UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-K

 

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

 

 

For The Year Ended December 31, 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 

(I.R.S. Employer

incorporation or organization)

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.

 

Securities registered pursuant to Section 12(g) of the Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes ☐ No ☒

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes ☐ No ☒

 

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 ☒ 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 ☒ No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or 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 ☒ 
  Non-accelerated filer ☐  Small reporting company ☐
    Emerging growth company ☐

               

Page 1

 

 

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 in Rule 12b-2 of the Act).      Yes ☐ No ☒

 

As of June 28, 2019, the aggregate market value of voting stock held by non-affiliates of the registrant based on the closing price at which such stock was sold on the Nasdaq Global Select Market on such date approximated $121,663,479.

 

The number of shares of common stock outstanding as of February 21, 2020 was 11,001,068.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

The registrant intends to file with the Securities and Exchange Commission a definitive Proxy Statement pursuant to Regulation 14A of the Securities Exchange Act of 1934 within 120 days of the close of its fiscal year ended December 31, 2019, portions of which document shall be deemed to be incorporated by reference in Part III of this Annual Report on Form 10-K from the date such document is filed.

 



 

Page 2

 
 

 

 

TABLE OF CONTENTS

 

Page

 

Part I

 

 

 

Item 1.  

Business

4

 

Item 1A.  

Risk Factors

14

 

Item 1B.  

Unresolved Staff Comments

22

 

Item 2.  

Properties

23

 

Item 3.  

Legal Proceedings

24

 

Item 4.  

Mine Safety Disclosures

24

 

 

Information About Our Executive Officers 

25

 

 

 

 

Part II

 

 

 

Item 5.  

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

26

 

Item 6.  

Selected Financial Data

27

 

Item 7.  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

28

 

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk

41

 

Item 8.  

Financial Statements and Supplementary Data

42

 

Item 9.  

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

72

 

Item 9A.

Controls and Procedures

72

 

Item 9B.

Other Information

72

 

 

 

 

Part III

 

 

 

Item 10.  

Directors, Executive Officers and Corporate Governance

73

 

Item 11.

Executive Compensation

73

 

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

73

 

Item 13.

Certain Relationships and Related Transactions, and Director Independence

73

 

Item 14.

Principal Accountant Fees and Services 

73

 

 

 

 

Part IV

 

 

 

Item 15.

Exhibits and Financial Statement Schedules

74

 

 

Index to Exhibits 

74

 

Item 16.

Form 10-K Summary

77

 

 

Signatures

78

 

Page 3

 
 

 

 

PART I

 

ITEM 1. BUSINESS

 

The Company

 

We are a leading metals service center that operates in three reportable segments; carbon flat products, specialty metals flat products, and tubular and pipe products. We provide metals processing and distribution services for a wide range of customers. Our carbon flat products segment’s focus is on the direct sale and distribution of large volumes of processed carbon and coated flat-rolled sheet, coil and plate products and fabricated parts. Through the acquisition of McCullough Industries (McCullough) on January 2, 2019, our carbon flat products segment expanded its product offerings to include self-dumping metal hoppers and through the acquisition of EZ Dumper on August 5, 2019, to include steel and stainless-steel dump inserts for pickup truck and service truck beds. Our specialty metals flat products segment’s focus is on the direct sale and distribution of processed aluminum and stainless flat-rolled sheet and coil products, flat bar products and fabricated parts. Through the acquisition of Berlin Metals, LLC (Berlin Metals) on April 2, 2018, our specialty metals flat products segment expanded its product offerings to include differing types of stainless flat-rolled sheet and coil and prime tin mill products. In addition, we distribute metal tubing, pipe, bar, valves and fittings and fabricate pressure parts supplied to various industrial markets through our tubular and pipe products segment. Products that require more value-added processing generally have a higher gross profit. Accordingly, our overall gross profit is affected by, among other things, product mix, the amount of processing performed, the demand for and availability of metals, and volatility in selling prices and material purchase costs. We also perform toll processing of customer-owned metals. We sell certain products internationally, primarily in Canada and Mexico. International sales are immaterial to our consolidated financial results and to the individual segments’ results.

 

We are incorporated under the laws of the State of Ohio. Our executive offices are located at 22901 Millcreek Boulevard, Suite 650, Highland Hills, Ohio 44122. Our telephone number is (216) 292-3800, and our website address is www.olysteel.com. We are not including the information on our website as a part of, or incorporating it by reference into, this Annual Report on Form 10-K.

 

 

Industry Overview 

 

The metals industry is comprised of three types of entities: metals producers, intermediate metals processors and metals service centers. Metals producers have historically emphasized the sale of metals to volume purchasers and have generally viewed intermediate metals processors and metals service centers as part of their customer base. However, all three types of entities can compete for certain customers who purchase large quantities of metals. Intermediate metals processors tend to serve as processors in large quantities for metals producers and major industrial consumers of processed metals, including automobile and appliance manufacturers.

 

Services provided by metals service centers can range from storage and distribution of unprocessed metal products to complex, precision value-added metals processing. Metals service centers respond directly to customer needs and emphasize value-added processing of metals pursuant to specific customer demands, such as cutting-to-length, slitting, shearing, roll forming, shape correction and surface improvement, blanking, tempering, plate burning and stamping. These processes produce metals to specified lengths, widths, shapes and surface characteristics through the use of specialized equipment. Metals service centers typically have lower cost structures than, and provide services and value-added processing not otherwise available from, metals producers.

 

End product manufacturers and other metals users seek to purchase metals on shorter lead times and with more frequent and reliable deliveries than can normally be provided by metals producers. Metals service centers generally have lower labor costs than metals producers and consequently process metals on a more cost-effective basis. In addition, due to this lower cost structure, metals service centers are able to handle orders in quantities smaller than would be economical for metals producers. The benefits to customers purchasing products from metals service centers include lower inventory levels, lower overall cost of raw materials, more timely response and decreased manufacturing time and expense. Customers also benefit from a lower investment in production labor, buildings and equipment, which allows them to focus on the engineering, assembly and marketing of their products. We believe that customers’ demands for just-in-time delivery have made the value-added inventory, processing and delivery functions performed by metals service centers increasingly important.

 

Page 4

 

 

Corporate History

 

Our company was founded in 1954 by the Siegal family as a general steel service center. In the late 1980s, our business strategy changed from a focus on warehousing and distributing steel from a single facility with no major processing equipment to a focus on geographic and product growth, customer diversity and value-added processing. An integral part of our growth has been the acquisition and start-up of processing and sales operations, and the investment in processing equipment. In 1994, we completed an initial public offering and, in 1996, we completed a follow-on offering of our common stock.

 

In 2011, we acquired Chicago Tube and Iron, or CTI, a private leading distributor of tubing, pipe, bar, valves, and fittings, which represents our tubular and pipe products segment. In April 2018, we acquired the net assets of Berlin Metals, and in January 2019, we acquired the net assets of McCullough Industries and in August, 2019 certain assets related to the manufacturing of the EZ-Dumper® hydraulic dump inserts.

 

Michael Siegal, the son of one of our founders, began his career with us in the early 1970s and serves as our Executive Chairman of the Board of Directors. Mr. Siegal served as our Chief Executive Officer from 1984 until the end of 2018. Richard T. Marabito has served as our Chief Executive Officer since January 2019. Mr. Marabito joined us in 1994 as Corporate Controller and served as our Chief Financial Officer from 2000 until the end of 2018. Richard A. Manson has served as our Chief Financial Officer since January 2019. Mr. Manson has served in various capacities at our company since 1996, most recently serving as our Vice President and Treasurer. Effective January 1, 2020, Andrew S. Greiff succeeded David A. Wolfort as President in addition to his role as Chief Operating Officer. Mr. Greiff joined us in 2009 and most recently served as our Executive Vice President and Chief Operating Officer.

 

 

Business Strategy and Objectives

 

We believe that the metals service center and processing industry is driven by the following primary trends: (i) shift by customers to fewer suppliers that are larger and financially strong; (ii) increased customer demand for more frequent deliveries, higher quality products and services; and (iii) globalization of metals industry participants.

 

In recognition of these industry trends, our focus has been on achieving profitable geographic and product growth through the start-up and acquisition of service centers, processors, fabricators and related businesses, and investments in people, information systems, higher value-added processing equipment and services, while continuing our commitment to expanding and improving our operating efficiencies, sales and servicing efforts.

 

We are focused on specific operating objectives including: (i) improving safety performance; (ii) managing inventory turnover; (iii) managing operating expenses; (iv) diversifying product offerings; (v) growing our market share; (vi) maintaining targeted cash turnover rates; (vii) investing in technology and business information systems and; (viii) providing on-time delivery and quality performance for our customers.  

 

These operating objectives are supported by:

 

 

A set of core values, which are communicated, practiced and measured throughout the Company.

 

An internal communications program designed to engage and motivate employees to support our strategy, values and culture.

 

Our “flawless execution” program (Fe), which is an internal recognition program that rewards employees who achieve profitable growth by delivering superior customer service and exceeding customer expectations.

 

Operational initiatives designed to improve efficiencies and reduce costs by improving processes and creating an environment to facilitate change and improve the way we work and create value.

 

Information systems and key metric reporting to focus managers on achieving specific operating objectives.

 

Alignment of compensation with the financial objectives and performance of the Company and the achievement of specific financial and operating objectives.

 

We believe our depth of management, facilities, locations, processing capabilities, inventory, focus on safety, quality and customer service, extensive and experienced sales force, and the strength of our customer and supplier relationships provide a strong foundation for implementation of our strategy and achievement of our objectives. Certain elements of our strategy are set forth in more detail below.

 

Page 5

 

 

Investments and Acquisitions. During 2019 and 2018 we accelerated our growth through acquisitions and capital investments in facilities and processing equipment. Our Vice President of Strategic Development’s focus is on profitable growth opportunities, including acquisitions.

 

On August 5, 2019, we acquired certain assets related to the manufacturing of the EZ-Dumper® hydraulic dump inserts. The dump inserts are sold through a network of more than 100 dealers across the United States and Canada from our processing facilities in Chambersburg, Pennsylvania. On January 2, 2019, we acquired substantially all of the net assets of McCullough, based in Kenton, Ohio. McCullough is a manufacturer of self-dumping hoppers used in a variety of industrial applications. The downstream vertical integration of McCullough represents our first acquisition of a manufacturer of metal-intensive branded products, which allows us to deploy our purchasing, logistics and processing expertise to achieve synergies, expand margins and increase returns.

 

On April 2, 2018, we acquired substantially all of the net assets of Berlin Metals, based in Hammond, Indiana. Berlin Metals was founded in 1967 and is one of the largest North American service centers processing and distributing prime tin mill products and stainless steel strip in slit coil form. Berlin Metals is also a supplier of galvanized, light gauge cold rolled sheet and strip and other coated metals in coil forms, to customers in the building products, automotive and specialized industrial markets.

 

In addition to the acquisitions noted above, our capital investments during the past three years have primarily consisted of a building and equipment expansion in Chicago to expand our capabilities to process specialty metals, an additional slitter for our specialty metals flat products segment, processing equipment for our expanded value-added customer base in Winder, Georgia, added tube and pipe distribution capabilities from our Locust, North Carolina facility, and additional processing equipment for all three of our segments.

 

When the results of sales and marketing efforts and our financial justifications indicate that there is sufficient customer demand for a particular product, process or service, we may purchase equipment to satisfy that demand. We also evaluate our existing equipment to ensure that it remains productive, and we upgrade, replace, redeploy or dispose of equipment when necessary. We invest in processing equipment to support customer demand and to respond to the growing trend among original equipment manufacturers (our customers) to outsource non-core production processes, such as plate processing, machining, welding and fabrication, in order to concentrate on engineering, design and assembly.

 

Sales and Marketing. We believe that our commitments to quality, service, just-in-time delivery and field sales personnel have enabled us to build and maintain strong customer relationships. We continuously analyze our customer base to ensure that strategic customers are properly targeted and serviced, while focusing our efforts to supply and successfully service multi-location customers from multi-location Olympic facilities. We service certain customers with carbon and specialty metals flat products and tubular and pipe products through cross-stocking of products in certain facilities.

 

We offer business solutions to our customers through value-added and value-engineered services. We also provide inventory stocking programs and in-plant Olympic Steel employees located at certain customer locations to help reduce customers’ costs. Our owned truck fleet further enhances our just-in-time deliveries based on our customers’ requirements.

 

Our flawless execution (Fe) program is a commitment to provide superior customer service while striving to exceed customer expectations. This program includes tracking on-time delivery and quality performance against objectives, and recognition of employee initiatives to improve efficiencies, streamline processes or reduce operating expenses at each operation.

 

We believe our large and experienced sales force provides strategic advantages. Our sales force makes direct daily sales calls to customers throughout the continental United States, Canada and Mexico. The continuous interaction between our sales force and active and prospective customers provides us with valuable market information and sales opportunities, including opportunities for outsourcing, improving customer service and increasing sales.

 

Our sales efforts are further supported by metallurgists, engineers, technical and quality service personnel and product specialists who have specific expertise in carbon and stainless steel, aluminum, alloy plate and steel fabrication as well as tubular and pipe products. Our services for certain customers also include integration into our internal business systems to provide cost efficiencies for both us and our customers.

 

Management. We believe one of our strengths is the depth, knowledge and experience of our management team. In addition to our executive officers, members of our senior management team have a diversity of backgrounds within the metals industry, including management positions at metals producers and other metals service centers. They average 29 years of experience in the metals industry and 19 years with our company. Effective January 1, 2020 and January 1, 2019, we executed a succession plan which allowed us to further enhance our management team by the promotions of several employees to executive management positions within the organization.

 

Page 6

 

 

Products, Processing Services and Quality Standards

 

We maintain inventory of carbon, stainless and aluminum coil, plate and sheet products, and tubular and pipe products. Coil is in the form of a continuous sheet, typically 36 to 96 inches wide, between 0.015 and 0.625 inches thick, and rolled into 10 to 30 ton coils. Because of the size and weight of these coils and the equipment required to move and process them into smaller sizes, such coils do not meet the requirements, without further processing, of most customers. Plate is typically thicker than coil and is processed by laser, plasma or oxygen burning. Through our acquisition of Berlin Metals, 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.

 

Through CTI, we maintain inventory of round, square, and rectangular mechanical and structural tubing; hydraulic and stainless tubing; boiler tubing; carbon, stainless, and aluminum pipe; and valves and fittings. CTI provides a variety of value added services to its tube and pipe product line, including saw cutting, laser cutting, beveling, threading and grooving. CTI also fabricates pressure components supplied to various industrial markets.   

 

Customer orders are entered or electronically transmitted into computerized order entry systems, and appropriate inventory is selected and scheduled for processing in accordance with the customer’s specified delivery date. We attempt to maximize yield and equipment efficiency through the use of computer software and by combining customer orders for processing each coil, plate, tube or pipe to the fullest extent practicable.

 

Our services include both traditional service center processes of cutting-to-length, slitting, flattening, sawing and shearing and higher value-added processes of blanking, tempering, plate burning, laser cutting, precision machining, welding, fabricating, bending, beveling, polishing, kitting and painting to process metals to specified lengths, widths and shapes pursuant to specific customer orders. Cutting-to-length involves cutting metal along the width of the coil. Slitting involves cutting metal to specified widths along the length of the coil. Shearing is the process of cutting sheet metal. Blanking cuts the metal into specific shapes with close tolerances. Tempering improves the uniformity of the thickness and flatness of the metals through a cold rolling process. Plate and laser processing is the process of cutting metal into specific shapes and sizes. Our forming activities include bending metal. Our machining activities include drilling, milling, tapping, boring and sawing. Tube processing includes tube bending and end finishing. Finishing activities include shot blasting, grinding, edging and polishing. Our fabrication activities include machining, welding, assembly and painting of component parts.

 

With the acquisitions of EZ Dumper and McCullough Industries, we also manufacture hydraulic dump inserts and self-dumping hoppers.

 

The flat products segment is separated into two reportable segments; carbon flat products and specialty metals flat products. The flat products segments’ assets and resources are shared by the carbon and specialty metals segments and both segments’ products are, in some instances, stored in the shared facilities and processed on the shared equipment.

