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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.
FORM 10-Q
(Mark One)
X Quarterly report pursuant to Section 13 or 15 (d) of the Securities
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Act of 1934 For the quarterly period ended July 31, 1998.
OR
Transition report pursuant to Section 13 or 15 (d) of the Securities Act of
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1934 For the transition period from to
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Commission file number 33-92496
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GULF STATES STEEL, INC. OF ALABAMA
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(Exact name of registrant as specified in its charter)
Alabama 63-1141013
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
174 South 26th Street
Gadsden, Alabama 35904-1935
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(Address of principal executive offices) (Zip Code)
(205) 543-6100
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter periods that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
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Indicate the number of shares outstanding of each class of common stock, as of
the latest practical date:
Common Stock $ .01 par value - 3,610,000 shares as of September 1, 1998
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GULF STATES STEEL, INC. OF ALABAMA
INDEX
<TABLE>
<CAPTION>
Page
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<S> <C>
PART I FINANCIAL INFORMATION
ITEM 1. Financial Statements (Unaudited)
Consolidated Statements of Income
For the Three Months Ended July 31, 1998 and 1997; For the Nine Months
Ended July 31, 1998 and 1997.......................................... 1
Consolidated Balance Sheets -
as of July 31, 1998 and October 31, 1997.............................. 2
Consolidated Statements of Cash Flows -
For the Nine Months Ended July 31, 1998 and 1997...................... 3
Notes to Consolidated Financial Statements............................ 4 - 7
ITEM 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations......................... 8 - 11
PART II OTHER INFORMATION
ITEM 6. Exhibits & Reports on Form 8-K........................................ 12
</TABLE>
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PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
--------------------------------
GULF STATES STEEL, INC. OF ALABAMA
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(dollars in thousands except per share data)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
JULY 31 JULY 31
---------------------------------- -------------------------------------
1998 1997 1998 1997
----------------- --------------- ------------------ -----------------
<S> <C> <C> <C> <C>
Net sales.......................................... $ 107,356 $ 108,402 $ 314,265 $ 326,647
Costs of goods sold, excluding depreciation........ 92,229 98,750 269,026 289,813
Depreciation....................................... 5,043 4,518 15,129 14,086
Profit sharing..................................... - - - 10
Selling, general and administrative expenses....... 4,487 3,877 13,071 10,974
Write-down of fixed assets......................... - 1,800 - 1,800
---------- ---------- ---------- ----------
Operating profit................................... 5,597 (543) 17,039 9,964
Other (income) expense:
Interest expense................................ 6,868 7,149 20,930 20,378
Interest income................................. (90) (14) (93) (29)
---------- ---------- ---------- ----------
6,778 7,135 20,837 20,349
---------- ---------- ---------- ----------
Loss before income taxes........................... (1,181) (7,678) (3,798) 10,385)
Income tax benefit................................. - - - (768)
---------- ---------- ---------- ----------
Loss before extraordinary item..................... (1,181) (7,678) (3,798) (9,617)
Extraordinary charge for debt refinancing.......... - - (1,044) -
---------- ---------- ---------- ----------
Net loss........................................... $ (1,181) $ (7,678) $ (4,842) $ (9,617)
========== ========== ========== ==========
Basic earnings per share:
Loss before extraordinary item.................. $ (.33) $ (2.13) $ (1.05) $ (2.66)
Extraordinary charge (Note 6)................... - - (.29) -
---------- ---------- ---------- ----------
Net loss per share................................. $ (.33) $ (2.13) $ (1.34) $ (2.66)
========== ========== ========== ==========
Common and common equivalent shares
outstanding..................................... 3,610,000 3,610,000 3,610,000 3,610,000
========== ========== ========== ==========
</TABLE>
See accompanying notes
1
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GULF STATES STEEL, INC. OF ALABAMA
CONSOLIDATED BALANCE SHEETS
(dollars in thousands)
<TABLE>
<CAPTION>
(UNAUDITED)
JULY 31, 1998 OCTOBER 31, 1997
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<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents...................................... 5,790 $ 2,359
Accounts receivable, less allowance for doubtful accounts of
$563 in 1998 and $390 in 1997................................. 33,679 33,385
Inventories.................................................... 54,004 54,651
Deferred income taxes.......................................... 4,089 3,311
Prepaid expenses and other current assets...................... 4,522 7,140
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Total current assets........................................ 102,084 100,846
Property, plant and equipment, net............................... 200,812 197,706
Deferred charges, less accumulated amortization of $3,660 in
1998 and $3,109 in 1997........................................ 5,426 6,840
-------- --------
Total assets................................................ $308,322 $305,392
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable............................................... $ 33,721 $ 33,998
Accrued payroll and employee benefits.......................... 5,730 4,851
Accrued workers compensation................................... 3,473 3,056
Accrued gainsharing............................................ 2,309 2,934
Accrued interest payable....................................... 7,814 1,272
Other accrued liabilities...................................... 8,950 5,166
Income taxes payable........................................... 173 174
Current portion of long-term debt.............................. 1,036 643
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Total current liabilities................................... 63,206 52,094
Long-term debt................................................... 221,888 227,556
Deferred retiree health benefits................................. 4,287 2,736
Deferred income taxes............................................ 2,090 1,313
Common stock warrants subject to put options..................... 2,225 2,225
Stockholders' equity:
Common Stock, par value $.01 per share; 4,000,000 shares
authorized, 3,610,000 shares issued and outstanding........... 36 36
Additional paid-in capital..................................... 39,050 39,050
Notes receivable from officers................................. (750) (750)
Accumulated deficit............................................ (23,710) (18,868)
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Total stockholders' equity.................................. 14,626 19,468
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Total liabilities and stockholders' equity.................. $308,322 $305,392
======== ========
</TABLE>
See accompanying notes.
