OLYMPIC STEEL INC - Quarter Report: 2023 March (Form 10-Q)

Olympic Steel, Inc.

Index to Form 10-Q

Page No.

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 Company incurred $1.7 million of new financing lease obligations during the three months ended March 31, 2023. The Company incurred a nominal amount of new financing lease obligations during the three months ended March 31, 2022. These non-cash transactions have been excluded from the Consolidated Statements of Cash Flows for the three months ended March 31, 2023.

Olympic Steel, Inc.

Consolidated Statements of Shareholders’ Equity

For the Three Months Ended March 31,

(in thousands)

(unaudited)

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

Olympic Steel, Inc.

Notes to Unaudited Consolidated Financial Statements

March 31, 2023

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 2023 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, 2022. All intercompany transactions and balances have been eliminated in consolidation.

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

The primary focus of the specialty metals flat products segment is on the direct sale and distribution of processed stainless and aluminum flat-rolled sheet and coil products, flat bar products and fabricated parts.  Through recent acquisitions, the specialty metals flat products segment has expanded its geographic footprint and enhanced its product offerings in stainless steel and aluminum plate, sheet, angles, rounds, flat bar, tubing and pipe and prime tin mill products. 

The primary focus of the 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.  Through recent acquisitions, the carbon flat products segment has expanded its product offerings to include self-dumping metal hoppers, and steel and stainless-steel dump inserts for pickup truck and service truck beds.  Through the acquisition of Metal-Fab, Inc. (Metal-Fab) on January 3, 2023, the carbon flat products segment further expanded its product offerings to include venting, micro air and clean air products for residential, commercial and industrial applications. 

The Company acts as an intermediary between metals producers and manufacturers that require processed metals for their operations. The Company serves 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. These products are primarily distributed through a direct sales force. 

Combined, the carbon and specialty metals flat products segments have 36 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

Through its tubular and pipe products segment, which consists of the Chicago Tube and Iron subsidiary (CTI), the Company distributes metal tubing, pipe, bar, valves and fittings and fabricate pressure parts supplied to various industrial markets. CTI operates from seven 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 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.

Impact of Recently Issued Accounting Pronouncements

In March 2020, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2020-04, “Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting”. The objective of this ASU is to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform on financial reporting. In December 2022, FASB issued ASU No. 2022-06 “Deferral of the Sunset Date of Topic 848” which amends and extends the sunset date to December 31, 2024. The adoption of this ASU in the first quarter of 2023 did not have a material impact on the Company’s Consolidated Financial Statements.

On January 3, 2023, the Company acquired all the outstanding shares of capital stock of Metal-Fab for a cash purchase price of $131.2 million. Metal-Fab, headquartered in Wichita, Kansas, is a manufacturer of venting, micro air and clean air products for residential, commercial and industrial applications.

The Company paid total cash consideration of $131.2 million, consisting of a base purchase price of $131.0 million and a cash adjustment of $0.2 million. The acquisition was funded with borrowings under the Company’s asset-based credit facility (ABL Credit Facility). During 2023, the Company incurred $2.6 million of direct acquisition-related costs, which are included in “Administrative and general” in the Consolidated Statements of Comprehensive Income and $2.1 million of non-recurring amortization of inventory step up to fair market value adjustments, which are included in “Costs of materials sold” in the Consolidated Statements of Comprehensive Income for the three months ended March 31, 2023.

Purchase Price Allocation

The acquisition of Metal-Fab was accounted for as a business combination and the assets and liabilities were valued at fair market value on January 3, 2023, the date of acquisition. The Consolidated Balance Sheet as of March 31, 2023, reflects the allocation of Metal-Fab’s purchase price.

The purchase price allocations presented below is based upon management’s estimate of the fair value of the acquired assets and assumed liabilities using Level 3 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. The table below summarizes the preliminary purchase price allocation of the fair market values of the assets acquired and liabilities assumed.

In connection with the acquisition of Metal-Fab, the Company identified and valued certain intangible assets, including the Metal-Fab trade name, internally developed technology and know-how, restrictive covenants and customer relationships. 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 trade name intangible asset was valued at $11.5 million, and the useful life was determined to be indefinite primarily due to their history and reputation in the marketplace, the Company’s expectation that the trade name will continue to be used, and the conclusion that there are currently no other factors identified that would limit their useful life. The internally developed technology and know-how intangible asset was valued at $5.3 million, and the useful life was determined to be fifteen years. The non-compete agreements intangible asset was valued at $1.4 million, and the useful life was determined to be the length of the non-compete agreements, which range from two to five years. The customer relationships intangible asset was valued at $36.5 million, and the useful life was determined to be twenty-six years, based primarily on the consistent and predictable revenue source associated with the existing customer base, the present value of which extends through the twenty-six-year amortization period.

The accompanying Consolidated Statements of Comprehensive Income includes the revenues and expenses of Metal-Fab since the acquisition date. Metal-Fab’s operations are included within the carbon flat-rolled segment.

Pro Forma Financial Information

The following unaudited pro forma summary of financial results presents the consolidated results of operations as if the Metal-Fab acquisition had occurred on January 1, 2022, after the effect of certain adjustments. The historical consolidated financial information has been adjusted to give effect to the impact of the consideration issued by the Company to Metal-Fab’s stockholders in connection with the acquisition and the effect of debt refinancing necessary to complete the transaction. The unaudited pro forma summary also includes certain purchase price accounting adjustments, including the items expected to have a continuing impact on combined results, such as depreciation and amortization expense on acquired assets. The unaudited pro forma combined financial information does not reflect the cost of any integration activities or benefits that may result from synergies that may be derived from integration activities.

