Part I. FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

 

Olympic Steel, Inc.

Consolidated Balance Sheets

(in thousands)

 

 

 

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

 

 

Olympic Steel, Inc.

Consolidated Statements of Comprehensive Income

For the Three Months Ended March 31,

(in thousands, except per share data)

 

 

 

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

 

 

Olympic Steel, Inc.

Consolidated Statements of Cash Flows

For the Three Months Ended March 31,

(in thousands)

 

 

 

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

 

 

Olympic Steel, Inc.

Supplemental Disclosures of Cash Flow Information

For the Three Months Ended March 31,

(in thousands)

 

 

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

 

 

Olympic Steel, Inc.

Consolidated Statements of Shareholders’ Equity

For The Three Months Ended March 31,

(in thousands)

(unaudited)

 

 

 

 

 

 

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

 

 

Olympic Steel, Inc.

Notes to Unaudited Consolidated Financial Statements

March 31, 2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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, 2018. 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, 2018. 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:

 

	●	risks of falling metals prices and inventory devaluation;
	●	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;
	●	the levels of imported steel in the United States and the tariffs initiated by the U.S. government in 2018 under Section 232 of the Trade Expansion Act of 1962 and newly imposed tariffs and duties on exported steel or other products, U.S. trade policy and its impact on the U.S. manufacturing industry;
	●	cyclicality and volatility within the metals industry;
	●	fluctuations in the value of the U.S. dollar and the related impact on foreign steel pricing, U.S. exports, and foreign imports to the United States;
	●	the availability, and increased costs, of labor related to tighter employment markets;
	●	the availability and rising costs of transportation and logistical services;
	●	customer, supplier and competitor consolidation, bankruptcy or insolvency;
	●	reduced production schedules, layoffs or work stoppages by our own, our suppliers’ or customers’ personnel;
	●	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;
	●	the amounts, successes and our ability to continue our capital investments and strategic growth initiatives, including acquisitions and our business information system implementations;
	●	our ability to successfully integrate recent acquisitions into our business and risks inherent with the acquisitions in the achievement of expected results, including whether the acquisition will be accretive and within the expected timeframe;
	●	events or circumstances that could adversely impact the successful operation of our processing equipment and operations;
	●	rising interest rates and their impacts on our variable interest rate debt;
	●	the impacts of union organizing activities and the success of union contract renewals;
	●	changes in laws or regulations or the manner of their interpretation or enforcement could impact our financial performance and restrict our ability to operate our business or execute our strategies;
	●	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 impairment charges related to indefinite lived intangible assets;
	●	the timing and outcomes of inventory lower of cost or market adjustments and last-in, first-out, or LIFO, income or expense;
	●	the inflation or deflation existing within the metals industry, as well as 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;
	●	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. Through the acquisition of McCullough Industries, or McCullough, on January 2, 2019, the carbon flat products segment expanded its product offerings to include self-dumping metal hoppers.  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. Through the acquisition of Berlin Metals, LLC, or Berlin Metals, on April 2, 2018, our specialty metals flat products segment expanded its product offerings to include differing types of stainless flat-rolled sheet and coil and prime tin mill products. In addition, we distribute metal tubing, pipe, bar, valves and fittings and fabricate pressure parts supplied to various industrial markets through our tubular and pipe products segment. 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 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; transportation and energy costs; pricing and availability of raw materials used in the production of metals; global supply, the level of metals imported into the United States, tariffs, and inventory held in the supply chain; the availability, and increased costs of labor; 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. From time to time, we have entered into nickel 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.

 

At March 31, 2019, we employed approximately 1,870 people. Approximately 310 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
Hammond, Indiana	November 30, 2019
Locust, North Carolina	March 4, 2020
Romeoville, Illinois	May 31, 2020
Minneapolis (coil), Minnesota	September 30, 2020
Indianapolis, Indiana	January 29, 2021
St. Paul, Minnesota	May 25, 2021
Milan, Illinois	August 12, 2021
Minneapolis (plate), Minnesota	March 31, 2022
Detroit, Michigan	August 31, 2022

 

 

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

 

 

Reportable Segments

 

We operate in three reportable segments; carbon flat products, specialty metals flat products and tubular and pipe products. The carbon flat products segment and the specialty metals flat products segment are at times consolidated and referred to as the flat products segment. Some of 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, in some locations, 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 primarily 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.

