zeus20160630_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, 2016

 

(    )

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  

 

 

 

     (I.R.S.Employer

  incorporation or organization)        Identification Number)
           
  22901 Millcreek Boulevard, Suite 650, Highland Hills, OH              44122             
  (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 2, 2016

Common stock, without par value

10,959,293

 

 

                     

                    



 

 
 

 

 

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, 2016 (unaudited) and December 31, 2015 (audited) 

3

 

Consolidated Statements of Comprehensive Income – for the three and six months ended June 30, 2016 and 2015 (unaudited)

4

 

Consolidated Statements of Cash Flows – for the six months ended June 30, 2016 and 2015 (unaudited)

5

 

Supplemental Disclosures of Cash Flow Information – for the six months ended June 30, 2016 and 2015 (unaudited)  

6

 

Notes to Unaudited Consolidated Financial Statements   

7

 

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

16

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk   

28

 

Item 4. Controls and Procedures

29

 

Part II. OTHER INFORMATION

30

 

Item 6. Exhibits   

30

 

SIGNATURES 

31

 

 

 
2

 

 

Part I. FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

Olympic Steel, Inc.

Consolidated Balance Sheets

(in thousands)

 

 

   

As of

 
   

June 30, 2016

   

December 31, 2015

 
   

(unaudited)

   

(audited)

 

Assets

               

Cash and cash equivalents

  $ 3,990     $ 1,604  

Accounts receivable, net

    113,400       92,877  

Inventories, net (includes LIFO debit of $6,555 as of June 30, 2016 and December 31, 2015)

    210,784       206,645  

Prepaid expenses and other

    7,237       7,820  

Total current assets

    335,411       308,946  

Property and equipment, at cost

    374,031       372,129  

Accumulated depreciation

    (212,955 )     (205,591 )

Net property and equipment

    161,076       166,538  

Intangible assets, net

    24,313       24,757  

Other long-term assets

    17,335       13,229  

Total assets

  $ 538,135     $ 513,470  
                 

Liabilities

               

Current portion of long-term debt

  $ 1,825     $ 2,690  

Accounts payable

    71,230       55,685  

Accrued payroll

    10,118       6,884  

Other accrued liabilities

    14,149       11,801  

Total current liabilities

    97,322       77,060  

Credit facility revolver

    142,484       145,800  

Other long-term liabilities

    15,250       11,419  

Deferred income taxes

    25,711       24,496  

Total liabilities

    280,767       258,775  

Shareholders' Equity

               

Preferred stock

    -       -  

Common stock

    128,387       128,129  

Treasury stock

    (699 )     (699 )

Accumulated other comprehensive loss

    -       (70 )

Retained earnings

    129,680       127,335  

Total shareholders' equity

    257,368       254,695  

Total liabilities and shareholders' equity

  $ 538,135     $ 513,470  

 

 

 

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

   

Six months ended

 
   

June 30,

   

June 30,

 
   

2016

   

2015

   

2016

   

2015

 
   

(unaudited)

 

Net sales

  $ 273,608     $ 315,251     $ 531,957     $ 661,116  

Costs and expenses

                               

Cost of materials sold (excludes items shown separately below)

    205,688       255,838       405,508       535,777  

Warehouse and processing

    21,035       21,722       41,527       44,259  

Administrative and general

    16,011       16,014       32,051       33,343  

Distribution

    9,560       9,568       18,767       18,870  

Selling

    6,045       4,900       11,732       10,791  

Occupancy

    2,158       2,306       4,495       5,016  

Depreciation

    4,550       4,628       9,059       9,218  

Amortization

    222       222       444       444  

Goodwill and intangible asset impairment

    -       24,451       -       24,451  

Total costs and expenses

    265,269       339,649       523,583       682,169  

Operating income (loss)

    8,339       (24,398 )     8,374       (21,053 )

Other loss, net

    (58 )     (26 )     (63 )     (58 )

Income (loss) before interest and income taxes

    8,281       (24,424 )     8,311       (21,111 )

Interest and other expense on debt

    1,274       1,471       2,559       3,033  

Income (loss) before income taxes

    7,007       (25,895 )     5,752       (24,144 )

Income tax provision (benefit)

    3,457       (3,635 )     2,969       (2,953 )

Net income (loss)

  $ 3,550     $ (22,260 )   $ 2,783     $ (21,191 )

Net gain (loss) on cash flow hedge

    36       71       114       107  

Tax effect on cash flow hedge

    (14 )     (27 )     (44 )     (41 )

Total comprehensive income (loss)

  $ 3,572     $ (22,216 )   $ 2,853     $ (21,125 )
                                 

Earnings per share:

                               

Net income (loss) per share - basic

  $ 0.32     $ (1.99 )   $ 0.25     $ (1.89 )

Weighted average shares outstanding - basic

    11,216       11,201       11,199       11,198  

Net income (loss) per share - diluted

  $ 0.32     $ (1.99 )   $ 0.25     $ (1.89 )

Weighted average shares outstanding - diluted

    11,216       11,201       11,199       11,198  

 

 

 

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) 

 

 

   

2016

   

2015

 
   

(unaudited)

 

Cash flows from (used for) operating activities:

               

Net income (loss)

  $ 2,783     $ (21,191 )

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

               

Depreciation and amortization

    9,961       10,052  

Goodwill and intangible asset impairment

    -       24,451  

Gain on disposition of property and equipment

    (160 )     -  

Stock-based compensation

    224       1,309  

Other long-term assets

    (4,496 )     (1,022 )

Other long-term liabilities

    5,116       (6,590 )
      13,428       7,009  

Changes in working capital:

               

Accounts receivable

    (20,523 )     (13,908 )

Inventories

    (4,139 )     67,648  

Prepaid expenses and other

    640       10,105  

Accounts payable

    19,482       (25,008 )

Change in outstanding checks

    (3,937 )     6,460  

Accrued payroll and other accrued liabilities

    5,582       (7,427 )
      (2,895 )     37,870  

Net cash from operating activities

    10,533       44,879  
                 

Cash flows from (used for) investing activities:

               

Capital expenditures

    (3,597 )     (4,233 )

Proceeds from disposition of property and equipment

    160       3  

Net cash used for investing activities

    (3,437 )     (4,230 )
                 

Cash flows from (used for) financing activities:

               

Credit facility revolver borrowings

    128,183       209,247  

Credit facility revolver repayments

    (131,499 )     (243,942 )

Industrial revenue bond repayments

    (865 )     (840 )

Credit facility fees and expenses

    (125 )     -  

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

    34       14  

Dividends paid

    (438 )     (440 )

Net cash used for financing activities

    (4,710 )     (35,961 )
                 

Cash and cash equivalents:

               

Net change

    2,386       4,688  

Beginning balance

    1,604       2,238  

Ending balance

  $ 3,990     $ 6,926  

 

  

 

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)

 

 

   

2016

   

2015

 
   

(unaudited)

 
                 

Interest paid

  $ 2,133     $ 2,704  

Income taxes paid

  $ 115     $ 413  

 

 

 

The accompanying notes are an integral part of these consolidated statements.Olympic Steel, Inc.

 

 
6

 

 

Olympic Steel, Inc.

Notes to Unaudited Consolidated Financial Statements

June 30, 2016

 

 

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 2016 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, 2015. All intercompany transactions and balances have been eliminated in consolidation.