The pro forma results have been presented for comparative purposes only and are not indicative of what would have occurred had the acquisition been made on January 1, 2022, or of any potential results that may occur in the future.

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, venting, micro air and clean air products. 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 at a point in time 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.

Accounts receivable are presented net of allowances for credit losses and unissued credits of $4.7 million and $4.3 million as of March 31, 2023 and December 31, 2022, respectively. The allowance for credit losses is maintained at a level considered appropriate based on historical experience, specific customer collection issues that have been identified, current market conditions and estimates for supportable forecasts when appropriate. 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 credit losses and unissued credits.

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 March 31, 2023 and December 31, 2022, approximately $44.1 million, or 10.8% of consolidated inventory, and $46.3 million, or 11.1% 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 did not record any LIFO expense or income for the three months ended March 31, 2023 as current inventory price and volume projections anticipate no material change to the LIFO reserve by December 31, 2023. The Company did not record any LIFO expense or income for the three months ended March 31, 2022.

The Company’s intangible assets were recorded in connection with its acquisitions of Shaw Stainless & Alloy, Inc. (Shaw) in 2021, Action Stainless & Alloys (Action Stainless) in 2020 and Berlin Metals, LLC in 2018 for the specialty metals flat products segment and Metal-Fab in 2023 and EZ Dumper® and McCullough Industries in 2019 for the carbon flat products segment.  The intangible assets were evaluated on the premise of highest and best use to a market participant, primarily utilizing the income approach valuation methodology. 

Goodwill, by reportable unit, was as follows as of March 31, 2023 and December 31, 2022, respectively. The goodwill is deductible for tax purposes.

Intangible assets, net, consisted of the following as of March 31, 2023 and December 31, 2022, respectively:

The Company estimates that amortization expense for its intangible assets subject to amortization will be approximately $3.3 million per year for the next three years, $2.8 million the following year and then $2.0 million for the next year after.

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:

Finance lease right-of-use assets are included within “Property and equipment, at cost” and “Accumulated depreciation” on the Consolidated Balance Sheets.  The current portion of finance lease liabilities are included within “Other accrued liabilities” and the long-term portion of finance lease liabilities are included within “Other long-term liabilities” on the Consolidated Balance Sheets, respectively.

Maturities of lease liabilities were as follows:

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

On January 3, 2023, the Company entered into a Sixth Amendment to Third Amended and Restated Loan and Security Agreement, which amended the Company’s existing ABL Credit Facility. The amendment increased the Credit Facility by $150 million from $475 million to $625 million. The $625 million ABL Credit Facility consists of: (i) a revolving credit facility of up to $595 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, subject to the satisfaction of certain conditions, request additional commitments under the revolving credit facility in the aggregate principal amount of up to $200 million to the extent that existing or new lenders agree to provide such additional commitments, and add real estate as collateral at the Company’s discretion. The ABL Credit Facility matures on June 16, 2026.

The Company’s the ABL Credit Facility is collateralized by the Company’s accounts receivable, inventory, personal property and certain real estate. 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 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 ($62.5 million at March 31, 2023) or 10.0% of the aggregate borrowing base ($61.9 million at March 31, 2023), 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 Secured Overnight Financing Rate (SOFR) plus a premium ranging from 1.25% to 2.75%.

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. On January 3, 2023, the Company amended the interest rate hedge agreement to use SOFR as the reference rate and updated the fixed rate to 2.42% from 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.

As of March 31, 2023, the Company was in compliance with its covenants and had approximately $355 million of availability under the ABL Credit Facility.

As of March 31, 2023, and December 31, 2022, $2.0 million and $1.2 million, respectively, 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.

Metals swaps and embedded customer derivatives

During 2023 and 2022, 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 2023. 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 had not yet settled as of March 31, 2023, are included in “Other accrued liabilities” and the embedded customer derivatives are included in “Accounts receivable, net” on the Consolidated Balance Sheets as of March 31, 2023. 

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. On January 3, 2023, the Company amended the interest rate hedge agreement to use SOFR as the reference rate and updated the fixed rate to 2.42% from 2.57%. The interest rate hedge is included in “Prepaid expenses and other” on the Consolidated Balance Sheets as of March 31, 2023. 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.

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 months ended March 31, 2023 and 2022, respectively.

During the three months ended March 31, 2023, 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 March 31, 2023 since December 31, 2022.

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 carrying value of the ABL Credit Facility was $258.8 million and $165.7 million at March 31, 2023 and December 31, 2022, respectively. Management believes that the ABL Credit Facility’s carrying value approximates its fair value due to the variable interest rate on the ABL Credit Facility.

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. On January 3, 2023, the Company amended the interest rate hedge agreement to use SOFR as the reference rate and updated the fixed rate to 2.42% from 2.57%. The fair value of the interest rate hedge of $1.3 million, net of tax of $0.3 million is included in “Accumulated other comprehensive loss” on the Consolidated Balance Sheets at March 31, 2023. The fair value of the interest rate hedge was $1.7 million, net of tax of $0.4 million at December 31, 2022.

