OLYMPIC STEEL, INC. 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 ofMcCullough Industries , or McCullough, onJanuary 2, 2019 , our carbon flat products segment expanded its product offerings to include self-dumping metal hoppers and through the acquisition of EZ Dumper onAugust 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 ofBerlin Metals, LLC , or Berlin Metals, onApril 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 inCanada andMexico . 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 theU.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 intothe 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 onApril 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 inthe United States and one inMonterrey, 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 southernUnited States . Tubular and pipe products The tubular and pipe products segment consists of theChicago 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 southeasternUnited 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
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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 endedDecember 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 inJuly 2018 . The increases were driven by both the tariffs initiated by theU.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 onJanuary 2, 2019 and EZ Dumper onAugust 5, 2019 . 2018 operating results include the additional revenues and operating expenses resulting from the acquisition of Berlin Metals onApril 2, 2018 . Consolidated Operations
The following table sets forth certain consolidated income statement data for
the years ended
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 ourSchaumburg, Illinois andStreetsboro, 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 ofMcCullough Industries onJanuary 2, 2019 and a full year of operating expenses for theApril 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
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
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--------------------------------------------------------------------------------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 endedDecember 31, 2019 and 2018 (dollars shown in thousands, except per ton data): 2019 2018 % of net % of net $ sales $ 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
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--------------------------------------------------------------------------------Specialty metals flat products
The following table sets forth certain income statement data for the specialty
metals flat products segment for the years ended
2019 2018
% of net % of net
$ sales $ 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
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--------------------------------------------------------------------------------Tubular and pipe products The following table sets forth certain income statement data for the tubular and pipe products segment for the years endedDecember 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
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.
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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 atDecember 31, 2019 totaled$318.8 million , a$115.5 million decrease fromDecember 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 ofMcCullough 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. InFebruary 2020 , our Board of Directors approved a regular quarterly dividend of$0.02 per share, which is payable onMarch 16, 2020 to shareholders of record as ofMarch 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 ofDecember 31, 2019 ) or (ii) to maintain availability equal to or greater than 15% of the aggregate revolver commitments ($71.3 million as ofDecember 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
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--------------------------------------------------------------------------------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 onDecember 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 atDecember 31, 2019 ) or 10.0% of the aggregate borrowing base ($28.9 million atDecember 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
As ofDecember 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. OnJanuary 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$75 million of the outstanding LIBOR based borrowings under the ABL Credit Facility. The interest rate hedge fixed the rate at 2.57%. Contractual Obligations The following table reflects our contractual obligations as ofDecember 31, 2019 . Contractual Obligations Less than More than (amounts in thousands) Total 1 year 1-3 years 3-5 years 5 years Long-term debt obligations (a)$ 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
(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.
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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
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 inthe 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.
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--------------------------------------------------------------------------------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
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.
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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 endedDecember 31, 2019 . We expect no significant increases or decrease in unrecognized tax benefits due to changes in tax positions within one year ofDecember 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
InAugust 2018 , theFinancial 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 afterDecember 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 -------------------------------------------------------------------------------- InAugust 2017 , theFinancial 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 afterDecember 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. InJune 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 effectiveJanuary 1, 2020 is not expected to have a material impact on our Consolidated Financial Statements. InFebruary 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 afterDecember 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
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