 

The Company operates in three reportable segments; carbon flat products, specialty metals flat products, and tubular and pipe products. Through its carbon flat products segment, the Company sells and distributes large volumes of processed carbon and coated flat-rolled sheet, coil and plate products. Through its specialty metals flat products segment, the Company sells and distributes processed aluminum and stainless flat-rolled sheet and coil products, flat bar products and fabricated parts. 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.

 

Corporate expenses are reported as a separate line item for segment reporting purposes. Corporate expenses include the unallocated expenses related to managing the entire Company (i.e., all three 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.

 

 

2.            Accounts Receivable:

 

Accounts receivable are presented net of allowances for doubtful accounts and unissued credits of $2.5 million and $3.1 million as of June 30, 2016 and December 31, 2015, 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.

 

 

3.            Inventories:

 

Inventories consisted of the following:

 

   

Inventory as of

 

(in thousands)

 

June 30, 2016

   

December 31, 2015

 

Unprocessed

  $ 169,296     $ 163,942  

Processed and finished

    41,488       42,703  

Totals

  $ 210,784     $ 206,645  

 

The Company values certain of its tubular and pipe products inventory under the last-in, first-out (LIFO) method. At June 30, 2016 and December 31, 2015, approximately $41.5 million, or 19.7% of consolidated inventory, and $42.7 million, or 20.7% 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.

 

For the six months ended June 30, 2016, the Company did not record any LIFO income or expense as inventory values and quantities at December 31, 2016 are expected to be similar to December 31, 2015. For the six months ended June 30, 2015, the Company recorded $650 thousand of LIFO income as a result of then expected year-over-year decreases in carbon, nickel and base stainless steel pricing and expected lower inventory quantities at December 31, 2015. Of the $650 thousand LIFO income, $400 thousand was recorded in the second quarter of 2015. The LIFO income increased the Company’s inventory balance and decreased its cost of materials sold.

 

 
7

 

 

If the FIFO method had been in use, inventories would have been $6.6 million lower than reported at June 30, 2016 and December 31, 2015.

 

 

4.             Debt:

 

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

       
   

As of

 
   

June 30,

   

December 31,

 

(in thousands)

 

2016

   

2015

 

Asset-based revolving credit facility due June 30, 2019

  $ 142,484     $ 145,800  

Industrial revenue bond due April 1, 2018

    1,825       2,690  

Total debt

    144,309       148,490  

Less current amount

    (1,825 )     (2,690 )

Total long-term debt

  $ 142,484     $ 145,800  

 

The Company’s existing asset-based credit facility (the ABL Credit Facility) is collateralized by the Company’s accounts receivable and inventory. The ABL Credit Facility consists of a revolving credit line of $365 million. Revolver borrowings are limited to the lesser of a borrowing base, comprised of eligible receivables and inventories, or $365 million in the aggregate. The ABL Credit Facility matures on June 30, 2019.

 

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 $30 million or 10.0% of the aggregate amount of revolver commitments ($36.5 million at June 30, 2016), then the Company must maintain a ratio of EBITDA minus certain capital expenditures and cash taxes paid to fixed charges of at least 1.00 to 1.00 for the most recent twelve fiscal month period; (ii) limitations on dividend payments and common stock repurchases; and (iii) restrictions on additional indebtedness. 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 0.25% or the London Interbank Offered Rate (LIBOR) plus a premium ranging from 1.25% to 3.00%.

 

As of June 30, 2016, the Company was in compliance with its covenants and had approximately $105 million of availability under the ABL Credit Facility. 

 

As of June 30, 2016, $2.5 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 five-year term of the ABL Credit facility and are included in “Interest and other expense on debt” on the accompanying Consolidated Statements of Comprehensive Income.

 

In June 2012, the Company entered into a forward starting fixed rate interest rate hedge that commenced 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, which matured on June 1, 2016, fixed the rate at 1.21% plus a premium ranging from 1.25% to 1.75%.

 

As part of the Chicago Tube and Iron (CTI) acquisition in July 2011, the Company assumed approximately $5.9 million of Industrial Revenue Bond (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. On April 1, 2016, the Company paid an optional principal payment of $865 thousand. Since the IRB is remarketed annually, it is included in “Current portion of long-term debt” on the accompanying Consolidated Balance Sheets. 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, 2016 was 0.7% 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, 2016, 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.

 

 
8

 

 

5.            Derivative Instruments:

 

Metals swaps and embedded customer derivatives

 

During 2016 and 2015, the Company entered into nickel swaps indexed to the London Metal Exchange (LME) price of nickel with third-party brokers. The nickel swaps are accounted for as derivatives for accounting purposes. The Company entered into them to mitigate its customers’ risk of volatility in the price of metals. The outstanding nickel swaps have one to five months remaining. The swaps 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 metals 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 metals swaps.

 

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 metals and embedded customer derivative instruments are included in “Cost of materials sold” in the Consolidated Statements of Comprehensive Income. The Company recognizes derivative positions with both the customer and the third party for the derivatives and classifies cash settlement amounts associated with them as part of “Cost of materials sold” in the Consolidated Statements of Comprehensive Income. The cumulative change in fair value of the metals swaps that have not yet been settled are included in “Accounts receivable, net”, and the embedded customer derivatives are included in “Other accrued liabilities” on the Consolidated Balance Sheets at June 30, 2016. At December 31, 2015, the cumulative change in fair value of the metals swaps that had not yet settled were included in “Other accrued liabilities”, and the embedded customer derivatives were included in “Accounts receivable, net” on the Consolidated Balance Sheets.

 

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, which matured on June 1, 2016, fixed the rate at 1.21% plus a premium ranging from 1.25% to 1.75%.. The fixed rate interest rate hedge was accounted for as a cash flow hedging instrument for accounting purposes.

 

 
9

 

 

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 and six months ended June 30, 2016 and 2015. 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, 2016 and 2015.

       
   

Net Gain (Loss) Recognized

 
   

For the Three Months

Ended June 30,

   

For the Six Months

Ended June 30,

 

(in thousands)

 

2016

   

2015

   

2016

   

2015

 

Interest rate swap (CTI)

  $ (13 )   $ (18 )   $ (33 )   $ (35 )

Fixed interest rate swap (ABL)

    (37 )     (95 )     (98 )     (194 )

Metals swaps

    138       (270 )     62       (1,387 )

Embedded customer derivatives

    (138 )     270       (62 )     1,387  

Total loss

  $ (50 )   $ (113 )   $ (131 )   $ (229 )

 

 

6.           Fair Value of Financial Instruments:

 

During the three months ended June 30, 2016, 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, 2016 since December 31, 2015. Following is a description of the valuation methodologies used for assets and liabilities measured at fair value as of June 30, 2016 and December 31, 2015:

 

Metals 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 swaps – 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, 2016

 

(in thousands)

 

Level 1

   

Level 2

   

Level 3

   

Total

 

Assets:

                               

Metals swaps

  $ -     $ 85     $ -     $ 85  

Total assets at fair value

  $ -     $ 85     $ -     $ 85  
                                 

Liabilities:

                               

Embedded customer derivative

  $ -     $ 85     $ -     $ 85  

Interest rate swap (CTI)

    -       69       -       69  

Total liabilities recorded at fair value

  $ -     $ 154     $ -     $ 154  

 

   

Value of Items Not Recorded at Fair Value

 
   

As of June 30, 2016

 

(in thousands)

 

Level 1

   

Level 2

   

Level 3

   

Total

 

Liabilities:

                               

IRB

  $ 1,825     $ -     $ -     $ 1,825  

Revolver

    -       142,484       -       142,484  

Total liabilities not recorded at fair value

  $ 1,825     $ 142,484     $ -     $ 144,309  

 