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 (RSUs), 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, 1,400,000 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 RSUs to each non-employee director as part of their annual compensation. The annual awards for 2023 and 2022 per director were $80,000. Subject to the terms of the Incentive 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.

In January 2022, the Company adopted a new C-Suite Long-Term Incentive Plan (the C-Suite Plan) that operates under the Senior Manager Stock Incentive Plan. Under the C-Suite Plan, the Chief Executive Officer, the Chief Financial Officer and the President and Chief Operating Officer are eligible for participation. In each calendar year, the Committee may award eligible participants a long-term incentive of both a RSU grant and a performance stock unit (PSU) grant. Additionally, the Committee may offer a long-term cash incentive (split equally between service and performance-based portions) to supplement both the RSU and PSU grants in order to arrive at the total long-term award target. The total long-term award target is $1.1 million for the Chief Executive Officer, $0.3 million for the Chief Financial Officer and $0.6 million for the President and Chief Operating Officer. The PSUs will vest if the return on net assets, calculated as EBITDA divided by Average Accounts Receivable, Inventory and Property and Equipment, exceeds five percent. Each RSU and service-based cash incentive vests three years after the grant date. Each vested RSU will convert into the right to receive one share of common stock. During 2023, a total of 20,000 RSUs and 20,000 PSUs were granted to the participants under the C-Suite Plan, and $0.3 million and $0.3 million, respectively, were granted in service-based and performance-based cash awards. During 2022, a total of 20,000 RSUs and 20,000 PSUs were granted to the participants under the C-Suite Plan, and $0.5 million and $0.5 million, respectively, were granted in service-based and performance-based cash awards. If the return on net assets falls below 5 percent, no performance-based incentive will be awarded. The maximum performance-based award is achieved if return on net assets exceeds ten percent, and is capped at 150% of the grant.

Stock-based compensation expense recognized on RSUs for the three months ended March 31, 2023 and 2022, 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 three months ended March 31, 2023 and 2022, respectively:

For the three months ended March 31, 2023, the Company recorded an income tax provision of $3.6 million, or 26.8%, compared to an income tax provision of $13.8 million, or 27.0%, for the three months ended March 31, 2022.

The tax provision for the interim period 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 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.

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

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 $15.0 million in the aggregate during any trailing twelve months without restrictions. Purchases of common stock or dividend payments in excess of $15.0 million in the aggregate require the Company to (i) maintain availability in excess of 20.0% of the aggregate revolver commitments ($125.0 million at March 31, 2023) or (ii) to maintain availability equal to or greater than 15.0% of the aggregate revolver commitments ($93.8 million at March 31, 2023) 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.

There were no shares repurchased during the three months ended March 31, 2023 or March 31, 2022. As of March 31, 2023, 360,212 shares remain authorized for repurchase under the program.

At-the-Market Equity Program

On September 3, 2021, the Company commenced an at-the-market (ATM) equity program under its shelf registration statement, which allows it to sell and issue up to $50 million in shares of its common stock from time to time. The Company entered into an Equity Distribution Agreement on September 3, 2021 with KeyBanc Capital Markets Inc. (KeyBanc) relating to the issuance and sale of shares of common stock pursuant to the program. KeyBanc is not required to sell any specific amount of securities but will act as the Company’s sales agent using commercially reasonable efforts consistent with its normal trading and sales practices, on mutually agreed terms between KeyBanc and the Company. KeyBanc will be entitled to compensation for shares sold pursuant to the program of 2.0% of the gross proceeds of any shares of common stock sold under the Equity Distribution Agreement. No shares were sold under the ATM program during the three months ended March 31, 2023 and March 31, 2022.

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. The operating segments are based primarily on internal management reporting.

The Company operates in three reportable segments; specialty metals flat products, carbon flat products, and tubular and pipe products. The specialty metals flat products segment and the carbon flat products segment 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 specialty metals and carbon flat products segments and both segments’ products are stored in the shared facilities and, in some locations, processed on shared equipment. Since the January 3, 2023 acquisition, Metal-Fab’s financial results are included in the carbon flat products segment.

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 (loss) before income taxes for the three months ended March 31, 2023 and 2022, respectively.

There were no material revenue transactions between the specialty metals products, carbon flat 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.

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, 2022. 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, 2022, and in Part II, Item 1A (Risk Factors) in this Quarterly Report on Form 10-Q. 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 Securities and Exchange Commission, or 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; specialty metals flat products, carbon flat products, and tubular and pipe products. We provide metals processing and distribution services for a wide range of customers. 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, prime tin mill products and fabricated parts. Through the acquisition of Shaw Stainless & Alloy, Inc., or Shaw, on October 1, 2021 and Action Stainless & Alloys, Inc., or Action Stainless, on December 14, 2020, our specialty metals flat products segment expanded its geographic footprint and enhanced its product offerings in stainless steel and aluminum plate, sheet, angles, rounds, flat bar, tubing and pipe. Shaw also manufactures and distributes stainless steel bollards and water treatment systems. Action Stainless offers a range of processing capabilities, including plasma, laser and waterjet cutting and computer numerical control, or CNC, machining. Our carbon flat products segment’s focus is on the direct sale and distribution of large volumes of processed carbon and coated flat-rolled sheet, coil and plate products and fabricated parts. Through acquisitions, our carbon flat products segment expanded its product offerings to include self-dumping metal hoppers and steel and stainless-steel dump inserts for pickup truck and service truck beds. Through the acquisition of Metal-Fab, Inc., or Metal-Fab, on January 3, 2023, our carbon flat products segment expanded its product offerings to include the manufacture of venting, micro air and clean air products for residential, commercial and industrial applications. In addition, we distribute metal tubing, pipe, bar, valves and fittings and fabricate parts supplied to various industrial markets through our tubular and pipe products segment. Products that require more value-added processing generally have a higher gross profit. Accordingly, our overall gross profit is affected by, among other things, product mix, the amount of processing performed, the demand for and availability of metals, and volatility in selling prices and material purchase costs. We also perform toll processing of customer-owned metals. We sell certain products internationally, primarily in Canada and Mexico. International sales are immaterial to our consolidated financial results and to the individual segments’ results.