 

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.

 

 

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. Through its acquisition of Berlin Metals on April 2, 2018, our specialty metals flat products segment expanded its product offerings to include differing types of stainless flat-rolled sheet and coil and prime tin mill products. 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 21 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 eight 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 compensation 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 impacted by the market price of metals.  Through 2017 and the first seven months of 2018, metals prices increased significantly and changes to our net sales, cost of materials sold, gross profit, cost of inventory and profitability, were all impacted by industry metals pricing. The price increases resulted in metals pricing reaching its highest point in 10 years in July 2018. The increases were driven by both the tariffs initiated by the U.S. government in 2018 under Section 232 of the Trade Expansion Act of 1962 (section 232 tariffs) and strong customer demand.  Since the third quarter of 2018, market prices for metals have declined from the prior months, but overall market prices for metal in the first quarter of 2019 were still higher than in the first quarter of 2018.

 

Transactional or “spot” selling prices generally move in tandem with market price changes, while fixed selling prices typically lag and reset quarterly.  Similarly, inventory costs (and, therefore, 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.  When average selling prices increase, and net sales increase, gross profit and operating expenses as a percentage of net sales will generally decrease.  Our net sales were positively impacted by the price increases in the first quarter of 2019 compared to the first quarter of 2018.  However, decreased demand, in particular for carbon flat products and higher inventory costs pressured our gross margin.  We expect the margin pressures and decreased customer demand compared to 2018 to continue into the second quarter of 2019.

 

 

Consolidated Operations

 

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

 

		For the Three Months Ended March 31,
		2019								2018
		$				% of net sales				$				% of net sales
Net sales		$	445,919				100.0			$	375,598				100.0
Cost of materials sold (a)			366,382				82.2				294,777				78.5
Gross profit (b)			79,537				17.8				80,821				21.5
Operating expenses (c)			73,463				16.5				68,476				18.2
Operating income			6,074				1.3				12,345				3.3
Other loss, net			14				-				(46	)			-
Interest and other expense on debt			3,242				0.7				1,986				0.5
Income before income taxes			2,846				0.6				10,313				2.7
Income tax provision			772				0.1				2,684				0.7
Net income		$	2,074				0.5			$	7,629				2.0

 

(a)	Includes $500 of LIFO expense in 2018.
(b)	Gross profit is calculated as net sales less the cost of materials sold.
(c)	Operating expenses are calculated as total costs and expenses from the Statement of Comprehensive Income less the cost of materials sold.

 

Net sales increased 18.7% to $445.9 million in the first quarter of 2019 from $375.6 million in the first quarter of 2018. Carbon flat products net sales were 62.4% of total net sales in the first quarter of 2019 compared to 64.2% of total net sales in the first quarter of 2018. Specialty metals products net sales were 19.8% of total net sales in the first quarter of 2019 compared to 17.4% of total net sales in the first quarter of 2018. Tubular and pipe products net sales were 17.8% of total net sales in the first quarter of 2019 compared to 18.4% of total net sales in the first quarter of 2018. The increase in net sales was due to a 22.8% increase in average selling prices during the first quarter of 2019 compared to the first quarter of 2018, offset by a 3.3% decrease in volume. We expect shipping levels to increase minimally and metals prices to decrease in the second quarter of 2019.

 

Cost of materials sold increased 24.3% to $366.4 million in the first quarter of 2019 from $294.8 million in the first quarter of 2018. The increase in cost of materials sold in the first quarter of 2019 is related to the increased metals pricing discussed above. 

