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EX-31.1 - KEYSTONE CONSOLIDATED INDUSTRIES, INC. - 10K FOR YEAR 12-31-2009 EXHIBIT 31.1 - KEYSTONE CONSOLIDATED INDUSTRIES INCkci10k12312009exh31_1.htm
EX-21.1 - KEYSTONE CONSOLIDATED INDUSTRIES, INC. - 10K FOR YEAR 12-31-2009 EXHIBIT 21.1 - KEYSTONE CONSOLIDATED INDUSTRIES INCkci10k12312009exh21_1.htm
EX-32.1 - KEYSTONE CONSOLIDATED INDUSTRIES, INC. - 10K FOR YEAR 12-31-2009 EXHIBIT 32.1 - KEYSTONE CONSOLIDATED INDUSTRIES INCkci10k12312009exh32_1.htm
EX-31.2 - KEYSTONE CONSOLIDATED INDUSTRIES, INC. - 10K FOR YEAR 12-31-2009 EXHIBIT 31.2 - KEYSTONE CONSOLIDATED INDUSTRIES INCkci10k12312009exh31_2.htm

SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K


S           ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 - For the fiscal year ended December 31, 2009

Commission file number 1-3919

Keystone Consolidated Industries, Inc.
(Exact name of Registrant as specified in its charter)

Delaware
 
37-0364250
(State or other jurisdiction of
Incorporation or organization)
 
(IRS Employer
Identification No.)

5430 LBJ Freeway, Suite 1740,
Three Lincoln Centre, Dallas, Texas
 
75240-2697
(Address of principal executive offices)
 
(Zip Code)

Registrant’s telephone number, including area code:
(972) 458-0028
   
Securities registered pursuant to Section 12(b) of the Act:
None.

Securities registered pursuant to Section 12(g) of the Act:
Title of each class
 
Common Stock, $.01 par value

Indicate by check mark:

If the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes £  No S

If the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes £  No S

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 and (2) has been subject to such filing requirements for the past 90 days. Yes S  No £

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.  S

Whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company (as defined in Rule 12b-2 of the Act).
Large accelerated filer  £ Accelerated filer £  Non-accelerated filer S Smaller reporting company £

Whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes £ No S
 
 


 
The aggregate market value of the 4.6 million shares of voting stock held by nonaffiliates of the Registrant, as of June 30, 2009 (the last business day of the Registrant’s most-recently completed second fiscal quarter), was approximately $12.9 million.

Whether the Registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes S  No £

As of March 11, 2010, 12,101,932 shares of common stock were outstanding.


Documents incorporated by reference

The information required by Part III is incorporated by reference from the Registrant’s definitive proxy statement to be filed with the Commission pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report.
 

 
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PART I

This Annual Report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.  Statements in this Annual Report on Form 10-K that are not historical in nature are forward-looking and are not statements of fact.  Some statements found in this report including, but not limited to, statements found in Item 1 – "Business", Item 1A – "Risk Factors", Item 3 – "Legal Proceedings", Item 7 – "Management’s Discussion and Analysis of Financial Condition and Results of Operations" and Item 7A – "Quantitative and Qualitative Disclosures About Market Risk" are forward-looking statements that represent our beliefs and assumptions based on currently available information.  In some cases you can identify these forward-looking statements by the use of words such as "believes", "intends", "may", "should", "could", "anticipates", "expected" or comparable terminology, or by discussions of strategies or trends.  Although we believe the expectations reflected in forward-looking statements are reasonable, we do not know if these expectations will be correct.  Forward-looking statements by their nature involve substantial risks and uncertainties that could significantly impact expected results. Actual future results could differ materially from those predicted. While it is not possible to identify all factors, we continue to face many risks and uncertainties.  Among the factors that could cause our actual future results to differ materially from those described herein are the risks and uncertainties discussed in this Annual Report and those described from time to time in our other filings with the Securities and Exchange Commission (“SEC”) including, but not limited to, the following:

·  
Future supply and demand for our products (including cyclicality thereof),
·  
Customer inventory levels,
·  
Changes in raw material and other operating costs (such as ferrous scrap and energy),
·  
The possibility of labor disruptions,
·  
General global economic and political conditions,
·  
Competitive products (including low-priced imports) and substitute products,
·  
Customer and competitor strategies,
·  
The impact of pricing and production decisions,
·  
Environmental matters (such as those requiring emission and discharge limits for existing and new facilities),
·  
Government regulations and possible changes thereof,
·  
Significant increases in the cost of providing medical coverage to employees,
·  
The ultimate resolution of pending litigation,
·  
International trade policies of the United States and certain foreign countries,
·  
Operating interruptions (including, but not limited to, labor disputes, fires, explosions, unscheduled or unplanned downtime, supply disruptions and transportation interruptions),
·  
Our ability to renew or refinance credit facilities,
·  
The ability of our customers to obtain adequate credit, and
·  
Any possible future litigation.

Should one or more of these risks materialize, if the consequences worsen, or if the underlying assumptions prove incorrect, actual results could differ materially from those forecasted or expected.  We disclaim any intention or obligation to update or revise any forward-looking statement whether as a result of changes in information, future events or otherwise.

 
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ITEM 1. BUSINESS.

Keystone Consolidated Industries, Inc. (“KCI”) is a leading domestic producer of steel fabricated wire products, industrial wire and wire rod.  We also manufacture wire mesh, coiled rebar, steel bar and other products.  Our products are used in the agricultural, industrial, cold drawn, construction, transportation, original equipment manufacturer and retail consumer markets.  We are vertically integrated, converting substantially all of our products from billets produced in our steel mini-mill.  Historically, our vertical integration has allowed us to benefit from the higher and more stable margins associated with fabricated wire products and wire mesh as compared to wire rod, as well as from lower costs of billets and wire rod as compared to bar manufacturers and wire fabricators that purchase billet and wire rod in the open market.  Moreover, we believe our downstream fabricated wire products, wire mesh, coiled rebar and industrial wire businesses are better insulated from the effects of wire rod imports as compared to non-integrated wire rod producers.

Our operating segments are organized by our manufacturing facilities and include three reportable segments:

·  
Keystone Steel & Wire (“KSW”), located in Peoria, Illinois, operates an electric arc furnace mini-mill and manufactures and sells wire rod, coiled rebar, industrial wire, fabricated wire and other products to agricultural, industrial, construction, commercial, original equipment manufacturers and retail consumer markets;
·  
Engineered Wire Products, Inc. (“EWP”), located in Upper Sandusky, Ohio, manufactures and sells wire mesh in both roll and sheet form that is utilized in concrete construction products including pipe, pre-cast boxes and applications for use in roadways, buildings and bridges; and
·  
Keystone-Calumet, Inc. (“Calumet”), located in Chicago Heights, Illinois, manufactures and sells merchant and special bar quality products and special sections in carbon and alloy steel grades for use in agricultural, cold drawn, construction, industrial chain, service centers and transportation applications as well as in the production of a wide variety of products by original equipment manufacturers.

For additional information about our segments see “Part II – Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 5 to our Consolidated Financial Statements.

We are the successor to Keystone Steel & Wire Company, which was founded in 1889.  At December 31, 2009, Contran Corporation (“Contran”) owned approximately 62% of our outstanding common stock.  Substantially all of Contran's outstanding voting stock is held by trusts established for the benefit of certain children and grandchildren of Harold C. Simmons (for which Mr. Simmons is the sole trustee) or is held directly by Mr. Simmons or other persons or companies related to Mr. Simmons. Consequently, Mr. Simmons may be deemed to control Contran and us.

Unless otherwise indicated, references in this report to "we", "us" or "our" refer to KCI and its subsidiaries, taken as a whole.


 
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Manufacturing

Overview

Our manufacturing operations consist of an electric arc furnace mini-mill, a rod mill, a wire mill and three steel product fabrication facilities as outlined in our segment discussion above.  The manufacturing process commences at KSW where ferrous scrap is loaded into an electric arc furnace, converted into molten steel and then transferred to a ladle refining furnace where chemistries and temperatures are monitored and adjusted to specifications prior to casting.  The molten steel is transferred from the ladle refining furnace into a six-strand continuous casting machine which produces five-inch square strands, referred to as billets, that are cut to predetermined lengths.  These billets are then either transferred to the adjoining rod mill, shipped to Calumet for the production of steel bars or sometimes sold to third party customers.

Upon entering the rod mill, the billets are brought to rolling temperature in a reheat furnace and are fed through the rolling mill, where they are rolled into either wire rod or coiled rebar in a variety of diameters, surface characteristics and specifications. After rolling, the wire rod or rebar is coiled and cooled.  After cooling, the coiled wire rod or rebar passes through inspection stations for metallurgical, surface and diameter checks.  Finished coils are compacted and tied.  Coiled rebar is shipped to customers and wire rod is either further processed into industrial wire, wire mesh and fabricated wire products at our wire mill and wire product fabrication facilities at KSW or EWP, or shipped to wire rod customers.

While we do not maintain a significant "shelf" inventory of finished wire rod, we generally have on hand approximately a one-month supply of industrial wire, wire mesh, coiled rebar, fabricated wire products and steel bars inventory which enables us to fill customer orders and respond to shifts in product demand.

Raw Materials and Energy

The primary raw material used in our operations is ferrous scrap.  Our steel mill is located close to numerous sources of high density automobile, industrial and railroad ferrous scrap, all of which are currently available.  We believe we are one of the largest recyclers of ferrous scrap in Illinois.  The purchase of ferrous scrap is highly competitive and its price volatility is influenced by periodic shortages, export activity, freight costs, weather and other conditions beyond our control.  The cost of ferrous scrap can fluctuate significantly and product selling prices cannot always be adjusted, especially in the short-term, to recover the costs of increases in ferrous scrap prices.  We have not entered into any hedging programs or long-term contracts for the purchase or supply of ferrous scrap; therefore, we are subject to the price fluctuation of ferrous scrap.