 

Page 7

 

 

The following table sets forth, as of December 31, 2019, the major pieces of processing equipment in operation by segment:

 

Processing Equipment

 

Consolidated Flat

Products

   

Tubular and Pipe

Products

   

Total

 

Tempering

    3       -       3  

Stretcher-leveling

    2       -       2  

Cutting-to-length

    14       13       27  

Slitting

    15       -       15  

Shearing

    8       -       8  

Blanking

    4       -       4  

Plate processing

    23       -       23  

Laser processing

    29       9       38  

Forming

    20       -       20  

Machining

    39       85       124  

Painting

    1       1       2  

Tube processing

    2       39       41  

Finishing

    24       3       27  

Total

    184       150       334  

 

Our quality assurance system, led by certified specialists and engineers, establishes controls and procedures covering all aspects of our products from the time the material is ordered through receipt, processing and shipment to the customer. These controls and procedures encompass periodic supplier and customer audits, workshops with customers, inspection equipment and criteria, preventative actions, traceability and certification. We have quality testing labs at several of our facilities, including at our temper mill facilities in Cleveland, Ohio and Bettendorf, Iowa.

 

In addition, 26 of our facilities have earned International Organization for Standardization (ISO) 9001:2015 certifications. Detroit has earned both International Automotive Task Force (IATF) 16949:2016 and (ISO) 14001:2105 certifications. CTI has earned The American Society of Mechanical Engineers S Certification and The National Board of Boiler & Pressure Vessel Inspectors R Certification. Our office building in Winder, Georgia has received Leadership in Energy and Environmental Design (LEED) certification.

 

 

Customers and Distribution

 

We have a diverse customer and geographic base, which helps to reduce the inherent risk and cyclicality of our business. Net sales to our top three customers, in the aggregate, approximated 10%, 9% and 8% of our consolidated net sales in 2019, 2018 and 2017, respectively. We serve customers in metals consuming industries, including manufacturers and fabricators of transportation and material handling lift equipment, construction, mining and farm equipment, storage tanks, environmental and energy generation equipment, automobiles, food service and electrical equipment, military vehicles and equipment, as well as general and plate fabricators and metals service centers. The table below shows the percentage of our consolidated net sales to the largest industries for the past three years.

 

Industry

 

2019

   

2018

   

2017

 

Industrial machinery and equipment manufacturers and their fabricators

    46%       48%       51%  

Residential and commercial construction

    13%       13%       9%  

Automobile manufacturers and their suppliers

    11%       10%       9%  

Metals service centers

    8%       10%       11%  

Transportation equipment manufacturers

    8%       8%       6%  

All others <5%

    14%       11%       14%  

 

While we ship products throughout the United States, most of our customers are located in the midwestern, eastern and southern regions of the United States. Most customers are located within a 250-mile radius of one of our processing facilities, thus enabling an efficient delivery system capable of handling a high frequency of short lead time orders. We transport our products directly to customers via our in-house truck fleet, which further supports the just-in-time delivery requirements of our customers, and third-party trucking firms. Products sold to foreign customers, which have been immaterial to our consolidated results, are shipped either directly from metals producers to the customer or to an intermediate processor, and then to the customer by rail, truck or ocean carrier. Through our facility in Monterrey, Mexico, we are able to stock material and service our customers in that country with shorter lead times.

 

Page 8

 

 

We process our metals to specific customer orders as well as for stocking programs. Many of our larger customers commit to purchase on a regular basis at agreed upon or indexed prices for periods ranging from three to twelve months. To help mitigate price volatility risks, these price commitments are generally matched with corresponding supply arrangements, or to a lesser degree by commodities hedging. Customers notify us of specific release dates as processed products are required. Customers typically notify us of release dates anywhere from a just-in-time basis to one month before the release date. Therefore, we are required to carry sufficient inventory to meet the short lead time and just-in-time delivery requirements of our customers. CTI produces pressure parts and other fabricated components primarily for industrial boiler applications. These products typically take several months to produce due to their size and complexity. Due to the time required for production, we may require progress payments throughout the construction period.

 

The current global economic environment has resulted in increased supply chain scrutiny by our customers and potential customers. We believe our size, geographic footprint, financial position, dedication to a field sales force, and our focus on quality and customer service are advantageous in maintaining our customer base and in securing new customers.

 

 

Raw Materials

 

Our principal raw materials are carbon, coated, and stainless steel and aluminum, in the forms of pipe, tube, flat rolled sheet, coil 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 material can be volatile due to numerous factors beyond our control, including general domestic and global economic conditions, domestic and global supply and demand imbalance, competition, quickly changing lead times and late deliveries from metals producers, fluctuations in the costs of raw materials necessary to produce metals, import duties and tariffs and currency exchange rates. This volatility can significantly affect the availability and cost of raw materials to us.

 

Inventory management is a key profitability driver in the metals service center industry. Similar to many 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 historic buying practices, purchase commitments 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. During the past three years, we have entered into pass through nickel and carbon swaps at the request of our customers in order to mitigate our customers’ risk of volatility in the price of metals. The swaps are settled with the brokers at maturity and the economic benefit or loss arising from the changes in fair value of the swaps is contractually passed through to the customer.

 

We have no long-term, fixed-price metals purchase contracts, except for commodity hedges. 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.

 

 

Suppliers

 

We concentrate on developing supply relationships with high-quality domestic and international metals producers, using a coordinated effort to be the customer of choice for business critical suppliers. We employ sourcing strategies that maximize the quality, production lead times and transportation economies of a global supply base. We are an important customer of flat-rolled coil and plate, pipe and tube for many of our principal suppliers, but we are not dependent on any one supplier. We purchase in bulk from metals producers in quantities that are efficient for such producers. This enables us to maintain a continued source of supply at what we believe to be competitive prices. We believe the access to our facilities and equipment, and our high quality customer services and solutions, combined with our long-standing and continuous prompt pay practices, will continue to be an important factor in maintaining strong relationships with metals suppliers.

 

The metals producing supply base has experienced significant consolidation, with a few suppliers accounting for a majority of the domestic carbon steel market. We purchased approximately 57% and 52% of our total metals requirements from our three largest suppliers in 2019 and 2018, respectively. Although we have no long-term supply commitments, we believe we have good relationships with our metals suppliers. If, in the future, we are unable to obtain sufficient amounts of metals on a timely basis, we may not be able to obtain metals from alternate sources at competitive prices. In addition, interruptions or reductions in our supply of metals could make it difficult to satisfy our customers’ just-in-time delivery requirements, which could have a material adverse effect on our business, financial condition, results of operations and cash flows.

 

Page 9

 

 

Competition

 

Our principal markets are highly competitive. We compete with other public and private regional and national metals service centers, single location service centers and, to a certain degree, metals producers and intermediate metals processors on a regional basis. We have different competitors for each of our products and within each region.  We compete on the basis of price, product selection and availability, customer service, value-added capabilities, quality, financial strength and geographic proximity. Certain of our competitors have greater financial and operating resources than we have.

 

With the exception of certain Canadian or Mexican operations, foreign-located metals service centers are generally not a material competitive factor in our principal domestic markets.

 

 

Management Information Systems

 

Information systems are an important component of our strategy. We have invested in technologies and human resources as a foundation for growth.  We depend on our Enterprise Resource Planning (ERP) systems for financial reporting, management decision-making, inventory management, order tracking and fulfillment and production optimization.  We continue to upgrade and consolidate our systems for optimal use of resources and to assure we are taking advantage of technology offerings.

 

Our information systems focus on the following core application areas:

 

Inventory Management.  Our information systems track the status, quantity and cost of inventories by product, location and process on a daily basis.  This information is essential to optimize management of inventory.

 

Differentiated Services To Customers.  Our information systems support value-added services to customers, including quality control and on-time delivery monitoring and reporting, just-in-time inventory management and shipping services.

 

E-Commerce and Advanced Customer Interaction.  We are actively participating in electronic commerce initiatives to reduce processing cost and time.  In addition to full electronic data interchange (EDI) capabilities with our customers and vendors, we also have implemented extranet sites for specific customers which are integrated with our internal business systems. 

 

System and Process Enhancements. We have completed development of business system solutions to replace our legacy information systems and have successfully implemented new ERP systems at most of our locations. We continue to implement these systems to provide standardized business processes, enhanced inventory management, production cost, and sales administrative controls, and reduced technical support requirements. Our business analysts work with our quality team to identify opportunities for efficiency and improved customer service. We collaborate across the metal supply chain, working with metals producers, service providers, customers, and industry-sponsored organizations to develop industry processing standards to drive cost out of the supply chain.

 

Information security and continuous availability of information processing are of highest priority. Our information professionals employ proven security and monitoring practices and tools to mitigate cyber-security risks and threats. In case of physical emergency or threat, our ERP systems, accounting systems, internet and communications systems are duplicated at a secure off-site computing facility or through secure, multi-site cloud providers, with migration of our other systems which are in progress.

 

Page 10

 

 

Employees

 

At December 31, 2019, we employed approximately 1,860 people. Approximately 300 of the hourly plant personnel are represented by nine separate collective bargaining units. The table below shows the expiration dates of the collective bargaining agreements.

 

Facility

Expiration date

Locust, North Carolina

March 4, 2020

Romeoville, Illinois

May 31, 2020

Minneapolis coil, Minnesota

September 30, 2020

Indianapolis, Indiana

January 29, 2021

St. Paul, Minnesota

May 25, 2021

Milan, Illinois

August 12, 2021

Minneapolis plate, Minnesota

March 31, 2022

Detroit, Michigan

August 31, 2022

Hammond, Indiana

November 30, 2024

 

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. 

 

 

Service Marks, Trade Names and Patents

 

We conduct our business under the name “Olympic Steel.” A provision of federal law grants exclusive rights to the word “Olympic” to the U.S. Olympic Committee. The U.S. Supreme Court has recognized, however, that certain users may continue to use the word based on long-term and continuous use. We have used the name Olympic Steel since 1954, but are prevented from registering the name “Olympic” and from being qualified to do business as a foreign corporation under that name in certain states. In such states, we have registered under different names, including “Oly Steel” and “Olympia Steel.” Our wholly-owned subsidiary, Olympic Steel Lafayette, Inc., does business in certain states under the names “Olympic Steel Detroit,” “Lafayette Steel and Processing” and “Lafayette Steel.” Our wholly-owned subsidiary, Olympic Steel Iowa, Inc. does business in certain states under the name “Oly Steel Iowa, Inc.”. Our North Carolina operation conducted business under the name “Olympic Steel North Carolina.” Our Integrity Stainless operation conducts business under the name “Integrity Stainless.” Our CTI operation conducts business under the name “CTI Power.” Our operation in Monterrey, Mexico operates under the name “Metales de Olympic S. de.R.L. de C.V.” We operate under the name “Berlin Metals” through our B Metals, Inc. subsidiary. We operate under the name “McCullough Industries” through our MCI, Inc. subsidiary and we conduct business under the name “EZ Dumper” for certain of our products.

 

We hold a trademark for our stainless steel sheet and plate product “OLY-FLATBRITE,” which has a unique combination of surface finish and flatness and for our “WRIGHT” self-dumping metal hoppers produced by McCullough Industries.

 

The “EZ DUMPER®” tradename was acquired by us in conjunction with the acquisition of certain assets related to the manufacturing of the EZ Dumper hydraulic dump inserts.

 

 

Government Regulation

 

Our operations are governed by many laws and regulations, including those relating to workplace safety and worker health, principally the Occupational Safety and Health Act and regulations thereunder. We believe that we are in material compliance with these laws and regulations and do not believe that future compliance with such laws and regulations will have a material adverse effect on our business, financial condition, results of operations and cash flows.

 

 

Environmental

 

Our facilities are subject to certain federal, state and local requirements relating to the protection of the environment. We believe that we are in material compliance with all environmental laws, do not anticipate any material expenditures to meet environmental requirements and do not believe that compliance with such laws and regulations will have a material adverse effect on our business, financial condition, results of operations and cash flows.

 

 

Seasonality

 

Seasonal factors may cause demand fluctuations within the year which could impact our results of operations. Typically, demand in the first half of the year is stronger than the second half of the year, as it contains more ship days and is not impacted by the seasonal shut-downs in July, November and December due to holidays.

 

Page 11

 

 

Effects of Inflation

 

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

 

 

Backlog

 

Because we conduct our operations generally on the basis of short-term orders, we do not believe that backlog is a material or meaningful indicator of future performance.

 

 

Available Information

 

We file annual, quarterly, and current reports, proxy statements, and other documents with the SEC under the Securities Exchange Act of 1934. The SEC maintains an Internet website that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. The public can obtain any documents that are filed by the Company at http://www.sec.gov.

 

In addition, our annual reports on Form 10-K, as well as our quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to all of the foregoing reports, are made available free of charge on or through the “Investor Relations” section of our website at www.olysteel.com as soon as reasonably practicable after such reports are electronically filed with or furnished to the SEC.

 

Information relating to our corporate governance at Olympic Steel, including our Business Ethics Policy, information concerning our executive officers, directors and Board committees (including committee charters), and transactions in our securities by directors and officers, is available free of charge on or through the “Investor Relations” section of our website at www.olysteel.com. We are not including the information on our website as a part of, or incorporating it by reference into, this Annual Report on Form 10-K.

 

Page 12

 

 

Forward-Looking Information

 

This Annual Report on Form 10-K and other documents we file with the SEC contain various forward-looking statements that are based on current expectations, estimates, forecasts and projections about our future performance, business, our beliefs and our 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, those set forth in Item 1A (Risk Factors) below and the following:

 

 

risks of falling metals prices and inventory devaluation;

 

general and global business, economic, financial and political conditions, including the 2020 U.S. election; 

 

competitive factors such as the availability, global pricing of metals and production levels (including the increased U.S. capacity), industry shipping and inventory levels and rapid fluctuations in customer demand and metals pricing;  
 

the levels of imported steel in the United States and the tariffs initiated by the U.S. government in 2018 under Section 232 of the Trade Expansion Act of 1962 and imposed tariffs and duties on exported steel or other products, U.S. trade policy and its impact on the U.S. manufacturing industry;

 

cyclicality and volatility within the metals industry;

 

fluctuations in the value of the U.S. dollar and the related impact on foreign steel pricing, U.S. exports, and foreign imports to the United States;

 

the successes of our efforts and initiatives to improve working capital turnover and cash flows, and achieve cost savings;

 

our ability to generate free cash flow through operations and repay debt;

 

the availability, and increased costs, of labor related to tighter employment markets;

 

the availability and rising costs of transportation and logistical services;

 

customer, supplier and competitor consolidation, bankruptcy or insolvency;

 

reduced production schedules, layoffs or work stoppages by our own, our suppliers’ or customers’ personnel;

 

the adequacy of our existing information technology and business system software, including duplication and security processes;

 

the adequacy of our efforts to mitigate cyber security risks and threats;

 

the amounts, successes and our ability to continue our capital investments and strategic growth initiatives, including acquisitions and our business information system implementations;

 

our ability to successfully integrate recent acquisitions into our business and risks inherent with the acquisitions in the achievement of expected results, including whether the acquisition will be accretive and within the expected timeframe;

 

events or circumstances that could adversely impact the successful operation of our processing equipment and operations;

 

rising interest rates and their impacts on our variable interest rate debt;

 

the impacts of union organizing activities and the success of union contract renewals;

 

changes in laws or regulations or the manner of their interpretation or enforcement could impact our financial performance and restrict our ability to operate our business or execute our strategies;

 

events or circumstances that could impair or adversely impact the carrying value of any of our assets;

 

risks and uncertainties associated with intangible assets, including impairment charges related to indefinite lived intangible assets;

 

the timing and outcomes of inventory lower of cost or market adjustments and last-in, first-out, or LIFO, income or expense;

 

the inflation or deflation existing within the metals industry, as well as product mix and inventory levels on hand, which can impact our cost of materials sold as a result of the fluctuations in the LIFO inventory valuation;

 

our ability to pay regular quarterly cash dividends and the amounts and timing of any future dividends;

 

our ability to repurchase shares of our common stock and the amounts and timing of repurchases, if any; and

 

unanticipated developments that could occur with respect to contingencies such as litigation, arbitration and environmental matters, including any developments that would require any increase in our costs for such contingencies.

 

Should one or more of these or other risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, intended, expected, believed, estimated, projected or planned. You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. We undertake no obligation to republish revised forward-looking statements to reflect the occurrence of unanticipated events or circumstances after the date hereof, except as otherwise required by law.

 

Page 13

 

 

ITEM 1A.  RISK FACTORS

 

In addition to the other information in this Annual Report on Form 10-K and our other filings with the SEC, the following risk factors should be carefully considered in evaluating us and our business before investing in our common stock. The risks and uncertainties described below are not the only ones facing us. Additional risks and uncertainties, not presently known to us or otherwise, may also impair our business. If any of the risks actually occur, our business, financial condition or results of operations could be materially and adversely affected. In that case, the trading price of our common stock could decline, and investors may lose all or part of their investment.

