-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Ru1GTEsd/jbyrioF+I7efrHj7omPigjB39TVYBaVr8K9ecJP+gMwpaVWPZhPzDXx kRhmidaZ1sePGi3Of3O6Ww== 0000910394-02-000011.txt : 20020813 0000910394-02-000011.hdr.sgml : 20020813 20020813140136 ACCESSION NUMBER: 0000910394-02-000011 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20020629 FILED AS OF DATE: 20020813 FILER: COMPANY DATA: COMPANY CONFORMED NAME: KENTUCKY ELECTRIC STEEL INC /DE/ CENTRAL INDEX KEY: 0000910394 STANDARD INDUSTRIAL CLASSIFICATION: STEEL WORKS, BLAST FURNACES ROLLING MILLS (COKE OVENS) [3312] IRS NUMBER: 611244541 STATE OF INCORPORATION: DE FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-22416 FILM NUMBER: 02729037 BUSINESS ADDRESS: STREET 1: P O BOX 3500 CITY: ASHLAND STATE: KY ZIP: 41105-3500 BUSINESS PHONE: 6069291222 MAIL ADDRESS: STREET 1: P O BOX 3500 CITY: ASHLAND STATE: KY ZIP: 41105-3500 10-Q 1 thirdq.txt FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 (Mark One) X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 29, 2002 OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ______________ to ___________________. Commission File No. 0-22416 KENTUCKY ELECTRIC STEEL, INC. (Exact name of Registrant as specified in its charter) Delaware 61-1244541 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) P. O. Box 3500, Ashland, Kentucky 41105-3500 (Address of principal executive office, Zip Code) (606) 929-1222 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x NO The number of shares outstanding of each of the issuer's classes of common stock, as of August 13, 2002, is as follows: 4,100,285 shares of voting common stock, par value $.01 per share. KENTUCKY ELECTRIC STEEL, INC. AND SUBSIDIARY TABLE OF CONTENTS Page PART I. FINANCIAL INFORMATION Item 1 - Financial Statements Condensed Consolidated Balance Sheets ............ 3 Condensed Consolidated Statements of Operations .. 4 Condensed Consolidated Statements of Cash Flows .. 5 Notes to Condensed Consolidated Financial Statements 6-12 Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations ............ 13-19 Item 3 - Quantitative and Qualitative Disclosure About Market Risk .................................... 19 PART II. OTHER INFORMATION Item 6 - Exhibits and Reports on Form 8-K ................. 20 SIGNATURES ...................................... 21 KENTUCKY ELECTRIC STEEL, INC. AND SUBSIDIARY CONDENSED CONSOLIDATED BALANCE SHEETS (Dollars in Thousands) (Unaudited) June 29, Sep. 29, 2002 2001 ASSETS CURRENT ASSETS Cash and cash equivalents $ 196 $ 7,505 Accounts receivable, less allowance for doubtful accounts and claims of $610 at June 29, 2002 and $695 at September 29, 2001 11,053 8,600 Insurance claim receivable 2,575 - Inventories 17,125 16,962 Operating supplies and other current assets 5,110 5,128 Total current assets 36,059 38,195 PROPERTY, PLANT AND EQUIPMENT Land and buildings 5,881 5,881 Machinery and equipment 35,422 35,252 Construction in progress 481 162 Less - accumulated depreciation (22,104) (19,936) Net property, plant and equipment 19,680 21,359 DEFERRED FINANCING FEES 682 82 OTHER ASSETS 339 378 Total assets $ 56,760 $ 60,014 LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES Advances on line of credit $ 14,622 $ 12,141 Accounts payable 8,594 6,303 Accrued liabilities 3,357 3,691 Current maturities of long-term debt 1,625 125 Total current liabilities 28,198 22,260 LONG-TERM DEBT 15,167 16,667 DEFERRED GAIN FROM SALE-LEASEBACK 616 704 Total liabilities 43,981 39,631 SHAREHOLDERS' EQUITY Preferred stock, $.01 par value, 1,000,000 shares authorized, no shares issued - - Common stock, $.01 par value, 15,000,000 shares authorized, 5,051,566 and 5,051,566 shares issued, respectively 51 51 Additional paid-in capital 15,817 15,817 Less treasury stock - 951,281 shares at cost, respectively (4,309) (4,309) Retained earnings 1,220 8,824 Total shareholders' equity 12,779 20,383 Total liabilities and shareholders' equity $ 56,760 $ 60,014 See notes to condensed consolidated financial statements KENTUCKY ELECTRIC STEEL, INC. AND SUBSIDIARY CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Dollars in Thousands, Except Share and Per Share Data) (Unaudited) Three Months Ended Nine Months Ended June 29, June 30, June 29, June 30, 2002 2001 2002 2001 NET SALES $ 22,983 $ 19,442 $ 58,209 $ 59,458 COST OF GOODS SOLD 21,933 19,408 58,916 58,661 Gross profit (loss) 1,050 34 (707) 797 SELLING AND ADMINISTRATIVE EXPENSES 1,918 1,789 5,396 6,127 WORKFORCE REDUCTION CHARGES - - - 300 Operating loss (868) (1,755) (6,103) (5,630) INTEREST INCOME AND OTHER 38 123 139 800 INTEREST EXPENSE (592) (523) (1,640) (1,543) Loss before income taxes (1,422) (2,155) (7,604) (6,373) CREDIT FOR INCOME TAXES - (809) - (2,396) Net loss $ (1,422) $ (1,346) $ (7,604) $ (3,977) NET LOSS PER COMMON SHARE - BASIC AND DILUTED $ (.35) $ (.33) $ (1.85) $ (.98) WEIGHTED AVERAGE SHARES OUTSTANDING - BASIC AND DILUTED 4,100,285 4,085,150 4,100,285 4,078,057 See notes to condensed consolidated financial statements KENTUCKY ELECTRIC STEEL, INC. AND SUBSIDIARY CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in Thousands) (Unaudited) Nine Months Ended June 29, June 30, 2002 2001 Cash Flows From Operating Activities: Net loss $ (7,604) $ (3,977) Adjustments to reconcile net loss to net cash flows from operating activities: Depreciation and amortization 2,178 2,088 Change in deferred taxes - (2,303) Change in other assets 39 97 Change in current assets and current liabilities: Accounts receivable (2,453) 2,805 Insurance claim receivable (2,575) - Inventories (163) 5,361 Operating supplies and other current assets 18 (206) Refundable income taxes - 80 Deferred tax assets - (94) Accounts payable 2,291 (2,892) Accrued liabilities (334) (243) Net cash flows from operating activities (8,603) 716 Cash Flows From Investing Activities: Capital expenditures (489) (365) Net cash flows from investing activities (489) (365) Cash Flows From Financing Activities: Net advances on line