Our manufacturing processes consume large amounts of energy in the form of electricity and natural gas.  Electricity in Illinois is not regulated.  We have an electric service agreement for KSW’s facility whereby, on a daily basis, we are required to notify the utility provider of the amount of electricity we expect to consume on the next day. The price we pay for electricity is determined when we provide such notification based on the forecasted hourly energy market rate for the next day.  Any difference between our forecasted consumption and actual consumption is settled based on the actual hourly market rate.  However, to allow us to avoid pricing fluctuations, the contract allows us to purchase blocks of power in the forward markets at our discretion at prices negotiated at the time of purchase.  Under this agreement, our power was uninterruptible until the agreement was amended in June 2008 to allow interruption.  The amendment stipulates a maximum interruption period of 16 hours per occurrence and a maximum number of interruption events of three times per month.  Additionally, we will be compensated for each interruption based on market rates and the difference between our forecasted and actual consumption for the interruption period.  We did not suffer any interruptions to our power during 2008 or 2009.
 
 
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Employment

As of December 31, 2009, we employed 1,000 people, some of whom are covered under collective bargaining agreements, as follows:
·  
686 are represented by the Independent Steel Workers’ Alliance (the “ISWA”) at KSW under an agreement expiring in May 2012; and
·  
63 are represented by Local Union #40, an Affiliate to the International Brotherhood of Teamsters' Chauffeurs Warehousemen and Helpers of America (the “AFL-CIO”), at EWP under an agreement expiring in November 2010.

We believe our labor relations are good.

Products, Markets and Distribution

The following table sets forth certain information with respect to our product mix in each of the last three years.

   
Year Ended December 31,
 
   
2007
   
2008
   
2009
 
 
 
Product
 
Percent
of Tons
Shipped
   
Percent
of
Sales
   
Percent
of Tons
Shipped
   
Percent
of
Sales
   
Percent
of Tons
Shipped
   
Percent
of
Sales
 
                                     
Wire rod
    61.0 %     48.5 %     58.5 %     48.8 %     60.8 %     46.0 %
Fabricated wire products
    16.0       25.2       14.7       21.3       15.6       28.2  
Wire mesh
    9.0       11.7       9.2       11.3       9.7       11.7  
Industrial wire
    10.1       11.2       10.4       12.1       8.2       9.6  
Bar
    1.3       1.3       3.1       3.0       3.2       3.3  
Coiled rebar
    2.4       1.9       2.6       2.3       1.2       0.8  
Other
    0.2        0.2       1.5       1.2       1.3       0.4  
      100.0 %     100.0 %     100.0 %     100.0 %     100.0 %     100.0 %
                                                 

Wire Rod.  We produce primarily low carbon steel wire rod and some higher carbon steel wire rod at KSW’s rod mill.  Low carbon steel wire rod, with carbon content of up to 0.38%, is more easily shaped and formed than higher carbon wire rod and is suitable for a variety of applications where ease of forming/manipulation is a consideration.  During 2009, we used approximately 34% of the wire rod we manufactured to produce our industrial wire, wire mesh and fabricated wire products.  The remainder of our wire rod production was sold directly to producers of construction products, fabricated wire products and industrial wire, including products similar to those we manufacture.

Fabricated Wire Products.  KSW is one of the leading U.S. manufacturers of agricultural fencing, barbed wire, stockade panels and a variety of woven wire, fabric and netting for agricultural and industrial applications.  We sell these products to agricultural, industrial, consumer do-it-yourself and other end-user markets, which we believe are less cyclical than many steel consuming end-use markets such as the automotive, construction, appliance and machinery manufacturing industries.  We serve these markets through distributors, agricultural retailers, building supply centers and consumer do-it-yourself chains such as Tractor Supply Co. and Lowe's Companies, Inc.  We believe our ability to service these customers with a wide range of fabricated wire products through multiple distribution locations provides a competitive advantage in accessing these growing and less cyclical markets. As part of our marketing strategy, we design merchandise packaging and supportive product literature for marketing many of these products to the retail consumer market.
 
 
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KSW also manufactures products for residential and commercial construction, including rebar ty wire and stucco netting.  The primary customers for these products are construction contractors and building materials manufacturers and distributors.

We believe our fabricated wire products are less susceptible to selling price changes caused by the cyclical nature of the steel business than industrial wire, coiled rebar or wire rod because the commodity-priced raw materials used in these products, such as ferrous scrap, represent a lower percentage of the total cost of these value-added products.

Wire mesh.  EWP manufactures a wide variety of wire mesh rolls and sheets used to form wire reinforcement in concrete construction projects such as pipe, precast boxes and other applications, including use in roadways, buildings and bridges.  Our wire mesh customers include pipe manufacturers, culvert manufacturers, rebar fabricators and steel reinforcing distributors.  Like our fabricated wire products, we believe our wire mesh products are also less susceptible to selling price changes caused by the cyclical nature of the steel business than industrial wire, coiled rebar or wire rod because the commodity-priced raw materials used in these products, such as ferrous scrap, represent a lower percentage of the total cost of such value-added products when compared to wire rod or other less value-added products.  EWP’s primary raw material is wire rod and KSW provides the majority of EWP’s wire rod requirements.

Industrial Wire.  KSW is one of the largest manufacturers of industrial wire in the United States.  We produce custom-drawn industrial wire in a variety of gauges, finishes and packages for further consumption by our fabricated wire products operations or for sale to industrial fabrication and original equipment manufacturer customers, who are generally not our competitors.  Our industrial wire is used by customers in the production of a broad range of finished goods, including nails, coat hangers, barbecue grills, air conditioners, tools, containers, refrigerators and other appliances.
 
Bar.  Calumet manufactures merchant and special bar quality products and special sections in carbon and alloy steel grades, offering a broad range of value-added products for use in agricultural, cold drawn, construction, industrial chain, service centers and transportation applications as well as in the production of a wide variety of products by original equipment manufacturers.  Calumet’s product line consists primarily of angles, flats, channels, rounds, squares and other related products. Calumet’s primary raw material is billet and KSW provides the majority of Calumet’s billet requirements.

Coiled Rebar.  We produce several sizes of coiled rebar at KSW’s rod mill.  The coils are typically used by fabricators who will process the material as straightened and cut-to-length bars or fabricated shapes for specific reinforcement applications such as building and road construction.

Trademarks

Many of our fencing and related fabricated wire products are marketed under our RED BRAND® label, a widely recognized brand name in the agricultural fencing and construction marketplaces for more than 80 years.  RED BRAND® sales represented approximately 77% of our fabricated wire products net sales in 2009.  We also maintain other trademarks for various products that are promoted in their respective markets.
 
 
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Customers

Our customers are primarily located in the Midwestern, Southwestern and Southeastern regions of the United States.  Our customers vary considerably by product.  We believe our ability to offer a broad range of products represents a competitive advantage in servicing the diverse needs of our customers.

Our segments are not dependent upon a single customer or a few customers, and the loss of any one, or a few, would not have a material adverse effect on our segments’ business.  The percentage of each of our segments’ external sales related to their ten largest external customers and the one external customer at each of our segments that accounted for more than 10% of that segment’s external sales during 2009 is set forth in the following table:

 
    KSW    
 
    EWP    
 
   Calumet   
 
% of segments’ sales
           
Ten largest customers
61%
 
54%
 
56%
           
Customer > 10%
11%
 
11%
 
10%


Seasonality

Historically, we have experienced greater sales and profits during the second and third quarters of each year due to the seasonality of sales in principal fabricated wire products and wire mesh markets, including the agricultural and construction markets.

Backlog

Our backlog of unfilled, cancelable steel products purchase orders, for delivery generally within three months, approximated $23.4 million and $25.9 million at December 31, 2008 and 2009, respectively.  We do not believe backlog is a significant factor in our business, and we expect all of the backlog at December 31, 2009 will be shipped during 2010.

Industry and Competition

The fabricated wire products, wire mesh, industrial wire, bar, coiled rebar and wire rod businesses in the United States are highly competitive and are comprised primarily of several large mini-mill wire rod producers, many small independent wire companies and a few large diversified wire producers.  We also face significant foreign competition.  Lower wage rates, less regulatory requirements and other costs in foreign countries sometimes result in market prices that significantly reduce and sometimes eliminate the profitability of certain products.

We believe we are well positioned to compete effectively due to:
·  
the breadth of our fabricated wire products, wire mesh, industrial wire and bar offerings;
·  
our ability to service diverse geographic and product markets; and
·  
the relatively low cost of our internal supply of billet and wire rod.

We believe our facilities are well located to serve the Midwestern, Southwestern and Southeastern regions of the United States.  Close proximity to our customer base provides us with certain advantages over foreign and certain domestic competition including reduced shipping costs, improved customer service and shortened delivery times.
 
 
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Wire Rod.  Since wire rod is a commodity steel product, we believe the wire rod market is more competitive than the fabricated wire products and industrial wire markets, and price is the primary competitive factor.  Among our principal domestic competitors in these markets are Gerdau Ameristeel and Rocky Mountain Steel.  We also face significant foreign competition. The domestic steel industry continues to experience consolidation.  During the last ten years, we and the majority of our major domestic competitors have either filed for protection under Federal bankruptcy laws and discontinued operations, were acquired, or reduced or completely shut-down operations.  We believe these shut-downs or production curtailments represent a significant decrease in estimated domestic annual capacity.  However, worldwide overcapacity in the steel industry continues to exist and although imports of wire rod were lower in 2008 and 2009 than in 2007, imports of wire rod have become much more substantial in recent years.

Fabricated Wire Products and Industrial Wire.  Our principal competitors in the fabricated wire products and industrial wire markets are Leggett & Platt, Deacero, Oklahoma Steel and Wire and Davis Wire.  Competition in the fabricated wire products and industrial wire markets is based on a variety of factors, including distribution channels, price, delivery performance, product quality, service and brand name preference.  Our RED BRAND® label has been a widely recognized brand name in the agricultural fencing and construction marketplaces for more than 80 years.  Additionally, we believe higher transportation costs and the lack of local distribution centers tend to limit foreign producers' penetration into our principal fabricated wire products and industrial wire markets, but we do not know if this will continue to be the case.

Wire mesh.  Our principal competitors in our wire mesh markets are Insteel Wire Products and Ivy Steel & Wire.  We also face competition from smaller regional manufacturers and wholesalers of wire mesh products. We believe EWP’s superior products and renowned customer service distinguish EWP from its competitors.  In addition, we believe our vertical integration enhances EWP’s ability to compete more effectively in the market as EWP can rely on a more stable supply of wire rod.  Competitors of EWP have at times faced raw material shortages that have negatively impacted their daily production capability and delivery reliability.