Our results of operations are affected by numerous external factors, including, but not limited to: general and global business, economic, financial, banking and political conditions; fluctuations in the value of the U.S. dollar to foreign currencies, competition; metals pricing, demand and availability; transportation and energy costs; pricing and availability of raw materials used in the production of metals; global supply, the level of metals imported into the United States, tariffs, and inventory held in the supply chain; the availability and increased costs of labor; customers’ ability to manage their credit line availability; and layoffs or work stoppages by our own, our suppliers’ or our customers’ personnel. The metals industry also continues to be affected by the global consolidation of our suppliers, competitors and end-use customers.

Like other metals service centers, we maintain substantial inventories of metals to accommodate the short lead times and just-in-time delivery requirements of our customers. Accordingly, we purchase metals in an effort to maintain our inventory at levels that we believe to be appropriate to satisfy the anticipated needs of our customers based upon customer forecasts, historic buying practices, supply agreements with customers and market conditions. Our commitments to purchase metals are generally at prevailing market prices in effect at the time we place our orders. From time to time, we have entered into nickel swaps at the request of our customers in order to mitigate our customers’ risk of volatility in the price of metals. 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, 2023, we employed approximately 1,961 people. Approximately 186 of the hourly plant personnel at the facilities listed below are represented by seven 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

We operate in three reportable segments: specialty metals flat products, carbon flat products and tubular and pipe products. The specialty metals flat products segment and the carbon flat products segment are at times consolidated and referred to as the flat products segment.  Some of the flat products segments’ assets and resources are shared by the specialty metals and carbon flat products segments and both segments’ products are stored in the shared facilities and, in some locations, processed on shared equipment.  As such, total assets and capital expenditures are reported in the aggregate for the flat products segments.  Due to the shared assets and resources, certain of the flat products segment expenses are allocated between the specialty metals flat products segment and the carbon flat products segment based upon an established allocation methodology.

We follow the accounting guidance that requires the utilization of a “management approach” to define and report the financial results of operating segments. The management approach defines operating segments along the lines used by the chief operating decision maker, or CODM, to assess performance and make operating and resource allocation decisions. Our CODM evaluates performance and allocates resources based primarily on operating income. Our operating segments are based primarily on internal management reporting.

Due to the nature of the products sold in each segment, there are significant differences in the segments’ average selling price and the cost of materials sold.  The specialty metals flat products segment generally has the highest average selling price among the three segments followed by the tubular and pipe products segment and carbon flat products segment.  Due to the nature of the tubular and pipe product and our operations that manufacture end user products within the flat product segments, 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 higher in the specialty metals flat products and tubular and pipe products segments than the carbon flat products segment.  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.

Specialty metals flat products

The primary focus of our specialty metals flat products segment is on the direct sale and distribution of processed aluminum and stainless flat-rolled sheet and coil products, flat bar products, prime tin mill products and fabricated parts.  Through recent acquisitions, our specialty metals flat products segment has expanded its geographic footprint and enhanced its product offerings in stainless steel and aluminum plate, sheet, angles, rounds, flat bar, tubing and pipe and prime tin mill products. 

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.  Through prior acquisitions, our carbon flat products segment expanded its product offerings to include self-dumping metal hoppers, steel and stainless-steel dump inserts for pickup truck and service truck beds.  Through the recent acquisition of Metal-Fab on January 3, 2023, the carbon flat products segment further expanded its product offerings to include venting, micro air and clean air products for residential, commercial and industrial applications.  These new product offerings generate higher gross profit as a percentage of sales when compared to traditional carbon service center business. 

We act as an intermediary between metals producers and manufacturers that require processed metal for their operations.  We serve customers in most metal 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 metal service centers.  We distribute these products primarily through a directed sales force. 

Combined, the carbon and specialty metals flat products segments have 36 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

Through our tubular and pipe products segment, which consists of the Chicago Tube and Iron subsidiary, or CTI, we distribute metal tubing, pipe, bar, valve and fittings and fabricate pressure parts supplied to various industrial markets. CTI operates from seven locations in the Midwestern and southeastern United States.  The tubular and pipe products segment distributes its products primarily through a direct sales force.

Corporate expenses

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

Results of Operations

Our results of operations are impacted by the market price of metals.  Metals prices fluctuate significantly and changes to our net sales, cost of materials sold, gross profit, cost of inventory and profitability, are all impacted by industry metals pricing.    Index pricing on carbon steel increased during the first quarter of 2023 by $488 per ton, or 73.5%.  Despite the increase in index pricing during 2023, our average selling prices and average cost of materials sold were lower during the first quarter of 2023 than during record high prices experienced the same period of 2022. 

