Part I. FINANCIAL INFORMATION

Item 1. Financial Statements

Olympic Steel, Inc.

Consolidated Balance Sheets

(in thousands)

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

Olympic Steel, Inc.

Consolidated Statements of Comprehensive Income

For the Three Months Ended March 31,

(in thousands, except per share data)

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

Olympic Steel, Inc.

Consolidated Statements of Cash Flows

For the Three Months Ended March 31,

(in thousands) 

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

Olympic Steel, Inc.

Supplemental Disclosures of Cash Flow Information

For the Three Months Ended March 31,

(in thousands)

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

Olympic Steel, Inc.

Consolidated Statements of Shareholders’ Equity

For The Three Months Ended March 31,

(in thousands)

(unaudited)

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

Olympic Steel, Inc.

Notes to Unaudited Consolidated Financial Statements

March 31, 2020

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis should be read in conjunction with our unaudited consolidated financial statements and accompanying notes contained herein and our consolidated financial statements, accompanying notes and Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the year ended December 31, 2019. The following Management’s Discussion and Analysis of Financial Condition and Results of Operations contain forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from the results discussed in the forward-looking statements. Factors that might cause a difference include, but are not limited to, those discussed under Item 1A (Risk Factors) in our Annual Report on Form 10-K for the year ended December 31, 2019, and in Part II, Item 1A (Risk Factors) in this Quarterly Report on Form 10-Q. The following section is qualified in its entirety by the more detailed information, including our financial statements and the notes thereto, which appear elsewhere in this Quarterly Report on Form 10-Q.

Forward-Looking Information

This Quarterly Report on Form 10-Q and other documents we file with the SEC contain various forward-looking statements that are based on current expectations, estimates, forecasts and projections about our future performance, business, our beliefs and management’s assumptions. In addition, we, or others on our behalf, may make forward-looking statements in press releases or written statements, or in our communications and discussions with investors and analysts in the normal course of business through meetings, conferences, webcasts, phone calls and conference calls. Words such as “may,” “will,” “anticipate,” “should,” “intend,” “expect,” “believe,” “estimate,” “project,” “plan,” “potential,” and “continue,” as well as the negative of these terms or similar expressions, are intended to identify forward-looking statements, which are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are subject to certain risks and uncertainties that could cause our actual results to differ materially from those implied by such statements including, but not limited to:

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

Overview

We are a leading metals service center that operates in three reportable segments; carbon flat products, specialty metals flat products, and tubular and pipe products. We provide metals processing and distribution services for a wide range of customers. Our carbon flat products segment’s focus is on the direct sale and distribution of large volumes of processed carbon and coated flat-rolled sheet, coil and plate products and fabricated parts. Through the acquisition of McCullough Industries, or McCullough, on January 2, 2019, the 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 from 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, including the current impact of the COVID-19 pandemic; 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.

At March 31, 2020 we employed approximately 1,792 people. Approximately 297 of the hourly plant personnel at the facilities listed below are represented by nine separate collective bargaining units. The table below shows the expiration dates of the collective bargaining agreements.

We have never experienced a work stoppage and we believe that our relationship with employees is good. However, any prolonged work stoppages by our personnel represented by collective bargaining units could have a material adverse impact on our business, financial condition, results of operations and cash flows. 

COVID-19

The COVID-19 pandemic had an immaterial impact on our first quarter 2020 results. We are an essential business and remain open in all locations, adhering to all health guidelines to operate safely provided by our government officials and the U.S. Centers for Disease Control and Prevention. However, toward the end of the first quarter, some customers – particularity those associated with the automotive industry – announced temporary closures with re-openings in early April 2020. As April began, those automotive customers further delayed their re-openings. Additionally, customers across most other industrial segments announced temporary closings. These collective temporary closings will negatively impact our April sales and their effect will continue throughout the second quarter of 2020 and potentially the third and/or fourth quarters of 2020.

In addition to negatively impacting our sales and earnings, a prolonged COVID-19 pandemic could result in falling metals prices that could lead to lower of cost or market inventory adjustments and the impairment of intangible and long-lived assets. The operations and liquidity of our customers could also be challenged, which could lead to higher bad debt expense during the second quarter and second half of 2020.