Bar. Our principal competitors for our bar business include Gerdau Ameristeel, Nucor and Alton Steel. The primary competitive factors are delivered price and the breadth of product within the production capability of the mill.  Throughout 2009 and continuing into 2010, Calumet has been conducting trials for many different customer-specific products which has resulted in new customers and increased sales volume.  Calumet’s mill location in Chicago Heights, Illinois is well suited to serve the bar market in the upper Midwest.

Coiled Rebar.  The principal competitors for our assortment of coiled rebar products include Gerdau Ameristeel, Rocky Mountain Steel and Nucor Connecticut.  The primary competitive factors of the coiled rebar business are delivered price, coil size and product quality.  Due to our location, we believe we can effectively serve customers in the Midwestern region of the United States.

Environmental Matters

Our production facilities are affected by a variety of environmental laws and regulations, including laws governing the discharge of water pollutants and air contaminants, the generation, containment, transportation, storage, treatment and disposal of solid wastes and hazardous substances and the handling of toxic substances, including certain substances used in, or generated by, our manufacturing operations.  Many of these laws and regulations require permits to operate the facilities to which they pertain.  Denial, revocation, suspension or expiration of such permits could impair the ability of the affected facility to continue operations.
 

 
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We record liabilities related to environmental issues when information becomes available and is sufficient to support a reasonable estimate of a range of probable loss.  If we are unable to determine that a single amount in an estimated range is more likely, the minimum amount of the range is recorded.  We do not discount costs of future expenditures for environmental remediation obligations to their present value due to the uncertain timeframe of payout.  Recoveries of environmental remediation costs from other parties are recorded as assets when their receipt is deemed probable.

On July 2, 2009, the Illinois Environmental Protection Agency (the “IEPA”) approved the completion of the soil portion of the remediation plan of certain waste management units at KSW which resulted in us decreasing our accrued environmental costs by $4.2 million.  We believe the upper end of the range of reasonably possible costs to us for the remaining sites where we have been named a defendant is approximately $2.0 million, including the $.7 million accrued as of December 31, 2009.
 
We believe our current operating facilities are in material compliance with all presently applicable federal, state and local laws regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment.  Environmental legislation and regulations change rapidly and we may be subject to increasingly stringent environmental standards in the future.

Information in Note 10 to our Consolidated Financial Statements is incorporated herein by reference.

Acquisition, Restructuring and Other Activities

We routinely compare our liquidity requirements against our estimated future cash flows.  As a result of this process, we have in the past and may in the future seek to raise additional capital, refinance or restructure indebtedness, consider the sale of interests in subsidiaries, business units or other assets, or take a combination of such steps or other steps, to increase liquidity, reduce indebtedness and fund future activities.  Such activities have in the past and may in the future involve related companies.  From time to time, we and related entities also evaluate the restructuring of ownership interests among our subsidiaries and related companies and expect to continue this activity in the future and may in connection with such activities, consider issuing additional equity securities and increasing our indebtedness.

Amendment of Financial Covenants Included in Credit Facility

We anticipated we would be out of compliance with certain financial covenants as of September 30, 2009 and, as such, amended our primary credit facility on October 2, 2009 (retroactive to September 30, 2009) to, among other things, waive particular financial covenants until December 31, 2009 and modify a specific financial covenant during 2010.  Prior to the amendment of our primary credit agreement, interest rates on our credit facility ranged from prime to prime plus 0.5% or LIBOR plus 2.0% to LIBOR plus 2.75%.  As amended, our revolving credit facility bears interest at prime plus 1% or LIBOR plus 2.75% and interest rates on our credit facility’s term loan bears interest at prime plus 1.25% or LIBOR plus 3%.
 
 

 
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We were in compliance with the amended covenants as of December 31, 2009.  We believe we will be able to comply with the covenant restrictions, as amended, through the maturity of the facility in August 2010; however if future operating results differ materially from our predictions we may be unable to maintain compliance.
 
Issuance of Common Stock

On March 24, 2008 we issued 2.5 million shares of our common stock pursuant to a subscription rights offering to our stockholders of record as of January 28, 2008 at a price of $10.00 per share (the “Offering”).  The Offering expired on March 17, 2008, and upon closing we received $25.0 million in proceeds.  We incurred approximately $.3 million of expenses related to the Offering.  We used the net proceeds to reduce indebtedness under our revolving credit facility, which in turn created additional availability under that facility that can be used for general corporate purposes, including scheduled debt payments, capital expenditures, potential acquisitions or the liquidity needs of our current operations.

In connection with the Offering, in January 2008 we amended our Certificate of Incorporation to increase the number of authorized shares of our common stock from 11 million shares to 20 million shares.

Acquisition and Amendment of Credit Facility

During the first quarter of 2007 we formed Keystone-Calumet, Inc., which acquired substantially all of the real estate, equipment and inventory of CaluMetals, Inc.  In connection with this acquisition, we also completed an amendment to our credit facility during the first quarter of 2007, increasing the total committed facility amount from $80.0 million to $100.0 million, in part to finance the CaluMetals acquisition.

Restructuring

Previously, Keystone Wire Products, Inc. (“KWP”), located in Sherman, Texas, manufactured and sold industrial wire and fabricated wire products.  Approximately 60% of KWP’s sales were to KSW in 2006 and substantially all of KWP’s sales in 2007 were to KSW.  During the third quarter of 2006, in an effort to reduce costs, we relocated KWP’s industrial wire manufacturing operations to KSW.  During the third quarter of 2007, in further efforts to reduce costs, we discontinued all remaining manufacturing operations at KWP.  The majority of KWP’s wire products production equipment was transferred to KSW or sold.  The former KWP facility is now operated solely as a KSW distribution center.  There have been no changes in our customer base as a result of this decision, as shipments that are distributed through the former KWP location are now recognized as KSW sales.  KWP is now considered part of our KSW segment, and for comparability purposes we have combined KWP’s prior segment results with KSW’s segment results.

We will continue to analyze the profitability of our operations and make operating decisions accordingly.

Bankruptcy

On February 26, 2004, we and five of our direct and indirect subsidiaries filed for voluntary protection under Chapter 11 of the Federal Bankruptcy Code.  We attributed the need to reorganize to weaknesses in product selling prices over the preceding several years, unprecedented increases in ferrous scrap costs and significant liquidity needs to service retiree medical costs.  These problems substantially limited our liquidity and undermined our ability to obtain sufficient debt or equity capital to operate as a going concern.
 
 
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We emerged from bankruptcy protection on August 31, 2005.  Significant provisions of our plan of reorganization included greater employee participation in healthcare costs and an agreement (the “1114 Agreement”) with certain retirees that replaced their medical and prescription drug coverage with fixed monthly cash payments.

During 2007, the final pending claims of the bankruptcy were settled or fully adjudicated.  However, at that time, an amendment to the 1114 Agreement was in negotiation. Upon finalization of the amendment to the 1114 Agreement in 2008, we sought final closure of our bankruptcy case and on September 11, 2008, the United States Bankruptcy Court for the Eastern District of Wisconsin issued our final decree.  See Note 4 to our Consolidated Financial Statements.

Availability of Company Reports Filed with the SEC

Our fiscal year is 52 or 53 weeks and ends on the last Sunday in December.  We furnish our stockholders with annual reports containing audited financial statements.  In addition, we file annual, quarterly and current reports, proxy and information statements and other information with the SEC.  We also make our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments thereto, available free of charge through our website at www.keystoneconsolidated.com as soon as reasonably practical after they have been filed with the SEC.  We also provide to anyone, without charge, copies of such documents upon written request.  Requests should be directed to the attention of the Corporate Secretary at our address on the cover page of this Form 10-K.

The general public may read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, 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.  We are an electronic filer.  The SEC maintains an Internet website at www.sec.gov that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC, including us.
 
 

ITEM 1A. RISK FACTORS.

Listed below are certain risk factors associated with our businesses.  In addition to the potential effect of these risk factors discussed below, any risk factor which could result in reduced earnings or operating losses, or reduced liquidity, could in turn adversely affect our ability to service our liabilities or adversely affect the quoted market prices for our publicly-traded securities.

Our leverage may impair our financial condition or limit our ability to operate our businesses.

We fund our operations primarily through cash from operations and borrowings on our revolving credit facility.  Our revolving credit facility requires us to use our daily cash receipts to reduce outstanding borrowings, which results in us maintaining zero cash balances when there are balances outstanding under the credit facility.  The amount of available borrowings under our revolving credit facility is based on formula-determined amounts of trade receivables and inventories.

Our revolving credit facility contains covenants requiring us to maintain certain financial ratios.  We were in compliance with the financial covenants at December 31, 2009 and we believe we will be able to comply with the covenant restrictions through the maturity of the facility; however if future operating results differ materially from our predictions we may be unable to maintain compliance.  The credit facility is collateralized by substantially all of our operating assets and failure to comply with the covenants contained in the credit facility could result in the acceleration of any outstanding balances under the facility prior to their stated maturity date.  Additionally, the lenders participating in the credit facility can restrict our ability to incur additional secured indebtedness and can declare a default under the credit facility in the event of, among other things, a material adverse change in our business.  In the event of an uncured default of our primary credit facility agreement, we would seek to refinance the facility with a new group of lenders or, if required, we will use other existing liquidity resources (which could include funds provided by our affiliates).

 
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Our revolving credit facility expires in August 2010.  We believe we will be able to obtain sufficient financing for our operations upon expiration of the credit facility through renewal of the existing facility or a new facility with a new group of lenders.  However, there is no assurance that such financing can be obtained, or if obtained that it would not be on terms that would result in higher costs to us (such as a higher interest rate on outstanding borrowings).  If we were unable to obtain such financing, our liquidity could be negatively affected.

Our dependence on borrowing availability from our revolving credit facility could have important consequences to our stockholders and creditors, including:

·  
making it more difficult for us to satisfy our obligations with respect to our liabilities;
·  
increasing our vulnerability to adverse general economic and industry conditions;
·  
requiring a portion of our cash flow from operations be used for the payment of interest on our debt, therefore reducing our ability to use our cash flow to fund working capital, capital expenditures, acquisitions and general corporate requirements;
·  
limiting our ability to obtain additional financing to fund future working capital, capital expenditures, acquisitions and general corporate requirements;
·  
limiting our flexibility in planning for, or reacting to, changes in our business, regulatory requirements and the industry in which we operate; and
·  
placing us at a competitive disadvantage relative to other less-leveraged competitors.