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

 

 
10

 

 

   

Value of Items Recorded at Fair Value

 
   

As of December 31, 2015

 

(in thousands)

 

Level 1

   

Level 2

   

Level 3

   

Total

 

Assets:

                               

Embedded customer derivative

  $ -     $ 384     $ -     $ 384  

Total assets at fair value

  $ -     $ 384     $ -     $ 384  
                                 

Liabilities:

                               

Metals swaps

  $ -     $ 384     $ -     $ 384  

Interest rate swap (CTI)

    -       102       -       102  

Fixed interest rate swap (ABL)

    -       114       -       114  

Total liabilities recorded at fair value

  $ -     $ 600     $ -     $ 600  
       
   

Value of Items Not Recorded at Fair Value

 
   

As of December 31, 2015

 

(in thousands)

 

Level 1

   

Level 2

   

Level 3

   

Total

 

Liabilities:

                               

IRB

  $ 2,690     $ -     $ -     $ 2,690  

Revolver

    -       145,800       -       145,800  

Total liabilities not recorded at fair value

  $ 2,690     $ 145,800     $ -     $ 148,490  

 

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

 

The fair value of the IRB is determined using Level 1 inputs. The carrying value and the fair value of the IRB that qualify as financial instruments was $1.8 million and $2.7 million at June 30, 2016 and December 31, 2015, respectively.

 

The fair value of the revolver is determined using Level 2 inputs. The Level 2 fair value of the Company's long-term debt was estimated using prevailing market interest rates on debt with similar credit worthiness, terms and maturities.

 

 

7.           Equity Plans:

  

Pursuant to the Amended and Restated Olympic Steel 2007 Omnibus Incentive Plan (Plan), the Company may 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, 1,000,000 shares of common stock are available for equity grants.

 

On May 1, 2016 and March 1, 2015, the Compensation Committee of the Company’s Board of Directors approved the grant of 3,094 and 4,639 restricted stock units (RSUs), respectively, 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.

 

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 $22.62 and $15.09 on May 1, 2016 and March 1, 2015, respectively.

 

The Company’s Senior Management Compensation Program includes an equity component in order to encourage more ownership of common stock by the senior management. The Senior Management Compensation Program imposes 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 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, 2016 and 2015, the Company matched 2,500 and 7,750 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.

 

 
11

 

  

The above liability award plan will be terminated during 2016 and replaced with a new equity award plan discussed below. As part of the termination of the old plan and the transition to the new plan, participants were paid the RSU grants that were earned to date, or a pro-rata amount of the RSUs earned, depending on the individual participants’ length of time they participated in the plan. After the payment of the RSUs noted above, the remaining liability of approximately $880 thousand was reversed in the second quarter of 2016 in accordance with Accounting Standards Codification No. 718.

 

On July 1, 2016, the Company created a new Senior Management Stock Incentive Program for certain participants. Under the new program, each participant is awarded RSUs with a dollar value equal to 10% of the participant’s base salary, up to a maximum of $17,500. The RSUs have a five-year vesting period and the RSUs 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 or income recognized on RSUs for the three and six months ended June 30, 2016 and 2015, respectively, is summarized in the following table:

 

   

For the Three Months Ended

   

For the Six Months Ended

 
   

June 30,

   

June 30,

 

(in thousands, except per share data)

 

2016

   

2015

   

2016

   

2015

 

RSU expense (income) before taxes

  $ (570 )   $ 311     $ (332 )   $ 542  

RSU expense (income) after taxes

  $ (289 )   $ 191     $ (160 )   $ 317  

 

All pre-tax income and expense 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 six months ended June 30, 2016:

 

                   

Aggregate

 
   

Number of

   

Weighted Average

   

Intrinsic Value

 
   

Shares

   

Granted Price

   

(in thousands)

 

Outstanding at December 31, 2015

    287,894     $ 22.39          

Granted

    110,429       12.91          

Converted into shares

    -       -          

Forfeited

    -       -          

Outstanding at June 30, 2016

    398,323     $ 19.76     $ 3,264  

Vested at June 30, 2016

    390,175     $ 19.68     $ 3,227  

 

No RSUs were converted into shares during the six months ended June 30, 2016. During the six months ended June 30, 2015, 2,437 RSUs were converted into shares.

 

 

8.           Income Taxes:

  

For the three months ended June 30, 2016, the Company recorded an income tax provision of $3.5 million, or 49.3% of pre-tax income, compared to an income tax benefit of $3.6 million, or 14.0%, for the three months ended June 30, 2015. During the three months ended June 30, 2016, the Company recorded a valuation allowance of $0.7 million to reduce certain state deferred tax assets to the amount that is more likely than not to be realized. The valuation allowance increased the Company’s effective tax rate by 9.4% for the three months ended June 30, 2016. During the three months ended June 30, 2015, the Company recorded a $16.5 million goodwill impairment charge pertaining to its tubular and pipe products segment. This non-deductible impairment charge reduced the Company’s effective tax rate by 24.5% for the three months ended June 30, 2015.

 

For the six months ended June 30, 2016, the Company recorded an income tax provision of $3.0 million, or 51.6% of pre-tax income, compared to an income tax benefit of $3.0 million, or 12.2%, for the six months ended June 30, 2015. During the six months ended June 30, 2016, the Company recorded a valuation allowance of $0.7 million to reduce certain state deferred tax assets to the amount that is more likely than not to be realized. The valuation allowance increased the Company’s effective tax rate by 11.4% for the six months ended June 30, 2016. During the six months ended June 30, 2015, the Company recorded a $16.5 million goodwill impairment charge pertaining to its tubular and pipe products segment. This non-deductible impairment charge reduced the Company’s effective tax rate by 26.2% for the six months ended June 30, 2015.

 

 
12

 

 

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.

 

 

9.           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

   

For the Six Months Ended

 
   

June 30,

   

June 30,

 

(in thousands, except per share data)

 

2016

   

2015

   

2016

   

2015

 

Weighted average basic shares outstanding

    11,216       11,201       11,199       11,198  

Assumed exercise of stock options and issuance of stock awards

    -       -       -       -  

Weighted average diluted shares outstanding

    11,216       11,201       11,199       11,198  

Net income (loss)

  $ 3,550     $ (22,260 )   $ 2,783     $ (21,191 )

Basic earnings (loss) per share

  $ 0.32     $ (1.99 )   $ 0.25     $ (1.89 )

Diluted earnings (loss) per share

  $ 0.32     $ (1.99 )   $ 0.25     $ (1.89 )

Anti-dilutive securities outstanding

    129       -       129       -  

 

 

10.          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 primarily on internal management reporting.

 

The Company operates in three reportable segments; carbon flat products, specialty metals flat products, and tubular and pipe products. The flat products segments’ assets and resources are shared by the carbon and specialty metals segments and both segments’ products are stored in the shared facilities and processed on the shared equipment. As such, total assets and capital expenditures are reported in the aggregate for the flat products segments. Due to the shared assets and resources, certain of the flat products segment expenses are allocated between the carbon flat products segment and the specialty metals flat products segment based upon an established allocation methodology. Through its carbon flat products segment, the Company sells and distributes large volumes of processed carbon and coated flat-rolled sheet, coil and plate products. Through its specialty metals flat products segment, the Company sells and distributes processed aluminum and stainless flat-rolled sheet and coil products, flat bar products and fabricated parts. 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.

 

Corporate expenses are reported as a separate line item for segment reporting purposes. Corporate expenses include the unallocated expenses related to managing the entire Company (i.e., all three 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.

