OLYMPIC STEEL INC - Quarter Report: 2019 June (Form 10-Q)

 

 

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

( X )

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2019

 

(    )

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from __________ to ____________

 

Commission File Number 0-23320

 

 

OLYMPIC STEEL, INC.

(Exact name of registrant as specified in its charter)

 

Ohio		34-1245650
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)
22901 Millcreek Boulevard, Suite 650, Highland Hills, OH		44122
(Address of principal executive offices)		(Zip Code)

 

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

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common stock, without par value	ZEUS	The NASDAQ Stock Market, LLC.

 

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 every Interactive Data File required to be submitted 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 such files). Yes (X) No ( )

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer (   )	Accelerated filer (X)
Non-accelerated filer (   )	Smaller reporting company (   )
	Emerging growth company (   )

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) 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:

 

Class		Outstanding as of August 1, 2019
Common stock, without par value		10,899,065

         

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Olympic Steel, Inc.

Index to Form 10-Q

 

 

	Page No.
Part I.  FINANCIAL INFORMATION	3
Item 1.  Financial Statements	3
Consolidated Balance Sheets – June 30, 2019 and December 31, 2018 (unaudited)	3
Consolidated Statements of Comprehensive Income – for the three and six months ended June 30, 2019 and 2018 (unaudited)	4
Consolidated Statements of Cash Flows – for the six months ended June 30, 2019 and 2018 (unaudited)	5
Supplemental Disclosures of Cash Flow Information – for the six months ended June 30, 2019 and 2018 (unaudited)	6
Consolidated Statements of Shareholders’ Equity – for the three and six months ended June 30, 2019 and 2018 (unaudited)	7
Notes to Unaudited Consolidated Financial Statements	8
Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations	22
Item 3.  Quantitative and Qualitative Disclosures About Market Risk	34
Item 4.  Controls and Procedures	35
Part II.  OTHER INFORMATION	36
Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds	36
Item 6.  Exhibits	36
SIGNATURES	37

 

 

 

		As of
		June 30, 2019				December 31, 2018
		(unaudited)
Assets
Cash and cash equivalents		$	6,373			$	9,319
Accounts receivable, net			185,048				175,252
Inventories, net (includes LIFO reserve of $2,821 as of June 30, 2019 and $3,071 as of December 31, 2018)			288,183				368,738
Prepaid expenses and other			9,973				9,460
Total current assets			489,577				562,769
Property and equipment, at cost			410,995				403,785
Accumulated depreciation			(251,784	)			(244,176	)
Net property and equipment			159,211				159,609
Goodwill			3,256				2,358
Intangible assets, net			29,873				24,914
Other long-term assets			13,416				11,090
Right of use assets, net			29,072				-
Total assets		$	724,405			$	760,740
Liabilities
Accounts payable		$	70,457			$	95,367
Accrued payroll			11,375				19,665
Other accrued liabilities			15,496				13,395
Current portion of lease liabilities			5,793				-
Total current liabilities			103,121				128,427
Credit facility revolver			264,649				302,530
Other long-term liabilities			11,775				9,327
Deferred income taxes			13,055				13,465
Lease liabilities			23,342				-
Total liabilities			415,942				453,749
Shareholders' Equity
Preferred stock			-				-
Common stock			132,420				130,778
Treasury stock			(1,653	)			(132	)
Accumulated other comprehensive loss			(2,365	)			-
Retained earnings			180,061				176,345
Total shareholders' equity			308,463				306,991
Total liabilities and shareholders' equity		$	724,405			$	760,740

 