Demand for, and prices of, certain of our products are cyclical and we are currently operating in depressed market conditions, which may result in reduced earnings or operating losses.

A significant portion of our revenues are attributable to sales of products into the agricultural and construction industries.  These two industries themselves are cyclical and changes in those industries’ economic conditions can significantly impact our earnings and operating cash flows.  Additionally, the current world-wide economic downturn has depressed sales volumes, and we are unable to predict with a high degree of certainty when demand will return to the levels experienced prior to the fourth quarter of 2008.  Our operating results and our business and financial condition could be adversely affected by, among other things, economic conditions, availability of credit to fund agricultural and construction projects, short and long-term weather patterns, interest rates and embargos placed by foreign countries on U.S. agricultural products.
 
 
- 13 -


 
We sell the majority of our products in mature and highly competitive industries and face price pressures in the markets in which we operate, which may result in reduced earnings or operating losses.

The markets in which we operate our businesses are highly competitive.  Competition is based on a number of factors, such as price, product quality, delivery times and service.  Some of our competitors may be able to drive down prices for our products because the competitors’ costs are lower than our costs.  In addition, some of our competitors’ financial, technological and other resources may be greater than our resources, and such competitors may be better able to withstand negative changes in market conditions.  Our competitors may be able to respond more quickly than we can to new or emerging technologies and changes in customer requirements.  Further, consolidation of our competitors or customers in any of the industries in which we compete may result in reduced demand for our products.  In addition, in some of our businesses new competitors could emerge by modifying their existing production facilities so they could manufacture products that compete with our products.  The occurrence of any of these events could result in reduced earnings or operating losses.

Many of EWP’s products are ultimately used in infrastructure projects by local, state or federal governments.

Such projects are impacted by the availability of governmental funding for such projects.  A decline in the availability of governmental funds for such projects could ultimately result in a decline in demand or selling prices of EWP’s products.  Such a decline could result in reduced earnings or operating losses.

Wire rod continues to be imported into the U.S.  Global producers of wire rod are able to import their products into the U.S. with minimal tariffs and duties.

Many of these global wire rod producers are able to produce wire rod at costs lower than we incur in our production.  As such, these wire rod imports are often able to be priced at lower levels than similar products manufactured by us.  In addition, we believe certain foreign governments subsidize their local wire rod producers.  These events can adversely impact our shipment levels and pricing decisions and, as such, could result in reduced earnings or operating losses.

Higher costs or limited availability of ferrous scrap may decrease our liquidity.

The cost of ferrous scrap, our primary raw material, can fluctuate significantly and product selling prices cannot always be adjusted, especially in the short-term, to recover the costs of increases in ferrous scrap prices.  Additionally, should our local ferrous scrap suppliers not be able to meet their contractual obligations, we may incur higher costs for ferrous scrap.
 
Negative global economic conditions increase the risk that we could suffer unrecoverable losses on our customers' accounts receivable which would adversely affect our financial results.
 
We extend credit and payment terms to some of our customers. Although we have an ongoing process of evaluating our customers' financial condition, we could suffer significant losses if a customer fails and is unable to pay us. A significant loss of an accounts receivable would have a negative impact on our financial results.
 
 
- 14 -

 
Climate change legislation could negatively impact our financial results or limit our ability to operate our businesses. 
 
We believe all of our production facilities are in substantial compliance with applicable environmental laws.  Proposed legislation is being considered to limit green house gases through various means, including emissions permits and/or energy taxes.   Our production facilities consume large amounts of energy, including electricity and natural gas.  To date the permit system in effect has not had a material adverse effect on our financial results.  However, if green house gas legislation were to be enacted, it could negatively impact our future results from operations through increased costs of production, particularly as it relates to our energy requirements. If such increased costs of production were to materialize, we may be unable to pass price increases on to our customers to compensate for increased production costs, which may decrease our liquidity, operating income and results of operations.

ITEM 1B. UNRESOLVED STAFF COMMENTS.

None.

ITEM 2. PROPERTIES.

Our principal executive offices are located in approximately 3,200 square feet of leased space at 5430 LBJ Freeway, Suite 1740, Dallas, Texas 75240-2697.

Our production facilities utilize approximately 2.3 million square feet for manufacturing, approximately 85% of which is located at our Peoria, Illinois facility.

The following table sets forth the location, size and general product types produced for each of our manufacturing facilities, as of December 31, 2009, all of which are owned by us:

 
 
      Facility Name      
 
 
      Location      
 
Approximate
Size
(Square Feet)
 
 
 
    Primary Products Produced for External Sales       
           
Keystone Steel & Wire
Peoria, IL
    1,951,000  
    Fabricated wire products, industrial wire and wire rod
Engineered Wire Products
Upper Sandusky, OH
    126,000  
Wire mesh
Keystone-Calumet
Chicago Heights, IL
    216,000  
Steel bar
             
        2,293,000    

We believe all of our facilities are adequately maintained and are satisfactory for their intended purposes.

ITEM 3. LEGAL PROCEEDINGS.

We are also involved in various legal proceedings.  Information required by this Item is included in Notes 4, 10 and 11 to our Consolidated Financial Statements, which information is incorporated herein by reference.

ITEM 4. RESERVED.



 
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PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

Our common stock trades on the OTC Bulletin Board (Symbol: KYCN).  As of March 4, 2010, we had approximately 1,354 holders of record of our common stock at a closing price of $4.12.  The following table sets forth the high and low closing per share sales prices for our common stock for the periods indicated:

   
High
   
Low
 
             
Year ended December 31, 2008
           
             
  First quarter
  $ 16.98     $ 9.35  
  Second quarter
  $ 12.45     $ 9.00  
  Third quarter
  $ 15.51     $ 10.35  
  Fourth quarter
  $ 10.50     $ 5.01  
                 
Year ended December 31, 2009
               
                 
  First quarter
  $ 6.25     $ 2.80  
  Second quarter
  $ 3.32     $ 2.25  
  Third quarter
  $ 4.11     $ 2.70  
  Fourth quarter
  $ 5.05     $ 3.50  
                 
First quarter 2010 through March 4, 2010
  $ 4.70     $ 4.00  

We have not paid cash dividends on our common stock since 1977 and currently we retain all earnings to fund working capital requirements, capital expenditures and scheduled debt repayments.  Although our primary credit facility currently restricts our ability to pay dividends, including a prohibition against the payment of cash dividends on our common stock without lender consent, depending on our financial position, we may at some time in the future decide it is in our best interest to pay cash dividends on our common stock.  Such a decision would be subject to negotiating an amendment to our primary credit facility.

Performance Graph - Set forth below is a line graph comparing the change in our cumulative total stockholder return on our common stock against the cumulative total return of the S&P 500 Index, the S&P 500 Steel Index and a self-selected peer group for the period from June 23, 2006 (the first date on which our common stock began public trading following our emergence from Chapter 11 bankruptcy protection) through December 31, 2009.  The graph shows the value at December 31 of each year assuming an original investment of $100 at June 23, 2006.
 
 

 
- 16 -

 

Our self-selected peer group includes competitors whose principal operations closely align with ours for which meaningful stockholder return information is available:
 
·  
Gerdau Ameristeel Corporation – owns and operates mini-mills that produces wire rod, rebar, bar, shapes, beams and special sections with downstream operations including rebar fabrication and epoxy coating, railroad spike operations, cold drawn plants, super light beam processing and the production of elevator guide rails, grinding balls, wire mesh, and wire drawing.
·  
Nucor Corporation – owns and operates steel mills that produce hot-rolled steel (angles, rounds, flats, channels, sheet, wide-flange beams, pilings, billets, blooms, beam blanks and plate) and cold-rolled steel. Downstream operations produce steel joists and joist girders, steel deck, fabricated concrete reinforcing steel, cold finished steel, steel fasteners, metal building systems, light gauge steel framing, steel grating and expanded metal, and wire and wire mesh.
·  
Insteel Industries – a wire mesh and PC strand producer.
 

 
   
June 23,
   
December 31,
 
   
2006
   
2006
   
2007
   
2008
   
2009
 
                               
Keystone common stock
  $ 100     $ 750     $ 725     $ 300     $ 200  
S&P 500 Index
    100       115       121       76       97  
S&P 500 Steel Index
    100       117       142       69       88  
Peer Group
    100       107       128       91       100  

 
 
Keystone Consolidated Industries, Inc. - 10K for year 12-31-2009 Comparison Chart

 

 
- 17 -

 

ITEM 6. SELECTED FINANCIAL DATA.

The following selected consolidated financial data should be read in conjunction with our Consolidated Financial Statements and Item 7. "Management's Discussion and Analysis Of Financial Condition And Results Of Operations."