Transactional or “spot” selling prices generally move in tandem with market price changes, while fixed selling prices typically lag and reset quarterly. Similarly, inventory costs (and, therefore, cost of materials sold) tend to move slower than market selling price changes due to mill lead times and inventory turnover impacting the rate of change in average cost. When average selling prices increase, and net sales increase, gross profit and operating expenses as a percentage of net sales will generally decrease.

Consolidated Operations

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

Net sales decreased 17.7% to $573.1 million in the first quarter of 2023 from $696.3 million in the first quarter of 2022.  Specialty metals flat products net sales were 29.1% of total net sales in the first quarter of 2023 compared to 28.6% of total net sales in the first quarter of 2022.  Carbon flat products net sales were 54.0% of total net sales in the first quarter of 2023 compared to 54.6% of total net sales in the first quarter of 2022.  Tubular and pipe products net sales were 16.9% of total net sales in the first quarter of 2023 compared to 16.8% of total net sales in the first quarter of 2022.  The decrease in net sales during the first quarter of 2023 was due to a 18.9% decrease in average selling price, partially offset by a 1.5% increase in sales volume and from sales after the January 3, 2023, Metal-Fab acquisition when compared to the first quarter of 2022. 

Cost of materials sold decreased 18.5% to $452.6 million in the first quarter of 2023 from $555.1 million in the first quarter of 2022.  The decrease in cost of materials sold in the first quarter of 2023 is related to the decreased metals pricing discussed above in Results of Operations.  In addition, we recorded $2.1 million of non-recurring amortization expense of inventory step up to fair market value adjustments made as part of the Purchase Price Allocation for the January 3, 2023 acquisition of Metal-Fab in the first quarter of 2023.

As a percentage of net sales, gross profit (as defined in footnote (b) in the table above) increased to 21.0% in the first quarter of 2023 from 20.3% in the first quarter of 2022.  The increase in the gross profit as a percentage of net sales is due to net sales decreasing less than cost of materials sold.

Operating expenses in the first quarter of 2023 increased $14.6 million, or 16.6%, to $102.7 million from $88.1 million in the first quarter of 2022.  As a percentage of net sales, operating expenses increased to 17.9% for the first quarter of 2023 from 12.7% in the first quarter of 2022.  Operating expenses in the specialty metals flat products segment decreased $4.8 million, operating expenses in the carbon flat products segment increased $13.5 million, operating expenses in the tubular and pipe products segment increased $4.1 million and Corporate expenses increased $1.8 million in the first quarter of 2023 compared to the first quarter of 2022.  The increase in operating expenses was primarily attributable to the inclusion of Metal-Fab operating expenses, $2.6 million of acquisition-related expenses and the year-over-year absence of the $2.1 million gain on the sale of the Milan, Iowa facility in the first quarter of 2022, partially offset by lower performance-based incentive compensation during the first three months of 2023.

Interest and other expense on debt totaled $4.2 million, or 0.7% of net sales, in the first quarter of 2023 compared to $2.0 million, or 0.3% of net sales, in the first quarter of 2022. The increase was due to a higher effective borrowing rate partially offset by lower average borrowings in the first three months of 2023 compared to the first three months of 2022. Our effective borrowing rate, exclusive of deferred financing fees and commitment fees, was 5.7% for the first three months of 2023 compared to 2.2% for the first three months of 2022.

In the first quarter of 2023, income before income taxes totaled $13.5 million compared to income before income taxes of $51.1 million in the first quarter of 2022.

An income tax provision of 26.8% was recorded for the first quarter of 2023, compared to an income tax provision of 27.0% for the first quarter of 2022. Our tax provision for interim periods is determined using an estimate of our annual effective tax rate, adjusted for discrete items that are considered in the relevant period. Each quarter, we update our estimate of the annual effective tax rate, and if our estimated tax rate changes, we make a cumulative adjustment.

Net income for the first quarter of 2023 totaled $9.9 million, or $0.85 per basic share and diluted share, compared to net income of $37.3 million, or $3.23 per basic and diluted share, for the first quarter of 2022.

Segment Operations

Specialty metals flat products

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

Tons sold by our specialty metals flat products segment decreased 15.4% to 33 thousand in the first quarter of 2023 from 38 thousand in the first quarter of 2022. The decrease in tons sold was due to current economic trends.

Net sales in our specialty metals flat products segment decreased $32.9 million, or 16.5%, to $166.6 million in the first quarter of 2023 from $199.5 million in the first quarter of 2022.  The decrease in net sales was due to a 15.4% decrease in sales volumes and a 1.3% decrease in average selling prices during the first quarter of 2023 compared to the first quarter of 2022.  Average selling prices in the first quarter of 2023 were $5,123 per ton, compared with $5,189 per ton in the first quarter of 2022. 

Cost of materials sold in our specialty metals flat products segment decreased $3.3 million, or 2.3%, to $137.7 million in the first quarter of 2023 from $141.0 million in the first quarter of 2022. The decrease in cost of materials sold was due to a 15.4% decrease in sales volumes offset by a 15.5% increase in average cost of materials sold during the first quarter of 2023 compared to the first quarter of 2022.