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		Three months ended								Six months ended
		June 30,								June 30,
		2019				2018				2019				2018
Net sales		$	429,151			$	452,917			$	875,070			$	828,515
Costs and expenses
Cost of materials sold (excludes items shown separately below)			351,494				356,061				717,876				650,838
Warehouse and processing			25,123				23,813				50,734				47,249
Administrative and general			19,396				21,523				39,525				40,396
Distribution			12,495				13,386				25,330				25,525
Selling			7,420				7,107				14,760				14,335
Occupancy			2,466				2,297				5,264				4,852
Depreciation			4,488				4,164				8,919				8,187
Amortization			329				247				648				469
Total costs and expenses			423,211				428,598				863,056				791,851
Operating income			5,940				24,319				12,014				36,664
Other loss, net			(59	)			(93	)			(45	)			(139	)
Income before interest and income taxes			5,881				24,226				11,969				36,525
Interest and other expense on debt			3,174				2,670				6,416				4,656
Income before income taxes			2,707				21,556				5,553				31,869
Income tax provision			626				5,708				1,398				8,392
Net income		$	2,081			$	15,848			$	4,155			$	23,477
Loss on cash flow hedge			(1,739	)			-				(3,196	)			-
Tax effect on cash flow hedge			452				-				831				-
Total comprehensive income		$	794			$	15,848			$	1,790			$	23,477
Earnings per share:
Net income per share - basic		$	0.18			$	1.39			$	0.36			$	2.06
Weighted average shares outstanding - basic			11,415				11,435				11,482				11,419
Net income per share - diluted		$	0.18			$	1.39			$	0.36			$	2.06
Weighted average shares outstanding - diluted			11,415				11,435				11,482				11,419
Dividends declared per share of common stock		$	0.02			$	0.02			$	0.04			$	0.04

 

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		2019				2018
Cash flows from (used for) operating activities:
Net income		$	4,155			$	23,477
Adjustments to reconcile net income to net cash from (used for) operating activities -
Depreciation and amortization			9,826				8,885
(Gain) loss on disposition of property and equipment			(195	)			5
Stock-based compensation			1,642				1,168
Other long-term assets			(2,544	)			(68	)
Other long-term liabilities			(261	)			2,195
			12,623				35,662
Changes in working capital:
Accounts receivable			(9,335	)			(65,899	)
Inventories			81,141				(73,519	)
Prepaid expenses and other			(462	)			3,391
Accounts payable			(24,510	)			41,184
Change in outstanding checks			(1,083	)			(5,318	)
Accrued payroll and other accrued liabilities			(6,187	)			2,616
			39,564				(97,545	)
Net cash from (used for) operating activities			52,187				(61,883	)
Cash flows from (used for) investing activities:
Acquisition			(11,000	)			(21,907	)
Capital expenditures			(4,421	)			(13,775	)
Proceeds from disposition of property and equipment			234				60
Net cash used for investing activities			(15,187	)			(35,622	)
Cash flows from (used for) financing activities:
Credit facility revolver borrowings			324,744				285,167
Credit facility revolver repayments			(362,625	)			(183,728	)
Principal payment under capital lease obligation			(5	)			(2	)
Industrial revenue bond repayments			-				(930	)
Credit facility fees and expenses			(100	)			(70	)
Repurchase of common stock			(1,521	)			-
Dividends paid			(439	)			(440	)
Net cash from (used for) financing activities			(39,946	)			99,997
Cash and cash equivalents:
Net change			(2,946	)			2,492
Beginning balance			9,319				3,009
Ending balance		$	6,373			$	5,501

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		2019				2018
Interest paid		$	6,348			$	4,306
Income taxes paid		$	248			$	2,055

 

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		For the Three Months Ended June 30, 2019
										Accumulated
										Other
		Common				Treasury				Comprehensive				Retained				Total
		Stock				Stock				Loss				Earnings				Equity
Balance at March 31, 2019		$	132,275			$	(196	)		$	(1,078	)		$	178,199			$	309,200
Net income			-				-				-				2,081				2,081
Payment of dividends			-				-				-				(219	)			(219	)
Stock-based compensation			145				-				-				-				145
Changes in fair value of hedges, net of tax			-				-				(1,287	)			-				(1,287	)
Repurchase of common stock			-				(1,457	)			-				-				(1,457	)
Balance at June 30, 2019		$	132,420			$	(1,653	)		$	(2,365	)		$	180,061			$	308,463

		For the Six Months Ended June 30, 2019
										Accumulated
										Other
		Common				Treasury				Comprehensive				Retained				Total
		Stock				Stock				Loss				Earnings				Equity
Balance at December 31, 2018		$	130,778			$	(132	)		$	-			$	176,345			$	306,991
Net income			-				-				-				4,155				4,155
Payment of dividends			-				-				-				(439	)			(439	)
Stock-based compensation			1,642				-				-				-				1,642
Changes in fair value of hedges, net of tax			-				-				(2,365	)			-				(2,365	)
Repurchase of common stock			-				(1,521	)			-				-				(1,521	)
Balance at June 30, 2019		$	132,420			$	(1,653	)		$	(2,365	)		$	180,061			$	308,463