 

As a percentage of net sales, gross profit (as defined in footnote (b) in the table above) decreased to 17.8% in the first quarter of 2019 from 21.5% in the first quarter of 2018. The decrease in the gross profit as a percentage of net sales is due to the impact of higher average selling prices, as the average gross profit per ton increased in the first quarter of 2019 compared to the first quarter of 2018.

 

Operating expenses in the first quarter of 2019 increased $5.0 million, or 7.2%, to $73.5 million from $68.5 million in the first quarter of 2018. As a percentage of net sales, operating expenses decreased to 16.5% for the first quarter of 2019 from 18.2% in the comparable 2018 period. Operating expenses in the carbon flat products segment increased $1.0 million, operating expenses in the specialty metals products segment increased $3.2 million, operating expenses in the tubular and pipe products segment increased $0.8 million and Corporate expenses were flat compared to prior year’s first quarter. The increase in operating expenses for the carbon and specialty flat products segments is primarily attributable to the acquisition of McCullough on January 2, 2019 and the acquisition of Berlin Metals on April 2, 2018, respectively, and increased depreciation expense related to 2018 capital expenditures. 

 

Interest and other expense on debt totaled $3.2 million, or 0.7% of net sales, for the first quarter of 2019 compared to $2.0 million, or 0.5% of net sales, for the first quarter of 2018. The increase was due to increased borrowings to fund working capital needs, the two acquisitions noted above, and increased interest rates. Our effective borrowing rate, exclusive of deferred financing fees and commitment fees, was 4.0% for the first three months of 2019 compared to 3.4% for the first three months of 2018 due to the increase in LIBOR rates since the first quarter of 2018. 

 

For the first quarter of 2019, income before income taxes totaled $2.8 million compared to $10.3 million in the first quarter of 2018.

 

An income tax provision of 27.1% was recorded for the first quarter of 2019, compared to an income tax provision of 26.0% for the first quarter of 2018. Our tax provision or benefit for interim periods is determined using an estimate of our annual effective tax rate, adjusted for discrete items that are considered 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 operational effective tax rate to approximate 26% to 28% on an annual basis in 2019. 

 

Net income for the first quarter of 2019 totaled $2.1 million or $0.18 per basic and diluted share, compared to $7.6 million or $0.67 per basic and diluted share for the first quarter of 2018. 

 

 

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 March 31,
		2019								2018
		$				% of net sales				$				% of net sales
Direct tons sold			257,814								274,509
Toll tons sold			15,357								23,095
Total tons sold			273,171								297,604
Net sales		$	278,536				100.0			$	240,894				100.0
Average selling price per ton			1,020								809
Cost of materials sold			233,316				83.8				189,775				78.8
Gross profit (a)			45,220				16.2				51,119				21.2
Operating expenses (b)			43,994				15.8				43,013				17.9
Operating income		$	1,226				0.4			$	8,106				3.3

 

	(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 8.2% to 273 thousand in the first quarter of 2019 from 298 thousand in the first quarter of 2018. The decrease in tons sold is due to decreased customer demand experienced in the metals industry. We expect sales volumes in the second quarter of 2019 to increase sequentially from the first quarter of 2019, but to remain below 2018 levels.

 

Net sales in our carbon flat products segment increased $37.6 million, or 15.6%, to $278.5 million in the first quarter of 2019 from $240.9 million in the first quarter of 2018. The increase in sales was attributable to a 26.0% increase in average selling prices in the first quarter of 2019 compared to the first quarter of 2018, offset by a decrease in tons sold by 8.2%. Average selling prices in the first quarter of 2019 increased to $1,020 per ton, compared with $809 per ton in the first quarter of 2018 and decreased from $1,043 per ton in the fourth quarter of 2018. The increase in the average selling price is a result of the market pricing dynamics discussed in the overview of Results of Operations above.

 

Cost of materials sold increased $43.5 million, or 22.9%, to $233.3 million in the first quarter of 2019 from $189.8 million in the first quarter of 2018. The average cost of materials sold per ton increased by 33.9% in the first quarter of 2019 compared to the same period in 2018. The increase was due to the increased market price for metals discussed above and the impact of selling higher costed inventory during the first quarter of 2019 compared to the first quarter of 2018.   