of credit 2,481 2,579 Deferred financing fees (698) (49) Repayment of long-term debt - (3,333) Issuance of common stock - 25 Net cash flows from financing activities 1,783 (778) Net decrease in cash and cash equivalents (7,309) (427) Cash and Cash Equivalents at Beginning of Period 7,505 8,688 Cash and Cash Equivalents at End of Period $ 196 $ 8,261 Interest Paid $ 2,023 $ 1,927 Income Taxes Paid $ - $ - See notes to condensed consolidated financial statements. KENTUCKY ELECTRIC STEEL, INC. AND SUBSIDIARY NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (1) Basis of Presentation The accompanying unaudited condensed consolidated financial statements include the accounts of Kentucky Electric Steel, Inc. and its wholly-owned subsidiary, KESI Finance Company, which was formed in October 1996 to finance the ladle metallurgy facility. On September 28, 2001, the Company dissolved KESI Finance Company as a separate legal entity. As such, the financial statements for the three-month and nine-month periods ended June 30, 2001 reflect the activity for KESI Finance Company. All significant intercompany accounts and transactions have been eliminated. These statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the three-month and nine-month periods ended June 29, 2002 are not necessarily indicative of the results that may be expected for the year ending September 28, 2002. For further information, refer to the financial statements and footnotes thereto included in the Company's annual report on Form 10-K for the year ended September 29, 2001. (2) Nature of Operations Kentucky Electric Steel, Inc. (KESI or the Company), a Delaware corporation, owns and operates a steel mini-mill near Ashland, Kentucky. The Company manufactures special bar quality alloy and carbon steel bar flats to precise customer specifications for sale in a variety of niche markets. During the past three years, market conditions within the domestic steel industry have experienced significant downward economic pressure largely due to market price and shipment volume declines. These market conditions are a result of a number of factors including a decline in the general economy of the United States, a decline in the industries of the Company's customers, the increased cost of production due to high electricity and natural gas costs and an increase in competition from foreign and domestic steel companies. These forces have driven market prices to levels below the cost of production for certain domestic producers, and as a result, many steel manufacturers have curtailed production or ceased operations, and a number of steel industry producers have sought protection under the United States Bankruptcy Code. (3) Accounting Principles Accounting Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. Reclassifications Certain reclassifications of previously reported amounts have been made to conform with current classifications. Cash and Cash Equivalents Cash includes currency on-hand and deposits with financial institutions. Cash equivalents consist of investments with original maturities of three months or less. Amounts are stated at cost, which approximates market value. Inventories Inventory costs include material, labor and manufacturing overhead. Inventories are valued at the lower of average cost or market. Property, Plant and Equipment and Depreciation Property, plant and equipment is recorded at cost, less accumulated depreciation. For financial reporting purposes, depreciation is provided on the straight-line method over the estimated useful lives of the assets, generally 3 to 12 years for machinery and equipment and 15 to 30 years for buildings and improvements. Depreciation for income tax purposes is computed using accelerated methods. Expenditures for maintenance and repairs are charged to expense as incurred. Expenditures for equipment renewals, which extend the useful life of any asset, are capitalized. The Company assesses its long-lived assets for impairment when events and circumstances indicate the assets may be impaired and the undiscounted cash flows estimated to be generated by those assets are less than their carrying amounts. Revenue Recognition The Company recognizes revenue from sales when risk and title passes to the customer, which generally occurs at the time of shipment. Income Taxes The Company accounts for income taxes pursuant to the asset and liability method. Deferred tax assets and liabilities are recognized based upon the estimated increase or decrease in taxes payable or refundable in future years expected to result from reversal of temporary differences and utilization of carryforwards which exist at the end of the current year. Temporary differences represent the differences between the financial statement carrying amount of assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates scheduled to apply to taxable income in the years in which the temporary differences are expected to be settled, and are adjusted in the period of enactment for the effect of a change in tax law or rates. Valuation allowances are provided against deferred tax assets for which it is "more likely than not" the assets will not be realized. The realization of deferred tax assets is dependent in part upon generation of sufficient future taxable income. Management has considered the levels of currently anticipated pre-tax income in assessing the required level of the deferred tax asset valuation allowance. After taking into consideration historical pre-tax income levels, the results of operations from fiscal 1999, 2000 and 2001, the potential limitation of net operating losses under Section 382 of the Internal Revenue Code and other available objective evidence, the realization of the deferred tax asset is no longer more likely than not. Therefore, the Company's valuation allowance fully reserves for the net deferred tax asset. Also, realization of deferred tax assets may be limited by Section 382 of the Internal Revenue Code. Section 