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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

 

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

For the quarterly period ended September 30, 2010

OR

 

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

For the transition period from              to             

Commission File Number 333-79587

 

 

CALIFORNIA STEEL INDUSTRIES, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   33-0051150
(State or other jurisdiction of incorporation or organization)   (I.R.S. Employer Identification No.)

 

14000 San Bernardino Avenue

Fontana, California

  92335
(Address of principal executive offices)   (Zip Code)

(909) 350-6300

(Registrant’s telephone number including area code)

N/A

(Former name, former address and former fiscal year, if changed since last report)

 

 

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.    x  Yes    ¨  No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     ¨  Yes    ¨  No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer   ¨    Accelerated filer    ¨
Non-accelerated filer   x  (Do not check if a smaller reporting company)    Smaller reporting company    ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.).     ¨  Yes    x  No

As of October 27, 2010, 4,000 shares of the Company’s common stock, no par value, were outstanding.

 

 

 


Table of Contents

 

CALIFORNIA STEEL INDUSTRIES, INC.

Table of Contents

 

     Page  

PART I   FINANCIAL INFORMATION

     1   

ITEM 1.     FINANCIAL STATEMENTS

     1   

Balance Sheets as of September 30, 2010 (unaudited) and December 31, 2009

     1   

Statements of Operations for the three and nine months ended September 30, 2010 and 2009 (unaudited)

     2   

Statements of Cash Flows for the nine months ended September 30, 2010 and 2009 (unaudited)

     3   

Notes to Financial Statements (unaudited)

     4   

ITEM 2.      MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     6   

ITEM 3.     QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     12   

ITEM 4.     CONTROLS AND PROCEDURES

     13   

PART II   OTHER INFORMATION

     14   

ITEM 6.     EXHIBITS

     14   

SIGNATURE

     15   

INDEX TO EXHIBITS

     16   

EXHIBITS

  

 

ii


Table of Contents

 

PART I FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

CALIFORNIA STEEL INDUSTRIES, INC.

Balance Sheets

($ in thousands except share and per share amounts)

 

     September 30,
2010
     December 31,
2009
 
     (Unaudited)         
Assets      

Current assets

     

Cash and cash equivalents

   $ 9,491       $ 61,671   

Trade accounts receivable, excluding affiliated company, less allowance for doubtful accounts of $800 and $700 at September 30, 2010 and December 31, 2009, respectively

     90,308         23,916   

Trade accounts receivable, affiliated company

     3,484         192   

Inventories

     242,145         185,068   

Prepaid income taxes

     12,002         16,160   

Other receivables and prepaid expenses

     3,183         2,201   
                 

Total current assets

     360,613         289,208   

Other assets

     20,059         19,646   

Property, plant and equipment, net

     278,037         276,593   
                 

Total assets

   $ 658,709       $ 585,447   
                 
Liabilities and Stockholders’ Equity      

Current liabilities

     

Accounts payable

   $ 75,906       $ 39,793   

Accrued interest expense

     641         3,010   

Accrued utilities

     2,977         1,433   

Deferred income taxes

     6,682         6,682   

Other accrued expenses

     10,127         6,290   

Current portion of long-term debt

     10,000         10,000   
                 

Total current liabilities

     106,333         67,208   
                 

Other liabilities

     2,452         2,506   

Long-term debt

     192,700         175,000   

Deferred income taxes

     40,062         40,062   

Commitments and contingencies

     

Stockholders’ equity

     

Class A preferred stock, $10,000 par value per share. Authorized 1,000 shares; none issued

     —           —     

Class B preferred stock, $10,000 par value per share. Authorized 2,000 shares; none issued

     —           —     

Class C preferred stock, $10,000 par value per share. Authorized 3,000 shares; none issued

     —           —     

Common stock, no par value. Authorized 5,000 shares; 4,000 shares issued and outstanding

     40,000         40,000   

Retained earnings

     277,162         260,671   
                 

Total stockholders’ equity

     317,162         300,671   
                 

Total liabilities and stockholders’ equity

   $ 658,709       $ 585,447   
                 

See accompanying notes to financial statements.

 

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CALIFORNIA STEEL INDUSTRIES, INC.

Statements of Operations

(In thousands)

 

     Three months ended
September 30,
    Nine months ended
September 30,
 
     (Unaudited)  
     2010     2009     2010     2009  

Net sales:

        

Net sales, excluding affiliated company

   $ 295,418      $ 136,617      $ 793,291      $ 375,513   

Affiliated company

     18,457        10,366        54,993        22,732   

Cost of sales:

        

Cost of sales, excluding lower of cost or market adjustment

     296,352        132,753        774,081        367,940   

Lower of cost or market adjustment

     7,500        2,000        8,300        41,800   
                                

Gross profit (loss)

     10,023        12,230        65,903        (11,495

Selling, general and administrative expenses

     4,534        4,285        14,200        12,819   

Loss on disposition of property, plant and equipment

     335        29        671        29   
                                

Income (loss) from operations

     5,154        7,916        51,032        (24,343

Other (expense) income:

        

Interest expense, net

     (2,736     (1,960     (6,393     (6,201

Other income, net

     566        2,110        2,100        7,095   
                                

Income (loss) before income tax expense (benefit)

     2,984        8,066        46,739        (23,449

Income tax (benefit) expense

     936        716        15,805        (12,639
                                

Net income (loss)

   $ 2,048      $ 7,350      $ 30,934      $ (10,810
                                

See accompanying notes to financial statements.

 

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CALIFORNIA STEEL INDUSTRIES, INC.