 

 
13

 

 

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, 2016 and 2015.

 

   

For the Three Months Ended

   

For the Six Months Ended

 
   

June 30,

   

June 30,

 

(in thousands)

 

2016

   

2015

   

2016

   

2015

 

Net sales

                               

Carbon flat products

  $ 173,122     $ 209,207     $ 334,556     $ 437,752  

Specialty metals flat products

    49,529       52,715       95,359       105,346  

Tubular and pipe products

    50,957       53,329       102,042       118,018  

Total net sales

  $ 273,608     $ 315,251     $ 531,957     $ 661,116  
                                 

Depreciation and amortization

                               

Carbon flat products

  $ 2,988     $ 3,147     $ 5,942     $ 6,308  

Specialty metals flat products

    190       190       383       350  

Tubular and pipe products

    1,568       1,488       3,127       2,953  

Corporate

    26       25       51       51  

Total depreciation and amortization

  $ 4,772     $ 4,850     $ 9,503     $ 9,662  
                                 

Operating income (loss)

                               

Carbon flat products

  $ 5,669     $ (298 )   $ 3,491     $ 173  

Specialty metals flat products

    2,567       (574 )     4,323       16  

Tubular and pipe products

    2,133       2,504       4,376       6,758  

Corporate expenses

    (2,030 )     (1,579 )     (3,816 )     (3,549 )

Goodwill and intangible asset impairment (a)

    -       (24,451 )     -       (24,451 )

Total operating income (loss)

  $ 8,339     $ (24,398 )   $ 8,374     $ (21,053 )

Other loss, net

    (58 )     (26 )     (63 )     (58 )

Income (loss) before interest and income taxes

    8,281       (24,424 )     8,311       (21,111 )

Interest and other expense on debt

    1,274       1,471       2,559       3,033  

Income (loss) before income taxes

  $ 7,007     $ (25,895 )   $ 5,752     $ (24,144 )

 

(a) The goodwill and intangible asset impairments relate to the Company's tubular and pipe products segment.

 

 

   

For the Three Months Ended

   

For the Six Months Ended

 
   

June 30,

   

June 30,

 

(in thousands)

 

2016

   

2015

   

2016

   

2015

 

Capital expenditures

                               

Flat products segments

  $ 1,551     $ 918     $ 2,785     $ 2,106  

Tubular and pipe products

    650       1,624       812       2,127  

Corporate

    -       -       -       -  

Total capital expenditures

  $ 2,201     $ 2,542     $ 3,597     $ 4,233  

 

 

   

As of

 
   

June 30,

   

December 31,

 

(in thousands)

 

2016

   

2015

 

Total assets

               

Flat products segments

  $ 343,168     $ 329,885  

Tubular and pipe products

    194,562       183,129  

Corporate

    405       456  

Total assets

  $ 538,135     $ 513,470  

 

There were no material revenue transactions between the carbon flat products, specialty metals products, and tubular and pipe products segments.

 

The Company sells certain products internationally, primarily in Canada, Puerto Rico and Mexico. International sales are immaterial to the consolidated financial results and to the individual segments’ results.

 

 

11.           Recently Issued Accounting Updates:

 

In March 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No 2016-09, “Improvements to Employee Share-Based Payment Accounting”. This ASU is part of the FASB’s Simplification Initiative and has been issued to reduce complexity in the presentation of employee share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The guidance will be effective for annual reporting periods beginning after December 15, 2016 and interim periods within those fiscal years with early adoption permitted. We are evaluating the impact of the future adoption of this standard on our consolidated financial statements.

 

 
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In February 2016, the FASB, issued ASU No. 2016-02, “Leases”, which specifies the accounting for leases. The objective is to establish the principles that lessees and lessors shall apply to report useful information to users of financial statements about the amount, timing and uncertainty of cash flows arising from a lease. This ASU introduces the recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases under previous guidance. The guidance will be effective for annual reporting periods beginning after December 15, 2018 and interim periods within those fiscal years with early adoption permitted. We are in the process of evaluating the impact of the future adoption of this standard on our consolidated financial statements.

 

In November 2015, the FASB issued ASU No. 2015-17, “Balance Sheet Classification of Deferred Taxes.” This ASU is part of the FASB’s Simplification Initiative and has been issued to reduce complexity in the presentation of deferred taxes. This new guidance eliminates the requirement for entities that present a classified statement of financial position to classify deferred tax assets and liabilities as current and noncurrent, and instead require that they classify all deferred tax assets and liabilities as noncurrent. As a result, each jurisdiction will now only have one net noncurrent deferred tax asset or liability. However, the guidance does not change the existing requirement that only permits offsetting within a jurisdiction. Companies are still prohibited from offsetting deferred tax liabilities from one jurisdiction against deferred tax assets of another jurisdiction. This ASU is effective for financial statements issued for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years, with early adoption permitted. The guidance may be applied either prospectively, for all deferred tax assets and liabilities, or retrospectively (i.e., by reclassifying the comparative balance sheet). If applied prospectively, entities are required to include a statement that prior periods were not retrospectively adjusted. If applied retrospectively, entities are also required to include quantitative information about the effects of the change on prior periods. The prospective adoption of this guidance on January 1, 2016 did not have a material impact on the Company’s consolidated financial statements and the prior periods were not retrospectively adjusted.

 

In April 2015, the FASB issued ASU No. 2015-03, “Simplifying the Presentation of Debt Issuance Costs.” This ASU is part of the FASB’s Simplification Initiative and has been issued to reduce the complexity in the presentation of debt issuance costs. This new guidance requires companies to present debt issuance costs the same way they currently present debt discounts, as a direct deduction from the carrying value of that debt liability. The guidance is limited to simplifying the presentation of debt issuance costs and does not impact the recognition and measurement guidance for debt issuance costs. This ASU is effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years, with early adoption permitted. The amendments of ASU No. 2015-03 must be applied retrospectively, where the balance sheet of each presented individual period is adjusted to indicate the period-specific impact of using the new guidance. The FASB considered that because both debt issuance costs and debt discounts are amortized using the effective interest method, there would be no effect on the income statement upon adoption of the amendments. The adoption of this guidance on January 1, 2016 did not have an impact on the Company’s consolidated financial statements because it does not apply to revolving credit agreements.

 

In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers.” This ASU is a joint project initiated by the FASB and the International Accounting Standards Board to clarify the principles for recognizing revenue and to develop a common revenue standard for U.S. generally accepted accounting principles and International Financial Reporting Standards that will: remove inconsistencies and weaknesses in revenue requirements; provide a more robust framework for addressing revenue issues; improve comparability of revenue recognition practices across entities, industries, jurisdictions and capital markets; provide more useful information to users of financial statements through improved disclosure requirements; and simplify the preparation of financial statements by reducing the number of requirements to which an entity must refer. As originally proposed, the guidance is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. The Company is in the process of determining the method of adoption and assessing the impact of this ASU on its consolidated financial statements, and interim periods within those fiscal years, with early adoption permitted. In August 2015, the FASB issued ASU No. 2015-14, “Revenue from Contracts with Customers.” This ASU deferred the effective date of ASU No. 2014-09 by one year.