We enter the second quarter of 2020 with approximately $112 million of availability under our asset-based revolving credit facility, or the ABL Credit Facility.  Additionally, management has taken proactive steps to aggressively reduce expenses to reflect the expected decreased business levels in the second quarter of 2020.   Further, our entire real estate portfolio is unencumbered by debt and can serve as a source of liquidity beyond our ABL Credit Facility, if needed. As a result, we believe that we have sufficient liquidity and capital resources to withstand the adverse effects on our financial condition and results of operations resulting from the COVID-19 pandemic for the next 12 months.  However, the impact of the COVID-19 pandemic is fluid and continues to evolve, and therefore, we cannot currently predict the extent to which our business, results of operations, financial condition or liquidity will ultimately be impacted.

Reportable Segments

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.

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 our 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.

Results of Operations

Our results of operations are impacted by the market price of metals. Over the past 24 months, metals prices have fluctuated significantly and changes to our net sales, cost of materials sold, gross profit, cost of inventory and profitability, are all impacted by industry metals pricing. Average metals prices were 17% lower in the first quarter of 2020 compared to the first quarter of 2019.

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. During the first quarter of 2020, our net sales were negatively impacted by the price decreases experienced in the quarter and decreased customer demand, in particular for carbon flat products, which pressured our profitability during the first quarter of 2020.

During the last two weeks of March 2020 some of our customers announced temporary closures, reduced hours or staggered production schedules as a result of the stay at home, or shelter in place orders enacted in several U.S states as a result of the COVID-19 pandemic. During the first quarter of 2020, these announcements did not significantly impact our consolidated business volumes, but we expect to see a significant impact during the second quarter of 2020 as the number of customers impacted and the length of the temporary closures extend, especially for those in the automotive and heavy industrial segment. During the first quarter of 2020, our net sales were negatively impacted by the price decreases experienced in the quarter and decreased customer demand, in particular for carbon flat products, which pressured our profitability during the first quarter of 2020.

Consolidated Operations

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

Net sales decreased 20.5% to $354.4 million in the first quarter of 2020 from $445.9 million in the first quarter of 2019. Carbon flat products net sales were 57.3% of total net sales in the first quarter of 2020 compared to 62.5% of total net sales in the first quarter of 2019. Specialty metals flat products net sales were 25.0% of total net sales in the first quarter of 2020 compared to 19.8% of total net sales in the first quarter of 2019. Tubular and pipe products net sales were 17.8% of total net sales for the first quarter of both 2020 and 2019. The decrease in net sales was due to a 17.0% decrease in average selling prices during the first quarter of 2020 compared to the first quarter of 2019, and a 4.2% decrease in volume. We expect shipping levels to decrease significantly during the second quarter of 2020 due to the actions taken by our customers related to the COVID-19 pandemic.

Cost of materials sold decreased 22.9% to $282.5 million in the first quarter of 2020 from $366.4 million in the first quarter of 2019. The decrease in cost of materials sold in the first quarter of 2020 is related to the decreased metals pricing discussed above.

As a percentage of net sales, gross profit (as defined in footnote (b) in the table above) increased to 20.3% in the first quarter of 2020 from 17.8% in the first quarter of 2019. The increase in the gross profit as a percentage of net sales is due to the impact of lower average selling prices, the decreased costs of inventory due to decreased industry metals pricing and the recognition of LIFO income.

Operating expenses in the first quarter of 2020 decreased $4.7 million, or 6.3%, to $68.8 million from $73.5 million in the first quarter of 2019. As a percentage of net sales, operating expenses increased to 19.4% for the first quarter of 2020 from 16.5% in the comparable 2019 period. Operating expenses in the carbon flat products segment decreased $2.8 million, operating expenses in the specialty metals products segment decreased $0.1 million, operating expenses in the tubular and pipe products segment decreased $1.4 million and Corporate expenses decreased $0.4 million compared to prior year’s first quarter. The decrease in operating expenses was primarily attributable to decreased variable warehouse and processing and distribution expenses related to decreased sales volume, decreased variable performance-based incentive compensation and actions taken by management in the second half of 2019 to reduce overall operating expenses. During the second quarter of 2020, we initiated temporary and permanent layoffs at our facilities to reflect our staffing needs with our decreased sales levels.

Interest and other expense on debt totaled $2.2 million, or 0.6% of net sales, for the first quarter of 2020 compared to $3.2 million, or 0.7% of net sales, for the first quarter of 2019. The decrease was due to decreased borrowings to fund working capital needs and decreased interest rates. Our effective borrowing rate, exclusive of deferred financing fees and commitment fees, was 3.9% for the first three months of 2020 compared to 4.0% for the first three months of 2019 due to the decrease in prime and LIBOR rates since the first quarter of 2019.

