zeus20130630_10q.htm



 

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 June 30, 2013

 

(   )

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 0-23320

 

OLYMPIC STEEL, INC.

(Exact name of registrant as specified in its charter)

 

 Ohio

 

 34-1245650

 (State or other jurisdiction of incorporation or organization)

 

 (I.R.S.Employer Identification Number)

 

 

 

 5096 Richmond Road, Bedford Heights, Ohio

 

 44146

 (Address of principal executive offices) 

 

 (Zip Code)

 

Registrant's telephone number, including area code (216) 292-3800

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes (X) No ( )

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, 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 (X) 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 the definitions of “large accelerated filer” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act:

 

 

Large accelerated filer ( )

 

Accelerated filer (X)

 

 

Non-accelerated filer ( )

 

Smaller reporting company ( )

 

 

(Do not check if a smaller reporting company)  

 

 

 

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

 

Indicate the number of shares of each of the issuer's classes of common stock, as of the latest practicable date:

 

 Class

 

 Outstanding as of August 9, 2013

 Common stock, without par value

 

 10,951,017



 

 
 

 

  

Olympic Steel, Inc.

Index to Form 10-Q

 

Page No.

  

Part I. FINANCIAL INFORMATION

3

   

Item 1. Financial Statements

3

   

Consolidated Balance Sheets – June 30, 2013 (unaudited) and December 31, 2012 (audited)

3

   

Consolidated Statements of Comprehensive Income – for the three and six months ended June 30, 2013 and 2012 (unaudited)

4

   

Consolidated Statements of Cash Flows – for the six months ended June 30, 2013 and 2012 (unaudited)

5

   

Supplemental Disclosures of Cash Flow Information – for the six months ended June 30, 2013 and 2012 (unaudited)

6

   

Notes to Unaudited Consolidated Financial Statements

7

   

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

17

   

Item 3. Quantitative and Qualitative Disclosures About Market Risk

26

   

Item 4. Controls and Procedures

28

   

Part II. OTHER INFORMATION

29

   

Item 6. Exhibits

29

   

SIGNATURES

30

 

 
2

 

 

Part I. FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

Olympic Steel, Inc.

Consolidated Balance Sheets

(in thousands)

  

     

As of

 
     

June 30,

2013

   

December 31,

2012

 
     

(unaudited)

   

(audited)

 

Assets

               

Cash and cash equivalents

  $ 3,798     $ 7,782  

Accounts receivable, net

    143,108       112,841  

Inventories, net (includes LIFO debit of $2,307 as of June 30, 2013)

    248,787       290,023  

Prepaid expenses and other

    9,049       11,731  
 

Total current assets

    404,742       422,377  

Property and equipment, at cost

    349,393       347,935  

Accumulated depreciation

    (159,993 )     (151,608 )
 

Net property and equipment

    189,400       196,327  

Goodwill

    40,787       40,787  

Intangible assets, net

    34,979       35,424  

Other long-term assets

    13,022       11,079  
 

Total assets

  $ 682,930     $ 705,994  
                   

Liabilities

               

Current portion of long-term debt

  $ 13,090     $ 15,282  

Accounts payable

    102,358       101,471  

Accrued payroll

    11,370       10,705  

Other accrued liabilities

    16,873       14,984  
 

Total current liabilities

    143,691       142,442  

Credit facility revolver

    150,020       177,575  

Long-term debt

    44,479       48,854  

Other long-term liabilities

    12,508       11,410  

Deferred income taxes

    33,812       35,856  
 

Total liabilities

    384,510       416,137  
                 

Shareholders' Equity

               

Preferred stock

    -       -  

Common stock

    123,454       122,272  

Accumulated other comprehensive loss

    (448 )     (579 )

Retained earnings

    175,414       168,164  
 

Total shareholders' equity

    298,420       289,857  
 

Total liabilities and shareholders' equity

  $ 682,930     $ 705,994  

 

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

 

 
3

 

 

Olympic Steel, Inc.

Consolidated Statements of Comprehensive Income

(in thousands, except per share data)

 

       

Three months ended

June 30,

   

Six months ended

June 30,

 
       

2013

   

2012

   

2013

   

2012

 
       

(unaudited)

   

(unaudited)

 

Net sales

  $ 330,804     $ 367,365     $ 668,868     $ 749,417  

Costs and expenses

                               
 

Cost of materials sold (excludes items shown seperately below)

    261,854       295,878       528,008       602,556  
 

Warehouse and processing

    21,559       21,003       42,065       42,225  
 

Administrative and general

    18,170       17,508       36,319       35,882  
 

Distribution

    8,981       9,219       17,955       18,278  
 

Selling

    6,371       6,763       12,957       13,904  
 

Occupancy

    2,322       2,115       4,921       4,438  
 

Depreciation

    5,301       4,913       10,594       9,683  
 

Amortization

    222       222       444       444  
   

Total costs and expenses

    324,780       357,621       653,263       727,410  
 

Operating income

    6,024       9,744       15,605       22,007  

Other income (loss), net

    (41 )     5       (17 )     39  
 

Income before interest and income taxes

    5,983       9,749       15,588       22,046  

Interest and other expense on debt

    1,668       2,183       3,366       4,291  
 

Income before income taxes

    4,315       7,566       12,222       17,755  

Income tax provision

    1,790       3,040       4,533       6,999  
 

Net income

  $ 2,525     $ 4,526     $ 7,689     $ 10,756  
                                     

Net loss on interest rate hedge, net of tax

    (128 )     (403 )     (131 )     (403 )

Total comprehensive income

  $ 2,397     $ 4,123     $ 7,558     $ 10,353  
                                     

Earnings per share:

                               
 

Net income per share - basic

  $ 0.23     $ 0.41     $ 0.70     $ 0.98  
 

Weighted average shares outstanding - basic

    11,062       10,960       11,059       10,956  
 

Net income per share - diluted

  $ 0.23     $ 0.41     $ 0.69     $ 0.98  
 

Weighted average shares outstanding - diluted

    11,072       10,989       11,067       10,987  
  

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

 

 
4

 

 

Olympic Steel, Inc.

Consolidated Statements of Cash Flows

For the Six Months Ended June 30,

 

(in thousands)

 

         

2013

   

2012

 
         

(unaudited)

 

Cash flows from (used for) operating activities:

               
 

Net income

  $ 7,689     $ 10,756  
 

Adjustments to reconcile net income to net cash from (used for) operating activities -

               
     

Depreciation and amortization

    11,710       10,753  
     

Loss on disposition of property and equipment

    104       174  
     

Stock-based compensation

    971       1,436  
     

Insurance recovery receivable

    (1,787 )     -  
     

Other long-term assets

    (2,611 )     (2,032 )
     

Other long-term liabilities

    (816 )     1,255  
            15,260       22,342  
 

Changes in working capital:

               
   

Accounts receivable

    (28,481 )     (36,274 )
   

Inventories

    41,236       (34,510 )
   

Prepaid expenses and other

    2,682       3,602  
   

Accounts payable

    979       8,628  
   

Change in outstanding checks

    (92 )     3,629  
   

Accrued payroll and other accrued liabilities

    2,555       782  
            18,879       (54,143 )
   

Net cash from (used for) operating activities

    34,139       (31,801 )
                       

Cash flows from (used for) investing activities:

               
 

Capital expenditures

    (3,779 )     (15,683 )
 

Proceeds from disposition of property and equipment

    8       2  
   

Net cash used for investing activities

    (3,771 )     (15,681 )
                       

Cash flows from (used for) financing activities:

               
 

Credit facility revolver borrowings

    207,012       303,470  
 

Credit facility revolver repayments

    (234,567 )     (253,960 )
 

Principal payments under capital lease obligations

    (1,407 )     (90 )
 

Term loan repayments

    (4,375 )     (4,375 )
 

Industrial revenue bond repayments

    (785 )     (755 )
 

Credit facility fees and expenses

    (3 )     (1,203 )
 

Proceeds from exercise of stock options (including tax benefits) and employee stock purchases

    211       244  
 

Dividends paid

    (438 )     (436 )
   

Net cash from (used for) financing activities

    (34,352 )     42,895  
                       

Cash and cash equivalents:

               
 

Net change

    (3,984 )     (4,587 )
 

Beginning balance

    7,782       7,403  
 

Ending balance

  $ 3,798     $ 2,816  

 

The accompanying notes are an integral part of these consolidated statements

 

 
5

 

 

Olympic Steel, Inc.