   
Years ended December 31, 
 
   
2005
   
2006
   
2007
   
2008
   
2009
 
   
(In thousands, except per share and per ton amounts)
 
Statement of Operations Data:
                             
  Net sales
  $ 367,545     $ 440,540     $ 451,178     $ 562,693     $ 322,347  
  Operating income
    20,193       79,750       97,972       110,493       3,209  
                                         
  Defined benefit pension credit (expense)
    11,710       55,978       80,443       73,923       (5,887 )
  OPEB credit (expense)
    (8,885 )     8,297       8,526       8,474       4,748  
      Operating income before pension and OPEB (1)
    17,368       15,475       9,003       28,096       4,348  
  Gain on cancellation of debt
    32,510       -       10,074       -       -  
  Gain on legal settlement
    -       -       5,400       -       -  
  Reorganization costs
    (10,308 )     (679 )     (190 )     (225 )     -  
  Provision for income taxes
    (430 )     (17,055 )     (37,619 )     (40,014 )     (2,292 )
                                         
  Net income
  $ 39,232     $ 57,732     $ 64,765     $ 66,114     $ 241  
                                         
 Basic income per share
  $ 4.12     $ 5.77     $ 6.48     $ 5.73     $ 0.02  
 Diluted income per share
  $ 1.88     $ 5.77     $ 6.48     $ 5.73     $ 0.02  
 Weighted average common and common equivalent shares outstanding (2):
                                       
    Basic
    10,046       10,000       10,000       11,533       12,102  
    Diluted
    22,029       10,000       10,000       11,533       12,102  
                                         
 
Other Operating Data:
                                       
  Shipments (000 tons):
                                       
    Wire rod
    236       349       395       343       257  
    Fabricated wire products
    101       112       103       86       66  
    Wire mesh
    71       67       58       54       41  
    Industrial wire
    72       75       66       61       34  
    Bar
    -       -       9       18       13  
    Coiled rebar
    -       1       15       15       5  
        Other
    46       71       2       9        6  
      Total
    526       675       648       586        422  
 
  Per-ton selling prices:
                                       
    Wire rod
  $ 503     $ 500     $ 548     $ 797     $ 575  
    Fabricated wire products
    1,090       1,037       1,089       1,380       1,373  
    Wire mesh
    881       870       896       1,168       916  
    Industrial wire
    731       726       763       1,103       897  
    Bar
    -       -       663       946       782  
    Coiled rebar
    -       529       563       841       540  
      All products in total
    696       645       690       955       760  
                                         
  Average per-ton ferrous scrap cost of goods sold
  $ 226     $ 210     $ 235     $ 363     $ 264  
                                         
      Increase (decrease) in LIFO reserve and cost of goods sold (3)
  $ (12,003 )   $ 3,367     $ 5,713     $ 10,142     $ (15,200 )
                                         
Other Financial Data:
                                       
  Capital expenditures
  $ 9,772     $ 18,739     $ 16,602     $ 13,298     $ 9,000  
  Depreciation and amortization
    15,745       15,222       15,434       15,164     $ 13,584  
                                         
 

 
 
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 As of December 31, 
 
   
2005
   
2006
   
2007
   
2008
   
2009
 
   
(In thousands)
 
Balance Sheet Data:
                             
  Working capital
  $ 36,373     $ 31,776     $ 20,630     $ 55,886     $ 49,063  
  Property, plant and equipment,  net
    86,773       88,695       92,469       89,987       85,169  
  Total assets (4)
    358,364       763,936       763,023       249,733       265,084  
  Total debt
    99,895       76,448       91,577       31,630       25,370  
  Stockholders’ equity (2) (4)
    67,531       403,662       404,694       119,644       147,770  

(1)  
Because pension and other postretirement benefit (“OPEB”) expense or credits are unrelated to the operating activities of our businesses, we measure and evaluate the performance of our businesses using operating income before pension and OPEB credit or expense.  As such, we believe the presentation of operating income before pension and OPEB credit or expense provides more useful information to investors.  Operating income before pension and OPEB credit or expense is a non-GAAP measure of profitability that is not in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and it should not be considered in isolation or as a substitute for a measure prepared in accordance with GAAP.  A reconciliation of operating income as reported to operating income adjusted for pension and OPEB expense or credit is set forth in the following table.
 

 
   
Years ended December 31, 
 
   
2005
   
2006
   
2007
   
2008
   
2009
 
   
(In thousands)
 
                                         
Operating income as reported
  $ 20,193     $ 79,750     $ 97,972     $ 110,493     $ 3,209  
  Defined benefit pension expense (credit)
    (11,710 )     (55,978 )     (80,443 )     (73,923 )     5,887  
  OPEB expense (credit)
    8,885       (8,297 )     (8,526 )     (8,474 )     (4,748 )
Operating income before pension/OPEB
  $ 17,368     $ 15,475     $ 9,003     $ 28,096     $ 4,348  

 
(2)  
All of our outstanding common and preferred stock at August 31, 2005 was cancelled in connection with our emergence from Chapter 11 on August 31, 2005, and at that time, we issued 10 million shares of a new issue of common stock.  On March 24, 2008 we issued 2.5 million shares of our common stock and received net proceeds of $24.7 million pursuant to a subscription rights offering.

(3)  
We use the last-in-first-out (“LIFO”) method to determine the cost of the majority of our productive inventories.  Changes in LIFO reserves are reflected in cost of goods sold.

(4)  
We adopted Accounting Standard Codification (“ASC”) Topic 715 effective December 31, 2006, and, as a result, amounts reported as of December 31, 2006 and subsequent periods include the funded status of our pension plans.



 
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

RESULTS OF OPERATIONS

Business Overview

We are a leading domestic producer of steel fabricated wire products, industrial wire and wire rod.  We also manufacture wire mesh, coiled rebar, steel bar and other products.  Our products are used in the agricultural, industrial, cold drawn, construction, transportation, original equipment manufacturer and retail consumer markets.  We are vertically integrated, converting substantially all of our products from billet produced in our steel mini-mill.  Historically, our vertical integration has allowed us to benefit from the higher and more stable margins associated with fabricated wire products and wire mesh as compared to wire rod, as well as from lower costs of billet and wire rod as compared to bar manufacturers and wire fabricators that purchase billet and wire rod in the open market.  Moreover, we believe our downstream fabricated wire products, wire mesh, coiled rebar and industrial wire businesses are better insulated from the effects of wire rod imports as compared to non-integrated wire rod producers.

Recent Developments

During the first half of 2009, the economic conditions resulted in customers cancelling or postponing certain projects due to an inability to secure financing in the current credit markets and choosing to conserve cash by liquidating their inventories and instituting just-in-time order philosophies.  In addition, while we experienced an unprecedented 90% increase in the cost of ferrous scrap from December 2007 to August 2008, a significant decline in ferrous scrap costs since that time resulted in customers limiting orders as they believed lower ferrous scrap prices would result in lower selling prices in the near future.  Given this sharply reduced market demand, we operated our facilities on substantially reduced production schedules during the first half of 2009, which resulted in a much higher percentage of fixed costs included in cost of goods sold as these costs could not be capitalized into inventory.  Our customers’ just-in-time order philosophies have resulted in additional costs due to frequent mill changes as customers are ordering much smaller quantities of our many different products.  Additionally, we experienced equipment break-downs and start-up issues as idle production facilities were difficult to re-start given the cold winter temperatures during the first quarter of 2009.  However, we believe our reduced production schedules allowed us to somewhat temper the adverse impact of the business downturn on our liquidity.

Shipment volumes and customer orders increased during the second half of 2009 as the economy began to recover slightly and the increase in shipment volumes resulted in increased production levels.  Based on current expectations that the economy will continue to recover at a modest pace, we believe 2010 shipment volumes will be higher than 2009 shipment volumes.  However, our customers have continued the just-in-time order philosophies discussed above and we adapted our production and inventory strategies accordingly.

One of the key drivers of our profitability is the margin between ferrous scrap costs and our selling prices.  As discussed above, ferrous scrap market prices have generally declined since August 2008, which resulted in market pressure to decrease our selling prices during the first half of 2009.  Ferrous scrap market prices increased slightly during the second half of 2009 and we announced and implemented price increases on selected products.  We currently believe we will be able to maintain positive overall margins on our products throughout 2010.
 
 
- 20 -


 
On July 2, 2009, the IEPA approved the completion of the soil portion of the remediation plan of certain waste management units (“WMUs”) at our Peoria, Illinois facility which resulted in us decreasing our accrued environmental costs by $4.2 million during 2009.  We believe the upper end of the range of reasonably possible costs to us for sites where we have been named a defendant is approximately $2.0 million, including the $.7 million accrued as of December 31, 2009.  In connection with the IEPA’s approval of the soil portion of the WMUs, the IEPA released approximately $2.0 million of escrowed funds to us.    See Note 10 to our Consolidated Financial Statements for discussions of our environmental liabilities.

Despite the poor business conditions during 2009, we were profitable and we managed our liquidity well by balancing production schedules with product demand, managing costs and maintaining selling price discipline despite continuous market pressure to sell below our costs.  Considering that principal payments due on our outstanding indebtedness in 2010 are about one-half of those paid in 2009, and availability under our revolving credit facility as of December 31, 2009 is similar to availability at December 31, 2008, we currently believe our cash flows from operating activities combined with availability under our revolving credit facility will be sufficient to enable us to meet our cash flow needs during 2010.

As discussed above, our credit facility expires in August 2010.  Due to our historical cash flows from operations, our ability to remain profitable throughout the negative economic conditions of 2009 and our relatively low debt position as of December 31, 2009, we believe we will be able to obtain sufficient financing for our operations upon expiration of the credit facility through renewal of the existing facility or a new facility with a new group of lenders.  If we are unable to obtain such financing, we believe we would have other sources of liquidity to meet our requirements, which could include funds provided by our affiliates.

As discussed in Note 7 to our Consolidated Financial Statements, we anticipated we would be out of compliance with certain financial covenants as of September 30, 2009 and, as such, amended our primary credit facility on October 2, 2009 (retroactive to September 30, 2009) to waive particular financial covenants until December 31, 2009 and modify a specific financial covenant during 2010.  We were in compliance with the amended covenants at December 31, 2009 and we believe we will be able to comply with the covenant restrictions, as amended, through the maturity of the facility; however if future operating results differ materially from our predictions we may be unable to maintain compliance.  The credit facility is collateralized by substantially all of our operating assets and failure to comply with the covenants contained in the credit facility could result in the acceleration of any outstanding balances under the facility prior to their stated maturity date.  Additionally, the lenders participating in the credit facility can restrict our ability to incur additional secured indebtedness and can declare a default under the credit facility in the event of, among other things, a material adverse change in our business.  In the event of an uncured default of our primary credit facility agreement, we would seek to refinance the facility with a new group of lenders or, if required, we believe we would have other sources of liquidity to meet our requirements, which could include funds provided by our affiliates.

Results of Operations

Our profitability is primarily dependent on sales volume, per-ton selling prices, per-ton ferrous scrap cost and energy costs.


 
- 21 -

 

Operating income before pension and OPEB for 2009 was significantly worse than 2008 primarily due to the net effects of the following factors:
·  
lower shipment volumes as discussed above;
·  
lower selling prices as discussed above;
·  
reduced production volumes as discussed above, which resulted in a higher percentage of fixed costs included in cost of goods sold;
·  
increased variable costs of production due to frequent mill changes as customers are managing their inventory by ordering much smaller quantities of our many different products;
·  
increased variable costs of production as idle production facilities were difficult to re-start given cold winter temperatures during the first quarter of 2009;
·  
a $2.7 million impairment charge to reduce certain inventories to net realizable value during 2009 as compared to a $1.2 million impairment charge during 2008;
·  
increased bad debt expense during 2009 of $2.9 million primarily due to the Chapter 11 proceedings of one of our customers;
·  
decreased cost of ferrous scrap;
·  
decreased cost of electricity and natural gas;
·  
decreased workers compensation expense;
·  
decreased employee incentive compensation accruals during 2009 resulting from lower profitability;
·  
decreases in our LIFO reserve and cost of goods sold during 2009 of $15.2 million as compared to a $10.1 million increase in our LIFO reserve and cost of goods sold during 2008 as discussed in Note 5 to our Consolidated Financial Statements; and
·  
a $4.2 million credit to general and administrative expense during 2009 related to the release of accrued environmental costs for certain inactive waste management units as discussed above.

