-----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, Rk01J3NHPNL/qYAdcK3OwBosebHAbypcXHJ4uSg67VnS9xtl2IjTcpB496ORwJm4 9/Tx12s4G/cE7rwQoFBsOQ== 0000910394-98-000004.txt : 19981228 0000910394-98-000004.hdr.sgml : 19981228 ACCESSION NUMBER: 0000910394-98-000004 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19980926 FILED AS OF DATE: 19981222 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-K SEC ACT: SEC FILE NUMBER: 000-22416 FILM NUMBER: 98773777 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-K 1 FORM 10-K SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 (Mark One) X ANNUAL REPORT PURSUANT TO SECTION 13 or 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 (FEE REQUIRED) For the fiscal year ended September 26, 1998 OR _____ TRANSITION REPORT PURSUANT TO SECTION 13 or 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED) 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 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $.01 per share (Title of Class) 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 ( ) Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Registration S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements (Cover Page 1 of 2 Pages) incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.(X) Aggregate market value of the voting stock held by non-affiliates of the Registrant based on the closing price on December 11, 1998: $10,552,000. Indicate the number of shares outstanding of each of the Registrant's classes of common stock as of December 11, 1998: 4,059,531 shares of Common Stock, par value $.01 per share. DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrant's Proxy Statement for the Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission pursuant to Regulation 14(a) are incorporated herein by reference in response to items 10 through 13 in Part III of this report. (Cover Page 2 of 2 Pages) KENTUCKY ELECTRIC STEEL, INC. FORM 10-K TABLE OF CONTENTS Page PART I ............................................................. 4 Item 1. Business ............................................. 4 Item 2. Properties ........................................... 10 Item 3. Legal Proceedings .................................... 10 Item 4. Submission of Matters to a Vote of Security Holders .. 10 PART II ............................................................ 12 Item 5. Market for Registrant's Common Equity and Related Shareholder Matters .................................. 12 Item 6. Selected Financial Data .............................. 12 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations .................. 13 Item 7A. Qualitative and Quantitative Disclosure about Market Risk ................................................. 12 Item 8. Financial Statements and Supplementary Data .......... 20 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure .................. 20 PART III ........................................................... 21 Item 10. Directors and Executive Officers of the Registrant ... 21 Item 11. Executive Compensation ............................... 21 Item 12. Security Ownership of Certain Beneficial Owners and Management ................................ 21 Item 13. Certain Relationships and Related Transactions ....... 21 PART IV ............................................................ 22 Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K .................................. 22 SIGNATURES ......................................................... 25 INDEX TO FINANCIAL STATEMENTS AND SCHEDULE ........................ 26 KENTUCKY ELECTRIC STEEL, INC. PART I Item 1. Business General Kentucky Electric Steel, Inc., a Delaware corporation incorporated in August, 1993 (the "Company"), owns and operates a steel mini-mill near Ashland, Kentucky. As a mini-mill producer of bar flats, the Company recycles steel from scrap, a process designed to result in lower production costs than those of integrated steel mills, which produce steel by processing iron ore and other raw materials in blast furnaces. Bar flats are produced to a variety of specifications and fall primarily into two general quality levels - merchant bar quality steel bar flats ("MBQ Bar Flats") for generic types of applications, and special bar quality steel bar flats ("SBQ Bar Flats"), where more precise customer specifications require the use of various alloys, customized equipment and special production procedures to insure that the finished product meets critical end-use performance characteristics. The Company is a leading manufacturer of SBQ Bar Flats for the cold drawn bar converter and truck trailer support beam markets. Approximately 80% of the Company's sales are of SBQ Bar Flats. The Company completed a two-phase capital expenditure program in fiscal 1996. The first phase expanded the Company's casting, rolling and finishing capacity and increased the size range of products the Company can produce. The second phase, installation of a ladle metallurgy facility, removed the refining cycle from the electric arc furnace, thereby increasing total melting capacity. The Company manufactures over 2,600 different SBQ Bar Flat items which are sold to a variety of relatively small volume niche markets, including the leaf-spring suspension market for light and heavy-duty trucks, mini-vans and utility vehicles, cold drawn bar converters, certain specialty applications for steel service centers, truck trailer manufacturers and other miscellaneous markets. The Company's mill was specifically designed to manufacture wider and thicker bar flats up to three inches in thickness and twelve inches in width that are required by these markets. In addition, the Company employs a variety of specially designed equipment which is necessary to manufacture SBQ Bar Flats to the specifications demanded by its customers. Although the Company specializes in SBQ Bar Flats, particularly in the thicker and wider sections, it also, to a much lesser extent, competes in the MBQ Bar Flat market. The Company's business strategy is to increase its share of the SBQ Bar Flat market and to expand into related niche market applications where it can profitably supply products for special customer needs. The completion of the capital expenditure program increased the range of thickness and width of the Company's products, thereby creating the capacity for the Company to expand its business primarily by increasing the number of products it sells to existing customers and the development of new customers. The Company has increased its shipments of the thicker, wider products from fiscal 1997 to fiscal 1998 and has continued to decrease its sales to the leaf-spring suspension market. Manufacturing Operations The Company recycles steel by melting steel scrap in two 50-ton electric arc furnaces. The molten steel is then taken to the ladle metallurgy facility where a variety of alloys are added to make different grades of steel in accordance with customer specifications. The refined molten steel is then poured into a continuous caster to produce continuous strands of steel with cross-sectional dimensions ranging from approximately 16 to 72 square inches. The Company can utilize up to four continuous strands in producing certain sizes. The strands are cut to produce billets of specified length which are reheated to approximately 2,300 degrees Fahrenheit at the Company's rolling mill and fed through a series of roll stands to reduce their size and form them into steel bar sections. These sections emerge from the rolling mill, are uniformly cooled on a cooling bed, and are cut to lengths specified by the customer. The cut bar flats are stacked into bundles ready for shipment. The production capacity of finished products from the Company's rolling and finishing facilities is approximately 400,000 tons per year but can vary with product mix. The annual production capacity of the melting and casting operation is approximately 300,000 tons of finished product. Thus, the Company is able to finish more product in its rolling operations than it is capable of producing with its melting facilities. The Company's ultimate goal is to balance its operations at approximately 400,000 tons per year. The Company sold 240,300 tons of finished goods in 1998 which constitutes 80% of its capacity. The Company transports its products by common carrier, generally shipping by truck and by rail. The Company has railroad sidings at its facilities. Capital Improvements and Expansion Annual capital expenditures over the last five fiscal years have averaged $8.1 million, which includes $2.8 million expended in fiscal year 1998. The Board of Directors has approved the fiscal 1999 capital expenditure plan for approximately $3.1 million, which includes completion of various projects begun in fiscal 1998, and equipment upgrades and replacements. Primary Markets and Products The Company is primarily a special bar quality ("SBQ") producer of alloy and carbon steel bar flats. Its primary markets are manufacturers of leaf-spring suspensions, cold drawn bar converters, flat bed truck trailer manufacturers and steel service centers. Leaf-Spring Suspension Market. High tensile SBQ spring steel is produced to customer and industry specifications for use in leaf-spring assemblies. These assemblies are utilized in light, medium and heavy duty trucks, trailers, mini-vans and four-wheel drive vehicles with off- road capability. The trend toward tapered leaf-spring products and air- ride suspension continues. These products use somewhat less steel but they are manufactured from larger cross section bar flats that match the Company's manufacturing strengths. Cold Drawn Bar Converters Market. The Company sells its expanded range of SBQ hot rolled bar products to cold drawn bar manufacturers. KESI's product range, 1/4" through 3" in thickness and 2" through 12" in width, enables the Company to supply practically all the sizes needed by the converters. The converters remove the scale from the hot rolled bar and draw it through a carbide die. The drawing reduces the cross section, improves surface and internal properties, and produces a more exacting tolerance bar. The end product is sold directly to original equipment manufacturers and through distributors, with the majority being sold by steel service centers. Steel Service Centers Market. Approximately 30% of all steel shipments to the end-user are distributed through steel service centers, making this the largest single market for steel manufacturers. The Company sells both MBQ and SBQ bar flats into this market. The majority of its sales consist of the less competitive heavier section sizes and difficult to make grades. Truck Trailers Market. The Company is a significant supplier of SBQ Bar Flats for flat bed trailer support beam flange material. This material is engineered and produced to exacting specifications consistent with trailer manufacturers' requirements. Miscellaneous Markets. The Company supplies other markets including metal building, grader blades, agricultural equipment, construction/fabricating, railroad and industrial chain manufacturers. The products furnished to these markets are primarily SBQ Bar Flats along with a mixture of MBQ Bar Flats. Although the Company has not focused its sales efforts on MBQ Bar Flats, attention to select sizes of MBQ Bar Flats has provided good balance for the Company's manufacturing facilities. Within the MBQ Bar Flat market, the Company has concentrated its sales on specialty items as opposed to higher volume commodity products. Targeted opportunities within this market match the Company's ability to produce thicker, wider bar flats described in "Business - General." Customers The Company sells to over 350 customers. Two wholly-owned subsidiaries of Niagara Corporation represented approximately 10.4% of sales for fiscal 1998. No other customer accounted for more than 10% of sales in fiscal 1998. The loss of a principal customer could have a material adverse effect on the Company's operations. The Company's foreign sales as a percentage of total sales were 7.5% in fiscal 1998. These sales consisted primarily of leaf-spring suspension products shipped to Canada, Mexico and South America. Marketing Senior management of the Company is directly involved in sales to new and existing customers. Sales are nationwide and in certain foreign markets. Sales efforts are performed by seven in-house sales personnel and six manufacturers' representative companies. The efforts of these sales representatives are directed by the Company's Vice President, Sales and Marketing. Competition and Other Market Factors The domestic and foreign steel industries are characterized by intense competition. The Company competes with domestic and foreign producers, many of whom have financial resources substantially greater than those available to the Company. The Company has identified its principal competition from the following sources: (i) in its leaf-spring suspension market, the Company faces competition from five North American mills; (ii) in its cold drawn bar converters market, the Company competes with five North American mills; (iii) in the steel service center market, the Company encounters competition from numerous North American mills; and (iv) in its truck trailer market, the Company competes with one North American mill. One company, which currently competes in the leaf spring market, has announced plans to increase the capacity of its plant and to expand the size range of the products it manufactures. Also, another mini-mill which currently competes in two of the Company's markets, is building a new rolling mill to produce both rounds and bar flats. Both of these projects may increase competition in the markets served by the Company. The Company believes that the principal competitive factors affecting its business are quality, service, price and geographic location. Backlog and Seasonality As of September 26, 1998, the Company had firm orders for approximately 54,000 tons representing approximately $26.0 million in sales, as compared with approximately 58,000 tons representing approximately $27.7 million in sales, at September 27, 1997. The Company operates on a continuous basis with only occasional scheduled shutdowns for heavy maintenance work. The Company's operations are not subject to seasonal fluctuations in operations or sales. Raw Materials The principal raw material used in the Company's steel mill is ferrous scrap. Ferrous scrap is derived from, among other sources, discarded automobiles, appliances, structural steel, railroad cars and machinery. The purchase price of scrap is subject to market conditions largely beyond the control of the Company. The Company is located in an area where scrap is generally available and typically maintains less than one month of scrap supply. Historically, price fluctuations of scrap have had no material long-term impact on the Company. However, while the Company has generally been successful in passing on scrap cost increases through price increases, the effect of steel imports, market price competition and under-utilized industry capacity has in the past, and could in the future, limit the Company's ability to increase prices. One scrap dealer supplied approximately 44% of the Company's scrap in fiscal 1998. In an attempt to insure an adequate source of raw materials, however, the Company has identified, inspected, and purchased scrap from over 30 dealers. The Company's manufacturing process consumes large amounts of electricity, which the Company purchases from Kentucky Power Company, d/b/a American Electric Power ("AEP"). An abundant regional supply of coal, used in producing electricity, helps keep the Company's energy costs relatively low. Prior to November 13, 1997, the Company purchased electricity from AEP under an Interruptible Power Contract ("Prior Contract") which was terminable by either party upon 12 months notice and under which AEP could interrupt service during times of peak demand. Effective November 13, 1997, the Company and AEP entered into a contract for Operating Reserve Interruptible Electric Service ("1997 Contract") which will have a minimum term of five years unless the Company gives AEP at least one year's notice of termination. The 1997 Contract limits