 

Risks Related to our Business

 

 

Volatile metals prices can cause significant fluctuations in our operating results. Our sales and operating income could decrease if metals prices decline or if we are unable to pass producer price increases on to our customers.

 

Our principal raw materials are carbon and stainless steel and aluminum flat rolled coil, sheet, plate, prime tin mill, pipe and tube 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, sales levels, competition, levels of inventory held by other metals service centers, producer lead times, higher raw material costs for the producers of metals, imports, import duties and tariffs and currency exchange rates. This volatility can significantly affect the availability and cost of raw materials to us.

 

Similar to many 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 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. Declining metals prices, customer demand for lower prices and our competitors’ responses to those demands could result in lower sale prices and, consequently, lower gross profits and potentially inventory lower of cost or market adjustments as we use 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 asset impairment charges. Changing metals prices therefore could significantly impact our net sales, gross profit, operating income and net income, and could impair or adversely impact the carrying value of any of our assets.

 

 

Quotas and tariffs imposed as a result of government actions can cause significant fluctuations in our operating results.

 

Global demand and global metals pricing, supply and demand are impacted by quotas and tariffs imposed as a result of government actions. The tariffs initiated by the U.S. government in 2018 under Section 232 of the Trade Expansion Act of 1962 (section 232 tariffs) resulted in increased metals prices in the United States during 2018. The subsequent deletion and addition of country-specific tariffs during both 2018 and 2019 has caused uncertainty in the metals marketplace. Any additional future tariffs or quotas imposed on steel and aluminum imports may increase the price of metal, which may impact our sales, gross margin and profitability if we are unable to pass the increased prices onto our customers. The prolonged imposition of tariffs could also lead to additional trade disputes that could impact the global demand for metals and impact on sales, gross margin and profitability. Conversely, the removal of existing tariffs could cause the price of metal to decline, which may impact our sales, gross margin and profitability.

 

 

We service industries that are highly cyclical, and any fluctuation in our customers’ demand could impact our sales, gross profits and profitability.

 

We sell our products in a variety of industries, including capital equipment manufacturers for industrial, agricultural and construction use, the automotive industry, the utilities industry, and manufacturers of fabricated metals products. Numerous factors, such as general economic conditions, fluctuations in the U.S. dollar, government stimulus or regulation, availability of adequate credit and financing, consumer confidence, significant business interruptions, labor shortages or work stoppages, energy prices, seasonality, customer inventory levels and other factors beyond our control, may cause significant demand fluctuations from one or more of these industries. Any fluctuation in demand within one or more of these industries may be significant and may last for a lengthy period of time. In periods of economic slowdown or recession in the United States, excess customer or service center inventory or a decrease in the prices that we can realize from sales of our products to customers in any of these industries could result in lower sales, gross profits and profitability.

 

Page 14

 

 

Approximately 46% of our 2019 consolidated net sales were to industrial machinery and equipment manufacturers and their fabricators. Due to the concentration of customers in the industrial machinery and equipment industry, a decline in production levels in that industry could result in lower sales, gross profits and profitability. Approximately 11% of our 2019 consolidated net sales were to automotive manufacturers or manufacturers of automotive components and parts, whom we refer to as automotive customers. Historically, due to the concentration of customers in the automotive industry, our gross profits on these sales have generally been less than our gross profits on sales to customers in other industries.

 

 

Our success is dependent upon our relationships with certain key customers. 

 

We have derived and expect to continue to derive a significant portion of our revenues from a relatively limited number of customers. Collectively, our top three customers accounted for approximately 10% and 9% of our consolidated net sales in 2019 and 2018, respectively. Approximately 46% and 48% of our consolidated net sales during 2019 and 2018, respectively, were directly related to industrial machinery and equipment manufacturers and their fabricators. Due to the large concentration of customers in few segments, changes to demand of product by customers in the industrial machinery and equipment manufacturers and their fabricators could have a material adverse effect on our business, our results of operations and our cash flows. Many of our larger customers commit to purchase on a regular basis at agreed upon prices over periods from three to twelve months. We generally do not have long-term contracts with our customers. As a result, the relationship, as well as particular orders, can generally be terminated with relatively little advance notice. The loss of any one of our major customers or decrease in demand by those customers or credit constraints placed on them could have a material adverse effect on our business, our results of operations and our cash flows.

 

 

Capital deployed for acquisitions and processing equipment investments at our existing locations may be unable to achieve expected results, or sustain our growth and events or circumstances that could adversely impact operations could have a material adverse effect on our results of operations.

 

We have grown through acquisitions and by increasing sales and services to our existing customers, aggressively pursuing new customers and services, building or purchasing new facilities, acquiring and upgrading processing equipment and expanded our product mix in order to expand the range of customer services and products that we offer. We intend to actively pursue our growth strategy in the future.

 

Future expansion or construction projects, could have adverse effects on our results of operations due to the impact of the associated start-up costs and the potential for underutilization in the start-up phase of a facility. While we continue to pursue potential acquisition targets, we are unable to predict whether or when any prospective acquisition candidate will become available or the likelihood that any acquisition will be completed. Moreover, in pursuing acquisition opportunities, we may compete for acquisition targets with other companies with similar growth strategies that may be larger and have greater financial and other resources than we have. Competition among potential acquirers could result in increased prices for acquisition targets. As a result, we may not be able to consummate acquisitions on terms satisfactory to us, or at all.

 

The pursuit of acquisitions and other growth initiatives may divert management’s time and attention away from day-to-day operations. In order to achieve growth through acquisitions, expansion of current facilities, greenfield construction or otherwise, additional funding sources may be needed and we may not be able to obtain the additional capital necessary to pursue our growth strategy on terms that are satisfactory to us, or at all.

 

We continue to invest in processing equipment to support customer demand. Although we have successfully installed new and used processing equipment in the past, we can provide no assurance that future installations will be successful, or achieve expected results. Risks associated with the installations include, but are not limited to:

 

 

a significant use of management and employee time;

 

the possibility that the performance of the equipment does not meet expectations; and

 

the possibility that disruptions from the installations may make it difficult for us to maintain relationships with our customers, employees or suppliers.

 

Page 15

 

 

Difficulties associated with the installation of new processing equipment could adversely affect our business, our customer service, our results of operations and our cash flows.

 

 

Our information technology systems could be negatively affected by cyber security threats.

 

Increased global information technology security requirements, vulnerabilities, threats and a rise in sophisticated and targeted cyber crime pose a risk to the security of our systems, networks and the confidentiality, availability and integrity of our data. Despite our efforts to protect sensitive information and confidential and personal data, our facilities and systems and those of our third-party service providers may be vulnerable to security breaches. This could lead to disclosure, modification or destruction of proprietary and other key information, production downtimes and operational disruptions, which in turn could adversely affect our results of operations.

 

 

Our implementation of information systems could adversely affect our results of operations and cash flows.

 

We are in the process of implementing information systems and eliminating our legacy operating systems. The objective is to standardize and streamline business processes and improve support for our service center and fabrication business. Risks associated with the phased implementation include, but are not limited to:

 

 

a significant deployment of capital and a significant use of management and employee time;

 

the possibility that software and implementation vendors may not be able to support the project as planned;

 

the possibility that the timelines, costs or complexities related to the new system implementation will be greater than expected;

 

the possibility that the software, once fully implemented, does not function as planned;

 

the possibility that benefits from the systems may be less or take longer to realize than expected;

 

the possibility that disruptions from the implementation may make it difficult for us to maintain relationships with our customers, employees or suppliers; and

 

limitations on the availability and adequacy of proprietary software or consulting, training and project management services, as well as our ability to retain key personnel.

 

Although we have successfully initiated use of the systems at most of our locations, we can provide no assurance that the rollout to the remaining locations will be successful or will occur as planned and without disruption to operations. Difficulties associated with the design and implementation of new information systems could adversely affect our business, our customer service, our results of operations and our cash flows.

 

 

The failure of our key computer-based systems could have a material adverse effect on our business.

 

Until our systems implementations are completed, we maintain separate regional legacy computer-based systems in the operation of our business and we depend on these systems to a significant degree, particularly for inventory management. These systems are vulnerable to, among other things, damage or interruption from fire, flood, tornado and other natural disasters, power loss, computer system and network failures, operator negligence, physical and electronic loss of data or security breaches and computer viruses. Although we have secure back-up systems off-site, the destruction or failure of any one of our computer-based systems for any significant period of time could materially adversely affect our business, financial condition, results of operations and cash flows.

 

 

Our business is dependent on transportation and labor. Increases in the cost or availability of transportation or labor could adversely affect our business and operations, as we may be unable to pass cost increases on to our customers.

 

We ship products throughout the United States via our in-house truck fleet or by third-party trucking firms. Products sold to foreign customers are shipped either directly from metals producers to the customer or to an intermediate processor, and then to the customer by rail, truck or ocean carrier. Our business depends on the daily transportation of a large number of products. We depend to a certain extent on third parties for transportation of our products to customers as well as inbound delivery of our raw materials. 

 

Page 16

 

 

If any of these providers were to fail to deliver materials to us in a timely manner, we may be unable to process and deliver our products in response to customer demand. If any of these third parties were to cease operations or cease doing business with us, we may be unable to replace them at a reasonable cost. In addition, the implementation of Electronic Logging Device rules in the United States began impacting the availability of drivers and third-party trucks in 2018 and significantly increased the price of transportation services in the United States. Failure of a third-party transportation provider to provide transportation services could harm our reputation, negatively affect our customer relationships and have a material adverse effect on our financial position and results of operations.

 

The economic expansion created a significant demand for labor in the United States, resulting in record low unemployment rates. The demand for skilled labor resulted in the need to increase pay rates in certain markets. Our operations are dependent on the labor used to operate our equipment and deliver products to our customers. Decreased availability of labor could harm our reputation, negatively affect our customer relationships and have a material adverse effect on our financial position and results of operations.

 

The availability of drivers and labor is integral to our operations, and increases in our cost of transportation or labor may have a material adverse effect on our financial position and results of operations.

 

 

Increased metals capacity or an interruption in the sources of our metals supply could have a material adverse effect on our results of operations.

 

We purchased approximately 57% and 52% of our total metals requirements from our three largest suppliers in 2019 and 2018, respectively. Over the past year, increased capacity has been added in the U.S. market. The addition of new mill sources and decreased domestic demand could lead to domestic over capacity, which could lead to a decrease in steel prices, which could have a material adverse effect on our business, financial condition, results of operations and cash flows.

 

Conversely, fewer available suppliers increases the risk of supply disruption through both scheduled and unscheduled supplier outages. We have no long-term supply commitments with our metals suppliers. If, in the future, we are unable to obtain sufficient amounts of metals on a timely basis, we may not be able to obtain metals from alternate sources at competitive prices. In addition, late deliveries, interruptions or reductions in our supply of metals could make it difficult to satisfy our customers’ just-in-time delivery requirements, which could have a material adverse effect on our business, financial condition, results of operations and cash flows.

 

 

Although we expect to finance our growth initiatives through borrowings under our credit facility, we may have to find additional sources of funding, which could be difficult. Additionally, increased leverage and borrowing rates could adversely impact our business and results of operations.

 

We expect to finance our growth initiatives through borrowings under our credit facility, which matures on December 8, 2022. However, our credit facility may not be sufficient or available to finance our growth initiatives, and we may have to find additional sources of financing. It may be difficult for us in the future to obtain the necessary funds and liquidity to run and expand our business.

 

The borrowings under our credit facility are primarily at variable interest rates. If interest rates in the future were to increase 100 basis points (1.0%) from December 31, 2019 rates and, assuming no change in total debt from December 31, 2019 levels, the additional annual interest expense to us would be approximately $1.2 million.

 

 

We depend on our senior management team and the loss of any member could prevent us from implementing our business strategy.

 

Our success is dependent upon the management and leadership skills of our senior management team. Effective January 1, 2019, Michael Siegal began serving as our Executive Chairman of the Board after serving as our Chief Executive Officer since 1984. Richard T. Marabito began serving as our Chief Executive Officer after serving as our Chief Financial Officer since 2010, and Richard A. Manson began serving as our Chief Financial Officer after serving as our Vice President and Treasurer since 2013. Andrew Greiff began serving as our President and Chief Operating Officer effective January 1, 2020 after serving as our Executive Vice President and Chief Operating Officer since 2016. The loss of any member of our senior management team or the failure to attract and retain additional qualified personnel could prevent us from implementing our business strategy. We have employment agreements, which include non-competition provisions, with our Chief Executive Officer, our President and Chief Operating Officer, and our Chief Financial Officer that expire on January 1, 2024, January 1, 2025, and January 1, 2022, respectively.

 

Page 17

 

 

Customer and third-party credit constraints and credit losses could have a material adverse effect on our results of operations.

 

Some of our customers may experience difficulty obtaining and/or maintaining credit availability. In particular, certain customers that are highly leveraged represent an increased credit risk. Some customers have reduced their purchases because of these credit constraints. Moreover, our disciplined credit policies have, in some instances, resulted in lost sales. If we have misjudged our credit estimations and they result in future credit losses, lost sales or lost customers, there could be a material adverse effect on our business, financial condition, results of operations, cash flows and our allowance for doubtful accounts.

 

 

Labor disruptions at any of our facilities or those of major customers could adversely affect our business, results of operations and financial condition.

 

At December 31, 2019, we employed approximately 1,860 people. Approximately 300 of the hourly plant personnel are represented by nine separate collective bargaining units. 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.

 

In addition, many of our larger customers, including those in the automotive industry, have unionized workforces and some have experienced significant labor disruptions in the past such as work stoppages, slow-downs and strikes. A labor disruption at one or more of our major customers could interrupt production or sales by that customer and cause that customer to halt or limit orders for our products. Any such reduction in the demand for our products could adversely affect our business, financial condition, results of operations and cash flows.

 

 

Participation in multiemployer pension plans carry withdrawal liability risks, which could impact our results of operations and financial condition.

 

Through CTI, we contribute to one multiemployer pension plan.  The risks of participating in the multiemployer plan are different from a single-employer plan in that 1) assets contributed to the multiemployer plan by one employer may be used to provide benefits to employees of other participating employers, 2) if a participating employer stops contributing to the plan, the unfunded obligations of the plan may be borne by the remaining participating employers, and 3) if CTI chooses to stop participating in the multiemployer plan, CTI may be required to pay the plan an amount based on the unfunded status of the plan, referred to as a withdrawal liability.

 

 

Increases in energy prices would increase our operating costs, and we may be unable to pass all these increases on to our customers in the form of higher prices.

 

If our energy costs increase disproportionately to our revenues, our earnings could be reduced. We use energy to process and transport our products. Our operating costs increase if energy costs, including electricity, diesel fuel and natural gas, rise. During periods of higher energy costs, we may not be able to recover our operating cost increases through price increases without reducing demand for our products. In addition, we generally do not hedge our exposure to higher prices via energy futures contracts. Increases in energy and fuel prices will increase our operating costs and may reduce our profitability if we are unable to pass all of the increases on to our customers.

 

 

Our insurance coverage, customer indemnifications or other liability protections may be unavailable or inadequate to cover all of our significant risks, which could have a material adverse effect on our results of operations.

 

From time to time, we may be subject to litigation incidental to our businesses, including claims for damages arising out of use of our products, claims involving employment matters, cyber security claims and commercial disputes.

 

We currently carry insurance from financially solid, highly rated counterparties in established markets to cover significant risks and liabilities. However, our insurance coverage may be inadequate if such claims do arise and any liability not covered by insurance could have a material adverse effect on our business. Disputes with insurance carriers, including over policy terms, reservation of rights, the applicability of coverage (including exclusions), compliance with provisions (including notice) and/or the insolvency of one or more of our insurers may significantly affect the amount or timing of recovery. Although we have been able to obtain insurance in amounts we believe to be appropriate to cover such liability to date, our insurance premiums may increase in the future as a consequence of conditions in the insurance business generally or our situation in particular. Any such increase could result in lower net income or cause the need to reduce our insurance coverage. In addition, a future claim may be brought against us that could have a material adverse effect on us.

 

In some circumstances, we may be entitled to certain legal protections or indemnifications from our customers through contractual provisions, laws, regulations or otherwise. However, these protections are not always available, are typically subject to certain terms or limitations, including the availability of funds, and may not be sufficient to cover all losses or liabilities incurred.

 

Page 18

 

 

If insurance coverage, customer indemnifications and/or other legal protections are not available or are not sufficient to cover our risks or losses, it could have a material adverse effect on our results of operations.

