OLYMPIC STEEL INC - Quarter Report: 2016 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

For the quarterly period ended September 30, 2016

For the transition period from __________ to ____________

Commission File Number 0-23320

OLYMPIC STEEL, INC.

(Exact name of registrant as specified in its charter)

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:

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:

Olympic Steel, Inc.

Index to Form 10-Q

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

(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 Nine Months Ended September 30,

(in thousands) 

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

Olympic Steel, Inc.

Supplemental Disclosures of Cash Flow Information

For the Nine Months Ended September 30,

(in thousands)

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

Olympic Steel, Inc.

Notes to Unaudited Consolidated Financial Statements

September 30, 2016

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:

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.

At September 30, 2016, we employed approximately 1,700 people. Approximately 290 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.

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.

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 24 months, metals prices have fluctuated significantly and changes to our net sales, cost of materials sold, gross profit, cost of inventory and profitability, 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 and fully recovered the decrease experienced during 2015. Metals pricing peaked in June 2016, and has since decreased. Third quarter 2016 metals pricing decreased rapidly, and has continued to decline into the fourth quarter. Softer demand and the normal seasonal slowdowns in the third and fourth quarter due to holidays are contributing to the second half of 2016 pricing pressure. Although prices increased during the first half of 2016, the average selling price during the first nine months of 2016 is still lower than the average selling price during the first nine months of 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 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. Our average cost of flat rolled inventory did not begin to increase until May 2016, even though market prices began increasing in mid-December 2015. As a result, our average selling prices in 2016 are still lower than our average selling prices in 2015, and together with lower year over year industry wide shipments, decreased our net sales in 2016.

Consolidated Operations

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

Net sales decreased $8.6 million, or 3.1%, to $268.3 million in the third quarter of 2016 from $276.9 million in the third quarter of 2015. Carbon flat products net sales were 63.1% of total net sales in the third quarter of 2016 compared to 63.8% of total net sales in the third quarter of 2015. Specialty metals flat products net sales were 18.5% of total net sales in the third quarter of 2016 compared to 16.8% of total net sales in the third quarter of 2015. Tubular and pipe products net sales were 18.4% of total net sales in the third quarter of 2016 compared to 19.4% of total net sales in the third quarter of 2015. The decrease in net sales was primarily due to a 2.5% decrease in sales volume during the third quarter of 2016 compared to the third quarter of 2015 and a 0.6% decrease in the average selling price. Average selling prices increased sequentially from the second quarter of 2016 by approximately 8.9%. Sales volumes increased in the specialty metals flat products segment and decreased in the carbon flat products and tubular and pipe products segments during the third quarter of 2016 compared to the third quarter of 2015. Average selling prices increased in the carbon flat products segment and decreased in the specialty metals flat products and tubular and pipe products segments during the third quarter of 2016 compared to the third quarter of 2015 as a result of year over year lower market pricing for metals.

Net sales decreased $137.8 million, or 14.7%, to $800.2 million during the nine months ended September 30, 2016 from $938.0 million during the nine months ended September 30, 2015. Carbon flat products net sales were 63.0% of total net sales in the first nine months of 2016 compared to 65.5% of total net sales in the first nine months of 2015. Specialty metals flat products net sales were 18.1% of total net sales in the first nine months of 2016 compared to 16.2% of total net sales in the first nine months of 2015. Tubular and pipe products net sales were 18.9% of total net sales in the first nine months of 2016 compared to 18.3% of total net sales in the first nine months of 2015. The decrease in net sales was due to a 2.0% decrease in sales volume, driven by a 6.8% decline in industry-wide shipments by U.S. service centers, and a 12.9% decline in average selling prices during the nine months ended September 30, 2016 compared to the nine months ended September 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 nine months of 2016 compared to the first nine months of 2015. Average selling prices decreased in all segments during the first nine months of 2016 compared to the first nine months of 2015 as market pricing for metals is still lower year-over-year.

Cost of materials sold decreased $7.1 million, or 3.3%, to $211.0 million in the third quarter of 2016 from $218.2 million in the third quarter of 2015. The decrease in cost of materials sold in the third quarter of 2016 is primarily related to lower sales levels. Cost of materials sold decreased $137.4 million, or 18.2%, to $616.5 million during the nine months ended September 30, 2016 from $753.9 million during the nine months ended September 30, 2015. The decrease in cost of materials sold was primarily due to the decrease in metals cost during the nine months ended September 30, 2016 compared to the nine months ended September 30, 2015 discussed above. During the three and nine months ended September 30, 2016, we accrued $1.7 million in our carbon flat products related to an arbitration decision for a 2015 foreign steel purchase which was paid in October 2016. The charge accounted for 0.8% of cost of materials sold during the three months ended September 30, 2016 and 0.3% of cost of materials sold during the nine months ended September 30, 2016.