Supplemental Disclosures of Cash Flow Information

For the Six Months Ended June 30,

 

(in thousands)

 

   

2013

   

2012

 
   

(unaudited)

 
                 

Interest paid

  $ 2,775     $ 3,816  

Income taxes paid

  $ 2,223     $ 3,344  

 

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

 

 
6

 

 

Olympic Steel, Inc.

Notes to Unaudited Consolidated Financial Statements

June 30, 2013

 

1.

Basis of Presentation:

 

The accompanying consolidated financial statements have been prepared from the financial records of Olympic Steel, Inc. and its wholly-owned subsidiaries (collectively, Olympic or the Company), without audit and reflect all normal and recurring adjustments which are, in the opinion of management, necessary to fairly state the results of the interim periods covered by this report. Year-to-date results are not necessarily indicative of 2013 annual results and these financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2012. All significant intercompany transactions and balances have been eliminated in consolidation.

 

The Company operates in two reportable segments; flat products and tubular and pipe products. Through its flat products segment, the Company sells and distributes large volumes of processed carbon, coated, aluminum and stainless flat-rolled sheet, coil and plate products. Through its tubular and pipe products segment, the Company distributes metal tubing, pipe, bar, valve and fittings and fabricates pressure parts supplied to various industrial markets.

 

Commencing with the first quarter of 2013, corporate expenses are reported as a separate line item in the segment reporting. Corporate expenses include the unallocated expenses related to managing the entire Company (i.e. both segments), including payroll expenses for certain personnel, expenses related to being a publicly traded entity such as board of directors expenses, audit expenses, and various other professional fees. Prior to 2013, these expenses were included in the flat products segment’s operating results. In March 2013, the Company revised the presentation of corporate expenses with a conforming change to the prior period presentation to reflect the new reporting structure.

 

In March 2013, the Company revised the presentation of the Industrial Revenue Bond (IRB) indebtedness to current portion of long-term debt on its Consolidated Balance Sheets with a conforming change to the prior period presentation because the IRB is remarketed on an annual basis. The effect of this revision had no impact on total liabilities, but it revised the total current liabilities as of December 31, 2012 from $138.1 million to $142.4 million.

 

 

2. 

Accounts Receivable: 

 

Accounts receivable are presented net of allowances for doubtful accounts and unissued credits of $3.0 million and $2.8 million as of June 30, 2013 and December 31, 2012, respectively. The allowance for doubtful accounts is maintained at a level considered appropriate based on historical experience and specific customer collection issues that have been identified. Estimations are based upon a calculated percentage of accounts receivable, which remains fairly level from year to year, and judgments about the probable effects of economic conditions on certain customers, which can fluctuate significantly from year to year. The Company cannot guarantee that the rate of future credit losses will be similar to past experience. The Company considers all available information when assessing the adequacy of its allowance for doubtful accounts and unissued credits each quarter.

 

As of June 30, 2013, “Accounts receivable, net” on the Company’s Consolidated Balance Sheets includes $1.8 million of an insurance receivable related to recovery of a portion of incremental expenses incurred during the first six months of 2013 related to the failure of a shear on one of our major pieces of processing equipment, which was repaired and became operational in May 2013. We expect to receive payment from the insurance company by the end of the year.

 

 

3. 

Inventories: 

 

Inventories consisted of the following:

 

   

Inventory as of

 

(in thousands)

 

June 30,

2013

   

December 31,

2012

 

Unprocessed

  $ 186,367     $ 215,526  

Processed and finished

    62,420       74,497  

Totals

  $ 248,787     $ 290,023  

 

 
7

 

 

The Company values certain of its tubular and pipe products inventory at the last-in, first-out (LIFO) method. At June 30, 2013 and December 31, 2012, approximately $44.9 million, or 18.1% of consolidated inventory, and $46.7 million, or 16.1% of consolidated inventory, respectively, was reported under the LIFO method of accounting. The cost of the remainder of the tubular and pipe products inventory is determined using a weighted average rolling first-in, first-out (FIFO) method.

 

In the first quarter of 2013, the Company made an out-of-period adjustment to record previously unrecognized LIFO income of $1.9 million, which resulted in an increase to after-tax income of $1.2 million.  The Company determined that this adjustment was not material to its current or prior period consolidated financial statements.

 

In the second quarter of 2013, the Company recorded $375 thousand of LIFO income as a result of the continued decline of metals pricing in 2013. The LIFO income increased the Company’s inventory balance and decreased its cost of materials sold.

 

If the FIFO method had been in use, inventories would have been $2.3 million lower than reported at June 30, 2013.

 

 

4.

Intangible Assets:

 

Intangible assets, net, consisted of the following as of June 30, 2013 and December 31, 2012:

 

   

As of June 30, 2013

 

(in thousands)

 

Gross Carrying Amount

   

Accumulated Amortization

   

Intangible Assets, Net

 
                         

Customer relationships - subject to amortization

  $ 13,332     $ (1,778 )   $ 11,554  

Trade name - not subject to amortization

    23,425       -       23,425  
    $ 36,757     $ (1,778 )   $ 34,979  

 

 

   

As of December 31, 2012

 

(in thousands)

 

Gross Carrying Amount

   

Accumulated Amortization

   

Intangible Assets, Net

 
                         

Customer relationships - subject to amortization

  $ 13,332     $ (1,333 )   $ 11,999  

Trade name - not subject to amortization

    23,425       -       23,425  
    $ 36,757     $ (1,333 )   $ 35,424  

 

The Company estimates that amortization expense for its intangible assets subject to amortization will be $889 thousand for the year ended December 31, 2013 and $889 thousand per year in each of the next five years.

 

 

5.

Debt:

 

The Company’s debt is comprised of the following components:

 

   

As of

 

(in thousands)

 

June 30,

2013

   

December 31,

2012

 

Asset-based credit facility revolver due June 30, 2016

  $ 150,020     $ 177,575  

Term loan due June 30, 2016

    53,229       57,604  

Industrial revenue bond due April 1, 2018

    4,340       5,125  

Capital lease

    -       1,407  

Total debt

    207,589       241,711  

Less current amount

    (13,090 )     (15,282 )

Total long-term debt

  $ 194,499     $ 226,429  

 

 
8

 

 

On March 16, 2012, the Company amended its existing asset-based credit facility (ABL Credit Facility). The amendment provided, among other things: (i) a reduction in the applicable margin for loans under the Company’s Loan and Security Agreement; (ii) additional revolving commitments to the borrowers in an aggregate principal amount of $50 million, which additional revolving commitments do not impact the borrowers’ incremental facilities; and (iii) permits certain transactions among the borrowers and Metales de Olympic, S. de R.L. de C.V., an indirect subsidiary of the Company. The amended ABL Credit Facility consists of a revolving credit line of $315 million and a $64 million term loan, with monthly principal payments. At June 30, 2013, the term loan balance was $53.2 million. Revolver borrowings are limited to the lesser of a borrowing base, comprised of eligible receivables and inventories, or $315 million in the aggregate. The ABL Credit Facility matures on June 30, 2016.

 

The ABL Credit Facility requires the Company to comply with various covenants, the most significant of which include: (i) until maturity of the ABL Credit Facility, if any commitments or obligations are outstanding and the Company’s availability is less than the greater of $20 million, 12.5% of the aggregate amount of revolver commitments ($39.4 million at June 30, 2013), or 60% of the principal balance of the term loan then outstanding ($31.9 million at June 30, 2013), then the Company must maintain a ratio of EBITDA minus certain capital expenditures and cash taxes paid to fixed charges of at least 1.10 to 1.00 for the most recent twelve fiscal month period; (ii) limitations on dividend payments; (iii) restrictions on additional indebtedness; and (iv) limitations on investments and joint ventures. Effective with the March 16, 2012 amendment, the Company has the option to borrow under its revolver based on the agent’s base rate plus a premium ranging from 0.00% to 0.50% or the London Interbank Offered Rate (LIBOR) plus a premium ranging from 1.50% to 2.00%. The interest rate under the term loan is based on the agent’s base rate plus a premium ranging from 0.25% to 0.75% or LIBOR plus a premium ranging from 1.75% to 2.25%.