		For the Three Months Ended June 30, 2018
		Common				Treasury				Retained				Total
		Stock				Stock				Earnings				Equity
Balance at March 31, 2018		$	130,379			$	(239	)		$	150,875			$	281,015
Net income			-				-				15,848				15,848
Payment of dividends			-				-				(220	)			(220	)
Stock-based compensation			38				106				-				144
Other			-				1				-				1
Balance at June 30, 2018		$	130,417			$	(132	)		$	166,503			$	296,788

		For the Six Months Ended June 30, 2018
		Common				Treasury				Retained				Total
		Stock				Stock				Earnings				Equity
Balance at December 31, 2017		$	129,453			$	(337	)		$	143,467			$	272,583
Net income			-				-				23,477				23,477
Payment of dividends			-				-				(440	)			(440	)
Stock-based compensation			964				204				-				1,168
Other			-				1				(1	)			-
Balance at June 30, 2018		$	130,417			$	(132	)		$	166,503			$	296,788

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1.	Basis of Presentation:

 

The accompanying consolidated financial statements have been prepared from the financial records of Olympic Steel, Inc. and its wholly-owned subsidiaries (collectively, Olympic or the Company), without audit and reflect all normal and recurring adjustments which are, in the opinion of management, necessary to fairly state the results of the interim periods covered by this report. Year-to-date results are not necessarily indicative of 2019 annual results and these financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2018. All intercompany transactions and balances have been eliminated in consolidation.

 

The Company operates in three reportable segments; carbon flat products, specialty metals flat products, and tubular and pipe products. The carbon flat products segment and the specialty metals flat products segments are at times consolidated and referred to as the flat products segments. Certain 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. 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. The carbon flat products segment sells and distributes large volumes of processed carbon and coated flat-rolled sheet, coil and plate products, and fabricated parts. Through its acquisition of McCullough Industries (McCullough) on January 2, 2019, the carbon flat products segment expanded its product offerings to include self-dumping metal hoppers. The specialty metals flat products segment sells and distributes processed aluminum and stainless flat-rolled sheet and coil products, flat bar products and fabricated parts. Through its acquisition of Berlin Metals, LLC (Berlin Metals) on April 2, 2018, the 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. The tubular and pipe products segment, which consists of the Chicago Tube and Iron subsidiary (CTI), distributes metal tubing, pipe, bar, valves and fittings and fabricates pressure parts supplied to various industrial markets.

 

Corporate expenses are reported as a separate line item for segment reporting purposes. Corporate expenses include the unallocated expenses related to managing the entire Company (i.e., all three segments), including payroll expenses for certain personnel, expenses related to being a publicly traded entity such as board of directors’ expenses, audit expenses, and various other professional fees.

 

Impact of Recently Issued Accounting Pronouncements

 

In August 2017, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No 2017-12, “Derivatives and Hedging”. This ASU aligns an entity’s risk management activities and financial reporting for hedging relationships through changes to both the designation and measurement guidance for qualifying hedging relationships and the presentation of hedge results. To meet that objective, the ASU expands and refines hedge accounting for both nonfinancial and financial risk components and align the recognition and presentation of the effects of the hedging instrument and the hedged item in the financial statements. This ASU also makes certain targeted improvements to simplify the application of hedge accounting guidance and ease the administrative burden of hedge documentation requirements and assessing hedge effectiveness. This ASU is the final version of proposed ASU 2016-310, “Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities”, which has been deleted. For public business entities, this ASU is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. All transition requirements and elections were applied to hedging relationships existing (that is, hedging relationships in which the hedging instrument has not expired, been sold, terminated, or exercised or the entity has not removed the designation of the hedging relationship) on the date of adoption. The effect of adoption was reflected as of the beginning of 2019. The adoption of this ASU did not have a material impact on the Company’s consolidated financial statements.

 

In February 2016, the FASB issued ASU No. 2016-02, “Leases,” which specifies the accounting for leases. The objective is to establish the principles that lessees and lessors shall apply to report useful information to users of financial statements about the amount, timing and uncertainty of cash flows arising from a lease. This ASU introduces the recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases under previous guidance. The guidance was effective for annual reporting periods beginning after December 15, 2018 and interim periods within those fiscal years. The adoption of the guidance impacted the Company’s Consolidated Balance Sheets by the creation of right to use assets and lease liabilities. The adoption of this ASU did not have a material impact on the Company’s Statement of Comprehensive Income or on the Statement of Cash Flows. See Note 7.