Statements of Cash Flows

($ in thousands)

 

     Nine months ended
September 30,
 
     2010     2009  
     (Unaudited)  

Cash flows from operating activities:

    

Net income (loss)

   $ 30,934      $ (10,810

Adjustments to reconcile net income (loss) to net cash (used in) provided by operating activities

    

Depreciation and amortization

     23,054        24,812   

Deferred income taxes

     —          283   

Loss (gain) on disposition of property, plant and equipment and equipment and intangible assets

     671        (409

Inventory write-down

     8,300        41,800   

Change in assets and liabilities:

    

Trade accounts receivable, excluding affiliated company, net

     (66,392     (3,269

Trade accounts receivable, affiliated company

     (3,292     (2,060

Inventories

     (65,377     42,508   

Other receivables and prepaid expenses

     (1,242     1,538   

Accounts payable, excluding affiliated company

     36,113        (25,393

Accounts payable, affiliated company

     —          14,399   

Prepaid income taxes

     4,158        39,166   

Accrued interest expense

     (2,369     (2,356

Other accrued expenses and liabilities

     5,327        222   
                

Net cash (used in) provided by operating activities

     (30,115     120,431   
                

Cash flows from investing activities:

    

Additions to property, plant and equipment

     (24,943     (33,524

(Removal cost) proceeds for the disposal and sale of property, plant and equipment and intangible assets, net

     (379     1,519   
                

Net cash used in investing activities

     (25,322     (32,005
                

Cash flows from financing activities:

    

Repayments of long-term debt

     (7,500     (2,500

Net advances under line-of-credit

     25,200        —     

Dividends paid

     (14,443     —     
                

Net cash provided by (used in) financing activities

     3,257        (2,500
                

Net (decrease) increase in cash and cash equivalents

     (52,180     85,926   

Cash and cash equivalents at beginning of period

     61,671        10,880   
                

Cash and cash equivalents at end of period

   $ 9,491      $ 96,806   
                

Supplemental disclosures of cash flow information:

    

Cash paid (received) during the period for:

    

Interest (net of amount capitalized)

   $ 8,617      $ 8,640   
                

Income taxes (net of amount refunded)

   $ 11,422      $ (51,900
                

See accompanying notes to financial statements.

 

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CALIFORNIA STEEL INDUSTRIES, INC.

Notes To Financial Statements

(Unaudited)

1. Basis of Presentation

Unless the context otherwise requires, the use of the terms “California Steel,” “we,” “us,” and “our” in these Notes to the Financial Statements refers to California Steel Industries, Inc.

In the opinion of management, the accompanying financial statements contain all adjustments necessary for a fair presentation as prescribed by accounting principles generally accepted in the United States. All adjustments were comprised of normal recurring adjustments, except as noted in these Notes to Financial Statements. Our interim results are not necessarily indicative of results for the entire fiscal year. The interim financial statements and the related notes in this Quarterly Report on Form 10-Q should be read in conjunction with the financial statements and related notes included in our Annual Report on Form 10-K for year ended December 31, 2009. Results of operations for the three and nine months ended September 30, 2010 are not necessarily indicative of results expected for the full year ending December 31, 2010.

Reclassifications

To maintain consistency and comparability, certain prior-year amounts were reclassified to conform to the current-year presentation. We reclassified:

 

   

to trade accounts receivable, affiliated company, $192 thousand for the year ended 2009, which were previously reported in trade accounts receivable, excluding affiliated company on our balance sheet;

 

   

to net sales, affiliated company, $10.4 million and $22.7 million for the three and nine months ended September 30, 2009, respectively, which were previously reported in net sales, excluding affiliated company on our statements of operations;

 

   

to trade accounts receivable, affiliated company and accounts payable, affiliated company, $(2.1) million and $14.4 million, respectively, for the nine months ended September 30, 2009, which were previously reported in trade accounts receivable, excluding affiliated company, net and accounts payable, excluding affiliated company on our statements of cash flow.

These reclassifications had no affect on previously reported income from operations, net income or stockholders’ equity.

2. Recent Accounting Pronouncements

In January 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2010-6, “Improving Disclosures about Fair Value Measurements” (ASU 2010-6”). This update amended guidance and issued a clarification with regard to disclosure requirements about fair market value measurement. A reporting entity is required to disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers. In addition, for measurements utilizing significant unobservable inputs, a reporting entity should present separately information about purchases, sales, issuances, and settlements. We adopted ASU 2010-6 on January 1, 2010. There was no impact upon adoption of ASU 2010-6 to our financial position or results of operations.

In February 2010, FASB issued ASU No. 2010-9, “Amendments to Certain Recognition and Disclosure Requirements” (“ASU 2010-9”). This amendment removed the requirement for a Securities and Exchange Commission (“SEC”) filer to disclose a date through which subsequent events have been evaluated in both issued and revised financial statements. This amendment was effective upon issuance date of February 24, 2010. There was no impact upon adoption of ASU 2010-9 to our financial position or results of operations.

 

4


Table of Contents

CALIFORNIA STEEL INDUSTRIES, INC.