382 of the Internal Revenue Code contains rules designed to discourage persons from buying and selling the net operating losses of companies. These rules generally operate by focusing on ownership changes among stockholders owning directly or indirectly 5% or more of the common stock of a company or any change in ownership arising from a new issuance of stock by a company. In general, Section 382 rules limit the ability of a company to utilize net operating losses after a change of ownership of more than 50% of its common stock over a three-year period. Purchases of our common stock in amounts greater than specified levels could inadvertently create a limitation on our ability to utilize our net operating losses for tax purposes in the future. Fiscal Year End The Company's fiscal year ends on the last Saturday of September. Segment Information Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the decision-making group in deciding how to allocate resources. The Company has one business unit. New Accounting Pronouncements SFAS No. 142 "Goodwill and Other Intangible Assets" In July 2001, the Financial Accounting Standards Board issued Statement No. 142 (SFAS 142) "Goodwill and Other Intangible Assets". SFAS 142 establishes accounting and reporting standards for acquired goodwill and other intangible assets. It requires that an entity cease amortization of goodwill and certain intangible assets and establishes an annual requirement to test these assets for impairment. This standard is required to be adopted for fiscal years beginning after December 15, 2001. As such, the Company is not required to adopt this standard until the fiscal year beginning September 29, 2002. Early application of this standard is permitted for entities with fiscal years beginning after March 15, 2001. The Company did not early adopt this standard. Management does not believe that the adoption of this standard will have a material impact on the financial position or results of operations of the Company. SFAS No. 143 "Accounting for Asset Retirement Obligations" In August 2001, the Financial Accounting Standards Board issued Statement No. 143 (SFAS 143) "Accounting for Asset Retirement Obligations". SFAS 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. This standard is required to be adopted for fiscal years beginning after June 15, 2002. As such, the Company is not required to adopt this standard until the fiscal year beginning September 29, 2002. Management does not believe that the adoption of this standard will have a material impact on the financial position or results of operations of the Company. SFAS No. 144 "Accounting for the Impairment or Disposal of Long- Lived Assets" In October 2001, the Financial Accounting Standards Board issued Statement No. 144 (SFAS 144) "Accounting for the Impairment or Disposal of Long-Lived Assets". SFAS 144 addresses financial accounting impairment or disposal of long-lived assets and requires that one accounting model be used for long-lived assets to be disposed of by sale and broadens the presentation of discontinued operations to include more disposal transactions. This standard is required to be adopted for fiscal years beginning after December 15, 2001. As such, the Company is not required to adopt this standard until the fiscal year beginning September 29, 2002. Management does not believe that the adoption of this standard will have a material impact on the financial position or results of operations of the Company. SFAS No. 145 "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections" In April 2002, the Financial Accounting Standards Board issued Statement No. 145 (SFAS 145) "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections". SFAS 145 rescinds FASB Statement No. 4, Reporting Gains and Losses from Extinguishment of Debt, and an amendment of that Statement, FASB Statement No. 64, Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements. This Statement also rescinds FASB Statement No. 44, Accounting for Intangible Assets of Motor Carriers. This Statement amends FASB Statement No. 13, Accounting for Leases, to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. This Statement also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions. This standard is required to be adopted for fiscal years beginning after May 15, 2002 and certain transactions after May 15, 2002. As such, the Company is not required to adopt this standard until the fiscal year beginning September 29, 2002 and has not entered into any certain transactions since May 15, 2002. Management does not believe that the adoption of this standard will have a material impact on the financial position or results of operations of the Company. SFAS No. 146 "Accounting for Costs Associated with Exit or Disposal Activities" In July 2002, the Financial Accounting Standards Board issued Statement No. 146 (SFAS 146), "Accounting for Costs Associated with Exit or Disposal Activities". SFAS 146 required companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. Examples of costs covered by the standard include lease termination costs and certain employee severance costs that are associated with a restructuring, discontinued operation, plant closing, or other exit or disposal activity. Statement 146 is to be applied prospectively to exit or disposal activities initiated after December 31, 2002. (4) Inventories Inventories at June 29, 2002 and September 29, 2001 consist of the following ($000's): June 29, Sept. 29, 2002 2001 Raw materials $ 3,355 $ 2,113 Semi-finished and finished goods 13,770 14,849 Total inventories $ 17,125 $ 16,962 (5) Earnings Per Share The following is the reconciliation of the numerators and denominators of the basic and diluted earnings per share computations. For the Three For the Three Months Ended Months Ended June 29, 2002 June 30, 2001 Net Per Net Per Loss Share Loss Share (000's) Shares Amount (000's) Shares Amount Amounts for Basic Earnings Per Share $(1,422) 4,100,285 $(.35) $(1,346) 4,085,150 $(.33) Effect of Dilutive Securities - Options - - - - - - Amounts for Diluted Earnings Per Share $(1,422) 4,100,285 $(.35) $(1,346) 4,085,150 $(.33)