 

 

 

2.	Acquisitions:

 

On January 2, 2019, the Company acquired substantially all of the net assets of McCullough, based in Kenton, Ohio. McCullough was founded in 1965 and manufactures and sells branded self-dumping metal hoppers used in a variety of industrial applications. McCullough’s products are primarily sold through industrial distributors and catalogues.

 

The acquisition is not considered significant and thus pro forma information has not been provided. The acquisition was accounted for as a business combination and the assets and liabilities were valued at fair market value. The table below summarizes the preliminary purchase price allocation of the fair market values of the assets acquired and liabilities assumed.

 

 

The purchase price allocation presented above is based upon management’s estimate of the fair value of the acquired assets and assumed liabilities using valuation techniques including income, cost and market approaches. The fair value estimates involve the use of estimates and assumptions, including, but not limited to, the timing and amounts of future cash flows, revenue growth rates, discount rates, and royalty rates.

 

As of the effective date of the acquisition, McCullough’s results are included in the Company’s carbon flat products segment. Upon the acquisition, the Company entered into an amendment to its credit facility to include the eligible assets of McCullough.

 

3.	Revenue Recognition:

 

The Company provides metals processing, distribution and delivery of large volumes of processed carbon, coated flat rolled sheet, coil and plate products, aluminum, and stainless flat rolled products, prime tin mill products, flat bar products, metal tubing, pipe, bar, valves, fittings, fabricated parts and self-dumping hoppers. The Company's contracts with customers are comprised of purchase orders with standard terms and conditions. Occasionally the Company may also have longer-term agreements with customers. Substantially all of the contracts with customers require the delivery of metals which represent single performance obligations that are satisfied upon transfer of control of the product to the customer.

 

Transfer of control is assessed based on the use of the product distributed and rights to payment for performance under the contract terms. Transfer of control and revenue recognition for substantially all of the Company’s sales occur upon shipment or delivery of the product, which is when title, ownership and risk of loss pass to the customer and is based on the applicable shipping terms. The shipping terms depend on the customer contract. An invoice for payment is issued at time of shipment and terms are generally net 30 days. The Company has certain fabrication contracts in one business unit for which revenue is recognized over time as performance obligations are achieved. This fabrication business is not material to the Company's consolidated results.

 

 

Within the metals industry, revenue is frequently disaggregated by products sold. The table below disaggregates the Company’s revenues by segment and products sold.

 

 

 

 

 

 

 

4.	Accounts Receivable:

 

Accounts receivable are presented net of allowances for doubtful accounts and unissued credits of $3.9 million as of both June 30, 2019 and December 31, 2018. The allowance for doubtful accounts is maintained at a level considered appropriate based on historical experience and specific customer collection issues that have been identified. Estimations are based upon a calculated percentage of accounts receivable, which remains fairly level from year to year, and judgments about the probable effects of economic conditions on certain customers, which can fluctuate significantly from year to year. The Company cannot guarantee that the rate of future credit losses will be similar to past experience. The Company considers all available information when assessing the adequacy of its allowance for doubtful accounts and unissued credits each quarter.

 

 

5.	Inventories:

 

Inventories consisted of the following:

 

 

The Company values certain of its tubular and pipe products inventory at the last-in, first-out (LIFO) method. At June 30, 2019 and December 31, 2018, approximately $47.9 million, or 16.6% of consolidated inventory, and $51.1 million, or 13.9% of consolidated inventory, respectively, was reported under the LIFO method of accounting. The cost of the remainder of the tubular and pipe products inventory is determined using a weighted average rolling first-in, first-out (FIFO) method.

 

The Company recorded $0.3 million of LIFO income during the three and six months ended June 30, 2019, as current projections anticipate a decrease in the LIFO reserve by December 31, 2019. During the three and six months ended June 30, 2018, the Company recorded $0.5 million and $1.5 million of LIFO expense, respectively.

 

If the FIFO method had been in use, inventories would have been $2.8 million higher than reported at June 30, 2019 and $3.1 million higher than reported at December 31, 2018.