Notes To Financial Statements—(Continued)

(Unaudited)

 

 

3. Inventories

Inventories are stated at the lower of cost (determined under the first-in, first-out method of accounting) or market value and consist of the following ($ in thousands):

 

     September 30,
2010
     December 31,
2009
 
     (Unaudited)         

Finished goods

   $ 25,436       $ 11,294   

Work in process

     25,095         17,164   

Raw materials

     173,157         137,234   

Supplies

     18,457         19,376   
                 
   $ 242,145       $ 185,068   
                 

4. Credit Facility

In September 2010, we entered into a five year $110.0 million credit facility with Wells Fargo Bank, N.A., as administrative agent and lender. Subject to the satisfaction of customary conditions and a borrowing base, advances under this facility may be made at any time prior to the credit facility termination date. Borrowings under the credit facility were $25.2 million as of September 30, 2010. The credit facility is collateralized by accounts receivable and inventory. Advances under this facility may be used for letters of credit, working capital, capital expenditures, payment of dividends and other lawful corporate purposes, including the refinancing of existing debt. The facility requires us to maintain certain financial ratios and other financial covenants. We were in compliance with all the covenants at September 30, 2010. This credit facility replaced the existing $110.0 million credit facility with Mizuho Corporate Bank which matured on September 29, 2010.

In September 2005, we entered into a five year $110.0 million credit facility with a bank group led by Mizuho Corporation Bank, as administrative agent and a lender, The Bank of Tokyo-Mitsubishi, Ltd., Citibank (West), FSB and Wells Fargo Bank. Subject to the satisfaction of customary conditions and a borrowing base, advances under this facility may be made at any time prior to the credit facility termination date. This credit facility expired on September 29, 2010.

5. Commitments and Contingencies

At September 30, 2010, we are committed in the form of open purchase orders, to purchase approximately $90.0 million in steel slabs, of which $20.4 million is from a related party, material commitments for capital expenditures of $8.4 million and other assorted contractual commitments of $700 thousand.

When market conditions warrant, we enter into contracts to purchase certain commodities used in the manufacturing of our products, such as electricity and natural gas. Some of these forward contracts do not require derivative accounting as we take possession of the commodities in the normal course of business whereas other forward contracts are accounted for as derivatives in accordance with the accounting literature related to derivatives and hedges by us.

We have been contacted by various governmental agencies regarding specified environmental matters at our operating facility in Fontana, California. During September 1990, we reached preliminary agreement with the California Regional Department of Health Services, which allows us to draft our own remediation agreement and move forward with our own plan of action at our operating facility. In November 1992, we entered into a Voluntary and Enforceable Agreement (the “Agreement”) with the California Department of Toxic Substances Control (“DTSC”) which sets forth certain terms and conditions related to the remediation of hazardous substances at our operating facility. The Agreement also preserves our right as to future assignment and apportionment of costs to other parties.

We are addressing environmental concerns caused by the former occupant at our Fontana site. We have engaged an environmental consultant to conduct a remedial investigation and develop a remediation plan and remediation cost projections based upon the plan. Utilizing the remediation plan developed by the environmental consultant, we developed an estimate of future costs of the remediation plan. The total aggregate cost of remediation is estimated to be approximately $1.8 million, which is included in other liabilities at September 30, 2010 and December 31, 2009. The DTSC has not yet completed its review and approval of our remediation plan; however, preliminary discussions between the DTSC and us have not indicated the need for any significant changes to the remediation plan or our estimate of related costs. The estimate of costs could change as a result of changes to the remediation plan required by the DTSC or unforeseen circumstances, including without limitations, unknown site conditions, changes to applicable regulations or increased enforcement requirements by the regulators existing at the site.

 

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Table of Contents

CALIFORNIA STEEL INDUSTRIES, INC.

Notes To Financial Statements—(Continued)

(Unaudited)

 

 

We are involved in legal actions and claims arising in the ordinary course of business. It is in our opinion, based on advice of legal counsel, that this litigation will be resolved without material effect on our financial position, results of operations, or liquidity.

We are self-insured for workers’ compensation. The accrued liability associated with these programs is based on our estimate of the ultimate costs to settle known claims as well as claims incurred but not yet reported (IBNR claims) as of the balance sheet date. The estimated liability is not discounted and is based on information provided by our insurance brokers and insurers, combined with our judgments regarding a number of assumptions and factors, including the frequency and severity of claims, our claims development history, case jurisdiction, related legislation, and our claim settlement practice. Significant judgment is required to estimate IBNR claims as parties have yet to assert such claims. If actual trends, including the severity or frequency of claims, differ from our estimates, our financial results could be impacted.

6. Fair Value of Financial Instruments

Our financial instruments are primarily comprised of cash and cash equivalents, receivables, accounts payable, accrued liabilities and long-term debt. For cash and cash equivalents, receivables, accounts payable and accrued liabilities, the carrying amount approximates fair value because of the short maturity of these instruments. Our senior notes are reported at carrying value. The fair value of our senior notes is the asking price of our senior notes at the end of the fiscal quarter. The carrying value and fair value of our senior notes are $150.0 million and $148.5 million at September 30, 2010 and $150.0 million and $144.0 million at December 31, 2009, respectively. Management estimates that the carrying values of our other financial instruments approximate their value since their realization or satisfaction is expected to occur in the short term or have been renegotiated at a date close to quarter end.

7. Revenue Recognition

We recognize revenue when products are shipped or delivered to the customer, depending on the terms of the sale. For products shipped FOB shipping point, revenue is recognized at the time of shipment when title and risk of loss are transferred to the customer. For products shipped FOB destination, revenue is recognized at the time of delivery when title and risk of loss are transferred to the customer. Sales to the affiliated company are at current market rates and terms. In certain cases, at the customer’s request, we will enter into bill and hold transactions whereby title transfers to the customer, but the product does not ship until a specified later date. Revenue on such transactions is recognized when the product is ready for shipment, and only after all conditions set forth under Accounting Standard Codification (“ASC”) Topic 605 have been met. As of September 30, 2010, we had approximately 1,500 tons of bill and hold product. Based on our average sales price at that time, the sales revenue was approximately $1.2 million.

