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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------------
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE YEAR ENDED DECEMBER 31, 2003 COMMISSION FILE NUMBER 1-9838
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NS GROUP, INC.
(Exact name of registrant as specified in its charter)
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KENTUCKY 61-0985936
(State of Incorporation) (I.R.S. Employer Identification Number)
530 WEST NINTH STREET, NEWPORT, KENTUCKY 41071
(Address of principal executive offices)
Registrant's telephone number, including area code (859) 292-6809
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
Title of each class Name of each exchange on which registered
COMMON STOCK, NO PAR VALUE NEW YORK STOCK EXCHANGE
PREFERRED STOCK PURCHASE RIGHTS NEW YORK STOCK EXCHANGE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: NONE
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 Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K [x]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2. YES [X] NO [ ]
Based on the closing sales price of June 30, 2003, as reported in The Wall
Street Journal, the aggregate market value of the voting stock held by
non-affiliates of the registrant was approximately $172.3 million.
The number of shares outstanding of the registrant's Common Stock, no par
value, was 20,908,935 at February 29, 2004.
DOCUMENTS INCORPORATED BY REFERENCE
Part III incorporates certain information by reference from the Company's
Proxy Statement dated March 12, 2004 for the Annual Meeting of Shareholders on
May 12, 2004 ("Proxy").
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TABLE OF CONTENTS
PAGE
PART I
Item 1. Business ............................................................... 3
Item 2. Properties ............................................................. 8
Item 3. Legal Proceedings ...................................................... 9
Item 4. Submission of Matters to a Vote of Security Holders .................... 9
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters ................................................ 10
Item 6. Selected Consolidated Financial Data ................................... 11
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations .......................................... 12
Item 7A. Quantitative and Qualitative Disclosures About Market
Risk ............................................................... 25
Item 8. Financial Statements and Supplementary Data ............................ 26
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure ................................ 51
Item 9A. Controls and Procedures ................................................ 51
PART III
Item 10. Directors and Executive Officers of the Registrant ..................... 51
Item 11. Executive Compensation ................................................. 51
Item 12. Security Ownership of Certain Beneficial Owners
and Management ..................................................... 51
Item 13. Certain Relationships and Related Transactions ......................... 52
Item 14. Principal Accounting Fees and Services ................................. 52
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on
Form 8-K ........................................................... 52
2
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 may cause the actual results or performance of NS Group, Inc. to
differ materially from any future results or performance expressed or implied by
such forward-looking statements. See the introductory paragraph of Management's
Discussion and Analysis of Financial Condition and Results of Operations
included in Item 7 of this report and Exhibit 99.1 to this Form 10-K for a
discussion of risks and uncertainties.
PART I
ITEM 1. BUSINESS
NS Group, Inc. was incorporated in Kentucky in 1980. As used herein, the
terms "Company", "NS Group," "we," "us" and "our" refer to NS Group, Inc. and
its wholly-owned subsidiaries - Newport Steel Corporation (Newport or Welded),
Koppel Steel Corporation (Koppel or Seamless), Erlanger Tubular Corporation
(Erlanger), and Northern Kentucky Management, Inc.
RESTRUCTURING
During the quarter ended March 31, 2001, we implemented restructuring
initiatives involving certain operations of our businesses. One initiative was
to purchase hot-rolled coils rather than manufacture them at our welded tubular
operations. As a result, we discontinued the production of hot-rolled coils by
closing the melt shop and hot strip mill operations at our welded tubular
facilities in Wilder, Kentucky effective March 31, 2001. In addition, we decided
to cease the manufacturing of special bar quality products by June 30, 2001,
which was operated from our Koppel, Pennsylvania facility. See Note 2 to the
Consolidated Financial Statements.
ENERGY PRODUCTS SEGMENT
GENERAL
We conduct our business within a single reportable business segment, which
we refer to as the Energy Products segment. Our Energy Products segment includes
welded and seamless tubular goods, primarily used in oil and natural gas
drilling and production operations, referred to as oil country tubular goods, or
OCTG. We also produce welded and seamless line pipe products used in the
transmission of oil and natural gas, as well as a limited amount of other
tubular products.
OCTG products are produced in numerous diameter sizes, gauges, grades and
end finishes. We manufacture most of our OCTG products to American Petroleum
Institute ("API") specifications. The grade of pipe used in a particular
application depends on technical requirements for strength, corrosion resistance
and other performance qualities. OCTG products are generally classified into
groupings of carbon and alloy grades. Carbon grades of OCTG products have lower
yield strength than alloy grades and, therefore, are generally used in shallower
oil and natural gas wells than alloy grades. The majority of our welded tubular
products are carbon grade and the majority of our seamless products are alloy
grade. In 2003, approximately 50% of our sales of energy products were alloy
grade compared to 51% and 55% in 2002 and 2001, respectively.
OCTG products are manufactured by both welded and seamless producers.
Welded products are produced by processing flat rolled steel into strips that
are cold-formed, welded, seam-annealed, heat-treated, and end-finished with
threads and couplings. Seamless products are produced by individually heating
and piercing solid steel billets into pipe and
3
then end finishing the pipe in a manner similar to welded pipe. The seamless
manufacturing process involves higher costs than the welded process and, as a
result, seamless products are generally priced higher than comparably sized
welded products.
Demand for our OCTG products is cyclical in nature, being dependent on the
number and depth of oil and natural gas wells being drilled in the United States
and globally. The level of drilling activity has been historically a function of
the current and anticipated prices of oil and natural gas. In addition,
shipments by domestic producers of OCTG products may be positively or negatively
affected by the amount of inventory held by producers, distributors and end
users, as well as imports of OCTG products.
The average number of oil and gas drilling rigs operating in the United
States (rig count), domestic shipments of OCTG products (excluding exports),
domestic OCTG inventories and imports of OCTG products for 2003, 2002 and 2001
were as follows:
2003 2002 2001
----------------------------
Average U.S. drill
rig count 1,029 830 1,156
OCTG shipments
(millions of tons ) 2.2 1.6 2.2
OCTG imports
(millions of tons) 0.8 0.5 0.9
OCTG inventories
(millions of tons
at year-end) 1.4 1.3 1.6
Inventory tons per rig
(at year-end) 1,254 1,540 1,852
----------------------------
(Source: Baker Hughes, Preston Pipe and Tube Report and Company estimates)
Demand for line pipe is only partially dependent on oil and natural gas
drilling activities. Line pipe demand is also dependent on factors such as the
level of pipeline construction activity, line pipe replacement requirements, new
residential construction and gas utility purchasing programs. Overall, total
domestic shipments of line pipe (excluding exports) were 1.2 million tons in
2003, 1.5 million tons in 2002, and 1.9 million tons in 2001. Total domestic
shipments of line pipe product 16 inches in diameter and smaller, the product
sizes that we produce, were 0.6 million tons in 2003, 0.7 million tons in 2002
and 1.2 million tons in 2001.
(Source for line pipe data: Preston Pipe and Tube Report)
Import levels of OCTG into the United States significantly affect the U.S.
OCTG market. High levels of imports reduce the volume sold by U.S. producers and
tend to put downward pressure on selling prices. We believe import levels are
affected by, among other things, currency exchange rates, overall world demand
for OCTG, the trade practices of foreign governments and producers and the
presence or absence of antidumping, countervailing duty or other U.S. government
orders that raise the cost or impose limits on imports.
In late 2001, the United States International Trade Commission (ITC)
reported injury from various imported steel products under Section 201 and
recommended to the President a wide-scale program of quotas and duties. However,
the ITC recommendation for quotas and duties did not include imports of oil
country tubular goods. In response, we, together with other domestic oil country
tubular goods producers, sought relief from unfair trade by filing petitions
with the ITC against certain countries. In May 2002, the ITC voted against our
suit and the case was terminated.
Since 1995, the U.S. government has been imposing duties on imports of
various OCTG products from Argentina, Italy, Japan, Korea and Mexico in response
to antidumping and countervailing duty cases filed by several U.S. companies. In
June 2001, the ITC voted to continue these duties for five more years.
Under the U.S. Continued Dumping and Subsidy Offset Act (CDSOA), tariffs
collected on dumped imports are required to be directed to the industries
harmed. These payments are made to cover certain operating expenses and
investment in manufacturing facilities. In September 2002, the World Trade
Organization (WTO) ruled that such payments violate international trade rules.
The U.S. Trade Representative appealed this ruling; however, the WTO upheld the
ruling in January 2003. We received $0.6 million in CDSOA payments in 2003. We
may not receive payments under the CDSOA in 2004 or any years thereafter, and we
cannot predict the amount of any such payments.
We cannot predict the U.S. government's future actions regarding these
duties and tariffs or any other future actions regarding import duties or other
trade restrictions on imports of OCTG and line pipe products. We expect to see
continued high levels of competition from imports.
4
PRODUCTS
Our seamless OCTG products are used as production tubing, casing and as
drill pipe. Production tubing is placed within the well and is used to convey
oil and natural gas to the surface. Casing forms the structural wall of oil and
natural gas wells to provide support and prevent caving during drilling
operations and is generally not removed after it has been installed in a well.
Drill pipe is used and may be reused to drill several wells. Our seamless OCTG
products are primarily sold as a finished upset, threaded and coupled product in
both carbon and alloy grades. Seamless production tubing and casing are commonly
used in hostile drilling environments, such as deeper wells or off-shore
drilling. The majority of our seamless OCTG product sales are of production
tubing. Our seamless products range in size from 1.9 inches to 5 inches in
outside diameter.
Our welded OCTG products are used primarily as casing in oil and natural
gas wells during drilling operations. Welded OCTG products are generally used in
wells less than 10,000 feet in depth. We sell our welded OCTG products in both a
plain end (unthreaded) condition as well as a threaded and coupled product in
both carbon and alloy grades. Our welded tubular products range in size from 4.5
to 16.0 inches in outside diameter.
Our OCTG products are inspected and tested to ensure that they meet or
exceed API specifications. Products that do not meet specification are
classified as less than prime products and are sold for use in other
applications at substantially reduced prices.
Our line pipe products are used primarily in gathering lines for the
transportation of oil and natural gas at the drilling site and in transmission
lines by both gas utility and transmission companies. Line pipe products are
shipped as a plain end product.
In addition, we also sell a limited amount of other products, including
standard pipe and piling.
MARKETS AND DISTRIBUTION
We market and sell our energy related tubular products throughout the
active drilling and production areas of North America, including the southwest
and Appalachian regions of the United States, as well as the western regions of
Canada. Our sales team of account and product managers focus on customer service
and value added products. Nearly all of our energy products are sold to domestic
distributors; some of whom sell our products into the international marketplace.
CUSTOMERS
Our OCTG and line pipe products are used by major and independent oil and
natural gas exploration and production companies in drilling and production
applications. Line pipe products are also used by gas utility and transmission
companies. Substantially all of our OCTG products are sold to domestic
distributors. Line pipe products are sold to both domestic distributors and
directly to end users. Our business philosophy is to provide on-time delivery of
competitively priced, quality products. We have long-standing relationships with
many of our larger customers. Bourland and Leverich Supply Co. Inc. and
Champions Pipe & Supply, Inc., our two largest customers, accounted for
approximately 20% and 13%, respectively, of total sales in 2003.
COMPETITION
The markets for our tubular products are highly competitive and cyclical.
Principal competitors in our primary markets include domestic and foreign
integrated producers, mini-mills and welded OCTG tubular product processing
companies. We believe that the principal competitive factors affecting our
business are price, quality and customer service.
In the small diameter seamless OCTG market in which we compete, our
principal competitors include U.S. Steel and a number of foreign producers. Our
principal competitors in the welded tubular market are Lone Star Steel Company,
Maverick Tube Corporation, IPSCO Steel, Inc. and foreign producers.
5
MANUFACTURING
Our seamless tubular products are manufactured at our facilities located in
Ambridge, Pennsylvania. We manufacture welded tubular products at our facilities
located in Wilder, Kentucky. During 2003, we made capital investments of $1.1
million in our Energy Products segment, which primarily represented replacement
and rehabilitation projects. The rated annual capacities of our welded and
seamless tubular facilities are 570,000 tons and 250,000 tons, respectively.
Capacity utilization of the welded tubular facilities during 2003 was 47%
compared to 30% in 2002 and capacity utilization for the seamless tubular
facilities was 77% during 2003 compared to 54% in 2002.
We process and finish our tubular products at facilities located at (i) the
Port of Catoosa, near Tulsa, Oklahoma; (ii) Baytown, Texas, located near
Houston, Texas; and (iii) the Seamless facilities located in Ambridge,
Pennsylvania. Our finishing processes include upsetting, which is a forging
process that thickens tube ends; heat treating, which is a furnace operation
designed to strengthen the steel; straightening; non-destructive testing;
coating for rust prevention; and threading.
All of our tube-making and finishing facilities are located on or near
major rivers or waterways, enabling us to transport our tubular products into
the southwest by barge. We ship substantially all of our seamless and welded
OCTG products destined for the southwest region by barge, which is normally a
lower cost alternative to rail and truck shipping.
We manufacture our seamless tubular products in a mini-mill environment.
The term mini-mill connotes a mill that typically uses steel scrap as its basic
raw material and offers a limited range of products. At our Seamless facilities,
steel scrap is melted in an electric arc furnace and poured into continuous
casting machines which cast tube rounds. These tube rounds are reheated, pierced
and rolled to specific size and wall thickness. The Seamless facility's melt
shop is rated at an annual capacity of 450,000 tons and capacity utilization
during 2003 was 49% compared to 32% in 2002.
At our Welded facility, the manufacturing process begins by feeding steel
coils into the material handling equipment of one of two welded pipe-making
facilities where they are fed through a series of rolls that cold-form it into a
tubular configuration. The resultant tube is welded in-line by a high-frequency
electric resistance welder and cut into designated lengths. After exiting the
mill, the products are straightened, inspected, tested and end-finished.
RAW MATERIALS AND ENERGY
The primary raw material used in our Seamless facility is steel scrap,
which is generated principally from industrial, automotive, demolition, railroad
and other steel scrap sources. We purchase steel scrap either through scrap
brokers or directly in the open market. While the potential for periodic
disruptions in supply exists, we believe that supplies of steel scrap will be
available in sufficient quantities for the foreseeable future.
At our Welded facility, purchased hot-rolled coils are the primary raw
material used. We purchase hot-rolled steel coil primarily from three domestic
steel producers, the majority of which is purchased from Nucor Corporation. We
order steel coils according to our business forecasts for our Welded operations.
Purchased steel coil represents the major cost component of cost of sales for
our welded products. The steel industry is highly cyclical in nature and steel
coil prices are influenced by numerous factors beyond our control, including
general economic conditions, raw material costs, energy costs, import duties and
other trade restrictions. While the potential for periodic disruptions in supply
exists, we believe that supplies of steel coils will be available in sufficient
quantities for the foreseeable future.
The melt shop at our Seamless facility consumes a significant amount of
electricity. We currently purchase electricity for our Seamless facility
pursuant to a contract that provides for unlimited power demand and discounted
rates in return for the utilities' right to periodically curtail service during
periods of peak demand. These curtailments are generally limited to a few hours
and historically have had a negligible impact on our operations.
6
ENVIRONMENTAL MATTERS
Our business is subject to federal, state and local environmental laws and
regulations, including, among others, the Resource Conservation and Recovery Act
(RCRA), the Clean Air Act, the 1990 Amendments to the Clean Air Act and the
Clean Water Act, and all regulations promulgated in connection with those laws.
Such laws and regulations include those concerning the discharge of contaminants
as air emissions or waste water effluents and the disposal of solid and/or
hazardous wastes, such as electric arc furnace dust. As such, we are from time
to time involved in administrative and judicial proceedings and administrative
inquiries related to environmental matters.
In October 2002, the United States Environmental Protection Agency ("EPA")
issued a Notice of Violation ("NOV") to Newport for certain alleged violations
dating from 1998 to April 2000 of its Clean Air Act emission permit for
Newport's electric arc furnace that was installed in 1999 and shuttered in early
2001. The NOV alleged that the permit issued to Newport in June 1998 was based
upon an incorrect analysis as to potential emissions, and thus represented a
violation of the Clean Air Act. In addition, the EPA alleged certain violations
of the Clean Water Act occurred at Newport's Wilder facility in 1998. Newport
and the EPA have settled all of these issues with final Agreed Orders for $0.1
million.
We have a hazardous waste landfill on our property in Wilder, Kentucky,
which is no longer utilized. In connection with our March 2001 restructuring
actions, in which we closed Newport's melt shop and hot strip mill operations,
we accrued the estimated costs for closure and post-closure care of the
landfill. These costs were included in restructuring charges in the first
quarter of 2001. We received final approval of our closure/post-closure plan
from the Kentucky Division of Waste Management in December 2002. As a result, we
increased our estimate of post-closure costs and they are included in
restructuring charges for the fourth quarter of 2002. The closure of the
landfill was completed in the fourth quarter of 2003.
We operate a steel mini-mill that produces dust that contains lead, cadmium
and chromium, and is classified as a hazardous waste. Dust produced by our
electric arc furnace is collected through emission control systems and recycled
at EPA-approved facilities.
In late 2001, the EPA designated Imperial Adhesives, Inc., a former
subsidiary of the Company, as one of a number of potentially responsible parties
(PRP) under the Comprehensive Environmental Response, Compensation and Liability
Act (CERCLA) at an environmental remediation site. The EPA has contended that
any company linked to a CERCLA site is potentially liable for costs under the
legal doctrine of joint and several liability. This environmental remediation
site involves a municipal waste disposal facility owned and operated by an
independent operator. A preliminary study of the site is ongoing. Consequently,
it is too early to determine our liability exposure. We believe that the
reasonably foreseeable resolution of this matter will not have a material
adverse effect on our financial statements.
We believe that we are currently in compliance in all material respects
with all applicable environmental regulations. We cannot predict the level of
required capital expenditures or operating costs that may result from compliance
with future environmental regulations.