 

As of June 30, 2013, $4.0 million of bank financing fees were included in “Prepaid expenses and other” and “Other long-term assets” on the accompanying Consolidated Balance Sheets. The financing fees are being amortized over the remaining term of the credit facility.

 

As of June 30, 2013, the Company was in compliance with its covenants and had approximately $93 million of availability under the ABL Credit Facility.   

 

As part of the Chicago Tube and Iron Company (CTI) acquisition on July 1, 2011, the Company assumed approximately $5.9 million of IRB indebtedness issued through the Stanly County, North Carolina Industrial Revenue and Pollution Control Authority. The bond matures in April 2018, with the option to provide principal payments annually on April 1st. The IRB bonds are remarketed annually and are included in “Current portion of long-term debt” on the accompanying Consolidated Balance Sheets. On April 1, 2013, the Company paid an optional principal payment of $785 thousand. Interest is payable monthly, with a variable rate that resets weekly. As a security for payment of the bonds, the Company obtained a direct pay letter of credit issued by JPMorgan Chase Bank, N.A. The letter of credit reduces annually by the principal reduction amount. The interest rate at June 30, 2013 was 0.17% for the IRB debt.

 

CTI entered into an interest rate swap agreement to reduce the impact of changes in interest rates on the above IRB. At June 30, 2013, the effect of the swap agreement on the bond was to fix the rate at 3.46%. The swap agreement matures in April 2018, and is reduced annually by the amount of the optional principal payments on the bond. The Company is exposed to credit loss in the event of nonperformance by the other parties to the interest rate swap agreement. However, the Company does not anticipate nonperformance by the counterparties.

 

 

6.

Derivative Instruments:

 

Nickel swaps

 

During 2013 and 2012, the Company entered into nickel swaps indexed to the London Metal Exchange (LME) price of nickel with third-party brokers. The nickel swaps are treated as derivatives for accounting purposes. The Company entered into them to mitigate its customers’ risk of volatility in the price of nickel. The outstanding nickel swaps have one to fifteen months remaining and are settled with the brokers at maturity. The economic benefit or loss arising from the changes in fair value of the swaps is contractually passed through to the customer. The primary risk associated with the nickel swaps is the ability of customers or third-party brokers to honor their agreements with the Company related to derivative instruments. If the customer or third-party brokers are unable to honor their agreements, the Company’s risk of loss is the fair value of the nickel swap.

 

In October 2011, MF Global UK Limited (MF Global UK), a United Kingdom based broker-dealer, was placed into the United Kingdom’s administration process (a process similar to bankruptcy proceedings in the United States) by the Financial Services Authority following the Chapter 11 bankruptcy filing of its U.S. parent, MF Global Holdings Ltd. The Company had used MF Global UK as one of its third-party brokers for nickel swaps. All of the Company’s open hedges with MF Global UK were closed effective November 1, 2011. As of June 30, 2013, the Company does not believe it has a material obligation to MF Global UK. Although bankruptcy and administration processes are uncertain and the results could change, the Company does not expect the outcome to be material to its financial statements.   

 

 
9

 

 

While these derivatives are intended to help the Company manage risk, they have not been designated as hedging instruments. The periodic changes in fair value of the nickel and embedded customer derivative instruments are included in “Cost of materials sold” in the Consolidated Statements of Comprehensive Income. We recognize derivative positions with both the customer and the third party for the derivatives and we classify cash settlement amounts associated with them as part of “Cost of materials sold” in the Consolidated Statements of Comprehensive Income. The embedded customer derivatives are included in “Accounts receivable, net”, and the nickel swaps are included in “Other accrued liabilities” on the Consolidated Balance Sheets at June 30, 2013 and December 31, 2012.

 

Interest rate swap

 

CTI entered into an interest rate swap to reduce the impact of changes in interest rates on its IRB. The swap agreement matures in April 2018, the same time as the IRB, and is reduced annually by the amount of the optional principal payments on the IRB. The Company is exposed to credit loss in the event of nonperformance by the other parties to the interest rate swap agreement. However, the Company does not anticipate nonperformance by the counterparties. The interest rate swap is not treated as a hedge for accounting purposes.

 

The periodic changes in fair value of the interest rate swap and cash settlement amounts associated with the interest rate swap are included in “Interest and other expense on debt” in the Consolidated Statements of Comprehensive Income.

 

Fixed rate interest rate hedge

 

In June 2012, the Company entered into a forward starting fixed rate interest rate hedge commencing June 2013 in order to eliminate the variability of cash interest payments on $53.2 million of the then outstanding LIBOR-based borrowings under the ABL Credit Facility. The hedge matures on June 1, 2016 and is reduced monthly by the principal payments on the term loan. The fixed rate interest rate hedge is accounted for as a cash flow hedging instrument for accounting purposes.

 

There was no net impact from the nickel swaps or embedded customer derivative agreements to the Company’s Consolidated Statements of Comprehensive Income for the three or six months ended June 30, 2013 and 2012. The table below shows the total impact to the Company’s Consolidated Statements of Comprehensive Income through net income of the derivatives for the three and six months ended June 30, 2013 and 2012.

 

   

Net Gain (Loss) Recognized

 
   

For the Three Months

Ended June 30,

   

For the Six Months

Ended June 30,

 
   

2013

   

2012

   

2013

   

2012

 

(in thousands)

                               

Interest rate swap (CTI)

  $ (71 )   $ (5 )   $ (113 )   $ (16 )

Fixed interest rate swap (ABL)

    (42 )     -       (42 )     -  

Nickel swaps

    938       (164 )     1,015       (229 )

Embedded customer derivatives

    (938 )     164       (1,015 )     229  

Net gain (loss)

    (113 )     (5 )     (155 )     (16 )
 

 

7.

Fair Value of Financial Instruments:

 

The Company’s financial instruments include cash and cash equivalents, short-term trade receivables, derivative instruments, accounts payable and debt instruments. For short-term instruments, other than those required to be reported at fair value on a recurring basis and for which additional disclosures are included below, management concluded the historical carrying value is a reasonable estimate of fair value because of the short period of time between the origination of such instruments and their expected realization.

 

 
10

 

 

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is an exit price concept that assumes an orderly transaction between willing market participants. Valuation techniques must maximize the use of observable inputs and minimize the use of unobservable inputs. To measure fair value, the Company applies a fair value hierarchy that is based on three levels of input, of which the first two are considered observable and the last unobservable, as follows:

 

Level 1 – Quoted prices in active markets for identical assets and liabilities.

 

Level 2 – Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

 

Level 3 – Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

 

During the six months ended June 30, 2013, there were no transfers of financial assets between Levels 1, 2 or 3 fair value measurements. There have been no changes in the methodologies used at June 30, 2013 since December 31, 2012. Following is a description of the valuation methodologies used for assets and liabilities measured at fair value as of June 30, 2013 and December 31, 2012:

 

Nickel swaps and embedded customer derivatives – Determined by using Level 2 inputs that include the price of nickel indexed to the LME. The fair value is determined based on quoted market prices and reflects the estimated amounts the Company would pay or receive to terminate the nickel swaps.

 

Interest rate swap – Based on the present value of the expected future cash flows, considering the risks involved, and using discount rates appropriate for the maturity date. Market observable Level 2 inputs are used to determine the present value of future cash flows.