8. Income Taxes

Our effective tax rate was 31.4% for the third quarter and an effective tax rate of 33.8% for the nine months ended September 30, 2010 compared to effective tax rate of 8.9% and an effective tax rate benefit of 53.9% in the same periods one year ago. The change in our effective tax rate is attributable to tax benefits related to California sales tax and hiring credits under the Enterprise Zone (“EZ”) designation and an overall reduction to our state tax liability due to filing in lower tax rate jurisdictions.

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Management’s Discussion and Analysis of Financial Conditions and Results of Operations (“MD&A”) is intended to provide a reader of our financial statements with a narrative from the perspective of our management on our financial condition, results of operations, liquidity and certain other factors that may affect our future results. Our MD&A is presented in six sections:

 

   

Overview

 

   

Results of Operations

 

   

Liquidity and Capital Resources

 

   

Contractual Obligations and Commitments

 

   

Critical Accounting Policies

 

   

Recent Accounting Pronouncements

 

6


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Overview

California Steel is the leading producer of flat rolled steel in the western United States based on tonnage billed. We produce the widest range of flat rolled steel products in the region, including hot rolled, cold rolled and galvanized coil and sheet. We also produce electric resistance welded (referred to herein as ERW) pipe. Unlike integrated steel mills and mini-mills, we do not manufacture steel. Rather, we process steel slab manufactured by third parties. Our principal market consists of the 11 states located west of the Rocky Mountains. We have two main competitors located in the western United States. Steel products are also supplied to the western United States via imports from foreign companies and from domestic suppliers located outside the western United States. We believe our slab-based business model, breadth of products, non-union work environment, southern California location and long-standing customer relationships provide us with significant advantages over our competition.

Results of Operations

Financial Results

The following table represents unaudited selected financial data (amounts in thousands, excepted for billed tons):

 

     Three months ended
September 30,
    Nine months ended
September 30,
 
     2010     2009     2010     2009  

Billed tons

     365,608        244,417        1,055,615        578,133   

Net sales

   $ 313,875      $ 146,983      $ 848,284      $ 398,245   

Net sales gain (loss) %

     114     -67     113     -68

Gross profit (loss) as % of net sales

     3.2     8.3     7.8     -2.9

SG&A

   $ 4,534      $ 4,285      $ 14,200      $ 12,819   

SG&A as % of net sales

     1.4     2.9     1.7     3.2

Operating income (loss)

   $ 5,154      $ 7,916      $ 51,032      $ (24,343

Operating income (loss) as % of net sales

     1.6     5.4     6.0     -6.1

Net income (loss)

   $ 2,048      $ 7,350      $ 30,934      $ (10,810

Net sales. Net sales in the third quarter of fiscal 2010 increased 114% to $313.9 million, compared with $147.0 million in the same period one year ago. The increase resulted primarily from an increase in sales volume and a higher average selling price. Sales volume increased 50% and the average selling price increased 41% compared to the same period one year ago. The higher sales volume increased net sales approximately $72.5 million and the higher average selling price increased net sales approximately $74.4 million. The remaining increase in net sales was primarily from higher value product mix and higher freight revenue in the third quarter of fiscal 2010 compared to the same period one year ago. The sales volume and the average selling price are expected to decrease during the fourth quarter of fiscal 2010 due to less demand for our products as our customers typically purchase less during this time frame.

Net sales for the first nine months of fiscal 2010 increased 113% to $848.3 million, compared with $398.2 million in the same period one year ago. The increase resulted primarily from an increase in sales volume and a higher average selling price. Sales volume increased 83% and the average selling price increased 15% compared to the same period one year ago. The higher sales volume increased net sales approximately $322.6 million and the higher average selling price increased net sales approximately $70.1 million. The remaining increase in net sales was primarily from higher value product mix and freight revenue during the first nine months of fiscal 2010 compared to the same period one year ago. The sales volume and the average selling price are expected to be higher for fiscal 2010 compared to fiscal 2009 due to improvement in the economy. This stimulated our customers to replenish their low inventories at higher prices.

Gross profit (loss). Our gross profit rate in the third quarter of fiscal 2010 decreased to 3.2% of net sales, compared with 8.3% of net sales in the same period one year ago. The decrease in our third quarter of fiscal 2010 gross profit rate is attributable to the rising cost of raw materials and a higher inventory write-down compared to the same period one year ago. Third quarter raw material prices are approximately 75% higher in fiscal 2010 compared to 2009. The write-down of inventory to the lower of cost or market of $7.5 million and $2.0 million for the three months ended September 30, 2010 and 2009 reduced the gross profit rate by 2.4% and 1.4%, respectively.

Our gross profit rate for the first nine months of fiscal 2010 increased to 7.8% of net sales, compared with a gross loss of 2.9% of net sales in the same period one year ago. The increase in our gross profit rate for the first nine months of fiscal 2010 is attributable to a higher average selling price and a lower inventory write-down which was partially offset by increased raw material cost. The average selling price increased approximately 15% and the raw material prices increased approximately 48% during the first nine months of fiscal 2010 compared to the same period one year ago. The write-down of inventory to the lower of cost or market of $8.3 million and $41.8 million for the nine months ended September 30, 2010 and 2009 reduced the gross profit rate by 1.0% and 10.5%, respectively.

 

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Selling, general and administrative (SG&A) expenses. Our SG&A expense rate in the third quarter of fiscal 2010 decreased by 1.5% to 1.4% of net sales, compared with 2.9% of net sales in the same period one year ago. Our SG&A expense rate for the first nine months of fiscal 2010 decreased by 1.5% to 1.7% of net sales, compared with 3.2% of net sales in the same period one year ago. The decrease in our SG&A expense rate for the third quarter and first nine months of fiscal 2010 is largely attributable to an increase of our net sales since the majority of our SG&A expenses are fixed costs. Our SG&A expenses consist primarily of labor and various administrative expenses. Labor costs comprised of approximately 59% and 58% of our SG&A expenses for the third quarter of fiscal 2010 and 2009, respectively, and approximately 59% of our SG&A expenses for the first nine months of fiscal 2010 and 2009, respectively.