 

 

Our business is highly competitive, and increased competition could reduce our market share and harm our financial performance.

 

Our business is highly competitive. We compete with metals service centers and, to a certain degree, metals producers and intermediate metals processors, on a regular basis, primarily on quality, price, inventory availability and the ability to meet the delivery schedules and service requirements of our customers. We have different competitors for each of our products and within each region. Certain of these competitors have financial and operating resources in excess of ours. Increased competition could lower our gross profits or reduce our market share and have a material adverse effect on our financial performance.

 

 

Changes in laws or regulations, including recently enacted tax reform legislation, or the manner of their interpretation or enforcement could adversely impact our financial performance and restrict our ability to operate our business or execute our strategies.

 

New laws or regulations, or changes in existing laws or regulations, or the manner of their interpretation or enforcement, could increase our cost of doing business and restrict our ability to operate our business or execute our strategies. In particular, there may be significant changes in U.S. laws and regulations and existing international trade agreements by the current U.S. presidential administration that could affect a wide variety of industries and businesses, including those businesses we own and operate. If the U.S. presidential administration materially modifies U.S. laws and regulations and international trade agreements, our business, financial condition, and results of operations could be affected.

 

 

Impairment in the carrying value of intangible assets could result in the incurrence of impairment charges and negatively impact our results of operations.

 

The net carrying value of intangibles represents non amortizable goodwill and trade names, covenant not to compete and customer relationships, net of accumulated amortization, related to our specialty metals flat products and tubular and pipe products segments. Indefinitely lived assets are evaluated for impairment annually or whenever events or changes in circumstance indicate that the carrying amounts of these assets may not be recoverable. Amortizable intangible assets are evaluated for impairment whenever events or changes in circumstance indicate that the carrying amounts of these assets may not be recoverable. Impairments to intangible assets may be caused by factors outside our control, such as increased competitive pricing pressures, lower than expected revenue and profit growth rates, changes in discount rates based on changes in the cost of capital (interest rates, etc.), or the loss of a significant customer and could result in the incurrence of impairment charges and negatively impact our results of operations.

 

 

Uncertainty relating to the calculation of London Interbank Offered Rate (LIBOR) and other reference rates and their potential discontinuance may adversely affect interest expense related to our outstanding debt, including amounts borrowed under our asset-based credit facility (ABL Credit Facility).

 

National and international regulators and law enforcement agencies have conducted investigations into a number of rates or indices, which are deemed to be “reference rates.” Actions by such regulators and law enforcement agencies may result in changes to the manner in which certain reference rates are determined, their discontinuance, or the establishment of alternative reference rates. In particular, on July 27, 2017, the Chief Executive of the U.K. Financial Conduct Authority, which regulates LIBOR, announced that it will no longer persuade or compel banks to submit rates for the calculation of LIBOR after 2021. Such announcement indicates that the continuation of LIBOR on the current basis cannot and will not be guaranteed after 2021. As such, it appears highly likely that LIBOR will be discontinued or modified by the end of 2021.

 

At this time, it is not possible to predict the effect that these developments, any discontinuance, modification or other reforms to LIBOR or any other reference rate, or the establishment of alternative reference rates, may have on LIBOR or other benchmarks, including LIBOR-based borrowings under our ABL Credit Facility. Furthermore, the use of alternative reference rates or other reforms could cause the market value of, the applicable interest rate on and the amount of interest paid on our benchmark-based borrowings to be materially different than expected and could materially adversely impact our ability to refinance such borrowings or raise future indebtedness on a cost effective basis.

 

Page 19

 

 

We are subject to significant environmental, health and safety laws and regulations and related compliance expenditures and liabilities.

 

Our businesses are subject to many federal, state and local environmental, health and safety laws and regulations, particularly with respect to the use, handling, treatment, and disposal of substances and waste used or generated in our manufacturing processes. We have incurred and expect to continue to incur expenditures to comply with applicable environmental laws and regulations. Our failure to comply with applicable environmental laws and regulations and permit requirements could result in civil or criminal fines or penalties or enforcement actions, including regulatory or judicial orders enjoining or curtailing operations or requiring corrective measures, installation of pollution control equipment or remedial actions.

 

We may in the future be required to incur costs relating to the investigation or remediation of property, and for addressing environmental conditions. Some environmental laws and regulations impose liability and responsibility on present and former owners, operators or users of facilities and sites for contamination at such facilities and sites without regard to causation or knowledge of contamination. Consequently, we cannot assure you that existing or future circumstances, the development of new facts or the failure of third parties to address contamination at current or former facilities or properties will not require significant expenditures by us.

 

We expect to continue to be subject to environmental and health and safety laws and regulations. It is difficult to predict the future interpretation and development of environmental and health and safety laws and regulations or their impact on our future earnings and operations. We anticipate that compliance will continue to require increased capital expenditures and operating costs. Any increase in these costs, or unanticipated liabilities arising for example, out of discovery of previously unknown conditions or more aggressive enforcement actions, could have a material adverse effect on our business, financial condition, results of operations and cash flows.

 

 

Risks Related to Our Common Stock

 

 

The market price for our common stock may be volatile.

 

Historically, there has been volatility in the market price for our common stock. Furthermore, the market price of our common stock could fluctuate substantially in the future in response to a number of factors, including, but not limited to, the risk factors described herein. Examples include:

 

 

changes in commodity prices, especially metals;

 

changes in financial estimates or recommendations by stock market analysts regarding us or our competitors;

 

the operating and stock performance of other companies that investors may deem comparable;

 

developments affecting us, our customers or our suppliers;

 

press releases, earnings releases or publicity relating to us or our competitors or relating to trends in the metals service center industry;

 

inability to meet securities analysts’ and investors’ quarterly or annual estimates or targets of our performance;

 

sales of our common stock by large shareholders;

 

the amount of shares acquired for short-term investments;

 

general domestic or international economic, market and political conditions;

 

fluctuations in the value of the U.S. dollar;

 

changes in the legal or regulatory environment affecting our business; and

 

announcements by us or our competitors of significant acquisitions, dispositions or joint ventures, or other material events impacting the domestic or global metals industry.

 

Page 20

 

 

In the past, the stock market has experienced significant price and volume fluctuations. This volatility has had a significant effect on the market prices of securities issued by many companies for reasons unrelated to their specific operating performance. These factors may adversely affect the trading price of our common stock, regardless of actual operating performance.

 

In addition, stock markets from time to time experience extreme price and volume fluctuations that may be unrelated or disproportionate to the operating performance of companies. In the past, some shareholders have brought securities class action lawsuits against companies following periods of volatility in the market price of their securities. We may in the future be the target of similar litigation. Securities litigation, regardless of whether our defense is ultimately successful, could result in substantial costs and divert management’s attention and resources.

 

 

Our quarterly results may be volatile.

 

Our operating results have varied on a quarterly basis during our operating history and are likely to fluctuate significantly in the future. Our operating results may be below the expectations of our investors or stock market analysts as a result of a variety of factors, including the impact of LIFO expense estimates, many of which are outside of our control. Factors that may affect our quarterly operating results include, but are not limited to, the risk factors listed above.

 

Many factors could cause our revenues and operating results to vary significantly in the future. Accordingly, we believe that quarter-to-quarter comparisons of our operating results are not necessarily meaningful. Investors should not rely on the results of one quarter as an indication of our future performance. Further, it is our practice not to provide forward-looking sales or earnings guidance and not to endorse any analyst’s sales or earnings estimates. Nonetheless, if our results of operations in any quarter do not meet analysts’ expectations, our stock price could materially decrease.

 

 

Certain provisions in our charter documents and Ohio law could delay or prevent a change in management or a takeover attempt that you may consider to be in your best interest.

 

We are subject to Chapter 1704 of the Ohio Revised Code, which prohibits certain business combinations and transactions between an “issuing public corporation” and an “Ohio law interested shareholder” for at least three years after the Ohio law interested shareholder attains 10% ownership, unless the Board of Directors of the issuing public corporation approves the transaction before the Ohio law interest shareholder attains 10% ownership. We are also subject to Section 1701.831 of the Ohio Revised Code, which provides that certain notice and informational filings and special shareholder meeting and voting procedures must be followed prior to consummation of a proposed “control share acquisition.” Assuming compliance with the notice and information filings prescribed by the statute, a proposed control share acquisition may be made only if the acquisition is approved by a majority of the voting power of the issuer represented at the meeting and at least a majority of the voting power remaining after excluding the combined voting power of the “interested shares.”

 

Certain provisions contained in our Amended and Restated Articles of Incorporation and Amended and Restated Code of Regulations and Ohio law could delay or prevent the removal of directors and other management and could make a merger, tender offer or proxy contest involving us that you may consider to be in your best interest more difficult. For example, these provisions: 

 

 

allow our Board of Directors to issue preferred stock without shareholder approval;

 

provide for our Board of Directors to be divided into two classes of directors serving staggered terms;

 

limit who can call a special meeting of shareholders; and

 

establish advance notice requirements for nomination for election to the Board of Directors or for proposing matters to be acted upon at shareholder meetings.

 

These provisions may discourage potential takeover attempts, discourage bids for our common stock at a premium over market price or adversely affect the market price of, and the voting and other rights of the holders of our common stock. These provisions could also discourage proxy contests and make it more difficult for you and other shareholders to elect directors other than the candidates nominated by our Board of Directors.

 

Page 21

 

 

Principal shareholders who own a significant numbers of shares of our common stock may have interests that conflict with yours.

 

Michael D. Siegal, our Executive Chairman of the Board and one of our largest shareholders, owned approximately 11.5% of our outstanding common stock as of December 31, 2019. Mr. Siegal may have the ability to significantly influence matters requiring shareholder approval. In deciding how to vote on such matters, Mr. Siegal may be influenced by interests that conflict with yours.

 

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

 

None.

 

Page 22

 

 

ITEM 2. PROPERTIES

 

We believe that our properties are strategically situated relative to our domestic suppliers, our customers and each other, allowing us to support customers from multiple locations. Product is shipped from the most advantageous facility, regardless of where the customer order is taken. The facilities are located in the hubs of major metals consumption markets, and within a 250-mile radius of most of our customers, a distance approximating the one-day driving and delivery limit for truck shipments. During 2019, we terminated the lease on the Washington distribution facility and entered into a lease commencing March 2020 for a processing facility in Buford, Georgia.

 

The following table sets forth certain information concerning our principal properties including which segment’s products are serviced out of each location:

 

 

Segment

Operation

Location

Square

Feet

 

Function

Owned or

Leased

Carbon

Specialty

Metals

Tube

and

Pipe

Cleveland

Bedford Heights, Ohio (1)

       127,000

 

Corporate offices, coil processing and distribution center

Owned

 
 

Bedford Heights, Ohio (1)

       121,500

 

Coil and plate processing, distribution center and offices

Owned

 

Bedford Heights, Ohio (1)

         59,500

 

Plate processing, distribution center and offices

Leased (2)

   
 

Dover, Ohio

         62,000

 

Plate processing, fabrication and distribution center

Owned

   

Minneapolis

Plymouth, Minnesota

       196,800

 

Coil and plate processing, distribution center and offices

Owned

 
 

Plymouth, Minnesota

       112,200

 

Plate processing, fabrication, distribution center and offices

Owned

   

Chambersburg

Chambersburg, Pennsylvania

       157,000

 

Plate processing, distribution center and offices

Owned

   
 

Chambersburg, Pennsylvania

       150,000

 

Plate processing, fabrication, manufacturing, distribution center and offices

Owned

   

Iowa

Bettendorf, Iowa

       244,000

 

Coil and plate processing, fabrication, distribution center and offices

Owned

 

Winder

Winder, Georgia

       285,000

 

Coil and plate processing, fabrication, distribution center and offices

Owned

Detroit

Detroit, Michigan

       256,000

 

Coil processing, distribution center and offices

Owned

 

Kentucky

Mt. Sterling, Kentucky

       100,000

 

Plate processing, fabrication and distribution center

Owned

   
 

Mt. Sterling, Kentucky

       107,000

 

Distribution center and offices

Owned

 

Gary

Gary, Indiana

       183,000

 

Coil processing, distribution center and offices

Owned

 

Connecticut

Milford, Connecticut

       134,000

 

Coil processing, distribution center and offices

Owned

 

Chicago

Schaumburg, Illinois

 122,500

 

Coil and sheet processing, distribution center and offices

Owned

 

Berlin Metals

Hammond, Indiana

         117,950

 

Coil processing, distribution center and offices

Leased (3)

 

 

McCullough Industries

Kenton, Ohio

75,000

 

Manufacturing facility

Owned

 

Streetsboro

Streetsboro, Ohio

         66,200

 

Coil and sheet processing, distribution center and offices

Owned

 

 
 

Latrobe, Pennsylvania

         43,200

 

Coil and sheet processing, distribution center

Leased (4)

 

 

Mexico

Monterrey, Mexico

         60,000

 

Distribution center

Leased (5)

Chicago

Romeoville, Illinois

363,000

 

Corporate offices, fabrication and distribution center

Owned

   

St. Paul

St. Paul, Minnesota

132,000

 

Distribution center and offices

Owned

 

               

 

Page 23

 

 

           

Segment

Operation

Location

Square

Feet

 

Function

Owned or

Leased

Carbon

Specialty

Metals

Tube

and

Pipe

Charlotte

Locust, North Carolina

127,600

 

Distribution center, fabrication and offices

Owned

   

Fond du Lac

Fond du Lac, Wisconsin

117,000

 

Distribution center and offices

Owned

 

Indianapolis

Indianapolis, Indiana

79,000

 

Distribution center and offices

Owned

   

Quad Cities

Milan, Illinois

57,600

 

 

Distribution center and offices

Owned

   

Des Moines

Ankeny, Iowa

50,000

 

 

Distribution center and offices

Owned

   

Owatonna

Owatonna, Minnesota

23,000

 

Production cutting center

Owned

   

 

(1)

The Bedford Heights facilities are all adjacent properties.

(2)

This facility is leased from a related party. The lease expires on December 31, 2023, with renewal options.

(3)

The lease on this facility expires on August 31, 2024, with renewal options.

(4)

The lease on this facility expires on May 1, 2024.

(5)

The lease on this facility expires on August 31, 2021. 75% of the facility is sub-leased to an unrelated party on a quarter-to-quarter basis.

 

In addition to the facilities listed above, our executive office is leased and located in Highland Hills, Ohio and we have leased offices located in Media, Pennsylvania; Bonita Springs, Florida; and Monterrey, Mexico. Management believes we will be able to accommodate our capacity needs for the immediate future at our existing facilities.

 

 

ITEM 3. LEGAL PROCEEDINGS

 

We are party to various legal actions that we believe are ordinary in nature and incidental to the operation of our business. In the opinion of management, the outcome of the proceedings to which we are currently a party will not have a material adverse effect upon our results of operations, financial condition or cash flows.

 

 

ITEM 4. MINE SAFETY DISCLOSURES

 

Not applicable.

 

Page 24

 

 

INFORMATION ABOUT OUR EXECUTIVE OFFICERS

 

This information is included in this Annual Report on Form 10-K pursuant to Instruction 3 of Item 401(b) of Regulation S-K. The following is a list of our executive officers and a brief description of their business experience. Each executive officer will hold office until his successor is chosen and qualified.

 

Michael D. Siegal, age 67, has served as the Executive Chairman of our Board of Directors since January 2019. He previously served as our Chief Executive Officer from 1984 until December 2018 and as Chairman of our Board of Directors from 1994 until December 2018.  From 1984 until January 2001, he also served as our President.  He has been employed by us in a variety of capacities since 1974. Mr. Siegal serves on the Board of Directors of Cleveland-Cliffs, Inc. and Twin City Fan. He is also the immediate past Board Chair of the Jewish Federations of North America and is currently on the Board of the Development Corporation for Israel and the Chair of the Board of Trustees of the Jewish Agency for Israel.

 

Richard T. Marabito, age 56, has served as our Chief Executive Officer since January 2019. From March 2000 through December 2018, he served as our Chief Financial Officer. He joined us in 1994 as Corporate Controller and served in this capacity until March 2000. He also served as Treasurer from 1994 through 2002 and again from 2010 through 2012. Prior to joining us, Mr. Marabito served as Corporate Controller for a publicly traded wholesale distribution company and was employed by a national accounting firm in its audit department. Mr. Marabito is a Vice Chair and Board member of the Metals Service Center Institute (MSCI). He is the Chair of the MSCI’s Governance Committee and past Chair of its Foundation for Education and Research. He served as a Governance board member of the Make-A-Wish Foundation of Ohio, Kentucky and Indiana and was past Chair of its Northeast Ohio regional board. Mr. Marabito also served on the Board of Trustees and was the Treasurer for Hawken School in Cleveland, Ohio.