As a percentage of net sales, gross profit (as defined in footnote (a) in the table above) decreased to 17.3% in the first quarter of 2023 from 29.3% in the first quarter of 2022. The decrease in gross profit as a percentage of net sales is due to the 15.5% increase in average costs of inventory in the first quarter of 2023 compared to the first quarter of 2022.

Operating expenses decreased $4.8 million, or 19.7%, to $19.6 million in the first quarter of 2023 from $24.4 million in the first quarter of 2022.  As a percentage of net sales, operating expenses decreased to 11.8% in the first quarter of 2023 compared to 12.3% in the first quarter of 2022.  The year-over-year decrease in operating expenses was primarily attributable to decreased variable performance-based incentive compensation and decreased distribution, warehouse and processing expenses due to lower sales volumes. 

Operating income in the first quarter of 2023 totaled $9.3 million, or 5.6% of net sales, compared to $34.1 million, or 17.0% of net sales, in the first quarter of 2022.

Carbon flat products

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

Tons sold by our carbon flat products segment increased 5.9% to 218 thousand in the first quarter of 2023 from 206 thousand in the first quarter of 2022.  The increase in tons sold is primarily due to increased volumes to industrial machinery and equipment manufacturers and their fabricators serviced.

Net sales in our carbon flat products segment decreased $69.7 million, or 18.4%, to $309.8 million in the first quarter of 2023 from $379.5 million in the first quarter of 2022.  The decrease in net sales was attributable to a 23.0% decrease in average selling prices offset by a 5.9% increase in sales volumes and an increase in sales generated from the Metal-Fab acquisition during the first quarter of 2023 when compared to the first quarter of 2022.  Average selling prices in the first quarter of 2023 were $1,419 per ton, compared with $1,842 per ton in the first quarter of 2022. 

Cost of materials sold decreased $79.3 million, or 24.2%, to $248.4 million in the first quarter of 2023 from $327.7 million in the first quarter of 2022.  The decrease was due to a 28.4% decrease in the average cost of materials sold, partially offset by a 5.9% increase in sales volume and an increase in cost of material sold from the Metal-Fab acquisition during the first quarter of 2023 when compared to the first quarter of 2022.  In addition, we recorded $2.1 million of non-recurring amortization expense of inventory step up to fair market value adjustments made as part of the Purchase Price Allocation for the January 3, 2023 acquisition of Metal-Fab in the first quarter of 2023.

As a percentage of net sales, gross profit (as defined in footnote (a) in the table above) increased to 19.8% in the first quarter of 2023 compared to 13.7% in the first quarter of 2022.  The increase in the gross profit as a percentage of net sales is due to the impact of the average costs of inventory decreasing more quickly than the decreases in average selling price and additional gross profit generated from the Metal-Fab acquisition. 

Operating expenses in the first quarter of 2023 increased $13.5 million, or 32.1%, to $55.4 million from $42.0 million in the first quarter of 2022.  The year-over-year increase in operating expenses was primarily attributable to the inclusion of Metal-Fab operating expenses.

Operating income in the first quarter of 2023 totaled $5.9 million, or 1.9% of net sales, compared to operating income of $9.9 million, or 2.6% of net sales, in the first quarter of 2022.

Tubular and pipe products

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

Net sales decreased $20.6 million, or 17.6%, to $96.7 million in the first quarter of 2023 from $117.3 million in the first quarter of 2022.  The decrease is a result of a 10.1% decrease in average selling prices and an 8.3% decrease in shipping volume during the first quarter of 2023 compared to the first quarter of 2022.

Cost of materials sold decreased $19.9 million, or 23.1%, to $66.5 million in the first quarter of 2023 from $86.4 million in the first quarter of 2022. The Company did not record LIFO income or expense during the three months ended March 31, 2023, or March 31, 2022.

As a percentage of net sales, gross profit (as defined in footnote (b) in the table above) increased to 31.2% in the first quarter of 2023 compared to 26.3% in the first quarter of 2022.

Operating expenses in the first quarter of 2023 increased $4.1 million, or 25.4%, to $20.5 million from $16.3 million in the first quarter of 2022. Operating expenses increased to 21.2% of net sales in the first quarter of 2023 compared to 13.9% in the first quarter of 2022. The increase in operating expenses was primarily due increased variable performance-based incentive compensation and the year-over-year absence of the $2.1 million gain on the sale of the Milan, Iowa facility in the first quarter of 2022.

Operating income in the first quarter of 2023 totaled $9.7 million, or 10.1% of net sales, compared to $14.6 million, or 12.4% of net sales, in the first quarter of 2022. 

Corporate expenses

Corporate expenses increased $1.8 million, or 33.3%, to $7.2 million in the first quarter of 2023 from $5.4 million in the first quarter of 2022. Corporate expenses primarily increased due to the $2.6 million of acquisition-related expenses partially offset by decreased variable performance-based compensation.

Liquidity, Capital Resources and Cash Flows

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

We believe that funds available under our ABL Credit Facility, together with funds generated from operations, will be sufficient to provide us with the liquidity necessary to fund anticipated working capital requirements, capital expenditure requirements, our dividend payments and any share repurchases and business acquisitions over at least the next 12 months and for the foreseeable future thereafter. 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, 2023, we generated $52.4 million of net cash from operations, of which $16.0 million was generated from operating activities and $36.5 million was generated from working capital.  For the three months ended March 31, 2022, we generated $14.9 million of net cash for operations, of which $46.1 million was generated from operating activities and $31.2 million was used for working capital.