Net interest expense. Net interest expense in the third quarter of fiscal 2010 increased $776 thousand, or 39.6%, to $2.7 million compared with $2.0 million in the same period one year ago. Net interest expense for the first nine months of fiscal 2010 increased $192,000, or 3.1%, to $6.4 million compared with $6.2 million in the same period one year ago. The increase in net interest expense was attributable to an increase in the average outstanding debt, a decrease in capitalized interest of $604 thousand and $40 thousand and a decrease in investment income of $124 thousand and $229 thousand when compared to the three and nine months ended September 30, 2009.

Other income, net. Other income, net was $566 thousand for the third quarter of fiscal 2010, compared with $2.1 million in the same period one year ago. Other income, net for the first nine months of fiscal 2010 was $2.1 million compared to $7.1 million in the same period one year ago. Other income is comprised of miscellaneous income items such as rental income, proceeds from legal settlements, gain on sale of environmental credits, refund from anti dumping subsidy, refund of prior periods property taxes, etc. The decrease in other income, net from the third quarter of fiscal 2009 was primarily attributable to the recording of a natural gas hedge benefit of $1.3 million in the third quarter of fiscal 2009 with no similar item in the third quarter of fiscal 2010. The decrease in other income, net from the first nine months of fiscal 2009 was attributable to the benefit of a natural gas settlement of $4.3 million and the recording of a natural gas hedge benefit of $1.3 million in the first nine months of fiscal 2009. There were no such items recorded during the first nine months of fiscal 2010. As many of these items occur infrequently or result in a one-time recognition of income, this category is subject to significant fluctuation from period to period.

Income tax expense (benefit). Our income tax expense was $936 thousand for the third quarter of fiscal 2010 compared with an income tax expense of $716 thousand in the same period one year ago. Income tax expense was $15.8 million for the first nine months of fiscal 2010 compared with an income tax benefit of $12.6 million in the same period one year ago. Our effective income tax rate was 31.4% for the third quarter of fiscal 2010 and in effective income tax rate of 33.8% for the nine months ended September 20, 2010 compared to an effective income tax rate of 8.9% and an effective income tax rate benefit of 53.9% in the same periods one year ago. The change in our effective tax rate is attributable to tax benefits related to California sales tax and hiring credits under the Enterprise Zone (“EZ”) designation and an overall reduction to our state tax liability due to filing in lower tax rate jurisdictions.

Net income (loss). Our net income for the three and nine months ended September 30, 2010 was $2.0 million and $30.9 million, respectively, compared to net income of $7.4 million and net loss of $10.8 million in the same periods in 2009.

Liquidity and Capital Resources

We ended the third quarter of fiscal year 2010 with $9.5 million of cash and cash equivalents compared with $61.7 million at the end of fiscal 2009. Working capital, the excess of current assets over current liabilities, was $254.3 million at the end of the third quarter of fiscal 2010, up from $222.0 million at the end of fiscal 2009. We ended the third quarter of fiscal 2010 with $84.8 million in financing available under our revolving credit facility.

 

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Cash Flows

The following table summarizes our cash flows in the first nine months of the current and prior fiscal years ($ in thousands):

 

     Nine months ended
September 30,
 
     2010     2009  

Total cash provided by (used in):

    

Operating activities

   $ (30,115   $ 120,431   

Investing activities

     (25,322     (32,005

Financing activities

     3,257        (2,500
                

(Decrease) increase in cash and cash equivalents

   $ (52,180   $ 85,926   
                

Operating Activities

Cash used in operating activities was $30.1 million for the first nine months of fiscal 2010 compared with cash provided by operating activities of $120.4 million in first nine months of fiscal 2009. The changes were due primarily to a change in net income, operating assets and liabilities and the lower of cost or market adjustment. The changes in operating assets and liabilities were due primarily to changes in trade accounts receivable, inventories, accounts payable and prepaid income taxes. The decrease of $35.0 million in cash provided for prepaid income taxes resulted mainly from an income tax refund that was received during the first nine months of fiscal 2009 which was partially offset by estimated tax payments due to higher estimated taxable income during the first nine months of fiscal 2010. The increase of $64.4 million in cash used in trade accounts receivable was primarily due to an increase in demand for our products at a higher average selling price compared to the first nine months of fiscal 2009. The increase of $47.1 million in cash provided for accounts payable was due primarily to an increase in raw material purchases at a higher average slab price to keep up with the increased demand and the timing of vendor payments compared to the first nine months of fiscal 2009. The increase of $141.4 million in cash used in inventories was due to higher inventory levels maintained due to increased sales, increase in the average cost and the write-down of inventory to the lower or cost or market.

Investing Activities

Cash used in investing activities was $25.3 million for the first nine months of fiscal 2010 compared with $32.0 million in the first nine months of fiscal 2009. The decrease in cash used by investing activities was primarily due to the reduction in capital expenditures, specifically the construction of the second reheat furnace. The primary purposes of our capital expenditures were to support our expansion plans and improve our operational efficiency.