 

6.	Goodwill and Intangible Assets:

 

The Company’s intangible assets were recorded in connection with its January 2, 2019 acquisition of McCullough, its April 2, 2018 acquisition of Berlin Metals and its 2011 acquisition of CTI. The intangible assets were evaluated on the premise of highest and best use to a market participant, primarily utilizing the income approach valuation methodology. The useful life of the customer relationships was determined to be fifteen years, based primarily on the consistent and predictable revenue source associated with the existing customer base, the present value of which extends through the fifteen year amortization period. The useful life of the non-compete agreements was determined to be the length of the non-compete agreements which range from one to five years. The useful life of the trade names was determined to be indefinite primarily due to their history and reputation in the marketplace, the Company’s expectation that the trade names will continue to be used, and the conclusion that there are currently no other factors identified that would limit their useful life. The Company will continue to evaluate the useful life assigned to its amortizable customer relationships in future periods.

 

 

Goodwill, by reportable segment, was as follows as of June 30, 2019 and December 31, 2018, respectively. The goodwill is deductible for tax purposes.

 

 

Intangible assets consisted of the following as of June 30, 2019 and December 31, 2018, respectively:

 

 

 

The Company estimates that amortization expense for its intangible assets subject to amortization will be approximately $1.3 million per year for the next two years and $1.2 million per year for the three years thereafter.  

 

7.	Right of use assets:

 

During the first quarter of 2019, the Company adopted ASU No. 2016-02, Leases. This ASU requires lessees to recognize a right of use (ROU) asset and a lease liability on the balance sheet, with the exception of short-term leases. The Company leases warehouses and office space, industrial equipment, office equipment, vehicles, industrial gas tanks and forklifts from other parties and leases land and warehouse space to third parties. The Company determines if a contract contains a lease when the contract conveys the right to control the use of identified assets for a period in exchange for consideration. Upon identification and commencement of a lease, the Company establishes a ROU asset and a lease liability. Operating leases are included in ROU assets, current portion of lease liabilities, and lease liabilities on the accompanying Consolidated Balance Sheets. Finance leases are included in property and equipment, other accrued liabilities, and other long-term liabilities on the accompanying Consolidated Balance Sheets.

 

The Company has remaining lease terms ranging from one year to 20 years, some of these include options to renew the lease for up to five years. The total lease term is determined by considering the initial term per the lease agreement which is adjusted to include any renewal options that the Company is reasonably certain to exercise as well as any period that the Company has control over the space before the stated initial term of the agreement. If the Company determines a reasonable certainty of exercising termination or early buyout options, then the lease terms are adjusted to account for these facts.

 

 

Under the transition method selected by the Company, leases existing at, or entered into after, January 1, 2019 were required to be recognized and measured. Prior period amounts have not been adjusted and continue to be reflected in accordance with the Company’s historical accounting. The adoption of this standard resulted in the recording of ROU assets and operating lease liabilities of approximately $30.1 million as of January 1, 2019, with no related impact on the Company’s Consolidated Statements of Comprehensive Income or Consolidated Statements of Cash Flows. Short-term leases have not been recorded on the balance sheet.

 

The Company leases one warehouse from a related party. The Company’s Executive Chairman of the Board owns 50% of an entity that owns one of the Cleveland warehouses and leases it to the Company at a fair market value annual rental of $0.2 million. The lease expires on December 31, 2023 with three five-year renewal options.

 

The Company elected the package of practical expedients permitted under the transition guidance within the new standard which, among other things, allows companies to carry forward their historical lease classification.

 

The Company has made an accounting policy election to not separate non-lease components from lease components for the vehicle ROU asset class. This election has been made to significantly reduce the administrative burden which would be imposed on the Company. No accounting policy elections were made for the remaining ROU asset classes.

 

ROU assets and lease liabilities are recognized based on the present value of the future minimum lease payments over the lease term at commencement date. As most of the leases do not provide an implicit rate, the Company uses its incremental borrowing rate based on the information available at commencement date in determining the present value of future payments. Lease expense is recognized on a straight-line basis over the lease term.

 

The components of lease expense were as follows:

 

 

Supplemental cash flow information related to leases was as follows:

 

 

 

Supplemental balance sheet information related to leases was as follows:

 

 

Maturities of lease liabilities were as follows:

 

 

 

 

8.

Debt:

 

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

 

 

The Company’s asset-based credit facility (the ABL Credit Facility) is collateralized by the Company’s 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, the Company 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 the ability of the Company 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 the Company; (vi) incur liens securing indebtedness; (vii) consolidate, merge or transfer all or substantially all of the Company’s 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 and the Company’s availability is less than the greater of $30 million or 10.0% of the aggregate amount of revolver commitments ($47.5 million at June 30, 2019) or 10.0% of the aggregate borrowing base ($40.1 million at June 30, 2019) then the Company 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.

