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

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

For the quarterly period ended March 31, 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

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.

Notes to Unaudited Consolidated Financial Statements

March 31, 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 March 31, 2016, we employed approximately 1,716 people. Approximately 311 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

The metals industry experienced a significant decline in the price of metals during 2015 as a result of the strengthened U.S. dollar, a historically high level of imported materials arriving in the United States, low raw material costs to produce metals and a global oversupply of metals. The price of hot-rolled carbon flat steel decreased approximately 41% during 2015. Similarly, the price of stainless steel and aluminum decreased during 2015. During the first quarter of 2016, metals prices increased. The price of hot-rolled carbon flat steel increased approximately 19% over the December 2015 price during the first quarter of 2016. Although the price of hot-rolled carbon flat steel sequentially increased in the first quarter of 2016, the average price during the quarter was still 19% lower than the average price of hot-rolled carbon flat steel during the first quarter of 2015. Industry demand has also softened in the first quarter of 2016 compared to 2015 as evidenced by lower year over year shipments by metals service centers in the United States. Lower industry demand and pricing negatively impacted our first quarter 2016 net sales and earnings as compared to the first quarter of 2015. Net sales and earnings improved as the first quarter progressed, and we expect this trend to continue into the second quarter of 2016.

Consolidated Operations

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

Net sales decreased 25.3% to $258.3 million in the first quarter of 2016 from $345.9 million in the first quarter of 2015. Carbon flat products net sales were 62.5% of total net sales in the first quarter of 2016 compared to 66.1% of total net sales in the first quarter of 2015. Specialty metals products net sales were 17.7% of total net sales in the first quarter of 2016 compared to 15.2% of total net sales in the first quarter of 2015. Tubular and pipe products net sales were 19.8% of total net sales in the first quarter of 2016 compared to 18.7% of total net sales in the first quarter of 2015. The decrease in net sales was due to a 2.8% decrease in sales volume and a 23.2% decrease in average selling prices during the first quarter of 2016 compared to the first quarter of 2015. Sales volumes decreased in the carbon flat products and tubular and pipe products segments and increased in the specialty metals flat products segment during the first quarter of 2016 compared to the first quarter of 2015. Average direct selling prices decreased in all segments during the first quarter of 2016 compared to the first quarter of 2015 as a result of year over year lower market pricing for metals.

Cost of materials sold decreased 28.6% to $199.8 million in the first quarter of 2016 from $279.9 million in the first quarter of 2015. The decrease in cost of materials sold in the first quarter of 2016 is primarily related to lower metals pricing discussed above as well as the 2.8% decrease in sales volume.

As a percentage of net sales, gross profit (as defined in footnote (b) in the table above) increased to 22.7% in the first quarter of 2016 compared to 19.1% in the first quarter of 2015. The increase in the gross profit percentage is a result of metals prices sequentially increasing during the first quarter of 2016 compared to the fourth quarter of 2015, while our average cost of inventory contained lower-costed metal as we historically hold approximately three months of material in inventory. This compares to the declining metals pricing environment during the first quarter of 2015, when the average cost of inventory contained higher-costed metal.

Operating expenses in the first quarter of 2016 decreased $4.1 million, or 6.5%, to $58.5 million from $62.6 million in the first quarter of 2015. As a percentage of net sales, operating expenses increased to 22.7% for the first quarter of 2016 from 18.1% in the comparable 2015 period due to the decrease in net sales during the first quarter of 2016. Operating expenses in the flat products segment decreased $2.7 million, operating expenses in the specialty metals products segment increased $0.4 million, operating expenses in the tubular and pipe products segment decreased $1.6 million and Corporate expenses decreased $0.2 million. Operating expenses decreased in all categories as reported on the Company’s Consolidated Statements of Comprehensive Income, as we continue to execute on the profit improvement plan initiated in 2015. Variable operating expenses, such as distribution and warehouse and processing, decreased $2.1 million, or 6.7%, as a result of the 2.8% first quarter 2016 volume decrease, reductions in labor and personnel expenses and reduced warehouse consumables expenses. Occupancy expenses decreased $0.4 million, or 13.8%, as a result of operating with less warehouse space and lower utility and maintenance expenses. Selling expenses decreased $0.2 million, or 3.5%, as a result of lower bad debt expense. Administrative and general expenses decreased by $1.3 million, or 7.4%, primarily related to reductions in labor and personnel expenses, centralization of certain administrative functions, and lower variable based incentive compensation.