Financing Activities

Cash provided by financing activities was $3.3 million for the first nine months of fiscal 2010 compared to cash used in financing activities of $2.5 million during the first nine months of fiscal 2009. The financing activities during the first nine months of fiscal 2010 were repayments of our term loan of $7.5 million, net advances under our line-of-credit of $25.2 million and the payment of $14.4 million in dividends to our stockholders during the first nine months of fiscal 2010. We repaid $2.5 million of our term loan during the first nine months of fiscal 2009.

Sources of Liquidity

Our most significant sources of liquidity continue to be funds generated by operating activities and cash and cash equivalents. We believe funds generated from the expected results of operations and available cash and cash equivalents will be sufficient to finance anticipated expansion plans for fiscal 2010. However, in the event our liquidity is insufficient, we may be required to limit our future expansion plans. In addition, our revolving credit facility is available for additional working capital needs. There can be no assurance that we will continue to generate cash flows at or above current levels or that we will be able to maintain our ability to borrow under our revolving credit facility or obtain additional financing, if necessary on favorable terms.

In September 2010, we entered into a five year $110.0 million credit facility with Wells Fargo Bank, N.A., as administrative agent and lender. Subject to the satisfaction of customary conditions and a borrowing base, advances under this facility may be made at any time prior to the credit facility termination date. Borrowings under the credit facility were $25.2 million as of September 30, 2010. The credit facility is collateralized by accounts receivable and inventory. Advances under this facility may be used for letters of credit, working capital, capital expenditures, payment of dividends and other lawful corporate purposes, including the refinancing of existing debt. This credit facility replaced the existing $110.0 million credit facility with Mizuho Corporate Bank which matured on September 29, 2010.

 

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On March 28, 2008, we entered into a Term Loan Agreement with The Bank of Tokyo-Mitsubishi, Ltd. for a $40.0 million unsecured five-year term loan maturing April 2013 to finance construction of our second reheat furnace and other working capital needs. The Term Loan Agreement provided for a single loan disbursement of the entire principal amount on April 1, 2008. Interest on the principal balance of the loan shall accrue at a rate of 3.38% for the first two years of the loan and a rate of 3.58% for the remaining three years of the loan and is payable quarterly commencing July 2008. Quarterly principal payments commenced in July 2009.

In September 2005, we entered into a five year $110.0 million credit facility with a bank group led by Mizuho Corporation Bank, as administrative agent and a lender, The Bank of Tokyo-Mitsubishi, Ltd., Citibank (West), FSB and Wells Fargo Bank. Subject to the satisfaction of customary conditions and a borrowing base, advances under this facility may be made at any time prior to the credit facility termination date. This credit facility expired on September 29, 2010.

On March 22, 2004, we issued an aggregate of $150.0 million of ten-year, 6.125% senior unsecured notes due in March 2014. With the proceeds of this issuance and cash on hand, we retired our 8.50% senior notes due in 2009. Interest on our 6.125% senior notes is payable on March 15 and September 15 of each year. The notes are senior in right of payment to all of our subordinated indebtedness and equal in right of payment to all of our existing and future indebtedness that is not by its terms subordinated to the notes. We may redeem the notes in whole or in part at any time after March 15, 2009. The redemption price is based on a percentage premium in excess of the face value of the notes which decreases over time. We periodically evaluate the cost of alternative forms of financing in the market versus the cost of redeeming and retiring the notes. Depending on the current market value of the notes, we further periodically evaluate whether to acquire notes in the market as a means to lower our financing costs. The indenture governing the notes contains covenants that limit our ability to incur additional indebtedness, pay dividends, redeem or repurchase capital stock and make investments, create liens, sell assets, sell capital stock of certain subsidiaries, engage in transactions with affiliates and consolidate, merge or transfer all or substantially all of our assets and the assets of certain subsidiaries on a consolidated basis. We were in compliance with all covenants and restrictions at September 30, 2010.

We currently have $8.4 million in material commitments for capital expenditures expected to be completed during fiscal 2010. These represent signed purchase orders for various production facility upgrades. Our total budget for capital improvements in 2010 is $36.7 million of which $6.7 million relates to the second reheat furnace project. We are committed, in the form of open purchase orders, to purchase $90.0 million in steel slabs, of which $20.4 million is from a related party.

We anticipate that our primary liquidity requirements will be for working capital, capital expenditures, debt service and the payment of dividends. We believe that cash generated from operations and available borrowings under our bank facility will be sufficient to meet our liquidity requirements for fiscal 2010.

 

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Contractual Obligations and Commitments

The following table represents a comprehensive list of our contractual obligations and commitments as of September 30, 2010 ($ in thousands):

 

     Total      Less
Than 1
Year
     1-3
Years
     3-5
Years
     More
Than 5
Years
 

Long Term Debt

   $ 202,700       $ 10,000       $ 17,500       $ 175,200       $ —     

Operating Leases

     604         321         252         31         —     

Purchase Obligations (1)

     99,086         99,086         —           —           —     

Estimated Interest Payments on Debt (2)

     33,025         9,963         18,851         4,211         —     

Planned Expenditures on Environmental

              

Matters (3)

     2,480         680         1,000         800         —     

Other Long Term Liabilities

     724         72         145         90         417   
                                            

Total

   $ 338,619       $ 120,122       $ 37,748       $ 180,332       $ 417   
                                            

 

(1) Amounts relate to contractual commitments to purchase $90.0 million of steel slabs, of which $20.4 million is from a related party, material commitments for capital expenditures of $8.4 million, and the remaining $700 thousand in assorted other contractual commitments.

 

(2) Amounts represent the annual accrued interest on our $150.0 million ten-year, 6.125% senior unsecured notes, which are due and payable in March 2014 and the interest on our $40.0 million five-year unsecured term loan maturing in April 2013.