Capital expenditures for the next twelve months relating to environmental
control facilities are expected to be immaterial, however, such expenditures
could be influenced by new or revised environmental regulations and laws or new
information or developments with respect to our operating facilities.
We have accrued liabilities of $3.9 million and $5.2 million for
environmental remediation obligations at December 31, 2003 and 2002,
respectively. Based upon evaluation of available information, we do not believe
that any of the environmental contingency matters discussed above are likely,
individually or in the aggregate, to have a material adverse effect upon our
consolidated financial position, results of operations or cash flows. However,
we cannot predict with certainty that new information or developments with
respect to our environmental contingency matters, individually or in the
aggregate, will not have a material adverse effect on our consolidated financial
position, results of operations or cash flows.
7
EMPLOYEES
As of December 31, 2003, we had approximately 1,115 employees comprised of
209 salaried employees with the remainder being hourly employees. Substantially
all of our hourly employees are represented by the United Steelworkers of
America under contracts which expire in April 2005, May 2006 and May 2007 for
the Newport, Koppel and Erlanger operations, respectively.
AVAILABLE INFORMATION
We file annual, quarterly and current reports, proxy statements, and other
documents with the Securities and Exchange Commission (SEC) under the Securities
Exchange Act of 1934. The public may read and copy any materials that we file
with the SEC at the SEC's Public Reference Room at 450 Fifth Street, NW,
Washington, DC 20549. The public may obtain information on the operation of the
Public Reference Room by calling the SEC at 1-800-SEC-0330. Also, the SEC
maintains an Internet website that contains reports, proxy and information
statements, and other information regarding issuers, including NS Group, that
file electronically with the SEC. The public can obtain any documents that we
file with the SEC at http://www.sec.gov.
We also make available free of charge on or through our Internet website at
www.nsgrouponline.com, our Annual Report on Form 10-K, Quarterly Reports on Form
10-Q, Current Reports on Form 8-K, and, if applicable, amendments to those
reports filed or furnished pursuant to Section 13(a) of the Exchange Act as soon
as reasonably practicable after we electronically file such material with, or
furnish it to, the SEC.
ITEM 2. PROPERTIES
Our principal operating properties are listed below. We believe our
facilities are adequate and suitable for our present level of operations.
OPERATING PROPERTIES
Koppel, Pennsylvania - We own approximately 160 acres of real estate upon
which are located a melt shop, machine and fabricating shops, storage and repair
facilities and administrative offices aggregating approximately 500,000 square
feet. The melt shop and administrative offices support the Seamless operations.
The facilities are located adjacent to rail lines. They also supported the
Industrial Products Segment for SBQ products until it was closed in the second
quarter of 2001. We also own an additional 67 acres of real estate upon which
are located a bar mill, machine and fabricating shops and storage repair
facilities aggregating approximately 400,000 square feet.
Ambridge, Pennsylvania - We own approximately 45 acres of real estate upon
which are located a seamless tube making facility and seamless tube finishing
facilities aggregating approximately 659,000 square feet. The facilities are
located adjacent to rail lines and river barge facilities.
Baytown, Texas - We own approximately 55 acres of real estate upon which
are located a tubular processing facility and barge facilities. Located on the
property are eight buildings aggregating approximately 82,000 square feet which
house the various finishing operations.
Wilder, Kentucky - We own approximately 250 acres of real estate upon which
are located two welded pipe mills, a barge facility, machine and fabricating
shops and storage and repair facilities aggregating approximately 675,000 square
feet, as well as administrative offices. The facilities are also located
adjacent to rail lines.
Tulsa, Oklahoma - We lease approximately 36 acres of real estate upon which
is located our Erlanger tubular processing facility. The facility is located at
the Tulsa Port of Catoosa where barge facilities are in close proximity. Located
on this property are six buildings aggregating approximately 119,000 square
feet, which house the various finishing operations.
8
Other
Newport, Kentucky - We own approximately 12 acres of partially developed
land near Newport, Kentucky, which is held as investment property and is listed
for sale.
Assets Held for Sale
In connection with our restructuring decisions in 2001, certain equipment
and facilities were designated as held for sale. In the fourth quarter of 2003,
we entered into a contract to sell our melt shop, which includes an electric arc
furnace, continuous slab caster and related storeroom supplies and spare parts.
Our hot strip mill equipment was sold in 2002. As of December 31, 2003, there
were $1.7 million in assets remaining to be sold. An outside company is
currently marketing all of these assets.
Information regarding encumbrances on our properties is included in Note 6
to the Consolidated Financial Statements.
ITEM 3. LEGAL PROCEEDINGS
We are subject to various claims, lawsuits and administrative proceedings
arising in the ordinary course of business with respect to workers compensation,
health care and product liability coverages, each of which is self-insured to
certain levels, as well as commercial and other matters. Reference is made to
Part I, Item 1, Environmental Matters, concerning certain proceedings we are
involved in with the EPA. Based upon evaluation of available information, we do
not believe that any such matters will have, individually or in the aggregate, a
material adverse effect upon our consolidated financial position, results of
operations or cash flows.
In March 2001, in connection with our restructuring, we closed the electric
arc furnace operation at our welded facilities, and as such, ceased using oxygen
and argon that was provided under a supply agreement with Air Products and
Chemicals, Inc. ("Air Products"). On December 31, 2001, Air Products filed a
civil action against Newport and NS Group, Inc. in the United States District
Court for the Eastern District of Pennsylvania, Civil Action No. 01-7227,
seeking damages for breach of contract. Based on current information, we believe
that the resolution of this matter will not have a material adverse affect on
our consolidated financial position, results of operations or cash flows.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
9
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock and associated preferred stock purchase rights are listed
on the New York Stock Exchange under the trading symbol NSS. As of February 29,
2004, there were approximately 165 holders of record of our common stock. The
following table sets forth, for the calendar quarters indicated, the high and
low closing sales prices of our common stock as reported on the New York Stock
Exchange.
STOCK PRICE
2003 HIGH LOW
- -------------------------------------------
1st Quarter $ 8.55 $ 6.15
2nd Quarter 10.80 7.27
3rd Quarter 9.85 6.15
4th Quarter 9.90 6.50
2002 HIGH LOW
- -------------------------------------------
1st Quarter $ 9.35 $ 6.66
2nd Quarter 10.61 7.60
3rd Quarter 9.55 5.75
4th Quarter 7.10 5.43
We have not declared or paid cash dividends on our common stock since 1992.
Information regarding restrictions on the payment of common stock dividends is
included in Note 6 to the Consolidated Financial Statements.
EQUITY COMPENSATION PLAN INFORMATION
Securities authorized for issuance under equity compensation plans at
December 31, 2003 are as follows:
NUMBER
OF
SECURITIES
NUMBER OF WEIGHTED- REMAINING
SECURITIES TO BE AVERAGE EXERCISE AVAILABLE FOR
ISSUED UPON PRICE OF FUTURE ISSUANCE
EXERCISE OF OUTSTANDING UNDER EQUITY
OUTSTANDING OPTIONS AND COMPENSATION
PLAN CATEGORY OPTIONS AND RIGHTS RIGHTS PLANS(a)
------------- ------------------ ---------------- ---------------
Equity compensation plans
approved by security holders 1,673,412 $ 10.80 548,010
Equity compensation plans not
approved by security holders 116,000 $ 10.06 34,000
--------- -------- -------
Total 1,789,412 $ 10.75 582,010
========= ======== =======
(a) Excludes securities reflected in the first column, "Number of Securities to
be issued upon exercise of outstanding options and rights".
See Note 9 to the consolidated financial statements for additional information.
10
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
Three Months
YEAR ENDED Ended Fiscal Year
DECEMBER 31, December 31, Ended in September
------------------------------------ ------------ ------------------
(Dollars in thousands, except per share amounts) 2003 2002 2001 2000 2000 1999
- ----------------------------------------------------------------------------------------------------------------------------
SUMMARY OF OPERATIONS
- ----------------------------------------------------------------------------------------------------------------------------
Net sales $ 258,987 $ 192,408 $ 315,458 $ 73,357 $ 358,705 $ 200,424
- ----------------------------------------------------------------------------------------------------------------------------
Restructuring charges 77 2,046 56,224 - - -
- ----------------------------------------------------------------------------------------------------------------------------
Operating income (loss) (18,196) (34,140) (50,167) (4,960) (18,566) (49,307)
- ----------------------------------------------------------------------------------------------------------------------------
Income (loss) from continuing operations (17,329) (39,930) (55,977) (4,065) (24,048) (46,766)
- ----------------------------------------------------------------------------------------------------------------------------
Income (loss) before extraordinary items (17,329) (39,930) (55,977) 6,890 (22,899) (45,553)
- ----------------------------------------------------------------------------------------------------------------------------
Net income (loss) (17,329) (39,930) (55,977) 7,790 (22,899) (49,390)
- ----------------------------------------------------------------------------------------------------------------------------
Per common share - diluted
Income (loss) from continuing operations (0.83) (1.93) (2.68) (0.19) (1.11) (2.14)
- ----------------------------------------------------------------------------------------------------------------------------
Income (loss) before extraordinary items (0.83) (1.93) (2.68) 0.32 (1.06) (2.08)
- ----------------------------------------------------------------------------------------------------------------------------
Net income (loss) (0.83) (1.93) (2.68) 0.36 (1.06) (2.26)
- ----------------------------------------------------------------------------------------------------------------------------
Dividends per common share - - - - - -
- ----------------------------------------------------------------------------------------------------------------------------
Average shares outstanding - diluted (000's) 20,774 20,647 20,889 21,620 21,651 21,852
- ---------------------------------------------------------------------------------------------------------------------------
OTHER FINANCIAL AND STATISTICAL DATA
- ---------------------------------------------------------------------------------------------------------------------------
Working capital $ 45,076 $ 42,993 $ 126,690 $ 129,186 $ 121,527 $ 96,976
- ----------------------------------------------------------------------------------------------------------------------------
Total assets 165,860 180,294 260,484 318,926 345,337 353,598
- ----------------------------------------------------------------------------------------------------------------------------
Revolving credit facility 14,936 - - - - -
- ----------------------------------------------------------------------------------------------------------------------------
Current portion of long-term debt 40 33,555 33 110 110 144
- ----------------------------------------------------------------------------------------------------------------------------
Long-term debt 461 482 68,070 68,207 72,915 72,321
- ----------------------------------------------------------------------------------------------------------------------------
Common shareholders' equity 88,608 104,383 143,662 196,478 198,845 221,152
- ----------------------------------------------------------------------------------------------------------------------------
Capital expenditures 1,137 2,422 2,198 586 7,499 27,818
- ----------------------------------------------------------------------------------------------------------------------------
Depreciation and amortization 7,274 12,281 14,681 6,060 22,691 22,665
- ----------------------------------------------------------------------------------------------------------------------------
Cash flows provided (used) by:
- ----------------------------------------------------------------------------------------------------------------------------
Operating activities (13,599) (20,558) 28,887 3,226 (24,587) (15,372)
- ----------------------------------------------------------------------------------------------------------------------------
Investing activities 5,040 10,846 4,173 26,706 22,323 (8,192)
- ----------------------------------------------------------------------------------------------------------------------------
Financing activities (18,170) (35,787) (3,355) (14,397) 1,996 (12,168)
- ----------------------------------------------------------------------------------------------------------------------------
Product tons shipped
Energy tubular products 428,900 323,300 478,900 101,700 574,200 317,000
Industrial tubular products - - 23,900 14,200 136,200 130,500
- ----------------------------------------------------------------------------------------------------------------------------
Employees 1,115 1,150 1,198 1,624 1,636 1,417
- ----------------------------------------------------------------------------------------------------------------------------
See Note 1 to the consolidated financial statements regarding impairment losses
on long-term investments and income from graphite electrodes anti-trust
settlements in 2003, 2002 and 2001.
The selected consolidated financial and other data has been restated to reflect
the disposition of Imperial Adhesives, Inc. in October 2000.
11
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
We make forward-looking statements in this report which represent our
expectations or beliefs about future events and financial performance. You can
identify these statements by forward-looking words such as "expect," "believe,"
"anticipate," "goal," "plan," "intend," "estimate," "may," "will" or similar
words. Forward-looking statements are subject to known and unknown risks,
uncertainties and assumptions, including:
- world-wide and domestic supplies of and demand for natural gas
and oil;
- fluctuations in industry-wide tubular inventory levels;
- domestic competitive pressures;
- the level and pricing of imports and the presence or absence
of governmentally imposed trade restrictions;
- steel coil and steel scrap price volatility;
- manufacturing efficiencies;
- costs of compliance with environmental regulations;
- asserted and unasserted claims;
- general economic conditions; and
- other risks and uncertainties described under "Risk Factors"
included in Exhibit 99.1 of this report.
In light of these risks, uncertainties and assumptions, the future
events discussed in this report might not occur. In addition, actual results
could differ materially from those suggested by the forward-looking statements.
Accordingly, you should not place undue reliance on the forward-looking
statements, which speak only as of the date on which they are made. We may not
update these forward-looking statements, even though our situation may change in
the future, unless we are obligated under federal securities laws to update and
disclose material developments related to previously disclosed information. We
qualify all of our forward-looking statements by these cautionary statements.
For a more complete understanding of our business activities and
financial results, you should read the analysis of financial condition and
results of operations together with the audited financial statements included in
this report.
OVERVIEW
OUR PRODUCTS AND FACILITIES
We are a domestic producer of seamless and welded tubular steel
products serving the energy industry. We conduct our business within a single
reportable business segment, which we refer to as the Energy Products segment.
Our tubular products, commonly referred to as oil country tubular goods (OCTG),
are used primarily in oil and natural gas drilling exploration and production
operations. We also manufacture line pipe, which is used as gathering lines for
the transmission of petrochemicals and hydrocarbons.
Our products are manufactured and sold under two brands. Our Koppel
brand is our seamless tubular product manufactured at our facility located near
Koppel, Pennsylvania. Our Newport brand is our welded tubular product
manufactured at our tubular facilities located near Newport, Kentucky. The
primary geographic market for our products is the southwestern and Appalachian
regions of the United States and western regions of Canada. We also operate
tubular finishing facilities in the southwest United States, where we can
provide further finishing processes to our product.
RESTRUCTURING OF OPERATIONS
During the quarter ended March 31, 2001, we implemented restructuring
initiatives designed to give us a lower, more flexible cost structure. One
initiative was to purchase hot-rolled coils rather than manufacture them at our
welded tubular operations. As a result, we closed the melt shop and hot strip
mill operations at our welded tubular facilities in Wilder, Kentucky effective
March 31, 2001. In addition, we decided to cease the manufacturing of special
bar quality products (which we refer to as "SBQ"), which were being manufactured
at our Koppel, Pennsylvania facility.
12
In the March 2001 quarter, we recorded total restructuring charges of
$56.2 million, including $43.4 million of charges resulting primarily from the
write-down of fixed assets and $0.6 million recorded to cost of products sold
related to inventories. The closures resulted in total workforce reductions of
approximately 270 positions at the welded tubular operations in Wilder, Kentucky
and the SBQ products operations in Koppel, Pennsylvania.
In the fourth quarter of 2002, we recorded $2.0 million of additional
restructuring charges related to the March 2001 restructuring. The charges
included a $1.2 million impairment loss on the assets being held for sale and
$0.8 million primarily related to an increase in our estimate of post-closure
costs for our closed landfill.
In the fourth quarter of 2003, we recorded $0.1 million of additional
restructuring charges resulting from an increase in the estimated cancellation
costs of operating contracts
Through June 30, 2001, we conducted our business within two reportable
business segments-the Energy Products segment and the Industrial Products
segment. In June 2001, we exited the SBQ business that comprised our Industrial
Products segment. Since that time, we have conducted our operations solely
within the Energy Products segment.
Our Industrial Products segment consisted solely of special bar quality
products used in a variety of industrial applications such as farm equipment,
heavy machinery, construction and off-road vehicles.
You should read Note 3 to the Consolidated Financial Statements
included in this report for additional information pertaining to segment data.
ECONOMIC AND INDUSTRY-WIDE FACTORS THAT AFFECT OUR BUSINESS
DEMAND FOR OUR PRODUCTS
Over 90% of our revenues are derived from the sale of OCTG. Therefore,
our revenue is directly dependent on the demand for OCTG, which is highly
cyclical in nature. There are a number of factors that we monitor to assist us
in estimating the future demand for our OCTG product. Demand for our OCTG
products is dependent on the number and depth of oil and natural gas wells being
drilled in the United States and globally. The level of drilling activity is,
among other things, dependent on the current and anticipated supply and demand
for oil and natural gas. Oil and natural gas prices are volatile and can have a
substantial effect upon drilling levels and resulting demand for our energy
related products. In addition, shipments by domestic producers of OCTG products
may be positively or negatively affected by the amount of inventory held by
producers, distributors and end-users, as well as by imports of OCTG products.
The average number of oil and gas drilling rigs operating in the United
States (rig count), domestic shipments of OCTG products (excluding exports),
domestic OCTG inventories and imports of OCTG products for 2003, 2002 and 2001
were as follows:
2003 2002 2001
---- ---- ----
Average U.S. drill
rig count 1,029 830 1,156
OCTG shipments
(millions of tons ) 2.2 1.6 2.2
OCTG imports
(millions of tons) 0.8 0.5 0.9
OCTG inventories
(millions of tons
at year-end) 1.4 1.3 1.6
Inventory tons per rig
(at year-end) 1,254 1,540 1,852
- ----------
(Source: Baker Hughes, Preston Pipe and Tube Report and Company estimates)
In response to strong oil and natural gas prices, rig count rose
steadily throughout the first half of 2001, reaching a high of 1,293 in July
2001. However, natural gas prices began to fall as the slowdown in the economy,
milder weather and fuel switching resulted in strong injection rates into
natural gas storage during the summer months of 2001. The weak economy and mild
weather in the latter part of 2001 resulted in historically high levels of
natural gas storage going into 2002. Consequently, rig count in 2002 fell 28%
from 2001 and demand for our OCTG products fell for the comparable periods as
well.