 

As a percentage of net sales, gross profit (as defined in footnote (a) in the table above) decreased to 16.2% in the first quarter of 2019 compared to 21.2% in the first quarter of 2018. The decrease in gross profit percentage in 2019 was primarily due to the impact of higher average selling prices, and the impact of selling higher costed inventory in the first quarter of 2019 compared to the first quarter of 2018. Gross profit per ton decreased by 3.6% or $6 per ton in the first quarter of 2019 compared to the first quarter of 2018.

 

Operating expenses in the first quarter of 2019 increased $1.0 million, or 2.3%, to $44.0 million from $43.0 million in the first quarter of 2018. Operating expenses increased as a result of the acquisition of McCullough on January 2, 2019. As a percentage of net sales, operating expenses decreased to 15.8% for the first quarter of 2019 compared to 17.9% for first quarter of 2018. 

 

Operating income for the first quarter of 2019 totaled $1.2 million, or 0.4% of net sales, compared to $8.1 million, or 3.3% of net sales, for the first quarter of 2018.

 

 

Specialty metals flat products

 

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

 

		For the Three Months Ended March 31,
		2019								2018
		$				% of net sales				$				% of net sales
Direct tons sold			32,190								24,848
Toll tons sold			3,594								15
Total tons sold			35,784								24,863
Net sales		$	88,097				100.0			$	65,529				100.0
Average selling price per ton			2,462								2,636
Cost of materials sold			76,245				86.5				56,131				85.7
Gross profit (a)			11,852				13.5				9,398				14.3
Operating expenses (b)			9,608				11.0				6,387				9.7
Operating income		$	2,244				2.5			$	3,011				4.6

 

	(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 43.9% to 36 thousand in the first quarter of 2019 from 25 thousand in the first quarter of 2018. The increase in tons sold was due to increased demand from customers and the acquisition of Berlin Metals on April 2, 2018.

 

Net sales in our specialty metals flat products segment increased $22.6 million, or 34.4%, to $88.1 million in the first quarter of 2019 from $65.5 million in the first quarter of 2018. The increase in sales was due to a 43.9% increase in volume offset by a 6.6% decrease in the average selling price during the first quarter of 2019 compared to the first quarter of 2018. Average selling prices in the first quarter of 2019 were $2,462 per ton, compared with $2,636 per ton in the first quarter of 2018, and $2,505 per ton in the fourth quarter of 2018. The decrease in the year over year average selling price per ton is a result of some of the products sold by Berlin Metals which have a lower average selling price.

 

Cost of materials sold increased $20.1 million, or 35.8%, to $76.2 million in the first quarter of 2019 from $56.1 million in the first quarter of 2018. The increase was due to a 43.9% increase in sales volume offset by a 5.6% decrease in the average cost of materials sold during the first quarter of 2019 compared to the first quarter of 2018.

 

As a percentage of net sales, gross profit (as defined in footnote (a) in the table above) decreased to 13.5% in the first quarter of 2019 from 14.3% in the first quarter of 2018. The gross profit per ton decreased 12.4% to $331 per ton in the first quarter of 2019 from $378 per ton in the first quarter of 2018. The decrease in the gross profit percentage and the gross profit per ton is a result of the acquisition of Berlin Metals, as the mix of the products sold have lower gross margin percentages and gross margins per ton compared to our traditional specialty metals business.

 

Operating expenses in the first quarter of 2019 increased $3.2 million, or 50.4%, to $9.6 million from $6.4 million in the first quarter of 2018. The most significant operating expense increase in the first quarter of 2019 was related to the acquisition of Berlin Metals on April 2, 2018 which accounted for 79.0% of the operating expense increase. Variable operating expenses, such as warehouse and processing increased as a result of higher sales volumes. As a percentage of net sales, operating expenses increased to 11.0% for the first quarter of 2019 compared to 9.7% for the first quarter of 2018.