For the first quarter of 2020, income before income taxes totaled $0.8 million compared to $2.8 million in the first quarter of 2019.

An income tax provision of 25.4% was recorded for the first quarter of 2020, compared to an income tax provision of 27.1% for the first quarter of 2019. Normally, our tax provision or benefit for interim periods is determined using an estimate of our annual effective tax rate, adjusted for discrete items that are considered in the relevant period. Each quarter, we update our estimate of the annual effective tax rate, and if our estimated tax rate changes, we make a cumulative adjustment. However, due to the COVID-19 pandemic, we are unable to accurately forecast an estimated annual effective tax rate. Therefore, we have recorded the tax provision for the first quarter of 2020 using an actual effective tax rate as of March 31, 2020.

Net income for the first quarter of 2020 totaled $0.6 million or $0.05 per basic and diluted share, compared to $2.1 million or $0.18 per basic and diluted share for the first quarter of 2019.

Segment Operations

Carbon flat products

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

Tons sold by our carbon flat products segment decreased 3.7% to 263 thousand in the first quarter of 2020 from 273 thousand in the first quarter of 2019. The decrease in tons sold is due to decreased customer demand experienced in the metals industry. We expect sales volumes in the second quarter of 2020 to decrease significantly from the first quarter of 2020, due to the actions taken by our customers related to the COVID-19 pandemic, especially for our automotive-related customers.

Net sales in our carbon flat products segment decreased $75.6 million, or 27.1%, to $203.0 million in the first quarter of 2020 from $278.5 million in the first quarter of 2019. The decrease in sales was attributable to a 24.3% decrease in average selling prices in the first quarter of 2020 compared to the first quarter of 2019, and a 3.7% decrease in tons sold. Average selling prices in the first quarter of 2020 decreased to $771 per ton, compared with $1,020 per ton in the first quarter of 2019 and $799 per ton in the fourth quarter of 2019.

Cost of materials sold decreased $70.2 million, or 30.1%, to $163.1 million in the first quarter of 2020 from $233.3 million in the first quarter of 2019. The average cost of materials sold per ton decreased by 27.4% in the first quarter of 2020 compared to the same period in 2019. The decrease was due to the decreased market price for metals discussed above and the impact of selling higher costed inventory during the first quarter of 2019 compared to the first quarter of 2020.

As a percentage of net sales, gross profit (as defined in footnote (a) in the table above) increased to 19.6% in the first quarter of 2020 compared to 16.2% in the first quarter of 2019. The increase in gross profit percentage in 2020 was primarily due to the impact of lower average selling prices, as the gross profit per ton decreased by 8.6% or $14 per ton in the first quarter of 2020 compared to the first quarter of 2019.

Operating expenses in the first quarter of 2020 decreased $2.8 million, or 6.4%, to $41.2 million from $44.0 million in the first quarter of 2019. Operating expenses decreased as a result of decreased variable warehouse and processing and distribution expenses related to decreased sales volume and decreased variable performance-based incentive compensation. As a percentage of net sales, operating expenses increased to 20.3% for the first quarter of 2020 compared to 15.8% for first quarter of 2019.

Operating loss for the first quarter of 2020 totaled $1.3 million, or 0.7% of net sales, compared to operating income of $1.2 million, or 0.4% of net sales, for the first quarter of 2019.

Specialty metals flat products

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

Tons sold by our specialty metals flat products segment decreased 3.4% to 35 thousand in the first quarter of 2020 from 36 thousand in the first quarter of 2019.

Net sales in our specialty metals flat products segment increased $0.4 million, or 0.4%, to $88.5 million in the first quarter of 2020 from $88.1 million in the first quarter of 2019. The increase in sales was due to a 4.0% increase in average selling prices offset by a 3.4% decrease in the volume during the first quarter of 2020 compared to the first quarter of 2019. Average selling prices in the first quarter of 2020 were $2,560 per ton, compared with $2,462 per ton in the first quarter of 2019, and $2,260 per ton in the fourth quarter of 2019. The increase in the year over year average selling price per ton is a result of the increased surcharges on materials that we sell, specifically stainless steel. We expect shipping levels to decrease significantly during the second quarter of 2020 due to the actions taken by our customers related to the COVID-19 pandemic. We expect this segment’s sales to be down in the second quarter of 2020, but by a lesser percentage than the carbon segment.