13
Natural gas prices rose steadily in the second half of 2002 and into
2003 due to low drilling levels during 2002 and increased demand for natural
gas. driven primarily by the winter weather of 2002/2003. These factors,
together with an improving U.S. economy, particularly in the second half of
2003, resulted in an increase in the 2003 rig count of 24% over 2002. Based upon
current settlement prices for natural gas futures, economists' forecasts of
approximately 4% real GDP growth in 2004, as well as other factors, we estimate
the rig count will average 1,160 in 2004. The rig count as of March 5, 2004 was
1,129.
Levels of OCTG inventories in the marketplace are also an indicator of
future demand. U.S. end-users obtain OCTG from domestic and foreign tubular
producers and from draw-downs of inventory from the end-user, distributor or
tubular producers. We believe the level of inventory per rig at December 31,
2003 will result in incremental demand for OCTG in 2004 from the need to
increase inventories.
IMPORTS
Imports command a significant portion of the domestic OCTG market. We
believe import levels are affected by, among other things:
- currency exchange rates
- overall world demand for OCTG;
- the trade practices of foreign governments and producers; and
- the presence or absence of antidumping countervailing duty or
other U.S. government orders that raise the cost or impose
limits on imports.
According to published industry reports, imports of OCTG products in 2003
comprised an estimated 25% of the total domestic market, compared to 23% in 2002
and 30% in 2001.
In late 2001, the United States International Trade Commission (ITC)
reported injury from various imported steel products under Section 201 and
recommended to the President a wide-scale program of quotas and duties. However,
the ITC recommendation for quotas and duties did not include imports of OCTG
products. In response, we, together with other domestic oil country tubular
goods producers, sought relief from unfair trade by filing petitions with the
ITC against certain countries. In May 2002, the ITC voted against our suit and
the case was terminated.
Since 1995, the U.S. government has been imposing duties on imports of
various OCTG products from Argentina, Italy, Japan, Korea and Mexico in response
to antidumping and countervailing duty cases filed by several U.S. companies. In
June 2001, the ITC voted to continue these duties for five more years.
Under the U.S. Continued Dumping and Subsidy Offset Act (CDSOA),
tariffs collected on dumped imports are required to be directed to the
industries harmed. These payments are made to cover certain operating expenses
and investment in manufacturing facilities. In September 2002, the World Trade
Organization (WTO) ruled that such payments violate international trade rules.
The U.S. Trade Representative appealed this ruling; however, the WTO upheld the
ruling in January 2003. We received $0.6 million in CDSOA payments in 2003. We
may not receive payments under the CDSOA in 2004 or any years thereafter, and we
cannot predict the amount of any such payments.
We cannot predict the U.S. government's future actions regarding duties
and tariffs or any other future actions regarding import duties or other trade
restrictions on imports of OCTG and line pipe products. We expect to continue to
experience high levels of competition from imports.
COSTS OF OUR PRODUCTS
As a manufacturer of tubular steel products, the costs of our products
include steel raw material costs, direct and indirect labor, energy costs and
other direct and indirect manufacturing costs. We have followed a strategy of
being a low cost, quality producer of energy tubular products by focusing on
reducing fixed costs; lowering our variable conversion costs by applying
continuous process improvement measures within our manufacturing processes; and
raw material cost management. For example, our 2001 restructuring initiatives
gave us a lower, more flexible cost structure for our welded products. Also, in
2003 we implemented various process improvement measures that enabled us to
reduce our variable conversion costs per ton through most of our key operations.
14
The primary raw material used in our seamless operations is steel
scrap, which represents approximately 15% of cost of goods sold for our seamless
products. At our welded facility, purchased steel coil is the primary raw
material, which represents approximately 65% of cost of goods sold for our
welded products. As a result, the steel industry, which is highly cyclical and
volatile in nature, can affect our costs both positively and negatively. Various
factors, most of which are beyond our control, affect the price of steel scrap
and coils. These factors include:
- supply and demand factors, both domestic and global;
- freight costs and transportation availability;
- inventory levels of brokers and distributors;
- the level of imports and exports; and,
- general economic conditions.
Increases in our steel costs adversely affect our financial results if
we are not able to successfully raise the price of our products to compensate.
In 2003, purchased scrap costs, which affect the cost of our seamless products,
increased approximately $28 per ton from 2002. Purchased steel coil costs, which
affect the cost of our welded products, increased approximately $25 per ton from
2002. Our 2003 average revenue per ton, adjusted for mix, was virtually
unchanged for our seamless products and increased approximately $23 per ton for
our welded products compared to 2002.
The effects of inflation did not have a material effect on our results
of operations in 2003, 2002 and 2001.
RECENT DEVELOPMENTS
A number of economic and steel industry related factors have combined
to result in significant increases in the cost of steel scrap and hot-rolled
coils beginning late in the fourth quarter of 2003. Strong U.S. and
international economic growth, led by China, has significantly increased demand
for steel scrap. Demand by foreign countries and the fall in the value of the
U.S. dollar have resulted in the highest level of U.S. exports of steel scrap
since 1990. In addition, export restrictions placed on steel scrap by certain
foreign countries has reduced worldwide supply. Finally, there are seasonal
constraints on the North American scrap supply due to the negative effect winter
weather has on collecting and transporting steel scrap. As a result, we estimate
our 2004 first quarter purchased steel scrap cost will increase by over $100 per
ton, nearly double our average purchased steel scrap cost for 2003.
The increase in steel scrap costs has resulted in an increase in
hot-rolled coil costs used in the manufacture of our welded tubular products.
Steel coils are similarly in high demand as a result of strong global economic
growth. U.S. supply has also been reduced due to the lack of imports, which has
occurred for several reasons, including (i) the fall in the value of the U.S.
dollar, (ii) the high cost of ocean freight transportation, and (iii) a delay in
the effect of the lifting of Section 201 tariffs on steel coils, which occurred
in December 2003. In addition, there are industry specific factors affecting
steel coil supply such as a tight supply of raw materials for integrated steel
companies and selected outages within the steel industry. These factors have
resulted in the imposition of steel surcharges and base price increases from
steel suppliers to all steel consuming industries, including our industry. As a
result of these factors, we estimate our first quarter 2004 purchased steel coil
costs will increase by over $135 per ton from our average purchased steel coil
cost in 2003. Current quotes for April 2004 reflect an additional cost of $150
per ton over our first quarter 2004 estimate.
To date, the OCTG industry has been passing these increases in steel
costs through to its customers in the form of base price increases as well as
steel surcharges. These surcharges have essentially matched surcharges imposed
by steel coil producers, as they attempt to recover increases in their steel raw
material costs. In addition to significantly higher steel prices, buyers of
steel products, including the OCTG industry, are experiencing extended lead
times on delivery of products and instances of cancellation of steel purchase
orders.
While our customers are currently placing orders at higher prices, thus
compensating us for increases in our raw material costs, there can be no
assurance that our customers will continue to pay higher prices for our tubular
products, and that raw material supply will be consistently available to meet
our customer demand. If either of these factors were to occur, we may have to
curtail or suspend operations for an unknown period of time.
15
Our net sales, gross profit (loss), operating loss, revenue per ton and
tons shipped for the years ended December 31, 2003, 2002 and 2001 are summarized
in the following table. (Dollars in thousands except for revenue per ton.)
Change Change
2003 vs. 2002 2002 vs. 2001
------------- -------------
2003 2002 $ % 2001 $ %
---------------------------------------- -------------------------------
Net sales
Energy products
Welded products $ 116,631 $ 87,306 $ 29,325 33.6 $ 143,540 $ (56,234) (39.2)
Seamless products 142,356 105,102 37,254 35.4 162,069 (56,967) (35.1)
- --------------------------------------------------------------------------------------------------------------
258,987 192,408 66,579 34.6 305,609 (113,201) (37.0)
Industrial products-SBQ - - - - 9,849 (9,849) (100.0)
- --------------------------------------------------------------------------------------------------------------
$ 258,987 $192,408 $ 66,579 34.6 $ 315,458 $(123,050) (39.0)
==============================================================================================================
Gross profit (loss)
Energy products $ (3,965) $(14,585) $ 10,620 72.8 $ 28,025 $ (42,610) (152.0)
Industrial products-SBQ - - - - (2,625) 2,625 100.0
- --------------------------------------------------------------------------------------------------------------
$ (3,965) $(14,585) $ 10,620 72.8 $ 25,400 $ (39,985) (157.4)
==============================================================================================================
Selling, general and administrative
Energy products $ 14,721 $ 17,509 $ (2,788) (15.9) $ 18,696 $ (1,187) (6.3)
Industrial products-SBQ - - - - 1,286 (1,286) (100.0)
- --------------------------------------------------------------------------------------------------------------
$ 14,721 $ 17,509 $ (2,788) (15.9) $ 19,982 $ (2,473) (12.4)
==============================================================================================================
Operating loss
Energy products (1) $ (18,196) $(34,140) $ 15,944 46.7 $ (36,017) $ 1,877 5.2
Industrial products-SBQ (2) - - - - (12,949) 12,949 100.0
Corporate (3) - - - - (1,201) 1,201 100.0
- --------------------------------------------------------------------------------------------------------------
$ (18,196) $(34,140) $ 15,944 46.7 $ (50,167) $ 16,027 31.9
==============================================================================================================
Revenue per ton
Welded products $ 458 $ 445 $ 13 2.9 $ 490 $ (45) (9.2)
Seamless products $ 816 $ 826 $ (10) (1.2) $ 872 $ (46) (5.3)
- --------------------------------------------------------------------------------------------------------------
Tons shipped
Energy products
Welded products 254,500 196,100 58,400 29.8 293,200 (97,100) (33.1)
Seamless products 174,400 127,200 47,200 37.1 185,700 (58,500) (31.5)
- --------------------------------------------------------------------------------------------------------------
428,900 323,300 105,600 32.7 478,900 (155,600) (32.5)
Industrial products-SBQ - - - - 23,900 (23,900) (100.0)
- --------------------------------------------------------------------------------------------------------------
428,900 323,300 105,600 32.7 502,800 (179,500) (35.7)
==============================================================================================================
Average rig count 1,029 830 199 24.0 1,156 (326) (28.2)
- --------------------------------------------------------------------------------------------------------------
See Note 2: Restructuring Charges to the Consolidated Financial Statements.
(1) Includes restructuring charges of $0.1 million, $2.0 million and $45.3
million for 2003, 2002 and 2001, respectively. Results for 2003
includes income of $0.6 million from the receipt of payments under "The
Continued Dumping and Subsidy Offset Act of 2000" and a $0.2 million
impairment loss on certain long-lived assets.
(2) Includes restructuring charges of $9.7 million for 2001.
(3) Represents primarily professional fees related to restructuring
activities.
16
2003 COMPARED TO 2002
SUMMARY
Net sales for 2003 were $259.0 million compared to $192.4 million in
2002, an increase of $66.6 million, or 34.6%.
The operating loss for 2003 was $18.2 million compared to an operating
loss of $34.1 million in 2002, which included $2.0 million of restructuring
charges.
Net loss for 2003 was $17.3 million, or an $0.83 loss per diluted
share, compared to a net loss for 2002 of $39.9 million, or a loss of $1.93 loss
per diluted share. Included in the 2003 results was $4.0 million of cash
receipts from a favorable claim settlement, which reduced the loss by $0.19 per
diluted share. Results for 2002 included $2.0 million of restructuring charges,
which increased the loss by $0.10 per diluted share.
ENERGY PRODUCTS
Our net sales in 2003 increased over 2002 primarily as a result of an
increase in our energy product shipments. The increase in shipments was caused
by higher consumption of OCTG products in light of increased drilling activity
in 2003. Changes in our 2003 average revenue per ton were not significant and
primarily price driven. Prices in 2003 were suppressed as U.S. and foreign
producers competed for the increase in energy tubular product demand.
Our 2003 gross loss was reduced by $10.6 million from 2002 due to a
number of factors, including, but not limited to a higher absorption of fixed
costs due to the significantly higher operating levels in 2003; lower variable
conversion costs per ton; lower fixed costs, and increased revenue per ton for
welded products.
In 2003, we implemented management process changes to reduce spending
and improve prime yield and productivity measures throughout all of our major
operations. As a result of these efforts, we estimate that we reduced our
variable conversion costs in our major operations by 10% to 25%, depending on
the operation. We also reduced our manufacturing fixed costs in 2003 due to
lower wage and fringe costs associated with a reduction in salaried personnel as
well as other cost reduction measures. Depreciation expense declined by $4.6
million from 2002 as a result of the machinery and equipment placed in service
in 1991 for the opening of our seamless operations becoming fully depreciated.
These factors were partially offset by higher purchased steel scrap and coil
costs of approximately 30% and 9%, respectively.
Selling, general and administrative expenses in 2003 were lower by $2.8
million compared to 2002. Contributing factors included a reduction in wages and
fringe costs associated with a reduction in salaried personnel and a decrease in
discretionary spending, primarily pertaining to professional consulting fees for
various project work.
2002 COMPARED TO 2001
SUMMARY
Net sales for 2002 were $192.4 million compared to $315.5 million in
2001, a decrease of $123.1 million, or 39.0%.
The operating loss for 2002 was $34.1 million compared to an operating
loss of $50.2 million in 2001, including restructuring charges of $2.0 million
in 2002 and $56.2 million in 2001, respectively.
In 2002, we reported a $39.9 million net loss, or a $1.93 loss per
diluted share, compared to a $56.0 million net loss, or a $2.68 loss per diluted
share in 2001. Results for 2002 included restructuring charges which increased
the net loss by $2.0 million, or $0.10 per diluted share. Results for 2001
included restructuring charges which increased the net loss by $53.7 million, or
$2.57 per diluted share.
ENERGY PRODUCTS
Energy Products segment sales of $192.4 million in 2002 were $113.2
million, or 37.0%, less than the $305.6 million reported for 2001. Product
shipments of 323,300 tons in 2002 were 155,600 tons, or 32.5%, less than the
478,900 tons in 2001. The significant decreases in sales and shipments were
experienced by both our seamless and welded products. The decrease in shipments
was a direct result of the lower rig count in 2002. Also, distributors lowered
their inventories in 2002, which further negatively impacted our shipments. In
17
addition, the level of imports negatively impacted our shipments of OCTG
products. The average revenue per ton for our welded tubular products was $445
per ton, a decrease of 9.2% from 2001. The average revenue per ton for our
seamless tubular products was $826 per ton, a decrease of 5.3% from 2001. The
decreases in average revenue per ton were due primarily to the weak market
conditions in 2002.
The Energy Product segment reported a gross loss of $14.6 million and
an operating loss of $34.1 million in 2002, which includes $2.0 million of
restructuring charges. In 2001 the segment reported a gross profit of $28.0
million and operating loss of $36.0 million, which includes $45.3 million of
restructuring charges. The decline in gross profit from 2001 was primarily the
result of the significant decline in shipments, lower pricing for our products
and an increase in purchased steel costs. In addition, due to lower operating
levels in 2002, our margins were negatively impacted due to lower fixed cost
absorption.
Selling, general and administrative expenses for the Energy Product
segment in 2002 decreased $1.2 million, or 6.3%, from 2001 primarily as a result
of reduced employee and related costs due to the restructuring, as well as
general cost reduction efforts implemented in 2002.
INDUSTRIAL PRODUCTS-SBQ
As mentioned previously, the Industrial Products-SBQ segment was
closed in June 2001. The segment recorded sales of $9.8 million, gross losses of
$2.6 million and operating losses of $12.9 million in the first six months of
2001. Included in the operating losses for 2001 are $9.7 million of
restructuring charges. SBQ product shipments for the first six months of
2001 were 23,900 tons.
INVESTMENT INCOME, INTEREST EXPENSE, OTHER INCOME
Our net investment loss was $0.1 million in 2003, compared to income of
$0.7 million in 2002 and a loss of $2.1 million in 2001. Impairment losses on
long-term investments were $0.1 million, $1.0 million and $6.2 million in 2003,
2002 and 2001, respectively. Interest income before impairment losses decreased
in 2003 and 2002 because of lower invested balances as we liquidated our
investments to pay down our senior notes and fund operating losses. Interest
income was also lower due to by declining interest rates paid on investments.
During 2003 and 2002, we reduced our interest expense by paying down
our 13.5% senior notes by $35.0 million in July 2002 and retiring the remaining
principal balance of $33.8 million in the second quarter of 2003. The senior
note retirements were funded from existing cash and investment balances and
borrowings under our credit facility.
Other income net, for 2003, 2002 and 2001 includes $4.0 million, $0.8
million and $1.3 million, respectively, of cash receipts from favorable claim
settlements with electrode suppliers relating to purchases in prior years. We do
not anticipate any additional material receipts related to this issue.
INCOME TAXES
We exhausted our federal income tax refund capability in fiscal 1999,
and as such, tax benefits from operating losses are offset by valuation
allowances resulting in no net federal tax benefit being recorded for losses.
The $0.2 million tax benefit recorded in 2003 resulted from
reclassifying to income the deferred tax benefits related to our long-term
investments that were sold in 2003. The $0.9 million tax benefit recorded in
2002 resulted primarily from refund claims filed in connection with newly
enacted federal income tax law changes. The tax benefit of $3.9 million recorded
in 2001 resulted primarily from state income tax benefits associated with the
restructuring charges and the investment impairment losses.
18
LIQUIDITY AND CAPITAL RESOURCES
OVERVIEW
Our principal sources of liquidity have historically included cash flow
from operating activities, our revolving credit facilities and other sources of
financing through the capital markets. Our business is highly cyclical in
nature, and therefore our cash flows from operating activities can vary
significantly. For example, cash flows from operating activities provided $28.9
million in 2001; however, they used $20.6 million and $13.6 million in 2002 and
2003, respectively. We consider working capital items such as accounts
receivable, inventory, accounts payable and accrued liabilities as critical
components to managing our liquidity.