 

The following table presents information about the Company’s assets and liabilities that were measured at fair value on a recurring basis and indicates the fair value hierarchy of the valuation techniques utilized by the Company:

 

   

Value of Items Recorded at Fair Value

As of June 30, 2013

 

(in thousands)

 

Level 1

   

Level 2

   

Level 3

   

Total

 

Assets:

                               

Embedded customer derivatives (Nickel swaps)

  $ -     $ 950     $ -     $ 950  

Total assets at fair value

  $ -     $ 950     $ -     $ 950  
                                 

Liabilities:

                               

Nickel swaps

  $ -     $ 1,006     $ -     $ 1,006  

Interest rate swap (CTI)

    -       332       -       332  

Fixed interest rate swap (ABL)

    -       728       -       728  

Total liabilities at fair value

  $ -     $ 2,066     $ -     $ 2,066  

 

   

Value of Items Not Recorded at Fair Value

As of June 30, 2013

 

(in thousands)

 

Level 1

   

Level 2

   

Level 3

   

Total

 

Liabilities:

                               

IRB

  $ 4,340     $ -     $ -     $ 4,340  

Term loan

    -       53,229       -       53,229  

Revolver

    -       150,020       -       150,020  

Total liabilities not recorded at fair value

  $ 4,340     $ 203,249     $ -     $ 207,589  

 

The value of the items not recorded at fair value represent the carrying value of the liabilities.

 

 
11

 

 

   

Value of Items Recorded at Fair Value

As of December 31, 2012

 

(in thousands)

 

Level 1

   

Level 2

   

Level 3

   

Total

 

Assets:

                               

Embedded customer derivatives (Nickel swaps)

  $ -     $ 113     $ -     $ 113  

Total assets recorded at fair value

  $ -     $ 113     $ -     $ 113  
                                 

Liabilities:

                               

Nickel swaps

  $ -     $ 168     $ -     $ 168  

Interest rate swap (CTI)

    -       446       -       446  

Fixed interest rate swap (ABL)

    -       941       -       941  

Total liabilities recorded at fair value

  $ -     $ 1,555     $ -     $ 1,555  

 

   

Value of Items Not Recorded at Fair Value

As of December 31, 2012

 

(in thousands)

 

Level 1

   

Level 2

   

Level 3

   

Total

 

Liabilities:

                               

IRB

  $ 5,125     $ -     $ -     $ 5,125  

Term loan

    -       57,604       -       57,604  

Revolver

    -       177,575       -       177,575  

Total liabilities not recorded at fair value

  $ 5,125     $ 235,179     $ -     $ 240,304  

 

The value of the items not recorded at fair value represent the carrying value of the liabilities.

 

 

8.

Equity Plans:

 

Stock Options

 

The following table summarizes stock option activity during the six months ended June 30, 2013:

 

   

Number of

Options

   

Weighted Average

Exercise Price

 

Weighted Average

Remaining

Contractual Term

(years)

 

Aggregate Intrinsic

Value

(in thousands)

 

Outstanding at December 31, 2012

    40,339     $ 21.79            

Granted

    -       -            

Exercised

    (1,667 )     3.50            

Canceled

    -       -            

Outstanding at June 30, 2013

    38,672     $ 22.58  

2.5

  $ 251  

Exercisable at June 30, 2013

    38,672     $ 22.58  

2.5

  $ 251  
 

There were 1,667 and 2,170 stock options exercised during the six months ended June 30, 2013 and 2012, respectively. The total intrinsic value of stock options exercised during the six months ended June 30, 2013 and 2012 was $28 thousand and $52 thousand, respectively. All options outstanding are vested as of June 30, 2013.

 

 

Restricted Stock Units and Performance Share Units

 

The Olympic Steel 2007 Omnibus Incentive Plan (Plan) was approved by the Company’s shareholders in 2007. The Plan authorizes the Company to grant stock options, stock appreciation rights, restricted shares, restricted share units, performance shares, and other stock and cash-based awards to employees and Directors of, and consultants to, the Company and its affiliates. Under the Plan, 500,000 shares of common stock are available for equity grants.

 

On January 2, 2013 and January 3, 2012, the Compensation Committee of the Company’s Board of Directors approved the grant of 1,800 restricted stock units (RSUs) to each non-employee Director. Subject to the terms of the Plan and the RSU agreement, the RSUs vest after one year of service (from the date of grant). The RSUs are not converted into shares of common stock until the director either resigns or is terminated from the Board of Directors.

 

 
12

 

 

The fair value of each RSU was estimated to be the closing price of the Company’s common stock on the date of the grant, which was $23.41 and $25.55 for the grants on January 2, 2013 and January 3, 2012, respectively.

 

In 2011, the Compensation Committee for the Company’s Board of Directors approved changes to the Senior Management Compensation Program to include an equity component in order to encourage more ownership of common stock by the senior management. Beginning in 2011, the Senior Management Compensation Program imposed stock ownership requirements upon the participants. Each participant is required to own at least 750 shares of common stock for each year that the participant participates in the Senior Management Compensation Program. Any participant that fails to meet to the stock ownership requirements will be ineligible to receive any equity awards under the Company’s equity compensation plans, including the Plan, until the participant satisfies the ownership requirements. To assist participants in meeting the stock ownership requirements, on an annual basis, if a participant purchases 500 shares of common stock on the open market, the Company will award that participant 250 shares of common stock. During the six months ended June 30, 2013 and 2012 the Company matched 6,500 and 6,750 shares, respectively. Additionally, any participant who continues to comply with the stock ownership requirements as of the five-year, 10-year, 15-year, 20-year and 25-year anniversaries of the participant’s participation in the Senior Management Compensation Program will receive a restricted stock unit award with a dollar value of $25 thousand, $50 thousand, $75 thousand, $100 thousand and $100 thousand, respectively. Restricted stock unit awards will convert into the right to receive shares of common stock upon a participant’s retirement, or earlier upon the participant’s death or disability or upon a change in control of the Company.

 

Stock-based compensation expense recognized on RSUs for the three and six months ended June 30, 2013 and 2012, respectively, is summarized in the following table:

 

   

For the Three Months Ended

June 30,

   

For the Six Months Ended

June 30,

 
   

2013

   

2012

   

2013

   

2012

 

(in thousands, except per share data)

                               

RSU expense before taxes

  $ 205     $ 272     $ 449     $ 552  

RSU expense after taxes

  $ 120     $ 163     $ 283     $ 335  

Impact per basic share

  $ 0.01     $ 0.01     $ 0.03     $ 0.03  

Impact per diluted share

  $ 0.01     $ 0.01     $ 0.03     $ 0.03  
  

All pre-tax charges related to RSUs were included in the caption “Administrative and general” on the accompanying Consolidated Statements of Comprehensive Income.

 

The following table summarizes the activity related to RSUs for the three and six months ended June 30, 2013:

 

   

Number of

Shares

   

Weighted Average

Granted Price

   

Aggregate

Intrinsic Value

(in thousands)

 

Outstanding at December 31, 2012

    192,819     $ 26.22          

Granted

    37,341       21.33          

Converted into shares

    -       -          

Forfeited

    -       -          

Outstanding at June 30, 2013

    230,160     $ 25.43     $ 251  

Vested at June 30, 2013

    168,808     $ 26.07     $ 196  

  

No RSUs were converted into shares during the six months ended June 30, 2013. During the six months ended June 30, 2012, 375 RSU’s were converted into shares.

 

 
13

 

 

9.

Capital Lease:

 

On April 1, 2013, the Company purchased a facility in Streetsboro, Ohio for $1.4 million that was previously financed under a capital lease agreement. The capital lease obligation of $1.4 million was included in “Current portion of long-term debt” on the accompanying Consolidated Balance Sheets as of December 31, 2012.

 

 

10.

Income Taxes:

 

For the three months ended June 30, 2013, the Company recorded an income tax provision of $1.8 million, or 41.5%, compared to $3.0 million, or 40.2%, for the three months ended June 30, 2012.

 

For the six months ended June 30, 2013, the Company recorded an income tax provision of $4.5 million, or 37.1%, compared to $7.0 million, or 39.4%, for the six months ended June 30, 2012. The lower effective tax rate for the six months ended June 30, 2013 is primarily a result of the tax law changes that went into effect January 1, 2013 extending certain tax credits.

 

Our tax provision for interim periods is determined using an estimate of our annual effective tax rate, adjusted for discrete items that are taken into account in the relevant period. Each quarter we update our estimate of the annual effective tax rate, and if our estimated tax rate changes, we make a cumulative adjustment.