Cost of materials sold remained flat at $76.2 million in the first quarter of 2020, as compared to the first quarter of 2019. The 3.5% increase in average cost of materials sold was offset by the 3.4% decrease in volume during the first quarter of 2020 compared to the first quarter of 2019.

As a percentage of net sales, gross profit (as defined in footnote (a) in the table above) increased to 13.8% in the first quarter of 2020 from 13.5% in the first quarter of 2019. The gross profit per ton increased 7.0% to $354 per ton in the first quarter of 2020 from $331 per ton in the first quarter of 2019.

Operating expenses in the first quarter of 2020 decreased $0.1 million, or 1.0%, to $9.5 million from $9.6 million in the first quarter of 2019. As a percentage of net sales, operating expenses decreased to 10.8% for the first quarter of 2020 compared to 10.9% for the first quarter of 2019.

Operating income for the first quarter of 2020 totaled $2.7 million, or 3.1% of net sales, compared to $2.2 million, or 2.5% of net sales, for the first quarter of 2019.

Tubular and pipe products

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

Net sales decreased $16.4 million, or 20.6%, to $62.9 million in the first quarter of 2020 from $79.3 million in the first quarter of 2019. The decrease is a result of an 11.2% decrease in shipping volume and a 10.6% decrease in average selling prices during the first quarter of 2020 compared to the first quarter of 2019. We expect shipping levels to decrease significantly during the second quarter of 2020 due to the actions taken by our customers related to the COVID-19 pandemic. We expect this segment’s sales to be down in the second quarter of 2020, but to a lesser percentage than the carbon segment.

Cost of materials sold decreased $13.7 million, or 24.1%, to $43.2 million in the first quarter of 2020 from $56.8 million in the first quarter of 2019. The decrease in cost of materials sold is primarily a result of the 11.2% decrease in sales volume and the 14.5% decrease in the average cost of materials sold in the first quarter of 2020 compared to the first quarter of 2019. During the first quarter of 2020, our tubular and pipe products segment recorded $0.5 million of LIFO income. There was no LIFO impact recorded during the first quarter of 2019.

As a percentage of net sales, gross profit (as defined in footnote (b) in the table above) increased to 31.4% in the first quarter of 2020 compared to 28.3% in the first quarter of 2019. As a percentage of net sales, the LIFO income recorded in the first quarter of 2020 increased gross profit by 0.8%.

Operating expenses in the first quarter of 2020 decreased $1.4 million, or 8.2%, to $15.5 million from $16.9 million in the first quarter of 2019. Operating expenses decreased in the first quarter of 2020 as a result of decreased variable warehouse and processing and distribution expenses related to decreased sales volume and decreased variable performance-based incentive compensation. Operating expenses increased to 24.6% of net sales in the first quarter of 2020 compared to 21.2% in the first quarter of 2019.

Operating income for the first quarter 2020 totaled $4.3 million, or 6.8% of net sales, compared to $5.6 million, or 7.1% of net sales, for the first quarter of 2019.

Corporate expenses

Corporate expenses were $2.6 million in the first quarter of 2020 compared to $3.0 million in the first quarter of 2019. Corporate expense decreased in the first quarter of 2020 as a result of decreased performance-based incentive compensation.

Liquidity, Capital Resources and Cash Flows

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

We believe that funds available under our ABL Credit Facility together with funds generated from operations, will be sufficient to provide us with the liquidity necessary to fund anticipated working capital requirements, capital expenditure requirements, our dividend payments and any share repurchases and business acquisitions over at least the next 12 months. However, if the COVID-19 pandemic suppresses business levels and metals prices for a prolonged period of time, we may need to seek some sources of liquidity beyond our current ABL Credit Facility. Our entire real estate portfolio is unencumbered by debt and could be used to generate additional liquidity, if required. We expect to generate cash and liquidity during the COVID-19 pandemic from working capital as business levels and metals pricing decreases. In addition, we have limited our capital spending during the COVID-19 pandemic to projects already in process, essential maintenance projects and safety projects. In the future, we may as part of our business strategy, acquire and dispose of assets or other companies in the same or complementary lines of business, or enter into or exit strategic alliances and joint ventures. Accordingly, the timing and size of our capital requirements are subject to change as business conditions warrant and opportunities arise.