Our capital expenditures have totaled $5.8 million over the past three
years and have not been a significant liquidity requirement in any one year. We
have limited our capital spending in the past three years primarily to
non-discretionary spending. We may adjust our capital spending upward as market
conditions and financial results allow.
In the past three years, we have spent $69.8 million to retire the
remaining principal portion of our 13.5% senior notes. We funded these
retirements principally from existing cash and investment balances as well as
borrowings under our revolving credit facility. As of December 31, 2003, we have
cash and equivalents of $2.6 million. We are currently dependent on cash flows
from operations and our credit facility to fund our working capital needs.
CASH REQUIREMENTS
The following table summarizes our expected cash outflows resulting
from contractual obligations and our commerical commitments under our revolving
credit facility. We have not included information on our recurring purchases of
materials for use in our manufacturing operations. These amounts closely reflect
our levels of production and are not long-term in nature (less than three
months). Certain obligations are described more fully in of the Notes to the
Consolidated Financial Statements.
Payments Due by Period
----------------------
Less than 1-3 3-5 More than
(In thousands) Total 1 year Years Years 5 years
- -----------------------------------------------------------------------------------------
Other notes payable $ 106 $ 106 $ - $ - $ -
Long-term debt 501 40 40 40 381
Operating leases 938 127 238 252 321
Restructuring liabilities 5,562 3,653 360 160 1,389
Employee benefit plans 7,949 721 1,512 1,611 4,105
- -----------------------------------------------------------------------------------------
Total $ 15,056 $4,647 $ 2,150 $ 2,063 $ 6,196
=========================================================================================
Amount of Commitment Expirations by Period
--------------------------------------------------------
Less than 1-3 3-5 More than
(In thousands) Total 1 year Years Years 5 years
- -----------------------------------------------------------------------------------------
Revolving credit facility $ 45,000 $ - $ - $45,000 $ -
=========================================================================================
We have a $45.0 million revolving credit facility that expires in March
2007. As of December 31, 2003, we had a balance of $14.9 million outstanding
under the credit facility. We also had outstanding letters of credit in the
amount of $5.0 million, reducing the amount of funds available under the credit
facility to approximately $15.5 million as of December 31, 2003. See Note 6 to
the consolidated financial statements for additional information.
19
The amount due in less than one year for restructuring liabilities
includes our estimate of contract cancellation costs, including those in
dispute. Therefore, the ultimate amount and timing of such payments could differ
from the amounts and timing reflected in the table.
We currently purchase electricity for our seamless facility pursuant to
long-term contracts. Amounts paid under these contracts are not included in the
table because they can vary significantly based on the level of our operations.
We paid $7.4 million, $7.1 million and $10.7 million to our electricity
providers in 2003, 2002 and 2001, respectively.
We are subject to various claims, lawsuits and administrative
proceedings arising in the ordinary course of business with respect to
environmental matters, workers compensation, health care and product liability
(each of which is self-insured to certain levels) as well as commercial and
other matters. We accrue for the cost of such matters when the incurrence of
such costs is probable and can be reasonably estimated. In 2003 we increased our
reserves for warranty claims by $1.2 million for new claims and changes in
estimates of existing claims. See Note 13 to the consolidated financial
statements for further discussion of product warranty claims. While the ultimate
amount and timing of payment for loss contingencies can be difficult to
determine, we do not believe that such amounts and the timing of payment will
result in a material adverse affect on our cash flows. See Note 4 to the
consolidated financial statements for a description of accrued liabilities.
In October 2003, we entered into a contract to sell a significant
portion of our assets held for sale. In accordance with the contract, payments
of $7.0 million are scheduled to be received over the first six months of 2004.
Based upon our current market outlook, we believe income from
operations will improve in 2004 due to increased revenues, resulting from both
increased shipments and pricing, as well as further reductions in our conversion
costs. As such, we believe cash flows from operations, together with our credit
facility and other sources, including the capital markets, will be sufficient to
meet our anticipated working capital and capital expenditure requirements.
WORKING CAPITAL
Working capital at December 31, 2003 was $45.1 million compared to
$43.0 million at December 31, 2002, and the ratio of current assets to current
liabilities at December 31, 2003 was 1.7 to 1 compared to 1.6 to 1 at December
31, 2002. The working capital increase was primarily due to increases in
accounts receivable and inventories in excess of increases in accounts payable
and accrued liabilities, resulting from a substantial increase in business
activity and shipment volumes. We also used existing cash balances and
borrowings under our credit facility to repay $33.8 million of our long-term
debt and to fund operating losses in 2003. At December 31, 2003 we had cash
totaling $2.6 million compared to cash and investments of $33.2 million at
December 31, 2002. Our credit facility borrowings at December 31, 2003 were
$14.9 million.
OPERATING CASH FLOWS
Cash used by operating activities in 2003 was $13.6 million. This use
of cash was primarily the result of an operating loss of $18.2 million, which
included depreciation and amortization charges of $7.3 million. In addition,
changes in our operating assets and liabilities resulted in a use of cash of
$4.7 million in 2003. Major components of these changes included a $14.6
million increase in accounts receivable and a $10.7 million increase in
inventories, partially offset by increases of $15.9 million and $4.7 million in
accounts payable and accrued liabilities, respectively. The increase in our
accounts receivable balance was the result of higher sales in the fourth quarter
of 2003 as compared to sales in the fourth quarter of 2002. The increase in
inventories and accounts payable was the result of increased business levels and
incremental investments made in anticipation of raw material cost increases.
Accrued liabilities increased principally as the result of a $5.3 million
increase in deferred revenue resulting from the higher level of business
activity. We made $4.5 million in interest payments in 2003, or $4.8 million
less than we paid in 2002, due to the payoff of our senior secured notes in
2003. Operating cash flows in 2003 included cash receipts of $4.0 million
related to antitrust litigation against manufacturers of graphite electrodes
used in the steel-making process.
20
Cash used by operating activities in 2002 was $20.6 million. This use
of cash was primarily the result of an operating loss of $34.1 million, which
included depreciation and amortization charges of $12.3 million. Changes in our
operating assets and liabilities generated $5.6 million in cash in 2002. Major
components of these changes in 2002 included a decrease in accounts receivable
and accounts payable of $10.5 million and $5.7 million, respectively, resulting
primarily from a decline in business activity in 2002. Also, we made $9.3
million in interest payments in 2002.
Cash provided by operating activities totaled $28.9 million in 2001.
Although we incurred a $50.2 million operating loss for 2001, it included $14.7
million in depreciation and amortization charges; restructuring charges of $42.8
million, representing charges primarily for the write-down of fixed assets; and
$4.7 million in net impairment losses on investments. Changes in our operating
assets and liabilities generated $24.1 million of cash in 2001. Major
components of these changes included a decrease in accounts receivable and
inventories of $22.2 million and $3.2 million, respectively, resulting
primarily from a decline in business activity in the second half of 2001 and
the effect of exiting the SBQ business. The decrease in accrued liabilities of
$9.8 million resulted primarily from a lower balance of deferred revenue at
December 31, 2001. Also, we made $9.4 million in interest payments in 2001.
INVESTING CASH FLOWS
Cash flows from investing activities were $5.0 million in 2003.
Proceeds from sales of long-term investments were used for general corporate
purposes. Changes in other assets in 2003 included $1.9 million from the cash
value of terminated corporate-owned life insurance policies.
We made capital investments of $1.1 million in 2003, primarily for
maintenance capital.
We made capital investments totaling $2.4 million in 2002 and $2.2
million in 2001. These capital expenditures were primarily related to
improvements to our Energy Products segment facilities.
We currently estimate that 2004 capital spending will be approximately
$3.0 million. Our sources of funding for capital expenditures include available
cash flows from operations and borrowing availability under our credit facility.
The amount ultimately spent will depend upon the availability of these
resources.
FINANCING CASH FLOWS
In the second quarter of 2003, we redeemed the remaining $33.8 million
of our outstanding 13 1/2% senior secured notes that were due on July 15, 2003.
The notes were redeemed at par plus accrued interest and was funded from
existing cash balances and borrowings under our credit facility.
In the second quarter of 2003, in connection with the redemption of our
senior secured notes, we amended our credit facility. The facility provides up
to $45.0 million under a borrowing formula that is based upon eligible inventory
and accounts receivable, subject to certain reserves and satisfaction of certain
conditions to each draw under the facility. Interest rates on the facility vary
according to the amount of loans outstanding and range from the prime rate plus
1.00% to prime plus 1.75% with respect to domestic rate loans, and from the
LIBOR rate plus 2.50% to LIBOR plus 3.25% with respect to LIBOR rate loans. In
addition, there is a line usage fee imposed in periods in which the outstanding
amount of the line exceeds $30.0 million. The credit agreement contains
financial and other covenants, including a minimum level of earnings, as defined
in the agreement, and limitations on certain types of transactions, including
the ability of our subsidiaries to declare and pay dividends.
As of December 31, 2003, we were not in compliance with the minimum
level of defined earnings covenant, which resulted in the imposition of $7.5
million of additional reserves against availability. At December 31, 2003, we
had $14.9 million of loans and $5.0 million of letters of credit outstanding
under the credit facility and approximately $15.5 million in additional
borrowing availability. The letters of credit were issued against the credit
facility as collateral on our self-insured workers compensation program. The
weighted average interest rate on borrowings as of December 31, 2003 was 3.78%.
The facility is secured by a first priority lien on substantially all of our
inventories, accounts receivable, property, plant and equipment and related
intangibles. This facility expires in March 2007.
21
In 2003, we received $0.7 million from the exercise of common stock
warrants resulting in the issuance of 187,184 of our common shares.
On July 15, 2002, we redeemed $35.0 million in principal amount of our
13.5% senior secured notes at par plus accrued interest using existing cash
balances. In addition, repayments of long-term debt in 2001 included the early
retirement of $0.9 million of principal amount of our senior secured notes.
Long-term debt maturities for each of the next five years are less than
$0.1 million.
In July 2002 we filed a universal shelf registration statement for the
issuance and sale from time to time to the public of up to $100 million in
securities, including debt, preferred stock, common stock and warrants. The
shelf registration was declared effective by the SEC in September 2002. We have
not sold any securities pursuant to the shelf registration. See Note 6 in the
accompanying financial statements for more information on the credit facility
and shelf registration. We believe the shelf registration affords us the
financial flexibility to react to future opportunities in the market.
During 2001, we repurchased 376,300 of our outstanding shares in open
market transactions for $2.3 million.
At December 31, 2003, we had regular tax net operating loss
carryforwards which will fully eliminate the regular tax liability on
approximately $153.0 million of future regular taxable income. While we may have
alternative minimum tax (AMT) liability, we also have AMT net operating loss
carryforwards which will eliminate 90% of the AMT liability on approximately
$118.0 million of future AMT income. While future tax provisions will depend in
part on our ongoing assessment of our future ability to utilize our tax
benefits, we expect that the tax provisions that we record on approximately the
next $131.0 million in pre-tax income will be substantially less than the
amounts at full statutory rates. You should read Note 12 to the Consolidated
Financial Statements for further information concerning our federal tax status.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our management's discussion and analysis of our financial condition and
results of operations are based upon our consolidated financial statements,
which have been prepared in accordance with accounting principles generally
accepted in the United States of America. The preparation of these consolidated
financial statements requires us to make estimates and judgments that affect the
reported amounts of assets, liabilities, revenues and expenses, and related
disclosure of contingent assets and liabilities. On an on-going basis, we
evaluate our estimates, including those related to customer claims, allowance
for doubtful accounts, inventories, investments, long-lived assets, assets held
for sale, income taxes, product liability, workers compensation claims,
restructuring liabilities, environmental contingencies and litigation. We base
our estimates on historical experience and on various other assumptions that we
believe are reasonable under the circumstances. Actual results may differ from
these estimates under different assumptions or conditions. We believe the
following critical accounting policies affect our more significant judgments and
estimates used in the preparation of our consolidated financial statements.
REVENUE RECOGNITION
We recognize revenue from product sales when the product is shipped
from our facilities and risk of loss and title has passed to the customer or, at
the customer's request, the goods are set aside in storage and are paid for in
full. For transactions where we have not obtained customer acceptance, revenue
is deferred until the terms of acceptance are satisfied.
ACCOUNTS RECEIVABLE ALLOWANCES
We evaluate the collectibility of our receivables based on a
combination of factors. We regularly analyze our customer accounts and, when we
become aware of a specific customer's inability to meet its financial
obligations to us, such as in the case of bankruptcy filings or deterioration of
the customer's operating results or financial position, we record a specific
reserve for bad debt to reduce the related receivable to the amount we
reasonably believe is collectible.
22
We also maintain a reserve for customer claims for returns of defective
materials. This reserve is recorded as a percentage of sales and estimated based
upon historical experience. The adequacy of reserve estimates is periodically
reviewed by comparison to actual experience. Claims in any future period could
differ from our estimates and impact the net sales we report.
INVENTORY VALUATION
We value our inventories principally at the lower of cost or market and
regularly review the book value to determine if items are properly valued. We
record adjustments to the value of our inventory based on sales and production
forecasts. These adjustments are estimates, which can vary significantly, either
favorably or unfavorably, from actual amounts if future costs or levels of
business activity differ from our expectations. Generally, we do not experience
issues with slow-moving or obsolete inventory due to the nature of our products.
If we are not able to achieve our expectations of the net realizable value of
the inventory at its current value, we would have to adjust our reserves
accordingly.
LONG-LIVED ASSET IMPAIRMENT
We evaluate our long-lived assets used in operations, consisting of
property, plant and equipment, when indicators of impairment, such as reductions
in demand or significant economic factors are present. When such indicators of
impairment exist, an evaluation is performed to determine whether the carrying
value of an asset is impaired based on a comparison to the undiscounted
estimated future cash flows from the asset. The evaluations involve a
significant amount of judgment since the results are based on estimated future
events. Assets held for sale are reviewed for impairment when we approve the
plan to sell, and thereafter while the asset is held for sale. Estimates of
anticipated sales prices are highly judgmental and subject to material revision
in future periods. Because of the uncertainty inherent in these factors, we
cannot predict when or if future impairment charges will be recorded. During
2003, 2002 and 2001, we recorded impairment losses on our long-lived assets
primarily related to the restructuring of our operations
EMPLOYEE BENEFITS PLANS
We record liabilities and expense for deferred compensation agreements,
salary continuation agreements (SCA) and postretirement health benefit costs
based on actuarial valuations. All benefits paid under the agreements are
unfunded and benefits are paid from operating cash flows. The net present value
of the benefits provided under the deferred compensation agreements were accrued
over the period of the employee's active employment from the time the contract
was signed to the employee's retirement date using a discount rate of eleven
percent, which approximated our incremental borrowing rate at that time.
Inherent in the valuations for the SCA and postretirement health
benefits are key assumptions including assumptions about discount rates. These
assumptions are updated on an annual basis at the beginning of each fiscal year.
We are required to consider current market conditions, including changes in
interest rates, in making these assumptions. To develop our discount rate, we
considered the available yields on high-quality fixed-income investments with
maturities corresponding to our benefit obligations. We used a discount rate of
6.00% and 6.75% to determine the SCA and postretirement health benefit liability
as of December 31, 2003 and 2002, respectively. The decline in the discount rate
used to estimate the SCA and postretirement health benefit liability is a result
of declining interest rates in the United States. Changes in the related SCA and
postretirement health benefit costs may occur in the future due to changes in
the assumptions primarily as a result of changes in the discount rate.
23
RESTRUCTURING RESERVES
Our restructuring reserves reflect many estimates, including those
pertaining to settlements of contractual obligations and environmental
remediation obligations. We reassess the reserve requirements for completing the
restructuring program at the end of each reporting period. Actual experience has
been and may continue to be different from these estimates. For example, we
recognized $0.1 million and $0.8 million of restructuring charges in 2003 and
2002, respectively, related to revisions of our estimates for the restructuring
plan initiated in 2001. As of December 31, 2003 and 2002, liabilities associated
with our restructuring program were $5.6 million and $6.7 million, respectively.
Additional charges may be required in the future if the expected results of
litigation and estimates of environmental remediation costs are not realized.
Refer to Notes 2 and 10 to our consolidated financial statements for more
information.
RESERVES FOR CONTINGENCIES
We have other potential exposures, such as workers compensation claims,
environmental claims, product liability, litigation and recoverability of
deferred income taxes. Establishing loss reserves or valuation allowances for
these matters requires us to estimate and make judgments with regard to risk
exposure and ultimate liability. We establish accruals for these exposures;
however, if our exposure exceeds our estimates, we could be required to record
additional charges.
RECENTLY ISSUED ACCOUNTING STANDARDS
In May 2003, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standard (SFAS) No. 150, "Accounting for
Certain Financial Instruments with Characteristics of Both Liabilities and
Equity" ("SFAS No. 150"). SFAS No. 150 requires certain financial instruments
that embody obligations of the issuer and have characteristics of both
liabilities and equity to be classified as liabilities. The provisions of SFAS
No. 150 are effective for financial instruments entered into or modified after
May 31, 2003 and to all other instruments that exist as of the beginning of the
first interim financial reporting period beginning after June 15, 2003. We have
issued no financial instruments that meet the provisions of SFAS No. 150;
therefore, adopting the provisions of SFAS No. 150 had no effect on our
consolidated financial position, consolidated results of operations, or cash
flows.
In January 2003, the FASB issued FASB Interpretation No. 46,
"Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51."
("FIN No. 46"). The interpretation requires certain variable interest entities
to be consolidated by the primary beneficiary of the entity if the equity
investors in the entity do not have the characteristics of a controlling
financial interest or do not have sufficient equity at risk for the entity to
finance its activities without additional subordinated financial support from
other parties. In December 2003, FASB issued a revised interpretation of FIN No.