Operating income before pension and OPEB for 2008 was significantly higher than 2007 primarily due to the net effects of the following factors:
·  
higher per-ton product selling prices resulting from price increases we implemented to offset our increased costs for ferrous scrap throughout the year, as well as increased demand for domestic wire rod and industrial wire during the first three quarters of 2008 due to lower quantities of import product available for sale and higher prices for import products as well as the weak U.S. dollar;
·  
decreased costs for zinc during 2008;
·  
cost savings of $1.7 million resulting from a reduction-in-force during the first quarter of 2008;
·  
income of $.9 million related to obtaining an excise tax exemption in 2008 on 2007 electricity costs;
·  
lower shipment volumes for the majority of our products as customers held orders during the fourth quarter of 2008 due to negative economic conditions;
·  
increased costs for ferrous scrap and energy during 2008;
·  
a $1.2 million impairment charge during the fourth quarter of 2008 to reduce certain inventories to net realizable value;
·  
increased employee incentive compensation accruals as a result of increased profitability during 2008;
·  
increased costs for workers compensation and personal injury claims under our general liability insurance in 2008; and
·  
a legal settlement with a former insurance carrier of $5.4 million during 2007.
 

 
- 22 -


Segment Operating Results

Our operating segments are organized by our manufacturing facilities and include three reportable segments:

·  
KSW, located in Peoria, Illinois, operates an electric arc furnace mini-mill and manufactures and sells wire rod, industrial wire, coiled rebar, fabricated wire and other products to agricultural, industrial, construction, commercial, original equipment manufacturers and retail consumer markets;
·  
EWP, located in Upper Sandusky, Ohio, manufactures and sells wire mesh in both roll and sheet form that is utilized in concrete construction products including pipe, pre-cast boxes and applications for use in roadways, buildings and bridges; and
·  
Calumet, located in Chicago Heights, Illinois, manufactures and sells merchant and special bar quality products and special sections in carbon and alloy steel grades for use in agricultural, cold drawn, construction, industrial chain, service centers and transportation applications as well as in the production of a wide variety of products by original equipment manufacturers.


 
- 23 -

 

Our consolidated net sales, cost of goods sold, operating costs and operating income before pension and OPEB by segment are set forth in the following table:

   
 
KSW
   
 
EWP
   
 
Calumet
   
 
Other(1)
   
 
Total
 
   
(In thousands)
 
                               
For the year ended December 31, 2007:
                   
                               
 Net sales
  $ 426,652     $ 52,509     $ 5,659     $ (33,642 )   $ 451,178  
 Cost of goods sold
    (413,556 )     (41,189 )     (6,651 )     33,488       (427,908 )
   Gross margin (loss)
    13,096       11,320       (992 )     (154 )     23,270  
                                         
 Selling and
   administrative expense
    (14,026 )     (3,618 )     (399 )     (1,624 )     (19,667 )
 Gain on legal settlement
    -       -       -       5,400       5,400  
 Operating income (loss) before pension/OPEB
  $ (930 )   $ 7,702     $ (1,391 )   $ 3,622     $ 9,003  
                                         
For the year ended December 31, 2008:
                         
                                         
 Net sales
  $ 542,106     $ 63,433     $ 17,165     $ (60,011 )   $ 562,693  
 Cost of goods sold
    (494,776 )     (54,676 )     (18,981 )     57,236       (511,197 )
   Gross margin (loss)
    47,330       8,757       (1,816 )     (2,775 )     51,496  
                                         
 Selling and
   administrative expense
    (15,156 )     (3,419 )     (1,113 )     (3,712 )     (23,400 )
 Operating income (loss) before pension/OPEB
  $ 32,174     $ 5,338     $ (2,929 )   $ (6,487 )   $ 28,096  
                           
For the year ended December 31, 2009:
                         
                                         
 Net sales
  $ 298,219     $ 37,575     $ 11,127     $ (24,574 )   $ 322,347  
 Cost of goods sold
    (279,380 )     (33,572 )     (14,350 )     27,515       (299,787 )
   Gross margin (loss)
    18,839       4,003       (3,223 )     2,941       22,560  
                                         
 Selling and
   administrative expense
    (12,863 )     (2,598 )     (480 )     (2,271 )     (18,212 )
 Operating income (loss) before pension/OPEB
  $ 5,976     $ 1,405     $ (3,703 )   $ 670     $ 4,348  
                                         

 (1)  Other items primarily consist of the elimination of intercompany sales, the elimination of intercompany profit or loss on ending inventory balances and general corporate expenses.



 
- 24 -

 

Keystone Steel & Wire

       
   
2007
   
% of
sales
   
2008
   
% of
sales
   
2009
   
% of
sales
 
   
($ in thousands)
 
       
Net sales
  $ 426,652       100.0 %   $ 542,106       100.0 %   $ 298,219       100.0 %
Cost of goods sold
    (413,556 )     (96.9 )     (494,776 )     (91.3 )     (279,380 )     (93.7 )
  Gross margin
    13,096       3.1       47,330       8.7       18,839       6.3  
                                                 
Selling and administrative
    (14,026 )     (3.3 )     (15,156 )     (2.8 )     (12,863 )     (4.3 )
  Operating income (loss) before pension/OPEB
  $ (930 )     (0.2 )%   $ 32,174       5.9 %   $ 5,976       2.0 %
                                                 

The primary drivers of sales, cost of goods sold and the resulting gross margin are as follows:

   
2007
   
2008
   
2009
 
Sales volume (000 tons):
                 
  Wire rod
    448       398       291  
  Fabricated wire products
    103       86       66  
  Industrial wire
    66       61       34  
  Coiled rebar
    15       15       5  
  Other
    16       35       16  
    Total
    648       595       412  
                         
                         
Per-ton selling prices:
                       
  Wire rod
  $ 545     $ 797     $ 575  
  Fabricated wire products
    1,089       1,380       1,373  
  Industrial wire
    763       1,103       897  
  Coiled rebar
    563       841       540  
    All products
    653       906       720  
                         
Average per-ton ferrous scrap cost of goods sold
  $ 235     $ 363     $ 264  
                         
Increase (decrease) in LIFO reserve and cost of goods sold
  $ 6,928     $ 6,588     $ (9,125 )
                         
Average electricity cost per kilowatt hour
  $ 0.05     $ 0.05     $ 0.03  
                         
Kilowatt hours consumed (000 hours)
    505,115       485,446       341,392  
                         
Average natural gas cost per therm
  $ 0.76     $ 0.95     $ 0.50  
                         
Natural gas therms consumed (000 therms)
    21,007       19,380       14,115  
 
Sales volume decreased from 2008 to 2009 as the negative economic conditions that began late in 2008 continued throughout 2009.

 
- 25 -

 
Total sales volume decreased from 2007 to 2008 as our customers limited orders during the fourth quarter of 2008 due to the negative economic conditions.  Fourth quarter 2008 shipment volumes of approximately 59,000 tons decreased 63% from fourth quarter 2007 shipment volumes of approximately 161,000 tons.

However, shipment volumes for the first nine months of 2008 were approximately 10% higher than the same period of 2007 primarily due to the net effects of the following factors:
·  
higher shipment volumes of industrial wire due to increased domestic demand as a result of higher prices for import products as well as the weak U.S. dollar;
·  
higher shipment volumes of coiled rebar due to acceptance of our product in the market with a larger number of customers than in 2007;
·  
higher shipment volumes of wire rod due to lower quantities of import product available for sale and higher prices for import products as well as the weak U.S. dollar; and
·  
lower shipment volumes of fabricated wire products as a result of customer resistance to our price increases.

As discussed above, ferrous scrap market prices have generally declined since August 2008, which resulted in market pressure to decrease our selling prices during 2009.  The higher per-ton selling prices during 2008 as compared to 2007 were due primarily to price increases we implemented in response to significantly higher ferrous scrap costs as well as increased market demand for domestic wire rod and industrial wire.  Ferrous scrap is KSW’s primary raw material.
 
KSW’s operating income before pension and OPEB for 2009 as compared to 2008 was also impacted by the following:
·  
reduced production volumes as discussed above, which resulted in a higher percentage of fixed costs included in cost of goods sold;
·  
increased variable costs of production due to frequent mill changes as customers are managing their inventory by ordering much smaller quantities of our many different product lines;
·  
increased variable costs of production as idle production facilities were difficult to re-start given cold winter temperatures during the first quarter of 2009;
·  
increased bad debt expense of $2.9 million primarily due to the Chapter 11 proceedings of one of KSW’s customers;
·  
decreased employee incentive compensation accruals during 2009 as discussed above;
·  
decreased workers compensation expense; and
·  
a $4.2 million credit related to the release of accrued environmental costs during 2009 as discussed above.

KSW’s operating income before pension and OPEB for 2008 as compared to 2007 was also impacted by:
·  
a 34% decline in zinc costs;
·  
cost savings of approximately $2.5 million resulting from KSW’s reduction-in-force during the first quarter of 2008 partially offset by the related $.8 million severance expense;
·  
income of approximately $.9 million related to KSW obtaining an excise tax exemption in 2008 on 2007 electricity costs;
·  
increased employee incentive compensation accruals as a result of increased profitability; and
·  
increased costs for workers compensation and personal injury claims under our general liability insurance in 2008.
 
 
- 26 -


 
Engineered Wire Products, Inc.