2
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GULF STATES STEEL, INC. OF ALABAMA
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(dollars in thousands)
<TABLE>
<CAPTION>
NINE MONTHS ENDED NINE MONTHS ENDED
JULY 31, 1998 JULY 31, 1997
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<S> <C> <C>
OPERATING ACTIVITIES:
Net loss............................................................. $ (4,842) $ (9,617)
Adjustments to reconcile net loss to net cash provided by
operating activities:
Depreciation....................................................... 15,129 14,086
Amortization....................................................... 1,154 1,142
Deferred income taxes.............................................. - (617)
Write-down of fixed assets......................................... - 1,800
Extraordinary item................................................. 859 -
Changes in operating assets and liabilities:
Accounts receivable............................................. (294) 2,714
Inventories..................................................... 647 (9,105)
Prepaid expenses and other current assets....................... 2,618 (520)
Accounts payable................................................ (277) (1,019)
Accrued payroll and employee benefits........................... 2,222 850
Accrued interest payable........................................ 6,542 6,605
Other accrued liabilities....................................... 3,784 (820)
Income taxes prepaid and payable................................ (1) (156)
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Net cash provided (used) by operations............................... 27,541 5,343
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INVESTING ACTIVITIES:
Building and equipment purchases..................................... (17,902) (27,077)
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Net cash used in investing activities................................ (17,902) (27,077)
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FINANCING ACTIVITIES:
Net borrowings (payments) on revolving credit facilities............. 31,457 19,857
Prepayment of prior revolving credit facility (Note 6)............... (37,393) -
Proceeds from issuance of long-term debt............................. 735 -
Payments on long-term debt........................................... (519) (492)
Reduction of capitalized lease obligations........................... (97) -
Debt issuance costs.................................................. (391) -
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Net cash provided by financing activities............................ (6,208) 19,365
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Net increase (decrease) in cash and cash equivalents................. 3,431 (2,369)
Cash and cash equivalents at beginning of year....................... 2,359 4,458
-------- ---------
Cash and cash equivalents at end of period........................... $ 5,790 $ 1,639
======== =========
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid during the year for:
Interest........................................................... $ 15,782 $ 15,399
Income taxes....................................................... 1 -
Noncash investing and financing activities:
Capital lease obligations.......................................... $ 333 -
</TABLE>
See accompanying notes.
3
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GULF STATES STEEL, INC. OF ALABAMA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1 - BASIS OF PRESENTATION
The accompanying financial statements present the consolidated financial
position, results of operations and cash flows of Gulf States Steel, Inc. of
Alabama and its wholly-owned subsidiary (the "Company") for the fiscal nine
month periods ended July 31, 1998 and 1997. All material intercompany accounts
and transactions have been eliminated. Effective January 30, 1998, the
Company's wholly-owned subsidiary, Alabama Structural Beam Corp., was merged
into the Company. Certain amounts in the 1997 Consolidated Balance Sheet and
Statement of Cash Flows have been reclassified to conform to the 1998
presentation.
The accompanying unaudited financial statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information. Accordingly, they do not include all the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of the Company, all adjustments
(consisting of normal recurring accruals) considered necessary for a fair
presentation have been included. Operating results for the period November 1,
1997 to July 31, 1998 are not necessarily indicative of the results that may be
expected for the fiscal year ending October 31, 1998. For further information,
refer to the consolidated financial statements of the Company and the notes
thereto included in the Company's Form 10-K for the year ended October 31, 1997.