46 ("FIN No. 46-R"), which supercededs FIN No. 46 and clarifies and expands
current accounting guidance for variable interest entities. FIN No. 46 and FIN
No. 46-R are effective immediately for all variable interest entities created
after January 31, 2003, and for variable interest entities created prior to
February 1, 2003, no later than the end of the first reporting period after
March 15, 2004. We have not utilized such entities and therefore the adoption of
FIN No. 46 and FIN No. 46-R had no effect on our consolidated financial
position, consolidated results of operations, or cash flows.
24
In December 2003, the FASB issued SFAS No. 132, "Employers' Disclosures
about Pensions and Other Postretirement Benefits ("SFAS No. 132")." This
statement revises employers' disclosures about pension plans and other
postretirement benefit plans. It requires additional disclosures to those in the
original SFAS No. 132 about the assets, obligations, cash flows and net periodic
benefit cost of defined benefit pension plans and other defined benefit
postretirement plans. The required information should be provided separately for
pension plans and for other postretirement benefit plans. This statement, which
also requires new disclosures for interim periods beginning after December 15,
2003, is effective for fiscal years ending after December 15, 2003. The Company
adopted this statement for the year ended December 31, 2003.
OTHER MATTERS
You should read Note 10 to the Consolidated Financial Statements for
information pertaining to commitments and contingencies.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We have not used derivative financial instruments for any purpose
during the periods shown, including trading or speculating on changes in
interest rates or commodity prices of materials.
Purchased steel, in the form of hot-rolled coils and steel scrap,
represents the largest portion of our cost of goods sold. The price and
availability of steel coils and scrap that we use in our manufacturing processes
are highly competitive and volatile. Various factors, most of which are beyond
our control, affect the supply and price of steel coils and scrap. We believe
that changes in steel coil and scrap costs have had a significant impact on our
earnings, and we expect that future changes will continue to significantly
impact our earnings. Reference is made to "Recent Developments" in Item 7 of
this report for recent developments regarding steel costs.
We are exposed to market risk for changes in interest rates for
borrowings under our revolving credit facility. Borrowings under the credit
facility bear interest at variable rates, and the fair value of the borrowings
are not significantly affected by changes in market interest rates. If the
interest rates on our credit facility were to increase by 1%, assuming our
borrowings level at December 31, 2003, the increase in our interest expense
would be less than $0.2 million on an annualized basis.
We purchase natural gas and electricity for our operations and,
therefore, have a market risk related to gas and electricity purchases in the
open market at spot prices. The prices of such purchases and futures positions
are subject to wide fluctuations due to unpredictable factors such as weather,
government policies and demand for natural gas and competitive fuels. As a
result, our earnings could be affected by changes in the price and availability
of gas and electricity. As market conditions dictate, we from time to time will
lock in future gas and electricity prices using fixed price contracts.
25
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE
Consolidated Financial Statements
Report of Management .......................... 27
Independent Auditors' Report .................. 28
Consolidated Statements of Operations ......... 30
Consolidated Balance Sheets ................... 31
Consolidated Statements of Cash Flows ......... 32
Consolidated Statements of Common
Shareholders' Equity ....................... 33
Notes to Consolidated Financial Statements .... 34
Financial Statement Schedule
Schedule II ................................... 50
26
REPORT OF MANAGEMENT
The accompanying consolidated financial statements have been prepared
by the management of NS Group, Inc., in conformity with accounting principles
generally accepted in the United States of America and, in the judgment of
management, present fairly and consistently the Company's consolidated financial
position and results of operations. These statements necessarily include amounts
that are based on management's best estimates and judgments. The financial
information contained elsewhere in this report is consistent with that contained
in the consolidated financial statements.
In fulfilling its responsibilities for the integrity of financial
information, management maintains accounting systems and related controls. These
controls provide reasonable assurance that assets are safeguarded against loss
and that financial records are reliable for use in preparing financial
statements. These systems are enhanced by written policies, an organizational
structure that provides division of responsibilities and careful selection and
training of qualified people.
In connection with their annual audit, independent public accountants
perform an examination in accordance with auditing standards generally accepted
in the United States of America which includes a review of the system of
internal accounting control and an expression of an opinion that the
consolidated financial statements are fairly presented in all material respects.
The board of directors, through its audit committee composed solely of
independent, non-employee directors, reviews the Company's financial reporting
and accounting practices. The Company's independent public accountants and
internal auditors meet regularly with, and have access to, the audit committee,
with or without management present, to discuss the results of their audit work.
/s/ Rene J. Robichaud
Rene J. Robichaud
President and Chief Executive Officer
/s/ Thomas J. Depenbrock
Thomas J. Depenbrock
Vice President - Finance, Treasurer
and Chief Financial Officer
27
INDEPENDENT AUDITORS' REPORT
TO THE BOARD OF DIRECTORS AND SHAREHOLDERS OF NS GROUP, INC.
Newport, Kentucky
We have audited the accompanying consolidated balance sheets of NS Group, Inc.
and subsidiaries as of December 31, 2003 and 2002, and the related consolidated
statements of operations, common shareholders' equity, and cash flows for the
years then ended. Our audits also included the consolidated financial statement
schedules listed in the Index at Item 15 for the years ended December 31, 2003
and 2002. These consolidated financial statements and financial statement
schedules are the responsibility of the Company's management. Our responsibility
is to express an opinion on the 2003 and 2002 consolidated financial statements
and financial statement schedules based on our audits. The consolidated
financial statements and financial statement schedule of the Company for the
year ended December 31, 2001, were audited by other auditors who have ceased
operations. Those auditors expressed an unqualified opinion on those
consolidated financial statements and included an explanatory paragraph that
stated that the schedule fairly stated in all material respects the financial
data required to be set forth therein in relation to the basic financial
statements taken as a whole in their report dated February 5, 2002 (except for
Note 17, as to which the date is March 15, 2002).
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. 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, such 2003 and 2002 consolidated financial statements present
fairly, in all material respects, the financial position of the Company at
December 31, 2003 and 2002, and the results of its operations and its cash flows
for the years then ended in conformity with accounting principles generally
accepted in the United States of America. Also, in our opinion, such 2003 and
2002 consolidated financial statement schedules, when considered in relation to
the basic 2003 and 2002 consolidated financial statements taken as a whole,
present fairly in all material respects the information set forth therein.
As discussed above, the consolidated financial statements of the Company for the
year ended December 31, 2001 were audited by other auditors who have ceased
operations. As described in Note 1, those consolidated financial statements have
been reclassified to give effect to Statement of Financial Accounting Standards
No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB
Statement No. 13, and Technical Corrections (SFAS 145), which was adopted by the
Company on January 1, 2003. We audited the adjustment described in Note 1 that
was applied to conform the 2001 consolidated financial statements to the
presentation required by SFAS 145. Our audit procedures with respect to the 2001
disclosures in Note 1 included (1) comparing the previously reported loss on
extinguishment of debt to the previously issued consolidated financial
statements and (2) tracing the reclassification adjustment amount into other
income, net in the Company's 2001 consolidated statement of operations. In our
opinion, such reclassification has been properly applied. However, we were not
engaged to audit, review, or apply any procedures to the 2001 financial
statements of the Company other than with respect to such reclassification and,
accordingly, we do not express an opinion or any form of assurance on the 2001
financial statements taken as a whole.
/s/ DELOITTE & TOUCHE LLP
Cincinnati, Ohio
March 8, 2004
28
The following report is a copy of a previously issued Arthur Andersen
LLP ("Andersen") report, and the report has not been reissued by Andersen. The
Andersen report refers to the consolidated balance sheet as of December 31, 2001
and September 30, 2000 and the consolidated statements of operations, common
shareholders' equity and cash flows for the three-month period ended December
31, 2000, and the years ended September 30, 2000 and September 25, 1999, which
are no longer included in the accompanying financial statements.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
TO THE SHAREHOLDERS OF NS GROUP, INC.:
We have audited the accompanying consolidated balance sheets of NS
Group, Inc. (a Kentucky corporation) and subsidiaries as of December 31, 2001
and September 30, 2000, and the related consolidated statements of operations,
common shareholders' equity and cash flows for the year ended December 31, 2001,
and three-month period ended December 31, 2000, and the years ended September
30, 2000 and September 25, 1999. These financial statements and the schedule
referred to below, are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. 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 NS Group, Inc. and
subsidiaries as of December 31, 2001 and September 30, 2000, and the results of
their operations and their cash flows for the year ended December 31, 2001, the
three-month period ended December 31, 2000, and the years ended September 30,
2000 and September 25, 1999 in conformity with accounting principles generally
accepted in the United States.
Our audit was made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule listed in the Index to
Consolidated Financial Statements is presented for purposes of complying with
the Securities and Exchange Commission's rules and is not part of the basic
financial statements. The 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.
Cincinnati, Ohio /s/ARTHUR ANDERSEN LLP
February 5, 2002 (except for Note 17, as to which the date is March 15, 2002)
29
CONSOLIDATED STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31,
-----------------------
(In thousands, except per share amounts) 2003 2002 2001
============================================= ========= ========== ==========
NET SALES $ 258,987 $ 192,408 $ 315,458
COST OF PRODUCTS SOLD 262,952 206,993 290,058
--------- ---------- ----------
Gross profit (loss) (3,965) (14,585) 25,400
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 14,721 17,509 19,982
RESTRUCTURING CHARGES 77 2,046 55,585
TRADE CASE RECEIPTS (567) - -
--------- ---------- ----------
Operating loss (18,196) (34,140) (50,167)
INVESTMENT INCOME (LOSS) (117) 737 (2,114)
INTEREST EXPENSE (3,391) (8,180) (10,342)
OTHER INCOME, NET 4,206 795 2,729
--------- ---------- ----------
Loss before income taxes (17,498) (40,788) (59,894)
PROVISION (BENEFIT) FOR INCOME TAXES (169) (858) (3,917)
--------- ---------- ----------
Net loss $ (17,329) $ (39,930) $ (55,977)
========= ========== ==========
Other comprehensive loss, net of taxes:
Net unrealized gain on investments 425 514 5,416
--------- ---------- ----------
Comprehensive loss $ (16,904) $ (39,416) $ (50,561)
========= ========== ==========
NET LOSS PER COMMON SHARE - BASIC AND DILUTED $ (0.83) $ (1.93) $ (2.68)
--------- ---------- ----------
WEIGHTED AVERAGE SHARES OUTSTANDING
Basic and diluted 20,774 20,647 20,889
See notes to consolidated financial statements
30
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
---------------------
(In thousands) 2003 2002
- -------------- --------- ---------
ASSETS
CURRENT ASSETS
Cash and equivalents $ 2,628 $ 29,357
Accounts receivable, less allowances
of $852 and $591, respectively 27,261 12,653
Inventories 66,568 55,874
Operating supplies and prepaids 9,236 10,968
Assets held for sale 7,000 -
Deferred income taxes 424 332
Other current assets 74 782
--------- ---------
Total current assets 113,191 109,966
--------- ---------
PROPERTY, PLANT AND EQUIPMENT, NET 45,954 51,651
LONG-TERM INVESTMENTS - 3,848
--------- ---------
OTHER ASSETS 4,981 5,416
--------- ---------
ASSETS HELD FOR SALE 1,734 9,413
--------- ---------
Total assets $ 165,860 $ 180,294
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 24,507 $ 8,600
Accrued liabilities and other 24,873 20,162
Revolving credit facility 14,936 -
Other notes payable 106 -
Current portion of restructuring liabilities 3,653 4,656
Current portion of long-term debt 40 33,555
--------- ---------
Total current liabilities 68,115 66,973
--------- ---------
LONG-TERM DEBT 461 482
--------- ---------
DEFERRED INCOME TAXES 424 332
--------- ---------
OTHER LONG-TERM LIABILITIES 8,252 8,124
--------- ---------
COMMON SHAREHOLDERS' EQUITY
Common stock, no par value, 40,000 shares authorized,
25,090 and 24,860, shares issued 284,161 282,935
Treasury stock, at cost, 4,192 and 4,213 shares (35,420) (35,572)
Common stock options and warrants 576 759
Accumulated other comprehensive income (loss) 97 (328)
Accumulated deficit (160,806) (143,411)
--------- ---------
Common shareholders' equity 88,608 104,383
--------- ---------
Total liabilities and shareholders' equity $ 165,860 $ 180,294
========= =========
See notes to consolidated financial statements
31
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
--------------------------------
(In thousands) 2003 2002 2001
- ---------------------------------------------------------------------- -------- --------- ---------
CASH FLOWS - OPERATING ACTIVITIES
Net loss $(17,329) $ (39,930) $ (55,977)
Adjustments to reconcile net loss to net
cash flows provided (used) by operating activities:
Depreciation and amortization 6,672 11,272 13,604
Amortization of debt discount and
finance costs 602 1,009 1,077
Impairment loss on investments 141 1,000 4,718
Deferred income taxes (77) (2,871) (2,360)
Restructuring charges, including asset impairment 308 2,046 42,820
Deferred costs written off related to extinguishment of debt - 615 59
Loss on sales of securities 347 86 511
Other, net 427 662 308
Changes in operating assets and liabilities:
Accounts receivable, net (14,608) 10,508 22,193
Inventories (10,694) (545) 3,155
Other current assets 1,178 808 1,332
Accounts payable 15,907 (5,703) 941
Accrued liabilities 4,711 957 (9,789)
Restructuring liabilities (1,184) (472) 6,295
-------- --------- ---------
Net cash flows provided (used) by operating activities (13,599) (20,558) 28,887
-------- --------- ---------
CASH FLOWS - INVESTING ACTIVITIES
Purchases of property, plant and equipment (1,137) (2,422) (2,198)
Proceeds from sales of assets held for sale 479 834 2,144
Maturities of available-for-sale securities - 2,844 -
Sales of available-for-sale securities 3,751 9,455 3,752
Changes in other assets 1,947 135 475
-------- --------- ---------
Net cash flows provided by investing activities 5,040 10,846 4,173
======== ========= =========
CASH FLOWS - FINANCING ACTIVITIES
Repayments of long-term debt (33,802) (35,033) (962)
Net borrowings under revolving credit facility 14,936 - -
Increase in other notes payable 106 - -
Proceeds from option and warrant exercises 1,029 11 328
Additions to cost of treasury stock (28) - (2,721)
Payment of financing costs (411) (765) -
-------- --------- ---------
Net cash flows used by financing activities (18,170) (35,787) (3,355)
======== ========= =========
Increase (decrease) in cash and equivalents (26,729) (45,499) 29,705
CASH AND EQUIVALENTS AT BEGINNING OF PERIOD 29,357 74,856 45,151
-------- --------- ---------
CASH AND EQUIVALENTS AT END OF PERIOD $ 2,628 $ 29,357 $ 74,856
======== ========= =========
Supplemental disclosure of cash flow information:
Cash paid during the period for interest $ 4,543 $ 9,295 $ 9,362
Cash recovered during the period for income taxes $ 670 $ 50 $ 1,326
See notes to consolidated financial statements
32
CONSOLIDATED STATEMENTS OF COMMON SHAREHOLDERS' EQUITY
Accumulated
Common Stock Treasury Stock Options Other
------------ -------------- and Comprehensive Accumulated
(In thousands) Shares Amount Shares Amount Warrants Income (Loss) Deficit Total
- ---------------------------------- ------ ------ ------ ------ -------- ------------- ------- -----
Balance, December 31, 2000 24,786 $ 282,750 3,858 $(33,035) $ 497 $ (6,258) $ (47,476) $196,478
Net loss (55,977) (55,977)
Net unrealized gain on investments 187 187
Reclassification of investment
losses to income statement 5,229 5,229
Purchase of treasury stock 376 (2,721) (2,721)
Stock option plans 73 178 (20) 178 138 (28) 466
------ --------- ------ -------- ------ -------- --------- --------
Balance, December 31, 2001 24,859 $ 282,928 4,214 $(35,578) $ 635 $ (842) $(103,481) $143,662
Net loss (39,930) (39,930)
Net unrealized loss on investments (552) (552)
Reclassification of investment
losses to income statement 1,066 1,066
Stock option plans 1 7 (1) 6 124 137
------ --------- ------ -------- ------ -------- --------- --------
Balance, December 31, 2002 24,860 $ 282,935 4,213 $(35,572) $ 759 $ (328) $(143,411) $104,383
NET LOSS (17,329) (17,329)
NET UNREALIZED LOSS ON INVESTMENTS (63) (63)
RECLASSIFICATION OF INVESTMENT
LOSSES TO INCOME STATEMENT 488 488
EXERCISE OF COMMON STOCK WARRANTS 187 749 (308) 441
STOCK OPTION PLANS 43 477 (21) 152 125 (66) 688
------ --------- ------ -------- ------ -------- --------- --------
BALANCE, DECEMBER 31, 2003 25,090 $ 284,161 4,192 $(35,420) $ 576 $ 97 $(160,806) $ 88,608
====== ========= ====== ======== ====== ======== ========= ========
See notes to consolidated financial statements
33
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of NS Group,
Inc. and its wholly-owned subsidiaries (the Company): Newport Steel Corporation
(Newport), Koppel Steel Corporation (Koppel), Erlanger Tubular Corporation
(Erlanger), and Northern Kentucky Management, Inc. All significant intercompany
accounts and transactions have been eliminated.
RECLASSIFICATIONS
Extraordinary charges of $0.6 million in 2002 and $0.1 million in 2001
related to the extinguishment of debt have been reclassified to Other income,
net as an effect of the Company adopting SFAS No. 145 as of January 1, 2003.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires that
management make certain estimates and assumptions that affect the amounts
reported in the consolidated financial statements and accompanying notes. Actual
results could differ from those recorded estimates.