 

Richard A. Manson, age 51, has served as our Chief Financial Officer since January 2019, and has been employed by us since 1996.  From January 2013 through December 2018, he served as our Vice President and Treasurer. From March 2010 through December 2012, he served as our Vice President of Human Resources and Administration.  From January 2003 through March 2010, he served as our Treasurer and Corporate Controller.  From 1996 through 2002, he served as our Director of Taxes and Risk Management.  Prior to joining us, Mr. Manson was employed for seven years by a national accounting firm in its tax department.  Mr. Manson is a Board Member of the Cleveland Catholic Cemeteries Association and a member of the Advisory Board of Seeds for Literacy.  Mr. Manson is a certified public accountant and member of the Ohio Society of Certified Public Accountants and the American Institute of Certified Public Accountants.

 

Andrew S. Greiff, age 58, has served as our President and Chief Operating Officer since January 2020. From August 2016 through December 2019, he served as Executive Vice President and Chief Operating Officer. He previously served as President, Specialty Metals from 2011 to 2016 after having joined us in 2009 as Vice President of Specialty Metals. Prior thereto, Mr. Greiff spent 24 years in various positions within the steel industry and served as the President and CEO of his own steel trading company. Mr. Greiff is a past director of Hawken School, the MSCI Specialty Metals Product Council, Jewish Big Brother Big Sister and the Anti Defamation League.

 

Lisa K. Christen, age 43, has served as our Treasurer and Corporate Controller since January 2019, and has been employed by us since 1999.  From March 2010 through December 2018, she served as our Corporate Controller. From 1999 through 2010 she served in various positions within the accounting department.  Ms. Christen serves as the Treasurer and is a Board Member of Seton Catholic School in Hudson, Ohio. Ms. Christen is a certified public accountant and member of the Ohio Society of Certified Public Accountants.

 

Page 25

 

 

PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

Common Stock

 

Our common stock trades on the Nasdaq Global Select Market under the symbol “ZEUS.”

 

 

Holders of Record

 

As of January 31, 2020, we estimate there were approximately 52 holders of record and 4,633 beneficial holders of our common stock.

 

 

Dividends

 

We expect to continue to make regular quarterly dividend distributions in the future, subject to the continuing determination by our Board of Directors that the dividend remains in the best interest of our shareholders. Our ABL Credit Facility restricts the aggregate amount of dividends and common stock repurchases that we can pay to $5.0 million annually without limitations. Dividend distributions in excess of $5.0 million require us to (i) maintain availability in excess of 20.0% of the aggregate revolver commitments or (ii) to maintain availability equal to or greater than 15.0% of the aggregate revolver commitments, and we must maintain a pro-forma 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. Any determinations by the Board of Directors to pay cash dividends in the future will take into account various factors, including our financial condition, results of operations, current and anticipated cash needs, plans for expansion and restrictions under our credit agreement and any agreements governing our future debt. We cannot assure you that dividends will be paid in the future or that, if paid, the dividends will be at the same amount or frequency.

 

 

Issuer Purchases of Equity Securities

 

We did not purchase any of our equity securities during the quarter ended December 31, 2019.

 

On October 2, 2015, we announced that our Board of Directors authorized a stock repurchase program of up to 550,000 shares of the Company’s issued and outstanding common stock, which could include open market repurchases, negotiated block transactions, accelerated stock repurchases or open market solicitations for shares, all or some of which may be effected through Rule 10b5-1 plans. Any of the repurchased shares will be held in our treasury, or canceled and retired as our Board may determine from time to time. Any repurchases of common stock are subject to the covenants contained in the ABL Credit Facility. Our ABL Credit Facility restricts the aggregate amount of dividends and common stock repurchases that we can pay to $5.0 million annually without limitations. Purchases in excess of $5.0 million require us to (i) maintain availability in excess of 20.0% of the aggregate revolver commitments or (ii) to maintain availability equal to or greater than 15.0% of the aggregate revolver commitments and we must maintain a pro-forma ratio of EBITDA minus certain capital expenditures and cash taxes paid to fixed charges of at least 1.00 to 1.00. The timing and amount of any repurchases under the stock repurchase program will depend upon several factors, including market and business conditions, and limitations under the ABL Credit Facility, and repurchases may be discontinued at any time.

 

 

Recent Sales of Unregistered Securities

 

We did not have any unregistered sales of equity securities during the quarter ended December 31, 2019.

 

Page 26

 

 

ITEM 6. SELECTED FINANCIAL DATA

 

The following table sets forth selected financial and other data for each of the five years in the period ended December 31, 2019. The data presented should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the consolidated financial statements and notes thereto included elsewhere in this Annual Report on Form 10-K.

                                       

    For the Years Ended December 31,  
   

2019

   

2018

   

2017

   

2016

   

2015

 
   

(in thousands, except per share data)

 
                                         

Income Statement Data:

                                       

Net sales

  $ 1,579,040     $ 1,715,081     $ 1,330,696     $ 1,055,116     $ 1,175,543  

Cost of materials sold

    1,280,110       1,372,954       1,055,212       820,040       942,214  

Gross profit (a)

    298,930       342,127       275,484       235,076       233,329  

Operating expenses (b)

    282,320       285,075       251,498       229,328       236,157  

Goodwill and intangible asset impairment

    -       -       -       -       24,951  

Operating income (loss)

    16,610       57,052       23,986       5,748       (27,779 )

Interest and other expense on debt

    11,289       10,681       7,518       5,273       5,690  

Income (loss) before income taxes

    5,289       46,064       16,350       420       (33,594 )

Net income (loss) (c)

  $ 3,856     $ 33,759     $ 18,963     $ (1,078 )   $ (26,777 )
                                         

Per Share Data:

                                       

Net income (loss) - basic (d)

  $ 0.34     $ 2.95     $ 1.67     $ (0.10 )   $ (2.39 )

Net income (loss) - diluted (e)

  $ 0.34     $ 2.95     $ 1.67     $ (0.10 )   $ (2.39 )

Dividends paid

  $ 0.08     $ 0.08     $ 0.08     $ 0.08     $ 0.08  
                                         

Shares Outstanding:

                                       

Weighted average shares - basic

    11,509       11,432       11,381       11,210       11,192  

Weighted average shares - diluted

    11,509       11,440       11,381       11,210       11,192  
                                         
                                         

Balance Sheet Data (as of December 31):

                                       

Current assets (f)

  $ 419,842     $ 562,769     $ 420,136     $ 364,940     $ 308,946  

Current liabilities (f)

    101,087       128,427       111,147       104,898       77,060  

Working capital (g)

    318,755       434,342       308,989       260,042       231,886  

Total assets (f)

    649,555       760,740       604,158       556,068       511,880  

Total debt

    192,925       302,530       197,165       166,424       148,490  

Shareholders' equity

  $ 308,352     $ 306,991     $ 272,583     $ 253,390     $ 254,695  

 

(a)

Gross profit is calculated as net sales less the cost of materials sold (includes LIFO income of $3,669 in 2019, LIFO expense of $8,408 and $2,707, in 2018 and 2017, respectively and LIFO income of $1,489 and $3,347 in 2016 and 2015, respectively).

(b)

Operating expenses are calculated as total costs and expenses less the cost of materials sold. It does not include the goodwill and intangible asset impairment charge shown separately below.

(c)

The year ended December 31, 2017, includes a $6.2 million benefit related to the Tax Cuts and Jobs Act.

(d)

Calculated by dividing net income (loss) by weighted average basic shares outstanding.

(e)

Calculated by dividing net income (loss) by weighted average diluted shares outstanding.

(f)

Prospective adjustment of deferred tax assets and liabilities in 2016, prior periods were not retrospectively adjusted.

(g)

Calculated as current assets less current liabilities.

 

Page 27

 

 

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations contains 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 this Annual Report on Form 10-K. The following section is qualified in its entirety by the more detailed information, including our financial statements and the notes thereto, which appears elsewhere in this Annual Report.

 

Overview

 

We are a leading metals service center that operates in three reportable segments; carbon flat products, specialty metals flat products, and tubular and pipe products. We provide metals processing and distribution services for a wide range of customers. Our carbon flat products segment’s focus is on the direct sale and distribution of large volumes of processed carbon and coated flat-rolled sheet, coil and plate products and fabricated parts. Through the acquisition of McCullough Industries, or McCullough, on January 2, 2019, our carbon flat products segment expanded its product offerings to include self-dumping metal hoppers and through the acquisition of EZ Dumper on August 5, 2019, to include steel and stainless- steel dump inserts for pickup truck and service truck beds. Our specialty metals flat products segment’s focus is on the direct sale and distribution of processed aluminum and stainless flat-rolled sheet and coil products, flat bar products and fabricated parts. Through the acquisition of Berlin Metals, LLC, or Berlin Metals, on April 2, 2018, our specialty metals flat products segment expanded its product offerings to include differing types of stainless flat-rolled sheet and coil and prime tin mill products. In addition, we distribute metal tubing, pipe, bar, valves and fittings and fabricate pressure parts supplied to various industrial markets through our tubular and pipe products segment. Products that require more value-added processing generally have a higher gross profit. Accordingly, our overall gross profit is affected by, among other things, product mix, the amount of processing performed, the demand for and availability of metals, and volatility in selling prices and material purchase costs. We also perform toll processing of customer-owned metals. We sell certain products internationally, primarily in Canada and Mexico. International sales are immaterial to our consolidated financial results and to the individual segments’ results.

 

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

 

Like other metals service centers, we maintain substantial inventories of metals to accommodate the short lead times and just-in-time delivery requirements of our customers. Accordingly, we purchase metals in an effort to maintain our inventory at levels that we believe to be appropriate to satisfy the anticipated needs of our customers based upon customer forecasts, historic buying practices, supply agreements with customers and market conditions. Our commitments to purchase metals

are generally at prevailing market prices in effect at the time we place our orders. From time to time, we have entered into nickel swaps at the request of our customers in order to mitigate our customers’ risk of volatility in the price of metals, and we have entered into metals hedges to mitigate our risk of volatility in the price of metals. We have no long-term, fixed-price metals purchase contracts. When metals prices decline, customer demands for lower prices and our competitors’ responses to those demands could result in lower sale prices and, consequently, lower gross profits and earnings as we use existing metals inventory. When metals prices increase, competitive conditions will influence how much of the price increase we can pass on to our customers. To the extent we are unable to pass on future price increases in our raw materials to our customers, the net sales and gross profits of our business could be adversely affected.

 

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

 

Page 28

 

 

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

 

Due to the nature of the products sold in each segment, there are significant differences in the segments’ average selling price and the cost of materials sold. The tubular and pipe products segment generally has the highest average selling price among the three segments followed by the specialty metals flat products and carbon flat products segments. Due to the nature of the tubular and pipe products, we do not report tons sold or per ton information. Gross profit per ton is generally higher in the specialty metals flat products segment than the carbon flat products segment. Gross profit as a percentage of net sales is generally highest in the tubular and pipe products segment, followed by the carbon and specialty metals flat products segments.

 

Due to the differences in average selling prices, gross profit and gross profit percentage among the segments, a change in the mix of sales could impact total net sales, gross profit, and gross profit percentage. In addition, certain inventory in the tubular and pipe products segment is valued under the LIFO method. Adjustments to the LIFO inventory value are recorded to cost of materials sold and may impact the gross margin and gross margin percentage at the consolidated Company and tubular and pipe products segment levels.

 

Carbon flat products

 

The primary focus of our carbon flat products segment is on the direct sale and distribution of large volumes of processed carbon and coated flat-rolled sheet, coil and plate products and fabricated parts. We act as an intermediary between metals producers and manufacturers that require processed metals for their operations. We serve customers in most metals consuming industries, including manufacturers and fabricators of transportation and material handling equipment, construction and farm machinery, storage tanks, environmental and energy generation equipment, automobiles, military vehicles and equipment, as well as general and plate fabricators and metals service centers. We distribute these products primarily through a direct sales force.

 

Specialty metals flat products

 

The primary focus of our specialty metals flat products segment is on the direct sale and distribution of processed stainless and aluminum flat-rolled sheet and coil products, flat bar products and fabricated parts. Through its acquisition of Berlin Metals on April 2, 2018, our specialty metals flat products segment expanded its product offerings to include differing types of stainless flat-rolled sheet and coil and prime tin mill products. We act as an intermediary between metals producers and manufacturers that require processed metals for their operations. We serve customers in various industries, including manufacturers of food service and commercial appliances, agriculture equipment, transportation and automotive equipment. We distribute these products primarily through a direct sales force.

 

Combined, the carbon and specialty metals flat products segments have 21 strategically-located processing and distribution facilities in the United States and one in Monterrey, Mexico. Many of our facilities service both the carbon and the specialty metals flat products segments, and certain assets and resources are shared by the segments. Our geographic footprint allows us to focus on regional customers and larger national and multi-national accounts, primarily located throughout the midwestern, eastern and southern United States.

 

Tubular and pipe products

 

The tubular and pipe products segment consists of the Chicago Tube and Iron, or CTI, business, acquired in 2011. Through our tubular and pipe products segment, we distribute metal tubing, pipe, bar, valve and fittings and fabricate pressure parts supplied to various industrial markets. Founded in 1914, CTI operates from eight locations in the Midwestern and southeastern United States. The tubular and pipe products segment distributes its products primarily through a direct sales force.

 

Corporate expenses

 

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

 

Page 29

 

 

 Results of Operations

 

This section of this Form 10-K generally discusses 2019 and 2018 items and year-to-year comparisons between 2019 and 2018. Discussions of 2017 items and year-to-year comparisons between 2018 and 2017 that are not included in this Form 10-K can be found in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2018.

 

2019 Compared to 2018

 

Our results of operations are impacted by the market price of metals. Through 2017 and the first seven months of 2018, metals prices increased significantly and changes to our net sales, cost of materials sold, gross profit, cost of inventory and profitability, were all impacted by industry metals pricing. The price increases resulted in metals pricing reaching its highest point in 10 years in July 2018. The increases were driven by both the tariffs initiated by the U.S. government in 2018 under Section 232 of the Trade Expansion Act of 1962 (section 232 tariffs) and strong customer demand. Since the third quarter of 2018, market prices for metals have declined, and overall metals market prices during 2019 were lower than 2018. The rapid decline of metals pricing during 2019 negatively impacted our financial results during 2019, primarily in the carbon flat-products segment. In addition, lower customer demand in 2019 compared to 2018, primarily in the carbon flat-products segment, negatively impacted our sales, gross profit and profitability.

 

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.

 

Operating results for 2019 include the additional revenues and operating expenses resulting from the acquisitions of McCullough industries on January 2, 2019 and EZ Dumper on August 5, 2019.  2018 operating results include the additional revenues and operating expenses resulting from the acquisition of Berlin Metals on April 2, 2018. 

 

Consolidated Operations

 

The following table sets forth certain consolidated income statement data for the years ended December 31, 2019 and 2018 (dollars shown in thousands):

 

 

   

2019

   

2018

 
   

$

   

% of net sales

   

$

   

% of net sales

 

Net sales

  $ 1,579,040       100.0     $ 1,715,081       100.0  

Cost of materials sold (a)

    1,280,110       81.1       1,372,954       80.1  

Gross profit (b)

    298,930       18.9       342,127       19.9  

Operating expenses (c)

    282,320       17.9       285,075       16.6  

Operating income

    16,610       1.1       57,052       3.3  

Other loss, net

    (32 )     (0.0 )     (307 )     (0.0 )

Interest and other expense on debt

    11,289       0.7       10,681       0.6  

Income before income taxes

    5,289       0.3       46,064       2.7  

Income taxes

    1,433       0.1       12,305       0.7  

Net income

  $ 3,856       0.2     $ 33,759       2.0  

 

(a) Includes $3,669 of LIFO income and $8,408 of LIFO expense for 2019 and 2018, respectively.

(b) Gross profit is calculated as net sales less the cost of materials sold.

(c) Operating expenses are calculated as total costs and expenses less the cost of materials sold.