 

Our quarterly tax provision and our quarterly estimate of our annual effective tax rate is subject to significant volatility due to several factors, including variability in accurately predicting our pre-tax and taxable income and loss and the mix of jurisdictions to which they relate, changes in law and relative changes of expenses or losses for which tax benefits are not recognized. Additionally, our effective tax rate can be more or less volatile based on the amount of pre-tax income. For example, the impact of discrete items and non-deductible expenses on our effective tax rate is greater when our pre-tax income is lower.

 

 

11.

Shares Outstanding and Earnings Per Share:

 

Earnings per share have been calculated based on the weighted average number of shares outstanding as set forth below:

 

   

For the Three Months Ended

June 30,

   

For the Six Months Ended

June 30,

 
   

2013

   

2012

   

2013

   

2012

 

(in thousands, except per share data)

                               

Weighted average basic shares outstanding

    11,062       10,960       11,059       10,956  

Assumed exercise of stock options and issuance of stock awards

    10       29       8       31  

Weighted average diluted shares outstanding

    11,072       10,989       11,067       10,987  
                                 

Net income

  $ 2,525     $ 4,526     $ 7,689     $ 10,756  
                                 

Basic earnings per share

  $ 0.23     $ 0.41     $ 0.70     $ 0.98  

Diluted earnings per share

  $ 0.23     $ 0.41     $ 0.69     $ 0.98  
                                 

Anti-dilutive securities outstanding

    199       178       199       178  
 

 

12.

Segment Information:

 

The Company follows the accounting guidance that requires the utilization of a “management approach” to define and report the financial results of operating segments. The management approach defines operating segments along the lines used by the Company’s chief operating decision maker (CODM) to assess performance and make operating and resource allocation decisions. Our CODM evaluates performance and allocates resources based primarily on operating income (loss). Our operating segments are based internal management reporting.

 

The Company operates in two reportable segments: flat products and tubular and pipe products. Through its flat products segment, the Company sells and distributes large volumes of processed carbon, coated, aluminum and stainless flat-rolled sheet, coil and plate products. Through its tubular and pipe products segment, the Company distributes metal tubing, pipe, bar, valve and fittings and fabricates pressure parts supplied to various industrial markets.

 

 
14

 

 

Commencing with the first quarter of 2013, corporate expenses are reported as a separate line item in the segment reporting. Corporate expenses include the unallocated expenses related to managing the entire Company (i.e. both segments), including payroll expenses for certain personnel, expenses related to being a publicly traded entity such as board of directors expenses, audit expenses, and various other professional fees. Prior to 2013, these expenses were included in the flat products segment’s operating results. The 2012 financial information below has been revised to reflect the new reporting structure.

 

The following table provides financial information by segment and reconciles the Company’s operating income by segment to the consolidated income before income taxes for the three and six months ended June 30, 2013 and 2012.

 

     

For the Three Months Ended

June 30,

   

For the Six Months Ended

June 30,

 

(in thousands)

 

2013

   

2012

   

2013

   

2012

 

Net sales

                               
 

Flat products

  $ 267,444     $ 307,887     $ 543,192     $ 624,516  
 

Tubular and pipe products

    63,360       59,478       125,676       124,901  

Total net sales

  $ 330,804     $ 367,365     $ 668,868     $ 749,417  
                                   

Depreciation and amortization

                               
 

Flat products

  $ 4,243     $ 3,952     $ 8,485     $ 7,822  
 

Tubular and pipe products

    1,280       1,183       2,553       2,305  

Total depreciation and amortization

  $ 5,523     $ 5,135     $ 11,038     $ 10,127  
                                   

Operating income

                               
 

Flat products

  $ 4,999     $ 7,273     $ 9,804     $ 15,067  
 

Tubular and pipe products

    3,009       4,445       9,769       10,889  
 

Corporate expenses

    (1,984 )     (1,974 )     (3,968 )     (3,949 )

Total operating income

  $ 6,024     $ 9,744     $ 15,605     $ 22,007  
                                   

Other income (loss), net

    (41 )     5       (17 )     39  
                                   

Income before interest and income taxes

    5,983       9,749       15,588       22,046  
                                   

Interest and other expense on debt

    1,668       2,183       3,366       4,291  
                                   

Income before income taxes

  $ 4,315     $ 7,566     $ 12,222     $ 17,755  

 

     

For the Three Months Ended

June 30,

   

For the Six Months Ended

June 30,

 

(in thousands)

 

2013

   

2012

   

2013

   

2012

 

Capital expenditures

                               
 

Flat products

  $ 717     $ 5,286     $ 1,396     $ 10,732  
 

Tubular and pipe products

    1,348       2,428       2,383       4,951  

Total capital expenditures

  $ 2,065     $ 7,714     $ 3,779     $ 15,683  

     

As of

                 

(in thousands)

 

June 30,

2013

   

December 31,

2012

                 

Goodwill

                               
 

Flat products

  $ 500     $ 500                  
 

Tubular and pipe products

    40,287       40,287                  

Total goodwill

  $ 40,787     $ 40,787                  
                                   

Assets

                               
 

Flat products

  $ 459,240     $ 480,487                  
 

Tubular and pipe products

    223,690       225,507                  

Total assets

  $ 682,930     $ 705,994                  

 

 

 
15

 

 

There were no material intercompany revenue transactions between the flat products and tubular and pipe products segments.

 

The Company sells certain products internationally, primarily in North, Central and South America. International sales are immaterial to the consolidated financial results and to the individual segments’ results.

 

 

13.

Recently Issued Accounting Updates:

 

There were no accounting updates issued in the second quarter of 2013 that would have an impact on the Company’s financial statements.

 

 
16

 

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion and analysis should be read in conjunction with our unaudited consolidated financial statements and accompanying notes contained herein and our consolidated financial statements, accompanying notes and Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the year ended December 31, 2012. The following Management’s Discussion and Analysis of Financial Condition and Results of Operations contain forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from the results discussed in the forward-looking statements. Factors that might cause a difference include, but are not limited to, those discussed under Item 1A (Risk Factors) in our Annual Report on Form 10-K for the year ended December 31, 2012. The following section is qualified in its entirety by the more detailed information, including our financial statements and the notes thereto, which appear elsewhere in this Quarterly Report on Form 10-Q.

 

Forward-Looking Information

 

This Quarterly Report on Form 10-Q and other documents we file with the SEC contain various forward-looking statements that are based on current expectations, estimates, forecasts and projections about our future performance, business, our beliefs and management’s assumptions. In addition, we, or others on our behalf, may make forward-looking statements in press releases or written statements, or in our communications and discussions with investors and analysts in the normal course of business through meetings, conferences, webcasts, phone calls and conference calls. Words such as “may,” “will,” “anticipate,” “should,” “intend,” “expect,” “believe,” “estimate,” “project,” “plan,” “potential,” and “continue,” as well as the negative of these terms or similar expressions, are intended to identify forward-looking statements, which are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are subject to certain risks and uncertainties that could cause our actual results to differ materially from those implied by such statements including, but not limited to:

 

 

 

general and global business, economic, financial and political conditions, including the ongoing effects of the global economic recovery;

 

 

access to capital and global credit markets;

 

 

competitive factors such as the availability and pricing of metals, industry shipping and inventory levels and rapid fluctuations in customer demand and metals pricing;

 

 

cyclicality and volatility within the metals industry;

 

 

the ability of our customers (especially those that may be highly leveraged, and those with inadequate liquidity) to maintain their credit availability;

 

 

the ability to successfully integrate our new locations into our operations and achieve expected results;

 

 

events or circumstances that could adversely impact the successful operation of our processing equipment and operations;

 

 

the ability to comply with the terms of our asset-based credit facility and to make the required term loan payments;

 

 

the ability of our customers and third parties to honor their agreements related to derivative instruments, including the outcome of the MF Global UK Limited administration process;

 

 

customer, supplier and competitor consolidation, bankruptcy or insolvency;

 

 

reduced production schedules, layoffs or work stoppages by our own or our suppliers’ or customers’ personnel;

 

 

the success of union contract renewals;

 

 

the availability and costs of transportation and logistical services;

 

 

the amounts, successes and our ability to continue our capital investments and strategic growth initiatives and our business information system implementations;