Operating Activities

For the three months ended March 31, 2020, we used $12.0 million of net cash for operations of which $5.0 million was generated from operating activities and $17.0 million was used for working capital. For the three months ended March 31, 2019, we used $1.2 million of net cash for operations, net of assets acquired as part of the McCullough acquisition on January 2, 2019, of which $6.7 million was generated from operating activities and $7.9 million was used for working capital.

Net cash from operations totaled $5.0 million during the first quarter of 2020 and mainly consisted of net income of $0.6 million, depreciation and amortization of $5.1 million and stock-based compensation of $0.4 million, offset by changes in other long-term assets and other long-term liabilities of $1.1 million. Net cash from operations totaled $6.7 million during the first quarter of 2019 and mainly consisted of net income of $2.1 million, depreciation and amortization of $4.9 million and stock-based compensation of $1.5 million, offset by changes in other long-term assets and other long-term liabilities of $1.7 million.

Working capital at March 31, 2020 totaled $334.7 million, a $16.0 million increase from December 31, 2019. The increase was primarily attributable to a $32.2 million increase in accounts receivable (resulting from higher sales normally experienced in the first quarter compared to the lower sales in the fourth quarter) and an $4.9 million decrease in accrued payroll and other accrued liabilities, offset by $13.5 million increase in accounts payable and outstanding checks and a $6.0 million decrease in inventories (resulting from decreased inventory purchases and lower average inventory costs in the first quarter of 2020 compared to the fourth quarter of 2019).

Investing Activities

Net cash used for investing activities totaled $4.2 million during the three months ended March 31, 2020, compared to $13.4 million during the three months ended March 31, 2019. The $4.2 million of capital expenditures were 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. During the COVID-19 pandemic, we are limiting our spending to projects already in process, essential maintenance projects and safety projects.

Financing Activities

During the first three months of 2020, $15.8 million of cash was generated from financing activities, which primarily consisted of $16.1 million of net borrowings under our ABL Credit Facility offset by $0.2 million of dividends paid and $0.1 million used to repurchase common stock.

Dividends paid were $0.2 million for both the three months ended March 31, 2020 and March 31, 2019. In April 2020, our Board of Directors approved a regular quarterly dividend of $0.02 per share, which will be paid on June 15, 2020 to shareholders of record as of June 1, 2020. Regular dividend distributions in the future are subject to the availability of cash, the $5.0 million annual limitation on cash dividends and common stock repurchases under our ABL Credit Facility and continuing determination by our Board of Directors that the payment of dividends remains in the best interest of our shareholders.

Stock Repurchase Program

In 2015, our Board of Directors authorized a stock repurchase program of up to 550,000 shares of our issued and outstanding common stock, which could include open market repurchases, negotiated block transactions, accelerated stock repurchases or open market solicitations for shares, all or some of which may be effected through Rule 10b5-1 plans. Repurchased shares will be held in our treasury, or canceled and retired as our Board 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 at March 31, 2020) or (ii) to maintain availability equal to or greater than 15% of the aggregate revolver commitments ($71.3 million at March 31, 2020) 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 the three months ended March 31, 2020 we repurchased 15,000 shares, for an aggregate cost of $145 thousand. During the three months ended March 31, 2019 we repurchased 3,800 shares, for an aggregate cost of $64 thousand.

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 March 31, 2020) or 10.0% of the aggregate borrowing base ($32.4 million at March 31, 2020) then we must maintain a ratio of Earnings before Interest, Taxes, Depreciation and Amortization (EBITDA) minus certain capital expenditures and cash taxes paid to fixed charges of at least 1.00 to 1.00 for the most recent twelve fiscal month period.

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

As of March 31, 2020, we were in compliance with our covenants and had approximately $112.2 million of availability under the ABL Credit Facility.

As of March 31, 2020, $1.2 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%.

Critical Accounting Policies

This Management’s Discussion and Analysis of Financial Condition and Results of Operations is based on the consolidated financial statements included in this Quarterly Report on Form 10-Q, which have been prepared in conformity with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and assumptions that affect the amounts reported in the financial statements. We monitor and evaluate our estimates and assumptions, based on historical experience and various other factors that are believed to be reasonable under the circumstances. Actual results could differ from these estimates under different assumptions or conditions.