 

Net sales decreased $136.0 million, or 7.9%, to $1.6 billion in 2019 from $1.7 billion in 2018. Carbon flat products net sales decreased $146.4 million, or 13.6%, in 2019 compared to 2018 and were 58.7% of total net sales in 2019 compared to 62.6% in 2018. Specialty metals flat products net sales increased $20.2 million, or 5.9%, in 2019 compared to 2018 and were 23.0% of total net sales in 2019 compared to 20.0% in 2018. Tubular and pipe products net sales decreased $9.8 million, or 3.3%, in 2019 compared to 2018 and were 18.3% of total net sales in 2019 compared to 17.4% of total net sales in 2018. The decrease in sales was due to a 9.3% decrease in sales volume offset by a 1.5% increase in average selling prices. Average selling prices in 2019 were $1,263 per ton, compared to $1,244 per ton in 2018. The increase in the average selling price is a result of the market pricing dynamics discussed in the overview of Results of Operations above.

 

Page 30

 

 

Cost of materials sold decreased $92.8 million, or 6.8%, to $1.28 billion in 2019 from $1.37 billion in 2018. During 2019, we recorded LIFO income of $3.7 million compared to $8.4 million of LIFO expense in 2018. The decrease in cost of materials sold in 2019 is primarily related to decreased sales volume and the impact of LIFO income in 2019 compared to LIFO expense in 2018.

 

As a percentage of net sales, gross profit (as defined in footnote (b) in the table above) decreased to 18.9% in 2019 from 19.9% in 2018. LIFO income increased gross profit by 0.2% of net sales in 2019 and LIFO expense decreased gross profit by 0.5% of net sales in 2018. The decrease in gross profit as a percentage of net sales in 2019 was primarily due to the impact of selling higher costed inventory in 2019 compared to 2018 as market prices for metals was decreasing.

 

Operating expenses (as defined in footnote (c) in the table above) decreased $2.8 million, or 1.0%, to $282.3 million in 2019 from $285.1 million in 2018. As a percentage of net sales, operating expenses increased to 17.9% in 2019 from 16.6% in 2018. Variable operating expenses, such as distribution and warehouse and processing, decreased as a result of decreased sales volume and decreased labor hours at our current operating facilities. Selling and administrative and general expenses decreased as a result of decreased variable based incentive compensation related to decreased profitability. Operating expenses in the carbon flat products segment decreased $4.6 million, operating expenses in the specialty metals products segment increased $4.7 million (due to the addition of specific metals processing capabilities in our Schaumburg, Illinois and Streetsboro, Ohio locations), operating expenses in the tubular and pipe products were flat between the years, and Corporate expenses decreased $2.8 million primarily due to decreased variable incentive compensation related to lower operating income in 2019. Operating expenses were $7.4 million higher in 2019 compared to 2018 due to the acquisition of McCullough Industries on January 2, 2019 and a full year of operating expenses for the April 2, 2018 acquisition of Berlin Metals.

 

Interest and other expense on debt totaled $11.3 million in 2019 compared to $10.7 million in 2018. Our effective borrowing rate, exclusive of deferred financing fees and commitment fees, was 4.0% in 2019 compared to 3.7% in 2018 due to the increases in LIBOR rates since 2018. Total average borrowings decreased $17.7 million, or 6.4% to $257.6 million in 2019 from $275.3 million in 2018, primarily related to decreased working capital needs in 2019.

 

Income before income taxes totaled $5.3 million in 2019 compared to $46.1 million in 2018.

 

An income tax provision of 27.1% was recorded in 2019, compared to an income tax provision of 26.7% in 2018. The higher rate was attributable to the impact of permanently non-deductible items on lower pre-tax income.

 

Net income for 2019 totaled $3.9 million, or $0.34 per basic and diluted share, compared to $33.8 million, or $2.95 per basic and diluted share, for 2018.

 

Page 31

 

 

Segment Results of Operations

 

Carbon flat products

 

The following table sets forth certain income statement data for the carbon flat products segment for the years ended December 31, 2019 and 2018 (dollars shown in thousands, except per ton data):

 

   

2019

   

2018

 
   

$

   

% of net

sales

   

$

   

% of net

sales

 

Direct tons sold

    943,536               1,060,990          

Toll tons sold

    66,804               81,381          

Total tons sold

    1,010,340               1,142,371          
                                 

Net sales

  $ 926,903       100.0     $ 1,073,292       100.0  

Average selling price per ton

    917               940          

Cost of materials sold

    763,549       82.4       855,942       79.7  

Gross profit (a)

    163,354       17.6       217,350       20.3  

Operating expenses (b)

    168,377       18.2       172,996       16.1  

Operating income (loss)

  $ (5,023 )     (0.6 )   $ 44,354       4.2  

 

(a) Gross profit is calculated as net sales less the cost of materials sold.

(b) Operating expenses are calculated as total costs and expenses less the cost of materials sold.  

 

Tons sold decreased 132 thousand tons, or 11.6%, to 1.01 million tons in 2019 from 1.14 million tons in 2018. Toll tons sold decreased 15 thousand tons, or 17.9% to 67 thousand tons in 2019 from 81 thousand tons in 2018. The decrease in tons sold is due to decreased customer demand for carbon flat products experienced in the metals industry, particularly in the agricultural and auto industries. We expect sales volumes in 2020 to improve over 2019 levels.

 

Net sales decreased $146.4 million, or 13.6%, to $926.9 million in 2019 from $1.1 billion in 2018. Average selling prices in 2019 decreased 2.4% to $917 per ton, compared to $940 per ton in 2018. The decrease in sales was due to an 11.6% decrease in sales volume and a 2.4% decrease in average selling prices.

 

Cost of materials sold decreased $92.4 million, or 10.8%, to $763.5 million in 2019 from $855.9 million in 2018. The decrease in cost of materials sold was primarily due to a 11.6% decrease in sales volume and the impact of selling higher costed inventory during 2019 compared to 2018.

 

As a percentage of net sales, gross profit (as defined in footnote (a) in the table above) decreased to 17.6% in 2019 from 20.3% in 2018. The average gross profit per ton sold decreased $28 per ton to $162 in 2019 from $190 in 2018.

 

Operating expenses in 2019 decreased $4.6 million, or 2.7%, to $168.4 million from $173.0 million in 2018. As a percentage of net sales, operating expenses increased to 18.2% in 2019 from 16.1% in 2018. Variable operating expenses, such as warehouse and processing and distribution decreased as a result of decreased sales and production volumes at our facilities and selling and administrative and general expense decreased due to decreased variable performance based incentive compensation. The operating expense decreases were offset by the operating expense increases related to the acquisitions of McCullough and EZ Dumper during 2019.    

 

Operating loss totaled $5.0 million in 2019 compared to operating income of $44.4 million in 2018.

 

Page 32

 

 

Specialty metals flat products

 

The following table sets forth certain income statement data for the specialty metals flat products segment for the years ended December 31, 2019 and 2018 (dollars shown in thousands, except per ton data):

 

 

   

2019

   

2018

 
   

$

   

% of net

sales

   

$

   

% of net

sales

 

Direct tons sold

    130,104               125,870          

Toll tons sold

    11,724               9,717          

Total tons sold

    141,828               135,587          
                                 

Net sales

  $ 363,634       100.0     $ 343,479       100.0  

Average selling price per ton

    2,564               2,533          

Cost of materials sold

    310,931       85.5       294,553       85.8  

Gross profit (a)

    52,703       14.5       48,926       14.2  

Operating expenses (b)

    38,382       10.6       33,678       9.8  

Operating income

  $ 14,321       3.9     $ 15,248       4.4  

 

(a) Gross profit is calculated as net sales less the cost of materials sold.

(b) Operating expenses are calculated as total costs and expenses less the cost of materials sold.  

 

Tons sold increased 6 thousand tons, or 4.6%, to 142 thousand tons in 2019 from 136 thousand tons in 2018. The increase in tons sold is due to the acquisition of Berlin Metals on April 2, 2018 and improved customer demand in the markets we served during 2019.

 

Net sales increased $20.2 million, or 5.9%, to $363.6 million in 2019 from $343.5 million in 2018. The increase in net sales is due to the acquisition of Berlin Metals on April 2, 2018 and improved customer demand in the markets we served during 2019. Average selling prices in 2019 increased to $2,564 per ton, compared to $2,533 per ton in 2018. The increase in sales was due to the 4.6% increase in sales volume and a 1.2% increase in the average selling prices during 2019 compared to 2018.

 

Cost of materials sold increased $16.4 million, or 5.6%, to $310.9 million in 2019 from $294.6 million in 2018. The increase in cost of materials sold was primarily due to the increase in sales volume in 2019 compared to 2018.

 

As a percentage of net sales, gross profit (as defined in footnote (a) in the table above) increased to 14.5% in 2019 from 14.2% in 2018. The average gross profit per ton sold totaled $372 in 2019 compared to $361 per ton in 2018. The increase in the gross profit percentage is a result of a change in the mix of products that we sold in 2019 compared to 2018.

 

Operating expenses (as defined in footnote (b) in the table above) increased $4.7 million, or 14.0%, to $38.4 million in 2019 from $33.7 million in 2018. As a percentage of net sales, operating expenses increased to 10.6% of net sales in 2019 from 9.8% in 2018. The increase in operating expenses in 2019 was related to the acquisition of Berlin Metals on April 2, 2018, as 2018 only included nine months of operating expenses for Berlin Metals, as well as the addition of processing capabilities in our Schaumburg, Illinois and Streetsboro, Ohio locations.

 

Operating income for 2019 totaled $14.3 million compared to $15.2 million in 2018.

 

Page 33

 

 

Tubular and pipe products

 

The following table sets forth certain income statement data for the tubular and pipe products segment for the years ended December 31, 2019 and 2018 (dollars shown in thousands).

 

   

2019

   

2018

 
   

$

   

% of net sales

   

$

   

% of net sales

 

Net sales

  $ 288,503       100.0     $ 298,310       100.0  

Cost of materials sold (a)

    205,630       71.3       222,459       74.6  

Gross profit (b)

    82,873       28.7       75,851       25.4  

Operating expenses (c)

    64,266       22.2       64,331       21.5  

Operating income

  $ 18,607       6.4     $ 11,520       3.9  

 

(a) Includes $3,669 of LIFO income and $8,408 of LIFO expense in 2019 and 2018, respectively. 

(b) Gross profit is calculated as net sales less the cost of materials sold.

(c) Operating expenses are calculated as total costs and expenses less the cost of materials sold.  

 

Net sales decreased $9.8 million, or 3.3%, to $288.5 million in 2019 from $298.3 million in 2018. The decrease in net sales was due to a 2.4% decrease in sales volume and a 0.9% decrease in average selling prices during 2019.

 

Cost of materials sold decreased $16.8 million, or 7.6%, to $205.6 million in 2019 from $222.5 million in 2018. The decrease in cost of materials sold was due to a 2.4% decrease in sales volume and the impact of $3.7 million of LIFO income in 2019 compared to LIFO expense of $8.4 million in 2018.

 

As a percentage of net sales, gross profit (as defined in footnote (b) in the table above) increased to 28.7% in 2019 compared to 25.4%, in 2018. LIFO income increased gross profit by 1.3% of net sales in 2019 compared to LIFO expense decreased gross profit by 2.8% of net sales in 2018

 

Operating expenses (as defined in footnote (c) in the table above) were $64.3 million in both 2019 and 2018. As a percentage of net sales, operating expenses increased to 22.2% in 2019 compared to 21.5% in 2018.

 

Operating income for 2019 totaled $18.6 million, compared to $11.5 million in 2018.

 

 

Corporate expenses

 

Corporate expenses decreased $2.8 million, or 19.7%, to $11.3 million in 2019 compared to $14.1 million in 2018. The decrease in corporate expenses is primarily attributable to decreased variable incentive compensation related to lower operating income in 2019.

 

 

Liquidity, Capital Resources and Cash Flows

 

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

 

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

 

Page 34

 

 

2019 Compared to 2018

 

Operating Activities

 

During 2019, we generated $129.6 million of net cash from operations, of which $22.8 million was generated from operating activities and $106.8 million was generated from working capital. Net cash from operations during 2019 was primarily comprised of net income of $3.9 million and the addback of non-cash depreciation and amortization expense. During 2018, we used $50.5 million of net cash for operations, of which $53.9 million was generated from operating activities and $104.4 million was used for working capital. Net cash from operations during 2018 was primarily comprised of net income of $33.8 million.

 

Working capital at December 31, 2019 totaled $318.8 million, a $115.5 million decrease from December 31, 2018. The decrease was primarily attributable to a $95.8 million decrease in inventory (resulting from lower inventory levels and lower average inventory costs in 2019 compared to 2018), and a $42.1 million decrease in accounts receivable (resulting primarily from lower sales prices and shipping volumes in 2019 compared to 2018) offset by a $26.6 million decrease in accounts payable and outstanding checks (resulting from decreased inventory purchases and lower inventory costs at the end of 2019 compared to 2018) and a $7.0 million decrease in accrued payroll and other accrued liabilities.

 

Investing Activities

 

Net cash used for investing activities was $21.0 million during 2019, compared to $47.5 million during 2018. Investment activities in 2019 included the acquisitions of McCullough Industries and EZ Dumper for $11.1 million in the aggregate and $10.2 million of capital expenditures, primarily attributable to additional processing equipment at our existing facilities. During 2020, we expect our capital spending to be less than our annual depreciation expense. Investment activities in 2018 included the acquisition of Berlin Metals for $21.9 million and $25.7 million of capital expenditures, primarily attributable to a building expansion and additional processing equipment at our existing facilities.

 

Financing Activities

 

During 2019, $112.1 million of cash was used for financing activities, which primarily consisted of $109.6 million of net repayments under our asset based credit facility, or ABL Credit Facility, $1.5 million of repurchases of common stock and $0.9 million of dividends paid. During 2018, $104.3 million of cash was generated from financing activities, which primarily consisted of $106.3 million of net borrowings under our ABL Credit Facility offset by a $0.9 million IRB repayment and $0.9 million of dividends paid.

 

In February 2020, our Board of Directors approved a regular quarterly dividend of $0.02 per share, which is payable on March 16, 2020 to shareholders of record as of March 2, 2020. Our Board previously approved 2019 and 2018 regular quarterly dividends of $0.02 per share, which were paid in March, June, September and December of 2019 and 2018. Dividend distributions in the future are subject to the availability of cash, limitations on cash dividends under our ABL Credit Facility and continuing determination by our Board of Directors that the payment of dividends remains in the best interest of our shareholders.

 

Stock Repurchase Program

 

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

 

During 2019, we repurchased 109,505 shares, for an aggregate cost of $1.5 million. There were no shares repurchased during 2018 or 2017.

 

Page 35

 

 

Debt Arrangements

 

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

 

The ABL Credit Facility contains customary representations and warranties and certain covenants that limit our ability to, among other things: (i) incur or guarantee additional indebtedness; (ii) pay distributions on, redeem or repurchase capital stock or redeem or repurchase subordinated debt; (iii) make investments; (iv) sell assets; (v) enter into agreements that restrict distributions or other payments from restricted subsidiaries to us; (vi) incur liens securing indebtedness; (vii) consolidate, merge or transfer all or substantially all of our assets; and (viii) engage in transactions with affiliates. In addition, the ABL Credit Facility contains a financial covenant which requires (i) if any commitments or obligations are outstanding our availability is less than the greater of $30 million or 10.0% of the aggregate amount of revolver commitments ($47.5 million at December 31, 2019) or 10.0% of the aggregate borrowing base ($28.9 million at December 31, 2019) then we must maintain a ratio of Earnings before Interest, Taxes, Depreciation and Amortization (EBITDA) minus certain capital expenditures and cash taxes paid to fixed charges of at least 1.00 to 1.00 for the most recent twelve fiscal month period.

 

We have the option to borrow under its revolver based on the agent’s base rate plus a premium ranging from 0.00% to 0.25% or LIBOR plus a premium ranging from 1.25% to 2.75%.

 

As of December 31, 2019, we were in compliance with our covenants and had approximately $93.3 million of availability under the ABL Credit Facility.

 

As of December 31, 2019, $1.3 million of bank financing fees were included in “Prepaid expenses and other” and “Other long-term assets” on the accompanying Consolidated Balance Sheets. The financing fees are being amortized over the five-year term of the ABL Credit Facility and are included in “Interest and other expense on debt” on the accompanying Consolidated Statements of Comprehensive Income.

 

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

 

 

Contractual Obligations

 

The following table reflects our contractual obligations as of December 31, 2019.

 

Contractual Obligations

           

Less than

                   

More than

 

(amounts in thousands)

   

Total

   

1 year

   

1-3 years

   

3-5 years

   

5 years

 

Long-term debt obligations

(a)

  $ 192,925     $ -     $ 192,925     $ -     $ -  

Interest obligations

(b)

    23,435       7,593       15,185       657       -  

Unrecognized tax positions

(c)

    28       10       18       -       -  

Other long-term liabilities

(d)

    11,566       700       8,708       1,796       362  

Total contractual obligations

  $ 227,954     $ 8,303     $ 216,836     $ 2,453     $ 362  

 

(a)

See Note 9 to the Consolidated Financial Statements.