For the Nine For the Nine Months Ended Months Ended June 29, 2002 June 30, 2001 Net Per Net Per Loss Share Loss Share (000's) Shares Amount (000's) Shares Amount Amounts for Basic Earnings Per Share $(7,604) 4,100,285 $(1.85) $(3,977) 4,078,057 $(.98) Effect of Dilutive Securities - Options - - - - - Amounts for Diluted Earnings Per Share $(7,604) 4,100,285 $(1.85) $(3,977) 4,078,057 $(.98)
The following options were not included in the computation of diluted loss per share because to do so would have been antidilutive for the applicable period: June 29, 2002 June 30, 2001 Transition stock options 23,233 42,160 Employee stock options 660,900 616,244 684,133 658,404 (6) Advances on Line of Credit and Long-Term Debt Long-term debt of the Company at June 29, 2002 and September 29, 2001, as restructured, consists of the following ($000's): June 29, Sept. 29, 2002 2001 Secured senior notes, due in annual installments from November 2002 through 2005, interest at 9.00% $ 16,667 $ 16,667 Other 125 125 16,792 16,792 Less - Current portion (1,625) (125) $ 15,167 $ 16,667 On January 14, 2002, the Company obtained restructured financing of its existing debt obligations. As a result of this restructured financing, the Company deferred its November 1, 2001 principal payment and a portion of the scheduled November 1, 2002 principal payment under the senior notes until November 1, 2005. Annual maturities of the senior notes under the restructured financing are $1,500,000 due on November 1, 2002, $3,333,333 due on September 30, 2003, $3,333,333 due on November 1, 2004 and $8,500,000 due on November 1, 2005. These notes bear interest at the fixed rate of 9.00% per annum, with interest paid monthly. The restructured financing also includes an $18 million secured bank credit facility which expires on November 1, 2005. Borrowings are limited to defined percentages of eligible inventory and accounts receivable. Interest on borrowings accrues at the rate of prime plus 2.5%. As of June 29, 2002, approximately $14.6 million was outstanding under the Company's line of credit, and approximately $1.1 million was utilized to collateralize various letters of credit. Under the terms of the restructured financing, both the senior notes and the borrowings on the line of credit are secured by all current and future assets of the Company, including, but not limited to, accounts receivable, inventory, and all real property, plant and equipment. The senior notes and bank credit facility in the restructured financing contain restrictive covenants, which include, among other requirements, the maintenance of minimum shareholders' equity; minimum earnings before interest, taxes, depreciation, and amortization (EBITDA); minimum interest coverage ratio; minimum debt service coverage ratio; capital expenditure restrictions; and prohibition on the payment of dividends. (7) Insurance Claim Receivable The Company experienced a flood on March 20, 2002 which shut down operations in the melt shop until April 1 and rolling mill until April 5. The Company currently estimates that the total cost to clean, repair, and replace its damaged equipment and facilities to be approximately $4.0 million. The Company maintains flood insurance, including business interruption coverage, and expects substantially all such costs to be covered by insurance except for the $125,000 deductible. Through June 29, 2002, the Company had incurred cleanup and other costs of approximately $3,320,000. The accompanying statements of operations for the quarter and nine months ended June 29, 2002 include a credit of $880,000 for the currently estimated and agreed upon reimbursement for business interruption claims with the insurance carrier, which is included in the calculation of cost of goods sold. The accompanying statement of operations for the nine months ended June 29, 2002 also includes the Company's deductible for this claim of $125,000. As of June 29, 2002, the Company had a net receivable of $2,575,000; the insurance carrier had advanced the Company $1.5 million on this claim as of June 29, 2002. Subsequent to June 29, 2002 the insurance carrier advanced the Company an additional $1.5 million on this claim. The Company expects to complete all remaining repairs and finalize the settlement with the insurance company during the fourth quarter of fiscal 2002 and does not anticipate a material effect on fourth quarter operating results. (8) Commitments and Contingencies The Company has various commitments for the purchase of materials, supplies and energy arising in the ordinary course of business. The Company is subject to various claims, lawsuits and administrative proceedings arising in the ordinary course of business with respect to commercial, product liability, environmental and other matters, which seek remedies or damages. Costs to be incurred in connection with environmental matters are accrued when the prospect of incurring costs for testing or remedial action is deemed probable and such amounts can be estimated. The Company maintains reserves which it believes are adequate related to testing, consulting fees and minor remediation. However, new information or developments with respect to known matters or unknown conditions could result in the recording of accruals in the periods in which they become known. The Company believes that any liability that may ultimately be determined with respect to commercial, product liability, environmental or other matters will not have a material effect on its financial condition or results of operations. KENTUCKY ELECTRIC STEEL, INC. AND SUBSIDIARY MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS General. The Company manufactures special bar quality alloy and carbon steel bar flats to precise customer specifications for sale in a variety of niche markets. Its