NOTE 2 - ACCOUNTING CHANGE
Effective October 31, 1997, the Company changed its method of accounting for
costs incurred for process reengineering. These costs, totaling $2.6 million at
October 31, 1997, were previously capitalized by the Company and were written
off in 1997 as the cumulative effect of an accounting change. This accounting
change is in accordance with a consensus reached by the Emerging Issues Task
Force, Issue 97-13, Accounting for Costs Incurred in Connection with a
Consulting Contract or an Internal Project That Combines Business Process
Reengineering and Information Technology Transformation ("EITF 97-13"). The
income tax benefit relating to this write-off is reserved by a deferred income
tax valuation allowance. The effect of this accounting change was not material
for years prior to 1997. Approximately, $38,800 of business process
reengineering costs which are required to be expensed per EIFT 97-13 were
incurred during the first nine months of fiscal 1998.
NOTE 3 - INVENTORIES
Inventories are as follows:
<TABLE>
<CAPTION>
(UNAUDITED)
JULY 31, 1998 OCTOBER 31, 1997
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(dollars in thousands)
<S> <C> <C>
Raw Materials and Supplies $16,097 $19,534
Work-in-Process 8,709 13,528
Finished Products 29,198 21,589
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Total $54,004 $54,651
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</TABLE>
The Company's inventories are valued at the lower of cost, as determined by the
first-in first-out (FIFO) method, or market.
4
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NOTE 4 - DEFERRED INCOME TAXES
At July 31, 1998, the Company had net current deferred tax assets of $5.0
million and net non-current deferred tax assets of $4.2 million. As of July 31,
1998, the Company has established a deferred tax valuation allowance of $7.2
million due to operating losses in the current and prior years. This valuation
allowance will be reviewed on a quarterly basis.
NOTE 5 - CONTINGENCIES
The Company is subject to a broad range of federal, state and local
environmental laws and regulations, including those governing discharges to the
air and water, the handling and disposal of solid and/or hazardous wastes, and
the remediation of contamination associated with releases of hazardous
substances. The Company conducts continuous environmental compliance and
monitoring programs and believes that it is currently in substantial compliance
with all known material and applicable environmental regulations except as
follows:
The predecessor company settled with the Alabama Department of Environmental
Management ("ADEM") during 1994 for all outstanding air and water violations,
and the Company believes that its facility now operates, as a general matter, in
substantial compliance with existing air emission regulations and its water
discharge permit, subject, however, to the matters set forth below.
During 1992, the U.S. Environmental Protection Agency ("EPA") asserted that a
wastewater ditch system on the Company's property should be remediated and
"closed" under the Resource Conservation and Recovery Act. As of October 31,
1994, the predecessor Company had remediated a portion of the ditch. On
November 26, 1997, ADEM approved the closure plan for the wastewater ditch
system. The requirements of the closure plan are: (1) sediment sampling in the
ditch system and (2) ground water monitoring. Sixty-six sediment samples have
been taken throughout the system. If background levels are exceeded, some sort
of risk-based closure or soil removal will be required. Eleven groundwater-
monitoring wells have been installed. These will be monitored until EPA and
ADEM approve the closure certification. Based upon the preliminary results of
sampling, the Company believes that clean closure will be achieved; however, if
clean closure cannot be achieved, the Company estimates the contingent closure
costs will be $1.1 million, with post-closure costs of $2.8 million ($94,000
annually for 30 years).
The Company faces an enforcement action under the Clean Water Act. The U.S.
Department of Justice ("DOJ") notified the Company that it, at the request of
EPA, was prepared to take "appropriate enforcement action in federal court"
against the Company for alleged violations of its water discharge permit, and
invited the Company to discuss a possible settlement prior to filing suit. The
Company opened discussions with DOJ in an attempt to settle these claims. These
discussions have resulted in substantial agreement as to certain additional
upgrades to the Company's waste water treatment system. On August 28, 1997,
while negotiations were ongoing with DOJ, a 60-day notice of intent to file a
citizen suit under the Clean Water Act was sent by one Johnny Williams, a
resident of Rainbow City, Alabama. Prior to expiration of the 60-day period,
DOJ filed its action under the Clean Water Act, thus precluding the citizen
suit. On October 27, 1997, Mr. Williams moved to intervene in the government's
action, and this intervention was allowed by the court. On April 21, 1998, a
second motion to intervene was filed by L.E. McGriff and Herbert Patterson, and
this motion was also allowed by the court. Despite the filing of this
litigation, the Company and DOJ have been continuing to explore possible
settlement of the civil penalty. As a result of these discussions, an agreement
in principle has been reached with EPA and DOJ pursuant to the terms of
which the Company will pay $500,000 as a cash civil penalty and will agree to
implement $4,000,000 in facility improvements as Supplemental Environmental
Projects ("SEPs") which offer environmental benefits. Certain aspects of this
agreement in principle are still being finalized, including the time period over
which the SEPs are to be made. Once finalized, the terms of the settlement will
be set forth in a proposed Consent Decree which will be filed with the court for
its approval. The Clean Water Act provides for civil penalties of up to $25,000
per day for violations occurring before January 30, 1997 and $27,500 per day for
violations occurring on or after January 30, 1997.