 

 
15

 

 

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, 2015. 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, 2015. 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;

 

competitive factors such as the availability, global production levels 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 strengthening of the U.S. dollar and the related impact on foreign steel pricing, U.S. exports, and foreign imports to the United States;

 

the levels of imported steel in the United States;

 

the availability and costs of transportation and logistical services;

 

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

 

our ability to generate free cash flow through operations and limited 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 additional impairment charges related to indefinite lived intangible assets;

 

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

 

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

 

the successes of our operational excellence initiatives to improve our operating, cultural and management systems and reduce our costs;

 

the ability to comply with the terms of our asset-based credit facility;

 

the ability of our customers and third parties to honor their agreements related to derivative instruments;

 

customer, supplier and competitor consolidation, bankruptcy or insolvency;

 

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

 

the impacts of union organizing activities and the success of union contract renewals;

 

the timing and outcomes of inventory lower of cost or market adjustments and last-in, first-out, or LIFO, income, especially during periods of declining market pricing;

 

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

 

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 LIFO inventory valuation;

     
 
16

 

 

 

the adequacy of our existing information technology and business system software, including duplication and security processes;

 

the adequacy of our efforts to mitigate cyber security risks and threats;

 

access to capital and global credit markets;

 

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

 

our ability to repurchase shares of our common stock and the amounts and timing of repurchases, if any; and

 

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

 

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 three reportable segments; carbon flat products, specialty metals flat products, and tubular and pipe products. We provide metals processing and distribution services for a wide range of customers. Our carbon flat products segment’s focus is on the direct sale and distribution of large volumes of processed carbon and coated flat-rolled sheet, coil and plate products and fabricated parts. Our specialty metals flat products segment’s focus is on the direct sale and distribution of processed aluminum and stainless flat-rolled sheet and coil products, flat bar products and fabricated parts. In addition, 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. 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 Canada, Puerto Rico and Mexico. 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; fluctuations in the value of the U.S. dollar to foreign currencies, competition; metals pricing, demand and availability; energy prices; pricing and availability of raw materials used in the production of metals; global supply, the level of metals imported into the United States, 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 metals 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.  We have entered into nickel and carbon swaps at the request of our customers in order to mitigate our customers’ risk of volatility in the price of metals, and we have entered into metals hedges to mitigate our risk of volatility in the price of metals.  We have no long-term, fixed-price metals purchase contracts.  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 and earnings as we use existing metals inventory.  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.

 

 
17

 

 

At June 30, 2016, we employed approximately 1,750 people. Approximately 296 of the hourly plant personnel at the facilities listed below are represented by nine separate collective bargaining units. The table below shows the expiration dates of the collective bargaining agreements.

   

Facility

Expiration date

Minneapolis plate, Minnesota

March 31, 2017

Detroit, Michigan

August 31, 2017

Duluth, Minnesota

December 21, 2017

St. Paul, Minnesota

May 25, 2018

Milan, Illinois

August 12, 2018

Locust, North Carolina

March 4, 2020

Romeoville, Illinois

May 31, 2020

Minneapolis coil, Minnesota

September 30, 2020

Indianapolis, Indiana

January 29, 2021

 

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

 

The Company operates in three reportable segments; carbon flat products, specialty metals flat products and tubular and pipe products. The flat products segments’ assets and resources are shared by the carbon and specialty metals segments and both segments’ products are stored in shared facilities and processed on shared equipment. As such, total assets and capital expenditures are reported in the aggregate for the flat products segments. Due to the shared assets and resources, certain of the flat products segment expenses are allocated between the carbon flat products segment and the specialty metals flat products segment based upon an established allocation methodology.

 

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 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. Our operating segments are based on internal management reporting.

 

Due to the nature of the products sold in each segment, there are significant differences in the segments’ average selling price and the cost of materials sold. The tubular and pipe products segment generally has the highest average selling price among the three segments followed by the specialty metals flat products and carbon flat products segments. Due to the nature of the tubular and pipe products, we do not report tons sold or per ton information. Gross profit per ton is generally higher in the specialty metals flat products segment than the carbon flat products segment. Gross profit as a percentage of net sales is generally highest in the tubular and pipe products segment, followed by the carbon and specialty metals flat products segments.

 

Due to the differences in average selling prices, gross profit and gross profit percentage among the segments, a change in the mix of sales could impact total net sales, gross profit, and gross profit percentage. In addition, certain inventory in the tubular and pipe products segment is valued under the LIFO method. Adjustments to the LIFO inventory value are recorded to cost of materials sold and may impact the gross margin and gross margin percentage at the consolidated Company and tubular and pipe products segment levels.

 

Corporate expenses are reported as a separate line item for segment reporting purposes. Corporate expenses include the unallocated expenses related to managing the entire Company (i.e., all three 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.

 

Carbon flat products

 

The primary focus of our carbon flat products segment is on the direct sale and distribution of large volumes of processed carbon and coated flat-rolled sheet, coil and plate products and fabricated parts. 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, 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.

 

 
18

 

 

Specialty metals flat products

 

The primary focus of our specialty metals flat products segment is on the direct sale and distribution of processed stainless and aluminum flat-rolled sheet and coil products, flat bar products and fabricated parts. We act as an intermediary between metals producers and manufacturers that require processed metals for their operations. We serve customers in various industries, including manufacturers of food service and commercial appliances, agriculture equipment, transportation and automotive equipment. We distribute these products primarily through a direct sales force.

 

Combined, the carbon and specialty metals flat products segments have 23 strategically-located processing and distribution facilities in the United States and one in Monterrey, Mexico. Many of our facilities service both the carbon and the specialty metals flat products segments, and certain assets and resources are shared by the segments. Our 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.

 

Tubular and pipe products

 

The tubular and pipe products segment consists of the Chicago Tube and Iron, or CTI, business, acquired in 2011. Through our tubular and pipe products segment, we distribute metal 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.

 

Corporate expenses

 

Corporate expenses are reported as a separate line item for segment reporting purposes. Corporate expenses include the unallocated expenses related to managing the entire Company (i.e., all three 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.

 

Results of Operations

  

Our results of operations are heavily impacted by the market price of metals. Over the past 18 months, metals prices have fluctuated significantly and changes to our net sales, cost of materials sold, gross profit and cost of inventory, are all impacted by industry metals pricing.

 

During 2015, the price of hot-rolled carbon coil index pricing declined by approximately 36% as a result of the strengthened U.S. dollar, a historically high level of imported material arriving in the United States, low raw material costs to produce metals and a global oversupply of metals. The pricing environment in 2015 drove our average selling price down and caused margins to be pressured as the average cost of inventory did not decrease as quickly as the average selling price as we traditionally keep approximately two and a half to three months of inventory on hand.

 

During the first six months of 2016, the price of metals increased, specifically during the second quarter of 2016, where the price of hot-rolled carbon coil index pricing increased 38% over the March 2016 price, and fully recovered the decrease experienced during 2015. Prices recovered twice as fast as the 2015 decline, due to decreased domestic and North American production levels, decreased imports resulting from the U.S. steel trade cases filed in 2015, and an increase in raw material pricing during 2016. Although prices are sequentially increasing in 2016, the second quarter and first half average selling prices are still lower year-over-year compared to 2015. Spot selling prices generally move in tandem with market price changes, while contract selling prices typically lag and reset quarterly. Similarly, inventory costs (and therefor cost of materials sold) tend to move slower than market selling price changes due to mill lead times and inventory turnover impacting the rate of change in average cost. Our average cost of flat rolled inventory did not begin to increase until May of 2016 even though market prices have been increasing since mid-December of 2015. As a result, our average selling prices in 2016 are still lower than our average selling prices in 2015, and together with lower industry wide shipments, decreased our net sales in 2016. However, due to lower average inventory costs, and lower cost of materials sold, we were able to improve our gross profit as a percentage of net sales, which positively impacted our results for the three and six months ended June 30, 2016.