 

 

the successes of our strategic efforts and initiatives to increase sales volumes, maintain or improve working capital turnover and free cash flows, improve inventory turnover; improve our customer service, and achieve cost savings;

 

 

the timing and outcome of inventory lower of cost or market adjustments;

 

 

the inflation or deflation existing within the metals industry, as well as our product mix and inventory levels on hand, which can impact our cost of materials sold as a result of the fluctuations in the last-in, first-out, or LIFO, inventory reserve;

 

 

the adequacy of our existing information technology and business system software;

 

 

our ability to pay regular quarterly cash dividends and the amounts and timing of any future dividends;

 

 

our ability to generate free cash flow through operations and decreased future capital expenditures, reduce inventory and repay debt within anticipated time frames;

 

 

events or circumstances that could impair or adversely impact the carrying value of any of our assets;

 

 

risks and uncertainties associated with intangible assets, including potential impairment charges;

 

 

the enacted federal healthcare legislation’s impact on the healthcare benefits required to be provided by us and the impact of such legislation on our compensation and administrative costs;

 

 

unanticipated developments that could occur with respect to contingencies such as litigation and environmental matters, including any developments that would require any increase in our costs for such contingencies; and

 

 

those risks set forth in Item 1A (Risk Factors), as found in our Annual Report on Form 10-K for the year ended December 31, 2012.

 

 
17

 

  

Should one or more of these or other risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, intended, expected, believed, estimated, projected or planned. You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. We undertake no obligation to republish revised forward-looking statements to reflect the occurrence of unanticipated events or circumstances after the date hereof, except as otherwise required by law.

 

Overview

 

We are a leading metals service center that operates in two reportable segments; flat products and tubular and pipe products. We provide metals processing and distribution services for a wide range of customers. Our primary flat products focus is on the direct sale and distribution of large volumes of processed carbon, coated, aluminum and stainless flat-rolled sheet, coil and plate products. Commencing with the July 1, 2011 acquisition of Chicago Tube and Iron Company, or CTI, we distribute metal tubing, pipe, bar, valves and fittings and fabricate pressure parts supplied to various industrial markets. Products that require more value-added processing generally have a higher gross profit. In addition, tubular and pipe products segment gross margins are generally higher than our traditional flat products segment gross margins. Accordingly, our overall gross profit is affected by, among other things, product mix, the amount of processing performed, the demand for and availability of metals, and volatility in selling prices and material purchase costs. We also perform toll processing of customer-owned metals. We sell certain products internationally, primarily in North, Central and South America. International sales are immaterial to our consolidated financial results and to the individual segments’ results.

 

Our results of operations are affected by numerous external factors including, but not limited to: general and global business, economic, financial, banking and political conditions; competition; metals pricing, demand and availability; energy prices; pricing and availability of raw materials used in the production of metals; global supply and inventory held in the supply chain; customers’ ability to manage their credit line availability; and layoffs or work stoppages by our own, our suppliers’ or our customers’ personnel. The metals industry also continues to be affected by the global consolidation of our suppliers, competitors and end-use customers.

 

Like other service centers, we maintain substantial inventories of metals to accommodate the short lead times and just-in-time delivery requirements of our customers. Accordingly, we purchase metals in an effort to maintain our inventory at levels that we believe to be appropriate to satisfy the anticipated needs of our customers based upon customer forecasts, historic buying practices, supply agreements with customers and market conditions. Our commitments to purchase metals are generally at prevailing market prices in effect at the time we place our orders. When metals prices increase, competitive conditions will influence how much of the price increase we can pass on to our customers. To the extent we are unable to pass on future price increases in our raw materials to our customers, the net sales and gross profits of our business could be adversely affected. When metals prices decline, customer demands for lower prices and our competitors’ responses to those demands could result in lower sale prices and, consequently, lower gross profits as we sell existing metals inventory.

 

At June 30, 2013, we employed approximately 1,800 people. Approximately 330 of the hourly plant personnel at our Milan, Illinois; Duluth, Minnesota; Locust, North Carolina; Romeoville, Illinois; Minneapolis, Minnesota; Indianapolis, Indiana; Detroit, Michigan; Kansas City, Missouri; and St. Paul, Minnesota facilities are represented by ten separate collective bargaining units. The table below shows the expiration dates of the collective bargaining agreements.

 

Facility 

 

Expiration date 

Duluth, Minnesota

 

December 21, 2014

Locust, North Carolina

 

March 4, 2015

Romeoville, Illinois

 

May 31, 2015

Minneapolis coil, Minnesota

 

September 30, 2015

Indianapolis, Indiana

 

January 29, 2016

Minneapolis plate, Minnesota

 

March 31, 2017

Detroit, Michigan

 

August 31, 2017

Kansas City, Missouri

 

November 18, 2017

St. Paul, Minnesota

 

May 25, 2018

Milan, Illinois

 

August 12, 2018

  

 
18

 

 

We have never experienced a work stoppage and we believe that our relationship with employees is good. However, any prolonged work stoppages by our personnel represented by collective bargaining units could have a material adverse impact on our business, financial condition, results of operations and cash flows.

 

Reportable Segments

 

We operate in two reportable segments; flat products and tubular and pipe products. We follow the accounting guidance that requires the utilization of a “management approach” to define and report the financial results of operating segments. The management approach defines operating segments along the lines used by the our chief operating decision maker, or CODM, to assess performance and make operating and resource allocation decisions. Our CODM evaluates performance and allocates resources based primarily on operating income (loss). Our operating segments are based on internal management reporting.

 

Commencing with the first quarter of 2013, corporate expenses are now reported as a separate line item in the segment reporting. Corporate expenses include the unallocated expenses related to managing the entire Company (i.e. both segments), including payroll expenses for certain personnel, expenses related to being a publicly traded entity such as board of directors expenses, audit expenses, and various other professional fees. Prior to 2013, these expenses were included in the flat products segment’s operating results. The 2012 financial information below has been revised to reflect the new reporting structure.

 

Flat products

 

The primary focus of our flat products segment is on the direct sale and distribution of large volumes of processed carbon, coated, aluminum and stainless flat-rolled sheet, coil and plate products. We act as an intermediary between metals producers and manufacturers that require processed metals for their operations. We serve customers in most metals consuming industries, including manufacturers and fabricators of transportation and material handling equipment, construction and farm machinery, storage tanks, environmental and energy generation equipment, automobiles, food service and electrical equipment, military vehicles and equipment, as well as general and plate fabricators and metals service centers. We distribute these products primarily through a direct sales force.

 

The flat products segment has 24 strategically-located processing and distribution facilities in the United States and one in Monterrey, Mexico. This geographic footprint allows us to focus on regional customers and larger national and multi-national accounts, primarily located throughout the midwestern, eastern and southern United States. The flat products segment distributes these products primarily through a direct sales force.

 

Tubular and pipe products

 

The tubular and pipe products segment consists of the CTI business, acquired in 2011. Through our tubular and pipe products segment, we distribute metals tubing, pipe, bar, valve and fittings and fabricate pressure parts supplied to various industrial markets. Founded in 1914, CTI operates from nine locations in the midwestern and southeastern United States. The tubular and pipe products segment distributes its products primarily through a direct sales force.

 

 

 
19

 

 

Results of Operations

 

Consolidated Operations

 

The following table presents consolidated operating results for the three and six months ended June 30, 2013 and 2012 (dollars are shown in thousands):

 

   

For the Three Months Ended June 30,

   

For the Six Months Ended June 30,

 
   

2013

   

2012

   

2013

   

2012

 
    $    

% of net sales

    $    

% of net sales

    $    

% of net sales

    $    

% of net sales

 

Net sales

  $ 330,804       100.0     $ 367,365       100.0     $ 668,868       100.0     $ 749,417       100.0  

Cost of materials sold (a)

    261,854       79.2       295,878       80.5       528,008       78.9       602,556       80.4  

Gross profit (b)

    68,950       20.8       71,487       19.5       140,860       21.1       146,861       19.6  

Operating expenses (c)

    62,926       19.0       61,743       16.8       125,255       18.7       124,854       16.7  

Operating income

    6,024       1.8       9,744       2.7       15,605       2.3       22,007       2.9  

Other income (loss), net

    (41 )     (0.0 )     5       0.0       (17 )     (0.0 )     39       0.0  

Interest and other expense on debt

    1,668       0.5       2,183       0.6       3,366       0.5       4,291       0.6  

Income before income taxes

    4,315       1.3       7,566       2.1       12,222       1.8       17,755       2.4  

Income taxes

    1,790       0.5       3,040       0.8       4,533       0.7       6,999       0.9  

Net income

  $ 2,525       0.8     $ 4,526       1.2     $ 7,689       1.1     $ 10,756       1.4  

(a)

Includes $375 thousand of LIFO income for the three months ended June 30, 2013 and $2.3 million of LIFO income for the six months ended June 30, 2013 (inclusive of a $1.9 million out of period LIFO adjustment recorded in the first quarter of 2013).

