulated and communicated to the Company's management, including its principal executive officer and its principal financial officer, or persons performing similar functions, as appropriate to allow timely decisions to be made regarding required disclosure. Each of David L. Cheek, the Company's President and Chief Executive Officer, and Bert E. Downing, Jr., the Company's Vice President, Chief Financial Officer, Corporate Controller and Treasurer, have evaluated the Company's disclosure controls and procedures as of June 30, 2005. Based upon their evaluation, and solely as a result of the material weaknesses discussed below, these executive officers have concluded the Company's disclosure controls and procedures were not effective as of June 30, 2005. Internal Control Over Financial Reporting. A material weakness is a control deficiency, or a combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. Management of the Company has concluded that the following control deficiencies constitute material weaknesses in the Company's internal control over financial reporting: (1) As of June 30, 2005, the Company did not maintain effective controls over the completeness and accuracy of net sales and related cost of goods sold. Specifically, the Company did not have controls designed and in place to detect sales made under the terms F.O.B. at the customer's location. Additionally, the Company did not maintain effective controls over the review and monitoring of the accuracy and completeness of net sales and costs of goods sold. This control deficiency resulted in adjustments to net sales and cost of goods sold in the third quarter of 2005. (2) As of June 30, 2005, the Company did not maintain effective controls over the presentation and classification of cash overdrafts. Specifically, effective controls were not designed and in place to ensure that cash overdrafts were properly classified as indebtedness in the Company's consolidated balance sheet, and that changes in its cash overdrafts were properly included in the determination of cash flows from financing activities. This control deficiency resulted in the restatement of the Company's 2003 and 2004 annual consolidated financial statements and audit adjustments to both its 2004 interim consolidated financial statements and its annual and interim 2005 consolidated financial statements affecting accounts payable and the current portion of long-term debt. Each of these two control deficiencies could result in a misstatement of the aforementioned accounts that would result in a material misstatement to the Company's annual or interim consolidated financial statements that would not be prevented or detected. Accordingly, management of the Company determined that each of these control deficiencies constitutes a material weakness. The Company currently expects that Section 404 of the Sarbanes-Oxley Act of 2002 will require the Company to annually include a management report on internal control over financial reporting starting with the Company's Annual Report on Form 10-K for the year ended December 31, 2007. The Company will have to document, test and evaluate its internal control over financial reporting, using a combination of internal and external resources. The process of documenting, testing and evaluating the Company's internal control over financial reporting under the applicable guidelines is expected to be complex and time consuming, and available internal and external resources necessary to assist the Company in the documentation and testing required to comply with Section 404 could be limited. While the Company currently believes it will be able to dedicate the appropriate resources, and that it will be able to fully comply with Section 404 in its Annual Report on Form 10-K for the year ended December 31, 2007 and be in a position to conclude that the Company's internal control over financial reporting is effective as of December 31, 2007, because the applicable requirements are complex and time consuming, and because currently unforeseen events or circumstances beyond the Company's control could arise, there can be no assurance that the Company will ultimately be able to fully comply with Section 404 in its Annual Report on Form 10-K for the year ended December 31, 2007 or whether it will be able to conclude that the Company's internal control over financial reporting is effective as of December 31, 2007. Remediation of Material Weakness. In order to remediate the first material weakness discussed above, in March 2006, the Company modified its information system to appropriately identify products shipped to its customers under delivery terms of F.O.B. at the customer location. In addition, the Company intends to institute a quarterly close procedure, to be implemented for the first time for the quarter ending March 31, 2006, to review all sales within a specified number of weeks prior to the end of the quarter to ensure the delivery terms are consistent with revenue recognition in the quarter of shipment. In order to remediate the second material weakness discussed above, in March 2006 the Company revised the recurring reclassification journal entry used in the preparation of its consolidated balance sheet to properly classify the amount of any cash overdrafts as part of the current portion of long-term debt. In addition, the Company intends to institute quarterly close procedures, to be implemented for the first time for the quarter ending March 31, 2006, to ensure (i) that an adequate review of the Company's balance sheet and statement of cash flow consolidation occurs each quarter and (ii) the continued appropriateness of the reclassification journal entry to classify bank overdrafts as part of the current portion of long-term debt. Changes in Internal Control Over Financial Reporting. There have been no changes in the Company's internal control over financial reporting during the quarter ended June 30, 2005 that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. PART II. OTHER INFORMATION ITEM 1. Legal Proceedings Reference is made to disclosure provided under the caption "Current litigation" in Note 12 to the Consolidated Financial Statements. ITEM 6. Exhibits (a) The Company has retained a signed original of any exhibit listed below that contains signatures, and the Company will provide any such exhibit to the Commission or its staff upon request. The following exhibit is included herein: 31.1 Chief Executive Officer's Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Chief Financial Officer's Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Chief Executive and Chief Financial Officers' Certification Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Keystone Consolidated Industries, Inc. -------------------------------------- (Registrant) Date: March 31, 2006 By /s/Bert E. Downing, Jr. -------------- ------------------------------- Bert E. Downing, Jr. Vice President, Chief Financial Officer, Corporate Controller and Treasurer (Principal Financial and Accounting Officer)