primary markets are manufacturers of leaf-spring suspensions and flat bed truck trailers, cold drawn bar converters, and steel service centers. Net Sales. Net sales increased $3.6 million (18.2%) in the third quarter of fiscal 2002 to $23.0 million, as compared to $19.4 million for the third quarter of fiscal 2001. The increase in sales for the third quarter of fiscal 2002 as compared to the third quarter of fiscal 2001 is attributed to an increase in finished goods shipments offset somewhat by a decrease in average selling price. Finished goods tons shipped increased 24.8% in the third quarter of fiscal 2002 as compared to the third quarter of fiscal 2001. The average selling price for finished goods shipped was down 6.4% in the third quarter of fiscal 2002 from the comparable period of fiscal 2001. The decrease in average selling price is attributed to market price reductions and changes in product mix. Net sales for the nine months ended June 29, 2002 decreased $1.3 million (2.1%) to $58.2 million as compared to $59.5 million for the nine months ended June 30, 2001. The decrease in sales for the nine months ended June 29, 2002 as compared to the nine months ended June 30, 2001 is primarily due to a decrease in average selling price offset slightly by an increase in finished goods tons shipped. The average selling price per ton for finished goods shipped was down 5.3% for the nine months ended June 29, 2002 as compared to the nine months ended June 30, 2001. The decrease in average selling price is attributed to market price reductions and changes in product mix. Finished goods tons shipped increased 2.0% for the nine months ended June 29, 2002 as compared to the nine months ended June 30, 2001. Cost of Goods Sold. Cost of goods sold increased $2.5 million (13.0%) in the third quarter of fiscal 2002 to $21.9 million, as compared to $19.4 million for the third quarter of fiscal 2001. As a percentage of net sales, cost of goods sold decreased from 99.8% for the third quarter of fiscal 2001 to 95.4% for the third quarter of fiscal 2002. The increase in cost of goods sold for the third quarter of fiscal 2002 as compared to the third quarter of fiscal 2001 is primarily due to the increase in finished goods and billet shipments (as discussed above) partially offset by a decrease in per ton manufacturing costs. The decrease in per ton manufacturing costs reflects significantly higher production levels, the inclusion of $880,000 from business interruption reimbursement and a charge of $200,000 related to a four-year sales and property tax audit in the calculation of cost of goods sold. Also, per ton manufacturing costs reflects the benefits of the workforce restructuring implemented in 2001 complimented by a decrease in self-insured health and workers compensation costs. These decreases to per ton manufacturing costs were partially offset by higher scrap costs due to an increase in purchase price of scrap. The decrease in cost of goods sold as a percentage of net sales for the third quarter of fiscal 2002 as compared to the third quarter of fiscal 2001 is primarily due to the decrease in per ton manufacturing costs (as discussed above) partially offset by the decrease in average selling price (as discussed above). Cost of goods sold for the nine months ended June 29, 2002 increased $.2 million (.4%) to $58.9 million as compared to $58.7 million for the nine months ended June 30, 2001. As a percentage of net sales, cost of goods sold increased from 98.7% for the nine months ended June 30, 2001 to 101.2% for the nine months ended June 29, 2002. The slight increase in cost of goods sold for the nine months ended June 29, 2002 as compared to the nine months ended June 30, 2001 is due to the increase in finished goods shipments (as discussed above) and billet shipments partially offset by a decrease in per ton manufacturing cost of tons shipped. The decrease in per ton manufacturing costs reflects significantly higher production levels, the inclusion of $880,000 from business interruption reimbursement and a charge of $200,000 related to a four-year sales and property tax audit in the calculation of cost of goods sold. Also, per ton manufacturing costs reflects the benefits of the workforce restructuring implemented in 2001 complimented by a decrease in self-insured health and workers compensation costs. The increase in cost of goods sold as a percentage of net sales for the nine months ended June 29, 2002 as compared to the nine months ended June 30, 2001 is attributed to lower selling prices (as discussed above) partially offset by decreases in per ton manufacturing costs (as discussed above). The Company experienced a flood on March 20, 2002 which shut down operations in the melt shop until April 1 and rolling mill until April 5. The Company currently estimates that the total cost to clean, repair, and replace its damaged equipment and facilities to be approximately $4.0 million. The Company maintains flood insurance, including business interruption coverage, and expects substantially all such costs to be covered by insurance except for the $125,000 deductible. Through June 29, 2002, the Company had incurred cleanup and other costs of approximately $3,320,000. The accompanying statements of operations for the quarter and nine months ended June 29, 2002 include a credit of $880,000 for the currently estimated and agreed upon reimbursement for business interruption claims with the insurance carrier, which is included in the calculation of cost of goods sold. The accompanying statement of operations for the nine months ended June 29, 2002 also include the Company's deductible for this claim of $125,000. As of June 29, 2002, the Company had a net receivable of $2,575,000; the insurance carrier had advanced the Company $1.5 million on this claim as of June 29, 2002. Subsequent to June 29, 2002 the insurance carrier advanced the Company an additional $1.5 million on this claim. The Company expects to complete all