(b)

Gross profit is calculated as net sales less the cost of materials sold.

(c)

Operating expenses are calculated as total costs and expenses less the cost of materials sold.

 

Net sales decreased 10.0% to $330.8 million in the second quarter of 2013 from $367.4 million in the second quarter of 2012. Flat products net sales were 80.8% of total net sales in the second quarter of 2013 compared to 83.8% of total net sales in the second quarter of 2012. Tubular and pipe products net sales were 19.2% of total net sales in the second quarter of 2013 compared to 16.2% of total net sales in the second quarter of 2012. The decrease in net sales was due to a 6.5% decline in consolidated sales volume as well as a 3.7% decline in consolidated selling prices during the second quarter of 2013 compared to the second quarter of 2012.

 

Net sales decreased 10.7% to $668.9 million in the first six months of 2013 from $749.4 million in the first six months of 2012. Flat products net sales were 81.2% of total net sales in the first six months of 2013 compared to 83.3% of total net sales in the first six months of 2012. Tubular and pipe products net sales were 18.8% of total net sales in the first six months of 2013 compared to 16.7% of total net sales in the first six months of 2012. The decrease in net sales was due to a 6.1% decline in consolidated sales volume as well as a 4.9% decline in consolidated selling prices during the first six months of 2013 compared to the first six months of 2012.

 

Cost of materials sold decreased 11.5% to $261.9 million in the second quarter of 2013 from $295.9 million in the second quarter of 2012. The decrease in the cost of materials sold was due to the decline in consolidated sales volume and lower metals pricing in the second quarter of 2013 compared to the second quarter of 2012 as well as the impact of LIFO income recorded in the second quarter of 2013, which resulted in a decrease to cost of materials sold of $375 thousand. 

 

Cost of materials sold decreased 12.4% to $528.0 million in the first six months of 2013 from $602.6 million in the first six months of 2012. The decrease in cost of materials sold was due to the consolidated decline in sales volume and lower metals pricing in the first six months of 2013 compared to the first six months of 2012 as well as the impact of LIFO income recorded in the first six months of 2013. In the first quarter of 2013, we made an out-of-period adjustment to record previously unrecognized LIFO income, which resulted in a decrease to cost of materials sold of $1.9 million. The total impact of LIFO income for the first six months of 2013 was $2.3 million. 

 

As a percentage of net sales, gross profit (as defined in footnote (b) in the table above) increased to 20.8% in the second quarter of 2013 compared to 19.5% in the second quarter of 2012. As a percentage of net sales, gross profit increased to 21.1% in the first six months of 2013 compared to 19.6% in the first six months of 2012. As a percentage of net sales, the impact of LIFO income in 2013 increased first half gross profit by 0.3% of sales. The increase in gross profit for the three and six months ended June 30, 2013 was primarily due to the cost of materials sold decreasing more than selling prices, as well as the impact of LIFO income. We expect our gross profit in the third quarter of 2013 to be consistent with the second quarter of 2013, excluding LIFO income.

 

 
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Operating expenses in the second quarter of 2013 increased $1.2 million, or 1.9%, to $62.9 million from $61.7 million in the second quarter of 2012. As a percentage of net sales, operating expenses increased to 19.0% for the second quarter of 2013 from 16.8% in the comparable 2012 period. Operating expenses in the flat products segment decreased $2.1 million due to lower variable expenses, such as warehouse and processing, distribution and selling expenses, as a result of lower sales volume and net sales. Operating expenses in the tubular and pipe products segment increased $3.3 million due to increased variable expenses, such as warehouse and processing, distribution and selling expenses, as a result of increased sales volume and sales.

 

Operating expenses in the first six months of 2013 increased $0.4 million, or 0.3%, to $125.3 million from $124.9 million in the first six months of 2012. As a percentage of net sales, operating expenses increased to 18.7% for the first six months of 2013 from 16.7% in the comparable 2012 period. Operating expenses in the flat products segment decreased $3.2 million and operating expenses in the tubular and pipe products segment increased $3.5 million. Variable operating expenses, such as warehouse and processing, distribution and selling expenses, decreased as a result of lower sales volume and net sales. Depreciation and occupancy expenses increased as a result of the recent investments in new facilities. During the second quarter of 2013, we initiated cost reduction initiatives, including headcount reductions and restrictions on temporary labor and overtime as well as heightened control over all discretionary spending, to reduce our operating expenses as a result of the decreased sales volumes and operating income. The impact of the cost reduction efforts is expected to decrease our operating expenses by over $4 million on an annualized basis, and the efforts will reduce our operating expenses commencing in the third quarter of 2013 and continue through the remainder of the year.

 

During the first quarter of 2013, we experienced a failure of a shear on one of our major pieces of processing equipment in the flat products segment which was repaired and became fully operational in May 2013. The incremental expense of approximately $1.0 million during the second quarter of 2013 and $2.0 million for the six months ended June 30, 2013 related to the shear failure has been recorded in the “Cost of materials sold” and “Warehouse and processing” captions in our Consolidated Statements of Comprehensive Income, and a $1.8 million related insurance recovery receivable has been recorded to the same captions in our Consolidated Statements of Comprehensive Income and is included in “Accounts receivable, net” on our Consolidated Balance Sheets as of June 30, 2013. We do not expect to incur any additional expenses during the remainder of 2013 related to the failure of the shear. We expect the expenses to be recoverable under our insurance policy and expect to receive payment from the insurance company by the end of the year.

 

Commencing with the first quarter of 2013, corporate expenses are now reported as a separate line item in the segment reporting and is disclosed separately to reconcile segment operating income to consolidated operating income on the Consolidated Statements of Comprehensive Income. Corporate expenses include the unallocated expenses related to managing the entire Company (i.e. both segments), including payroll expenses for certain personnel, expenses related to being a publicly traded entity such as board of directors expenses, audit expenses, and various other professional fees. Prior to 2013 these expenses were included in the flat products segment’s operating results. Corporate expenses totaled $2.0 million for three months ended June 30, 2013 and June 30, 2012. Corporate expenses totaled $4.0 million and $3.9 million for the six months ended June 30, 2013 and June 30, 2012, respectively.

 

Interest and other expense on debt totaled $1.7 million, or 0.5% of net sales, for the three months ended June 30, 2013 compared to $2.2 million, or 0.6% of net sales, for the three months ended June 30, 2012. Interest and other expense on debt totaled $3.4 million, or 0.5% of net sales, for the six months ended June 30, 2013 compared to $4.3 million, or 0.6% of net sales, for the six months ended June 30, 2012. Our effective borrowing rate, exclusive of deferred financing fees and commitment fees, was 2.2% for the first six months of 2013 compared to 2.9% for the first six months of 2012. The decrease in interest and other expense on debt in 2013 was primarily due to lower average borrowings and the lower effective borrowing rate.

 

For the second quarter of 2013, income before income taxes totaled $4.3 million compared to $7.6 million in the second quarter of 2012. For the second quarter of 2013, income before income taxes included LIFO income of 375 thousand. For the six months ended June 30, 2012, income before income taxes totaled $12.2 million compared to $17.8 million for the six months ended June 30, 2013. The six months ended June 30, 2013 included LIFO income of $2.3 million, inclusive of an out-of-period LIFO income adjustment of $1.9 million.