(b)

Future interest obligations are calculated using the debt balances and interest rates in effect on December 31, 2019.

(c)

See Note 14 to the Consolidated Financial Statements. Classification is based on expected settlement dates and the expiration of certain statutes of limitations.

(d)

Primarily consists of retirement liabilities and deferred compensation payable in future years.

 

Page 36

 

 

Off-Balance Sheet Arrangements

 

An off-balance sheet arrangement is any contractual arrangement involving an unconsolidated entity under which a company has (a) made guarantees, (b) a retained or a contingent interest in transferred assets, (c) any obligation under certain derivative instruments or (d) any obligation under a material variable interest in an unconsolidated entity that provides financing, liquidity, market risk or credit risk support to a company, or engages in leasing, hedging, or research and development services within a company.

 

Other than derivative instruments discussed in Note 10 to the Consolidated Financial Statements, as of December 31, 2019, we had no material off-balance sheet arrangements.

 

 

Effects of Inflation

 

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

 

 

Critical Accounting Policies

 

This discussion and analysis of financial condition and results of operations is based on our consolidated financial statements, 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. Actual results could differ from these estimates under different assumptions or conditions. On an on-going basis, we monitor and evaluate our estimates and assumptions.

 

We believe the following critical accounting policies affect our more significant judgments and estimates used in preparation of our consolidated financial statements:

 

Cash and Cash Equivalents

 

Cash equivalents consist of short-term highly liquid investments, with a three-month or less maturity, which are readily convertible into cash. We maintain cash levels in bank accounts that, at times, may exceed federally-insured limits. We have not experienced significant loss, and believe we are not exposed to significant risk of loss, in these accounts.

 

Fair Market Value

 

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability in the principal or most advantageous market for the liability in an orderly transaction between market participants on the measurement date.  Valuation techniques must maximize the use of observable inputs and minimize the use of unobservable inputs.  To measure fair value, we apply a fair value hierarchy that is based on three levels of inputs, of which the first two are considered observable and the last unobservable, as follows:

 

Level 1 – Quoted prices in active markets for identical assets or liabilities.

 

Level 2 – Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

 

Level 3 – Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

 

Financial instruments, such as cash and cash equivalents, accounts receivable, accounts payable and the credit facility revolver, are stated at their carrying value, which is a reasonable estimate of fair value. The fair value of marketable securities is based on quoted market prices.

 

Page 37

 

 

Allowance for Doubtful Accounts Receivable

 

The allowance for doubtful accounts in maintained at a level considered appropriate based on historical experience and specific customer collection issues that we have identified. Estimations are based upon the application of a historical collection rate to the outstanding accounts receivable balance, 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. We cannot be certain that the rate of future credit losses will be similar to past experience. We consider all available information when assessing the adequacy of our allowance for doubtful accounts each quarter.

 

Inventory Valuation

 

Non-LIFO inventories are stated at the lower of its cost or net realizable value. LIFO inventories are stated at the lower of cost or market. Inventory costs include the costs of the purchased metals, inbound freight, external and internal processing and applicable labor and overhead costs. Net realizable value is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation.

 

Costs of our carbon and specialty metals flat products segments’ inventories, including flat-rolled sheet, coil and plate products are determined using the specific identification method.

 

Certain of our tubular and pipe products inventory is stated under the LIFO method. At December 31, 2019, approximately $39.1 million, or 14.3% of consolidated inventory, was reported under the LIFO method of accounting. The cost of the remainder of tubular and pipe product segment’s inventory is determined using a weighted average rolling first-in, first-out method.

 

On the Consolidated Statements of Comprehensive Income, “Cost of materials sold (exclusive of items shown separately below)” consists of the cost of purchased metals, inbound and internal transfer freight, external processing costs, and LIFO income or expense.

 

Property and Equipment, and Depreciation

 

Property and equipment are stated at cost. Depreciation is provided using the straight-line method over the estimated useful lives of the assets ranging from two to 30 years. We capitalize the costs of obtaining or developing internal-use software, including directly related payroll costs. We amortize those costs over five years, beginning when the software is ready for its intended use.

 

Intangible Assets and Recoverability of Long-lived Assets

 

The Company performs an annual impairment test of indefinite-lived intangible assets in the fourth quarter, or more frequently if changes in circumstances or the occurrence of events indicate potential impairment. Events or changes in circumstances that could trigger an impairment review include significant nonperformance relative to the expected historical or projected future operating results, significant changes in the manner of the use of the acquired assets or the strategy for the overall business or significant negative industry or economic trends. Management uses judgment to determine whether to use a qualitative analysis or a quantitative fair value measurement for the reporting unit that carries intangible assets.

 

If a quantitative fair value measurement is used, the fair value of each indefinite-lived intangible asset is compared to its carrying value and an impairment charge is recorded if the carrying value exceeds the fair value. We estimate the fair value of indefinite-lived intangible assets using a discounted cash flow methodology. Management’s assumptions used for the calculations are based on historical results, projected financial information and recent economic events. Actual results could differ from these estimates under different assumptions or conditions which could adversely affect the reported value of intangible assets.

 

We evaluate the recoverability of long-lived assets and the related estimated remaining lives whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Events or changes in circumstances that could trigger an impairment review include significant underperformance relative to the expected historical or projected future operating results, significant changes in the manner of the use of the acquired assets or the strategy for the overall business or significant negative industry or economic trends. We record an impairment or change in useful life whenever events or changes in circumstances indicate that the carrying amount may not be recoverable or the useful life has changed.

 

Page 38

 

 

Income Taxes

 

Deferred income taxes on the consolidated balance sheet include, as an offset to the estimated temporary differences between the tax basis of assets and liabilities and the reported amounts on the consolidated balance sheets, the tax effect of operating loss and tax credit carryforwards. If we determine that we will not be able to fully realize a deferred tax asset, we will record a valuation allowance to reduce such deferred tax asset to its net realizable value. We recognize interest accrued related to unrecognized tax benefits in normal income tax expense. Penalties, if incurred, would be recognized as a component of administrative and general expense.

 

We recognize the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit.  For tax positions meeting the more-likely-than-not threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement with the relevant tax authority.

 

We had no material unrecognized tax benefits as of or during the year period ended December 31, 2019.  We expect no significant increases or decrease in unrecognized tax benefits due to changes in tax positions within one year of December 31, 2019.

 

Revenue Recognition

 

Our contracts with customers are comprised of purchase orders with standard terms and conditions. Occasionally we 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 our 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. We have certain fabrication contracts in one business unit for which revenue is recognized over time as performance obligations are achieved. This fabrication business is immaterial to our consolidated results.

 

Sales returns and allowances are treated as reductions to sales and are provided for based on historical experience and current estimates and are immaterial to the consolidated financial statements.

 

Shipping and Handling Fees and Costs

 

Amounts charged to customers for shipping and other transportation services are included in net sales. The distribution expense line on the accompanying Consolidated Statements of Comprehensive Income is entirely comprised of all shipping and other transportation costs incurred by us in shipping goods to its customers.

 

Stock-Based Compensation

 

We record compensation expense for stock awards issued to employees and directors. For additional information, see Note 12 to the Consolidated Financial Statements.

 

 

Impact of Recently Issued Accounting Pronouncements 

 

In August 2018, the Financial Account Standards Board, or FASB, issued Accounting Standards Update (ASU) No. 2018-15, “Intangibles – Goodwill and other – Internal-use software: Customer’s accounting for implementation costs incurred in a cloud computing arrangement that is a service contract”. This ASU aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). Accordingly, this ASU requires an entity (customer) in a hosting arrangement that is a service contract to follow the guidance in Subtopic 350-40 to determine which implementation costs to capitalize as an asset related to the service contract and which costs to expense. This ASU also requires the entity (customer) to expense the capitalized implementation costs of a hosting arrangement that is a service contract over the term of the hosting arrangement, which includes reasonably certain renewals. For public business entities, this ASU is effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years with early adoption permitted. We early adopted ASU 2018-15 in the third quarter of 2018 and the adoption of this ASU did not materially impact our Consolidated Financial Statements.

 

Page 39

 

 

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 our Consolidated Financial Statements.

 

In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments-Credit Losses (Topic 326)”, which requires the measurement and recognition of expected credit losses for financial assets held at amortized cost. The ASU replaces the existing incurred loss impairment model with a forward-looking expected credit loss model which will result in earlier recognition of credit losses. The adoption of this ASU effective January 1, 2020 is not expected to have a material impact on our 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 our 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 our Statements of Comprehensive Income or on the Statements of Cash Flows. See Note 8 to the Consolidated Financial Statements.

 

Page 40

 

 

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Our principal raw materials are carbon, coated and stainless steel, and aluminum, prime tin mill, 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, including the section 232 tariffs initiated by the U.S. government in 2018, and currency exchange rates. This volatility can significantly affect the availability and cost of raw materials for us.

 

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

 

Declining metals prices, which we experienced since the third quarter of 2018, have generally adversely affected our net sales and net income, while increasing metals prices have generally favorably affected our net sales and net income. Rising metals prices, like we experienced in the first half of 2018, 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.

 

Approximately 46%, 48% and 51% of our consolidated net sales in 2019, 2018 and 2017, respectively, were directly related to industrial machinery and equipment manufacturers and their fabricators.

 

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

 

We are exposed to the impact of fluctuating metals prices and interest rate changes. During 2019, 2018 and 2017, 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. If interest rates in the future were to increase 100 basis points (1.0%) from December 31, 2019 rates and, assuming no change in total debt from December 31, 2019 levels, the additional annual interest expense to us would be approximately $1.2 million. We have the option to enter into 30- to 180-day fixed base rate LIBOR loans under the revolving credit facility provided by our ABL Credit Facility.

 

On January 10, 2019, we entered into a five-year interest rate swap that locked the interest rate at 2.567% on $75 million of our revolving debt.

 

Page 41

 

 

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

 

Olympic Steel, Inc.

 

Index to Consolidated Financial Statements

 

 

   Page

 

Reports of Independent Registered Public Accounting Firms

43

Management’s Report on Internal Control Over Financial Reporting

46

Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2019, 2018 and 2017

47

Consolidated Balance Sheets as of December 31, 2019 and 2018

48

Consolidated Statements of Cash Flows for the Years Ended December 31, 2019, 2018 and 2017

49

Supplemental Disclosures of Cash Flow Information for the Years Ended December 31, 2019, 2018 and 2017

50

Consolidated Statements of Shareholders’ Equity for the Years Ended December 31, 2019, 2018 and 2017

51

Notes to Consolidated Financial Statements for the Years Ended December 31, 2019, 2018 and 2017

52

Schedule II – Valuation and Qualifying Accounts for the Years Ended December 31, 2019, 2018 and 2017

71

 

 

Page 42

 

 

Report of Independent Registered Public Accounting Firm

 

Board of Directors and Shareholders

Olympic Steel, Inc.

 

Opinion on the financial statements

 

We have audited the accompanying consolidated balance sheets of Olympic Steel, Inc. (an Ohio corporation) and subsidiaries (the “Company”) as of December 31, 2019, the related consolidated statements of comprehensive income, shareholders’ equity, and cash flows for the year ended December 31, 2019, and the related notes and financial statement schedule included under Item 15(a) (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2019, and the results of its operations and its cash flows for the year ended December 31, 2019, in conformity with accounting principles generally accepted in the United States of America.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the Company’s internal control over financial reporting as of December 31, 2019, based on criteria established in the 2013 Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”), and our report dated February 21, 2020 expressed an unqualified opinion.

 

Change in accounting principle

 

As discussed in Note 1 to the consolidated financial statements, the Company has changed its method of accounting for leases in 2019 due to the adoption of ASU No. 2016-02, Leases (Topic 842).

 

Basis for opinion

 

These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

 

/s/ GRANT THORNTON LLP

 

We have served as the Company’s auditor since 2019.

 

Cleveland, Ohio

February 21, 2020

 

Page 43

 

 

Report of Independent Registered Public Accounting Firm

 

Board of Directors and Shareholders

Olympic Steel, Inc.

 

Opinion on internal control over financial reporting

 

We have audited the internal control over financial reporting of Olympic Steel, Inc. (an Ohio corporation) and subsidiaries (the “Company”) as of December 31, 2019, based on criteria established in the 2013 Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019, based on criteria established in the 2013 Internal Control—Integrated Framework issued by COSO.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the consolidated financial statements of the Company as of and for the year ended December 31, 2019, and our report dated February 21, 2020 expressed an unqualified opinion on those financial statements.

 

Basis for opinion

 

The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

 

Definition and limitations of internal control over financial reporting

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

/s/ GRANT THORNTON LLP

 

Cleveland, Ohio

February 21, 2020

 

Page 44

 

 

Report of Independent Registered Public Accounting Firm

 

To the Shareholders and Board of Directors of Olympic Steel, Inc.

 

Opinion on the Financial Statements

 

We have audited the consolidated balance sheet of Olympic Steel, Inc. and its subsidiaries (the “Company”) as of December 31, 2018, and the related consolidated statements of comprehensive income, shareholders’ equity and cash flows for each of the two years in the period ended December 31, 2018, including the related notes and financial statement schedule for each of the two years in the period ended December 31, 2018 listed in the accompanying index (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2018, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2018 in conformity with accounting principles generally accepted in the United States of America.   

 

Basis for Opinion

 

These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. 

 

We conducted our audits of these consolidated financial statements in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud.

 

Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.

 

 

/s/ PricewaterhouseCoopers LLP

Cleveland, Ohio

February 15, 2019

 

We served as the Company's auditor from 2002 to 2019.

 

Page 45

 

Management’s Report on Internal Control Over Financial Reporting

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.

 

Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2019. In making this assessment, our management used the criteria established in Internal Control - Integrated Framework (2013), issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

 

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

 

Based on our assessment, we concluded that, as of December 31, 2019, our internal control over financial reporting was effective based on those criteria.

 

The effectiveness of our internal control over financial reporting as of December 31, 2019 has been audited by Grant Thornton LLP, an independent registered public accounting firm, as stated in their report which appears herein.

 

Page 46

 

 

 

Olympic Steel, Inc.

Consolidated Statements of Comprehensive Income

For The Years Ended December 31,

(in thousands, except per share data)

 

 

   

2019

   

2018

   

2017

 
                         

Net sales

  $ 1,579,040     $ 1,715,081     $ 1,330,696  
                         

Costs and expenses

                       

Cost of materials sold (excludes items shown separately below)

    1,280,110       1,372,954       1,055,212  

Warehouse and processing

    99,457       97,565       87,425  

Administrative and general

    76,863       81,107       69,659  

Distribution

    48,159       50,347       41,789  

Selling

    28,839       29,020       26,285  

Occupancy

    9,972       9,428       8,862  

Depreciation

    17,686       16,645       16,589  

Amortization

    1,344       963       889  

Total costs and expenses

    1,562,430       1,658,029       1,306,710  

Operating income

    16,610       57,052       23,986  

Other loss, net

    (32 )     (307 )     (118 )

Income before interest and income taxes

    16,578       56,745       23,868  

Interest and other expense on debt

    11,289       10,681       7,518  

Income before income taxes

    5,289       46,064       16,350  

Income tax provision (benefit)

    1,433       12,305       (2,613 )

Net income

  $ 3,856     $ 33,759     $ 18,963  
                         

Loss on cash flow hedges

    (3,041 )     -       -  

Tax effect of hedges

    760       -       -  

Total comprehensive income

  $ 1,575     $ 33,759     $ 18,963  
                         

Net income per share - basic

  $ 0.34     $ 2.95     $ 1.67  

Weighted average shares outstanding - basic

    11,509       11,432       11,381  

Net income per share - diluted

  $ 0.34     $ 2.95     $ 1.67  

Weighted average shares outstanding - diluted

    11,509       11,440       11,381  
                         

Dividends declared per share of common stock

  $ 0.08     $ 0.08     $ 0.08  

 

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

 

Page 47

 

 

 

 Olympic Steel, Inc.