Interest and other expense on debt totaled $1.3 million, or 0.5% of net sales, for the first quarter of 2016 compared to $1.6 million, or 0.5% of net sales, for the first quarter of 2015. Our effective borrowing rate, exclusive of deferred financing fees and commitment fees, was 2.5% for the first three months of 2016 compared to 2.1% for the first three months of 2015.

For the first quarter of 2016, loss before income taxes totaled $1.3 million compared to income before income taxes of $1.8 million in the first quarter of 2015.

An income tax benefit of 38.9% was recorded for the first quarter of 2016, compared to an income tax provision of 38.9% for the first quarter of 2015. Our tax benefit or provision for interim periods is determined using an estimate of our annual effective tax rate, adjusted for discrete items that are taken into account in the relevant period. Each quarter, we update our estimate of the annual effective tax rate, and if our estimated tax rate changes, we make a cumulative adjustment. We expect our effective tax rate to approximate 38% to 40% on an annual basis in 2016.

Net loss for the first quarter of 2016 totaled $0.8 million or $0.07 per basic and diluted share, compared to net income of $1.1 million or $0.10 per basic and diluted share for the first quarter of 2015.

Segment Operations

Carbon flat products

The following table presents selected operating results for our carbon flat products segment for the three months ended March 31, 2016 and 2015 (dollars are shown in thousands, except for per ton information):

Tons sold by our flat products segment decreased 3.2% to 267 thousand in the first quarter of 2016 from 276 thousand in the first quarter of 2015. The decrease in tons sold is due to decreased customer demand and lower industry-wide shipments in the first quarter of 2016 compared to the first quarter of 2015.

Net sales in our carbon flat products segment decreased $67.1 million, or 29.4%, to $161.4 million in the first quarter of 2016 from $228.5 million in the first quarter of 2015. The decrease in sales was due to a 27.0% decrease in the average selling prices during the first quarter of 2016 compared to the first quarter of 2015 as well as a 3.2% decrease in sales volume. Average selling prices in the first quarter of 2016 were $605 per ton, compared with $829 per ton in the first quarter of 2015 and $658 per ton in the fourth quarter of 2015. The decrease 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 decreased $61.9 million, or 32.8%, to $126.5 million in the first quarter of 2016 from $188.4 million in the first quarter of 2015. The decrease was due to lower pricing and shipments discussed above, which decreased the average cost of goods sold per ton by 30.6% in the first quarter of 2016 compared to the same period in 2015.

As a percentage of net sales, gross profit (as defined in footnote (a) in the table above) increased to 21.6% in the first quarter of 2016 compared to 17.6% in the first quarter of 2015.    The increase in gross profit percentage in 2016 was primarily due to the cost of materials sold decreasing more than selling prices. Gross profit per ton decreased $15 per ton to $131 per ton in the first quarter of 2016 from $146 per ton in the first quarter of 2015.

Operating expenses in the first quarter of 2016 decreased $2.7 million, or 6.8%, to $37.1 million from $39.8 million in the first quarter of 2015. Variable operating expenses, such as distribution and warehouse and processing, decreased as a result of lower sales volume. Occupancy expenses decreased as a result of decreased utility and maintenance expense due to operating with less warehouse space. Selling and administrative and general expenses decreased as a result of reductions in labor and personnel expenses, centralization of certain administrative functions, and lower variable based incentive compensation. As a percentage of net sales, operating expenses increased to 23.0% for the first quarter of 2016 compared to 17.4% for first quarter of 2015.

Operating loss for the first quarter of 2016 totaled $2.2 million, or 1.3% of net sales, compared to operating income of $0.5 million, or 0.2% of net sales, for the first quarter of 2015.