5
<PAGE>
In addition, on February 5, 1998, Mr. Williams instituted an action in the
Circuit Court of Etowah County, individually and as a representative of a
putative class of downstream property owners, seeking unspecified damages and
injunctive relief on a variety of theories for the alleged diminution of
downstream property values and unspecified health hazards as a result of the
Company's waste water discharges. The Company believes the claims of Mr.
Williams are without merit, and that no class should be certified. On motion of
the Company, this action has been stayed pending possible resolution of the
Clean Water Act enforcement action.
During negotiations with DOJ over the Clean Water Act matter described above,
DOJ raised remediation of Black Creek as a possible issue. EPA is now
investigating Black Creek and has performed sampling in Black Creek and Lake
Gadsden. Sampling results thus far indicate levels of metals, primarily lead and
zinc, in the sediment of Black Creek and in certain locations in Lake Gadsden.
The levels of metals in the sediment generally increase with depth, indicating
historical discharges are a greater contributor to the elevated levels. EPA has
made no determination of what remediation, if any, will be necessary. The
Company has expressed its position to EPA that its contribution, if any, to the
sediment findings is divisible, and that apportioned, rather than joint and
several liability, is appropriate. Additionally, the Company's relative
contribution, if any, to the sediment results must be further reduced to the
extent that it is the result of a federally permitted discharge. The combined
effect of the Company's analysis is that any potential liability that is
assignable to it is so small as to be de minimis. Given current information, it
is not possible to predict the scope or cost of any potentially required
remediation of Black Creek and/or Lake Gadsden, nor is it known whether the
Company's analysis regarding its potential liability will be accepted.
On February 20, 1996, ADEM issued a Notice of Violation ("NOV") to the Company
for continuing violation of opacity limits from the combustion stacks of the
coke ovens, and included in the NOV a requirement that the Company install
continuous opacity monitors in the stacks. The Company appealed this
requirement, and it was subsequently withdrawn by ADEM on the condition that the
Company employ an independent contractor to conduct visible emission readings on
the stacks. The Company complied with this condition. While there has been no
renewed request by ADEM that the Company install opacity monitors, ADEM has, in
subsequent NOV's, identified such monitors as a possible future requirement.
The Company has taken the position, in its communications with ADEM, that the
installation of such monitors on its existing stacks is not feasible; however,
it is not currently possible to predict whether ADEM will again attempt to
require that continuous opacity monitors be installed in the coke oven
combustion stacks.
On April 22, 1998, EPA issued an NOV to the Company relating to alleged
violations of the Toxic Substance Control Act ("TSCA") based upon an inspection
conducted on May 16, 1996. In this NOV, the EPA requested that a meeting be
held to show cause why the EPA should not proceed with an enforcement action.
The meeting has been held, and settlement discussions are ongoing with the EPA,
which has proposed a penalty of $144,000. The Company has proposed a reduced
penalty amount, coupled with a SEP involving replacement of certain PCB
transformers. The conditions cited in the April 22, 1998 NOV had been promptly
addressed by the Company following the May 16, 1996 inspection.
As a result of a September 1997 inspection, ADEM determined that certain
violations of hazardous waste rules had occurred at the facility and had
resulted in the release of hazardous waste from a containment area on site. The
Company is addressing assessment and possible remediation of this on site area
with ADEM. ADEM has proposed a Consent Action with an administrative penalty of
$80,000. The Company has not had an opportunity to respond to the ADEM proposal
as of this date.
Though the Company believes that it has adequately provided for the cost of
all known environmental conditions, the applicable agencies could insist upon
different and possibly more costly remedial measures than those believed by the
Company to be adequate or required by existing law. The Company's expenditures
for environmental capital projects aggregated $3.1 million and $3.0 million for
the nine months ended July 31, 1998 and 1997, respectively. As of July 31,
1998, the Company has accrued $1.7 million for unresolved environmental
matters.