 

An income tax provision of 41.5% was recorded for the second quarter of 2013, compared to 40.2% for the second quarter of 2012. The higher effective tax rate for the second quarter of 2013 was primarily a result of the impact of permanent non-deductible tax items applied to a lower pre-tax income level. An income tax provision of 37.1% was recorded for the six months ended June 30, 2013, compared to 39.4% for the six months ended June 30, 2012. The lower effective tax rate for the six months ended June 30, 2013 was a result of the tax law changes that went into effect January 1, 2013 extending certain tax credits. Our tax provision for interim periods is determined using an estimate of our annual effective tax rate, adjusted for discrete items that are taken into account in the relevant period. Each quarter we update our estimate of the annual effective tax rate, and if our estimated tax rate changes, we make a cumulative adjustment. We expect our effective tax rate to increase during the remainder of the year, and approximate 37% to 39% on an annual basis in 2013.

 

 
21

 

 

Net income for the second quarter of 2013 totaled $2.5 million or $0.23 per basic and diluted share, compared to $4.5 million or $0.41 per basic and diluted share for the second quarter of 2012. For the second quarter of 2013, the impact of LIFO income increased earnings per share by $0.02 per basic and diluted share. Net income for the six months ended June 30, 2013 totaled $7.7 million or $0.70 per basic share and $0.69 per diluted share, compared to $10.8 million or $0.98 per basic and diluted share for the comparable period in 2012. For the six months ended June 30, 2013, the impact of LIFO income increased earnings per share by $0.13 per basic and diluted shares, inclusive of the out-of-period LIFO income adjustment which increased earnings per share by $0.11 per basic and diluted share.

 

Segment Operations

 

Flat products

 

The following table presents selected operating results for our flat products segment for the three and six months ended June 30, 2013 and 2012 (dollars are shown in thousands):

 

   

For the Three Months Ended June 30,

   

For the Six Months Ended June 30,

 
   

2013

   

2012

   

2013

   

2012

 
           

% of net sales

           

% of net sales

           

% of net sales

           

% of net sales

 

Direct tons sold

    262,628               280,149               532,043               573,687          

Toll tons sold

    18,647               22,205               40,832               39,844          

Total tons sold

    281,275               302,354               572,875               613,531          
                                                                 

Net sales

  $ 267,444       100.0     $ 307,887       100.0     $ 543,192       100.0     $ 624,516       100.0  

Average selling price per ton

    951               1,018               948               1,018          

Cost of materials sold

    216,713       81.0       252,771       82.1       441,664       81.3       514,568       82.4  

Gross profit (a)

    50,731       19.0       55,116       17.9       101,528       18.7       109,948       17.6  

Operating expenses (b)

    45,732       17.1       47,843       15.5       91,724       16.9       94,881       15.2  

Operating income

  $ 4,999       1.9     $ 7,273       2.4     $ 9,804       1.8     $ 15,067       2.4  

(a)

Gross profit is calculated as net sales less the cost of materials sold.

(b)

Operating expenses are calculated as total costs and expenses less the cost of materials sold.

 

Tons sold by our flat products segment decreased 7.0% to 281 thousand in the second quarter of 2013 from 302 thousand in the second quarter of 2012. Tons sold by our flat products segment decreased 6.6% to 573 thousand in the six months ended June 30, 2013 from 614 thousand in the six months ended June 30, 2012. The decreases in tons sold were due to decreased customer demand as evidenced by lower industry-wide shipments in the three and six months ended June 30, 2013 compared to the three and six months ended June 30, 2012.

 

Toll tons sold decreased 16.0% to 19 thousand in the second quarter of 2013 from 22 thousand in the second quarter of 2012. Toll tons sold increased 2.5% to 41 thousand in the six months ended June 30, 2013 from 40 thousand in the six months ended June 30, 2012. Toll tons sold in the second quarter of 2013 was lower than the second quarter of 2012 as the second quarter of 2012 included one-time additional toll business for one of our existing customers while its processing equipment was under repair.

 

Net sales in our flat products segment decreased 13.1% to $267.4 million in the second quarter of 2013 from $307.9 million in the second quarter of 2012. Net sales decreased 13.0% to $543.2 million in the six months ended June 30, 2013 from $624.5 million in the six months ended June 30, 2012. The decrease in sales was due to a 6.6% decline in sales volume as well as a 6.9% decline in metals average sell prices during the six months ended June 30, 2013 compared to the six months ended June 30, 2012. Average selling prices in the second quarter of 2013 were $951 per ton, compared with $1,018 per ton in the second quarter of 2012, and $946 per ton in the first quarter of 2013.

 

Cost of materials sold decreased 14.3% to $216.7 million in the second quarter of 2013 from $252.8 million in the second quarter of 2012. Cost of materials sold decreased 14.2% to $441.7 million in the six months ended June 30, 2013 from $514.6 million in the six months ended June 30, 2012. The decrease in cost of materials sold was due to a decline in sales volume as well as a decline in metals market pricing during the three and six months ended June 30, 2013 compared to the comparable period in 2012.

 

 
22

 

 

As a percentage of net sales, gross profit (as defined in footnote (a) in the table above) totaled 19.0% in the second quarter of 2013 compared to 17.9% in the second quarter of 2012. As a percentage of net sales, gross profit (as defined in footnote (a) in the table above) totaled 18.7% in the six months ended June 30, 2013 compared to 17.6% in the six months ended June 30, 2012. The increase in gross profit percentage for the three and six months ended June 30, 2013 was primarily due to the cost of materials sold decreasing more than selling prices. The average gross margin per ton has stayed relatively flat between the three and six months ended June 30, 2013 and June 30, 2012.

 

Operating expenses in the second quarter of 2013 decreased $2.1 million, or 4.4%, to $45.7 million from $47.8 million in the second quarter of 2012. As a percentage of net sales, operating expenses increased to 17.1% for the three months ended June 30, 2013 from 15.5% for the three months ended June 30, 2012. Operating expenses in the six months ended June 30, 2013 decreased $3.2 million, or 3.3%, to $91.7 million from $94.9 million in the six months ended June 30, 2012. As a percentage of net sales, operating expenses increased to 16.9% for the six months ended June 30, 2013 from 15.2% for the six months ended June 30, 2012. Variable operating expenses, such as distribution, warehouse and processing, and selling expenses, decreased as a result of lower sales volume, net sales and gross margins. Depreciation and occupancy expenses increased as a result of the recent investments in new facilities. During the second quarter of 2013 we initiated cost reduction initiatives to reduce our operating expenses as a result of the decreased sales volumes and operating income. The impact of the cost reduction efforts is expected to decrease our operating expenses during the remainder of the year.

 

During the first quarter of 2013, we experienced a failure of a shear on one of our major pieces of processing equipment in the flat products segment, which was repaired and became fully operational in May 2013. The incremental expense of approximately $1.0 million during the second quarter of 2013 and $2.0 million for the six months ended June 30, 2013 related to the shear failure has been recorded in the “Cost of materials sold” and “Warehouse and processing” captions in our Consolidated Statements of Comprehensive Income, and a $1.8 million related insurance recovery receivable has been recorded to the same captions in our Consolidated Statements of Comprehensive Income and is included in “Accounts receivable, net” on our Consolidated Balance Sheets as of June 30, 2013. We do not expect to incur any additional expenses during the remainder of 2013 related to the failure of the shear. We expect the expenses to be recoverable under our insurance policy and expect to receive payment from the insurance company by the end of the year.

 

Operating income for the second quarter of 2013 totaled $5.0 million, or 1.9% of net sales, compared to $7.3 million, or 2.3% of net sales, in the comparable 2012 period. Operating income for the six months ended June 30, 2013 totaled $9.8 million, or 1.8% of net sales, compared to $15.1 million, or 2.3% of net sales, in the comparable 2012 period.

 

Tubular and pipe products

 

The following table presents selected operating results for our tubular and pipe products segment for the three and six months ended June 30, 2013 and 2012 (dollars are shown in thousands):

 

   

For the Three Months Ended June 30,

   

For the Six Months Ended June 30,

 
   

2013

   

2012

   

2013

   

2012

 
           

% of net sales