 

Operating income for the first quarter of 2019 totaled $2.2 million, or 2.5% of net sales, compared to $3.0 million, or 4.6% of net sales, for the first quarter of 2018.

 

 

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 March 31,
		2019								2018
		$				% of net sales				$				% of net sales
Net sales		$	79,286				100.0			$	69,175				100.0
Cost of materials sold (a)			56,821				71.7				48,871				70.6
Gross profit (b)			22,465				28.3				20,304				29.4
Operating expenses (c)			16,850				21.2				16,037				23.2
Operating income		$	5,615				7.1			$	4,267				6.2

 

	(a)	Includes $500 of LIFO expense for 2018.
	(b)	Gross profit is calculated as net sales less the cost of materials sold.
	(c)	Operating expenses are calculated as total costs and expenses less the cost of materials sold.

 

Net sales increased $10.1 million, or 14.6%, to $79.3 million in the first quarter of 2019 from $69.2 million in the first quarter of 2018. The increase is a result of an 8.1% increase in shipping volume and a 6.0% increase in average selling prices during the first quarter of 2019 compared to the first quarter of 2018.

 

Cost of materials sold increased $8.0 million, or 16.3%, to $56.8 million in the first quarter of 2019 from $48.9 million in the first quarter of 2018.  The increase in cost of materials sold is primarily a result of the 8.1% increase in sales volume and the 7.5% increase in the average cost of materials sold in the first quarter of 2019 compared to the first quarter of 2018.   There was no LIFO impact recorded during the first quarter of 2019.  During the first quarter of 2018, $0.5 million of LIFO expense was recorded.

 

As a percentage of net sales, gross profit (as defined in footnote (b) in the table above) decreased to 28.3% in the first quarter of 2019 compared to 29.4% in the first quarter of 2018. As a percentage of net sales, the LIFO expense recorded in the first quarter of 2018 decreased gross profit by 0.7%.

 

Operating expenses in the first quarter of 2019 increased $0.9 million, or 5.0%, to $16.9 million from $16.0 million in the first quarter of 2018. Operating expenses increased in the first quarter of 2019 as a result of higher shipping volume and less labor and overhead capitalization into inventory. Operating expenses decreased to 21.2% of net sales in the first quarter of 2019 compared to 23.2% in the first quarter of 2018.

 

Operating income for the first quarter 2019 totaled $5.6 million, or 7.1% of net sales, compared to $4.3 million, or.6.2% of net sales, for the first quarter of 2018.

 

Corporate expenses

 

Corporate expenses were $3.0 million in both the first quarter of 2019 and in the first quarter of 2018.

 

 

Liquidity, Capital Resources and Cash Flows

 

Our principal capital requirements include funding working capital needs, purchasing, upgrading and acquiring processing equipment and facilities, making acquisitions and paying dividends. We use cash generated from operations and borrowings under our credit facility to fund these requirements.

 

We believe that funds available under our credit facility together with funds generated from operations, will be sufficient to provide us with the liquidity necessary to fund anticipated working capital requirements, capital expenditure requirements, our dividend payments and any share repurchases and business acquisitions over at least the next 12 months. In the future, we may as part of our business strategy, acquire and dispose of assets or other companies in the same or complementary lines of business, or enter into or exit strategic alliances and joint ventures. Accordingly, the timing and size of our capital requirements are subject to change as business conditions warrant and opportunities arise.

 

Operating Activities

 

For the three months ended March 31, 2019, we used $1.2 million of net cash for operations, net of assets acquired as part of the McCullough acquisition on January 2, 2019, of which $6.7 million was generated from operating activities and $7.9 million was used for working capital. For the three months ended March 31, 2018, we used $43.5 million of net cash for operations, of which $13.1 million was generated from operating activities and $56.5 million was used for working capital.