 

(3) Amounts reflect $680 thousand of self assessed environmental clean-up of our facility and $1.8 million of anticipated expenditures on environmental matters pursuant to a proposed remediation plan submitted to the California Department of Toxic Substances Control. See discussion in Note 5 to the Financial Statements.

Critical Accounting Policies

We describe our significant accounting policies in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, in our Annual Report on Form 10-K for the year ended December 31, 2009. There has been no change in our significant accounting policies since the end of 2009.

Recent Accounting Pronouncements

In January 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2010-6, “Improving Disclosures about Fair Value Measurements” (ASU 2010-6”). This update amended guidance and issued a clarification with regard to disclosure requirements about fair market value measurement. A reporting entity is required to disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers. In addition, for measurements utilizing significant unobservable inputs, a reporting entity should present separately information about purchases, sales, issuances, and settlements. We adopted ASU 2010-6 on January 1, 2010. There was no impact upon adoption of ASU 2010-6 to our financial position or results of operations.

In February 2010, FASB issued ASU No. 2010-9, “Amendments to Certain Recognition and Disclosure Requirements” (“ASU 2010-9”). This amendment removed the requirement for a Securities and Exchange Commission (“SEC”) filer to disclose a date through which subsequent events have been evaluated in both issued and revised financial statements. This amendment is effective upon issuance date of February 24, 2010. There was no impact upon adoption of ASU 2010-9 to our financial position or results of operations.

Safe Harbor Statement Under the Private Securities Litigation Reform Act

Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Act”), provide a “safe harbor” for forward-looking statements to encourage companies to provide prospective information about their companies. With the exception of historical information, the matters discussed in this Quarterly Report on Form 10-Q are forward-looking statements and may be identified by the use of words such as “anticipate,” “estimate,” “expect,” “intend,” “plan,” “project,” and other words and terms of similar meaning. Such statements reflect our current view with respect to future events and are subject to certain risks, uncertainties and assumptions. A variety of factors could cause our future results to differ materially from the anticipated results expressed in such forward-looking statements. Readers should review Item 1A, Risk Factors, of our Annual Report on Form 10-K for the year ended December 31, 2009, for a description of important factors that could cause future results to differ materially from those contemplated by the forward-looking statements made in this Quarterly Report on Form 10-Q.

 

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The following risk factors may affect our operating results and the environment within which we conduct our business:

 

   

Fluctuations in raw materials and freight prices as a result of changes in industry dynamics, increased oil prices and global steel consumption;

 

   

Our substantial indebtedness, interest expense and principal repayment obligations under our credit facility, when drawn upon, and 6.125% senior notes, which could limit its ability to use operating cash flow in our business other than for debt-servicing obligations, obtain additional financing and react to changing market and general conditions, and which increase our vulnerability to interest rate increases;

 

   

The possibility of deadlocks among our board of directors that could result in delays in making important business decisions which could result in a competitive disadvantage due to the size of the board currently consisting of four members as elected by our two stockholders, each of whom holds 50% of our stock;

 

   

Fluctuations in commodity prices for our electricity and natural gas requirements, as well as the viability of the electrical power distribution system within the State of California;

 

   

Possible adverse effects resulting from new U.S. trade measures or increases in tariffs on imported steel slab;

 

   

Competitive factors and pricing pressures;

 

   

The ability to control costs and maintain quality;

 

   

Future expenditures for capital projects;

 

   

Fluctuations in the cost of management and hourly labor or other resources necessary to successfully operate our manufacturing plant;

 

   

Our ability to raise prices sufficiently to offset cost increases, including increased costs for minimum wages, employee benefits and insurance arrangements;

 

   

Legal claims and litigation against us;

 

   

Changes in, or any failure to comply with, governmental regulations;

 

   

Industry-wide market factors and general economic and business conditions; changes in general economic, demographic, geopolitical or public safety conditions which affect consumer behavior and spending for the products which use our goods, including the ongoing armed conflict in Iraq and Afghanistan and security concerns related to the continuing response of governments to the threat of terrorism and instability in certain regions of the world; and

 

   

Changes in accounting standards or interpretations of existing standards adopted by the Financial Accounting Standards Board, the Securities and Exchange Commission, and the American Institute of Certified Public Accountants that could impact our reported financial results.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

In addition to the risks inherent in our operations, we are exposed to market risks, including interest rates and utility consumption rates.

Interest Rate Risk

Floating rate credit facility

At September 30, 2010, borrowings on our $110.0 million floating rate credit facility were $25.2 million. The carrying value of the floating rate credit facility approximates fair value as the interest rate is variable and resets frequently. Changes in interest rates generally do not affect the fair value of our credit facility, but do affect earnings and cash flow. The credit facility bears interest at the Eurodollar rate or the prime rate, which was approximately 1.5% (one month rate) (including margin) and 3.25%, respectively, at September 30, 2010. We expect to borrow approximately $37.5 million from our credit facility during the remainder of fiscal 2010. We estimate that the average amount of debt outstanding under the facility for the remainder of fiscal 2010 will be approximately $12.5 million. Therefore, a one-percentage point increase in interest rates would result in an increase in interest expense of $125 thousand for the year. We do not manage the interest rate risk on our credit facility through the use of derivative instruments.

 

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Fixed rate debt

At September 30, 2010, our short-term and long-term fixed rate debt comprised of our $150.0 million senior notes and $40.0 million term loan of which $27.5 million is outstanding at September 30, 2010. Changes in interest rates generally affect the fair value of our fixed rate debt instruments. We do not have an obligation to repay our senior notes prior to maturity and, as a result, interest rate risk and changes in fair value should not have a significant impact on us. We believe that the interest rate on our term loan approximates the current rate available for similar types of financing and as a result the carrying amount approximates the fair value. We do not manage the interest rate risk on our fixed rate debt through the use of derivative instruments.