 

 
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Consolidated Operations

 

The following table presents consolidated operating results for the periods indicated (dollars are shown in thousands):

 

   

For the Three Months Ended June 30,

   

For the Six Months Ended June 30,

 
   

2016

   

2015

   

2016

   

2015

 
           

% of net sales

           

% of net sales

           

% of net sales

           

% of net sales

 

Net sales

  $ 273,608       100.0     $ 315,251       100.0     $ 531,957       100.0     $ 661,116       100.0  

Cost of materials sold (a)

    205,688       75.2       255,838       81.2       405,508       76.2       535,777       81.0  

Gross profit (b)

    67,920       24.8       59,413       18.8       126,449       23.8       125,339       19.0  

Operating expenses (c)

    59,581       21.8       59,360       18.8       118,075       22.2       121,941       18.5  

Goodwill and intangible asset impairment (d)

    -       -       24,451       7.7       -       -       24,451       3.7  

Operating income (loss)

  $ 8,339       3.0     $ (24,398 )     (7.7 )   $ 8,374       1.6     $ (21,053 )     (3.2 )

Other loss, net

    58       0.0       26       0.0       63       0.0       58       0.0  

Interest and other expense on debt

    1,274       0.4       1,471       0.5       2,559       0.5       3,033       0.5  

Income (loss) before income taxes

    7,007       2.6       (25,895 )     (8.2 )     5,752       1.1       (24,144 )     (3.7 )

Income taxes

    3,457       1.3       (3,635 )     (1.1 )     2,969       0.6       (2,953 )     (0.5 )

Net income (loss)

    3,550       1.3       (22,260 )     (7.1 )     2,783       0.5       (21,191 )     (3.2 )

 

(a)

Includes $400 and $650 of LIFO income for the three and six months ended June 30, 2015, respectively. There was no LIFO impact recorded in 2016.

(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. 2015 excludes a non-cash $16,451 goodwill impairment charge and a non-cash $8,000 intangible asset impairment charge for the tubular and pipe products segment. (See note d).

(d)

Goodwill and intangible asset impairment charges pertaining to the pipe and tube segment is separately displayed for comparability purposes.

 

Net sales decreased $41.7 million, or 13.2%, to $273.6 million in the second quarter of 2016 from $315.3 million in the second quarter of 2015. Carbon flat products net sales were 63.3% of total net sales in the second quarter of 2016 compared to 66.4% of total net sales in the second quarter of 2015. Specialty metals flat products net sales were 18.1% of total net sales in the second quarter of 2016 compared to 16.7% of total net sales in the second quarter of 2015. Tubular and pipe products net sales were 18.6% of total net sales in the second quarter of 2016 compared to 16.9% of total net sales in the second quarter of 2015. The decrease in net sales was primarily due to a 12.5% decrease in average selling prices during the second quarter of 2016 compared to the second quarter of 2015 as the sales volume decreased less than 1% between the quarters. Average selling prices increased sequentially from the first quarter of 2016 by approximately 3.3%. Sales volumes decreased in the carbon flat products segment and increased in the specialty metals flat products and tubular and pipe products segments during the second quarter of 2016 compared to the second quarter of 2015. Average direct selling prices decreased in all segments during the second quarter of 2016 compared to the second quarter of 2015 as a result of year over year lower market pricing for metals.

 

Net sales decreased $129.1 million, or 19.5%, to $532.0 million during the six months ended June 30, 2016 from $661.1 million during the six months ended June 30, 2015. Carbon flat products net sales were 62.9% of total net sales in the first six months of 2016 compared to 66.2% of total net sales in the first six months of 2015. Specialty metals flat products net sales were 17.9% of total net sales in the first six months of 2016 compared to 15.9% of total net sales in the first six months of 2015. Tubular and pipe products net sales were 19.2% of total net sales in the first six months of 2016 compared to 17.9% of total net sales in the first six months of 2015. The decrease in net sales was due to a 1.8% decrease in sales volume, driven by a 7.1% decline in industry-wide shipments, and an 18.1% decline in average selling prices during the six months ended June 30, 2016 compared to the six months ended June 30, 2015. Sales volumes decreased in the carbon flat products segment and increased in the specialty metals flat products and tubular and pipe products segments during the first six months of 2016 compared to the first six months of 2015. Average direct selling prices decreased in all segments during the first six months of 2016 compared to the first six months of 2015 as market pricing for metals is still lower year-over-year even though pricing increased sequentially from the first quarter of 2016 and the second half of 2015.

 

Cost of materials sold decreased $50.1 million, or 19.6%, to $205.7 million in the second quarter of 2016 from $255.8 million in the second quarter of 2015. The decrease in cost of materials sold in the second quarter of 2016 is primarily related to lower metals pricing discussed above.

 

 
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Cost of materials sold decreased $130.3 million, or 24.3%, to $405.5 million during the six months ended June 30, 2016 from $535.8 million during the six months ended June 30, 2015. The decrease in cost of materials sold was due to the decrease in metals cost during the six months ended June 30, 2016 compared to the six months ended June 30, 2015 discussed above.

 

As a percentage of net sales, gross profit (as defined in footnote (b) in the table above) increased to 24.8% in the second quarter of 2016 compared to 18.8% in the second quarter of 2015. As a percentage of net sales, gross profit increased to 23.8% in the six months ended June 30, 2016 compared to 19.0% in the six months ended June 30, 2015. The increase in the gross profit percentage during both periods is a result of metals prices sequentially increasing during the first six months of 2016, while our average cost of inventory and cost of materials sold contained lower-costed metal as we historically hold approximately two and a half to three months of material in inventory. This contrast to the declining metals pricing environment during the second quarter of 2015, when the average cost of inventory and cost of materials sold contained higher-costed metal.

 

Operating expenses in the second quarter of 2016 decreased $24.2 million, or 28.9%, to $59.6 million from $83.8 million in the second quarter of 2015. As a percentage of net sales, operating expenses decreased to 21.8% for the second quarter of 2016 from 26.5% in the comparable 2015 period. The $24.2 million decrease in operating expenses is attributable to the $24.5 million non-cash intangible asset impairment charges recorded in the second quarter of 2015 related to the tubular and pipe products segment. Operating expenses, excluding the impairment charges, increased $0.2 million, or 0.4% compared to a volume decrease of 0.8%. Operating expenses in the carbon flat products segment decreased $0.9 million, operating expenses in the specialty metals flat products segment increased $0.6 million, operating expenses in the tubular and pipe products segment decreased $24.4 million, of which $24.5 million related to non-cash intangible asset impairment charges, and Corporate expenses increased $0.5 million.

 

Operating expenses in the first six months of 2016 decreased $28.3 million, or 19.3%, to $118.1 million from $146.4 million in the first six months of 2015. As a percentage of net sales, operating expenses were 22.2% for the six months ended June 30, 2016 and 2015. The $28.3 million decrease in operating expenses is primarily attributable to the $24.5 million non-cash intangible asset impairment charges recorded during the first six months of 2015 related to the tubular and pipe products segment. Operating expenses, excluding the impairment charges, decreased $3.9 million, or 3.2% compared to a volume decrease of 1.8%. Operating expenses decreased in all categories, except for selling expenses, as reported on the Company’s Consolidated Statements of Comprehensive Income. Variable operating expenses, such as distribution and warehouse and processing, decreased $2.8 million, or 4.5%, as a result of the 1.8% volume decrease during the first six months of 2016. Occupancy expenses decreased $0.5 million, or 10.4%, as a result of operating with less warehouse space and lower utility and maintenance expenses. Selling expenses increased $0.9 million, or 8.7%, as a result of increased variable incentive compensation and increased headcount. Administrative and general expenses decreased by $1.3 million, or 3.9%, primarily related to reductions in labor and personnel expenses and centralization of certain administrative functions. Operating expenses in the carbon flat products segment decreased $3.6 million, operating expenses in the specialty metals products segment increased $1.0 million, operating expenses in the tubular and pipe products segment decreased $26.0 million, most of which related to the non-cash intangible asset impairment charges, and Corporate expenses increased $0.3 million.