 

Net cash from operations totaled $6.7 million during the first quarter of 2019 and mainly consisted of net income of $2.1 million, depreciation and amortization of $4.9 million and stock-based compensation of $1.5 million, offset by changes in other long-term assets and other long-term liabilities of $1.7 million. Net cash from operations totaled $13.1 million during the first quarter of 2018 and mainly consisted of net income of $7.6 million, depreciation and amortization of $4.4 million and stock-based compensation of $1.0 million.

 

Working capital at March 31, 2019 totaled $432.6 million, a $1.7 million decrease from December 31, 2018.  The decrease was primarily attributable to a $26.4 million decrease in inventories (resulting from decreased inventory purchases and lower average inventory costs in the first quarter of 2019 compared to the fourth quarter of 2018) and a $3.5 million increase in accounts payable and outstanding checks, offset by a $28.7 million increase in accounts receivable (resulting from higher sales normally experienced in the first quarter compared to the lower sales in the fourth quarter) and an $8.7 million decrease in accrued payroll and other accrued liabilities.

 

Investing Activities

 

Net cash used for investing activities was $13.4 million during the three months ended March 31, 2019, compared to $7.7 million during the three months ended March 31, 2018.  $11.0 million was related to the acquisition of McCullough Industries and the $2.4 million of capital expenditures were primarily attributable to the completion of a building expansion and additional processing equipment at our existing facilities.  During 2019, we expect our capital spending to be less than our annual depreciation expense.

 

Financing Activities

 

During the first three months of 2019, $10.4 million of cash was generated from financing activities, which primarily consisted of $10.7 million of net borrowings under our ABL Credit Facility (as defined below) offset by $0.2 million of dividends paid. During the second quarter of 2019, we expect our net borrowings under our ABL Credit Facility to decrease due to the decreasing industry metals prices and reduced inventory levels.

 

Dividends paid were $0.2 million for both the three months ended March 31, 2019 and March 31, 2018. In May 2019, our Board of Directors approved a regular quarterly dividend of $0.02 per share, which will be paid on June 17, 2019 to shareholders of record as of June 3, 2019. Regular dividend distributions in the future are subject to the availability of cash, the $5.0 million annual limitation on cash dividends and common stock repurchases under our ABL Credit Facility and continuing determination by our Board of Directors that the payment of dividends remains in the best interest of our shareholders.

 

Stock Repurchase Program

 

In 2015, our Board of Directors authorized a stock repurchase program of up to 550,000 shares of our issued and outstanding common stock, which could include open market repurchases, negotiated block transactions, accelerated stock repurchases or open market solicitations for shares, all or some of which may be effected through Rule 10b5-1 plans. Repurchased shares will be held in our treasury, or canceled and retired as our Board may determine from time to time. Any repurchases of common stock are subject to the covenants contained in the ABL Credit Facility. Under the ABL Credit Facility, we may repurchase common stock and pay dividends up to $5.0 million in the aggregate during any trailing twelve months without restrictions. Purchases in excess of $5.0 million require us to (i) maintain availability in excess of 20% of the aggregate revolver commitments ($95.0 million at March 31, 2019) or (ii) to maintain availability equal to or greater than 15% of the aggregate revolver commitments ($71.3 million at March 31, 2019) and we must maintain a pro-forma ratio of EBITDA, minus certain capital expenditures and cash taxes paid to fixed charges of at least 1.00 to 1.00. The timing and amount of any repurchases under the stock repurchase program will depend upon several factors, including market and business conditions, and limitations under the ABL Credit Facility, and repurchases may be discontinued at any time.

 

During the three months ended March 31, 2019, we repurchased 3,800 shares, for an aggregate cost of $64 thousand. There were no shares repurchased during the three months ended March 31, 2018.

  

 

Debt Arrangements

 

Our asset-based credit facility, or ABL Credit Facility, is collateralized by our accounts receivable inventory and personal property. The ABL Credit Facility consists of (i) a revolving credit facility of $445 million, including a $20 million sub-limit for letters of credit and (ii) a first in, last out revolving credit facility of up to $30 million. Under the terms of the ABL Credit Facility, we may request additional commitments in the aggregate principal amount of up to $200 million to the extent that existing or new lenders agree to provide such additional commitments. Revolver borrowings are limited to the lesser of a borrowing base, comprised of eligible receivables and inventories, or $475 million in the aggregate. The ABL Credit Facility matures on December 8, 2022.