 

The Company has the option to borrow under its revolver based on the agent’s base rate plus a premium ranging from 0.00% to 0.25% or the London Interbank Offered Rate (LIBOR) plus a premium ranging from 1.25% to 2.75%.

 

As of June 30, 2019, the Company was in compliance with its covenants and had approximately $133.0 million of availability under the ABL Credit Facility.   

 

As of June 30, 2019, $1.5 million of bank financing fees were included in “Prepaid expenses and other” and “Other long-term assets” on the accompanying Consolidated Balance Sheets. The financing fees are being amortized over the five-year term of the ABL Credit Facility and are included in “Interest and other expense on debt” on the accompanying Consolidated Statements of Comprehensive Income.

 

On January 10, 2019, the Company 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%. Although the Company is exposed to credit loss in the event of nonperformance by the other party to the interest rate hedge agreement, the Company anticipates performance by the counterparty.

 

9.	Derivative Instruments:

 

Metals swaps and embedded customer derivatives

 

During 2019 and 2018, the Company entered into nickel swaps indexed to the London Metal Exchange (LME) price of nickel with third-party brokers. The nickel swaps are accounted for as derivatives for accounting purposes. The Company entered into them to mitigate its customers’ risk of volatility in the price of metals. The outstanding nickel swaps mature in 2019. The swaps are settled with the brokers at maturity. The economic benefit or loss arising from the changes in fair value of the swaps is contractually passed through to the customer. The primary risk associated with the metals swaps is the ability of customers or third-party brokers to honor their agreements with the Company related to derivative instruments. If the customer or third-party brokers are unable to honor their agreements, the Company’s risk of loss is the fair value of the metals swaps.

 

 

These derivatives have not been designated as hedging instruments. The periodic changes in fair value of the metals and embedded customer derivative instruments are included in “Cost of materials sold” in the Consolidated Statements of Comprehensive Income. The Company recognizes derivative positions with both the customer and the third party for the derivatives and classifies cash settlement amounts associated with them as part of “Cost of materials sold” in the Consolidated Statements of Comprehensive Income. The cumulative change in fair value of the metals swaps that have not yet been settled are included in “Accounts receivable,” and the embedded customer derivatives are included in “Other accrued liabilities” on the Consolidated Balance Sheets at June 30, 2019. The cumulative change in fair value of the metals swaps that had not yet settled as of December 31, 2018 are included in “Other accrued liabilities”, and the embedded customer derivatives are included in “Accounts Receivable, net” on the Consolidated Balance Sheets at December 31, 2018.

 

Fixed rate interest rate hedge

 

On January 10, 2019, the Company 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%. The interest rate hedge is included in “Other long-term liabilities” on the Consolidated Balance Sheets as of June 30, 2019. Although the Company is exposed to credit loss in the event of nonperformance by the other party to the interest rate hedge agreement, the Company anticipates performance by the counterparty.

 

Interest rate swap

 

CTI entered into an interest rate swap to reduce the impact of changes in interest rates on its Industrial Revenue Bond (IRB). The swap agreement was terminated in March 2018 upon repayment of the IRB. The periodic changes in fair value of the interest rate swap and cash settlement amounts associated with the interest rate swap are included in “Interest and other expense on debt” in the Consolidated Statements of Comprehensive Income.

 

There was no net impact from the nickel swaps or embedded customer derivative agreements to the Company’s Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2019 and 2018. The table below shows the total impact to the Company’s Consolidated Statements of Comprehensive Income through net income of the derivatives for the three and six months ended June 30, 2019 and 2018.

 

 

 

10.	Fair Value of Assets and Liabilities:

 

During the three and six months ended June 30, 2019, there were no transfers of financial assets between Levels 1, 2 or 3 fair value measurements. There have been no changes in the methodologies used at June 30, 2019 since December 31, 2018.

 

Following is a description of the valuation methodologies used for assets and liabilities measured at fair value as of June 30, 2019 and December 31, 2018:

 

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

 

 

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

 

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

 

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

 

 

 

 

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

 

 

 

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

 

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

 

 

 

11.	Accumulated Other Comprehensive Loss:

 

On January 10, 2019, the Company 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%. The fair value of the interest rate hedge of $3.2 million, net of tax of $0.8 million is included in “Accumulated other comprehensive loss” on the Consolidated Balance Sheets at June 30, 2019.