As a percentage of net sales, gross profit (as defined in footnote (b) in the table above) remained relatively flat at 21.3% in the third quarter of 2016 compared to 21.2% in the third quarter of 2015. As a percentage of net sales, gross profit increased to 23.0% in the nine months ended September 30, 2016 compared to 19.6% in the nine months ended September 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 contrasts 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. Metals pricing rapidly declined during the third quarter of 2016, although metals prices in the third quarter of 2016 are higher than metals prices in the third quarter of 2015. During the three and nine months ended September 30, 2016, we accrued $1.7 million related to an arbitration decision for a 2015 foreign steel purchase. The charge reduced gross profit by 0.6% and 0.2% during the three and nine months ended September 30, 2016, respectively.

Operating expenses in the third quarter of 2016 decreased $1.1 million, or 1.9%, to $57.2 million from $58.3 million in the third quarter of 2015. As a percentage of net sales, operating expenses increased to 21.3% for the third quarter of 2016 from 21.1% in the comparable 2015 period. Variable operating expenses, such as warehouse and processing, decreased $1.2 million, or 5.8%, compared to a volume decrease of 2.5% during the third quarter of 2016. Selling expenses increased $0.3 million, or 5.9%, as a result of increased variable incentive compensation and our decision to invest in more sales people during 2016 in order to increase market share. Operating expenses in the carbon flat products segment decreased $1.9 million, operating expenses in the specialty metals flat products segment increased $1.0 million, operating expenses in the tubular and pipe products segment decreased $0.6 million, and Corporate expenses increased $0.4 million.

Operating expenses in the first nine months of 2016 decreased $29.4 million, or 14.4%, to $175.3 million from $204.7 million in the first nine months of 2015. As a percentage of net sales, operating expenses were 21.9% for the nine months ended September 30, 2016 and 21.8% for the nine months ended September 30, 2015. The $29.4 million decrease in operating expenses is primarily attributable to the $24.5 million non-cash intangible asset impairment charges recorded during the first nine months of 2015 related to the tubular and pipe products segment. Operating expenses, excluding the impairment charges, decreased $5.0 million, or 2.8% compared to a volume decrease of 2.0%. 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 $4.0 million, or 4.3%, as a result of the 2.0% volume decrease during the first nine months of 2016. Occupancy expenses decreased $0.6 million, or 8.1%, as a result of operating with less warehouse space and lower utility and maintenance expenses. Selling expenses increased $1.3 million, or 7.8%, as a result of increased variable incentive compensation and our decision to invest in more sales people during 2016 in order to increase market share. Administrative and general expenses decreased by $1.2 million, or 2.5%, primarily related to reductions in labor and personnel expenses and centralization of certain administrative functions. Operating expenses in the carbon flat products segment decreased $5.5 million, operating expenses in the specialty metals products segment increased $2.0 million, operating expenses in the tubular and pipe products segment decreased $26.6 million, mainly due to the non-cash intangible asset impairment charges recorded in 2015, and Corporate expenses increased $0.6 million.

Interest and other expense on debt totaled $1.3 million, or 0.5% of net sales, for the third quarter of 2016 compared to $1.4 million, or 0.5% of net sales, for the third quarter of 2015. Interest and other expense on debt totaled $3.9 million, or 0.5% of net sales, for the first nine months of 2016 compared to $4.4 million, or 0.5% of net sales, for the first nine months of 2015. Our effective borrowing rate, exclusive of deferred financing fees and commitment fees, was 2.4% for the first nine months of 2016 compared to 2.1% for the first nine months of 2015. Total average borrowings decreased $76 million, or 33.8%, from $225 million in the first nine months of 2015 to $149 million in the first nine months of 2016.

For the third quarter of 2016, loss before income taxes totaled $1.3 million compared to loss before income taxes of $1.0 million in the third quarter of 2015. For the first nine months of 2016, income before income taxes totaled $4.5 million compared to loss before income taxes of $25.2 million in the first nine months of 2015. Loss before income taxes in 2015 included a $24.5 million non-cash intangible asset impairment charge.

An income tax provision of $0.5 million on loss before income taxes of $1.3 million was recorded for the third quarter of 2016 resulting in an effective tax rate of negative 36.4%, compared to an income tax benefit of $0.4 million on loss before income taxes of $1.0 million, or 42.3%, for the third quarter of 2015.  The tax provision recorded for the three months ended September 30, 2016 is primarily a result of an increase in tax expense from state and local income taxes applied against forecasted income for 2016 and discrete tax expense recorded during the third quarter of 2016, applied against net loss for the quarter.