   
2007
   
% of
sales
   
2008
   
% of
sales
   
2009
   
% of
sales
 
   
($ in thousands)
 
                                     
Net sales
  $ 52,509       100.0 %   $ 63,433       100.0 %   $ 37,575       100.0 %
Cost of goods sold
    (41,189 )     (78.4 )     (54,676 )     (86.2 )     (33,572 )     (89.4 )
  Gross margin
    11,320       21.6       8,757       13.8       4,003       10.6  
                                                 
Selling and administrative
    (3,618 )     (6.9 )     (3,419 )     (5.4 )     (2,598 )     (6.9 )
  Operating income before pension/OPEB
  $ 7,702       14.7 %   $ 5,338       8.4 %   $ 1,405       3.7 %
                                                 

The primary drivers of sales, cost of goods sold and the resulting gross margin are as follows:

   
2007
   
2008
   
2009
 
Sales volume (000 tons)-
                 
  Wire mesh
    58       54       41  
                         
Per-ton selling prices -
                       
  Wire mesh
  $ 896     $ 1,168     $ 916  
                         
Average per-ton wire rod cost of goods sold
  $ 510     $ 713     $ 710  
                         
Increase (decrease) in LIFO reserve and cost of goods sold
  $ (1,215 )   $ 3,554     $ (6,075 )

Sales volume decreased from 2008 to 2009 as the negative economic conditions that began late in 2008 continued throughout 2009.  Sales volume decreased from 2007 to 2008 as our customers limited orders during the fourth quarter of 2008 due to the negative economic conditions.
 
Wire rod market prices have generally declined since August 2008, which resulted in market pressure to decrease our selling prices during 2009.  The higher per-ton selling prices during 2008 as compared to 2007 were due primarily to price increases we implemented in response to significantly higher wire rod costs.  Wire rod is EWP’s primary raw material.

Due to a wire rod market that had increased to unprecedented price levels during the second and third quarters of 2008 and due to low shipment volumes during the fourth quarter of 2008 and the first quarter of 2009, the wire rod costs included in the products EWP sold during 2009 were similar to the wire rod costs included in the products EWP sold during 2008; converse to wire rod market prices discussed above.

EWP’s operating performance during 2009 as compared to 2008 was also impacted by the following:
·  
increased variable costs of production due to frequent mill changes as customers are managing their inventory by ordering much smaller quantities of our different products;
·  
significantly higher percentage of fixed costs included in cost of goods sold during the first quarter of 2009 due to substantially reduced production volumes as discussed above; and
·  
decreased employee incentive compensation accruals during 2009 as discussed above.
 

 
- 27 -

 
 
Keystone-Calumet, Inc.

   
2007
   
% of
sales
   
2008
   
% of
sales
   
2009
   
% of
sales
 
   
($ in thousands)
 
                                     
Net sales
  $ 5,659       100.0 %   $ 17,165       100.0 %   $ 11,127       100.0 %
Cost of goods sold
    (6,651 )     (117.5 )     (18,981 )     (110.6 )     (14,350 )     (129.0 )
  Gross margin (loss)
    (992 )     (17.5 )     (1,816 )     (10.6 )     (3,223 )     (29.0 )
                                                 
Selling and administrative
     (399 )      (7.1 )     (1,113 )      (6.5 )     (480 )     (4.3 )
  Operating loss before pension/OPEB
  $ (1,391 )     (24.6 )%   $ (2,929 )     (17.1 )%   $ (3,703 )     (33.3 )%
 
 
The primary drivers of sales, cost of goods sold and the resulting gross margin are as follows:
 

   
 2007
   
 2008
   
2009
 
                   
Sales volume (000 tons) - Bar
    9       18       13  
                         
Per-ton selling prices - Bar
  $ 663     $ 946     $ 782  
                         
Average per-ton billet cost of goods sold
  $ 408     $ 549     $ 447  
 

Sales volume decreased from 2008 to 2009 as the negative economic conditions that began late in 2008 continued throughout 2009.  Shipment volumes in 2008 were higher than in 2007 as Calumet regained some of its former market share and obtained recurring monthly orders.  Additionally, the acquisition of Calumet was in late March 2007 which results in three additional months of operations in 2008.

Throughout 2009 and continuing into 2010, Calumet has been conducting trials for many different customer-specific products and has enhanced its sales force.  Both of these developments are contributing to new customers and increased sales volume which is key to this segment becoming profitable.  We believe increased sales volume would allow Calumet to achieve certain economies of scale and profitability.

During the fourth quarter of 2008 and throughout 2009, Calumet determined it would not be able to recover the cost of certain inventory items in future selling prices and recognized impairment charges of $1.2 million and $2.7 million, respectively, to reduce the inventory to its net realizable value.  During the third quarter of 2007, we decided to discontinue producing a certain bar product.  Accordingly, Calumet recognized a $.2 million impairment charge on related storeroom inventory items.  These impairment charges are included in cost of goods sold.

The higher selling and administrative expenses during 2008 as compared to 2007 and 2009 were primarily due to higher bonus accruals, severance expense and relocation expenses.


 
- 28 -

 

Calumet’s operating performance during 2009 as compared to 2008 was also impacted by the following:
·  
reduced production volumes as discussed above, which resulted in a higher percentage of fixed costs included in cost of goods sold;
·  
increased variable costs of production due to frequent mill changes as customers are managing their inventory by ordering much smaller quantities of Calumet’s many different product lines;
·  
increased variable costs of production as idle production facilities were difficult to re-start given cold winter temperatures during the first quarter of 2009; and
·  
decreased cost of electricity and natural gas.


Pension Expense and Credits

During 2009, we recorded a defined benefit pension expense of $5.9 million.  During 2008 and 2007, we recorded a defined benefit pension credit of $73.9 million and $80.4 million, respectively.  The fluctuations in the pension expense or credit were primarily the result of decreases in our plans’ assets of $510 million during 2008 and $19.5 million during 2007.  These decreases impact the subsequent year’s defined benefit pension expense or credit by (i) lowering the expected return on plan assets as the plan assets multiplied by the assumed long-term rate of return is lower than the prior year and (ii) decreasing the amortization of unrealized net gains or increasing the amortization of unrealized net losses as any differences between the expected return on plan assets and the actual return on plan assets are deferred and amortized into income over future periods.

As our plans’ assets increased by approximately $58 million during 2009, we currently expect to record a defined benefit pension credit of $4.9 million during 2010. See Note 9 to our Consolidated Financial Statements.

OPEB Credits

We recorded an OPEB credit of $4.7 million during 2009 and an OPEB credit of $8.5 million in each of 2007 and 2008.  The decrease in the OPEB credit during 2009 was primarily due to an amendment of one of our OPEB plans late in 2008 which, among other things, significantly increased fixed monthly benefits.  We currently expect to record a $5.5 million OPEB credit during 2010.   See Note 9 to our Consolidated Financial Statements.

Interest Expense

Interest expense during 2007, 2008 and 2009 as well as the primary drivers of interest expense are presented in the following table.

   
2007
   
2008
   
2009
 
   
($ in thousands)
 
                   
Interest expense
  $ 6,073     $ 3,798     $ 1,725  
                         
Average debt balance
  $ 95,483     $ 68,169     $ 35,129  
                         
Weighted average interest rate
    6.2 %     5.0 %     4.1 %

The decrease in the average debt balance during 2009 was primarily due to a lower balance on our revolving credit facility as a result of substantially reduced production schedules throughout 2009 and an exceptionally low balance on our revolving credit facility at the end of 2008.
 
 
- 29 -

 
The decrease in the average debt balance from 2007 to 2008 was primarily due to decreased borrowings on our revolving credit facility as a result of increased profitability in 2008 and proceeds from a $25 million subscription rights offering in March of 2008 which were used to reduce indebtedness under our revolving credit facility.

The decreases in the overall weighted average interest rate from 2008 to 2009 and from 2007 to 2008 were primarily due to decreases in LIBOR and the prime rate.  Prior to the amendment of our primary credit agreement in October 2009 (as discussed above and in Note 7 to our Consolidated Financial Statements), interest rates on our variable-rate debt ranged from prime to prime plus 0.5% or LIBOR plus 2.0% to LIBOR plus 2.75%.  As amended, our revolving credit facility bears interest at prime plus 1% or LIBOR plus 2.75% and interest rates on our credit facility’s term loan bears interest at prime plus 1.25% or LIBOR plus 3%.

Gain on Legal Settlement

During 2007, we received a $5.4 million legal settlement from one of our former insurance carriers. See Note 11 to our Consolidated Financial Statements.

Gain on Cancellation of Debt

During 2007, we recorded gains on cancellation of debt as a result of our bankruptcy proceedings.  See Note 4 to our Consolidated Financial Statements.

Provision for Income Taxes

A tabular reconciliation of the difference between the U.S. Federal statutory income tax rate and our effective income tax rates is included in Note 8 to our Consolidated Financial Statements.


LIQUIDITY AND CAPITAL RESOURCES

Historical Cash Flows

Operating Activities

During 2009, net cash provided by operations totaled $13.3 million as compared to net cash provided by operations of $48.3 million during 2008.  The $35.0 million decline in operating cash flows was primarily due to the net effects of:
·  
lower operating income before pension/OPEB during 2009 of $23.7 million;
·  
lower OPEB payments during 2009 of $1.1 million as a result of amendments to one of our OPEB plans and one of our pension plans to create supplemental pension benefits in lieu of us paying certain OPEB benefits throughout 2009;
·  
higher net cash used as a result of relative changes in our accounts receivable in 2009 of $46.0 million primarily due to an abnormally low accounts receivable balance at December 31, 2008 as a result of customers limiting orders during the fourth quarter of 2008 (Days Sales Outstanding (“DSO”) was 17 and 47 at December 31, 2008 and 2009, respectively);
·  
higher net cash provided by relative changes in our inventory in 2009 of $45.4 million due to lower scrap and utility costs as well as a significant reduction in inventory levels during 2009 as we adjusted production and inventory strategies based on changes in customer order patterns (Days of Sales in Inventory (“DSI”) was 51 and 50 at December 31, 2008 and 2009, respectively);
·  
lower net cash used due to relative changes in our accounts payable of $4.1 million in 2009 as a result of increased cost management efforts during 2009;
·  
higher net cash used as a result of relative changes in our accrued liabilities of $20.3 million in 2009 as 2008 employee incentive compensation paid in the first quarter of 2009 was significantly higher than 2007 employee incentive compensation paid in the first quarter of 2008;
·  
lower interest payments during 2009 of $2.1 million; and
·  
lower tax payments during 2009 of $1.9 million due to decreased profitability.
 