Net cash from operations totaled $16.0 million during the first three months of 2023 and was mainly comprised of net income of $9.9 million, the non-cash depreciation and amortization addback of $6.3 million and changes in other long-term liabilities of $1.0 million partially offset by changes in other long-term assets of $1.6 million.  Net cash from operations totaled $46.1 million during the first quarter of 2022 and was mainly comprised of net income of $37.3 million, the non-cash depreciation and amortization add back of $5.1 million, a $4.5 million increase in deferred income taxes and other long-term liabilities and a $1.1 million increase in other long-term assets offset by a gain on disposition of property, plant and equipment of $2.2 million.

Working capital at March 31, 2023 totaled $481.5 million, a $11.9 million decrease from December 31, 2022.  The decrease was primarily attributable to a $23.3 million decrease in accrued payroll and other accrued liabilities and a $6.5 million increase in accounts receivable offset by a $37.6 million increase in accounts payable and outstanding checks, a $26.2 million decrease in inventories and a $2.4 million decrease in prepaid expenses and other.

Investing Activities

Net cash used for investing activities totaled $136.8 million during the three months ended March 31, 2023, compared to net cash generated from investing activities of $1.2 million during the three months ended March 31, 2022.  Net cash used for investing activities during the first three months ended March 31, 2023, primarily consisted of the $129.5 million acquisition of Metal-Fab, inclusive of cash acquired of $1.7 million, and $7.4 million in new capital expenditures partially offset by $0.1 million in proceeds from disposition of property and equipment.  Net cash from investing activities totaled $1.2 million during the three months ended March 31, 2022, and primarily consisted of $3.2 million in proceeds from the sale of the Milan facility offset by $2.1 million in new capital expenditures.  The capital expenditures in the first quarter of 2023 and 2022 were primarily attributable to additional processing equipment at our existing facilities.

Financing Activities

During the first three months of 2023, $90.6 million of cash was generated from financing activities, which primarily consisted of $93.1 million of net borrowings under our ABL Credit Facility, $1.4 million of dividends paid, $0.9 million of credit facility fees and expenses related to amending the ABL Credit Facility and $0.2 million of principle payments under capital lease obligations.

Dividends paid were $1.4 million and $1.0 million for the three months ended March 31, 2023 and March 31, 2022, respectively.  In May 2023, our Board of Directors approved a regular quarterly dividend of $0.125 per share, which will be paid on June 15, 2023 to shareholders of record as of June 1, 2023.  Regular dividend distributions in the future are subject to the availability of cash, the $15.0 million annual limitation on cash dividends and common stock repurchases under our ABL Credit Facility and continuing determination by our Board of Directors that the payment of dividends remains in the best interest of our shareholders.

Stock Repurchase Program

In 2015, our Board of Directors authorized a stock repurchase program of up to 550,000 shares of our issued and outstanding common stock, which could include open market repurchases, negotiated block transactions, accelerated stock repurchases or open market solicitations for shares, all or some of which may be effected through Rule 10b5-1 plans.  Repurchased shares will be held in our treasury, or canceled and retired as our Board of Directors 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 $15.0 million in the aggregate during any trailing twelve months without restrictions.  Purchases in excess of $15.0 million require us to (i) maintain availability in excess of 20% of the aggregate revolver commitments ($125.0 million at March 31,2023) or (ii) to maintain availability equal to or greater than 15% of the aggregate revolver commitments ($93.8 million at March 31, 2023) and we must maintain a pro forma ratio of earnings before interest, taxes, depreciation and amortization, or 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.  As of March 31, 2023, 360,212 shares remain authorized for repurchase under the program.

There were no shares repurchased during 2023 or 2022.

At- the-Market Equity Program

On September 3, 2021, we commenced an at-the-market, or ATM, equity program under our shelf registration statement, which allows us to sell and issue up to $50 million in shares of our common stock from time to time. We entered into an Equity Distribution Agreement on September 3, 2021 with KeyBanc Capital Markets Inc., or KeyBanc, relating to the issuance and sale of shares of common stock pursuant to the program. KeyBanc is not required to sell any specific amount of securities but will act as our sales agent using commercially reasonable efforts consistent with its normal trading and sales practices, on mutually agreed terms between KeyBanc and us. KeyBanc will be entitled to compensation for shares sold pursuant to the program of 2.0% of the gross proceeds of any shares of common stock sold under the Equity Distribution Agreement. No shares were sold under the ATM program during the three months ended March 31, 2023, or March 31, 2022.

Debt Arrangements

On January 3, 2023, we entered into a Sixth Amendment to Third Amended and Restated Loan and Security Agreement, which amended our existing ABL Credit Facility.  The amendment increased the Credit Facility by $150 million from $475 million to $625 million.  The $625 million ABL Credit Facility consists of: (i) a revolving credit facility of up to $595 million, including a $20 million sub-limit for letters of credit, and (ii) a first in, last out revolving credit facility of up to $30 million.  Under the terms of the ABL Credit Facility we may, subject to the satisfaction of certain conditions, request additional commitments under the revolving credit facility in the aggregate principal amount of up to $200 million to the extent that existing or new lenders agree to provide such additional commitments, and add real estate as collateral at our discretion.  The ABL Credit Facility matures on June 16, 2026.