 

Interest and other expense on debt totaled $1.3 million, 0.4% of net sales, for the second quarter of 2016 compared to $1.5 million, or 0.5% of net sales, for the second quarter of 2015. Interest and other expense on debt totaled $2.6 million, 0.5% of net sales, for the first six months of 2016 compared to $3.0 million, or 0.5% of net sales, for the first six months of 2015. Our effective borrowing rate, exclusive of deferred financing fees and commitment fees, was 2.4% for the first six months of 2016 compared to 2.1% for the first six months of 2015. Total average borrowings decreased $94 million, or 39.7%, from $237 million in the first six months of 2015 to $143 million in the first six months of 2016.

 

For the second quarter of 2016, income before income taxes totaled $7.0 million compared to loss before income taxes of $25.9 million in the second quarter of 2015. For the first half of 2016, income before income taxes totaled $5.8 million compared to loss before income taxes of $24.1 million in the first half of 2015. Loss before income taxes in 2015 included a $24.5 million non-cash intangible asset impairment charge.

 

An income tax provision of 49.3% was recorded for the second quarter of 2016, compared to an income tax benefit of 14.0% for the second quarter of 2015. An income tax provision of 51.6% was recorded for the first half of 2016, compared to an income tax benefit of 12.2% for the first half of 2015. During the three and six months ended June 30, 2016, we recorded a valuation allowance of $0.7 million to reduce certain state deferred tax assets to the amount that is more likely than not to be realized. The valuation allowance increased the effective tax rate by 9.4% and 11.4% for the three and six months ended June 30, 2016, respectively. During the six months ended June 30, 2015, we recorded a $16.5 million goodwill impairment charge pertaining to our tubular and pipe products segment. This non-deductible impairment charge reduced the effective tax rate by 24.5% and 26.2% for the three and six months ended June 30, 2015, respectively. 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 approximate 39% to 40% on an annual basis in 2016, excluding the impact of any non-recurring items.

 

Net income for the second quarter of 2016 totaled $3.6 million or $0.32 per basic and diluted share, compared to net loss of $22.3 million or ($1.99) per basic and diluted share for the second quarter of 2015. Net income for the first half of 2016 totaled $2.8 million or $0.25 per basic and diluted share, compared to net loss of $21.2 million or ($1.89) per basic and diluted share for the first half of 2015. For the six months ended June 30, 2015, the intangible asset impairments decreased earnings per share by $1.91 per basic and diluted share.

 

 
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Segment Operations

 

Carbon flat products

 

The following table presents selected operating results for our carbon flat products segment for the periods indicated (dollars are shown in thousands, except for per ton information):

 

   

For the Three Months Ended June 30,

   

For the Six Months Ended June 30,

 
   

2016

   

2015

   

2016

   

2015

 
           

% of net sales

           

% of net sales

           

% of net sales

           

% of net sales

 

Direct tons sold

    252,368               250,588               496,867               498,547          

Toll tons sold

    20,079               27,964               42,430               55,704          

Total tons sold

    272,447               278,552               539,297               554,251          
                                                                 

Net sales

  $ 173,122       100.0     $ 209,207       100.0     $ 334,556       100.0     $ 437,752       100.0  

Average selling price per ton

    635               751               620               790          

Cost of materials sold

    129,137       74.6       170,312       81.4       255,664       76.4       358,589       81.9  

Gross profit (a)

    43,985       25.4       38,895       18.6       78,892       23.6       79,163       18.1  

Operating expenses (b)

    38,316       22.1       39,193       18.7       75,401       22.6       78,991       18.0  

Operating income (loss)

  $ 5,669       3.3     $ (298 )     (0.1 )   $ 3,491       1.0     $ 172       0.0  

 

(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 carbon flat products segment decreased 6 thousand tons, or 2.2%, to 272 thousand in the second quarter of 2016 from 279 thousand in the second quarter of 2015. The decrease in tons sold is due to decreased customer demand and lower industry-wide shipments in the second quarter of 2016 compared to the 2015 comparable period.

 

Tons sold by our carbon flat products segment decreased 15 thousand tons, or 2.7% to 539 thousand in the first half of 2016 from 554 thousand in the first half of 2015. The decrease in tons sold is due to decreased customer demand and lower industry-wide shipments in the first half of 2016 compared to the first half of 2015. Despite the further softening of industry-wide shipments in the second quarter of 2016, the Company maintained or grew its market share in most of the carbon flat products we sell. We expect the year-over-year demand trends to remain consistent in the third quarter of 2016 compared to the third quarter of 2015 with an anticipated sequential decrease from the second quarter of 2016 due to normal July shutdowns at our customers’ locations.

 

Net sales in our carbon flat products segment decreased $36.1 million, or 17.2%, to $173.1 million in the second quarter of 2016 from $209.2 million in the second quarter of 2015. The decrease in sales was due to a 2.2% decrease in sales volume and a 15.4% decrease in the average selling prices during the second quarter of 2016 compared to the second quarter of 2015. Average selling prices in the second quarter of 2016 were $635 per ton, compared with $751 per ton in the second quarter of 2015, and $605 per ton in the first quarter of 2016. The decrease in the average selling price is a result of the market dynamics discussed in the overview of Results of Operations above.

 

Net sales in our carbon flat products segment decreased $103.2 million, or 23.6% to $334.6 million in the first half of 2016 from $437.8 million in the first half of 2015. The decrease in sales was due to a 2.7% decrease in sales volume and a 21.5% decrease in average selling prices, as metals industry market prices are lower year-over-year even though they are increasing sequentially. Average selling prices in the first half of 2016 were $620 per ton, compared with $790 per ton in the first half of 2015.

 

Cost of materials sold decreased $41.2 million, or 24.2% to $129.1 million in the second quarter of 2016 from $170.3 million in the second quarter of 2015. The decrease in cost of materials sold was due to the lower market pricing and shipment levels discussed above, which decreased the average cost of goods sold per ton by 22.5% in the second quarter of 2016 compared to the same period in 2015.

 

 
22

 

 

Cost of materials sold decreased $102.9 million, or 28.7%, to $255.7 million in the first half of 2016 from $358.6 million in the first half of 2015. The decrease in cost of materials sold was due to a 2.7% decrease in sales volume and a 26.7% decrease in metals cost during the six months ended June 30, 2016 compared to the six months ended June 30, 2015.

 

As a percentage of net sales, gross profit (as defined in footnote (a) in the table above) increased to 25.4% in the second quarter of 2016 compared to 18.6% in the second quarter of 2015. Gross profit per ton increased $21 per ton to $161 per ton in the second quarter of 2016 from $140 per ton in the second quarter of 2015 and $131 per ton in the first quarter of 2016.

 

As a percentage of net sales, gross profit increased to 23.6% in the six months ended June 30, 2016 compared to 18.1% in the six months ended June 30, 2015. The increase in the gross profit percentage is a result of steel selling prices increasing faster than the cost of inventory, as we historically hold approximately two and a half to three months of material in inventory. Gross profit per ton increased $3 per ton to $146 per ton in the six months ended June 30, 2016 from $143 per ton in the six months ended June 30, 2015.