Specialty metals flat products

The following table presents selected operating results for our specialty metals flat products segment for the three months ended March 31, 2016 and 2015 (dollars are shown in thousands, except for per ton information):

Tons sold by our specialty metals flat products segment increased 6.8% to 20 thousand in the first quarter of 2016 from 19 thousand in the first quarter of 2015. The increase in tons sold is due to increased demand from existing customers, from the impact of new business awards in the first quarter of 2016 compared to the first quarter of 2015 and our growth in market share in specialty metals.

Net sales in our specialty metals flat products segment decreased $6.8 million, or 12.9%, to $45.8 million in the first quarter of 2016 from $52.6 million in the first quarter of 2015. The decrease in sales was due to an 18.5% decline in the average selling price offset by the 6.8% increase in sales volume during the first quarter of 2016 compared to the first quarter of 2015. Average selling prices in the first quarter of 2016 were $2,312 per ton, compared with $2,836 per ton in the first quarter of 2015 and $2,464 per ton in the fourth quarter of 2015. The decrease in the year over year average selling price per ton is a result of the market pricing dynamics, which continue to pressure metals pricing in the specialty metals segment.

Cost of materials sold decreased $8.4 million, or 17.6%, to $39.2 million in the first quarter of 2016 from $47.6 million in the first quarter of 2015. The decrease was due to a 22.9% decrease in the average cost of materials sold offset by a 6.8% increase in sales volume during the first quarter of 2016 compared to the first quarter of 2015.

As a percentage of net sales, gross profit (as defined in footnote (a) in the table above) increased to 14.5% in the first quarter of 2016 from 9.6% in the first quarter of 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 first quarter of 2016 compared to the first quarter of 2015.

Operating expenses in the first quarter of 2016 increased $0.4 million, or 9.0%, to $4.9 million from $4.5 million in the first quarter of 2015. Variable operating expenses, such as distribution and warehouse and processing increased 8.8% 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. As a percentage of net sales, operating expenses increased to 10.6% for the first quarter of 2016 compared to 8.5% for the first quarter of 2015.

Operating income for the first quarter of 2016 totaled $1.8 million, or 3.9% of net sales, compared to $0.6 million, or 1.1% of net sales, for the first quarter of 2015.

Tubular and pipe products

The following table presents selected operating results for our tubular and pipe products segment for the three months ended March 31, 2016 and 2015 (dollars are shown in thousands):

Net sales decreased $13.6 million, or 21.0%, to $51.1 million in the first quarter of 2016 from $64.7 million in the first quarter of 2015. The decrease is a result of a 5.3% decrease in sales volume and a 16.6% decrease in the pipe and tube products segment average selling prices over the first quarter of 2015.

Cost of materials sold decreased $10.0 million, or 22.7%, to $34.1 million in the first quarter of 2016 from $44.1 million in the first quarter of 2015. The decrease in cost of materials sold is primarily a result of decreased metals pricing in the first quarter of 2016 compared to the first quarter of 2015 and decreased sales volumes. There was no LIFO income or expense recorded in the first quarter of 2016 compared to $250 thousand of LIFO income recorded in the first quarter of 2015.

As a percentage of net sales, gross profit (as defined in footnote (b) in the table above) totaled 33.3% in the first quarter of 2016 compared to 31.8% in the first quarter of 2015. As a percentage of net sales, the $250 thousand LIFO income in 2015 increased current year gross profit by 0.4%.

Operating expenses in the first quarter of 2016 decreased $1.6 million, or 9.8%, to $14.7 million from $16.3 million in the first quarter of 2015. Variable operating expenses, such as distribution and warehouse and processing, decreased as a result of lower sales volumes and net sales. Operating expenses increased to 28.9% of net sales in the first quarter of 2016 compared to 25.3% in the first quarter of 2015.

Operating income for the first quarter 2016 totaled $2.2 million, or 4.4% of net sales, compared to $4.3 million, or 6.5% of net sales, for the first quarter of 2015.