 
- 30 -


 
During 2008, net cash provided by operations totaled $48.3 million as compared to net cash provided by operations of $2.6 million during 2007.  The $45.7 million improvement in operating cash flows was due primarily to the net effects of:
·  
higher operating income before pension/OPEB in 2008 of approximately $19.1 million;
·  
lower OPEB payments of $1.3 million in 2008 as a result of amendments to one of our OPEB plans and one of our pension plans to create supplemental pension benefits in lieu of us paying certain OPEB benefits during the last half of 2008;
·  
final payments of $4.3 million in 2007 to certain of our pre-petition creditors from our 2004 bankruptcy;
·  
higher net cash provided by relative changes in our accounts receivable in 2008 of $51.7 million primarily due to an abnormally low accounts receivable balance at December 31, 2008 as a result of customers limiting orders during the fourth quarter of 2008 as discussed above compared to an abnormally high accounts receivable balance at December 31, 2007 due to abnormally high demand at the end of 2007 (DSO was 44 and 17 at December 31, 2007 and 2008, respectively);
·  
higher net cash used due to relative changes in our inventory in 2008 of $28.8 million primarily due to increased costs of ferrous scrap and energy as well as higher levels of inventory as customers limited orders during the fourth quarter of 2008 as discussed above (DSI was 46 and 51 at December 31, 2007 and 2008, respectively);
·  
higher net cash used due to relative changes in our accounts payable in 2008 of $10.4 million as a result of purchasing significantly less ferrous scrap and energy at the end of 2008 as we substantially lowered production levels due to the rapid decline in product demand during the fourth quarter of 2008;
·  
higher net cash provided by relative changes in our accrued liabilities of $7.1 million in 2008 due in part to higher accruals for employee incentive compensation and workers compensation in 2008;
·  
lower interest payments during 2008 of $2.1 million; and
·  
higher cash paid for income taxes in 2008 of $2.7 million due to increased profitability.
 
 

 
- 31 -

 

Investing Activities

During 2007, 2008 and 2009, we had capital expenditures of approximately $16.6 million, $13.3 million and $9.0 million, respectively.  Capital expenditures for 2009 were lower than 2008 capital expenditures as we limited all non-critical capital projects during 2009 due to the economic conditions.  The decrease in capital expenditures from 2007 to 2008 was primarily related to the completion of a plant expansion at EWP during 2007.

During 2009, the IEPA released $2.0 million of restricted investments to us in connection with the IEPA’s approval of the soil portion of the WMUs.  During 2007, we made final distributions to our pre-petition unsecured creditors.  In connection with this distribution, $4.0 million of restricted funds were released to us.  These funds were used to reduce our indebtedness under our revolving credit facility.

Financing Activities

On March 24, 2008 we received $25.0 million from the issuance of 2.5 million shares of our common stock pursuant to a subscription rights offering.  We incurred approximately $.3 million of expenses related to the offering.  We used the net proceeds to reduce indebtedness under our revolving credit facility, which in turn created additional availability under that facility.

As a result of decreased profitability and the payment of 2008’s employee incentive compensation during the first quarter of 2009, we increased our borrowings on our revolving credit facilities by $9.3 million during 2009.  As a result of increased profitability and the subscription rights offering proceeds, we reduced our indebtedness under our revolving credit facility by $43.0 million during 2008 as compared to increased borrowings on our credit facilities during 2007 of $28.5 million.

During 2007, we drew an additional $4.0 million on our Wachovia Term Loans in connection with the CaluMetals acquisition.

Future Cash Requirements

Capital Expenditures

Capital expenditures for 2010 are expected to be approximately $10 million and are primarily related to upgrades of production equipment which are not critical to our operations.  We expect to fund capital expenditures using cash flows from operations and borrowing availability under credit facilities.


 
- 32 -

 

Summary of Debt and Other Contractual Commitments

As more fully described in Notes 7 and 11 to our Consolidated Financial Statements, we are a party to various debt, lease and other agreements which contractually and unconditionally commit us to pay certain amounts in the future.  The following table summarizes such contractual commitments that are unconditional both in terms of timing and amount by the type and date of payment:

   
Payment due date 
 
 
 Contractual commitment  
 
2010
      2011/2012       2013/2014    
2015 and after
   
Total
 
   
(In thousands)
 
                                   
Indebtedness:
                                 
   Principal
  $ 19,396     $ 2,745     $ 3,437     $ -     $ 25,578  
   Interest
    885       595       163       -       1,643  
                                         
Operating leases
    479       660       -       -       1,139  
                                         
Product supply agreements
    1,200       1,500       -       -       2,700  
                                         
Total
  $ 21,960     $ 5,500     $ 3,600     $ -     $ 31,060  

The timing and amounts shown in the above table related to indebtedness (both principal and interest), operating leases and product supply agreements are based upon the contractual payment amount and the contractual payment or maturity date for such commitments.

The above table does not reflect any amounts that we might pay to fund our defined benefit pension plans and OPEB plans, as the timing and amount of any such future fundings are unknown and dependent on, among other things, the future performance of defined benefit pension plan assets, interest rate assumptions and actual future census data.

Off-balance Sheet Financing

We do not have any off-balance sheet financing agreements other than the operating leases included in the table above.  See Note 11 to our Consolidated Financial Statements.

Environmental Obligations

At December 31, 2009, our financial statements reflected accrued liabilities of $.7 million for estimated remediation costs for those environmental matters which we believe are probable and reasonably estimable; $.4 million of which we believe will be paid during 2010.  Although we have established an accrual for estimated future required environmental remediation costs, we do not know the ultimate cost of remedial measures that might eventually be required by environmental authorities or that additional environmental hazards, requiring further remedial expenditures, might not be asserted by such authorities or private parties.  Accordingly, the costs of remedial measures may exceed the amounts accrued.  The upper end of the range of reasonably possible costs to us for sites where we have been named a defendant is approximately $2.0 million, including the $.7 million currently accrued.  See Note 10 to our Consolidated Financial Statements for discussions of our environmental liabilities.


 
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Pension and Other Postretirement Obligations

We were not required to make any cash contributions for defined benefit pension plan fundings during 2007, 2008 or 2009 and we do not expect to be required to make contributions to our defined benefit pension plans during 2010.  However, we contributed $3.8 million, $2.5 million and $1.3 million to our other postretirement benefit plans during 2007, 2008 and 2009, respectively, and we expect to contribute $1.4 million during 2010.  The decline in contributions to our other postretirement benefit plans has been the result of amendments to one of our OPEB plans and one of our pension plans to create supplemental pension benefits in lieu of certain OPEB benefit payments for August 2008 through December 2008, all of 2009 and all of 2010.  We have the ability to decide whether or not to exercise such rights on a year-by-year basis.  Future variances from assumed actuarial rates, including the rate of return on plan assets, may result in increases or decreases to pension and other postretirement benefit funding requirements in future periods.

Working Capital and Borrowing Availability

   
December 31,
 
   
2008
   
2009
 
   
(In thousands)
 
             
Working capital
  $ 55,886     $ 49,063  
Outstanding balance under revolving credit facility
    3,264       12,546  
                 
Additional borrowing availability
    46,500       38,637  

The revolving credit facility requires us to use our daily cash receipts to reduce outstanding borrowings, which results in us maintaining zero cash balances when there are balances outstanding under this credit facility.

The amount of available borrowings under our revolving credit facility is based on formula-determined amounts of trade receivables and inventories, less the amount of outstanding letters of credit ($5.5 million at December 31, 2009).

As discussed above, we anticipated we would be out of compliance with certain financial covenants set forth in our primary credit facility as of September 30, 2009 and, as such, amended that credit facility on October 2, 2009 (retroactive to September 30, 2009) to, among other things, waive particular financial covenants until December 31, 2009 and modify a specific financial covenant during 2010.  Additionally, our current credit facility expires in August 2010.  See the “Recent Developments” section of “Results of Operations” above for further discussion.

Liquidity Outlook

See the “Recent Developments” section of “Results of Operations” above.

RELATED PARTY TRANSACTIONS

As further discussed in Note 14 to our Consolidated Financial Statements, we are party to certain transactions with related parties. It is our policy to engage in transactions with related parties on terms no less favorable than could be obtained from unrelated parties.


 
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RECENT ACCOUNTING PRONOUNCEMENTS

See Note 15 to our Consolidated Financial Statements for the projected impact of recent accounting pronouncements on our financial position and results of operations.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The accompanying "Management's Discussion and Analysis of Financial Condition and Results of Operations" is based upon our Consolidated Financial Statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amount of revenues and expenses during the reported period.  On an on-going basis, we evaluate our estimates.  We base our estimates on historical experience and on various other assumptions we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the reported amounts of assets, liabilities, revenues and expenses.  Actual results may differ from previously-estimated amounts 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.

Impairment of long-lived assets.  We recognize an impairment charge associated with our long-lived assets, primarily property and equipment, whenever we determine that recovery of such long-lived asset is not probable.  Such determination is made in accordance with the applicable GAAP requirements associated with the long-lived asset, and is based upon, among other things, estimates of the amount of future net cash flows to be generated by the long-lived asset and estimates of the current fair value of the asset.  Adverse changes in such estimates of future net cash flows or estimates of fair value could result in an inability to recover the carrying value of the long-lived asset, thereby possibly requiring an impairment charge to be recognized in the future.

We assess property and equipment for impairment only when circumstances as specified in ASC 360-10-35, Property, Plant, and Equipment, indicate an impairment may exist.  During 2009, as a result of continued operating losses, property and equipment of our Calumet segment was evaluated for impairment as of December 31, 2009.  Our impairment analysis is based on estimated future undiscounted cash flows of Calumet’s operations assuming Calumet is able to increase its sales volume in order to achieve certain economies of scale.  This analysis indicated no impairment was present at December 31, 2009.  Considerable management judgment is necessary to estimate future sales volume and the associated economies of scale.  Assumptions used in our impairment evaluations are consistent with our internal projections and operating plans. However, if our future cash flows from operations less capital expenditures were to drop significantly below our current expectations (approximately 32%), we may conclude an impairment is present.  At December 31, 2009 Calumet’s property and equipment had a carrying value of $5.2 million.

No other long-lived assets were tested for impairment during 2009 because there were no circumstances to indicate an impairment may exist.