We do not believe that the future market rate risk related to our floating rate credit facility and fixed rate debt will have a material impact on our financial position, results of operations or liquidity.

Other Market Risks

Utility consumption rates

Our daily average electrical demand is approximately 35 megawatts to operate production equipment in manufacturing our products. We are currently a full-service bundled utility customer of Southern California Edison. Due to higher projected production in fiscal 2010, our electricity costs are expected to be higher than fiscal 2009 levels. Our electricity costs accounted for 1.8% and 1.9% of our cost of goods sold for the three and nine months ended September 30, 2010 compared to 3.9% and 3.1% in the same period one year ago.

At full capacity, we generally utilize a daily average of approximately 12,000 million British thermal units, or MMBTUs, of natural gas to produce our products. To stabilize price volatility, we regularly use a risk management approach to fix the price on portions of our natural gas requirements up to two years ahead through financial and/or physical hedging arrangements.

We currently have in place fixed price physical purchase agreements for approximately 4% of our natural gas commodity requirements for fiscal 2010. We continue to monitor the near and long term price trends of natural gas and may enter into additional purchase agreements when we deem it appropriate or when opportunities present themselves. Our natural gas costs accounted for 1.3% and 1.7% of our cost of goods sold for the three and nine months ended September 30, 2010 compared to 2.7% and 2.4% in the same period one year ago.

 

ITEM 4. CONTROLS AND PROCEDURES

For the period ending September 30, 2010 (the “Evaluation Date”), we carried out an evaluation, under the supervision and with the participation of our management, including the President and Chief Executive Officer and the Executive Vice President, Finance and Administration (the principal finance and accounting officer), of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rules 13a-15 and 15d-15 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based upon that evaluation, the President and Chief Executive Officer and the Executive Vice President, Finance and Administration concluded that, as of September 30, 2010, our disclosure controls and procedures were effective.

Additionally, the President and Chief Executive Officer and the Executive Vice President, Finance and Administration determined, as of September 30, 2010, that there were no changes in our internal controls over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) or in other factors that could significantly affect our internal controls over financial reporting.

 

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PART II OTHER INFORMATION

 

ITEM 6. EXHIBITS

The Exhibits required to be filed with this Quarterly Report on Form 10-Q are listed in the Exhibit Index included herein immediately following the Signature Page.

 

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SIGNATURE

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 thereunto duly authorized.

 

    CALIFORNIA STEEL INDUSTRIES, INC.
October 27, 2010     By:   /S/    VICENTE WRIGHT        
      Vicente Wright
      President and Chief Executive Officer

 

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INDEX OF EXHIBITS

 

Exhibit

Number

  

Description

  3.1    Certificate of Incorporation of the Registrant, as amended by Amendment to the Certificate of Incorporation filed June 6, 1984 with the Delaware Secretary of State, as amended by the Certificate of Amendment to the Certificate of Incorporation filed on August 2, 1984 with the Delaware Secretary of State, as amended by the Certificate of Amendment to the Certificate of Incorporation file on January 12, 1988 with the Delaware Secretary of State, and, as amended by the Certificate of Ownership merging CSI Tubular Products, Inc. into the Registrant filed with the Delaware Secretary of State on December 20, 1993. (1)
  3.2    Certificate of Amendment to the Certificate of Incorporation filed July 27, 1999, with the Delaware Secretary of State. (2)
  3.3    Certificate of Amendment to the Certificate of Incorporation filed July 24, 2006, with the Delaware Secretary of State. (3)
  3.4    Restated Bylaws of the Registrant dated as of April 1, 2008. (6)
  4.1    Indenture, dated as of March 22, 2004, between the Registrant and U.S. Bank National Association, Trustee. (4)
  4.2    Specimen Series A note – 6.125% Senior Notes due 2014 (included in Exhibit 4.4). (4)
  4.3    Shareholders’ Agreement, dated April 1, 2008, by and among Rio Doce Limited, Vale (Companhia Vale do Rio Doce), JFE Steel Corporation. (7)
10.1    Credit Agreement dated as of September 29, 2010, by and between California Steel Industries, Inc., and Wells Fargo Bank, National Association.
10.2    Term Loan Agreement dated March 28, 2008 by and among California Steel Industries, Inc., and The Bank of Tokyo-Mitsubishi, Ltd. (5)
31.1    Certification of President and Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2    Certification of Executive Vice President, Finance and Administration pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1    Certification of President and Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2    Certification of Executive Vice President, Finance and Administration pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

(1) Incorporated by reference to the Registrant’s Registration Statement on Form S-4, File No. 333-79587, as filed with the Securities and Exchange Commission on May 28, 1999, as amended.
(2) Incorporated by reference to the Registrant’s Annual Report on Form 10-K, for the year ended December 31, 2001, as filed with the Securities and Exchange Commission on March 28, 2002.
(3) Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q, for the quarter ended September 30, 2006, as filed with the Securities and Exchange Commission on October 27, 2006.
(4) Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q, for the quarter ended March 31, 2004, as filed with the Securities and Exchange Commission on April 28, 2004.
(5) Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q, for the quarter ended March 31, 2008, as file with the Securities and Exchange Commission on April 25, 2008.
(6) Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q, for the quarter ended June 30, 2008, as filed with the Securities and Exchange Commission on July 28, 2008.
(7) Incorporated by reference to the Registrant’s Annual Report on Form 10-K, for the year ended December 31, 2008, as filed with the Securities and Exchange Commission on March 13, 2009.

 

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