The ABL Credit Facility is collateralized by our accounts receivable, inventory, personal property and certain real estate.  The ABL Credit Facility contains customary representations and warranties and certain covenants that limit our ability to, among other things: (i) incur or guarantee additional indebtedness; (ii) pay distributions on, redeem or repurchase capital stock or redeem or repurchase subordinated debt; (iii) make investments; (iv) sell assets; (v) enter into agreements that restrict distributions or other payments from restricted subsidiaries to us; (vi) incur liens securing indebtedness; (vii) consolidate, merge or transfer all or substantially all of their assets; and (viii) engage in transactions with affiliates.  In addition, the ABL Credit Facility contains a financial covenant which requires if any commitments or obligations are outstanding and the our availability is less than the greater of $30 million or 10.0% of the aggregate amount of revolver commitments ($62.5 million at March 31, 2023) or 10.0% of the aggregate borrowing base ($61.9 million at March 31, 2023), then we must maintain a ratio of Earnings before Interest, Taxes, Depreciation and Amortization (EBITDA) minus certain capital expenditures and cash taxes paid to fixed charges of at least 1.00 to 1.00 for the most recent twelve fiscal month period.

We have the option to borrow under its revolver based on the agent’s base rate plus a premium ranging from 0.00% to 0.25% or the Secured Overnight Financing Rate (SOFR) plus a premium ranging from 1.25% to 2.75%. 

On January 10, 2019, we entered into a five-year forward starting fixed rate interest rate hedge in order to eliminate the variability of cash interest payments on $75 million of the outstanding LIBOR based borrowings under the ABL Credit Facility.  On January 3, 2023, we amended the interest rate hedge agreement to use SOFR as the reference rate and updated the fixed rate to 2.42% from 2.57%.  Although we are exposed to credit loss in the event of nonperformance by the other party to the interest rate hedge agreement, we anticipate performance by the counterparty.

As of March 31, 2023, we were in compliance with its covenants and had approximately $355 million of availability under the ABL Credit Facility.  

As of March 31, 2023, and December 31, 2022, $2.0 million and $1.2 million, respectively, 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.

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, 2022.

Item 3.  Quantitative and Qualitative Disclosures About Market Risk

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

We, like many other metals service centers, maintain substantial inventories of metals to accommodate the short lead times and just‑in‑time delivery requirements of our customers. Accordingly, we purchase metals in an effort to maintain our inventory at levels that we believe to be appropriate to satisfy the anticipated needs of our customers based upon historic buying practices, supply agreements with customers and market conditions. Our commitments to purchase metals are generally at prevailing market prices in effect at the time we place our orders. We have no long‑term, fixed‑price metals purchase contracts. When metals prices increase, competitive conditions will influence how much of the price increase we can pass on to our customers. To the extent we are unable to pass on future price increases in our raw materials to our customers, the net sales and profitability of our business could be adversely affected. When metals prices decline, customer demands for lower prices and our competitors’ responses to those demands could result in lower sale prices and, consequently, lower gross profits and inventory lower of cost or net realizable value adjustments as we sell existing inventory. Significant or rapid declines in metals prices or reductions in sales volumes could adversely impact our ability to remain in compliance with certain financial covenants in our credit facility, as well as result in us incurring inventory or intangible asset impairment charges. Changing metals prices therefore could significantly impact our net sales, gross profits, operating income and net income.

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

Approximately 50% and 53% of our consolidated net sales during the first three months of 2023 and 2022, respectively, were directly related to industrial machinery and equipment manufacturers and their fabricators. 

Inflation generally affects us by increasing the cost of employee wages and benefits, transportation services, energy, borrowings under our credit facility, processing equipment, and purchased metals. Although general inflation, excluding increases in the price of metals and increased labor and distribution expense, has increased during the first quarter of 2023, it has not had a material effect on our financial results during the last three years, but may have a significant impact in future years.

We are exposed to the impact of fluctuating metals prices and interest rate changes. During 2023 and 2022, we entered into metals swaps at the request of customers. These derivatives have not been designated as hedging instruments. For certain customers, we enter into contractual relationships that entitle us to pass through the economic effect of trading positions that we take with other third parties on our customers’ behalf.

Our primary interest rate risk exposure results from variable rate debt.  On January 10, 2019, we entered into a five-year forward starting fixed rate interest rate hedge in order to eliminate the variability of cash interest payments on $75 million of the outstanding LIBOR based borrowings under the ABL Credit Facility.  On January 3, 2023, we amended the interest rate hedge agreement to use SOFR as the reference rate and updated the fixed rate to 2.42% from 2.57%.  Although we are exposed to credit loss in the event of nonperformance by the other party to the interest rate hedge agreement, we anticipate performance by the counterparty.  We have the option to enter into 30- to 180-day fixed base rate SOFR loans under the ABL Credit Facility. 

Item 4.  Controls and Procedures

The evaluation required by Rule 13a-15(e) of the Securities Exchange Act of 1934 of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this Quarterly Report on Form 10-Q has been carried out under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer. These disclosure controls and procedures are designed to provide reasonable assurance that information required to be disclosed in reports that are filed with or submitted to the SEC is: (i) accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosures and (ii) recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC. Based on this evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of March 31, 2023, 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 2023 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.