CASH AND EQUIVALENTS
Cash includes currency on hand and demand deposits with financial
institutions. Cash equivalents consist primarily of money market mutual funds,
commercial paper and U.S. treasury securities with an original term of three
months or less.
LONG-TERM INVESTMENTS
Long-term investments consisted of corporate bonds and a retained
equity investment in a former subsidiary of the Company that were classified as
available for sale and carried at fair value, based on quoted market prices.
Realized gains and losses are included in investment income. The cost of
securities sold is based on the specific identification method. Unrealized gains
and losses on available for sale securities are included, net of tax, in
accumulated other comprehensive income (loss) within common shareholders' equity
until sold. The net unrealized gain at December 31, 2003, is related to the
Company's $1.8 million of U.S. government securities being held in trust for the
payment of environmental remediation costs for its closed landfill in Kentucky.
Long-term investments are periodically reviewed to determine if
declines in fair value below cost basis are other-than-temporary. Significant
and sustained decreases in quoted market prices, a series of historic and
projected operating losses by the investee or other factors are considered as
part of the review. If the decline in fair value has been determined to be
other-than-temporary, an impairment loss is recorded in investment income and
the individual security is written down to a new cost basis. The Company
recognized impairment losses of $0.1 million, $1.0 million and $6.2 million in
2003, 2002 and 2001, respectively. Losses for 2001 include $4.4 million of
impairment losses on a retained equity investment in a former subsidiary of the
Company.
34
Other comprehensive income (loss), net of applicable income taxes, if any,
consists of the following:
(In thousands) 2003 2002 2001
-------------- ------- ------- -------
Net unrealized holding gains (losses) for the period $ (63) $ (552) $ 187
Reclassification adjustment for impairment losses
included in income, net of income taxes 141 980 4,718
Reclassification adjustment for losses realized in income 347 86 511
------- ------- -------
Other comprehensive income (loss) $ 425 $ 514 $ 5,416
======= ======= =======
INVENTORIES
Inventories are stated at the lower of FIFO (first-in, first-out) cost
or market, or the lower of average cost or market. The Company records a
provision for excess and obsolete inventory whenever such an impairment has been
identified. Inventory costs include labor, material and manufacturing overhead.
Inventories at December 31, 2003 and 2002 consist of the following:
(In thousands) 2003 2002
-------------- -------- --------
Raw materials $ 20,514 $ 20,108
Finished and semi-
finished products 46,054 35,766
-------- --------
$ 66,568 $ 55,874
======== ========
PROPERTY, PLANT AND EQUIPMENT AND DEPRECIATION
Property, plant and equipment are stated on a cost basis. Expenditures
for additions, betterments and renewals are capitalized. Maintenance and repair
expenditures, which do not improve or extend productive life, are expensed as
incurred. For financial reporting purposes, plant and equipment are depreciated
on a straight-line method over the estimated useful lives of the assets. Useful
lives of the assets are 30 to 40 years for buildings and 5 to 12 years for
machinery and equipment.
The Company periodically evaluates property, plant and equipment for
indicators of potential impairment such as reductions in demand or significant
economic factors. When such indicators of impairment exist, a review is
performed to determine whether the carrying value of an asset is impaired based
on a comparison to the undiscounted estimated future cash flows from the asset.
If the comparison indicates that there is impairment, the impaired asset is
written down to fair value. See Note 2 regarding asset write-downs and
reclassifications as a result of the Company's restructuring initiatives in
2001.
Property, plant and equipment at December 31, 2003 and 2002 consist of
the following:
(In thousands) 2003 2002
-------------- ---------- ---------
Land and improvements $ 8,836 $ 8,836
Buildings 16,245 16,195
Machinery and equipment 173,153 171,418
Construction in progress 479 1,302
---------- ---------
198,713 197,751
Accumulated depreciation (152,759) (146,100)
---------- ---------
$ 45,954 $ 51,651
========== =========
TREASURY STOCK
The Company's repurchases of shares of common stock are recorded as
treasury stock at cost and result in a reduction of common shareholders' equity.
When treasury shares are reissued, the Company uses average cost to value
treasury shares and any excess of average cost over reissuance price is treated
as a reduction of retained earnings. The Company purchased 376,300 shares in the
open market for $2.3 million in the year ended December 31, 2001. See Note 9 for
additional information.
REVENUE RECOGNITION
The Company records revenue from product sales when the product is
shipped from its facilities and risk of loss and the title has passed to the
customer or, at the customer's request, the goods are set aside in storage and
are paid for in full. For transactions where we have not obtained customer
acceptance, revenue is deferred until the terms of the acceptance are satisfied.
OTHER INCOME, NET
The Company received settlements of $4.0 million, $0.8 million and $1.3
million in 2003, 2002 and 2001, respectively, as the result of antitrust
litigation against manufacturers of graphite electrodes used in the steel-making
process.
35
STOCK-BASED COMPENSATION
The Company accounts for stock-based compensation using the intrinsic
value method in accordance with Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees," and related interpretations. Stock
options granted during 2003, 2002 and 2001 were exercisable at prices equal to
the fair market value of the Company's common stock on the dates the options
were granted; accordingly, no compensation expense has been recognized for the
stock options granted.
If the Company accounted for stock-based compensation using the fair
value recognition provisions of SFAS No. 123, "Accounting for Stock-Based
Compensation", net loss and diluted loss per share would have been as follows:
(In thousands, except per share amounts) 2003 2002 2001
---------------------------------------- -------- -------- --------
Net loss - as reported $(17,329) $(39,930) $(55,977)
Less: Stock-based employee compensation
expense determined under the fair value
method for all awards, net of related tax effects (2,281) (3,034) (3,687)
-------- -------- --------
Net loss - pro forma $(19,610) $(42,964) $(59,664)
======== ======== ========
Diluted loss per share - as reported $ (0.83) $ (1.93) $ (2.68)
Effect of stock-based employee
compensation expense determined under the fair
value method for all awards, net of related tax effects (0.11) (0.15) (0.18)
-------- -------- --------
Diluted loss per share - pro forma $ (0.94) $ (2.08) $ (2.86)
======== ======== ========
The fair values of the granted options were determined using the
Black-Scholes option pricing model with the following weighted average
assumptions for 2003, 2002 and 2001, respectively; no common stock dividends;
expected volatility of 77%, 62% and 75%; risk-free interest rates of 3.1%, 4.7%
and 5.1%; and an expected life of 7 years for all periods.
INCOME TAXES
Deferred income tax balances represent the estimated future tax effects
of temporary differences between the financial reporting basis and the tax basis
of certain assets and liabilities. A valuation allowance is established to
reduce deferred tax assets to amounts that are more likely than not to be
realized.
ENVIRONMENTAL REMEDIATION AND COMPLIANCE
Environmental remediation costs are accrued, except to the extent
capitalizable, when incurrence of such costs are probable and the costs can be
reasonably estimated. Environmental compliance costs include maintenance and
operating costs associated with pollution control facilities, costs of ongoing
monitoring programs, permit costs and other similar costs. Such costs are
expensed as incurred.
EARNINGS (LOSS) PER SHARE
Basic earnings or loss per share is computed by dividing net income or
loss by the weighted-average number of common shares outstanding for the period.
Diluted earnings or loss per share is computed by dividing net income or loss by
the weighted average number of common shares outstanding and dilutive
equivalents, which, for the Company, includes stock options and warrants only.
Because the Company reported net losses in all periods shown, potentially
dilutive securities of 1.8 million, 2.0 million and 2.2 million shares for 2003,
2002 and 2001, respectively, were not included in the computation of diluted
earnings or loss per share for the periods because they would be antidilutive.
36
Note 2: RESTRUCTURING CHARGES
During the quarter ended March 31, 2001, the Company implemented
restructuring initiatives involving certain operations of its business. One
initiative was to purchase hot-rolled coils rather than manufacture them at the
Company's welded tubular operations. As a result, the Company discontinued the
production of hot-rolled coils and closed its melt shop and hot strip mill
operations at its welded tubular facilities in Wilder, Kentucky, effective March
31, 2001. In addition, the Company decided to exit the special bar quality
business by June 30, 2001, which was operated from its Koppel, Pennsylvania
facility.
Consequently, in the first quarter of 2001, the Company recorded $56.2
million of restructuring charges, including $43.4 million resulting primarily
from asset impairment losses related to machinery, equipment and related spare
parts inventories to be sold. The restructuring charges include a $0.6 million
write-down of special bar quality finished goods inventories that was included
in cost of products sold.
In the fourth quarter of 2002, the Company recorded $2.0 million of
additional restructuring charges related to the March 2001 restructuring. The
charges included a $1.2 million impairment loss on assets held for sale and $0.8
million primarily related to an increase in the estimate of post-closure costs
for the Company's closed landfill, net of employee separation accrual reversals.
In the fourth quarter of 2003, the Company recorded $0.1 million of
additional restructuring charges resulting from an increase in the estimated
cancellation costs of operating contracts.
Following is a summary of the accrued restructuring liabilities and
activity through December 31, 2003:
FACILITY
EMPLOYEE CLOSING
(In thousands) SEPARATION AND OTHER TOTAL
-------------- ---------- --------- --------
Initial reserves $ 4,941 $ 7,824 $ 12,765
Cash payments (4,238) (2,232) (6,470)
Accruals (reversals) (548) 548 -
-------- -------- --------
December 31, 2001 $ 155 $ 6,140 $ 6,295
-------- -------- --------
Cash payments (2) (470) (472)
Accruals (153) 999 846
-------- -------- --------
December 31, 2002 $ - $ 6,669 $ 6,669
-------- -------- --------
CASH PAYMENTS - (1,184) (1,184)
ACCRUALS - 77 77
-------- -------- --------
DECEMBER 31, 2003 $ - $ 5,562 $ 5,562
======== ======== ========
In 2001, the Company paid severance to the 205 hourly and 65 salaried
employees whose positions were eliminated by the restructuring. The
restructuring liabilities for facility closing and other costs consist primarily
of estimated cancellation costs of operating contracts and environmental
remediation costs. Payments in 2003 were primarily for environmental costs
related to the landfill closure. Accrued restructuring liabilities of $1.9
million, primarily related to post-closure costs of the Company's closed
landfill, have been classified as Other Long-term Liabilities as the payments
will be made over the next thirty years.
37
ASSETS HELD FOR SALE
Assets of the closed operations, consisting of machinery and equipment,
spare parts and supply inventories, are classified as Assets Held for Sale in
the Company's consolidated balance sheet. The assets include the Company's best
estimates of the amounts expected to be realized on the sale of the assets.
While the estimates are based on an analysis of the facilities, including
valuations by independent appraisers, the amounts the Company will ultimately
realize could differ materially from the amounts assumed in calculating the
impairment loss on the assets at December 31, 2003. The assets have been and are
currently being actively marketed by an outside broker.
In October 2003, the Company entered into a contract to sell a majority
of its assets held for sale of its welded tubular operations. The net sales
price for the assets approximates their recorded book value and have been
reclassified to current Assets Held for Sale in the December 31, 2003
consolidated balance sheet. In accordance with the contract, the Company is
scheduled to receive cash payments over the period the assets are removed, which
is expected to occur during the first half of 2004.
Note 3: BUSINESS SEGMENT INFORMATION
The Company has historically reported its operations in two reportable
segments. The Company's Energy Products segment consists primarily of (i) welded
and seamless tubular goods used primarily in oil and natural gas drilling and
production operations (oil country tubular goods, or OCTG); and (ii) line pipe
used in the transmission of oil, natural gas and other fluids. The Energy
Products segment reflects the aggregation of two business units which have
similar economic characteristics such as products and services, manufacturing
processes, customers and distribution channels and is consistent with both
internal management reporting and resource and budgetary allocations. The
Company's Industrial Products segment consisted of Special Bar Quality (SBQ)
products used primarily in the manufacture of heavy industrial equipment. As
discussed in Note 2, the Company exited the SBQ business and as such, the assets
of this segment at December 31, 2003 are classified as Assets Held for Sale.
The Company evaluated performance and allocated resources on operating
income before interest and income taxes. The accounting policies of the
reportable segments were the same as those described in Note 1. Corporate assets
are primarily cash, property, income tax assets and assets held for sale.
Corporate general and administrative expenses were fully allocated to the
Company's segments.
CONCENTRATIONS
The operations of the segments are conducted principally in the United
States. The Company grants trade credit to customers, the most significant of
which are distributors serving the oil and natural gas exploration and
production industries which purchase tubular steel products from the Energy
Products segment. Sales to a customer of the Company's energy products accounted
for approximately 20%, 17% and 16%, respectively, of total Energy Products
segment sales for 2003, 2002 and 2001. Another customer of the Company's Energy
Products segment accounted for 13%, 12% and 14% of total Energy Products segment
sales for 2003, 2002 and 2001.
The Company's welded tubular operations depends primarily on three
suppliers for its steel coils with one supplier accounting for the majority of
its purchases. If the Company would suffer the loss of a significant customer or
supplier, the effect could result in reduced sales or a delay in manufacturing
and would adversely affect operating results.
Substantially all of the Company's hourly employees are represented by
the United Steelworkers of America under contracts that expire in April 2005,
May 2006 and May 2007 for the Newport, Koppel and Erlanger operations,
respectively.
38
The following table sets forth selected financial information by
reportable business segment for 2003, 2002 and 2001.
ENERGY INDUSTRIAL
(IN THOUSANDS) PRODUCTS PRODUCTS CORPORATE TOTAL
-------------- --------- ---------- --------- ---------
2003
NET SALES
WELDED TUBULAR PRODUCTS $ 116,631 $ - $ - $ 116,631
SEAMLESS TUBULAR PRODUCTS 142,356 - - 142,356
--------- -------- --------- ---------
$ 258,987 $ - $ - $ 258,987
========= ======== ========= =========
OPERATING LOSS (1) $ (18,196) $ - $ - $ (18,196)
ASSETS 150,385 - 15,475 165,860
DEPRECIATION AND AMORTIZATION 6,672 - - 6,672
CAPITAL EXPENDITURES 1,137 - - 1,137
--------- -------- --------- ---------
2002
Net sales
Welded tubular products $ 87,306 $ - $ - $ 87,306
Seamless tubular products 105,102 - - 105,102
--------- -------- --------- ---------
$ 192,408 $ - $ - $ 192,408
========= ======== ========= =========
Operating loss (2) $ (34,140) $ - $ - $ (34,140)
Assets 128,739 - 51,555 180,294
Depreciation and amortization 11,272 - - 11,272
Capital expenditures 2,422 - - 2,422
--------- -------- --------- ---------
2001
Net sales
Welded tubular products $ 143,540 $ - $ - $ 143,540
Seamless tubular products 162,069 - - 162,069
SBQ products - 9,849 - 9,849
--------- -------- --------- ---------
$ 305,609 $ 9,849 $ - $ 315,458
========= ======== ========= =========
Operating loss (3) $ (36,017) $(12,949) $ (1,201) $ (50,167)
Assets 152,034 - 108,450 260,484
Depreciation and amortization 12,663 941 - 13,604
Capital expenditures 2,198 - - 2,198
--------- -------- --------- ---------
(1) Includes restructuring charges of $0.1 million, a $0.2 million impairment
loss on long-lived assets and and income of $0.6 million from trade case
receipts.
(2) Includes restructuring charges of $2.0 million.
(3) Includes restructuring charges of $45.3 million for Energy Products segment,
$9.7 million for Industrial Products segment, and $1.2 million for
Corporate, for a total of $56.2 million.
39
Note 4: ACCRUED LIABILITIES AND OTHER LONG-TERM LIABILITIES
Accrued liabilities and other at December 31, 2003 and 2002 consist of
the following:
(In thousands) 2003 2002
-------------- -------- --------
Deferred revenue $ 8,012 $ 2,663
Accrued payroll and benefits 6,198 5,907
Workers' compensation 3,403 3,225
Customer claims 2,694 1,485
Personal property and sales and use taxes 2,633 2,120
Accrued environmental remediation 1,880 2,081
Accrued interest 53 2,089
Other - 592
-------- --------
$ 24,873 $ 20,162
======== ========
Other long-term liabilities at December 31, 2003 and 2002 consist of
the following:
(In thousands) 2003 2002
-------------- -------- --------
Accrued employee benefits $ 6,343 $ 6,111
Long-term restructuring liabilities 1,909 2,013
-------- --------
$ 8,252 $ 8,124
======== ========
Note 5: LONG-TERM INVESTMENTS
At December 31, 2002, the Company's long-term investments consisted of
corporate bonds and were all classified as available for sale. The investments
had a market value of $3.8 million as a result of an amortized cost of $4.5
million and gross unrealized losses of $0.7 million.
Gross realized gains and losses for 2003, 2002 and 2001 were as follows:
(In thousands) 2003 2002 2001
-------------- ---- ---- ----
Realized gains $ 73 $328 $ 69
Realized losses $420 $414 $580
---- ---- ----
In addition, see Note 1 - Long-term Investments regarding the
impairment losses on investments which the Company recognized in 2003, 2002 and
2001 and assets held in trust.
40
NOTE 6: DEBT AND CREDIT FACILITY
Borrowings of the Company at December 31, 2003 and 2002 consist of the
following:
(In thousands) 2003 2002
- -------------------------------------------------- -------------- ---------------
Revolving credit facility $ 14,936 $ _
-------------- ---------------
Other notes payable $ 106 $ _
-------------- ---------------
Long-term debt:
13.5% senior secured notes due July 15, 2003
(Notes), interest due semi-annually, secured
by property, plant and equipment (net of
unamortized discount of $ 247) $ - $ 33,521
Other 501 516
-------------- ---------------
501 34,037
Less current portion (40) (33,555)
-------------- ---------------
Long-term debt $ 461 $ 482
============== ===============
In the second quarter of 2003, the Company redeemed the remaining $33.8
million of its outstanding Notes. The Notes were redeemed at par plus accrued
interest, and was funded from existing cash balances and borrowings under the
Company's credit facility.