An income tax provision of 77.0% was recorded for the first nine months of 2016, compared to an income tax benefit of 13.5% for the first nine months of 2015.  Through the nine months ended September 30, 2016, we recorded a valuation allowance of $0.8 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 18.3% for the nine months ended September 30, 2016. During the nine months ended September 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 25.3% for the nine months ended September 30, 2015.  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.   Given the relationship between fixed dollar tax items and income before taxes financial results, the effective tax rate can change materially based on small variations in income.

Net loss for the third quarter of 2016 totaled $1.8 million or $0.16 per basic and diluted share, compared to net loss of $0.6 million or $0.05 per basic and diluted share for the third quarter of 2015. Net income for the first nine months of 2016 totaled $1.0 million or $0.09 per basic and diluted share, compared to net loss of $21.8 million or $1.95 per basic and diluted share for the first nine months of 2015. For the nine months ended September 30, 2015, the intangible asset impairments decreased earnings per share by $1.91 per basic and diluted share.

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):

Tons sold by our carbon flat products segment decreased 11 thousand tons, or 4.4%, to 243 thousand in the third quarter of 2016 from 254 thousand in the third quarter of 2015. The decrease in tons sold is due to decreased customer demand and lower industry-wide shipments by U.S. service centers in the third quarter of 2016 compared to the 2015 comparable period.

Tons sold by our carbon flat products segment decreased 26 thousand tons, or 3.2% to 782 thousand in the first nine months of 2016 from 808 thousand in the first nine months of 2015. The decrease in tons sold is due to decreased customer demand and lower industry-wide shipments by U.S. service centers in the first nine months of 2016 compared to the first nine months of 2015. Despite the further softening of industry-wide shipments in the third quarter of 2016, the Company maintained or grew its market share in most of the carbon flat products it sells. We expect the year-over-year lower demand trends to remain consistent in the fourth quarter of 2016 compared to the fourth quarter of 2015 with an anticipated sequential decrease in shipments from the third quarter of 2016 due to the impacts of normal November and December holiday shutdowns at our customers’ locations.

Net sales in our carbon flat products segment decreased $7.3 million, or 4.1%, to $169.4 million in the third quarter of 2016 from $176.7 million in the third quarter of 2015. The decrease in sales was due to a 4.4% decrease in sales volume partially offset by a 0.3% increase in the average selling prices during the third quarter of 2016 compared to the third quarter of 2015. Average selling prices in the third quarter of 2016 were $698 per ton, compared with $696 per ton in the third quarter of 2015, and $635 per ton in the second quarter of 2016.

Net sales in our carbon flat products segment decreased $110.5 million, or 18.0% to $503.9 million in the first nine months of 2016 from $614.4 million in the first nine months of 2015. The decrease in sales was due to a 3.2% decrease in sales volume and a 15.2% decrease in average selling prices, as metals industry market prices are lower year-over-year. Average selling prices in the first nine months of 2016 were $645 per ton, compared with $760 per ton in the first nine months of 2015.

Cost of materials sold decreased $2.9 million, or 2.1%, to $136.4 million in the third quarter of 2016 from $139.3 million in the third quarter of 2015. The decrease in cost of materials sold was due to the lower shipment levels as the average cost of materials sold increased 2.5% in the third quarter of 2016 compared to the same period in 2015. During the three months ended September 30, 2016, we accrued $1.7 million related to an arbitration decision for a 2015 foreign steel purchase which was paid in October, 2016. The charge accounted for 1.3% of cost of materials sold during the three months ended September 30, 2016.

Cost of materials sold decreased $105.9 million, or 21.3%, to $392.0 million in the first nine months of 2016 from $497.9 million in the first nine months of 2015. The decrease in cost of materials sold was due to a 3.2% decrease in sales volume and a 18.6% decrease in metals cost during the nine months ended September 30, 2016 compared to the nine months ended September 30, 2015. During the nine months ended September 30, 2016, we accrued $1.7 million related to an arbitration decision for a 2015 foreign steel purchase which was paid in October 2016. The charge accounted for 0.4% of cost of materials sold during the nine months ended September 30, 2016.

As a percentage of net sales, gross profit (as defined in footnote (a) in the table above) decreased to 19.5% in the third quarter of 2016 compared to 21.2% in the third quarter of 2015. Gross profit per ton decreased $11 per ton to $136 per ton in the third quarter of 2016 from $147 per ton in the third quarter of 2015 and $161 per ton in the second quarter of 2016. The arbitration decision discussed above reduced gross profit by 1.0% during the three months ended September 30, 2016.

As a percentage of net sales, gross profit increased to 22.2% in the nine months ended September 30, 2016 compared to 19.0% in the nine months ended September 30, 2015. Gross profit per ton decreased $1 per ton to $143 per ton in the nine months ended September 30, 2016 from $144 per ton in the nine months ended September 30, 2015. The arbitration decision discussed above reduced gross profit by 0.3% during the nine months ended September 30, 2016.