The Company is also involved in litigation arising from its normal operations,
including employee matters, the resolution of which is not expected to have a
significant effect on the Company's financial position, results of operations or
liquidity.
6
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NOTE 6 - EXTRAORDINARY ITEM
On November 13, 1997, the Company retired its previous $70 million Revolving
Credit Facility and entered into a new $80 million Credit Facility which
includes a $70 million revolving credit facility and a $10 million equipment
financing facility. In connection with this refinancing, the Company recorded
an extraordinary expense of $1.04 million, consisting of a non-cash charge of
$0.86 million to write-off unamortized debt issuance costs and a prepayment
penalty of $0.18 million. The income tax benefit relating to this write-off is
reserved by a deferred income tax valuation allowance. Available borrowings are
subject to limits based on eligible accounts receivable and inventories. The
new Credit Facility has an original term of three years through November 13,
2000, at which time the agreement will automatically renew itself for successive
one-year terms unless terminated by either party. Obligations under the new
Credit Facility are secured by inventories and accounts receivable, and the
Company is required to maintain a defined amount of consolidated adjusted
tangible net worth at all times.
NOTE 7 - EARNINGS PER SHARE
Basic earnings per common share is computed by dividing net income (loss) by
the weighted average number of common shares outstanding. In addition, the
Company has outstanding common stock warrants subject to put options to purchase
190,000 shares of common stock. During periods of net losses, the warrants are
antidilutive and, therefore, are not considered common equivalent shares. As a
result, diluted earnings per share at July 31, 1998 and 1997 does not differ
from basic earnings per share.
7
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
---------------------------------------------------------------
RESULTS OF OPERATIONS
---------------------
FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q may contain forward-looking statements as
that term is defined in the Private Securities Litigation Reform Act of 1995.
The words "believe", "expect", "anticipate", "may", "intend", "could" and
similar expressions identify forward-looking statements. Such statements are
based on management's current assumptions and expectations and are subject to a
number of factors and uncertainties which could cause actual results or business
conditions to differ materially from those anticipated in the forward-looking
statements. There can be no assurance that actual results will not differ
materially from those described in such statements because of various factors,
including, but not limited to: the size and timing of significant orders, as
well as deferral of orders, over which the Company has little control; the
variation in the Company's sales cycles from customer to customer; increased
competition posed by other steel producers; changes in pricing policies by the
Company and its competitors; the need to secure or build manufacturing capacity
in order to meet demand for the Company's products; the Company's success in
expanding its sales programs and its ability to gain increased market acceptance
for its existing product lines; the gain or loss of significant customers; the
ability to complete the Company's capital investment program and successfully
produce its products; shortages in the availability of raw materials from the
Company's suppliers; fluctuations in the price and availability of energy; the
costs of environmental compliance and the impact of government regulations; the
Company's relationship with its work force; the restrictive covenants and tests
contained in the Company's debt instruments, which could limit the Company's
operating and financial flexibility; and, general economic conditions.
RESULTS OF OPERATIONS
Results of operations for an interim period are not necessarily indicative of
results for the full year.
THREE MONTHS ENDED JULY 31, 1998 COMPARED TO THREE MONTHS ENDED JULY 31, 1997
Net Sales. Net sales decreased 0.9% to $107.4 million for the 1998 period
from $108.4 million for the same period in fiscal 1997. The primary cause of
this decline in revenues was a 3.1% decrease in sales volume on shipments of
flat rolled products from 248,340 net tons during the third quarter of fiscal
1997 to 240,644 net tons during the comparable period in fiscal 1998. This
decrease can be primarily attributed to a planned decrease in production due to
the closing the blooming mill in August 1997 and to decreased production during
the quarter resulting from equipment outages at the blast furnace. The effect
of the decreased production was partially offset by a rise in average selling
prices from $425 per ton in fiscal 1997 to $434 per ton during the same period
of fiscal 1998.