AEP's right to interrupt service, for no more than 30 minutes at a time, in only those instances that an AEP unit goes offline or that AEP is responsible to share reserves with other electrical generators pursuant to the East Central Area Reliability Coordination Agreement (ECAR). Employees As of September 26, 1998, the Company employed 421 people, approximately 78% of whom are members of the United Steelworkers of America. The Company and The United Steelworkers of America have agreed to a one-year extension of the current contract, which was to expire on September 10, 1998, and are continuing multi-year contract negotiations. The Company believes that its wage rates and benefits are competitive with other mini-mills. The Company offers no postretirement employee health care benefits or other benefit program subject to accounting under the provisions of Statement of Financial Accounting Standards No. 106 - "Employers' Accounting for Postretirement Benefits other than Pensions". Environmental and Regulatory Matters The Company is subject to federal, state, and local environmental laws and regulations concerning, among other matters, wastewater discharge, air emissions and furnace dust disposal. As with similar mills in the industry, the Company's furnaces are classified as generating hazardous waste (K061) because they produce certain types of dust containing lead, chromium and cadmium ("Furnace Dust"). The Company currently collects and handles Furnace Dust through a contract with Horsehead Resource Development Company, Inc. ("HRD"), which reclaims from the waste dust certain materials for reuse and arranges for further recycling or disposal of the residual material. Some of the Furnace Dust generated by the Company and shipped to HRD was processed at HRD's Palmerton, Pennsylvania facility (the "Palmerton Site"), which is the subject of a civil action ("Civil Action") filed in the United States District Court for the Middle District of Pennsylvania by USEPA (No. CV. 98-654) seeking recovery of costs for alleged environmental contamination at the Palmerton Site. HRD has negotiated a Consent Decree and a settlement of $4,984,000 with USEPA for the approximate 250 companies which sent 3,348,287 tons of Furnace Dust to the Palmerton Site. On October 16, 1998, the Company executed the Consent Decree in the Civil Action, which, if approved by the Court, will require the payment of $64,950.18 for the Company's 1.3032 percent volumetric share of the Furance Dust sent to the Palmerton Site. In consideration of this payment, the Company will be relieved of any liability that the Company may have for contribution or claims for response costs incurred in connection with the Palmerton Site as provided by Sections 113(f)(2) and 122(g)(5) of the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended. HRD has represented to the Company that HRD will pay USEPA the entire settlement of $4,984,000. However, should the settlement become final and HRD does not pay the $4,984,000 to USEPA, the Company will be required to pay $64,950.18. Should the settlement not become final and if HRD were to become insolvent, the Company could incur liability with respect to the remediation of the Palmerton Site or other HRD disposal sites. In addition, the cost of reclaiming or disposing of Furnace Dust may increase substantially in the future. Between 1981 and 1983, the prior operator (the "Prior Operator") disposed of Furnace Dust in the Cooksey Brother's landfill, in Cannonsburg, Kentucky ("Cooksey Landfill"). Before 1981 the Prior Operator disposed of Furnace Dust in other locations, including a strip mine. The Company did not assume any liability for disposal at the Cooksey Landfill or such other sites in the acquisition agreement pursuant to which the Company acquired its mini-mill in 1986. The Cooksey Landfill is operating pursuant to a permit and bond issued and approved by the Kentucky Division of Waste Management, and the Company has no reason to believe that the Cooksey Landfill or other sites are likely targets for listing as a Kentucky "uncontrolled site" or federal superfund site. Nevertheless, the Company could incur clean up expenses with respect to the Cooksey Landfill or such other sites if such sites are listed as a Kentucky "uncontrolled site" or federal superfund site and the Company is not successful in obtaining full indemnification from the Prior Operator. The Company's operations are subject to the Federal Clean Air Act which provides for regulation, through state implementation of federal require- ments, of the emission of certain air pollutants. As required by applicable regulations, on December 14, 1996, the Company filed a Title V permit application with the Kentucky Division for Air Quality ("DAQ"). The application required the Company to identify any of the nine emissions points within the Company's facility that were not in compliance with the Company's operating permits and/or applicable regulations. The Company listed Emission Unit Nos. 02 and 03, its electric arc furnaces A and B ("EAFs") in the Company's melt shop. In so doing, the Company's application indicated that the Company would conduct a diagnostic evaluation of its melt shop fume capture system and its baghouse. On July 10, 1998, the Company amended its application to provide a detailed description of the methods the Company would use to achieve compliance with the applicable regulations for the EAFs. In this submittal, the Company stated that it will modify its melt shop to improve updraft velocity to the canopy hoods and thereby bring emissions into compliance with applicable regulations during the charging and tapping of the EAFs. On July 24, 1998, the Company entered into an Agreed Order with DAQ which requires the Company to complete construction of the melt shop modifications and demonstrate compliance with applicable regulations by February 1, 1999. The Company has completed certain modifications to its melt shop and is evaluating whether additional modifications will be necessary to demonstrate compliance by February 1, 1999. Though the Company anticipates that it will be able to demonstrate compliance with the regulations by February 1, 1999 as required by the Agreed Order, if it fails to do so, the Company could be the subject of an enforcement action for failure to comply with the Agreed Order. Additionally, on August 21, 1998, the Company received a preliminary draft of its Title V permit from DAQ. The Company has submitted comments and has sought clarification concerning certain aspects of the draft permit but has not, as yet, received a response from DAQ. The Company, therefore, does not know whether it will be able to comply with its Title V Permit without additional capital and/or operating expense. Further, there can be no assurance that evolving federal and state environmental requirements or discovery of unknown conditions will not require the Company to make material expenditures in the future or affect the Company's ability to obtain permits for its existing operations or any future expansion. The Company will continue to plan and budget, as appropriate, for any additional capital and operating expenses that may be required to upgrade or install new or additional pollution control equipment in order to comply with all permits. On April 29, 1997, the Company ceased melting operations due to the melting of a radioactive source. The Company restarted its melt shop operations on May 11, 1997, after decontamination of the melt shop and related facilities. The melting of the radioactive source resulted in the classification of approximately 13,530 cubic feet of Furnace Dust and 7,000 cubic feet of baghouse filter bags and related supplies removed during decontamination as a mixed waste ("Mixed Waste") as defined in the Federal Facility Compliance Act. HRD does not have the regulatory permits to process Mixed Waste. The Company, therefore, on July 29, 1997, entered into a contract with Zhagrus Environmental, Inc. ("Zhagrus"), an affiliate of Envirocare of Utah, Inc. ("Envirocare"), for the packaging, transportation, treatment and disposal of the Mixed Waste at the waste disposal facility of Envirocare at Clive, Utah (the "Envirocare Facility"). The Envirocare Facility is licensed by the State of Utah to handle and dispose of the Mixed Waste. Zhagrus has completed transportation of the Mixed Waste to the Envirocare Facility. Zhagrus has advised that it has completed treatment of the Mixed Waste but was unable to complete disposal by September 1, 1998, as required by its contract due to lack of permitted disposal capacity at the Envirocare Facility. Zhagrus, however, has advised the Company that additional disposal capacity has been constructed and near term regulatory approval is anticipated allowing for the disposal of the Company's mixed waste by February 28, 1999. On June 29, 1998, the Company applied for reissuance of its Kentucky Pollutant Discharge Elimination System Permit ("KPDES Permit") which expired on October 31, 1998. Though the Company has supplied the Kentucky Division of Water ("DOW") all requested information, DOW has not reissued the KPDES Permit and the Company continues to operate under the provisions of the existing KPDES Permit. During warm weather, the Company has exceeded the discharge limitations for temperature at its Outfall No. 3. Though the Company has not received a Notice of Violation, DOW may seek penalties for any such temperature exceedences. Additionally, since the Company has not received its reissued KPDES Permit, the Company does not know whether it will be able to comply with the reissued KPDES Permit without additional capital and operating expense. Except as otherwise indicated, the Company believes it is in substantial compliance with applicable environmental laws and regulations. Notwithstand-ing such compliance, if damage to persons or property or contamination of the environment has been or is caused by the conduct of the Company's business or by hazardous substances or wastes used, generated or disposed of by the Company (or possibly by prior operators of the Company's mini-mill or by third parties), the Company may be held liable for such damages and be required to pay the cost of investigation and remediation of such contamination. The amount of such liability to the Company could be material. Changes in federal or state laws, regulations or requirements or discovery of unknown conditions could require additional expenditures by the Company. Item 2. Properties The Company's operations are located on approximately 122 acres of land near Ashland, Kentucky, next to an interstate highway and a rail line. The Company believes that its facilities are well maintained, in good condition and adequate and suitable for its operating needs. The Company has completed certain capital expenditures with respect to its properties. See Item 1 - Business - "Manufacturing Operations" and "Capital Improvements and Expansion." Item 3. Legal Proceedings The Company is subject to various claims and lawsuits arising in the ordinary course of business with respect to commercial, product liability and other matters, which seek remedies or damages. Based upon its evaluation of available information, management does not believe that any such matters are likely, individually or in the aggregate, to have a material adverse effect upon the Company's business, financial position, results of operations or cash flows. See also Item 1 "Business - Environmental and Regulatory Matters." Item 4. Submission of Matters to a Vote of Security Holders There were no matters submitted to a vote of shareholders during the fourth quarter of the fiscal year ended September 26, 1998. Executive Officers of the Registrant Pursuant to General Instruction G(3) of Form 10-K, the following list is included as an unnumbered Item in Part I of this report in lieu of being included in the Proxy Statement for the Annual Meeting of Stockholders scheduled to be held February 2, 1999. The names, ages and positions of all of the executive officers of the Registrant as of September 26, 1998 are listed below with their business experience with the Registrant for the past five years. Officers are elected annually by the Board of Directors at the first meeting of directors following the annual meeting of stockholders. There are no family relationships among these officers, nor any agreement or understanding between any officer and any other person pursuant to which the officer was selected. Charles C. Hanebuth, 54, has been President and Chief Executive Officer of the Company since its formation in August 1993. From November 1990 to October 1993, Mr. Hanebuth was President and Chief Operating Officer of Kentucky Electric Steel Corporation, a wholly-owned subsidiary of NS Group, Inc. Mr. Hanebuth has 19 years management experience in the steel industry. Mr. Hanebuth is a director of Ashland Bankshares, Inc., the holding company of the Bank of Ashland, and Ashland Hospital Corporation, which operates King's Daughters' Medical Center. William J. Jessie, 48, a certified public accountant, has been Vice President, Secretary, Treasurer and Chief Financial Officer of the Company since its formation in August 1993. Prior to August 1993, he was Controller of Kentucky Electric Steel Corporation since 1986. Mr. Jessie has 21 years of public accounting experience with national and local accounting firms. Joseph E. Harrison, 54, has been Vice President of Sales and Marketing of the Company since its formation in August 1993. From February 1991 to August 1993 he was General Sales Manager of Kentucky Electric Steel Corporation. Mr. Harrison has over 28 years of sales experience in the steel industry. William H. Gerak, 53, has been Vice President of Administration of the Company since January 1994. From February 1988 to December 1993 he was the Director of Human Resources and Labor Relations for Heekin Can, Inc., a wholly-owned subsidiary of Ball Corporation, a producer of steel food and aerosol containers, head-quartered in Cincinnati, Ohio. Mr. Gerak has over 24 years of human resource and administrative experience. PART II Item 5. Market for Registrant's Common Equity and Related Shareholder Matters The Company's common stock trades on the NASDAQ National Market under the symbol KESI. The following table sets forth, for the fiscal periods indicated, the high and low closing prices of the stock on the NASDAQ National Market: Fiscal 1997 Fiscal 1998 High Low High Low First Quarter $ 7-1/4 $ 5-1/4 $ 8 $ 4-1/2 Second Quarter 6-7/8 5-1/8 7-1/4 4-3/4 Third Quarter 5-3/4 4-1/8 6-15/16 4-15/16 Fourth Quarter 7-1/4 5-1/4 5-1/8 3-1/2 On December 11, 1998 there were approximately 1,500 beneficial owners of the Company's common stock. The Company currently intends to retain all earnings to support the development of its business, although the paying of dividends on its common stock is periodically reviewed. Certain of the Company's debt instruments currently restrict the payment of dividends. Specifically, the debt instruments restrict payment of dividends to the amount available in a "Restricted Payment Pool" as defined in the senior note agreement and amended bank credit facility. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and Note 6 of the Notes to Consolidated Financial Statements of the Company. Item 6. Selected Financial Data The selected financial data shown below for the five years in the period ended September 26, 1998 are derived from the audited financial statements of the Company. The information set forth below should be used in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Financial Statements and related notes thereto included elsewhere herein. Year Ended Sept. 24, Sept. 30, Sept. 28, Sept. 27, Sept. 26, 1994 1995 1996 1997 1998 (In thousands, except share and per share data) Income Statement Data: Net sales ......... $102,629 $107,402 $ 98,320 $ 94,652 $109,456 Cost of goods sold 86,892 91,642 89,783 89,992 97,720 ------- ------- ------- ------ ------ Gross profit .... 15,737 15,760 8,537 4,660 11,736 Selling and admini- strative expenses 6,963 7,696 7,391 6,800 7,011 ------- ------- ------- ------ ------ Operating income (loss) 8,774 8,064 1,146 (2,140) 4,725 Interest income from NS Group, Inc. - net 30 - - - - Interest expense ..... (586) (658) (1,453) (2,125) (2,395) Interest income and other .............. 