 

12.	Equity Plans:

 

Restricted Stock Units and Performance Share Units

 

Pursuant to the Amended and Restated Olympic Steel 2007 Omnibus Incentive Plan (the Incentive Plan), the Company may grant stock options, stock appreciation rights, restricted shares, restricted share units, performance shares, and other stock- and cash-based awards to employees and directors of, and consultants to, the Company and its affiliates. Since adoption of the Incentive Plan, 1,000,000 shares of common stock have been authorized for equity grants.

 

On an annual basis the compensation committee of the Company’s Board of Directors awards restricted stock units (RSUs), to each non-employee director as part of their annual compensation. The annual awards for 2019 and 2018 per director were $80,000. Subject to the terms of the Plan and the RSU agreement, the RSUs vest after one year of service (from the date of grant). The RSUs are not converted into shares of common stock until the director either resigns or is terminated from the board of directors.

 

Under the Senior Management Stock Incentive Program (the Plan), each eligible participant is awarded RSUs with a dollar value equal to 10% of the participant’s base salary, up to an annual maximum of $17,500. The RSUs have a five-year vesting period and the RSUs will convert into the right to receive shares of common stock upon a participant’s retirement, or earlier upon the participant’s death or disability or upon a change in control of the Company.

 

Under the Plan, the Company awards RSUs to newly-appointed executive officers, based upon a percentage of their base salary. Upon Mr. Marabito’s promotion to Chief Executive Officer and Mr. Manson’s promotion to Chief Financial Officer on January 1, 2019, each received 51,506 RSUs and 14,891 RSUs, respectively. The RSUs will vest five years from the grant date, or earlier upon death or disability or upon a change in control of the Company.

 

Stock-based compensation expense recognized on RSUs for the three and six months ended June 30, 2019 and 2018, respectively, is summarized in the following table:

 

 

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

 

 

The following table summarizes the activity related to RSUs for the six months ended June 30, 2019:

 

 

Of the RSUs granted in 2019 and 2018, 62,229 and 38,052, respectively, were used to fund supplemental executive retirement plan (SERP) contributions.

 

 

13.	Income Taxes:

 

For the three months ended June 30, 2019, the Company recorded an income tax provision of $0.6 million, or 23.1%, compared to an income tax provision of $5.7 million, or 26.5%, for the three months ended June 30, 2018. For the six months ended June 30, 2019, the Company recorded an income tax provision of $1.4 million, or 25.2%, compared to an income tax provision of $8.4 million, or 26.3%, for the six months ended June 30, 2018.

 

The tax provision or benefit for interim periods is determined using an estimate of the Company’s annual effective tax rate, adjusted for discrete items that are taken into account in the relevant period. Each quarter the Company updates the estimate of the annual effective tax rate, and if the estimated tax rate changes, the Company makes a cumulative adjustment.

 

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

 

14.	Shares Outstanding and Earnings Per Share:

 

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

 

 

 

15.	Stock Repurchase Program:

 

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. Any of the repurchased shares are held in the Company’s treasury, or canceled and retired as the 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, the Company may repurchase common stock and pay dividends up to $5.0 million in the aggregate during any trailing twelve months without restrictions. Purchases of common stock or dividend payments in excess of $5.0 million in the aggregate require the Company to (i) maintain availability in excess of 20.0% of the aggregate revolver commitments ($95.0 million at June 30, 2019) or (ii) to maintain availability equal to or greater than 15.0% of the aggregate revolver commitments ($71.3 million at June 30, 2019) and the Company 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.

 

 

During the three months ended June 30, 2019, the Company repurchased 105,534 shares, for an aggregate cost of $1.5 million. There were no shares repurchased during the three months ended June 30, 2018. During the six months ended June 30, 2019, the Company repurchased 109,334 shares, for an aggregate cost of $1.5 million. There were no shares repurchased during the six months ended June 30, 2018.

 

16.	Segment Information:

 

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

 

The Company operates in three reportable segments; carbon flat products, specialty metals flat products, and tubular and pipe products. The carbon flat products segment and the specialty metals flat products segments are at times consolidated and referred to as the flat products segments, as certain 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.

 

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.

 

 

The following table provides financial information by segment and reconciles the Company’s operating income by segment to the consolidated income before income taxes for the three and six months ended June 30, 2019 and 2018.

 

 

 

 

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

 

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

 

 

 

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