Cost of Goods Sold. Cost of goods sold, excluding depreciation, decreased
6.7% to $92.2 million for the 1998 period from $98.8 million for the 1997
period. As a percentage of net sales, cost of goods sold, excluding
depreciation, decreased to 85.9% for the 1998 period from 91.1% for the
comparable period in 1997. Although some of this decrease was due to the lower
sales volume in the 1998 period compared to the 1997 period, improvements which
favorably impacted cost of sales were the Company's cost reduction programs and
improved throughput at the steelmaking units and the hot strip mill. In
addition, planned outages for equipment upgrades in fiscal 1997 adversely
affected manufacturing costs during the period. Average manufacturing costs for
flat rolled products decreased to $368 per ton in the 1998 period from $384 per
ton during the comparable period in fiscal 1997. Depreciation expense increased
to $5.0 million during the third quarter of the fiscal 1998 period compared to
$4.5 million during the same period in 1997, primarily due to the Company's
continuing capital expenditures for the replacement, upgrading and improvement
of manufacturing facilities and equipment.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased to $4.5 million, or 4.2% of net sales, in the
1998 period from $3.9 million, or 3.6% of net sales, in the 1997 period. This
increase resulted from higher staffing costs, increased benefit plan costs and
higher costs relating to the Company's information technology transformation and
Year 2000 initiatives.
8
<PAGE>
Operating Profit. As a result of the changes in net sales, cost of goods sold
and selling and general and administrative expenses, operating profit increased
to $5.6 million, or 5.2% of net sales, in the 1998 period, from a loss of $0.5
million, or (0.5)% of net sales, in the 1997 period.
Interest Expense. Interest expense, net of interest income, decreased to $6.8
million in the fiscal 1998 period from $7.1 million during the comparable period
in 1997. This decrease was due to the lower average balance of borrowings under
the Company's revolving credit facility.
Income Taxes. There was no provision for (or benefit from) income taxes
during the third quarters of fiscal 1997 or fiscal 1998 due to the establishment
of a valuation allowance for the Company's deferred tax assets. The current tax
benefits of the Company's losses are being recorded in a valuation allowance
account until such time as the Company has returned to profitability.
NINE MONTHS ENDED JULY 31, 1998 COMPARED TO NINE MONTHS ENDED JULY 31, 1997
Net Sales. Net sales decreased 3.8% to $314.3 million for the 1998 period
from $326.6 million for the same period in 1997. The primary cause of this
decline in revenues was a decrease in net tons shipped of 4.3% from 755,170 tons
during the 1997 period to 722,661 tons during the comparable period in 1998.
Production for the first nine months of fiscal 1998 had been forecasted to
decline from that of fiscal 1997 due to the closing of the blooming mill in
August 1997 because of its unfavorable economic margins. During the first nine
months of fiscal 1998, the average selling price of flat rolled products
increased 0.5% to $428 per ton from $426 per ton during the 1997 period.
Cost of Goods Sold. Cost of goods sold, excluding depreciation, decreased
7.2% to $269.0 million for the 1998 period from $289.8 million for the 1997
period. As a percentage of net sales, cost of goods sold, excluding
depreciation, decreased to 85.6% for the 1998 period from 88.7% for the
comparable period in 1997. As was the case for the three months ended July 31,
1998, this decrease was primarily due to improved productivity and realized
benefits of the Company's cost reduction programs which, in turn, were partially
offset by higher hourly labor costs. Average manufacturing costs for flat
rolled products decreased to $363 per ton during the 1998 period from $376 per
ton during the 1997 period. Depreciation expense increased to $15.1 million in
the 1998 period compared to $14.1 million in the 1997 period, primarily due to
the Company's continuing capital expenditures for the replacement, upgrading and
improvement of manufacturing facilities and equipment.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased to $13.1 million, or 4.2% of net sales, during
the first nine months of fiscal 1998 from $11.0 million, or 3.4% of net sales,
during the same period of 1997. As noted for the three months ended July 31,
1998, the increase was primarily due to higher staffing costs, increased benefit
plan costs and higher costs relating to the Company's information technology
transformation and Year 2000 initiatives.
Operating Profit. As a result of the changes in net sales, cost of goods sold
and selling and general and administrative expenses, operating profit increased
to $17.0 million, or 5.4% of net sales, in the 1998 period, from $10.0 million,
or 3.1% of net sales, during the 1997 period.
Interest Expense. Interest expense, net of interest income, increased to
$20.8 million during the 1998 period from $20.3 million during the comparable
period in 1997. This increase was primarily due to the slightly higher average
balance of borrowings under the Company's revolving credit facility.
LIQUIDITY AND CAPITAL RESOURCES
The Company's net cash provided by operations was $27.5 million for the first
nine months of fiscal year 1998 compared to $5.3 million for the first nine
months of fiscal 1997. The primary reasons for the increase in cash provided by
operations was the decreased use of cash for inventories during the first nine
months of fiscal 1998 compared to the same period of fiscal 1997, a large
decrease in the prepaid ore and shipping accounts during the same period of
fiscal 1998 compared to fiscal 1997 and a substantial increase in accrued
employee benefits and other accrued liabilities during the first nine months of
fiscal 1998 compared to fiscal 1997.