164 57 31 34 80 Gain on involuntary con- version of equipment - - 369 - - ------- ------- ------- ------ ------ Income (loss) before income taxes ...... 8,382 7,463 93 (4,231) 2,410 Income taxes ......... 3,167 2,812 35 (1,599) 916 ------- ------- ------- ------ ------ Net income (loss)$ 5,215 $ 4,651 $ 58 $(2,632) $ 1,494 Net income (loss) per common share - basic and diluted..$ 1.06 $ .95 $ .01 $ (.57) $ .32 Weighted average shares outstanding - basic 4,908,158 4,905,456 4,806,161 4,633,315 4,624,671 Weighted average shares outstanding - - diluted 4,924,231 4,909,575 4,806,485 4,633,315 4,630,920 Balance Sheet Data: Working capital .. $ 21,553 $10,324 $14,963 $11,335 $14,153 Total assets ..... 56,870 72,625 78,433 78,770 80,251 Long-term debt (1) 9,001 7,287 20,000 20,000 20,000 Shareholders' equity 34,276 38,097 37,110 34,211 35,192 (1) Net of current portion. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The following analysis of results of operations and financial condition of the Company should be read in conjunction with "Selected Financial Data" and Financial Statements and Supplementary Data included elsewhere herein. General The Company manufactures special bar quality alloy and carbon steel bar flats to precise customer specification for sale in a variety of niche markets. As a result, while the Company's business is cyclical in nature, the Company has historically generated sufficient cash flow to meet its capital expenditure and debt service requirements. Results of Operations The following table sets forth the percentages of the Company's net sales represented by certain income and expense items for the periods indicated. Year Ended September September September 28, 1996 27, 1997 26, 1998 Net sales ...................... 100.0% 100.0% 100.0% Cost of goods sold ............. 91.3 95.1 89.3 ----- ----- ----- Gross profit ................... 8.7 4.9 10.7 Selling and administrative expenses ..................... 7.5 7.2 6.4 ----- ----- ----- Operating income (loss) ........ 1.2 (2.3) 4.3 Interest expense ............... (1.5) (2.2) (2.2) Interest income and other ...... - - .1 Gain on involuntary conversion of equipment ................. .4 - - ----- ----- ----- Income (loss) before income taxes .1 (4.5) 2.2 Income taxes ................... - (1.7) .8 ----- ----- ----- Net income (loss) ............... .1% (2.8%) 1.4% Year Ended September 26, 1998 Compared with Year Ended September 27, 1997 Net Sales. Net sales for fiscal 1998 increased by $14.8 million, or 15.6%, to $109.5 million from $94.7 million in fiscal 1997. The increase in sales is attributed to an increase in shipments and an increase in average selling price. Shipments increased by 10.7% from 217,000 tons in fiscal 1997 to 240,300 tons in fiscal 1998. The increase in shipments resulted from the strong demand for the Company's products during the first three quarters of fiscal 1998, and from the increase in tons available for shipment due to improvements in productivity. Also, shipments for fiscal 1997 were negatively impacted by the effect on production of the melt shop operations being shut down for twelve days in order to decontaminate the baghouse facility, after the detection of a radioactive substance in the baghouse dust. The increase in average selling price is attributed to the price increases implemented on many products during the first half of fiscal 1998. Cost of Goods Sold. Cost of goods sold for fiscal 1998 increased $7.7 million, or 8.6%, to $97.7 million from $90.0 million in fiscal 1997. As a percentage of net sales, cost of goods sold decreased from 95.1% in fiscal 1997 to 89.3% in fiscal 1998. The increase in cost of goods sold reflects the increase in shipments offset by a decrease in the per ton cost of tons shipped. The decrease in the per ton cost of tons shipped during fiscal 1998 as compared to fiscal 1997 resulted from lower conversion costs due to improvements in productivity, offset partially by an increase in scrap costs. The cost of goods sold for fiscal 1997 includes a $2.3 million reimbursement from business interruption insurance related to the decontamination of the baghouse. Gross Profit. As a result of the above, gross profit for fiscal 1998 increased by $7.0 million from $4.7 million in fiscal 1997 to $11.7 million in fiscal 1998. As a percentage of net sales, gross profit increased from 4.9% in fiscal 1997 to 10.7% in fiscal 1998. 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, human resources, and other administrative departments. Selling and administrative expenses for fiscal 1998 increased $.2 million, or 3.1%, to $7.0 million from $6.8 million for fiscal 1997. As a percentage of net sales, such expenses decreased from 7.2% for fiscal 1997 to 6.4% for fiscal 1998. The decrease as a percentage of sales is primarily the result of an increase in net sales (as discussed above) for fiscal 1998. Operating Income. Fiscal year 1998 reflected operating income of $4.7 million as compared to an operating loss of $2.1 million for fiscal 1997. As a percentage of net sales, operating income increased from (2.3%)in fiscal 1997 to 4.3% for fiscal 1998. Interest Expense. Interest expense increased by $.3 million to $2.4 million in fiscal 1998 from $2.1 million in fiscal 1997, net of interest capitalized of $11,000 for fiscal 1997. The increase is the result of additional borrowings on the Company's line of credit. Provision (Credit) for Income Taxes. The Company has recorded a tax provision of approximately $.9 million in fiscal 1998 as compared to a benefit of $1.6 million in fiscal 1997 at an effective tax rate of 38% for both years. As of September 26, 1998 the Company has net deferred tax assets of $6.6 million, which is net of a $2.7 million valuation allowance. Included in the $9.3 million of gross deferred tax assets is $5.4 million of net operating tax loss carryforwards which expire beginning in 2011. The realization of the 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. Taking into consideration historical pre-tax income levels, the nature of certain events which adversely affected operations in fiscal 1996 and 1997, the results of operations for fiscal 1998 and other factors, management believes it is more likely than not that the net deferred tax asset, after consideration of the valuation allowance which has been established, will be realized. The amount of the net deferred tax asset considered realizable, however, could be reduced if estimates of future taxable income during the carryforward period are reduced. Net Income. As a result of the above, fiscal 1998 reflected net income of $1.5 million as compared to a net loss of $2.6 million in fiscal 1997. As a percentage of net sales, net income increased from (2.8%) in fiscal 1997 to 1.4% in fiscal 1998. Year Ended September 27, 1997 Compared with Year Ended September 28, 1996 Net Sales. Net sales for fiscal 1997 decreased by $3.6 million (3.7%) to $94.7 million from $98.3 million for fiscal 1996 due to a decline in shipments. Total shipments for fiscal 1997 were approximately 217,000 tons, down 3.9% from fiscal 1996, while the average selling price per ton remained constant with the prior year. The decline in shipments primarily resulted from the third quarter shutdown caused by a radioactive contamination of the baghouse, continued start-up of the ladle metallurgy facility during the first half of fiscal 1997, and a ten day Melt Shop outage in the second quarter which is discussed below. Cost of Goods Sold. Cost of goods sold for fiscal 1997 increased $.2 million, or .2%, to $90.0 million from $89.8 million for fiscal 1996. As a percentage of net sales, cost of goods sold increased from 91.3% for fiscal 1996 to 95.1% in fiscal 1997. The increase in cost of goods sold is primarily due to higher conversion costs and additional depreciation, partially offset by a decrease in material costs. Conversion costs for fiscal 1997 were adversely impacted by lower production during the third quarter due to the twelve day shutdown of the Melt Shop operations required to decontaminate the baghouse facilities following detection of a radioactive substance in the baghouse dust and by the shut down and restart of the caster during the second quarter. The caster was also shut down for repairs for 10 days in late December and early January. During this 10 day shut down, the Company converted an additional caster strand to allow for increased production of thicker, wider products. The resulting shortage of billets idled the rolling mill for several days and negatively impacted rolling mill production and productivity. To a lesser degree, conversion costs were also adversely impacted by an increase in repair, maintenance and supply costs, health benefit costs and the continued start-up phase of the new ladle metallurgy facility in the first half of fiscal 1997. The cost of goods sold for fiscal 1996 includes a $1.7 million reimbursement from business interruption insurance, related to a caster fire. The fiscal year 1997 includes a $2.3 million reimbursement from business interruption insurance related to the decontamination of the baghouse in the calculation of cost of goods sold. Gross Profit. As a result of the above, gross profit for fiscal 1997 decreased by $3.8 million (45.4%) from $8.5 million in fiscal 1996 to $4.7 million in 1997. As a percentage of net sales, gross profit decreased from 8.7% in fiscal 1996 to 4.9% in fiscal 1997. 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, human resources, and other administrative departments. Selling and administrative expenses for fiscal 1997 decreased $.6 million (8.0%) to $6.8 million from $7.4 million for fiscal 1996. As a percentage of net sales, such expenses decreased from 7.5% for fiscal 1996 to 7.2% for fiscal 1997. The decrease is primarily the result of a reduction in the provision for uncollectible accounts (which was higher in the prior year due to problems with a few specific accounts). Operating Income. Fiscal year 1997 reflected an operating loss of $2.1 million as compared to operating income of $1.1 million for fiscal 1996. As a percentage of net sales, operating income decreased from 1.2% in fiscal 1996 to (2.3%) for fiscal 1997. Interest Expense. Interest expense increased by $.6 million to $2.1 million in fiscal 1997 from $1.5 million in fiscal 1996, net of interest capitalized of $11,000 and $262,000, respectively. The increase in interest expense is attributed to the additional debt incurred in financing the capital expansion projects and the reduction in capitalized interest due to the completion and start-up of the ladle metallurgy facility. Provision (Credit) for Income Taxes. The Company has recorded a tax benefit of approximately $1.6 million in fiscal 1997 as compared to a provision of $35,000 in fiscal 1996 at an effective tax rate of 38% for both years. The Company has recorded an increase in net deferred tax assets of $.7 million and has recorded refundable income taxes of $.9 million resulting from the $1.6 million benefit recorded in fiscal 1997. As of September 27, 1997 the Company has net deferred tax assets of $7.6 million, which is net of a $2.7 million valuation allowance. Included in the $10.3 million of gross deferred tax assets is $4.7 million of net operating tax loss carryforwards which expire beginning in 2011. The realization of the 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. Taking into consideration historical pre-tax income levels, the nature of certain events which adversely affected operations in fiscal 1996 and 1997, the Company's return to profitability during the third and fourth quarter of fiscal 1997, the continued improvement in productivity and other factors, management believes it is more likely than not that the net deferred tax asset, after consideration of the valuation allowance which has been established, will be realized. The amount of the net deferred tax asset considered realizable, however, could be reduced if estimates of future taxable income during the carryforward period are reduced. Net Income. As a result of the above, fiscal 1997 reflected a net loss of $2.6 million as compared to net income of $58,000 in fiscal 1996. As a percentage of net sales, net income decreased from .1% in fiscal 1996 to (2.8%) in fiscal 1997. Liquidity and Capital Resources Cash flows from operating activities amounted to $3.9 million, $2.5 million, and $2.3 million in fiscal 1996, 1997 and 1998, respectively. Fiscal 1996 operating cash flows reflect lower earnings which have partially been offset by additional depreciation and a reduction in accounts receivable and inventories. The additional depreciation is related to the equipment placed in service during the latter part of the third quarter of fiscal 1995. The decrease in accounts receivable reflects the lower average net selling price for shipments during the fourth quarter of fiscal 1996 as compared to the fourth quarter of fiscal 1995. The decrease in inventories is primarily attributed to a decrease in finished goods inventory, which has partially been offset by the increase in carrying value from the increase in conversion costs. Fiscal 1997 operating cash flows reflect the net loss of $2.6 million and the increase in the net deferred tax asset of $1.0 million, which has been partially offset by depreciation of $3.7 million, decrease in accounts receivable of $.5 million and inventories of $.8 million, and an increase in accounts payable of $.8 million. The additional depreciation is related to the start-up of the ladle metallurgy facility. The decrease in inventories is primarily related to a reduction in scrap inventory. Fiscal 1998 operating cash flows reflect net income of $1.5 million, depreciation and amortization of $3.7 million, and the decrease in net deferred tax asset of $1.2 million. Operating cash flows were negatively impacted by a $3.8 million increase in inventories. The increase in inventories is primarily attributed to an increase in finished goods inventory offset somewhat by a decrease in scrap inventory. The increase in finished goods inventory is due to lower than anticipated fourth quarter shipments in fiscal 1998 and lower than normal inventories in fiscal 1997 due to production problems. Cash flows used by investing activities consist of capital expenditures, net of changes in capital expenditures payables, of $11.2 million, $5.1 million, and $2.5 million in fiscal 1996, 1997, and 1998, respectively. The decrease in capital expenditures in fiscal 1998 is primarily due to capital expenditures returning to a more routine maintenance level following the completion of the capital expenditure program which expanded the Company's casting, rolling and finishing capacity and increased the size range of products the Company can produce, and the completion of the ladle metallurgy facility. Cash flows from investing activities for fiscal 1996 also include the proceeds from the involuntary conversion of equipment of $.9 million. Cash flows provided from financing activities amounted to $6.1 million, $2.6 million, and $.2 million in fiscal 1996, 1997, and 1998, respectively. The $6.1 million in fiscal 1996 reflects net repayments of $3.6 million on the Company's line of credit, $9.0 million repayment on long-term debt, and $1.3 million for purchases of treasury stock, offset by the proceeds of $20.0 million of unsecured senior notes. The $2.6 million in fiscal 1997 reflects $3.1 million in advances on the Company's line of credit facility offset by $.5 million used for the purchases of treasury stock. The $.2 million in fiscal 1998 reflects $.8 million in advances on the Company's line of credit facility offset by $.6 used for the purchase of treasury stock. Working capital at September 26, 1998, was $14.2 million as compared to $11.3 million at September 27, 1997. The current ratio was 1.6 to 1.0 at September 26, 1998 as compared to 1.5 to 1.0 at September 27, 1997. The increase in working capital and current ratio is primarily attributed to a decrease in capital expenditures as fiscal 1998 saw the Company return to a more routine maintenance capital expenditure level. The Company completed its 500,000 share buyback program during fiscal 