 

The ABL Credit Facility contains customary representations and warranties and certain covenants that limit our ability to, among other things: (i) incur or guarantee additional indebtedness; (ii) pay distributions on, redeem or repurchase capital stock or redeem or repurchase subordinated debt; (iii) make investments; (iv) sell assets; (v) enter into agreements that restrict distributions or other payments from restricted subsidiaries to us; (vi) incur liens securing indebtedness; (vii) consolidate, merge or transfer all or substantially all of our assets; and (viii) engage in transactions with affiliates. In addition, the ABL Credit Facility contains a financial covenant which requires (i) if any commitments or obligations are outstanding our availability is less than the greater of $30 million or 10.0% of the aggregate amount of revolver commitments ($47.5 million at March 31, 2019) or 10.0% of the aggregate borrowing base ($41.5 million at March 31, 2019) then we must maintain a ratio of Earnings before Interest, Taxes, Depreciation and Amortization (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.

 

We have 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 2.75%.

 

As of March 31, 2019, we were in compliance with our covenants and had approximately $127.0 million of availability under the ABL Credit Facility.

 

As of March 31, 2019, $1.6 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.

 

On January 10, 2019, we entered into a five-year forward starting fixed rate interest rate hedge in order to eliminate the variability of cash interest payments on $75 million of the outstanding LIBOR based borrowings under the ABL Credit Facility. The interest rate hedge fixed the rate at 2.57%.

 

 

Critical Accounting Policies

 

This Management’s Discussion and Analysis of Financial Condition and Results of Operations is based on the consolidated financial statements included in this Quarterly Report on Form 10-Q, which have been prepared in conformity with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and assumptions that affect the amounts reported in the financial statements. We monitor and evaluate our estimates and assumptions, based on historical experience and various other factors that are believed to be reasonable under the circumstances. Actual results could differ from these estimates under different assumptions or conditions.

 

We review our financial reporting and disclosure practices and accounting practices quarterly to ensure they provide accurate and transparent information relative to the current economic and business environment. For further information regarding the accounting policies that we believe to be critical accounting policies that affect our more significant judgments and estimates used in preparing our consolidated financial statements, see 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, 2018.

 

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

Our principal raw materials are carbon, coated and stainless steel, and aluminum, pipe and tube, flat rolled coil, sheet and plate that we typically purchase from multiple primary metals producers. The metals industry as a whole is cyclical and, at times, pricing and availability of metals can be volatile due to numerous factors beyond our control, including general domestic and international economic conditions, the levels of metals imported into the United States, labor costs, sales levels, competition, levels of inventory held by other metals service centers, consolidation of metals producers, new global capacity by metals producers, higher raw material costs for the producers of metals, import duties and tariffs and currency exchange rates. This volatility can significantly affect the availability and cost of raw materials for us.

 

We, like many other metals service centers, 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 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 no long-term, fixed-price metals purchase contracts. 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 profitability of our business could be adversely affected. When metals prices decline, customer demands for lower prices and our competitors’ responses to those demands could result in lower sale prices and, consequently, lower gross profits and inventory lower of cost or market adjustments as we sell existing inventory. Significant or rapid declines in metals prices or reductions in sales volumes could adversely impact our ability to remain in compliance with certain financial covenants in our credit facility, as well as result in us incurring inventory or intangible asset impairment charges. Changing metals prices therefore could significantly impact our net sales, gross profits, operating income and net income.

 

Rising metals prices result in higher working capital requirements for us and our customers. Some customers may not have sufficient credit lines or liquidity to absorb significant increases in the price of metals. While we have generally been successful in the past in passing on producers’ price increases and surcharges to our customers, there is no guarantee that we will be able to pass on price increases to our customers in the future. Declining metals prices have generally adversely affected our net sales and net income, while increasing metals prices have generally favorably affected our net sales and net income.