remaining repairs and finalize the settlement with the insurance company during the fourth quarter of fiscal 2002 and does not anticipate a material effect on fourth quarter operating results. Gross Profit (Loss). As a result of the above, the third quarter of fiscal 2002 reflected a gross profit of $1,050,000 as compared to a gross profit of $34,000 for the third quarter of fiscal 2001. As a percentage of net sales, gross profit increased from .2% in the third quarter of fiscal 2001 to 4.6% for the third quarter of fiscal 2002. The nine months ended June 29, 2002 reflected a gross profit (loss) of ($.7) million as compared to a gross profit of $.8 million for the nine months ended June 30, 2001. As a percentage of net sales, gross profit decreased from 1.3% for the nine months ended June 30, 2001 to (1.2%) for the nine months ended June 29, 2002. Selling and Administrative Expenses. Selling and administrative expenses include salaries and benefits, corporate overhead, insurance, sales commissions and other expenses incurred in the executive, sales and marketing, shipping, personnel, and other administrative departments. Selling and administrative expenses increased by $.1 million for the third quarter of fiscal 2002 as compared to the same period in fiscal 2001. As a percentage of net sales, such expenses decreased from 9.2% for the third quarter of fiscal 2001 to 8.3% for the third quarter of fiscal 2002. The increase in selling and administrative expenses in the third quarter of fiscal 2002 as compared to the third quarter of fiscal 2001 is primarily due to an increase in bad debt expense of $200,000 and a $46,000 increase in the amortization of deferred financing fees partially offset by a decrease in legal fees of $109,000. The increase in bad debt expense is due to the bankruptcy of a customer in the third quarter of fiscal 2002. Selling and administrative expenses decreased by $.7 million for the nine months ended June 29, 2002 as compared to the same period for fiscal 2001. As a percentage of net sales, such expenses decreased from 10.3% for the nine months ended June 30, 2001 to 9.3% for the nine months ended June 29, 2002. The decrease in selling and administrative expenses for the nine months ended June 29, 2002 as compared to the nine months ended June 30, 2001 is primarily due to a decrease in bad debt expense of $363,000 and a decrease in self-insured health and workers compensation costs of $254,000. Bad debt expense in fiscal 2001 was unusually high due to the bankruptcy of a large customer in fiscal 2001. Workforce Reduction Changes. Effective February 26, 2001, the Company adopted a plan to restructure its workforce. The restructuring was substantially completed by the fourth quarter of fiscal 2001. The Company estimated and accrued severance pay and related costs of approximately $300,000 which is reflected in the financial statements for the nine months ended June 30, 2001. Operating Income (Loss). For the reasons described above, the third quarter of fiscal 2002 reflected an operating loss of $(.9) million as compared to an operating loss of $(1.8) million for the third quarter of fiscal 2001. As a percentage of net sales, operating loss decreased from (9.0%) in the third quarter of 2001 to (3.8%) in the third quarter of 2002. The nine months ended June 29, 2002 reflected an operating loss of $(6.1) million as compared to operating loss of $(5.6) million for the nine months ended June 30, 2001. As a percentage of net sales, operating loss increased from (9.5%) for the nine months ended June 30, 2001 to (10.5%) for the nine months ended June 29, 2002. Interest Income and Other. Interest and other income decreased by $85,000 from $123,000 for the third quarter of fiscal 2001 to $38,000 for the third quarter of fiscal 2002. Interest and other income decreased by $661,000 for the nine months ended June 29, 2002 from $800,000 for the nine months ended June 30, 2001 to $139,000 for the nine months ended June 29, 2002. The first nine months of fiscal 2001 includes other income of $428,000 for a claim settlement pertaining to the Company's purchase of electrodes during the years 1992 to 1997. In addition, interest income decreased due to interest income being higher in the third quarter and nine months ended June 30, 2001 due to the investment of the proceeds from the sale and leaseback transaction completed in September 2000. Interest Expense. Interest expense increased by $69,000 for the three months ended June 29, 2002 from $523,000 for the third quarter of fiscal 2001 to $592,000 for the third quarter of fiscal 2002. Interest expense increased by $0.l million for the nine months ended June 29, 2002 from $1.5 million for the nine months ended June 30, 2001 to $1.6 million for the nine months ended June 29, 2002. The increase in interest expense for the third quarter and first nine months of fiscal 2002 is primarily due to an increase in interest rates on the Company's long-term debt and line of credit. Provision (Credit) for Income Taxes. Due to the loss incurred in fiscal 2001 and the first nine months of fiscal 2002, related debt restructurings, the potential limitation of utilizing net operating losses under Section 382 of the Internal Revenue Code (as discussed below) and management's current belief that the available objective evidence creates sufficient uncertainty regarding the realizability of previously recognized deferred tax assets, the Company recorded a valuation allowance of approximately $.5 million during the third quarter of fiscal 2002 and $2.8 million for the nine months ended June 29, 2002 which fully offsets recognized deferred tax assets. The Financial Accounting Standards Board Statement No. 109 (SFAS 109) "Accounting for Income Taxes" requires that the Company record a valuation allowance when it is "more likely than not that some portion or all of the deferred tax asset will not be realized." The Company will continue to provide a 100% valuation allowance for the deferred tax asset in the future until the Company returns to an appropriate level of profitability. The ultimate realization of a future tax benefit related to net operating loss carryforwards depends on the Company's ability to generate sufficient taxable income in the future. If the Company is able to generate sufficient taxable income in the future, the Company will reduce the valuation allowance through a reduction of income tax expense (and a corresponding increase in shareholders' equity). The realization of a benefit from net operating loss carryforwards which can, and previously did, generate deferred tax assets, may also be limited by Section 382 of the Internal Revenue Code. Section 382 of the Internal Revenue Code contains rules designed to discourage persons from buying and selling the net operating losses of companies. These rules generally operate by focusing on ownership changes among stockholders owning directly or indirectly 5% or more of the common stock of a company or any change in ownership arising from a new issuance of stock by a company. In general, Section 382 rules limit the ability of a company to utilize net operating losses after a change of ownership of more than 50% of its common stock over a three-year period. Purchases of the Company's common stock in amounts greater than specified levels could inadvertently create a limitation on the Company's ability to utilize its net operating losses for tax purposes in the future. Net Income (Loss). As a result of the above, the third quarter of fiscal 2002 reflected a net loss of $(1.4) million as compared to a net loss of $(1.3) million for the third quarter of fiscal 2001. The nine months ended June 29, 2002 reflected a net loss of $(7.6) million as compared to a net loss of $(4.0) million for the nine months ended June 30, 2001. Liquidity and Capital Resources The Company considers its level of cash, availability under its line of credit, and its current ratio and working capital to be its most important measures of short-term liquidity. In terms of long-term liquidity indicators, the Company believes its historical levels of cash generated from operations and required debt repayment to be the most important measures. Cash flows used by operating activities were $8.6 million for the nine months ended June 29, 2002 as compared to cash flows provided by operating activities of $.7 million for the nine months ended June 30, 2001. The nine months ended June 29, 2002 reflect the net loss of $7.6 million, $2.2 million in depreciation and amortization, an increase in accounts receivable of $2.5 million, an insurance claim receivable of $2.6 million, an increase in accounts payable of $2.3 million, and a decrease in accrued liabilities of $.3 million. The increase in accounts receivable is due to the increase in net sales. The insurance claim receivable of $2.5 million represents the estimated reimbursement receivable from the insurance carrier for the cost to repair and replace flood damaged equipment and business interruption as of June 29, 2002. Subsequent to June 29, 2002 the insurance carrier advanced the Company $1.5 million on this claim. The increase in accounts payable is due to the increase in operating levels and accounts payable related to the repairs covered by the insurance claim. The first nine months of fiscal 2001 cash flows reflect a net loss of $4.0 million, $2.1 million in depreciation and amortization, an increase in deferred tax assets of $2.4 million, a decrease in accounts receivable of $2.8 million, a decrease in inventories of $5.4 million, an increase in operating supplies and other current assets of $.2 million, a decrease in accounts payable of $2.9 million, and a decrease in accrued liabilities of $.2 million. The cash flows used in investing activities were $.5 million for the first nine months of fiscal 2002 as compared to $.4 million for the first nine months of fiscal 2001. The cash flows used in investing activities for the first nine months of fiscal 2002 and fiscal 2001 were used for capital expenditures. Cash flows provided by financing activities were $1.8 million for the first nine months of fiscal 2002 as compared to cash flows used by financing activities of $.8 million for the first nine months of fiscal 2001. The cash flows provided by financing activities for the first nine months of fiscal 2002 reflect financing charges of $.7 million related to the Company's debt restructuring and $2.5 million in advances on the Company's line of credit. The cash flows used by financing activities for the first nine months of fiscal 2001 reflect net advances of $2.6 million on the Company's line of credit and the repayment of $3.3 million in long-term debt. Working capital at June 29, 2002 was $7.9 million as compared to $15.9 million at September 29, 2001, and the current ratio was 1.3 to 1.0 as compared to 1.7 to 1.0. The decrease in working capital and current ratio are primarily due to the lower amount of cash and cash equivalents. The Company's primary ongoing cash requirements are for current capital expenditures and ongoing working capital. On January 14, 2002, the Company restructured its existing debt obligations. As a result of this restructured financing, the Company deferred its November 1, 2001 principal payment and a portion of the scheduled November 1, 2002 principal payment under the senior notes until November 1, 2005. Annual maturities of the senior notes under the restructured financing are $1,500,000 due on November 1, 2002, $3,333,333 due on September 30, 2003, $3,333,333 due on November 1, 2004 and $8,500,000 due on November 1, 2005. These notes bear interest at the fixed rate of 9.00% per annum, with interest paid monthly. In addition, prior covenant violations were waived in connection with the debt restructuring. The restructured financing also includes an $18 million secured bank credit facility which expires on November 1, 2005. Borrowings are limited to defined percentages of eligible inventory and accounts receivable. Interest on borrowings accrue at the rate of prime plus 2.5%. As of August 13, 2002, approximately $15.0 million was outstanding under the Company's line of credit, approximately $1.1 million was utilized to collateralize various letters of credit and $1.9 million was available for additional borrowings. The Company anticipates that the amount available under the line of credit will increase as payments are received from the business interruption portion of the insurance claim receivable. Under the terms of the restructured financing, both the senior notes and the borrowings on the line of credit are secured by all current and future assets of the Company, including but not limited to, accounts receivable, inventory, and all real property, plant and equipment. The senior notes and bank credit facility in the restructured financing contain restrictive covenants, which include, among other requirements, the maintenance of minimum shareholders' equity; minimum earnings before interest, taxes, depreciation, and amortization (EBITDA); minimum interest coverage ratio; minimum debt service coverage ratio; capital expenditure restrictions; and prohibition on the payment of dividends. Though the Company will continue its aggressive working capital management and cost reduction initiatives, continued losses similar to those incurred in fiscal 2001 and for the first nine months of fiscal 2002 will severely limit the Company's ability to provide future liquidity from operations and remain in compliance with the new covenants of the restructured financing. There can be no assurances that cash requirements and compliance with the new debt covenants will be met if the Company continues to incur significant financial losses. Critical Accounting Policies and Estimates The preparation of consolidated financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those related to allowance for bad debts, inventories, long-lived assets, income taxes, customer claims, product liability, restructuring liabilities, environmental contingencies and litigation. The Company bases its estimates on historical experience and on various other assumptions that management believes are reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. The critical accounting policies management believes affect the Company's more significant judgments and estimates used in the preparation of the consolidated financial statements are included in Item 7. "Management's Discussion and Analysis of Financial Conditions and Results of Operations" and the notes to the consolidated financial statements of the Company's Form 10-K for the year ended September 29, 2001. Outlook Demand and pricing for the Company's products improved during the third quarter of fiscal 2002 as compared to the first half of 2002. Management believes that both demand and pricing should continue to improve in the coming months. If the Company's business does continue to improve, management anticipates that additional financing will be needed to accommodate any associated growth in accounts receivable and inventory levels. Management will continue working with the Company's lenders to attempt to insure that adequate financing is available to meet any such increased working capital needs, as well as to make the scheduled $1,500,000 principal payment due on November 1, 2002 under existing debt obligations. Forward-Looking Statements The matters discussed or incorporated by reference in this Report on Form 10-Q that are forward-looking statements (as defined in the Private Securities Litigation Reform Act of 1995) involve risks and uncertainties. These risks and uncertainties include, but are not limited to, reliance on the truck and utility vehicle industry; excess industry capacity; product demand and industry pricing; volatility of raw material costs, especially steel scrap; intense foreign and domestic competition; management's estimate of niche market data; the cyclical and capital intensive nature of the industry; the cost of compliance with environmental regulations; and the ability to secure long-term financing. These risks and uncertainties could cause actual results of the Company to differ materially from those projected or implied by such forward-looking statements. Quantitative and Qualitative Disclosure About Market Risk The Company is exposed to certain market risks that are inherent in financial instruments arising from transactions that are entered into in the normal course of business. The Company does not enter into derivative financial instrument transactions to manage or reduce market risk or for speculative purposes but is subject to interest rate risk on its fixed interest rate secured senior notes. The bank credit facility has a variable interest rate which reduces the potential exposure of interest rate risk from a cash flow perspective. The fair value of debt with a fixed interest rate generally will increase as interest rates fall given consistency in all other factors. Conversely, the fair value of fixed rate debt will decrease as interest rates rise. The Company is also subject to increases in the cost of energy, supplies and steel scrap due to inflation and market conditions. PART II. - OTHER INFORMATION ITEM 6. Exhibits and Reports on Form 8-K A) Exhibits 3.1 Certificate of Incorporation of Kentucky Electric Steel, Inc., filed as Exhibit 3.1 to Registrant's Registration Statements on Form S-1 (No. 33-67140), and incorporated by reference herein. 3.2 By-Laws of Kentucky Electric Steel, Inc., filed as Exhibit 3.2 to Registrant's Registration Statement on Form S-1 (No. 33- 67140), and incorporated by reference herein. B) Reports on Form 8-K - None. 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. DATED: August 13, 2002 KENTUCKY ELECTRIC STEEL, INC. (Registrant) \s\ William J. Jessie William J. Jessie, Vice President, Secretary, Treasurer, and Principal Financial Officer -----END PRIVACY-ENHANCED MESSAGE-----