Operating expenses in the third quarter of 2016 decreased $1.9 million, or 4.9%, to $36.6 million from $38.5 million in the third quarter of 2015, compared to the 4.4% volume decrease. As a percentage of net sales, operating expenses decreased to 21.6% for the third quarter of 2016 from 21.8% in the comparable 2015 period. Operating expenses in the first nine months of 2016 decreased $5.5 million, or 4.7%, to $112.0 million from $117.5 million in the first nine months of 2015. The operating expense decrease of 4.7% was greater than the volume decrease of 3.2% during the first nine months of 2016. As a percentage of net sales, operating expenses increased to 22.3% for the first nine months of 2016 from 19.1% 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 loss for the third quarter of 2016 totaled $3.6 million, or 2.1% of net sales, compared to operating loss of $1.1 million, or 0.6% of net sales for the third quarter of 2015. Operating loss for the nine months ended September 30, 2016 totaled $0.1 million, or 0.0% of net sales, compared to operating loss of $0.9 million, or 0.2% of net sales for the nine months ended September 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):

Tons sold by our specialty metals flat products segment increased 4 thousand tons, or 22.7%, to 22 thousand in the third quarter of 2016 from 18 thousand in the third quarter of 2015. The specialty metals flat products segment increased its market share in 2016 for each of the stainless steel and aluminum products we sell.

Tons sold by our specialty metals flat products segment increased 7 thousand tons, or 13.9% to 63 thousand in the nine months ended September 30, 2016 from 56 thousand in the nine months ended September 30, 2015. We expect fourth quarter 2016 sales to increase over the same period in 2015 with an anticipated sequential decrease from the third quarter of 2016 due to the impact of normal seasonal holiday shutdowns at our customers’ locations.

Net sales in our specialty metals flat products segment increased $3.0 million, or 6.6%, to $49.5 million in the third quarter of 2016 from $46.5 million in the third quarter of 2015. The increase in sales was due to a 22.7% increase in sales volume offset by a 13.1% decrease in the average selling prices during the third quarter of 2016 compared to the third quarter of 2015. Average selling prices in the third quarter of 2016 were $2,285 per ton, down $345 per ton, or 13.1%, from $2,630 per ton in the third quarter of 2015, but up $10 per ton, or 0.4% from $2,275 per ton in the second quarter of 2016. The decrease in the year over year average selling price per ton is a result of the market pricing dynamics discussed in the overview of Results of Operations above.

Net sales in our specialty metals flat products segment decreased $6.9 million, or 4.6%, to $144.9 million in the first nine months of 2016 from $151.8 million in the first nine months of 2015. The decrease in sales was due to a 16.2% decrease in average selling prices, as metals industry market prices are lower year-over-year, offset by a 13.9% increase in sales volume. Average selling prices in the first nine months of 2016 were $2,290 per ton, compared with $2,733 per ton in the first nine months of 2015.

Cost of materials sold decreased $1.4 million, or 3.1% to $41.5 million in the third quarter of 2016 from $42.9 million in the third quarter of 2015. The decrease was due to a 21.0% decrease in the average cost of materials offset by a 22.7% increase in sales volume during the third quarter of 2016 compared to the third quarter of 2015.

Cost of materials sold decreased $16.6 million, or 11.9%, to $122.7 million in the first nine months of 2016 from $139.3 million in the first nine months of 2015. The decrease in cost of materials sold was due to a 22.6% decrease in metals cost offset by a 13.9% increase in sales volume during the nine months ended September 30, 2016 compared to the nine months ended September 30, 2015.

As a percentage of net sales, gross profit (as defined in footnote (a) in the table above) increased to 16.1% in the third quarter of 2016 from 7.7% in the third quarter of 2015. As a percentage of net sales, gross profit increased to 15.3% in the nine months ended September 30, 2016 from 8.2% in the nine months ended September 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 nine months ended September 30, 2016 compared to the same periods in 2015.

Operating expenses in the third quarter of 2016 increased $1.0 million, or 26.1%, to $5.0 million from $4.0 million in the third quarter of 2015. As a percentage of net sales, operating expenses increased to 10.1% for the third quarter of 2016 compared to 8.5% for the third quarter of 2015. Operating expenses in the first nine months of 2016 increased $2.0 million, or 15.5%, to $14.8 million from $12.8 million in the first nine months of 2015. As a percentage of net sales, operating expenses increased to 10.3% for the nine months ended September 30, 2016 compared to 8.4% for the nine months ended September 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 third quarter of 2016 totaled $3.0 million, or 6.1% of net sales, compared to operating loss of $0.4 million, or 0.8% of net sales, for the third quarter of 2015. Operating income for the nine months ended September 30, 2016 totaled $7.3 million, or 5.1% of net sales, compared to operating loss of $0.3 million, or 0.2% of net sales, for the nine months ended September 30, 2015.

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):