In connection with its Notes redemption, the Company amended its
revolving credit facility. The facility provides up to $45.0 million under a
borrowing formula that is based upon eligible inventory and accounts receivable,
subject to certain reserves and satisfaction of certain conditions to each draw
under the facility. Interest rates on the facility vary according to the amount
of loans outstanding and range from the prime rate plus 1.00% to prime plus
1.75% with respect to domestic rate loans, and from the LIBOR rate plus 2.50% to
LIBOR plus 3.25% with respect to LIBOR rate loans. In addition, there is a line
usage fee imposed in periods in which the outstanding amount of the line exceeds
$30.0 million. The credit agreement contains financial and other covenants,
including a minimum level of earnings, as defined in the agreement, and
limitations on certain types of transactions, including the ability of the
Company's subsidiaries to declare and pay dividends. The credit facility expires
in March 2007.
At December 31, 2003, the Company was not in compliance with the
minimum level of defined earnings covenant, which resulted in the imposition of
$7.5 million of additional reserves against availability. At December 31, 2003,
the Company had $14.9 million in loans and $5.0 million of letters of credit
outstanding under the credit facility and approximately $15.5 million in
additional borrowing availability. The letters of credit were issued against the
credit facility as collateral for the Company's self-insured workers
compensation program. The weighted average interest rate on the credit facility
borrowings at of December 31, 2003 was 3.78%. The facility is secured by a first
priority lien on substantially all of the Company's inventories, accounts
receivable, property, plant and equipment and related intangibles.
On July 15, 2002, the Company completed an early redemption call for
$35.0 million in principal of its Notes. The redemption was at par plus accrued
interest and was funded from existing cash balances. An extraordinary charge of
$0.6 million, or $0.03 per diluted share, was recorded in the third quarter of
2002, for the write-off of associated original discount and issue costs.
In the first quarter 2001, the Company purchased $0.9 million in
principal amount of its Notes in an open market transaction. In connection with
the purchase of the Notes, the Company recorded an extraordinary charge of $0.1
million for the premium incurred and write-off of associated original discount
and issue costs.
41
The extraordinary charges related to the extinguishment of debt in 2002
and 2001 have been reclassified to Other income, net in accordance with current
accounting rules.
In July 2002, the Company filed a universal shelf registration
statement with the SEC for the issuance and the sale from time to time to the
public of up to $100 million in securities, including debt, preferred stock,
common stock and warrants. The registration statement was declared effective by
the SEC in September 2002. The Company may sell the securities in one or more
separate offerings in amounts, at prices and on terms to be determined at the
time of sale. No securities have been sold pursuant to the shelf registration.
If and when the Company offers any securities under this registration statement,
the Company will prepare and make available a prospectus supplement that
includes the specific terms of the securities being offered.
NOTE 7: FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair
value of financial instruments:
Cash and equivalents, revolving credit facility borrowings, other notes
payable and current portion of long-term debt -- The carrying amounts
approximate fair value because of the short maturity of these instruments.
Long-term investments -- The carrying amount is fair value which is
based upon quoted market prices.
Long-term debt -- The fair value of long-term debt was estimated by
calculating the present value of the remaining interest and principal payments
on the debt to maturity. The present value computation uses a discount rate
based upon current market rates.
The carrying amounts and fair values of the Company's financial
instruments, except those noted above for which carrying amounts approximate
fair values, at December 31, 2003 and 2002 are as follows:
2003 2002
------------------ -------------------
Carrying Fair Carrying Fair
(In thousands) Amount Value Amount Value
- --------------------- -------- ----- -------- ------
Long-term investments $ - $ - $ 3,848 $3,848
Long-term debt 461 282 482 326
======= ===== ======== ======
NOTE 8: PREFERRED STOCK
The Company's authorized stock includes two million shares of Class A
Preferred Stock, issuable in one or more series. The rights, preferences,
privileges and restrictions of any series of Class A Preferred Stock, the number
of shares constituting any such series and the designation thereof, are subject
to determination by the Board of Directors.
One million shares of the Class A Preferred Stock have been designated
as Series B Junior Participating Preferred Stock, par value $10 per share, in
connection with a Shareholder Rights Plan (Plan) adopted in November 1998.
Pursuant to the Plan, one Preferred Stock Purchase Right (Right) is attached to
each outstanding share of common stock of the Company.
The Plan includes provisions which are intended to protect shareholders
against certain unfair and abusive takeover attempts by anyone acquiring or
tendering for 20% or more of the Company's common stock. The Company may redeem
the Rights for one-half cent per Right at any time before a 20% position has
been acquired. The Rights expire in November 2008.
NOTE 9: STOCK OPTIONS AND WARRANTS
The Company has various stock option plans under which the Company may
grant incentive and non-qualified stock options and stock appreciation rights to
purchase shares of the Company's common stock. All incentive stock options were
granted at fair market value on the date of grant. Incentive stock options
generally become exercisable beginning one to three years after the grant date
and expire after ten years.
42
Non-qualified stock options become exercisable according to a vesting
schedule determined at the grant date and expire no later than ten years after
grant. Non-qualified stock option grants since July 1999 were granted at
exercise prices approximating the market price on the date of grant. A summary
of transactions in the plans follows:
2003 2002 2001
-------------------- --------------------- --------------------
AVERAGE Average Average
EXERCISE Exercise Exercise
SHARES PRICE Shares Price Shares Price
--------- -------- ---------- --------- ---------- --------
Outstanding, beginning of period 1,807,290 $ 10.82 1,883,819 $ 11.75 2,005,021 $ 11.89
Granted 152,000 7.97 182,000 8.24 206,250 8.30
Expired (87,265) 12.92 (256,739) 15.85 (146,878) 15.18
Exercised (82,613) 4.77 (1,790) 6.25 (180,574) 7.28
--------- -------- ---------- --------- ---------- --------
Outstanding, end of period 1,789,412 $ 10.75 1,807,290 $ 10.82 1,883,819 $ 11.75
--------- -------- ---------- --------- ---------- --------
Exercisable, end of period 1,313,161 $ 11.31 1,106,247 $ 10.91 670,582 $ 9.01
--------- -------- ---------- --------- ---------- --------
Available for grant 582,010 646,745 572,006
--------- -------- ---------- --------- ---------- --------
Weighted average fair value
of options granted $ 5.79 $ 5.34 $ 6.18
--------- -------- ---------- --------- ---------- --------
A summary of information about stock options outstanding at December
31, 2003 follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------- ---------------------------------------
AVERAGE AVERAGE AVERAGE
RANGE OF EXERCISE REMAINING EXERCISE
EXERCISE PRICES SHARES PRICE LIFE SHARES PRICE
- ------------------- --------- ---------------- --------- --------- ----------------
$ 2.63 - $ 7.30 641,062 $ 6.91 5.1 529,288 $ 6.83
$ 7.77 - $ 16.63 781,350 10.67 6.6 421,273 11.48
17.63 - $ 19.09 367,000 17.64 6.4 362,600 17.64
--------- ---------------- ------ --------- ----------------
1,789,412 $ 10.75 6.0 1,313,161 $ 11.31
========= ================ ====== ========= ================
In 2003, the Company issued 187,184 shares of its common shares as a
result of the exercise of all remaining outstanding common stock warrants
related to the Company's senior notes. The warrants were exercisable at $4.00
per share and resulted in proceeds of $0.7 million.
In the first quarter of 2003, treasury stock was acquired in
consideration for common shares issued as a result of cashless stock option
transactions. The options were exercisable at $3.75 per share for 18,720 common
shares of the Company resulting in the issuance of 5,359 common shares. In
connection with the transactions, the Company incurred certain costs that were
included in the cost of treasury shares.
In the first quarter of 2001, treasury stock was acquired in
consideration for common shares issued as a result of cashless stock option
transactions. The options were exercisable at prices ranging from $3.75 to
$14.375 per share for 131,733 common shares of the Company, resulting in the
issuance of 44,241 common shares. In connection with the transactions, the
Company incurred $0.4 million of costs which was included in the cost of
treasury shares.
43
NOTE 10: COMMITMENTS AND CONTINGENCIES
The Company is subject to various claims, lawsuits and administrative
proceedings arising in the ordinary course of business with respect to
environmental matters, workers' compensation, health care and product liability
coverages (each of which is self-insured to certain levels), as well as
commercial and other matters. The Company accrues for the cost of such matters
when the incurrence of such costs is probable and can be reasonably estimated.
Based upon its evaluation of available information, management does not believe
that any such matters will have, individually or in the aggregate, a material
adverse effect upon the Company's consolidated financial position, results of
operations or cash flows.
In March 2001, in connection with its restructuring, Newport closed its
electric arc furnace operation and as such, ceased using oxygen and argon that
was provided under a supply agreement with Air Products and Chemicals, Inc.
("Air Products"). On December 31, 2001, Air Products filed a civil action
against Newport and NS Group, Inc. in the United States District Court for the
Eastern District of Pennsylvania, Civil Action No. 01-7227, seeking damages for
breach of contract. Based on current information, the Company believes that the
resolution of this matter will not have a material adverse affect on the
Company's consolidated financial position, results of operations or cash flows.
The Company is subject to federal, state and local environmental laws
and regulations, including, among others, the Resource Conservation and Recovery
Act (RCRA), the Clean Air Act, the 1990 Amendments to the Clean Air Act and the
Clean Water Act, and all regulations promulgated in connection therewith. Such
laws and regulations include those concerning the discharge of contaminants as
air emissions or waste water effluents and the disposal of solid and/or
hazardous wastes such as electric arc furnace dust. As such, the Company is from
time to time involved in administrative and judicial proceedings and
administrative inquiries related to environmental matters.
The Company operates a steel mini-mill at its Koppel, Pennsylvania
facility that produces dust that contains lead, cadmium and chromium, and is
classified as a hazardous waste. Dust produced by its electric arc furnace is
collected through emission control systems and recycled at EPA-approved
facilities.
In October 2002, the United States Environmental Protection Agency
("EPA") issued a Notice of Violation ("NOV") to Newport for certain alleged
violations dating from 1998 to April 2000 of its Clean Air Act emission permit
for Newport's electric arc furnace that was installed in 1999 and shuttered in
early 2001. The NOV alleged that the permit issued to Newport in June 1998 was
based upon an incorrect analysis as to potential emissions, and thus represented
a violation of the Clean Air Act. In addition, the EPA alleged certain
violations of the Clean Water Act occurred at Newport's Wilder facility in 1998.
Newport and the EPA have settled all of these issues with final Agreed Orders
for $0.1 million.
The Company has a hazardous waste landfill on its property in Wilder,
Kentucky, which it no longer uses. In connection with the March 2001
restructuring actions, in which the Company closed Newport's melt shop and hot
strip mill operations, the Company accrued the estimated costs for closure and
post-closure care of the landfill. These costs were included in restructuring
charges in the first quarter of 2001. The Company received final approval of its
closure/post-closure plan from the Kentucky Division of Waste Management in
December 2002. As a result, the Company increased its estimate of post-closure
costs by $1.0 million and they are included in restructuring charges for the
fourth quarter of 2002. The closure of the landfill was completed in the fourth
quarter of 2003.
In late 2001, the U.S. Environmental Protection Agency (EPA) designated
Imperial Adhesives, Inc., a former subsidiary of the Company, as one of a number
of potentially responsible parties under the Comprehensive Environmental
Response, Compensation and Liability Act (CERCLA) at an environmental
remediation site. The EPA has contended that any company linked to a CERCLA site
is potentially liable for costs under the legal doctrine of joint and several
liability. This environmental remediation site involves a municipal waste
disposal facility owned and operated by an independent operator. A preliminary
study of the site is ongoing. Consequently, it is too early to determine the
Company's liability exposure. The Company believes, however, that the reasonably
foreseeable resolution of this matter will not have a material adverse effect on
our consolidated financial statements.
44
The Company had accrued liabilities of $3.9 million and $5.2 million,
at December 31, 2003 and 2002, respectively, for environmental remediation
obligations. Based upon its evaluation of available information, management does
not believe that any of the environmental contingency matters discussed above
are likely, individually or in the aggregate, to have a material adverse effect
upon the Company's consolidated financial position, results of operations or
cash flows. However, the Company cannot predict with certainty that new
information or developments with respect to its environmental contingency
matters, individually or in the aggregate, will not have a material adverse
effect on the Company's consolidated financial position, results of operations
or cash flows.
The Company leases the real estate for its finishing facilities in
Catoosa, Oklahoma. The lease payments amount to $0.1 million per year through
2011.
The Company has change of control severance agreements (Agreements)
with certain of its key employees. The Agreements contain provisions that would
entitle each affected employee to receive an amount ranging from two to three
times the employee's base salary plus two to three times the employee's five
year average bonus, and continuation of certain benefits, if there is a change
of control of the Company, as defined, and a termination of employment. If a
change of control had occurred as of December 31, 2003, obligations under these
Agreements would be approximately $3.8 million. In addition, concurrent with a
change of control of the Company, amounts that are sufficient to pay the
benefits due under the deferred compensation agreements and salary continuation
agreements, would be required to be funded by the Company.
NOTE 11: EMPLOYEE BENEFIT PLANS
Defined Contribution Plans
The Company has established various profit sharing plans at the
operating companies which are based on the earnings of the respective companies.
Generally, the plans require mandatory contributions at a specified percentage
of pretax profits for the bargaining unit employees, and discretionary
contributions for salaried employees. The Company also has defined contribution
plans covering substantially all of its employees. The expense of these plans
was $0.4 million, $0.7 million and $0.8 million for 2003, 2002 and 2001,
respectively.
Effective January 1, 2003, the Company's bargaining unit employees at
its seamless operations in Pennsylvania joined the Steelworkers Pension Trust
(SPT), a multi-employer pension plan, in lieu of continued participation in the
Company's retirement savings plan. The Company does not administer this plan and
contributions are determined in accordance with provisions of negotiated labor
contracts. Based upon current available information, the Company would not have
a withdrawal liability if it withdrew from the SPT. Total contributions and
expense for this plan in 2003 were $0.6 million.
Deferred Compensation Agreements
Certain retired employees of the Company have individual deferred
compensation agreements that provide for monthly payments that will be paid for
life, with payments for a minimum of ten years. The net present value of the
benefits expected to be provided to the employee under the agreements was
accrued over the period of the employee's active employment from the time the
contract was signed to the employee's retirement date using a discount rate of
eleven percent, which approximated the Company's incremental borrowing rate at
that time. As of December 31, 2003 and 2002, the Company had accrued liabilities
for benefits payable under these agreements of $5.0 million and $5.1 million,
respectively, and recorded expense of $0.5 million, $0.6 million and $0.6
million, for these agreements in 2003, 2002 and 2001, respectively.
Salary Continuation Agreements and Postretirement Heath Benefits
The Company and certain active senior managers have entered into Salary
Continuation Agreements (SCA). The SCA provides for monthly payments that begin
at the employee's retirement date and are calculated as a percentage of the
employee's salary and will be paid for life, with a minimum of ten years. The
projected unit credit cost method is used for determining the cost of these
agreements for financial reporting purposes. The benefits do not vest until
retirement.
Retirees who are receiving payments under their deferred compensation
agreement and the employees who have an SCA are also eligible to receive
postretirement health care benefits from their retirement date until age 65.
45
SCA and postretirement health expense and other information for the
year ended December 31, 2001 was determined by the Company not to be material.
SCA and post-retirement benefit costs for 2003 and 2002 are as follows:
SCA HEALTH
(In thousands) 2003 2002 2003 2002
- --------------------------------------------- --------- -------- ------ -------
Service cost $ 286 $ 34 $ 11 $ 10
Interest cost on projected benefit obligation 106 82 23 24
Amortization of:
Transition obligation - - 28 28
Net loss - 212 - -
--------- -------- ------ -------
Actuarial expense for year $ 392 $ 328 $ 62 $ 62
========= ======== ====== =======
Reconciliation of the beginning and ending balances of the SCA and
post-retirement health plans funded status were:
SCA HEALTH
(In thousands) 2003 2002 2003 2002
- --------------------------------------------- --------- -------- ------ -------
Change in benefit obligation:
Benefit obligation at beginning of year $ 1,698 $ 747 $ 366 $ 364
Service cost 286 34 11 10
Interest cost 106 82 23 24
Actuarial (gain) loss (4) 835 (44) 15
Benefits paid - - (10) (47)
--------- -------- ------ -------
Benefit obligation at end of year $ 2,086 $ 1,698 $ 346 $ 366
========= ======== ====== =======
Reconciliation to balance sheet:
Funded (unfunded) status $ (2,086) $ (1,698) $ (346) $ (366)
Unrecognized transition obligation - - 308 336
Unrecognized net (gain) loss 92 96 (29) 15
--------- -------- ------ -------
Net liability recognized at December 31 $ (1,994) $ (1,602) $ (67) $ (15)
========= ======== ====== =======
The projected benefit obligations of both the SCA and post-retirement
health plans were calculated using a discount rate of 6.0% at December 31, 2003
and 6.75% at December 31, 2002. The Company uses a November 30 measurement date
for the SCA and postretirement health plans. The SCA calculations assumed a 3.0%
compensation growth rate for 2003 and 2002.
The assumed health care cost trend rate used to measure the
postretirement health benefit obligation at December 31, 2003, was 10.0% and is
assumed to decrease gradually to 6.0% by the year 2008. A one-percentage point
change in assumed health care cost trend rates would have the following effect
on the postretirement costs and obligation:
(In thousands) 1% Increase 1% Decrease
- ------------------------------------------ ----------- -----------
Effect on total service and interest costs $ 3 $ 3
Effect on postretirement benefit obligation $ 23 $ 20
------- --------
In addition, concurrent with a change of control of the Company,
amounts that are sufficient to pay the benefits under the deferred compensation
agreements and SCAs would be required to be funded by the Company.