Corporate expenses

Corporate expenses decreased $0.2 million to $1.8 million in the first quarter of 2016 compared to $2.0 million in the first quarter of 2015. 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.

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, leasing transactions and borrowings under our credit facility to fund these requirements.

We believe that funds available under our existing asset-based credit facility (the ABL Credit Facility), lease arrangement proceeds and the sale of equity or debt securities, 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 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, 2016, we generated $2.8 million of net cash from operations, of which $3.3 million was generated from operating activities and $0.5 million was used for working capital. For the three months ended March 31, 2015, we generated $14.6 million of net cash from operations, of which $3.0 million was generated from operating activities and $11.6 million was generated from a smaller working capital investment.

Net cash from operations totaled $3.3 million during the first quarter of 2016 and was generated from depreciation and amortization of $5.0 million, and stock-based compensation of $0.8 million, offset by the net loss of $0.8 million and a decrease in net long-term assets and liabilities of $1.5 million. Net cash from operations totaled $3.0 million during the first quarter of 2015 and was primarily generated from net income of $1.1 million, depreciation and amortization of $5.0 million, and stock-based compensation of $1.0 million, offset by a decrease in net long-term assets and liabilities of $4.0 million.

Working capital at March 31, 2016 totaled $233.2 million, a $1.3 million increase from December 31, 2015. The increase was primarily attributable to a $21.8 million, or 23.5%, increase in accounts receivable (resulting from higher sales normally experienced in the first quarter compared to the lower sales in the fourth quarter) offset by a $16.8 million, or 8.1%, decrease in inventories (resulting from increased inventory turnover, lower average inventory costs and increased sales in the first quarter of 2016 compared to the fourth quarter of 2015) and a $4.2 million decrease in accrued payroll and other accrued liabilities.

Investing Activities

Net cash used for investing activities was $1.2 million during the three months ended March 31, 2016, compared to $1.7 million during the three months ended March 31, 2015. The $1.4 million of 2016 capital expenditures were primarily attributable to additional processing equipment at our existing facilities. During 2016, we expect to limit our capital spending to less than our annual depreciation expense (approximately $18 million in 2016).

Financing Activities

During the first three months of 2016, $0.8 million of cash was used for financing activities, which primarily consisted of $0.6 million of net repayments under our ABL Credit Facility and $0.2 million of dividends paid. 

Dividends paid were $0.2 million for both the three months ended March 31, 2016 and March 31, 2015. In April 2016, our Board of Directors approved a regular quarterly dividend of $0.02 per share, which will be paid on June 15, 2016 to shareholders of record as of June 1, 2016. Regular dividend distributions in the future are subject to the availability of cash, the $2.5 million annual limitation on cash dividends 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

On October 2, 2015, we announced that our 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. Any of the 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 $2.5 million in the aggregate during any trailing twelve months without restrictions. Purchases in excess of $2.5 million require us to (i) maintain availability in excess of 25% of the aggregate revolver commitments ($91.3 million at March 31, 2016) or (ii) to maintain availability equal to or greater than 15% of the aggregate revolver commitments ($54.8 million at March 31, 2016) 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 2016, we expect to be limited to the $2.5 million available without restrictions to repurchase common stock and pay dividends.

No share repurchases were made during the first quarter of 2016.

Debt Arrangements

Our ABL Credit Facility is collateralized by our accounts receivable and inventory. The ABL Credit Facility consists of a revolving credit line of $365 million. Revolver borrowings are limited to the lesser of a borrowing base, comprised of eligible receivables and inventories, or $365 million in the aggregate. The ABL Credit Facility matures on June 30, 2019.

The ABL Credit Facility requires us to comply with various covenants, the most significant of which include: (i) until maturity of the ABL Credit Facility, if any commitments or obligations are outstanding and our availability is less than the greater of $30 million or 10.0% of the aggregate amount of revolver commitments ($36.5 million at March 31, 2016), then we must maintain a ratio of EBITDA minus certain capital expenditures and cash taxes paid to fixed charges of at least 1.00 to 1.00 for the most recent twelve fiscal month period; (ii) limitations on dividend payments and stock repurchases; and (iii) restrictions on additional indebtedness. We have the option to borrow under our revolver based on the agent’s base rate plus a premium ranging from 0.00% to 0.25% or the London Interbank Offered Rate (LIBOR) plus a premium ranging from 1.25% to 3.00%.