 

Operating expenses in the second quarter of 2016 decreased $0.9 million, or 2.2%, to $38.3 million from $39.2 million in the second quarter of 2015, which is consistent with the volume decrease. As a percentage of net sales, operating expenses increased to 22.1% for the second quarter of 2016 from 18.7% in the comparable 2015 period. Operating expenses in the first half of 2016 decreased $3.6 million, or 4.5%, to $75.4 million from $79.0 million in the first half of 2015. The operating expense decrease of 4.5% was greater than the volume decrease of 2.7% during the first six months of 2016. As a percentage of net sales, operating expenses increased to 22.6% for the first half of 2016 from 18.1% in the comparable 2015 period. The increase in operating expenses as a percentage of net sales is due to the decrease in net sales resulting from the lower metals prices discussed above.

 

Operating income for the second quarter of 2016 totaled $5.7 million, or 3.3% of net sales, compared to operating loss of $0.3 million, or (0.1%) of net sales for the second quarter of 2015. Operating income for the six months ended June 30, 2016 totaled $3.5 million, or 1.0% of net sales, compared to operating income of $0.2 million, or 0.0% of net sales for the six months ended June 30, 2015.

 

 

Specialty metals flat products

 

The following table presents selected operating results for our specialty metals flat products for the periods indicated (dollars are shown in thousands, except for per ton information):

 

   

For the Three Months Ended June 30,

   

For the Six Months Ended June 30,

 
   

2016

   

2015

   

2016

   

2015

 
           

% of net sales

           

% of net sales

           

% of net sales

           

% of net sales

 

Direct tons sold

    21,745               19,297               41,535               37,857          

Toll tons sold

    23               36               26               36          

Total tons sold

    21,768               19,333               41,561               37,893          
                                                                 

Net sales

  $ 49,529       100.0     $ 52,715       100.0     $ 95,359       100.0     $ 105,346       100.0  

Average selling price per ton

    2,275               2,727               2,294               2,780          

Cost of materials sold

    41,991       84.8       48,875       92.7       81,186       85.1       96,440       91.5  

Gross profit (a)

    7,538       15.2       3,840       7.3       14,173       14.9       8,906       8.5  

Operating expenses (b)

    4,971       10.0       4,414       8.4       9,850       10.4       8,890       8.5  

Operating income (loss)

  $ 2,567       5.2     $ (574 )     (1.1 )   $ 4,323       4.5     $ 16       0.0  

 

(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 specialty metals flat products segment increased 2 thousand tons, or 12.6%, to 22 thousand in the second quarter of 2016 from 19 thousand in the second quarter of 2015. The specialty metals flat products segment increased its market share in each of the stainless steel and aluminum products we sell.

 

 
23

 

 

Tons sold by our specialty metals flat products segment increased 4 thousand tons, or 9.7% to 42 thousand in the six months ended June 30, 2016 from 38 thousand in the six months ended June 30, 2015. We expect third quarter 2016 sales to increase over the same period in 2015 with an anticipated sequential decrease from the second quarter of 2016 due to normal July shutdowns at our customers’ locations.

 

Net sales in our specialty metals flat products segment decreased $3.2 million, or 6.0% to $49.5 million in the second quarter of 2016 from $52.7 million in the second quarter of 2015. The decrease in sales was due to a 16.6% decrease in average selling prices during the second quarter of 2016 compared to the second quarter of 2015, offset by a 12.6% increase in volume. Average selling prices in the second quarter of 2016 were $2,275 per ton, down $452 per ton, or 16.6%, from $2,727 per ton in the second quarter of 2015 and 0.2% from $2,312 per ton in the first quarter of 2016. The decrease in the year over year average selling price per ton is a result of the market dynamics discussed in the overview of Results of Operations above, including the declining price of nickel, which continue to pressure stainless steel and aluminum pricing.

 

Net sales in our specialty metals flat products segment decreased $9.9 million, or 9.5%, to $95.4 million in the first half of 2016 from $105.3 million in the first half of 2015. The decrease in sales was due to a 17.5% decrease in average selling prices, as metals industry market prices are lower year-over-year, offset by a 9.7% increase in sales volume. Average selling prices in the first half of 2016 were $2,294 per ton, compared with $2,780 per ton in the first half of 2015.

 

Cost of materials sold decreased $6.9 million, or 14.1% to $42.0 million in the second quarter of 2016 from $48.9 million in the second quarter of 2015. The decrease was due to a 23.7% decrease in the average cost of materials offset by a 12.6% increase in sales volume during the second quarter of 2016 compared to the second quarter of 2015.

 

Cost of materials sold decreased $15.2 million, or 15.8%, to $81.2 million in the first half of 2016 from $96.4 million in the first half of 2015. The decrease in cost of materials sold was due to a 23.3% decrease in metals cost offset by a 9.7% increase in sales volume during the six months ended June 30, 2016 compared to the six months ended June 30, 2015.

 

As a percentage of net sales, gross profit (as defined in footnote (a) in the table above) increased to 15.2% in the second quarter of 2016 from 7.3% in the second quarter of 2015. As a percentage of net sales, gross profit increased to 14.9% in the six months ended June 30, 2016 from 8.5% in the six months ended June 30, 2015. The increase in the gross profit percentage is a result of our cost of materials sold decreasing more than the average selling price during the three and six months ended June 30, 2016 compared to the same periods in 2015.

 

Operating expenses in the second quarter of 2016 increased $0.6 million, or 12.6%, to $5.0 million from $4.4 million in the second quarter of 2015, which is consistent with the volume increase. As a percentage of net sales, operating expenses increased to 10.0% of net sales for the second quarter of 2016 compared to 8.4% of net sales for the second quarter of 2015. Operating expenses in the first six months of 2016 increased $1.0 million, or 10.8%, to $9.9 million from $8.9 million in the first six months of 2015. The increase in operating expenses is consistent with the 9.8% volume increase. As a percentage of net sales, operating expenses increased to 10.4% of net sales for the six months ended June 30, 2016 compared to 8.5% for the six months ended June 30, 2015. Variable operating expenses, such as distribution and warehouse and processing increased as a result of higher sales volumes. Selling and administrative and general expenses increased as a result of increased variable based incentive compensation related to the increased sales volume and gross profit.

 

Operating income for the second quarter of 2016 totaled $2.6 million, or 5.2% of net sales, compared to operating loss of $0.6 million, or (1.1%) of net sales, for the second quarter of 2015. Operating income for the six months ended June 30, 2016 totaled $4.3 million, or 4.5% of net sales, compared to operating income of $16 thousand, or 0.0% of net sales, for the six months ended June 30, 2015.

 

 
24

 

 

Tubular and pipe products

 

The following table presents selected operating results for our tubular and pipe products segment for the periods indicated (dollars are shown in thousands):

 

   

For the Three Months Ended June 30,

   

For the Six Months Ended June 30,

 
   

2016

   

2015

   

2016

   

2015

 
           

% of net sales

           

% of net sales

           

% of net sales

           

% of net sales

 

Net sales

  $ 50,957       100.0     $ 53,329       100.0     $ 102,042       100.0     $ 118,018       100.0  

Cost of materials sold (a)

    34,560       67.8       36,651       68.7       68,658       67.3       80,748       68.4  

Gross profit (b)

    16,397       32.2       16,678       31.3       33,384       32.7       37,270       31.6  

Operating expenses (c)

    14,264