We review our financial reporting and disclosure practices and accounting practices quarterly to ensure they provide accurate and transparent information relative to the current economic and business environment. For further information regarding the accounting policies that we believe to be critical accounting policies that affect our more significant judgments and estimates used in preparing our consolidated financial statements, see Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the year ended December 31, 2019.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

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

We, like many other metals service centers, maintain substantial inventories of metals to accommodate the short lead times and just-in-time delivery requirements of our customers. Accordingly, we purchase metals in an effort to maintain our inventory at levels that we believe to be appropriate to satisfy the anticipated needs of our customers based upon historic buying practices, supply agreements with customers and market conditions. Our commitments to purchase metals are generally at prevailing market prices in effect at the time we place our orders. We have no long-term, fixed-price metals purchase contracts. When metals prices increase, competitive conditions will influence how much of the price increase we can pass on to our customers. To the extent we are unable to pass on future price increases in our raw materials to our customers, the net sales and profitability of our business could be adversely affected. When metals prices decline, customer demands for lower prices and our competitors’ responses to those demands could result in lower sale prices and, consequently, lower gross profits and inventory lower of cost or 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.

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

Approximately 45% and 48% of our consolidated net sales during the first three months of 2020 and 2019, 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, energy and borrowings under our credit facility. General inflation, excluding increases in the price of metals and increased distribution expense, has not had a material effect on our financial results during the past two years.

We are exposed to the impact of fluctuating metals prices and interest rate changes. During 2020 and 2019, 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. We have the option to enter into 30- to 180-day fixed base rate LIBOR loans under the ABL Credit Facility. On January 10, 2019, we entered into a five-year interest rate swap that locked the interest rate at 2.57% on $75 million of our revolving debt.

Item 4. Controls and Procedures

The evaluation required by Rule 13a-15(e) of the Securities Exchange Act of 1934 of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this Quarterly Report on Form 10-Q has been carried out under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer. These disclosure controls and procedures are designed to provide reasonable assurance that information required to be disclosed in reports that are filed with or submitted to the SEC is: (i) accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosures and (ii) recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC. Based on this evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of March 31, 2020, our disclosure controls and procedures were effective.

There were no changes in our internal control over financial reporting that occurred during the first quarter of 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

We are continually monitoring and assessing the COVID-19 situation on our internal controls to minimize the impact on their design and operating effectiveness.

Part II. OTHER INFORMATION

Items 1, 3, 4 and 5 of this Part II are either inapplicable or are answered in the negative and are omitted pursuant to the instructions to Part II.

Item 1A. Risk Factors

The following updates and should be read in conjunction with the risk factors set forth under Item 1A (Risk Factors) in our Annual Report on Form 10-K for the year ended December 31, 2019.

The COVID-19 pandemic could have an adverse effect on our business, financial condition and liquidity.

Although it is not possible to predict the ultimate impact of the COVID-19 pandemic, including on our business, financial position or liquidity, such impacts that may be material include, but are not limited to: (i) reduced sales and profit levels, (ii) the slower payment of accounts receivable and potential increases in uncollectible accounts receivable, (iii) falling metals prices that could lead to lower of cost or market inventory adjustments and the impairment of intangible and long-lived assets, (v) reduced availability and productivity of our employees, (vi) increased operational risks as a result of remote work arrangements, including the potential effects on internal controls, as well as cybersecurity risks and increased vulnerability to security breaches, information technology disruptions and other similar events, (vii) negative impacts on our liquidity position, and (viii) increased costs and less ability to access funds under our ABL Credit Facility and the capital markets.  To the extent the duration of any of these conditions extends for a longer period of time, the impact will generally be a more severe adverse impact.

In addition, we cannot predict the impact that the COVID-19 pandemic will have on our customers, suppliers, vendors, and other business partners, and each of their financial conditions; however, any material effect on these parties could adversely impact us. The impact of the COVID-19 pandemic may also exacerbate other risks discussed in Item 1A (Risk Factors) in our Annual Report on Form 10-K for the year ended December 31, 2019, any of which could have a material effect on us. This situation is changing rapidly and additional impacts may arise that we are not aware of currently.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

This table provides information with respect to purchases by the Company of shares of its Common Stock during the quarter ended March 31, 2020:

Item 6. Exhibits

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Exhibit 31.1

Certification of the Principal Executive Officer

Pursuant to 15 U.S.C. 78m(a) or 78o(d)

(Section 302 of the Sarbanes-Oxley Act of 2002)

I, Richard T. Marabito, certify that: