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SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2003
Commission file number 0-30417

PHILIP SERVICES CORPORATION

(713) 623-8777
(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 period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x   No o

     Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes o  No x

     Indicate by check mark 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 x  No o

     The number of shares of common stock of the Registrant outstanding at August 18, 2003 was 27,909,342.

REPORT INDEX
TO FORM 10-Q

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

     Certain statements contained in this Form 10-Q constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. When used in this document, the words “anticipate,” “believe,” “estimate,” “expect”, “probable” and similar expressions, as they relate to the Company or its management, are intended to identify forward-looking statements. Such statements reflect the current views of the Company with respect to future events and are subject to certain risks, uncertainties and assumptions. Many factors could cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements that may be expressed or implied by such forward-looking statements, including, among others, the effect of the Company’s filing and proceedings under Chapter 11 of the Bankruptcy Code on its relations with customers, employees, suppliers, and lenders; the adequacy of funding for the Company’s operations; the Company’s ability to continue as a going concern; actions that may be filed by third parties in the United States Bankruptcy Court for the Southern District of Texas, including actions seeking to liquidate rather than reorganize the Company; the Company’s ability to obtain court approval with respect to motions in the bankruptcy case; the Company’s ability to develop and consummate a plan of reorganization with respect to the bankruptcy case; the risks discussed in Item 2., Management’s Discussion and Analysis of Financial Condition and Results of Operations and the risks discussed in Item 7., Management’s Discussion and Analysis of Financial Condition and Results of Operations, in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2002; and risks discussed from time to time in the Company’s other filings with the Securities and Exchange Commission and other regulatory authorities. Should one or more of these risks or uncertainties materialize, or should assumptions underlying the forward-looking statements prove incorrect, actual results may vary materially from those described herein as anticipated, believed, estimated or expected. These risks and uncertainties should be considered in evaluating forward-looking statements, and undue reliance should not be placed on such statements. The Company does not assume any obligation to update these forward-looking statements.

PHILIP SERVICES CORPORATION

(DEBTOR-IN-POSSESSION AND SUBSIDIARIES)

CONSOLIDATED CONDENSED BALANCE SHEETS

(IN THOUSANDS)

The accompanying notes are an integral part
of these consolidated condensed financial statements.

1

PHILIP SERVICES CORPORATION

(DEBTOR-IN-POSSESSION AND SUBSIDIARIES)

CONSOLIDATED CONDENSED STATEMENTS OF EARNINGS

(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)

The accompanying notes are an integral part
of these consolidated condensed financial statements.

2

PHILIP SERVICES CORPORATION

(DEBTOR-IN-POSSESSION AND SUBSIDIARIES)

CONSOLIDATED CONDENSED STATEMENTS OF EARNINGS

(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)

The accompanying notes are an integral part
of these consolidated condensed financial statements.

3

PHILIP SERVICES CORPORATION

(DEBTOR-IN-POSSESSION AND SUBSIDIARIES)

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

(IN THOUSANDS)
(UNAUDITED)

The accompanying notes are an integral part
of these consolidated condensed financial statements.

4

PHILIP SERVICES CORPORATION

(DEBTOR-IN-POSSESSION AND SUBSIDIARIES)

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(UNAUDITED)

(1)

Organization, Voluntary Reorganization Under Chapter 11, Basis of Presentation and Ability to Continue Operations (in thousands)

Organization and Voluntary Reorganization under Chapter 11

     These Consolidated Condensed Financial Statements contain information relating to Philip Services Corporation (“PSC”), a Delaware corporation, and its subsidiaries (collectively, the “Company”), which has been prepared by management. The Company is an industrial services and metals services company that provides industrial outsourcing, environmental services and metals services to major industry sectors throughout North America. On June 2, 2003 (the “Petition Date”), PSC and substantially all of its U.S.–domiciled subsidiaries (collectively, the “Debtor”), which collectively possessed approximately 78% of the consolidated assets and generated approximately 89% of the consolidated revenues of the Company as of and for the six months ended June 30, 2003, filed voluntary petitions for relief under Chapter 11 of the United States Bankruptcy Code (the “Bankruptcy Code”), in the United States Bankruptcy Court for the Southern District of Texas (the “Bankruptcy Court”). The Debtor is currently operating its businesses as debtor-in-possession in accordance with applicable provisions of the Bankruptcy Code and is subject to the jurisdiction of the Bankruptcy Court while a plan of reorganization is formulated. A plan of reorganization sets forth the means for satisfying claims against and interests in a debtor, including the liabilities subject to compromise (See Note 9 of Notes to Consolidated Condensed Financial Statements). Many pre-petition liabilities are subject to settlement or compromise under such a plan of reorganization. The bankruptcy cases are being jointly administered by the Bankruptcy Court under the case number 03-37718-H2-11 (the “Chapter 11 Case”).

     The filing of the voluntary petitions under Chapter 11 constituted a default on substantially all debt and lease obligations of the Debtor. The filing of the bankruptcy petitions automatically stays most legal actions against the Company, including actions to collect pre-petition indebtedness or to exercise control over the property in the Debtor’s estate. Proceedings against PSC’s Canadian and other subsidiaries that have not filed bankruptcy petitions are not stayed. The Company is obligated to pay merchants and vendors for all goods furnished and services provided after the Petition Date. Additionally, under the Bankruptcy Code, the Debtor is permitted in the course of the Chapter 11 Case to reject certain pre-petition executory contracts and unexpired leases. Certain pre-petition liabilities of the Debtor, including, among other things, certain accrued environmental costs, certain insurance claims, deferred taxes, certain accrued asset retirement obligations and certain other accrued liabilities may not be subject to compromise in the Chapter 11 Case. In addition, liabilities of the Company’s Canadian and other subsidiaries that have not filed bankruptcy petitions are not subject to the Chapter 11 Case and therefore cannot be compromised under the Chapter 11 Case.

     The desired outcome of a case under Chapter 11 of the Bankruptcy Code is the confirmation of a plan of reorganization for the debtor by the bankruptcy court. The debtor has an “exclusivity period” during which it is the only party entitled to file a plan of reorganization. Under certain circumstances, the exclusivity period could be shortened or extended, or certain parties may obtain an exception from exclusivity, in the discretion of the Bankruptcy Court. The Company has filed with the Bankruptcy Court an Investment Agreement that establishes a possible basis for a plan of reorganization and provides for the Debtor’s emergence from bankruptcy. There can be no assurance that the Investment Agreement will be approved as the plan of reorganization or will be confirmed by the Bankruptcy Court, or whether an alternative plan will emerge, or that any such plan will be implemented successfully. The timing of confirmation of the plan of reorganization will depend on the timing and outcome of numerous other ongoing matters in the Chapter 11 Case. The plan of reorganization must be voted upon by the Debtor’s stakeholders and approved by the Bankruptcy Court.

Chapter 11 Plan, Bid Process and Debtor-in-Possession Financing

     The Debtor filed with the Bankruptcy Court, and the Bankruptcy Court approved on August 4, 2003, an Investment Agreement with an affiliate of Icahn Associates Corp. (“Icahn Associates”), pursuant to which such affiliate would be designated as a “stalking horse” in connection with the selection of a sponsor of a plan of reorganization. On that date, the Bankruptcy Court also approved a debtor-in-possession (“DIP”) financing facility (the “DIP Facility”) to be provided by another affiliate of Icahn Associates. Icahn Associates is controlled by Carl C. Icahn who, together with his affiliates, is the Company’s largest stockholder and largest debtholder as of June 30, 2003.

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     Prior to the Petition Date, the Company financed its activities in part through borrowings under its revolving operating facility (see Note 10 (c) of Notes to Consolidated Condensed Financial Statements). The Company is in default under the revolving operating facility, which also matured by its terms on June 2, 2003, the Petition Date, and borrowings are no longer available thereunder. On the Petition Date, Wells Fargo-Foothill, Inc. (“Wells Fargo-Foothill”), the agent under the revolving operating facility, held approximately $14,860 in cash as collateral security for the Company’s obligations under the revolving operating facility, which is shown as restricted cash on these Consolidated Condensed Financial Statements. With the approval of Wells Fargo-Foothill and the Bankruptcy Court, the Debtor has financed its activities since the Petition Date by using a portion of the cash collateral held by Wells Fargo-Foothill and cash subsequently provided in connection with the conduct of the Company’s business (collectively, the “cash collateral”). The subsequently provided cash is shown as cash collateral receivable on these Consolidated Condensed Financial Statements. See Note 5 of Notes to Consolidated Condensed Financial Statements for further discussion on the cash collateral.

     The DIP Facility initially provides a $25,000 line of credit. DIP Facility loans are advanced as a non-revolving line of credit and only as the cash collateral is exhausted or utilized for certain other purposes. The maximum availability under the DIP Facility will increase to $35,000 upon (i) final acceptance of the Icahn Associates-sponsored plan as the plan of reorganization; (ii) selection of an alternate plan; or (iii) approval of a satisfactory plan of sale of the Company’s assets pursuant to Section 363 of the Bankruptcy Code. The DIP Facility availability continues until the earlier of December 31, 2003 or the consummation of a plan of reorganization or Section 363 sale. Under defined circumstances, if the Icahn Associates-sponsored plan is not selected, a break-up fee of $5,000 plus expenses of up to $1,000 is payable by the Company.

     Loans under the DIP Facility bear interest at a rate equal to the base rate under the revolving operating facility (which is based on the Wells Fargo Bank “prime rate”) plus 2.5%. There is a fee equal to 0.5% per annum on the unused portion of the committed DIP Facility, which is payable at maturity or acceleration of the loans under the DIP Facility. A fee of $700 is payable to the Icahn Associates affiliate providing the DIP Facility at closing of the first loan and a fee of $100 is payable to Wells Fargo-Foothill, which will act as agent, at closing. Other fees to Wells Fargo-Foothill continue as they were under the revolving operating agreement. Amounts outstanding under the DIP Facility are entitled to a priority over all claims other than (i) super-priority administrative claims (as yet undetermined); and (ii) amounts outstanding under the revolving operating agreement. See Note 9 of Notes to Consolidated Condensed Financial Statements.

     It is currently anticipated that the Company will continue to solicit bids for the sale of its strategic business units pursuant to Section 363 of the Bankruptcy Code and to solicit alternate plans of reorganization until August 29, 2003, although this date may be extended in the discretion of the Bankruptcy Court. Thereafter, an auction will be conducted, and the Debtor will consider the bids received and select either a proposed plan of reorganization or a bid or group of bids for its business units as the prevailing transaction. The Debtor will then submit such transaction for approval by the Bankruptcy Court at a hearing expected to be held on or about September 8, 2003. The Debtor is working with potential bidders and plan sponsors to provide due diligence information and to evaluate executory contracts and unexpired leases to which the Debtor is a party and other matters affecting the business of the Company.

     Under the proposed Icahn Associates-sponsored plan of reorganization, an affiliate of Icahn Associates would pay $10,000 for 20% of the capital stock of the reorganized Company and receive an additional 5% of the stock as a commitment fee on the $160,000 exit loan facility which the affiliate would provide. A substantial part of the balance of the common stock would be distributed to lenders under the Company’s term facility (see Note 10(a) of Notes to Consolidated Condensed Financial Statements). These lenders may also participate in the initial stock purchase on certain terms if they so choose. Since affiliates of Icahn Associates are the largest debtholders under the term facility, it is probable that, when combined with the 25% described above, affiliates of Icahn Associates would hold more than 50% of the common stock of the reorganized Company. It is not expected that current holders of the common stock of the Company would receive any distribution in respect of their existing common stock or receive any shares of capital stock in the reorganized Company under the Icahn Associates-sponsored plan, any competing plan or any asset sale scenario.

     The foregoing is an abbreviated summary of a complex financing facility, Chapter 11 Case proceedings and bid procedures and does not describe the treatment of claims under the plan or other aspects of the plan which may prove material. Interested parties are strongly cautioned not to rely on the foregoing, but rather to examine the DIP Facility Agreement and Investment Agreement, which are on file with the Bankruptcy Court and are available on-line at www.ecf.txsb.uscourts.gov for a nominal charge. The DIP Facility documentation is included as an exhibit to the Bankruptcy Court Order issued on August 4, 2003, which is filed as Exhibit 99.1 to this Quarterly Report on Form 10-Q. In addition, the Debtor is obligated to file with the Bankruptcy Court a disclosure statement describing the plan of reorganization for interested parties. It is estimated that such disclosure statement will be filed on or about August 18, 2003.

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Basis of Presentation and Ability to Continue Operations

     The Consolidated Condensed Financial Statements have been prepared by the Company without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). As permitted under such regulations, certain information and footnote disclosures normally included in complete annual financial statements have been condensed or omitted. The Company believes that the presentation and disclosures herein are adequate to make the information not misleading, in any material respect, and the financial statements reflect all elimination entries and normal adjustments that are necessary for a fair statement of the results for the six months ended June 30, 2003. There have been no significant changes in the accounting policies of the Company during the periods presented except as identified in this Note under the caption “New Accounting Treatment”. See Note 2 of Notes to the Company’s Consolidated Financial Statements included in the Company’s Form 10-K for the fiscal year ended December 31, 2002, for a description of other accounting policies of the Company.

     The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make certain estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements. These estimates and assumptions will also affect the reported amount of certain revenues and expenses during the reporting period. Actual results could differ materially based on any changes in estimates and assumptions that the Company uses in the preparation of its financial statements.

     These Consolidated Condensed Financial Statements have been prepared on a “going concern” basis, which contemplate the realization of assets and the settlement of liabilities and commitments in the normal course of operations. The appropriateness of the “going concern” assumption is dependent upon, among other things, the successful completion of a plan of reorganization approved by the Bankruptcy Court, future profitable operations and the ability to generate sufficient cash from operations and obtain financing arrangements to meet obligations. If the “going concern” basis were not appropriate for these Consolidated Condensed Financial Statements, significant adjustments would need to be made to the carrying value of the assets and liabilities, the reported revenue and expenses and the balance sheet classifications used.

     If the Debtor successfully completes reorganization, the Company will be required to adopt “fresh start” accounting. This accounting would require that assets and liabilities be recorded at fair value, based on values determined in connection with the reorganization. Certain reported asset and liability balances do not yet give effect to the adjustments that may result from the adoption of “fresh-start” accounting and, as a result, would change materially.

New Accounting Treatment

     The Consolidated Condensed Financial Statements have been prepared in accordance with American Institute of Certified Public Accountants’ Statement of Position 90-7 (“SOP 90-7”), “Financial Reporting by Entities in Reorganization Under the Bankruptcy Code,” and on a going-concern basis, which contemplates continuity of operations and realization of assets and satisfaction of liabilities in the ordinary course of business.

     SOP 90-7 requires that the financial statements for periods subsequent to the filing of a Chapter 11 petition distinguish transactions and events that are directly associated with the reorganization from the operations of the business. Accordingly, revenues, expenses (including professional fees), realized gains and losses, and provisions for losses directly associated with the reorganization and restructuring of the business are reported separately in these Consolidated Condensed Financial Statements. The Consolidated Condensed Balance Sheets distinguish pre-petition liabilities subject to compromise both from those pre-petition liabilities that are not subject to compromise and from post-petition liabilities. Liabilities subject to compromise are reported at the amounts expected to be allowed, even if they may be settled for lesser amounts.

     In addition, as a result of the Chapter 11 Case, the realization of assets and satisfaction of liabilities, without substantial adjustments and/or changes in ownership, are subject to uncertainty. While operating as debtor-in-possession under the protection of Chapter 11 of the Bankruptcy Code and subject to approval of the Bankruptcy Court or otherwise as permitted in the ordinary course of business, the Debtor may sell or otherwise dispose of assets and liquidate or settle liabilities for some amounts other than those reflected in these Consolidated Condensed Financial Statements. Further, a plan of reorganization could materially change the amounts and classifications in the historical Consolidated Financial Statements.

     Pursuant to the Bankruptcy Code, the Debtor must file schedules with the Bankruptcy Court setting forth the assets and liabilities of the Debtor as of the Petition Date. Differences between amounts recorded by the Debtor and claims filed by creditors will be investigated and resolved as part of the Chapter 11 Case. The deadline for filing proofs of claim with the Bankruptcy Court is September 23, 2003. In certain cases, the period in which creditors may file proofs of claim may be extended with the express approval of the Bankruptcy Court. Accordingly, the ultimate number and allowed amounts of such claims are not presently known.

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     The Company incurred $3,631 of reorganization expenses associated with the Debtor’s bankruptcy filing during the three- and six-month periods ended June 30, 2003. These reorganization expenses were principally comprised of legal and other professional fees.

     Reported interest expense as shown on the Consolidated Condensed Statements of Earnings was $9,690 and $23,079 for the three- and six-month periods ended June 30, 2003. Reported interest expense was calculated using the provisions of SOP 90-7 and differs from stated contractual interest expense which would have been $12,444 and $25,829 for the three- and six-month periods ended June 30, 2003.

Reclassification

     Certain reclassifications of prior periods’ data have been made to conform with the current period reporting.

(2)

Discontinued Operations (in thousands)

     For the three months ended June 30, 2003 and 2002, the Company recognized before-tax loss on discontinued operations of $14,431 and $8,316, respectively, and for the six months ended June 30, 2003 and 2002 the Company recognized before-tax loss on discontinued operations of $19,577 and $894, respectively. The before-tax loss on discontinued operations comprises the following:

	•		During the three months ended June 30, 2003, the Company finalized plans to sell a portion of the remaining assets of the Company’s Project Services Division, comprising operations that perform refractory and union mechanical and turnaround services. The Company recorded the results of these operations as discontinued operations on the Consolidated Condensed Statement of Earnings for the three-month and six-month periods ended June 30, 2003 and 2002, respectively, and recorded the remaining assets of these operations as “held for sale” on the June 2003 Consolidated Condensed Balance Sheet. These businesses generated revenue of approximately $15,732 and $12,911, and before-tax loss from discontinued operations of $4,227 and $1,056 in the three months ended June 30, 2003 and 2002, respectively, and generated revenue of approximately $31,521 and $31,482, and before-tax loss from discontinued operations of $18,148 and $1,162 in the six months ended June 30, 2003 and 2002, respectively.
	•		On March 2, 2003, the bulk of the businesses of the Company’s Project Services Division were sold to Fluor Enterprises, Inc. (“Fluor”) for proceeds of $21,200, of which $4,000 was in the form of a deferred payment obligation that requires $2,000 be paid to the Company on March 2, 2004 and the remaining $2,000 be paid to the Company on March 2, 2005. The working capital of these businesses of approximately $43,000, was retained by PSC. As a result of the sale, assets with a net book value of $9,416 were transferred to Fluor generating a $8,166 gain on the divestiture, net of transaction and other costs. The Company has recorded the results of operations for these businesses as discontinued on the Consolidated Condensed Statements of Earnings for the three-month and six-month periods ended June 30, 2003 and 2002. The businesses divested to Fluor generated revenue of approximately $679 and $63,029, and before-tax loss from discontinued operations of $5,236 and $3,184 in the three months ended June 30, 2003 and 2002, respectively, and generated revenue of approximately $55,896 and $171,601, and before-tax income from discontinued operations, including the aforementioned gain recorded in the first quarter of 2003 on the sale of the Division’s assets, of $3,166 and $5,176 in the six months ended June 30, 2003 and 2002, respectively.
	•		During the three months ended March 31, 2003, certain assets of the Company’s Canadian Ferrous Division were sold for proceeds of $6,135, of which $2,000 was in the form of a deferred payment obligation. A gain on the divesture was recorded in the amount of $819. As such, the Company recorded the results of operations of the Canadian Ferrous Division as discontinued on the Consolidated Condensed Statements of Earnings and recorded the remaining assets of the Division as “held for sale” on the June 30, 2003 Consolidated Condensed Balance Sheet. The Company’s Canadian Ferrous Division generated revenue of approximately $964 and $10,909 and before-tax income (loss) from discontinued operations of ($4,598) and $393 in the three months ended June 30, 2003 and 2002, respectively, and generated revenue of approximately $5,638 and $20,254 and before-tax income (loss) from discontinued operations, including the aforementioned gain recorded in the first quarter of 2003 on the sale of certain of the Division’s assets, of ($4,225) and $761 in the six months ended June 30, 2003 and 2002, respectively.

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•

The impairment of as