 

Approximately 48% and 50% of our consolidated net sales during the first three months of 2019 and 2018, respectively, were directly related to industrial machinery and equipment manufacturers and their fabricators.

 

Inflation generally affects us by increasing the cost of employee wages and benefits, transportation services, processing equipment, energy and borrowings under our credit facility. General inflation, excluding increases in the price of metals and increased distribution expense, has not had a material effect on our financial results during the past two years.

 

We are exposed to the impact of fluctuating metals prices and interest rate changes. During 2019 and 2018, we entered into metals swaps at the request of customers. These derivatives have not been designated as hedging instruments. For certain customers, we enter into contractual relationships that entitle us to pass-through the economic effect of trading positions that we take with other third parties on our customers’ behalf.

 

Our primary interest rate risk exposure results from variable rate debt. We have the option to enter into 30- to 180-day fixed base rate LIBOR loans under the ABL Credit Facility. On January 10, 2019, we entered into a five-year interest rate swap that locked the interest rate at 2.57% on $75 million of our revolving debt.

 

 

Item 4. Controls and Procedures

 

The evaluation required by Rule 13a-15(e) of the Securities Exchange Act of 1934 of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this Quarterly Report on Form 10-Q has been carried out under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer. These disclosure controls and procedures are designed to provide reasonable assurance that information required to be disclosed in reports that are filed with or submitted to the SEC is: (i) accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosures and (ii) recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC. Based on this evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of March 31, 2019, our disclosure controls and procedures were effective.

 

Beginning January 1, 2019, the Company implemented ASC 842, “Leases” ("Topic 842"). For its adoption, the Company implemented changes to its lease and financial reporting process and control activities within them, such as development of new entity-wide policies, ongoing lease reviews and manual changes to accommodate presentation and disclosure requirements.

 

Except for Topic 842, there were no changes in our internal control over financial reporting that occurred during the first quarter of 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

 

Part II. OTHER INFORMATION

 

Items 1, 1A, 3, 4 and 5 of this Part II are either inapplicable or are answered in the negative and are omitted pursuant to the instructions to Part II.

 

 

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds

 

This table provides information with respect to purchases by the Company of shares of its Common Stock during the quarter ended March 31, 2019:

 

		Total number of shares purchased				Average price paid per share				Total number of shares purchased as part of publicly announced plans or programs				Maximum number of shares that may yet be purchased under the plans or programs (a)
01/01/19 thru 01/31/19			-			$	-				-				484,717
02/01/19 thru 02/28/19			-				-				-				484,717
03/01/19 thru 03/31/19			3,800				16.86				3,800				480,917
Total			3,800			$	16.86				3,800

 

(a)

On October 2, 2015, the Company announced that its Board of Directors authorized a stock repurchase program of up to 550,000 shares of the Company’s issued and outstanding common stock, which could include open market repurchases, negotiated block transactions, accelerated stock repurchases or open market solicitations for shares, all or some of which may be effected through Rule 10b5-1 plans.

 

 

Item 6.  Exhibits

 

Exhibit	Description of Document		Reference
31.1	Certification of the Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002		Filed herewith
31.2	Certification of the Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002		Filed herewith
32.1	Certification of the Principal Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002		Furnished herewith
32.2	Certification of the Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002		Furnished herewith
101.INS	XBRL Instance Document
101.SCH	XBRL Taxonomy Extension Schema Document
101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF	XBRL Taxonomy Extension Definition
101.LAB	XBRL Taxonomy Extension Label Linkbase Document
101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document

 

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

	OLYMPIC STEEL, INC.
	(Registrant)
Date: May 2, 2019	By:	/s/ Richard T. Marabito
	Richard T. Marabito
	Chief Executive Officer
	By:	/s/ Richard A. Manson
	Richard A. Manson
	Chief Financial Officer
	(Principal Financial and Accounting Officer)

 

 

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