The following table details expected benefit payments for the years
2004 through 2013:
(In thousands) SCA HEALTH
- ----------------- ------- -------
2004 $ - $ 48
2005 - 41
2006 80 46
2007 88 55
2008 88 38
Years 2009 - 2013 988 99
------- -------
46
NOTE 12: INCOME TAXES
The provision (benefit) for income taxes consists of the following:
(In thousands) 2003 2002 2001
- ----------------------- -------- -------- -------------
Current $ - $ (670) $ -
-------- -------- -------------
Deferred (169) (188) (3,917)
-------- -------- -------------
Provision (benefit) for
income taxes $ (169) $ (858) $ (3,917)
======== ======== =============
The income tax provision (benefit) differs from the amount computed by
applying the statutory federal income tax rate to income (loss), before income
taxes for the following reasons:
(In thousands) 2003 2002 2001
- ---------------------------------------------- ----------- --------- --------------
Income tax provision (benefit) at statutory
tax rate of 35% $ (6,108) $ (14,075) $ (20,963)
Change in taxes resulting from:
State income taxes, net of federal effect (567) (1,286) (1,947)
Change in valuation allowance 6,714 15,057 17,010
Rate differential on reclassification
of other comprehensive income - - 899
Other, net (208) (554) 1,084
----------- --------- --------------
Provision (benefit) for income taxes $ (169) $ (858) $ (3,917)
=========== ========= ==============
The following represents the components of deferred tax liabilities and
assets at December 31, 2003 and 2002:
(In thousands) 2003 2002
- --------------------------------------------------------- ---------- ---------
Current deferred tax assets:
Reserves and accruals $ 9,010 $ 10,195
Valuation allowance (8,586) (9,863)
---------- ---------
Total current deferred tax assets: $ 424 $ 332
========== =========
Noncurrent deferred tax assets:
Net operating tax loss carryforward $ 58,529 $ 46,757
Alternative minimum tax and other
tax credit carryforwards 2,628 2,707
Unrealized loss on investments - 2,076
---------- ---------
Total noncurrent tax assets 61,157 51,540
Valuation allowance (58,495) (50,504)
---------- ---------
Net noncurrent deferred tax assets 2,662 1,036
========== =========
Noncurrent deferred tax liabilities:
Property, plant and equipment (3,086) (1,368)
---------- ---------
Net noncurrent deferred tax assets (liabilities) $ (424) $ (332)
========== =========
For federal income tax purposes, the Company has alternative minimum
tax credit carryforwards of approximately $2.5 million, which are not limited by
expiration dates, and net operating tax loss carryforwards of approximately
$153.0 million, with expiration dates of 2008 through 2023. The Company has
recorded deferred tax assets related to these carryforwards, net of a deferred
tax asset valuation allowance. In estimating the amount of the valuation
allowance required, the Company has considered future taxable income related to
the reversal of temporary differences in the tax financial reporting basis of
assets and liabilities.
47
NOTE 13 : PRODUCT WARRANTIES
The Company's products are used in applications which are subject to
inherent risks including well failures, performance deficiencies, line pipe
leaks, personal injury, property damage, environmental contamination or loss of
production. The Company warrants its products to meet certain specifications and
actual or claimed deficiencies from these specifications may give rise to
claims. The Company maintains reserves for asserted and unasserted warranty
claims. The warranty claim exposure is evaluated using historical claim trends
and information available on specifically known claims. The Company considers
the extent of insurance coverage in its estimate of the reserve. The incurrence
of an unusually large or number of claims could alter the Company's exposure and
the related reserves.
The following table identifies changes in warranty reserves for the
years ended December 31, 2003 and 2002:
(In thousands) 2003 2002
- -------------------------------------------- --------- -----------
Balance, January 1 $ 1,842 $ 1,767
Accruals for warranties during the period 1,278 1,433
Accruals related to changes in estimates 858 235
Settlements made during the period (921) (1,593)
--------- -----------
Balance, December 31 $ 3,057 $ 1,842
--------- -----------
The balance at both December 31, 2003 and 2002 include $0.4 million of
valuation accounts that are reported against accounts receivable balances in the
consolidated balance sheets.
48
Note 14: QUARTERLY FINANCIAL DATA (Unaudited)
Quarterly results of operations for the years ended December 31, 2003 and
2002 were as follows:
(In thousands, except per share amounts) FIRST SECOND THIRD FOURTH
2003 QUARTER QUARTER QUARTER QUARTER
- ---------------------------------------- ---------- --------- ------- -------
Net sales $ 50,475 $ 65,909 $73,577 $69,026
Gross profit (loss) (5,298) (2,153) 1,210 2,276
Net income (loss) (11,215) (7,370) (2,210) 3,466
Net income (loss) per common share -
basic and diluted (0.54) (0.36) (0.11) 0.17
(In thousands, except per share amounts) First Second Third Fourth
2002 Quarter Quarter Quarter Quarter
- ---------------------------------------- ---------- --------- ------- -------
Net sales $ 38,848 $ 54,851 $57,297 $41,412
Gross profit (loss) (8,233) 2,253 (318) (8,287)
Net loss (14,307) (3,919) (7,458) (14,246)
Net loss per common share -
basic and diluted (0.69) (0.19) (0.36) (0.69)
---------- --------- ------- -------
The fourth quarter of 2003 and 2002 includes income of $4.0 million, or
$0.19 per share, and $0.8 million, or $0.04 per share, respectively, related to
a graphite electrode anti-trust settlement. Restructuring charges were recorded
in both the fourth quarter of 2003 and 2002. Charges were $0.1 million for 2003
and $2.0 million, or $0.10 per share in 2002.
The fourth quarter of 2003 includes income of $0.6 million, or $0.03 per
share, related to receipts under the "Continued Dumping and Subsidy Offset Act
of 2000".
The fourth quarter of 2003 includes a charge of $0.2 million, or $0.01 per
share, for impairment losses on certain long-lived assets.
The second and third quarter of 2002 include impairment losses related to
long-term investments of $0.2 million, or $0.01 per share. The fourth quarter of
2002 includes similar impairment losses of $0.6 million, or $0.03 per share.
49
SCHEDULE II
NS GROUP, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
Reserves Deducted from
Assets in Balance Sheets
------------------------
Allowance Allowance
for Doubtful for Cash
(In thousands) Accounts(1) Discounts(1)
- ------------------------------------------ ------------ -------------
Balance, December 31, 2000 $ 941 $ 497
Additions charged to costs and expenses 3,229 5,493
Deductions (2) (3,049) (5,621)
------------ ------------
Balance, December 31, 2001 $ 1,121 $ 369
Additions charged to costs and expenses 1,596 3,302
Deductions (2) (2,310) (3,487)
------------ ------------
Balance, December 31, 2002 $ 407 $ 184
Additions charged to costs and expenses 1,185 4,606
Deductions (2) (1,136) (4,394)
------------ ------------
Balance, December 31, 2003 $ 456 $ 396
------------ ------------
(1) Deducted from accounts receivable
(2) Net charges of nature for which reserves were created
50
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
Our Chief Executive Officer and the Chief Financial Officer have reviewed
our disclosure controls and procedures as of December 31, 2003. Based on that
review, they have concluded that these controls and procedures were, in design
and operation, effective to assure that the information required to be included
in this report has been properly collected, processed and timely communicated to
those responsible in order that it may be included in this report.
During our most recent quarter, there were no significant changes,
including corrective actions, in our internal controls or in other factors that
could significantly affect the disclosure controls and procedures.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Incorporated herein by reference from the Proxy under the captions
"Proposals of the Board, Item 1 -Election of Three Class III Directors,"
footnote (5) under "Securities Ownership of Management,"; "The Board of
Directors, Board Committees and Meeting Attendance"; and "Securities Ownership
of Management, Section 16(a) Beneficial Ownership Reporting Compliance".
We have adopted a code of ethics that applies to all our directors,
officers, and employees. This code is publicly available on our website at
http://www.nsgrouponline.com. Amendments to the code of ethics and any grant of
a waiver from a provision of the code requiring disclosure under applicable SEC
rules will be disclosed on our website. Our corporate governance guidelines and
the charters of our Audit Committee, Nominating/Corporate Governance,
Compensation Committee are available on our website under the "Corporate
Governance" section. These materials may also be requested in print by writing
to our Investor Relations Department at 530 West Ninth Street, Newport, Kentucky
41071.
ITEM 11. EXECUTIVE COMPENSATION
Incorporated herein by reference from the Proxy under the captions
"Compensation of Directors"; and "Compensation of Executive Officers".
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated herein by reference from the Proxy under the captions
"Securities Ownership of Management" and "Securities Ownership of Certain
Beneficial Owners". Also refer to "Equity Compensation Plan Information" under
Part II - Item 5 included therein.
51
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated herein by reference from the Proxy under the captions
"Compensation Committee Interlocks and Insider Participation" and "Certain
Relationships and Related Transactions."
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Incorporated herein by reference from the Proxy under the caption "Fees
Paid to Independent Accountants."
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. Consolidated Financial Statements - Audited consolidated financial
statements required by this item are presented and listed in Part II, Item 8.
2. Consolidated Financial Statement Schedule - The financial statement
schedule required to be filed as a part of this report is presented and listed
in Part II, Item 8.
3. Exhibits - Reference is made to the Index to Exhibits, which is
included herein as part of this report.
(b) Reports on Form 8-K
Current Report on Form 8-K dated October 7, 2003 furnishing under Item 12
the Company's press release regarding expected results for the quarter ended
September 30, 2003.
Current Report on Form 8-K dated October 15, 2003 furnishing under Item 9
the Company's press release regarding conference call to review the results for
the September 2003 quarter to be held on October 21, 2003.
Current Report on Form 8-K dated October 20, 2003 furnishing under Item 12
the Company's earnings press release for the quarter ended September 30, 2003.
Current Report on Form 8-K dated December 2, 2003 furnishing under Item 9
materials to be shown to investors commencing on December 2, 2003.
52
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.
NS GROUP, INC.
Date: March 12, 2004 By: /s/Thomas J. Depenbrock
-----------------------------------------------
Thomas J. Depenbrock, Vice President - Finance,
Treasurer and Chief Financial Officer
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Rene J. Robichaud and Thomas J. Depenbrock, and
each of them, his true and lawful attorneys-in-fact and agents, with full power
of substitution and resubstitution, for him and in his name, place and stead, in
any and all capacities to sign any and all amendments to this Annual Report on
Form 10-K and any other documents and instruments incidental thereto, and to
file the same, with all exhibits thereto, and other documents in connection
therewith, with the Securities and Exchange Commission, granting unto said
attorneys-in-fact and agents, and each of them, full power and authority to do
and perform each and every act and thing requisite or necessary to be done in
and about the premises, as fully to all intents and purposes as he might or
could do in person, hereby ratifying and confirming all that said
attorneys-in-fact and agents and/or any of them, or their or his substitute or
substitutes, may lawfully do or cause to be done by virtue hereof.
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.
Date: March 12, 2004 By: /s/Rene J. Robichaud
-----------------------------------------------
Rene J. Robichaud, President and
Chief Executive Officer and Director
Date: March 12, 2004 By: /s/Thomas J. Depenbrock
-----------------------------------------------
Thomas J. Depenbrock, Vice President - Finance,
Treasurer and Chief Financial Officer
(Principal Financial and Accounting Officer)
53
Date: March 12, 2004 By: /s/ Clifford R. Borland
-------------- ----------------------------------------------
Clifford R. Borland
Chairman of the Board, Director
Date: March 12, 2004 By: /s/ Paul C. Borland, Jr.
-------------- ----------------------------------------------
Paul C. Borland, Jr., Director
Date: March 12, 2004 By: /s/ David A. B. Brown
-------------- ----------------------------------------------
David A. B. Brown, Director
Date: March 12, 2004 By: /s/ J. C. Burton
-------------- ----------------------------------------------
J. C. Burton, Director
Date: March 12, 2004 By: /s/ Patrick J. B. Donnelly
-------------- ----------------------------------------------
Patrick J. B. Donnelly, Director
Date: March 12, 2004 By: /s/ George A. Helland, Jr.
-------------- ----------------------------------------------
George A. Helland, Jr., Director
Date: March 12, 2004 By: /s/ Gary L. Kott
-------------- ----------------------------------------------
Gary L. Kott, Director
Date: March 12, 2004 By: /s/ John F. Schwarz
-------------- ----------------------------------------------
John F. Schwarz, Director
54
INDEX TO EXHIBITS
NUMBER DESCRIPTION
3.1(a) Amended and Restated Articles of Incorporation of the Company, filed as
Exhibit 3.1 to Amendment No. 1 to the Company's Form S-1 dated January
17, 1995, File No. 33-56637, and incorporated herein by this reference.
3.1(b) Articles of Amendment to the Amended and Restated Articles of
Incorporation, dated November 4, 1998, filed as Exhibit 3.1 to the
Company's Form 10-Q for the quarter ended September 30, 2001, File No.
1-9838, and incorporated herein by this reference.
3.2 Amended and Restated By-Laws of the Company, dated July 30, 2003, filed
as Exhibit 3.2 to the Company's Form 10-Q for the fiscal quarter ended
June 30, 2003, File No. 1-9838, and incorporated herein by this
reference.
4.1 Rights Agreement dated November 17, 1998 between the Company and
Registrar and Transfer Company, filed as Exhibit 1 to the Company's
Form 8-K dated November 5, 1998, File No. 1-9838, and incorporated
herein by this reference
10.1 The Company's Amended Employee Incentive Stock Option Plan, filed as
Exhibit 10(a) to the Company's Form 10-K for the fiscal year ended
September 30, 1989, File No. 1-9838, and incorporated herein by this
reference*
10.2 The Company's Executive Compensation Short-Term Incentive Plan, filed
herewith*
10.3 The Company's Non-Qualified Stock Option and Stock Appreciation Rights
Plan of 1988, filed as Exhibit 1 to the Company's Proxy Statement dated
January 13, 1989, File No. 1-9838, and incorporated herein by this
reference*
10.4 The Company's 1993 Incentive Stock Option Plan, filed as Exhibit 1 to
the Company's Proxy Statement dated December 22, 1992, File No. 1-9838,
and incorporated herein by this reference*
10.5 The Company's Amended and Restated 1995 Stock Option and Stock
Appreciation Rights Plan, filed as Exhibit A to the Company's Proxy
Statement dated December 21, 1998, File No. 1-9838, and incorporated
herein by this reference*
10.6 Form of Change of Control Severance Agreement, filed herewith*
10.7 Form of Salary Continuation Agreement, filed herewith*
10.8 Employment Agreement between the Company and Rene J. Robichaud, dated
March 1, 2002, filed as Exhibit 10.1 to the Company's Form 10-Q for
quarterly period ended March 31, 2002, File No. 1-9838, and
incorporated herein by this reference*
10.9 The Company's Amended and Restated 2000 Non-Employee Director Stock
Option Plan (amended and restated as of February 2002) filed as Exhibit
10.4 to the Company's Form 10-Q for the three months ended June 30,
2002, File No. 1-9838, and incorporated herein by this reference*
55
10.10 Trust Under NS Group, Inc., Salary Continuation Plan, between NS Group,
Inc. and Huntington National Bank, Trustee, dated August 8, 2001 filed
as Exhibit 10.1 to the Company's Form 10-Q for the three months ended
September 30, 2001, File No. 1-9838, and incorporated herein by this
reference*
10.11 Financing and Security Agreement Between Newport Steel Corporation and
Koppel Steel Corporation and The CIT Group/Business Credit, Inc. dated
March 29, 2002, filed as Exhibit 4.1 to the Company's Form 10-Q for the
quarterly period ended March 31, 2002, File No. 1-9838, and
incorporated by this reference
10.12 Amendment No. 1 to Financing and Security Agreement Between The CIT
Group/Business Credit, Inc. and Newport Steel Corporation and Koppel
Steel Corporation, dated May 19, 2003, filed as Exhibit 10.1 to the
Company's Form 10-Q for the quarterly period ended June 30, 2003, File
No. 1-9838, and incorporated by this reference
10.13 Amended and Restated Guaranty Agreement of NS Group, Inc. and Erlanger
Tubular Corporation and Northern Kentucky Management, Inc., dated June
20, 2003, filed as Exhibit 10.2 to the Company's Form 10-Q for the
quarterly period ended June 30, 2003, File No. 1-9838, and incorporated
by this reference
10.14 Amendment No. 2 to Financing and Security Agreement Between The CIT
Group/Business Credit, Inc. and Newport Steel Corporation and Koppel
Steel Corporation, dated December 29, 2003, filed herewith.
10.15 The Company's Equity Plan, filed as Appendix C to the Company's Proxy
Statement dated March 12, 2004, File No. 1-9838, and incorporated
herein by this reference*
10.16 The Company's Non-Employee Director Equity Plan, filed as Appendix D to
the Company's Proxy Statement dated March 12, 2004, File No. 1-9838,
and incorporated herein by this reference*
12.1 Computation of Ratio of Earnings to Fixed Charges, filed herewith
21.1 Subsidiaries of the Company, filed herewith
23.1 Independent Auditor's Consent, filed herewith
23.2 Notice of Inability to Obtain Consent from Arthur Andersen LLP, filed
herewith
24.1 Power of Attorney (contained on Signature Page)
31.1 Certification of Chief Executive Officer pursuant to Exchange Act Rule
13a-14(a), filed herewith.
31.2 Certification of Chief Financial Officer pursuant to Exchange Act Rule
13a-14(a), filed herewith.
32.1 Certification Pursuant to 18 U.S.C. Section 1350 and Exchange Act Rule
13a-14(b), furnished herewith.
32.2 Certification Pursuant to 18 U.S.C. Section 1350 and Exchange Act Rule
13a-14(b), furnished herewith.
99.1 Risk Factors, filed herewith
* Indicates management contracts or compensatory plans or arrangements in which
one or more directors or executive officers of the Company participates or is
a party.
56