As of March 31, 2016, the Company was in compliance with its covenants and had approximately $93 million of availability under the ABL Credit Facility.

As of March 31, 2016, $2.6 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.

We entered into a forward starting fixed rate interest rate hedge that commenced June 2013, in order to eliminate the variability of cash interest payments on $53.2 million of then outstanding LIBOR-based borrowings under the ABL Credit Facility. The hedge matures on June 1, 2016 and the notional amount is reduced monthly by $729 thousand. The remaining hedged balance as of March 31, 2016 was $28.4 million. The interest rate hedge fixed the rate at 1.21% plus a premium ranging from 1.25% to 1.75%. Although we are exposed to credit loss in the event of nonperformance by the other parties to the interest rate hedge agreement, we anticipate performance by the counterparties.

As part of the CTI acquisition in July 2011, we assumed approximately $5.9 million of Industrial Revenue Bond (IRB) indebtedness issued through the Stanly County, North Carolina Industrial Revenue and Pollution Control Authority. The bond matures in April 2018, with the option to provide principal payments annually on April 1st. On April 1, 2016, we paid an optional principal payment of $865 thousand. Since the IRB is remarketed annually, it is included in “Current portion of long-term debt” on the accompanying Consolidated Balance Sheets. Interest is payable monthly, with a variable rate that resets weekly. As a security for payment of the bonds, we obtained a direct pay letter of credit issued by JPMorgan Chase Bank, N.A. The letter of credit reduces annually by the principal reduction amount. The interest rate at March 31, 2016 was 0.6% for the IRB debt.

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, 2015.

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, labor costs, sales levels, competition, levels of inventory held by other metals service centers, consolidation of metals producers, new global capacity by metals producers, volatility in 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, except for the metals hedges discussed in Note 5 to the Consolidated Financial Statements. 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 asset impairment charges. Changing metals prices therefore could significantly impact our net sales, gross profits, operating income and net income.

Rising 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 9.5% of our consolidated net sales in 2016 were directly related to automotive manufacturers or manufacturers of automotive components and parts. Historically, due to the concentration of customers in the automotive industry, our gross profits on these sales have generally been less than our gross profits on sales to customers in other industries.

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 steel and increased distribution expense, has not had a material effect on our financial results during the past three years. 

We are exposed to the impact of fluctuating metals prices and interest rate changes. During 2016 and 2015, we entered into metals swaps at the request of customers. While these derivatives are intended to be effective in helping us manage risk, they 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. The Company assumed an interest rate swap agreement on the $5.9 million of CTI IRB. The swap agreement matures in April 2018, but the notional amount may be reduced annually by the amount of the optional principal payments on the IRB. In June 2012, the Company entered into a forward starting fixed rate interest rate hedge commencing July 2013 in order to eliminate the variability of cash interest payments on approximately $53.2 million of the then outstanding LIBOR-based borrowings under the ABL Credit Facility. The balance as of March 31, 2016 was $28.4 million. The hedge matures on June 1, 2016 and the notional amount is reduced monthly by $729 thousand. The fixed rate interest rate hedge is accounted for as a cash flow hedging instrument for accounting purposes. The Company is exposed to credit loss in the event of nonperformance by the other parties to the interest rate swap and fixed interest rate hedge agreements. However, the Company does not anticipate nonperformance by the counterparties.

Item 4. Controls and Procedures

The evaluation required by Rule 13a-15 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, 2016, our disclosure controls and procedures were effective.

There were no changes in our internal control over financial reporting that occurred during the first quarter of 2016 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Part II. OTHER INFORMATION

Items 1, 1A, 2, 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 6. Exhibits

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.

EXHIBIT INDEX

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