Consolidated Balance Sheets

As of December 31,

(in thousands)

 

   

2019

   

2018

 

Assets

               

Cash and cash equivalents

  $ 5,742     $ 9,319  

Accounts receivable, net

    133,572       175,252  

Inventories, net (includes LIFO debit of $597 as of December 31, 2019 and LIFO credit of $3,071 as of December 31, 2018)

    273,531       368,738  

Prepaid expenses and other

    6,997       9,460  

Total current assets

    419,842       562,769  

Property and equipment, at cost

    416,511       403,785  

Accumulated depreciation

    (260,264 )     (244,176 )

Net property and equipment

    156,247       159,609  

Goodwill

    3,423       2,358  

Intangible assets, net

    29,259       24,914  

Other long-term assets

    14,439       11,090  

Right-of use assets, net

    26,345       -  

Total assets

  $ 649,555     $ 760,740  
                 

Liabilities

               

Accounts payable

  $ 69,452     $ 95,367  

Accrued payroll

    13,196       19,665  

Other accrued liabilities

    12,850       13,395  

Current portion of lease liabilities

    5,589       -  

Total current liabilities

    101,087       128,427  

Credit facility revolver

    192,925       302,530  

Other long-term liabilities

    14,068       9,327  

Deferred income taxes

    12,262       13,465  

Lease liabilities

    20,861       -  

Total liabilities

    341,203       453,749  
                 

Commitments and contingencies (Note 13)

               
                 

Shareholders' Equity

               

Preferred stock, without par value, 5,000 shares authorized, no shares issued or outstanding

    -       -  

Common stock, without par value, 20,000 shares authorized; 11,020 issued; 10,996 and 11,008 shares outstanding

    131,647       130,778  

Treasury stock, at cost, 25 and 12 shares held

    (335 )     (132 )

Accumulated other comprehensive loss

    (2,281 )     -  

Retained earnings

    179,321       176,345  

Total shareholders' equity

    308,352       306,991  

Total liabilities and shareholders' equity

  $ 649,555     $ 760,740  

 

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

 

Page 48

 

 

 

Olympic Steel, Inc.

Consolidated Statements of Cash Flows

For The Years Ended December 31,

(in thousands)

 

   

2019

   

2018

   

2017

 

Cash flows from (used for) operating activities:

                       

Net income

  $ 3,856     $ 33,759     $ 18,963  

Adjustments to reconcile net income to net cash from operating activities -

                       

Depreciation and amortization

    19,548       18,035       18,587  

(Gain) loss on disposition of property and equipment

    (222 )     64       (52 )

Stock-based compensation

    2,188       1,529       1,096  

Intangibles and other long-term assets

    (3,835 )     1,970       (2,874 )

Deferred income taxes and other long-term liabilities

    1,220       (1,467 )     (8,988 )
      22,755       53,890       26,732  

Changes in working capital:

                       

Accounts receivable

    42,141       (35,906 )     (30,835 )

Inventories

    95,836       (78,662 )     (20,781 )

Prepaid expenses and other

    2,464       47       (1,303 )

Accounts payable

    (33,651 )     2,898       3,918  

Change in outstanding checks

    7,053       1,038       658  

Accrued payroll and other accrued liabilities

    (7,040 )     6,194       2,570  
      106,803       (104,391 )     (45,773 )

Net cash from (used for) operating activities

    129,558       (50,501 )     (19,041 )
                         

Cash flows from (used for) investing activities:

                       

Acquisitions

    (11,133 )     (21,907 )     -  

Capital expenditures

    (10,165 )     (25,715 )     (10,160 )

Proceeds from disposition of property and equipment

    269       126       991  

Net cash used for investing activities

    (21,029 )     (47,496 )     (9,169 )
                         

Cash flows from (used for) financing activities:

                       

Credit facility revolver borrowings

    536,944       597,867       387,220  

Credit facility revolver repayments

    (646,549 )     (491,572 )     (355,584 )

Principal payments under capital lease obligation

    -       (7 )     -  

Industrial revenue bond repayments

    -       (930 )     (895 )

Credit facility fees and expenses

    (100 )     (171 )     (969 )

Proceeds from employee stock options

    -       -       10  

Repurchase of common stock

    (1,522 )     -       -  

Dividends paid

    (879 )     (880 )     (878 )

Net cash from (used for) financing activities

    (112,106 )     104,307       28,904  
                         

Cash and cash equivalents:

                       

Net change

    (3,577 )     6,310       694  

Beginning balance

    9,319       3,009       2,315  

Ending balance

  $ 5,742     $ 9,319     $ 3,009  

 

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

 

Page 49

 

 

Olympic Steel, Inc.

Supplemental Disclosures of Cash Flow Information

For The Years Ended December 31,

(in thousands)

 

   

2019

   

2018

   

2017

 

Cash paid during the period

                       
                         

Interest paid

  $ 10,951     $ 10,241     $ 6,433  

Income taxes paid

  $ 460     $ 11,316     $ 9,357  

 

 

The accompanying notes are an integral part of these consolidated statements

 

Page 50

 

 

 

Olympic Steel, Inc.

Consolidated Statements of Shareholders’ Equity

For The Years Ended December 31,

(in thousands)

 

                   

Accumulated

                 
                   

Other

                 
   

Common

   

Treasury

   

Comprehensive

   

Retained

   

Total

 
   

Stock

   

Stock

   

Loss

   

Earnings

   

Equity

 
                                         

Balance at December 31, 2016

  $ 128,619     $ (609 )   $ -     $ 125,380     $ 253,390  
                                         

Net income

  $ -     $ -     $ -     $ 18,963     $ 18,963  

Payment of dividends

    -       -       -       (878 )     (878 )

Employee stock purchase (1 shares)

    10       -       -       -       10  

Stock-based compensation

    824       272       -       -       1,096  

Other

    -       -       -       2       2  
                                         

Balance at December 31, 2017

  $ 129,453     $ (337 )   $ -     $ 143,467     $ 272,583  
                                         

Net income

  $ -     $ -     $ -     $ 33,759     $ 33,759  

Payment of dividends

    -       -       -       (880 )     (880 )

Stock-based compensation

    1,324       205       -       -       1,529  

Other

    1       -       -       (1 )     -  
                                         

Balance at December 31, 2018

  $ 130,778     $ (132 )   $ -     $ 176,345     $ 306,991  
                                         

Net income

  $ -     $ -     $ -     $ 3,856     $ 3,856  

Payment of dividends

    -       -       -       (879 )     (879 )

Stock-based compensation

    869       1,319       -       -       2,188  

Stock repurchase

    -       (1,522 )             -       (1,522 )

Change in fair value of hedges

    -       -       (2,281 )     -       (2,281 )

Other

    -       -       -       (1 )     (1 )
                                         

Balance at December 31, 2019

  $ 131,647     $ (335 )   $ (2,281 )   $ 179,321     $ 308,352  

 

 

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

 

Page 51

 

 

Olympic Steel, Inc.

Notes to Consolidated Financial Statements

For The Years Ended December 31, 2019, 2018 and 2017

 

 

 

1.     Summary of Significant Accounting Policies:

 

Nature of Business

 

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 and through its acquisition of EZ Dumper® on August 5, 2019, to include steel and stainless-steel dump inserts for pickup truck and service truck beds. 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.

 

Principles of Consolidation and Basis of Presentation

 

The accompanying consolidated financial statements include the accounts of Olympic Steel, Inc. and its wholly-owned subsidiaries (collectively, the Company or Olympic), after elimination of intercompany accounts and transactions.

 

Accounting Estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

Concentration Risks

 

The Company is a major customer of flat-rolled coil and plate and tubular and pipe steel for many of its principal suppliers, but is not dependent on any one supplier. The Company purchased approximately 57%, 52% and 53% of its total steel requirements from its three largest suppliers in 2019, 2018 and 2017, respectively.

 

The Company has a diversified customer and geographic base, which reduces the inherent risk and cyclicality of its business. The concentration of net sales to the Company’s top 20 customers approximated 29%, 29% and 27% of consolidated net sales in 2019, 2018 and 2017, respectively. In addition, the Company’s largest customer accounted for approximately 5%, 5% and 4% of consolidated net sales in 2019, 2018 and 2017, respectively. Sales to industrial machinery and equipment manufacturers and their fabricators accounted for 46%, 48% and 51% of consolidated net sales in 2019, 2018 and 2017, respectively.

 

Page 52

 

 

Cash and Cash Equivalents

 

Cash equivalents consist of short-term highly liquid investments, with a three month or less maturity, which are readily convertible into cash. The Company maintains cash levels in bank accounts that, at times, may exceed federally-insured limits. The Company have not experienced significant loss, and believe we are not exposed to significant risk of loss, in these accounts.

 

Fair Market Value

 

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability in the principal or most advantageous market for the liability in an orderly transaction between market participants on the measurement date.  Valuation techniques must maximize the use of observable inputs and minimize the use of unobservable inputs.  To measure fair value, the Company applies a fair value hierarchy that is based on three levels of inputs, of which the first two are considered observable and the last unobservable, as follows:

 

Level 1 – Quoted prices in active markets for identical assets or liabilities.

 

Level 2 – Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

 

Level 3 – Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

 

Financial instruments, such as cash and cash equivalents, accounts receivable, accounts payable and the credit facility, are stated at their carrying value, which is a reasonable estimate of fair value. The fair value of marketable securities is based on quoted market prices.

 

Accounts Receivable

 

The Company’s allowance for doubtful accounts is maintained at a level considered appropriate based on historical experience and specific customer collection issues that the Company has identified. Estimations are based upon the application of a historical collection rate to the outstanding accounts receivable balance, 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 the allowance for doubtful accounts each quarter.

 

Inventories

 

Non-LIFO inventories are stated at the lower of its cost or net realizable value. LIFO inventories are stated at the lower of cost or market. Inventory costs include the costs of the purchased metals, inbound freight, external and internal processing and applicable labor and overhead costs. Net realizable value is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation.

 

Costs of the Company’s carbon and specialty metals flat products segments’ inventories, including flat-rolled sheet, coil and plate products are determined using the specific identification method.

 

Certain of the Company’s tubular and pipe products inventory is stated under the last-in, first-out (LIFO) method. At December 31, 2019 and December 31, 2018, approximately $39.1 million, or 14.3% 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 tubular and pipe product segment’s inventory is determined using a weighted average rolling first-in, first-out (FIFO) method.

 

On the Consolidated Statements of Comprehensive Income, “Cost of materials sold (exclusive of items shown separately below)” consists of the cost of purchased metals, inbound and internal transfer freight, external processing costs, and LIFO income or expense.

 

Page 53

 

 

Property and Equipment, and Depreciation

 

Property and equipment are stated at cost. Depreciation is provided using the straight-line method over the estimated useful lives of the assets ranging from two to 30 years. The Company capitalizes the costs of obtaining or developing internal-use software, including directly related payroll costs. The Company amortizes those costs over five years, beginning when the software is ready for its intended use.

 

Intangible Assets and Recoverability of Long-lived Assets

 

The Company performs an annual impairment test of indefinite-lived intangible assets in the fourth quarter, or more frequently if changes in circumstances or the occurrence of events indicate potential impairment. Events or changes in circumstances that could trigger an impairment review include significant nonperformance relative to the expected historical or projected future operating results, significant changes in the manner of the use of the acquired assets or the strategy for the overall business or significant negative industry or economic trends. Management uses judgment to determine whether to use a qualitative analysis or a quantitative fair value measurement for each of the Company’s reporting units that carry intangible assets.

 

If a quantitative fair value measurement is used, the fair value of each indefinite-lived intangible asset is compared to its carrying value and an impairment charge is recorded if the carrying value exceeds the fair value. The Company estimates the fair value of indefinite-lived intangible assets using a discounted cash flow methodology. Management’s assumptions used for the calculations are based on historical results, projected financial information and recent economic events. Actual results could differ from these estimates under different assumptions or conditions which could adversely affect the reported value of intangible assets.

 

The Company evaluates the recoverability of long-lived assets and the related estimated remaining lives whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Events or changes in circumstances that could trigger an impairment review include significant underperformance relative to the expected historical or projected future operating results, significant changes in the manner of the use of the acquired assets or the strategy for the overall business or significant negative industry or economic trends. The Company records an impairment or change in useful life whenever events or changes in circumstances indicate that the carrying amount may not be recoverable or the useful life has changed.

 

Income Taxes

 

The Company records, as an offset to the estimated effect of temporary differences between the tax basis of assets and liabilities and the reported amounts in its consolidated balance sheets, the tax effect of operating loss and tax credit carryforwards. If the Company determines that it will not be able to fully realize a deferred tax asset, it will record a valuation allowance to reduce such deferred tax asset to its realizable value. The Company recognizes interest accrued related to unrecognized tax benefits in income tax expense. Penalties, if incurred, would be recognized as a component of administrative and general expense.

 

The Company recognizes the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit.  For tax positions meeting the more-likely-than-not threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement with the relevant tax authority.

 

The Company had no material unrecognized tax benefits as of or during the year period ended December 31, 2019.  The Company expects no significant increases or decrease in unrecognized tax benefits due to changes in tax positions within one year of December 31, 2019.

 

Revenue Recognition

 

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 immaterial to the Company's consolidated results.

 

Sales returns and allowances are treated as reductions to sales and are provided for based on historical experience and current estimates and are immaterial to the consolidated financial statements.

 

Page 54

 

 

Shipping and Handling Fees and Costs

 

Amounts charged to customers for shipping and other transportation services are included in net sales. The distribution expense line on the accompanying Consolidated Statements of Comprehensive Income is entirely comprised of all shipping and other transportation costs incurred by the Company in shipping goods to its customers.

 

Stock-Based Compensation

 

The Company records compensation expense for stock awards issued to employees and directors. For additional information, see Note 12, Equity Plans.

 

Impact of Recently Issued Accounting Pronouncements 

 

In August 2018, the Financial Account Standards Board, or FASB, issued Accounting Standards Update (ASU) No. 2018-15, “Intangibles – Goodwill and other – Internal-use software: Customer’s accounting for implementation costs incurred in a cloud computing arrangement that is a service contract”. This ASU aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). Accordingly, this ASU requires an entity (customer) in a hosting arrangement that is a service contract to follow the guidance in Subtopic 350-40 to determine which implementation costs to capitalize as an asset related to the service contract and which costs to expense. This ASU also requires the entity (customer) to expense the capitalized implementation costs of a hosting arrangement that is a service contract over the term of the hosting arrangement, which includes reasonably certain renewals. For public business entities, this ASU is effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years with early adoption permitted. The Company early adopted ASU 2018-15 in the third quarter of 2018 and the adoption of this ASU did not materially impact the Company’s Consolidated Financial Statements.

 

In August 2017, the FASB issued 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 June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments-Credit Losses (Topic 326)”, which requires the measurement and recognition of expected credit losses for financial assets held at amortized cost. The ASU replaces the existing incurred loss impairment model with a forward-looking expected credit loss model which will result in earlier recognition of credit losses. The adoption of this ASU effective January 1, 2020 is not expected to 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 Statements of Comprehensive Income or on the Statements of Cash Flows. See Note 8 to the Consolidated Financial Statements.

 

 

 

2.     Acquisitions

 

On August 5, 2019, the Company acquired certain assets related to the manufacturing of the EZ Dumper® hydraulic dump inserts for $0.1 million. The dump inserts are sold through a network of more than 100 dealers across the United States and Canada. As of the effective date of the acquisition, EZ Dumper’s results are included in the Company’s carbon flat products segment.

 

Page 55

 

 

On January 2, 2019, the Company acquired substantially all of the net assets of McCullough, based in Kenton, Ohio for $11.0 million. 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. 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.

 

On April 2, 2018, the Company acquired substantially all of the net assets of Berlin Metals, based in Hammond, Indiana, for $21.9 million. Berlin Metals was founded in 1967 and is one of the largest North American service centers processing and distributing prime tin mill products and stainless steel strip in slit coil form. Berlin Metals is also a supplier of galvanized, light gauge cold rolled sheet and strip and other coated metals in coil forms, to customers in the building products, automotive and specialized industrial markets. As of the effective date of the acquisition, Berlin Metals’ results are included in the Company’s specialty metals flat products segment in the Company’s 2018 financial results. Upon the acquisition, the Company entered into an amendment to its credit facility to include the eligible assets of Berlin Metals.

 

The acquisitions are not considered significant and thus pro forma information has not been provided. The acquisitions were accounted for as business combinations and the assets and liabilities were valued at fair market value. The table below summarizes the final purchase price allocation of the fair market values of the assets acquired and liabilities assumed.

 

   

EZ Dumper

   

McCullough

   

Berlin Metals

 
   

As of

   

As of

   

As of

 

Details of Acquisition (in thousands)

 

August 5, 2019

   

January 2, 2019

   

April 2, 2018

 

Assets acquired

                       

Accounts receivable, net

  $ -     $ 461