1998 and the Board of Directors authorized the repurchase of an additional 500,000 shares of the Company's common stock. Subsequent to the fiscal year ended September 26, 1998, the Company repurchased 403,785 shares of common stock. The Company's primary ongoing cash requirements are for current capital expenditures. The two sources for the Company's liquidity are internally generated funds and its bank credit facility. The Company has $11.4 million in borrowings outstanding on its line of credit as of September 26, 1998. The Company believes that the bank credit facility and internally generated funds will be sufficient to fund its ongoing cash needs through the next twelve-month period. Year 2000 Compliance The following Year 2000 discussion is provided in response to the Securities and Exchange Commission's recent interpretative statement expressing its view that public companies should include detailed discussion of Year 2000 issues in their MD&A. The Company is currently assessing the issues confronting it related to the "Year 2000 problem", which is the result of the inability of many computer systems and electronic equipment to distinguish the Year 2000 from the year 1900. The Company is following an organized program to assure the Company's information technology systems and related infrastructure will be Year 2000 compliant. The Company has divided its Year 2000 issues into three areas including: computer hardware and software business systems, manufacturing processing control devices and related systems, and facility support systems. The Company's Year 2000 program includes three phases: (1) an audit and assessment phase designed to identify Year 2000 issues; (2) a modification phase designed to correct Year 2000 issues (this phase includes testing of individual modifications as they are installed); and (3) a testing phase to test entire systems for Year 2000 compliance after individual modifications have been installed and tested. The Company has completed the audit and assessment phase for both the computer hardware and software business systems and the facility support systems. The Company currently expects that the audit and assessment phase for the manufacturing process control devices and related systems will be completed by December 31, 1998. The Company is currently performing the second phase of its program including modification and testing of individual modifications on its computer hardware and software business systems. The Company expects to complete the second phase of its program for these business systems by December 31, 1998. The Company also expects to conduct final testing of its business systems in the first calendar quarter of 1999. The Company currently expects to complete modification and testing of its manufacturing control devices and related systems by the first calendar quarter of 1999. After all modifications have been made, appropriate testing of the system will be performed prior to June 30, 1999. Management has estimated that the cost for correction of Year 2000 issues, including any software and hardware changes and the cost of personnel involved in working on the project, will be approximately $300,000. The Company estimates that 25% of the total cost has been spent to date. The Year 2000 updates are being funded out of funds generated from operations and account for less than 30% of the Company's information technology budget. The Company's Year 2000 program includes investigation of the Year 2000 readiness status of our major vendors and customers. The Company is using letters, questionnaires and protocols to determine its vendors' and customers' 2000 readiness. The Company has contacted all major vendors including energy and scrap suppliers and external service providers including banks, insurance companies and phone service providers to determine their Year 2000 compliance status. If any such vendor indicates that they will not be Year 2000 compliant, the Company will develop contingency plans to address the issue, which may include identifying and developing other vendors. The Company has also contacted significant customers to determine their progress towards Year 2000 compliance and to identify issues, if any, which might develop if a customer is unable to become year 2000 compliant on a timely basis. If any issues are identified, the Company expects to develop procedures to permit the Company to continue to supply the customer despite Year 2000 issues. The Company does not have a contingency plan to operate in the event that its business systems are not Year 2000 compliant. As our work progresses, if testing scheduled for the first calendar quarter of 1999 suggests that there is a significant risk that the business systems might not be Year 2000 compliant, a contingency plan will be developed. Impact of Inflation and Changing Prices While the Company has not experienced any material long-term adverse effects on operations in recent years because of inflation, margins have been affected by inflationary conditions. The Company's primary cost components are steel scrap, labor, and energy, all of which are susceptible to domestic inflationary pressures. Scrap costs are frequently influenced by supply and demand factors as well as general economic conditions. In contrast, finished product prices are influenced by nationwide economic trends and manufacturing capacity within the steel industry. While the Company has generally been successful in passing on cost increases through price increases, the effect of steel imports, market price competition and under-utilized industry capacity has in the past, and could in the future, limit the Company's ability to increase prices. See "Business - Employees," "Competition and Other Market Factors," "Raw Materials" and "Manufacturing Operation." Forward Looking Statements The matters discussed or incorporated by reference in this Report on Form 10-K 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, the reliance on 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 estimates of niche market data; the cyclical and capital intensive nature of the industry; and cost of compliance with environmental regulations. These risks and uncertainties could cause actual results of the Company to differ materially from those projected or implied by such forward-looking statements. Without limiting the foregoing, various statements in the previous discussion of Year 2000 are likewise forward-looking statements. These statements include statements of the Company's expectations, statements with regard to schedules and expected completion dates and statements regarding expected Year 2000 compliance. These forward-looking statements are subject to various risk factors which may materially affect the Company's efforts to achieve Year 2000 compliance. These risk factors include the inability of the Company to complete the plans and modifications that it has identified, the failure of software vendors to deliver the upgrades and repairs to which they have committed, the wide variety of information technology systems and components, both hardware and software, that must be evaluated and the large number of vendors and customers with which the Company interacts. The Company's assessments of the effects of Year 2000 on the Company are based, in part, upon information received from third parties and the Company's reasonable reliance on that information. Therefore, the risk that inaccurate information is supplied by third parties upon which the Company reasonably relied must be considered as a risk factor that might affect the Company's Year 2000 efforts. The Company is attempting to reduce the risks by utilizing an organized approach, extensive testing, and allowance of ample contingency time to address issues identified by tests. Impact of Recent Accounting Pronouncements See Note 2 "Summary of Significant Accounting Policies" of the Notes to Consolidated Financial Statements of the Company. Item 7A. Qualitative and Quantitative Disclosure about Market Risk Management does not believe that there is any material market risk exposure with respect to derivative or other financial instruments that would require disclosure under this item. Item 8. Financial Statements and Supplementary Data The financial statements and schedules referenced in Item 14(a)(1) and (a)(2) hereof are included herein and are filed as part of this report. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None. PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K (a)1. See Index to Financial Statements and Schedule (a)2. See Index to Financial Statements and Schedule (a)3. Exhibits 3.1 Certificate of Incorporation of Kentucky Electric Steel, Inc., filed as Exhibit 3.1 to Registrant's Registration Statement 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. 4.1 Senior Note Agreement between Registrant and a group of institutional investors. Filed as Exhibit 4.1 to Registrant's Form 10-K for the fiscal year ended September 30, 1995, File No. 0-22416, and incorporated by reference herein. 4.2 Amended and Restated Loan Agreement between Registrant and National City Bank, Kentucky, dated November 1, 1995. Filed as Exhibit 4.2 to Registrant's Form 10-K for the fiscal year ended September 30, 1995, File No. 0-22416, and incorporated by reference herein. 4.3 Amended and Restated Export Financing Agreement between Registrant and National City Bank, Kentucky, dated November 1, 1995. Filed as Exhibit 4.3 to Registrant's Form 10-K for the fiscal year ended September 30, 1995, File No. 0-22416, and incorporated by reference herein. 4.4 First Amendment Agreement to Senior Note Agreement between Registrant and a group of institutional investors. Filed as Exhibit 4.4 to Registrant's Form 10-Q, No. 0-22416, filed on February 11, 1997, and incorporated by reference herein. 4.5 Amendment No. 1 to Amended and Restated Loan Agreement between Registrant and National City Bank, Kentucky. Filed as Exhibit 4.5 to Registrant's Form 10-Q No. 0-22416, filed on February 11, 1997, and incorporated by reference herein. 4.6 Amendment No. 2 to Amended and Restated Loan Agreement between Registrant and National City Bank, Kentucky. Filed as Exhibit 4.6 to Registrant's Form 10-Q, No. 0-22416, filed on February 9, 1998, and incorporated by reference herein. 4.7 Amendment No. 1 to Amended and Restated Export Financing Agreement between Registrant and National City Bank, Kentucky. Filed as Exhibit 4.7 to Registrant's Form 10-Q, No. 0-22416, filed on February 9, 1998, and incorporated by reference herein. 10.1 Transfer Agreement between NS Group, Inc., Kentucky Electric Steel Corporation, and Registrant, filed as Exhibit 10.2 to Registrant's Form 10-K for the fiscal year ended September 25, 1993, File No. 0-22416, and incorporated by reference herein. 10.2 Tax Agreement between NS Group, Inc., Kentucky Electric Steel Corporation and Registrant, filed as Exhibit 10.3 to Registrant's Form 10-K for the fiscal year ended September 25, 1993, File No. 0-22416, and incorporated by reference herein. 10.3 Form of Indemnification Agreement between Registrant and Its Executive Officers and Directors, filed as Exhibit 10.4 to Amendment No. 1 to Registrant's Registration Statement on Form S-1 (No. 33-67140), and incorporated by reference herein.* 10.4 Registration Rights Agreement between Registrant and NS Group, Inc., filed as Exhibit 10.7 to Registrant's Form 10-K for the fiscal year ended September 25, 1993, File No. 0- 22416, and incorporated by reference herein. 10.5 Kentucky Electric Steel, Inc. 1993 Employee Stock Option/ Restricted Stock Plan, filed on Registrant's Form S-8 (No. 33-77598), filed on April 12, 1994, and incorporated by reference herein.* 10.6 Kentucky Electric Steel, Inc. 1993 Transition Stock Option Plan, filed on Registrant's Form S-8 (No. 33-77598), filed on April 12, 1994, and incorporated by reference herein. 10.7 Contract with Morgan-Pomini Company for Rolling and Finishing End Modernization filed as Exhibit 10.8 to Registrant's Form 10-Q, No. 0-22416, filed on May 4, 1994, and incorporated by reference herein. 10.8 The Kenucky Electric Steel, Inc. Salary Continuation Plan, effective June 7, 1994, for the benefit of the Company's eligible salaried employees, filed as Exhibit 10.10 to Registrant's Form 10-K for the fiscal year ended September 24, 1994, File No. 0-22416, and incorporated by reference herein.* 10.9 The Kentucky Electric Steel, Inc. Executive Severance Plan, effective June 7, 1994, for the benefit of the Company's eligible Executive Officers, filed as Exhibit 10.11 to Registrant's Form 10-K for the fiscal year ended September 24, 1994, File No. 0-22416, and incorporated by reference herein.* 10.10 Employment agreements dated June 7, 1994, between Kentucky Electric Steel, Inc. and its four Executive Officers, as amended, filed herewith.* 10.11 Salary Continuation Agreements entered into between Kentucky Electric Steel, Inc. and its four Executive Officers, filed herewith.* 10.12 The Kentucky Electric Steel, Inc. Key Employee Stock/Loan Plan, effective February 2, 1995 for the benefit of the Company's Executive Officers, filed as Exhibit 10.14 to Registrant's Form 10-Q, No. 0-22416, filed on February 9, 1995, and incorporated by reference herein.* 10.13 Contract with EMC International, Inc. for Ladle Metallurgy Facility, filed as Exhibit 10.15 to Registrant's Form 10-Q, No. 0-22416, filed on May 16, 1995, and incorporated by reference herein. 10.14 Kentucky Electric Steel, Inc. 1994 Employee Stock Option/ Restricted Stock Plan, filed on Registrant's Form S-8 (No. 33-301218), filed on February 12, 1996, and incorporated by reference herein.* 10.15 Rights Agreement between Kentucky Electric Steel, Inc. and Wachovia Bank of North Carolina, N.A., dated as of February 27, 1996, filed as Exhibit 4 to Registrant's Form 8-K, File No. 0-22416, filed on February 28, 1996 and incorporated by reference herein. 10.16 First Addendum to Agreement with Morgan-Pomini Company for Rolling and Finishing Fund Modernization, filed as Exhibit 10.15 to Registrant's Form 10-Q, No. 0-22416, filed on February 11, 1997, and incorporated by reference herein. 10.17 Remediation and Waste Disposal Agreement - Zhagrus Environmental, Inc., filed as Exhibit 10.16 to Registrant's Form 10-Q, No. 0-22416 filed on May 12, 1997 and incorporated by reference herein. 10.18 The Kentucky Electric Steel, Inc. Share Plan for Non-Employee Directors, filed as Exhibit 10.19 to Registrant's Form 10-K, No. 0-22416 filed on December 19, 1997 and incorporated by reference herein.* 10.19 Split Dollar Insurance Agreement dated September 1, 1998 between Kentucky Electric Steel, Inc. and its four Executive Officers, filed herewith.* 23 Consent of Arthur Andersen LLP 27 Financial Data Schedule (b) Reports on Form 8-K There were no reports on Form 8-K filed during the quarter ended September 26, 1998. * Indicates management contracts or compensatory plans or arrangements in which one or more Directors or Executive Officers of the Company participate or is a party. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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. KENTUCKY ELECTRIC STEEL, INC. December 11, 1998 By: \s\Charles C. Hanebuth Charles C. Hanebuth President, Chief Executive Officer and Chairman Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Signatures Title Date \s\Charles C. Hanebuth President, Chief Executive December 11, 1998 Charles C. Hanebuth Officer and Chairman \s\William J. Jessie Vice President, Secretary, December 11, 1998 William J. Jessie Treasurer and Chief Financial Officer (Principal Financial and Accounting Officer) \s\Clifford R. Borland Director December 11, 1998 Clifford R. Borland \s\Carl E. Edwards, Jr. Director December 11, 1998 Carl E. Edwards, Jr. \s\J. Marvin Quin, II Director December 11, 1998 J. Marvin Quin, II \s\David C. Struve Director December 11, 1998 David C. Struve REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To Kentucky Electric Steel, Inc.: We have audited the accompanying consolidated balance sheets of Kentucky Electric Steel, Inc. (a Delaware corporation) and subsidiary as of September 27, 1997 and September 26, 1998, and the related consolidated statements of operations, changes in shareholders' equity and cash flows for each of the three years in the period ended September 26, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Kentucky Electric Steel, Inc. and subsidiary as of September 27, 1997 and September 26, 1998 and the results of their operations and their cash flows for each of the three years in the period ending September 26, 1998 in conformity with generally accepted accounting principles. Arthur Andersen LLP Cincinnati, Ohio, October 28, 1998 KENTUCKY ELECTRIC STEEL, INC. CONSOLIDATED BALANCE SHEETS (Dollars in Thousands)
September September 27, 1997 26, 1998 ASSETS CURRENT ASSETS Cash and cash equivalents $ 127 $ 150 Accounts receivable, less allowance for doubtful accounts of $470 in 1997 and $460 in 1998 11,577 12,037 Insurance claim receivable 900 - Inventories 16,538 20,363 Operating supplies and other current assets 4,802 5,206 Refundable income taxes 900 - Deferred tax assets 457 648 ------- ------- Total current assets 35,301 38,404 ------- ------- PROPERTY, PLANT AND EQUIPMENT Land and buildings 4,448 4,532 Machinery and equipment 40,301 42,004 Construction in progress 2,012 3,031 Less - accumulated depreciation (11,229) (14,772) ------- ------- Net property, plant and equipment 35,532 34,795 ------- ------- DEFERRED TAX ASSETS 7,159 5,990 ------- ------- OTHER ASSETS 778 1,062 ------- ------- Total assets $ 78,770 $ 80,251 LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES Advances on line of credit $ 10,635 $ 11,397 Accounts payable 7,977 7,056 Capital expenditures payable 547 857 Accrued liabilities 3,700 3,834 Environmental liabilities 982 982 Current portion of long-term debt 125 125 ------- ------- Total current liabilities 23,966 24,251 ------- ------- LONG-TERM DEBT 20,000 20,000 ------- ------- OTHER LIABILITIES 593 808 ------- ------- Total liabilities 44,559 45,059 ------- ------- 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, 4,977,988 and 4,985,937 shares issued, respectively 50 50 Additional paid-in capital 15,665 15,671 Less treasury stock - 350,976 and 526,996 shares at cost, respectively (2,638) (3,254) Deferred compensation (170) (73) Retained earnings 21,304 22,798 ------- ------- Total shareholders' equity 34,211 35,192 ------- ------- Total liabilities and shareholders' equity $ 78,770 $ 80,251 See notes to consolidated financial statements
KENTUCKY ELECTRIC STEEL, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (Dollars in Thousands, Except Share and Per Share Data)
Year Ended September September September 28, 1996 27, 1997 26, 1998 NET SALES $ 98,320 $ 94,652 $109,456 COST OF GOODS SOLD 89,783 89,992 97,720 ------- ------- ------- Gross profit 8,537 4,660 11,736 SELLING AND ADMINISTRATIVE EXPENSES 7,391 6,800 7,011 ------- ------- ------- Operating income (loss) 1,146 (2,140) 4,725 INTEREST EXPENSE (1,453) (2,125) (2,395) INTEREST INCOME AND OTHER 31 34 80 GAIN ON INVOLUNTARY CONVERSION OF EQUIPMENT 369 - - ------- ------- ------- Income (loss) before income taxes 93 (4,231) 2,410 PROVISION (CREDIT) FOR INCOME TAXES 35 (1,599) 916 ------- ------- ------- Net income (loss) $ 58 $ (2,632) $ 1,494 NET INCOME (LOSS) PER COMMON SHARE - BASIC AND DILUTED $ .01 $ (.57) $ .32 WEIGHTED AVERAGE SHARES OUTSTANDING - BASIC 4,806,161 4,633,315 4,624,671 WEIGHTED AVERAGE SHARES OUTSTANDING - DILUTED 4,806,485 4,633,315 4,630,920 See notes to consolidated financial statements
KENTUCKY ELECTRIC STEEL, INC. CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY For the Three Years in the Period Ended September 26, 1998 (Dollars in Thousands)
Addi- tional Deferred Common Stock Paid-In Treasury Stock Compen- Retained Shares Amount Capital Shares Amount sation Earnings Total BALANCE, Sept. 30, 1995 4,974,099 $50 $15,710 (100,000) $ (869) $(672) $23,878 $38,097 Stock loan grants - - - - - (32) - (32) Amortization of deferred comp- ensation - - - - - 283 - 283 Purchases of treasury stock - - - (173,000) (1,296) - - (1,296) Net income - - - - - - 58 58 --------- -- ------ ------- ----- --- ------ ------ BALANCE, Sept. 28, 1996 4,974,099 50 15,710 (273,000) (2,165) (421) 23,936 37,110 Tax effect of restricted stock recognized differ- ently for financial reporting and tax purposes - - (66) - - - - (66) Amortization of deferred comp- ensation - - - - - 251 - 251 Issuance of stock 3,889 - 21 - - - - 21 Purchases of treasury stock - - - (77,976) (473) - - (473) Net (loss) - - - - - - (2,632) (2,632) --------- -- ------ ------- ----- --- ------ ------ BALANCE, Sept. 27, 1997 4,977,988 50 15,665 (350,976) (2,638) (170) 21,304 34,211 Tax effect of restricted stock recognized differ- ently for financial reporting and tax purposes - - (42) - - - - (42) Amortization of deferred comp- ensation - - - - - 97 - 97 Issuance of stock 7,949 - 48 - - - - 48 Purchases of treasury stock - - - (176,020) (616) - - (616) Net income - - - - - - 1,494 1,494 --------- -- ------ ------- ----- --- ------ ------ BALANCE, Sept. 26, 1998 4,985,937 $50 $15,671 (526,996) $(3,254) $(73) $22,798 $35,192 See notes to consolidated financial statements
KENTUCKY ELECTRIC STEEL, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in Thousands)
Year Ended September September September 28, 1996 27, 1997 26, 1998 Cash Flows From Operating Activities: Net income (loss) $ 58 $ (2,632) $ 1,494 Adjustments to reconcile net income (loss) to net cash flows from operating activities: Depreciation and amortization 2,769 3,737 3,683 Gain on involuntary conversion of equipment (369) - - Change in deferred taxes 618 (896) 1,169 Change in other (257) (158) (154) Changes in current assets and current liabilities: Accounts receivable 815 536 (460) Insurance claim receivable - (900) 900 Inventories 838 829 (3,825) Operating supplies and other current assets 206 265 (404) Refundable income taxes (88) (360) 900 Deferred tax assets (487) 223 (191) Accounts payable (81) 763 (921) Accrued liabilities (74) 61 134 Environmental liabilities - 982 - ------ ------ ------ Net cash flows from operating activities 3,948 2,450 2,325 ------ ------ ------ Cash Flows From Investing Activities: Proceeds from involuntary conversion of equipment 912 - - Capital expenditures (10,509) (3,226) (2,806) Change in capital expenditures payable (672) (1,858) 310 ------ ------ ------ Net cash flows from investing activities (10,269) (5,084) (2,496) ------ ------ ------ Cash Flows From Financing Activities: Net advances (repayments) on line of credit (3,585) 3,089 762 Repayments on long-term debt (9,001) - - Proceeds from long-term debt borrowings 20,000 - - Issuance of common stock - 21 48 Purchases of treasury stock (1,296) (473) (616) ------ ------ ------ Net cash flows from financing activities 6,118 2,637 194 ------ ------ ------ Net increase (decrease) in cash and cash equivalents (203) 3 23 Cash and Cash Equivalents - Beg. of Period 327 124 127 ------ ------ ------ Cash and Cash Equivalents - End of Period $ 124 $ 127 $ 150 Interest Paid, net of amount capitalized $ 884 $ 2,142 $ 2,371 Income Taxes Paid $ 376 $ - $ 200 See notes to consolidated financial statements
KENTUCKY ELECTRIC STEEL, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (1) Nature of Operations Kentucky Electric Steel, Inc. (KESI or the Company) 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. KESI was capitalized in an initial public offering of its common stock on October 6, 1993. (2) Summary of Significant Accounting Policies Principles of Consolidation The 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. All significant intercompany accounts and transactions have been eliminated. Accounting Estimates The preparation of financial statements in conformity with generally accepted accounting principles 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. 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 whenever events or changes in circumstances indicate that the carrying amounts may not be recoverable. The Company capitalizes interest costs as part of the historical cost of acquiring major capital assets. Interest cost of $262,000 and $11,000 was capitalized for the years ended September 28, 1996 and September 27, 1997, respectively. No interest was capitalized for the year ended September 26, 1998. 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. Recent Accounting Pronouncements In June 1997, the Financial Accounting Standards Board issued Statement No. 130 (SFAS No. 130) "Reporting Comprehensive Income". SFAS No. 130 establishes standards for reporting and displaying comprehensive income and its components in a full set of general-purpose financial statements. The Company currently has no items of other comprehensive income; therefore, SFAS No. 130 does not currently apply. The Company is required to adopt SFAS No. 130 effective with the fiscal year ending September 25, 1999. In June 1997, the Financial Accounting Standards Board issued Statement No. 131 (SFAS No. 131) "Disclosures about Segments of an Enterprise and Related Information." SFAS No. 131 establishes standards for reporting information about operating segments in annual financial statements and interim financial reports issued to shareholders. It also establishes standards for related disclosures about products and services, geographic areas, and major customers. Management is currently evaluating the provisions of this statement to determine its impact upon current reporting. The Company is required to adopt SFAS No. 131 effective with the fiscal year ending September 25, 1999. In June 1998, the Financial Accounting Standards Board issued Statement No. 133 (SFAS No. 133) "Accounting for Derivative Instruments and Hedging Activities". SFAS No. 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, (collectively referred to as derivatives) and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. The Company does not currently have any instruments that would qualify; therefore, SFAS No. 133 does not currently apply. The Company is required to adopt SFAS No. 133 effective as of the beginning of the first fiscal quarter of 2000. Fiscal Year End The Company's fiscal year ends on the last Saturday of September. (3) Inventories Inventories at September 27, 1997 and September 26, 1998 consist of the following ($000's): 1997 1998 Raw materials $ 3,280 $ 1,984 Semi-finished and finished goods 13,258 18,379 Total inventories $16,538 $20,363 (4) Insurance Claim Receivable and Environmental Liabilities The Company's melt shop operations were shut down for twelve days during the third quarter of fiscal 1997 in order to decontaminate its baghouse facilities after detection of a radioactive substance in the baghouse dust, a by-product of the melting process. The $1.0 million in environmental liabilities recorded as a current liability on the balance sheet represents final payment due an environmental services company for treatment and disposal of the contaminated baghouse dust. Payment for the disposal will occur within the next twelve months. Although it is possible that the ultimate disposal costs may change from current estimates, the effect of the change, if any, is not expected to be material to the financial statements due to the Company having applicable insurance coverage. (5) Accrued Liabilities Accrued liabilities at September 27, 1997 and September 26, 1998 consist of the following ($000's): 1997 1998 Accrued payroll and related liabilities $ 1,431 $ 1,431 Accrued insurance and workers' compensation 1,085 820 Accrued interest payable 679 702 Other 505 881 $ 3,700 $ 3,834 (6) Long-Term Debt Long-term debt of the Company at September 27, 1997 and September 26, 1998 consists of the following ($000's): 1997 1998 Unsecured senior notes, due in equal annual installments from November 2000 through 2005, interest at 7.66% $ 20,000 $20,000 Other 125 125 20,125 20,125 Less - Current portion (125) (125) $ 20,000 $20,000 The unsecured senior notes require no principal payments for the first five years. Principal payments commence on November 1, 2000 and are due in equal annual installments over six years. These notes bear interest at the rate of 7.66% per annum, with interest paid semi- annually. The Company has a $24.5 million unsecured bank credit facility. Borrowings are limited to defined percentages of eligible inventory and accounts receivable. Interests on borrowings accrue at the rate of LIBOR plus 1.35% or the prime rate minus 1/2%. The notes and bank credit facility contain restrictive covenants, which include, among other restrictions, a maximum ratio of total funded debt to total capitalization, a minimum fixed charge coverage ratio, a minimum net worth requirement and restrictions on the payment of dividends. As of September 26, 1998, approximately $11.4 million was outstanding under the bank credit facility, approximately $1.5 million was utilized to collateralize various letters of credit and $8.0 million was available for additional borrowings. The weighted average interest rate on short-term borrowings as of September 27, 1997 and September 26, 1998 were 7.3% for both years. The estimated fair value of the Company's unsecured senior notes is estimated using discounted cash flow analysis, based upon the estimated market rate as of September 26, 1998. The fair value of the unsecured senior notes was approximately $19.7 million as of September 26, 1998 and as of September 27, 1997. (7) Significant Customers and Foreign Sales The Company grants trade credit to customers within the markets it serves. Sales to the leaf-springs suspension market represented 25.3%, 18.6%, and 14.2% of total sales for 1996, 1997 and 1998, respectively. One company, through several wholly-owned subsidiaries which are customers of the Company, represented 11.7%, 9.6% and 9.2% of net sales in fiscal 1996, 1997 and 1998, respectively. Another customer, through two wholly-owned subsidiaries, which are customers of the Company, accounted for 14.0% and 10.4% of net sales in fiscal 1997 and 1998, respectively. No other customer accounted for more than 10% of net sales. The Company's foreign sales represented 8.8%, 8.5%, and 7.5% of total sales for 1996, 1997 and 1998, respectively. (8) Income Taxes The provision (credit) for income taxes consists of the following ($000's): 1996 1997 1998 Current: Federal $(2,510) $ (900) $ 200 State (379) - - (2,889) (900) 200 Deferred: Federal 2,541 (498) 596 State 383 (201) 120 2,924 (699) 716 Total provision (credit) for income taxes $ 35 $(1,599) $ 916 The provision (credit) for income taxes differs from the amount computed by applying the statutory federal income tax rate to income before income taxes for the following reasons ($000's): 1996 1997 1998 Income tax provision (credit) at statutory tax rate of 34% $ 32 $(1,438) $ 819 State income taxes, net of federal effect 1 (103) 64 Other, net 2 (58) 33 $ 35 $(1,599) $ 916 The components of the net deferred tax asset at September 27, 1997 and September 26, 1998 are as follows ($000's): Sept. 27, Sept. 26, 1997 1998 Deferred tax components: Property, plant and equipment $ 1,126 $ (307) Intangibles 2,737 2,526 AMT credit carryforwards 1,197 1,177 NOL carryforward 4,682 5,429 Other 555 494 10,297 9,319 Valuation allowance (2,681) (2,681) Net deferred tax assets $ 7,616 $ 6,638 For Federal income tax purposes the Company has alternative minimum tax carryforwards of approximately $1.2 million, which are not limited by expiration dates. The Company also has gross operating tax loss carryforwards of approximately $16.0 million, which expire beginning in 2011. The Company has recorded deferred tax assets related to these carryforwards. 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. Taking into consideration historical pre-tax income levels, the nature of certain events which adversely affected operations in fiscal 1996 and 1997, the results of operations for fiscal 1998, and other factors, management believes it is more likely than not that the net deferred tax asset, after consideration of the valuation allowance which has been established, will be realized. The amount of the net deferred tax asset considered realizable, however, could be reduced if estimates of future taxable income during the carryforward period are reduced. (9) Profit Sharing Plans The Company has established profit sharing plans for its bargaining unit (hourly) and salaried employees. Generally, the plans require mandatory contributions of five percent of pretax profits (with a guaranteed minimum based on hours worked) for the hourly employees, and an additional discretionary contribution set by the Board of Directors for salaried employees. Expense for contributions was approximately $213,000, $219,000, and $226,000 in 1996, 1997 and 1998, respectively. (10) Earnings Per Share Statement of Financial Accounting Standards No. 128 (SFAS No. 128) related to earnings per share requires dual presentation of basic and diluted earnings per share on the face of the income statement for all entities with complex capital structures. The Company adopted SFAS No. 128 during the first quarter of fiscal 1998. The following is the reconciliation of the numerators and denominators of the basic and diluted earnings per share computations. For the Year Ended For the Year Ended September 28, 1996 September 27, 1997 Per Per Share Share Income Shares Amount (Loss) Shares Amount Amounts for Basic Earnings (Loss) Per Share $58 4,806,161 $.01 $(2,632) 4,633,315 $(.57) Effect of Dilutive Securities Options - 324 - - - - Amounts for Diluted Earnings (Loss) Per Share $58 4,806,485 $.01 $(2,632) 4,633,315 $(.57) For the Year Ended September 26, 1998 Per Share Income Shares Amount Amounts for Basic Earnings Per Share $1,494 4,624,671 $.32 Effect of Dilutive Securities Options - 6,249 - Amounts for Diluted Earnings Per Share $1,494 4,630,920 $.32 The following options were not included in the computation of diluted earnings per share because to do so would have been antidilutive for the applicable period: 1996 1997 1998 Transition stock options 169,430 158,702 92,335 Employee stock options 236,784 405,168 301,976 406,214 563,870 394,311 See Note 11 for further information regarding options outstanding. (11) Stock Option/Restricted Stock Plan The Company has Employee Stock Option/Restricted Stock Plans which provide shares of common stock for awards to eligible employees in the form of stock options and restricted stock. Awards under the plans may be made to any officer or other key employees of the Company. The options become exercisable on a pro rata basis over a period of four years beginning one year after the grant date, except for options issued in conjunction with the initial public offering, which become exercisable over a three-year period, which began on approval by the stockholders of the 1993 Employee Stock Option/Restricted Stock Plan in February 1994. All unexercised options expire ten years after the date of grant. Option and restricted stock prices range from $5.56 to $12.31 per share. The plans also provide for the issuance of restricted stock. The restricted shares vest three years after the grant date. During 1994 in connection with the initial public offering, 18,000 restricted shares were granted and issued, and vest on a pro rata basis over a period of four years beginning one year after the grant date. Compensation expense of $208,000 and $53,000 was recognized in fiscal 1997 and 1998, respectively, as a result of amortization of restricted stock grants over the vesting periods. The unamortized portion of the restricted stock is reflected in deferred compensation and was $53,000 as of September 27, 1997. The restricted stock was fully amortized as of September 26, 1998. A summary of transactions in the above plans for fiscal 1997 and 1998 are as follows: 1997 1998 Weighted- Weighted- Average Average Stock Exercise Stock Exercise Options Price Options Price Options outstanding, beginning of year 327,976 $10.11 405,168 $ 9.12 Options granted 89,192 5.56 - - Options forfeited (12,000) 9.69 (18,500) 8.46 Options outstanding, end of year 405,168 $ 9.12 386,668 $ 9.15 Options exercisable, end of year 186,505 $10.96 263,877 $10.24 Restricted shares granted - - Options and restricted shares available for grant 10,733 29,233 The 1993 Transition Stock Option Plan (the "Transition Plan") was approved by the stockholders in 1994. The Transition Plan was designed to substitute KESI stock options for previously issued NS Group stock options. KESI incentive stock options for 186,539 shares of Common Stock were issued in 1994, with exercise prices varying from $8.76 per share to $20.86 per share. A summary of transactions in the plan for fiscal 1997 and 1998 are as follows: 1997 1998 Weighted- Weighted- Average Average Stock Exercise Stock Exercise Options Price Options Price Options outstanding, beginning of year 169,430 $14.00 158,702 $14.06 Options granted - - - - Options forfeited (10,728) 13.06 (24,892) 14.69 Options expired - - (41,475) 20.86 Options outstanding, end of year 158,702 $14.06 92,335 $10.84 Options exercisable, end of year 149,720 $14.38 92,335 $10.84 The Company accounts for its stock-based compensation plans using the intrinsic value method in accordance with APB Opinion No. 25 and related interpretations. Under this method, no compensation cost has been recognized for the Company's Employee Stock Option Plan for fiscal years 1996, 1997, and 1998. Had compensation cost for the stock options granted in fiscal 1996 and 1997 been determined based on the fair value of the options at the grant dates for awards under those plans consistent with the fair value method pro forma net income and basic and diluted earnings per share would have been a net loss of $4,000 and $.00 per share for fiscal 1996, a net loss of $2.7 million and $.59 per share for fiscal 1997, and net income of $1.4 million or $.30 per share for fiscal 1998. These pro forma disclosures are not likely to be representative of the effect on reported net income and basic and diluted earnings per share for future years since current options vest over a three to four year period and additional options are generally granted each year. The weighted-average fair value of options granted in fiscal 1996 and fiscal 1997 was $4.38 and $3.15 per share, respectively. The fair value of each option is estimated on the date of grant using the Black- Scholes options pricing model with the following assumptions: weighted average risk free interest rate of 6.96% for fiscal 1996 and 6.59% for fiscal 1997, weighted average volatility of 38.4%, expected life of eight years and zero dividends. The Company did not grant any options in fiscal 1998. The following table summarizes information about stock options outstanding at September 26, 1998 under the Employee Stock Option/Restricted Stock Plans and the Transition Plan: Options Outstanding Options Exercisable Weighted- Average Weighted- Weighted- Number Remaining Average Number Average Range of Outstanding Contractual Exercise Exercisable Exercise Exercise Prices at 9/26/98 Life Price at 9/26/98 Price Employee Stock Option/Restricted Stock Plans: $ 5.56 - 7.63 165,884 8.12 Years $ 6.57 62,642 $ 6.92 9.13 - 12.31 220,784 6.00 Years 11.09 201,235 ll.28 5.56 - 12.31 386,668 6.91 Years 9.15 263,877 10.24 Transition Plan: $ 8.76 - 9.05 60,405 3.88 Years $ 8.86 60,405 $ 8.96 14.40 - 19.57 31,930 .71 Years 14.60 31,930 l4.60 8.76 - 19.57 92,335 2.78 Years 10.84 92,335 10.84 The Company has a key employees' stock loan plan which provides for the granting of loans to eligible employees for the purchase of the Company's common stock in the open market. Under the terms of the plan, the loans are forgiven, and the related amounts expensed, on a pro-rata basis over a five-year period of service beginning at the date of grant. The unamortized balance due from eligible employees under the plan is reflected as deferred compensation and shown as a reduction of shareholders' equity and was $117,000 and $73,000 as of September 27, 1997 and September 26, 1998, respectively. In fiscal 1997 and fiscal 1998, the Company recognized $43,000 and $44,000 of compensation expense related to the plan. During 1997, the Board of Directors established the Kentucky Electric Steel, Inc. Share Plan for Non-Employee Directors (the "Plan"), which provides for the issuance of stock in lieu of cash for director services. Under the Plan, 25,000 shares were authorized for issuance. The Plan provides for issuance of common stock for at least 60% of the fees payable with respect to the applicable meeting for each Non-Employee Director. During fiscal 1997, 3,889 shares were issued at stock prices ranging from $5.13 to $5.50 per share. During fiscal 1998, 7,949 shares were issued at stock prices ranging from $3.50 to $6.94 per share. (12) Shareholders' Equity Each share of common stock outstanding (and each share of common stock issued prior to the occurrence of certain events) carries with it one Preferred Stock Purchase Right (a Right) to purchase at a price of $40, one-hundredth of a share of Series A Junior Participating Preferred Stock. The Rights are exercisable only if a person or group acquires or announces a tender offer which would result in ownership of 20% or more of the common stock. The Company can redeem the Rights for $.01 per Right at any time prior to the time a person or group acquires 20% or more of the Company's shares. Following the acquisition of 20% or more of the Company's common stock by a person or group, the holders of the Rights will be entitled to purchase additional shares of Company common stock at one-half the then current market price, and, in the event of a subsequent merger or other acquisition of the Company, to buy shares of common stock of the acquiring entity at one-half of the market price of those shares. In neither event, however, would the acquiring person or group be entitled to purchase shares at the reduced price. In connection with the shareholder rights plan, which was adopted by the Board of Directors on February 27, 1996, 150,000 shares of the Company's 1,000,000 authorized shares of preferred stock have been designated as Series A Junior Participating Preferred Stock. No shares of the Series A Junior Participating Preferred Stock have been issued. (13) 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 and other matters, which seek remedies or damages. The Company believes that any liability that may ultimately be determined will not have a material effect on its financial position or results of operations. The Company generates both hazardous wastes and non-hazardous wastes, which are subject to various governmental regulations. Estimated 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. The Company is not aware of any asserted or unasserted environmental claims against the Company and no accruals for such matters have been recorded in the accompanying balance sheets except as disclosed in Note 4. However, discovery of unknown conditions could result in the recording of accruals in the periods in which they become known. (14) Quarterly Financial Data (Unaudited) Quarterly results of operations (in thousands, except share and per share amounts) for fiscal 1997 and fiscal 1998 are as follows: First Second Third Fourth Quarter Quarter Quarter Quarter 1997 Net sales $ 23,382 $ 23,159 $ 22,724 $ 25,387 Gross profit $ (14) $ (456) $ 2,370 $ 2,760 Net income (loss) $ (1,384) $ (1,659) $ 45 $ 366 Net income (loss) per common share - basic and diluted $ (.30) $ (.36) $ .01 $ .08 Weighted average shares outstanding - basic 4,658,691 4,626,639 4,622,062 4,626,414 Weighted average shares outstanding - diluted 4,658,691 4,626,639 4,622,062 4,626,414 1998 Net sales $ 26,020 $ 29,610 $ 27,751 $ 26,075 Gross profit $ 2,340 $ 3,423 $ 3,457 $ 2,516 Net income $ 41 $ 563 $ 652 $ 238 Net income per common share - basic and diluted $ .01 $ .12 $ .14 $ .05 Weighted average shares outstanding - basic 4,626,383 4,626,033 4,626,375 4,619,893 Weighted average shares outstanding - diluted 4,643,073 4,630,520 4,630,192 4,619,893 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To Kentucky Electric Steel, Inc.: We have audited, in accordance with generally accepted auditing standards, the consolidated financial statements included in Kentucky Electric Steel, Inc.'s annual report on Form 10-K, and have issued our report thereon dated October 28, 1998. Our audit was made for the purpose of forming an opinion on those statements taken as a whole. The schedule listed in item 14(a)2 is the responsibility of the Company's management and is presented for purposes of complying with the Securities and Exchange Commission's rules and regulations and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole. Arthur Andersen LLP Cincinnati, Ohio, October 28, 1998 SCHEDULE II KENTUCKY ELECTRIC STEEL, INC. VALUATION AND QUALIFYING ACCOUNTS (Dollars in Thousands) Reserves Deducted from Assets in Balance Sheets Allowance for Doubtful Accounts (1) BALANCE, September 30, 1995 ..................... $ 625 Additions: Charged to costs and expenses ............... 651 Deductions: Net charge-off of accounts deemed uncollectible ......................... 470 --- BALANCE, September 28, 1996 ..................... 390 Additions: Charged to costs and expenses ............... 120 Deductions: Net charge-off of accounts deemed uncollectible ......................... (40) --- BALANCE, September 27, 1997 ..................... 470 Additions: Charged to costs and expenses ............... (10) Deductions: Net charge-off of accounts deemed uncollectible ......................... - --- BALANCE, September 26, 1998 ..................... $ 460 (1) Deducted from accounts receivable. EX-10.10 2 EMPLOYMENT AGREEMENT THIS AGREEMENT made this 1st day of September, 1998, by and between Kentucky Electric Steel, Inc., with its principal office in Ashland, Kentucky (the "Company"), and ________________________, residing at_______________________ (hereinafter called the "Executive"). WITNESSETH WHEREAS, the Company and the Executive executed an Employment Agreement effective as of June 7, 1994 ("Agreement"); and WHEREAS, the parties desire to amend and restate the Agreement to define the term "Change of Control" as if included in the original Agreement; NOW, THEREFORE, the Agreement is amended and restated in its entirety to read as follows: I. Employment Duties and Term A. Beginning on the Commencement Date (as hereinafter defined) the Company agrees to employ the Executive at not lower than the office held on the Commencement Date and the Executive agrees to faithfully and to the best of his ability discharge the responsibilities of said office and perform such duties and services of an executive, administrative and managerial nature as shall be specified and designated from time to time by the Board of Directors of the Company in connection with the business and activities of the Company. The Executive's duties and responsibilities shall be those normally associated with such office. The Executive's duties may be reasonably modified from time to time following the Commencement Date by the Board of Directors, but there shall be no significant change in his duties, position, title, job responsibility and authority, office facilities, support staff, growth potential and opportunity, or job location without his specific written agreement. The Executive agrees that during the Employment Period (as defined in Section I, B hereof), he shall devote substantially all his professional time and effort to the performance of his duties hereunder except for (i) time spent in managing his personal investments and services on corporate, civic or charitable boards or committees, in each case not significantly interfering with the performance of such duties, and (ii) periods of vacation and sick leave to which he is entitled. Furthermore, the Executive agrees that during the Employment Period, he shall refrain from engaging on his own behalf or on behalf of a third party, including without limitation, any customer or supplies of the Company, in any line of activities or business in which he knows or has reason to know that the Company is or is considering becoming engaged during the Employment Period or in any related activities or business without the express written consent of the Board of Directors of the Company. B. The term of the Executive's employment under this Agreement (the "Employment Period") shall commence on the effective date of a Change of Control (as hereinafter defined) ("Commencement Date") and shall be for an initial period commencing on the Commencement Date and ending on the third anniversary hereof (the "Initial Term"), plus all Renewal Periods, if applicable. After the Initial Term, this Agreement shall be automatically renewed for subsequent three (3) year periods (each such three (3) year period being referred to herein as a "Renewal Period") unless, no later than (i) one (1) year prior to the expiration of the Initial Term, or, (ii) if during a Renewal Period, one (1) year prior to the expiration of such Renewal Period, either party gives written notice of cancellation to the other party. After timely notice of cancellation has been given as required above, the Employment Period shall continue until the expiration of the Initial Term or the then current Renewal Period, as applicable, and the term "Termination Date," as used herein, shall be the last day of the Initial Term, or such Renewal Period, as applicable. The provisions of this Agreement shall not apply if, for any reason (other than as set forth in the following sentence), the Executive is not employed by the Company on the Commencement Date. The provisions of this Agreement shall apply in the event the Executive's employment is terminated prior to, but in connection with, a Change of Control, by the Company's Board of Directors in the exercise of its fiduciary duties as part of a negotiation with a third party that requires such termination of employment as a condition of consummating a transaction resulting in a Change of Control. II. Compensation and Termination A. During the Employment Period, the Company shall pay to the Executive, and the Executive agrees to accept as compensation for his services hereunder, a base annual salary in the amount of not less than the level in effect on the Commencement Date, payable in the manner and at the times the Company pays its senior executives. Such base annual salary shall be increased on each anniversary of the Commencement Date by an amount not less than that which is substantially similar, on a percentage basis, to the average percentage increase in base salary for all corporate officers of the Company during the preceding twelve (12) months. "Base Salary" at any time shall mean the Executive's base annual salary as adjusted by the Board of Directors and as in effect at the time in question. In addition to his Base Salary, the Executive shall be entitled to participate in and receive compensation pursuant to the Company's Incentive Bonus Plan, the Company's 1993 Incentive Stock Option Plan and all other benefit, bonus and stock plans that now exist or as may exist in the future (collectively, the "Benefit Plans"). B. In the event the Company terminates Executive's employment Without Cause (as defined in this Section II B below), the Company's obligation to pay Executive the compensation set forth herein shall nevertheless continue until the Termination Date. For the purposes of this Agreement, a termination "Without Cause" shall mean a termination by the Company for any reason other than for Cause (as defined in Section II C hereof) or Disability, and the Executive's employment with the Company shall be deemed terminated Without Cause by the Company in the event of a termination resulting from a change in duties, position, title, job responsibility and authority, office facilities, support staff, growth potential and opportunity, compensation, job location, or senior management of the Company which, in the reasonable judgement of the Executive, would have a material adverse impact on the Executive or the nature of work performed by the Executive, or which would require him to change the location of his residence to avoid a commuting distance greater than the greater of (i) his commuting distance prior to the change and (ii) thirty (30) miles. C. In the event that the Company terminates the Executive's employment under this Agreement for "Cause" (as hereinafter defined), except as provided in Section III, the Executive shall cease to receive compensation as of the date of termination of his employment. For the purpose of this Agreement, "Cause" shall mean (i) an act or acts of dishonesty on the Executive's part which are intended to result in the Executive's substantial personal enrichment at the expense of the Company or (ii) any gross misconduct by the Executive in the performance of his duties or responsibilities set forth in Section I hereof which is demonstrably willful and deliberate on the Executive's part and which results in material injury to the Company after written demand to cease such misconduct by the Board of Directors of the Company is delivered to the Executive. "Cause" shall not include any mistake of fact or opinion made in good faith with respect to the Company's business. III. Change of Control A. 1. In the event of a Change of Control (as hereinafter defined) which causes this Agreement to commence, Executive may terminate his employment hereunder at any time during the period commencing six (6) months following the Change of Control and ending thirty-six (36) months following the Change of Control. If (a) the Executive shall terminate his employment during such period for any reason other than death or Disability, (b) the Company shall terminate the Executive's employment during the Change of Control Period (as hereinafter defined) for any reason, or (c) the Executive terminates his employment during the first six (6) months of the Change of Control Period for Good Reason as hereinafter defined, the Company shall pay to the Executive upon such termination of employment, in a single lump cash sum, an amount equal to One Dollar ($1.00) less than 300% of Employee's Base Amount as hereinafter defined. Such payment shall be in lieu of further Base Salary payments under Section II except as otherwise provided in Section II-B. Notwithstanding anything to the contrary contained herein, nothing in this Agreement shall relieve the Company of its obligation of providing the Executive with all benefits in accordance with the terms of the Benefit Plans in which the Executive participates. 2. In addition to the foregoing, if requested by the Executive, the Company will purchase the Executive's principal residence at any time requested by the Executive within a period of two (2) years following termination of employment; provided, however, that the purchase price of the residence shall be the fair market value of such residence as established by the average of appraisals submitted by three (3) independent appraisers mutually selected by the Executive and the Company. B. 1. The term "Good Reason" shall mean the failure of the company to comply with the following requirement: During the Change of Control Period, (i) the Executive's Base Salary, position (including status, offices, titles and reporting requirements), authority, duties and responsibilities shall be at least commensurate in all material respects with the most significant of those held or exercised by or assigned to the Executive at any time during the 90-day period immediately preceding the date of the Change of Control and (ii) Executive's services shall be performed at the location where Executive was employed immediately preceding the date of the Change of Control. 2. The term "Base Amount" shall mean Executive's average annual compensation from the Company (as reported on Form W-2) for the five consecutive calendar years (or such lesser period as constitutes Executive's total years of employment with the Company) ending with the calendar year immediately preceding the Change of Control. 3. The term "Change of Control" shall mean (i) the consummation of (A) any consolidation or merger of the Company in which the Company is not the continuing or surviving corporation or pursuant to which shares of the Company's Common Stock would be converted into cash, securities or other property, other than a merger of the Company in which the holders of the Company's Common Stock immediately prior to the merger have substantially the same proportionate ownership of common stock of the surviving corporation immediately after the merger, or (B) any sale, lease, exchange or transfer (in one transaction or a series of related transactions) of all or substantially all the assets of the Company, or (ii) the approval by the shareholders of the Company of any plan or proposal for the liquidation or dissolution of the Company, other than in connection with a bankruptcy or reorganization proceeding of the Company under applicable federal or state bankruptcy laws, or (iii) any "person" (as such term is used in Sections 13(d) and 14(d)(2) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), other than the Company or a subsidiary thereof or any employee benefit plan sponsored by the Company or a subsidiary thereof, becoming the beneficial owner (within the meaning of Rule 13d-3 under the Exchange Act) of securities of the Company representing 20% or more of the combined voting power of the Company's then outstanding securities ordinarily (and apart from rights accruing in special circumstances) having the right to vote in the election of directors, as a result of a tender or exchange offer, open market purchases, privately-negotiated purchases or otherwise, or (iv) at any time during a period of two (2) consecutive years, individuals who at the beginning of such period constituted the Board of Directors of the Company ceasing for any reason to constitute at least a majority thereof, unless the election or the nomination for election by the Company's shareholders of each new director during such two-year period was approved by a vote of at least two-thirds of the directors then still in office who were directors at the beginning of such two-year period. 4. The term "Change of Control Period" shall mean the period beginning on the date of the Change of Control and ending thirty- six (36) months thereafter. C. Notwithstanding anything else contained herein, if the aggregate of the payments to be made under this Agreement as a result of a Change of Control, either alone or together with other payments to which the Executive is entitled from the Company, would constitute an "excess parachute payment" (as defined in Section 280G of the Internal Revenue Code of 1986, as amended (the "Code")), such total payments shall be reduced to the largest amount as will result in no portion of the payments made hereunder being subject to the excise tax imposed by Section 4999 of the Code or being disallowed as a deduction by the Company under Section 280G of the Code. The determination of any reduction in payments hereunder pursuant to the foregoing provisions shall be made by the Executive in good faith after consultation with the Company, and such determination shall be conclusive and binding on the Company. The Company shall cooperate in good faith with the Executive in making such determination and providing the necessary information for this purpose. IV. Executive's Rights Under Certain Plans and Policies The Company agrees that the benefits provided to the Executive herein are not in lieu of any rights and privileges to which the Executive may be entitled as an employee of the Company under retirement, pension, special salary continuation plan, disability, life insurance, hospitalization, vacation, business expense reimbursement or other plan or policy which may now or hereafter be in effect, it being understood that the Executive shall have no less than the same rights and privileges to participate in such plans, policies or benefits as any other employee of the Company. V. Covenant Not to Compete and Consultation A. For the period of two (2) years after the termination of the Executive's employment hereunder for any reason, the Executive shall not engage or attempt to engage on his own behalf or on behalf of a third party, in any "Competitive Activity". The term "Competitive Activity" shall mean participation by the Executive, without the written consent of the Board of Directors of the Company, in the management of any business operation of any enterprise if such operation (a "Competitive Operation") engages in substantial and direct competition with any business operation activity conducted by the Company or its subsidiaries at the time of the termination of the Executive's employment. A business operation shall be considered a Competitive Operation if such business operation's sales of any product or service competitive with any product or service of the Company amounts to thirty percent (30%) of that business operation's total sales and if the Company's sales of said product or service of its comparable business operation amounts to thirty percent (30%) of the Company's total sales. "Competitive Activity" shall not include (i) the mere ownership of securities in any enterprise, or (ii) participation in the management of any enterprise or any business operation thereof other than in connection with a Competitive Operation of such enterprise. Without limiting the generality of the foregoing, Competitive Activity shall include becoming employed by or associated with, Stelco-McMaster Ltd., Slater Steels or Atlantic Steel Industries, Inc. In addition, the Executive shall make himself available for reasonable consultation services with the Company for two (2) years after termination of employment. B. If the restrictions set forth in the preceding paragraph or any part thereof should, for any reason whatsoever, be declared invalid by a court of competent jurisdiction, the validity or enforceability of the remainder of such restriction shall not thereby be adversely affected. The Executive agrees that the foregoing territorial and time limitations are reasonable and properly required for the adequate protection of the business of the Company and that in the event that any such territorial or time limitation is deemed to be unreasonable by a court of competent jurisdiction, then the Executive agrees and submits to the reduction of either said territorial or time limitation to such an area or period as said court shall deem reasonable. In the event that the Executive shall be in violation of the aforementioned restrictive covenants, then the time limitation thereof shall be extended for a period of time equal to the period of time during which such breach or breaches should occur. VI. Confidential Information The Executive agrees to receive Confidential Information (as defined in this Section VI below) of the Company in confidence, and not to disclose to others, assist others in the application of, or use for his own gain, such information, or any part thereof, unless and until it has become public knowledge or has come into the possession of such other or others by legal and equitable means, except in the ordinary course of the Company's business, without the express written consent of the Board of Directors of the Company. The Executive further agrees that, upon termination of his employment with the Company, all documents, records, notebooks and similar repositories containing Confidential Information, including copies thereof, then in the Executive's possession, whether prepared by him or others, shall be left with the Company. For the purpose of this Agreement, "Confidential Information" means information disclosed to the Executive or known by the Company, not generally known in the industry in which the Company is or may become engaged, about the Company's products, processes or services. VII. Remedy for Violation of Noncompetition and Confidential Information Agreements The Executive acknowledges that the Company has no adequate remedy at law and would be irreparably harmed were the Executive to breach or threaten to breach the provisions of Section V or VI hereof, and, therefore, agrees that the Company shall be entitled to injunctive relief to prevent any breach or threatened breach of Section V or VI hereof, and to specific performance of the terms of each such sections in addition to any other legal or equitable remedy it may have. The Executive further agrees that he shall not, in any equity proceeding involving him relating to the enforcement of Section V or VI hereof, raise the defense that the Company has an adequate remedy at law. Nothing in this Agreement shall be construed as prohibiting the Company from pursuing any other remedies at law or in equity that it may have or any other rights that it may have under any other agreement. VIII. Indemnification for Expense If litigation or other judicial or arbitrative