9
<PAGE>
The Company's primary capital requirements consist of capital expenditures and
debt service. The Company makes capital expenditures for the replacement of
existing plant and equipment, compliance with environmental regulations, and the
upgrading and improvement of manufacturing facilities. The Company's capital
expenditures for the nine months ended July 31, 1998 were $17.9 million compared
to $27.1 million for the nine months ended July 31, 1997. For fiscal year
1998, the Company expects capital expenditures, excluding capitalized interest,
to total approximately $3.6 million for environmental projects and expenditures
for the replacement, upgrading and improvement of facilities and equipment to
total approximately $15.4 million.
On April 21, 1995, the Company completed the acquisition of substantially all
the assets and certain liabilities of the Gadsden, Alabama facilities of Gulf
States Steel, Inc. of Alabama (predecessor) from the Brenlin Group. In
connection with this acquisition, $190 million in First Mortgage Notes were
issued, upon which the Company is required to make semi-annual cash interest
payments of approximately $12.8 million ($25.7 annually). Although the Company
will not be required to make principal payments on the First Mortgage Notes
until maturity, in the event of Excess Cash Flow, as defined by the First
Mortgage Note Indenture, the Company will be required to purchase First Mortgage
Notes with 50% of such Excess Cash Flow. The Notes are senior obligations of
the Company and are secured by substantially all the assets of the Company
except accounts receivable and inventories. The Notes impose certain
limitations on the Company including restricting its ability to incur additional
indebtedness, pay dividends, make certain restricted payments, create liens or
sell substantially all of the Company's assets.
At the time of the acquisition, GSS Holdings Corp. issued certain promissory
notes to Capital Resource Lenders II, L.P. as a part of a related transaction.
Although the Company has no obligation with respect to these promissory notes,
GSS Holdings is required to make payments thereon in accordance with the
respective terms thereof, for which the source of funds is expected to be
dividend distributions or loans from the Company. The promissory notes require
GSS Holdings to cause the Company to pay dividends to Holdings to the maximum
extent allowed under the terms of the First Mortgage Notes indenture and
applicable law until the GSS Holdings notes are repaid in full. No dividends
are payable by the Company as of July 31, 1998. In addition, in connection with
the acquisition, GSS Holdings issued a promissory note to the seller for which
the source of funds for repayment is also expected to be dividend distributions
or loans from the Company. There have been no cash payments required or made on
the seller note through July 31, 1998.
On November 13, 1997, the Company retired its previous $70 million credit
facility and entered into a new $80 million credit facility. This new Credit
Facility includes a $70 million revolving credit line and a $10 million
equipment financing facility. Available borrowings are subject to limits based
on eligible accounts receivable and inventories. The new Credit Facility has an
original term of three years through November 13, 2000, at which time the
agreement will automatically renew itself for successive one-year terms unless
terminated by either party. Obligations under the new Credit Facility are
secured by inventories and accounts receivable, and the Company is required to
maintain a defined amount of consolidated adjusted tangible net worth at all
times. During November 1997, the Company recorded an extraordinary expense of
$1.0 million in connection with the refinancing, however, $0.9 million was a
noncash transaction consisting of the write-off of prior unamortized debt
issuance costs. As of July 31, 1998, approximately $31.3 million was borrowed
under the current Credit Facility.
The Company has incurred losses in the current and prior years. An
anticipated outage to repair the blast furnace is currently scheduled for fiscal
year 1999, although it could occur earlier depending on the blast furnace's
condition. This outage will impact operating results at the time the repairs
are made. In addition, the Company has initiated recent cost reduction measures
and expects to realize benefits in operating performance from its capital
improvement program; however, there can be no assurance that any of these
measures and improvements will result in the full realization of the Company's
recorded deferred tax assets. Considering these factors, the Company has
established a valuation allowance of $7.2 million relating to the net deferred
tax assets.
The Company believes that future cash flows from operations, together with
borrowings available under the new Credit Facility, will provide the Company
with sufficient liquidity and capital resources to conduct its business
activities (including its capital investments) and to meet its cash interest
payment requirements. Although the Company is continuously instituting cost
reduction initiatives and expects to benefit from improved operating performance
related to its capital investments, there can be no assurance that any or all of
10
<PAGE>
these potential savings will be realized. Failure to achieve these cost
reduction initiatives or improve operating performance through these capital
investments, could adversely affect the financial results or liquidity of the
Company in the future. In addition, external factors affect the Company's
market and related transaction prices for its products as well as its cost
structure for outside purchases (i.e., ore, natural gas, electricity, etc.). In
particular, recently many Asian and eastern European steel manufacturers have
significantly reduced their selling prices for steel products, and such
reductions may adversely impact selling prices for the Company's products.
Unfavorable price movements for outside purchases and the potential impact of
the Asian and eastern European economic problems, among others, could adversely
affect the Company's financial results and its ability to maintain compliance
with the restrictive covenants in the Company's borrowing agreements. In the
event that the Company's financial results and/or borrowing availability under
the new Credit Facility were so affected, the Company's liquidity and capital
resources could be adversely affected which could also significantly limit the
Company's ability to withstand competitive pressures or adverse economic
conditions.
YEAR 2000 ISSUE
The Company has conducted an assessment of its exposure to disruption
associated with the Year 2000 issue. Many of its computer-based transactional
business systems are subject to potential failure. The Company believes that
it could be materially affected by such failures. In addition, certain process
control systems are also exposed. The Company is also vulnerable to third-party
failures to correct their systems but believes that such exposure is minimal.
The Company believes that no material contingencies exist that would require it
to modify its products.
The Company has recognized the serious nature of its exposure under the Year
2000 Issue and has developed a modification plan that will minimize this
exposure. It has budgeted approximately $8.8 million (of which $6.2 million is
expected to be capitalized) for the purchase of Year 2000 compliant software and
consultant support all of which is expected to be funded through operating cash
flows. The Company has budgeted an additional $0.4 million in expense for the
rewrite of systems modules that cannot be purchased as packages. The Company
believes that these items, which will be expensed as incurred, are not expected
to have a material effect on its results of operation.
The Company anticipates completing the Year 2000 project by March 31, 1999,
which is prior to any anticipated impact on its operating systems. A team of
information systems personnel is evaluating the progress and is developing
contingency plans that ensure the continued operation of the business. The
Company has appointed a task force to further evaluate and develop action plans
for minimizing the impact of the Year 2000 issue on its process control systems.
11
<PAGE>
PART II OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
--------------------------------
A. EXHIBIT: Exhibit 27 -- Financial Data Schedule
B. No reports on Form 8-K were filed by the Company during the three
months ended July 31, 1998.
12
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereto duly authorized.
GULF STATES STEEL, INC. OF ALABAMA
----------------------------------
(registrant)
Dated: September 11, 1998 By: /s/ Robert Schaal
-----------------
Robert Schaal
Chairman & Chief Executive Officer
(principal executive officer)
Dated: September 11, 1998 By: /s/ Arthur S. Graf, Jr.
-----------------------
Arthur S. Graf, Jr.
Acting Chief Financial Officer
(principal financial officer)
13
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM QUARTERLY
REPORT ON FORM 10-Q AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS. FOR THE PERIOD ENDED JULY 31, 1998.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> 9-MOS 3-MOS
<FISCAL-YEAR-END> OCT-31-1998 OCT-31-1998
<PERIOD-START> NOV-01-1997 MAY-01-1998
<PERIOD-END> JUL-31-1998 JUL-31-1998
<CASH> 5,790 0
<SECURITIES> 0 0
<RECEIVABLES> 34,242 0
<ALLOWANCES> (563) 0
<INVENTORY> 54,004 0
<CURRENT-ASSETS> 102,084 0
<PP&E> 256,572 0
<DEPRECIATION> 55,760 0
<TOTAL-ASSETS> 308,322 0
<CURRENT-LIABILITIES> 63,206 0
<BONDS> 188,679 0
0 0
0 0
<COMMON> 36 0
<OTHER-SE> 14,590 0
<TOTAL-LIABILITY-AND-EQUITY> 308,322 0
<SALES> 314,265 107,356
<TOTAL-REVENUES> 314,265 107,356
<CGS> 269,026 92,229
<TOTAL-COSTS> 284,155 97,272
<OTHER-EXPENSES> 12,981 4,397
<LOSS-PROVISION> 90 90
<INTEREST-EXPENSE> 20,837 6,778
<INCOME-PRETAX> (3,798) (1,181)
<INCOME-TAX> 0 0
<INCOME-CONTINUING> (3,798) (1,181)
<DISCONTINUED> 0 0
<EXTRAORDINARY> (1,044) 0
<CHANGES> 0 0
<NET-INCOME> (4,842) (1,181)
<EPS-PRIMARY> (1.34) (0.33)
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