proceedings shall be brought to enforce or interpret any provision contained herein, the Company, to the extent permitted by applicable law and the Company's Certificate of Incorporation and By-laws as in effect on the date hereof, hereby indemnifies the Executive for his reasonable expenses (including without limitation, attorneys' fees and disbursements) incurred in connection with such proceeding. If so requested by the Executive, the Company shall pay to the Executive an amount equal to any and all such expenses within five (5) business days after the Executive's written request, which request shall be supported by reasonably adequate documentation. IX. Successors A. The rights and obligations of the Company under this Agreement shall inure to the benefit of and shall be binding upon the Company, its successors and assigns, including without limitation, any person, partnership or corporation which may acquire all or substantially all of the Company's assets and business, or with or into which the Company may be consolidated or merged. Any and all references to the Company in this Agreement shall be deemed to mean and include any successor or assignee. B. This Agreement shall also inure to the benefit of and be binding on the Executive and his legal representatives, but being a contract for personal services, cannot be assigned by Executive. X. Severability In the event that any provision or portion of this Agreement shall be determined to be invalid or unenforceable for any reason, in whole or in part, the remaining provisions of this Agreement shall be unaffected thereby and shall remain in full force and effect to the fullest extent permitted by law. XI. Applicable Law The construction and interpretation of this Agreement shall be governed by the laws of the State of Kentucky applicable to agreements made and to be performed within Kentucky, without regard to Kentucky's conflict of laws rules. XII. No Mitigation Required The Executive shall not be obligated to seek other employment in mitigation of the amounts payable or arrangements made under any provision of this Agreement, and the obtaining of any such other employment shall in no event effect any reduction of the Company's obligations to make the payments and arrangements required to be made under this Agreement. XIII. Notice All notices under this Agreement shall be made in writing and shall be duly sent if sent by registered mail or certified mail to the respective parties' address shown hereinabove or such other address as the parties may hereafter designate in writing for such purpose. XIV. Captions and Titles Captions and titles have been used in this Agreement only for convenience, and in no way define, limit or describe the meaning of this Agreement or any part thereof. IN WITNESS WHEREOF, the parties have signed this Agreement on this 1st day of September, 1998 effective as if adopted on June 7, 1994. KENTUCKY ELECTRIC STEEL, INC. By: ________________________ ________________________ _______________________ WITNESS This Agreement has been entered into between the Company and each of the named Executive Officers. Charles C. Hanebuth Chairman and President William J. Jessie Vice President - Finance, Chief Financial Officer, Secretary and Treasurer Joseph E. Harrison Vice President - Sales and Marketing William H. Gerak Vice President - Administration EX-10.12 3 KENTUCKY ELECTRIC STEEL, INC. SALARY CONTINUATION AGREEMENT This Agreement is entered into between Kentucky Electric Steel Inc., a corporation having its principal office in Ashland, Kentucky, (herein called the "Company"), and ___________________ (herein called the "Executive"). WITNESSETH WHEREAS, Executive is employed by the Company in the capacity of ________________________________________________ and by reason thereof has acquired experience and knowledge of considerable value to the Company; and WHEREAS, the Company wishes to offer an inducement to Executive to remain in its employ by compensating him beyond his regular salary for service which he had rendered or will hereafter render; and WHEREAS, the Company and the Executive executed a Salary Continuation Agreement effective September 22, 1994 ("Agreement"); and WHEREAS, the parties desire to amend and restate the Agreement to modify certain terms and conditions; and NOW, THEREFORE, the Agreement is amended and restated in its entirety to read as follows: (1) If Executive remains in the continuous employ of the Company he shall retire from active employment with the Company on his sixty-second (62nd) birthday, unless by action of the Board of Directors his period of active employment shall be shortened, or, with his consent, extended. (2) Upon said retirement the Company, commencing with the first day of the month following the date of such retirement, shall pay Executive $____________ per month to age 85, and $________ per month thereafter for life; provided that if less than one hundred twenty (120) such monthly payments shall be made prior to the death of the Executive the Company shall continue such monthly payment of $_____________ to whomever the Executive shall have designated, on the most recent Salary Continuation Agreement Designation of Beneficiary form filed with the Company, until the full number of one hundred twenty (120) monthly payments have been made. (3) In the event Executive should die while in the active employ of the Company, the Company and the Executive have entered into a Split Dollar Life Insurance Agreement that will provide benefits to the Executive's designated beneficiary, as provided for on the most recent Salary Continuation Agreement Designation of Beneficiary form filed with the Company. (4) In the event Executive terminates employment on account of permanent and total disability (as determined by the Board of Directors), he shall receive 100% of the benefit described in Section 2 commencing at age 62. In the event Executive terminates employment on account of permanent and total disability (as determined by the Board of Directors) and dies prior to attainment of age 62, Executive's designated beneficiary, as provided for on the most recent Salary Continuation Agreement Designation of Beneficiary form filed with the Company, shall receive the benefits described in Section 3. (5) Executive agrees that he will not, during or after his employment under this Agreement, engage in competitive activity, as it is defined in Section V of the Executive's Employment Agreement with the Company, directly or indirectly, or, without the specific authority of the Company's Board of Directors, serve as a director or employee of any corporation or business entity so engaged. Executive further agrees that he will not, either during or after his employment under this Agreement, disclose to anyone not legally entitled thereto any confidential information relative to the business of the Company. (6) Executive agrees that if he shall breach any covenant of Section 5 of this Agreement, and shall continue to breach such covenant for a period of thirty (30) days after the Company shall have requested him to desist from such breach, then, any of the provisions hereof to the contrary notwithstanding, no further payments shall be due or payable by the Company hereunder either to the Executive or to his wife or other designee, and the Company shall have no further liability hereunder. (7) It is agreed that neither Executive, nor his wife, nor any other designee, shall have any right to sell, assign, transfer, or otherwise convey the right to receive any payments hereunder which payments and the right thereto are expressly declared to be non- assignable or transfer, the Company shall have no further liability hereunder. (8) If the Company shall acquire an insurance policy or any other asset in connection with the liabilities assumed by it hereinunder it is expressly agreed that neither Executive nor any beneficiary of Executive shall have any right with respect to, or claim against, such policy or other asset above or beyond the rights conveyed in any existing split dollar agreement. Such policy or asset shall not be deemed to be held in trust for the benefit of Executive or his beneficiaries or to be held in any way as collateral security for the fulfilling of the obligations of the Company under this Agreement except as may be expressly provided by the terms of such policy or title to such other asset. It shall be, and remain, a general, unrestricted asset of the Company. Executive's rights to payment hereinunder shall be not greater than those of an unsecured general creditor of the Company. (9) The Company agrees that it will not merge or consolidate with any other company or organization, or permit its business activities to be taken over by any other organization unless and until the succeeding or continuing company or other organization shall expressly assume all obligations and liabilities herein set forth. (10) This Agreement may be revoked or amended in whole or in part only by mutual consent of the parties hereto. IN WITNESS WHEREOF, the parties have caused this Agreement to be executed this 1st day of September, 1998. ATTEST: KENTUCKY ELECTRIC STEEL, INC. ______________________ By:__________________________ Secretary ______________________ By:___________________________ Witness Kentucky Electric Steel, Inc. Supplemental Schedule for Exhibit 10.12 Salary Continuation Agreement
Monthly Retirement Benefit Monthly (Ten Year Certain) Retirement Benefit Name Title Age 62 to Age 85 After Age 85 for Life Charles C. Hanebuth President and Chief Executive Officer $13,518.00 $6,200.00 William J. Jessie Vice President, Chief Financial Officer $6,636.00 $0.00 Joseph E. Harrison Vice President, Sales and Marketing $5,750.00 $0.00 William H. Gerak Vice President, Administration $5,495.00 $0.00
EX-10.19 4 KENTUCKY ELECTRIC STEEL, INC. SPLIT DOLLAR INSURANCE AGREEMENT THIS AGREEMENT made on the 1st day of September, 1998, by and between Kentucky Electric Steel, Inc., a corporation (hereinafter called the "Company") and ____________________, (hereinafter called the "executive"). WITNESSETH WHEREAS, ___________________ is a valuable and experienced Executive of the Company; and WHEREAS, the Company whishes to set up a split-dollar arrangement in order to provide insurance protection for Executive's benefit; and WHEREAS, in furtherance of the relationship of the Company and Executive, the Company desires to enter into an agreement with respect to the payment of premiums of any policy(s) purchased under the terms of this Agreement in order to provide such insurance protection; NOW THEREFORE, the parties mutually agree as follows: 1. OWNERSHIP AND PURCHASE OF INSURANCE: The Company owns a life insurance policy issued by Pacific Life (the "Insurer"), policy number _____________, on Executive's life. The parties hereto agree that any policy purchased under the terms of this Agreement shall be subject to the terms and conditions of this Agreement and of the endorsement filed with the Insurer relating to the policy. 2. BENEFICIARY PROVISION. The beneficiary provisions of any policy purchased under the terms of this Agreement shall provide that, upon Executive's death, the total combined proceeds shall be paid as follows: A. An amount equal to $_____________ to the beneficiaries designated by Executive in the manner and in the amounts provided in the beneficiary designation provision of any policy purchased under the terms of this Agreement. Executive shall have the absolute right during the terms of this Agreement to designate beneficiaries for the above portion of the death benefit provided under any policy purchased under the terms of this Agreement. The parties agree that the beneficiary designation provision of any policy purchased under the terms of this Agreement shall conform to the provisions of this Agreement. B. To the Company, the portion of the proceeds in excess of $________________. 3. OWNERSHIP. Except for Executive's right to designate or change the beneficiary of any policy purchased under the terms of this Agreement as to the amount provided in paragraph 2.A hereof, the Company shall be the sole and absolute owner of the policy, and may exercise all other ownership rights granted to the owner by the terms of the policy. 4. DIVIDENDS. Any policy purchased under the terms of this Agreement shall provide that dividends are to be applied to purchase additional, paid-up insurance on Executive's life. The parties hereto agree that the dividend election provision of the policy shall conform to the provisions of this Agreement. 5. PREMIUMS. Premiums on any policy purchased under the terms of this Agreement shall be paid by the Company as they become due. The Company shall furnish Executive a statement of the amount of income reportable by Executive for Executive's federal and state income tax purposes as a result of its payment of the premiums. 6. TERMINATION OF AGREEMENT. Either party hereto, with or without the consent of the other, may terminate this Agreement by giving notice of termination in writing. This Agreement shall terminate, without notice, upon the first to occur of the following: (a) the total cessation of the business of the Company; (b) the bankruptcy, receivership or dissolution of the Company; or (c) the termination of Executive's employment for any reason other than death. Subject to the provision of this section, upon termination of the Agreement, the Company shall have the right to surrender or cancel any policy(s) purchased under the terms of this Agreement and retain proceeds hereof. 7. AMENDMENTS. Amendments may be made to this Agreement by a written agreement signed by each of the parties and attached hereto. Additional policies of insurance on Executive's life may be purchased under this Agreement by amendment to paragraph 1 hereof. 8. LIMITATION OF RIGHTS. This Agreement shall not give Executive any right or claim except to the extent that such right is specifically fixed under the terms of the Agreement. This Agreement shall not be construed to give Executive a right to be continued in the employ of the Company or as interfering with the right of the Company to terminate Executive's employment at any time. 9. EFFECT OF AGREEMENT. This Agreement shall be binding upon and inure to the benefit of the Company and its successors and assigns, and Executive and his respective successors, assigns, heirs, executors, administrators and beneficiaries. 10. GOVERNING LAW. This Agreement shall be governed and constructed in accordance with the laws of the Commonwealth of Kentucky. IN WITNESS WHEREOF, the parties have caused this Agreement to be executed as of the date first above written. ATTEST: KENTUCKY ELECTRIC STEEL, INC. _____________________ By:__________________________ Secretary _____________________ By:__________________________ Witness Kentucky Electric Steel, Inc. Supplemental Schedule for Exhibit 10.20 Split Dollar Insurance Agreement
Life Insurance Pre- retirement Name Title Policy Number Death Benefit Charles C. Hanebuth President and Chief Executive Officer 1A22856570 $2,040,000. 00 William J. Jessie Vice President and Chief Financial Officer 1A22856560 $1,000,000. 00 Joseph E. Harrison Vice President, Sales and Marketing 1A22856540 $860,000.00 William H. Gerak Vice President, Administration 1A22856530 $830,000.00
EX-23 5 EXHIBIT 23 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation by reference of our reports included in this Form 10-K into the Company's previously filed Registration Statements File Nos. 33- 301218 and 33-77598. Arthur Andersen LLP Cincinnati, Ohio, December 11, 199 EX-27 6 ART. 5 FDS FOR 10-K
5 This schedule contains summary financial information extracted from Kentucky Electric Steel, Inc.'s condensed financial statements as of and for the twelve month period ended September 26, 1998 included in this Company's annual report on Form 10-K and is qualified in its entirety by reference to such condensed financial statements. 0000910394 KENTUCKY ELECTRIC STEEL, INC. 1,000 U.S. DOLLARS 12-MOS SEP-26-1998 SEP-27-1997 SEP-26-1998 1 150 0 12,497 460 20,363 38,404 49,567 14,772 80,251 24,251 20,000 50 0 0 35,142 80,251 109,456 109,456 97,720 97,720 0 0 2,395 2,410 916 1,494 0 0 0 1,494 .32 .32
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