zeus20171231_10k.htm
 

 



 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-K

 

 

( X )

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

 

For The Year Ended December 31, 2017

 

 

(    )

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

 

For The Transition Period From _______________ To _______________

 

Commission File Number 0-23320

 

OLYMPIC STEEL, INC.

(Exact name of registrant as specified in its charter)

 

Ohio   34-1245650

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification Number)

     
22901 Millcreek Boulevard, Suite 650, Highland Hills, OH   44122
(Address of principal executive offices)   (Zip Code)

 

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

 

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

Title of each Class    Name of each Exchange on which registered
Common Stock, without par value  The NASDAQ Stock Market LLC

      

 

 

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

None

 

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

Yes (   ) No (X)

 

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

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes (X) No (   )

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes (X) No (   )

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. (X)

 

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

Large accelerated filer (  ) Accelerated filer (X) 
Non-accelerated filer (  ) Small reporting company (  )
(Do not check if a smaller reporting company) Emerging growth company (  )

               

 

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

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).      Yes (  )  No (X)

 

As of June 30, 2017, the aggregate market value of voting stock held by nonaffiliates of the registrant based on the closing price at which such stock was sold on the Nasdaq Global Select Market on such date approximated $176,429,526.   

 

The number of shares of common stock outstanding as of March 2, 2018 was 10,998,480.

 

 

DOCUMENTS INCORPORATED BY REFERENCE

 

The registrant intends to file with the Securities and Exchange Commission a definitive Proxy Statement pursuant to Regulation 14A of the Securities Exchange Act of 1934 within 120 days of the close of its fiscal year ended December 31, 2017, portions of which document shall be deemed to be incorporated by reference in Part III of this Annual Report on Form 10-K from the date such document is filed.

 



 

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TABLE OF CONTENTS

 

 

    Page

Part I

 

 

Item 1.  

Business

 4

Item 1A.  

Risk Factors

14

Item 1B.  

Unresolved Staff Comments

22

Item 2.  

Properties

23

Item 3.  

Legal Proceedings

24

Item 4.  

Mine Safety Disclosures

24

 

Executive Officers of the Registrant

25

 

 

 

Part II

 

 

Item 5.  

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

26

Item 6.  

Selected Financial Data

27

Item 7.  

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

28

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk

48

Item 8.  

Financial Statements and Supplementary Data

49

Item 9.  

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

78

Item 9A.

Controls and Procedures

78

Item 9B.

Other Information

78

 

 

 

Part III

 

 

Item 10.  

Directors, Executive Officers and Corporate Governance

79

Item 11.

Executive Compensation

79

Item 12.

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

79

Item 13.

Certain Relationships and Related Transactions, and Director Independence

79

Item 14.

Principal Accountant Fees and Services 

79

 

 

 

Part IV

 

 

Item 15.

Exhibits and Financial Statement Schedules

80

 

Index to Exhibits 

80

Item 16.

Form 10-K Summary

83

 

Signatures

84

 

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PART I

 

ITEM 1.  BUSINESS

 

 

The Company

 

We are a leading metals service center that operates in three reportable segments; carbon flat products, specialty metals flat products, and tubular and pipe products. We provide metals processing and distribution services for a wide range of customers. The 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. 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. In addition, through our tubular and pipe products segment, we distribute metal tubing, pipe, bar, valves and fittings and fabricate pressure parts supplied to various industrial markets. 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, Mexico and Central and South America. International sales totaled 2.4% and 2.2% of consolidated net sales in 2017 and 2016, respectively.

 

Segment reporting information is contained in Note 15 of Notes to Consolidated Financial Statements, which can be found in Part II, Item 8 of this Annual Report on Form 10-K and which is incorporated herein by reference.

 

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

 

 

Industry Overview 

 

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

 

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

 

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

 

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Corporate History

 

Our company was founded in 1954 by the Siegal family as a general steel service center. Michael Siegal, the son of one of the founders, began his career with us in the early 1970s and has served as our Chief Executive Officer since 1984, and as our Chairman of the Board of Directors since 1994. David Wolfort, our President, joined us as General Manager in 1984. In the late 1980s, our business strategy changed from a focus on warehousing and distributing steel from a single facility with no major processing equipment to a focus on geographic and product growth, customer diversity and value-added processing. An integral part of our growth has been the acquisition and start-up of processing and sales operations, and the investment in processing equipment. In 1994, we completed an initial public offering and, in 1996, we completed a follow-on offering of our common stock. In July 2011, we acquired Chicago Tube and Iron, or CTI, a private leading distributor of tubing, pipe, bar, valves, and fittings, which represents our tubular and pipe products segment. Andrew Greiff, our Executive Vice President and Chief Operating Officer joined us in 2009 and managed the Company’s rapidly expanding specialty metals business.

 

 

Business Strategy and Objectives

 

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

 

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

 

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

 

These operating objectives are supported by:

 

 

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

 

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

 

Operational initiatives designed to improve efficiencies and reduce costs by improving three key sub-systems:

 

Operating system: Focused on continuously improving processes through waste and variation elimination using Lean Six Sigma tools and employee certifications.

 

Cultural system: Focused on creating the environment to facilitate change and improve the way we work and create value.

 

Management system: Focused on creating the measurements and governance structure to support continuous improvement.

 

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

 

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

 

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

 

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Investments and Acquisitions. Historically, we have accelerated our growth through acquisitions and capital investments in facilities and processing equipment. During 2017, we created a new position, Vice President of Strategic Development, whose focus is on profitable growth opportunities, including acquisitions. When the results of sales and marketing efforts and our financial justifications indicate that there is sufficient customer demand for a particular product, process or service, we may purchase equipment to satisfy that demand. We also evaluate our existing equipment to ensure that it remains productive, and we upgrade, replace, redeploy or dispose of equipment when necessary. We invest in processing equipment to support customer demand and to respond to the growing trend among original equipment manufacturers (our customers) to outsource non-core production processes, such as plate processing, machining, welding and fabrication, in order to concentrate on engineering, design and assembly.

 

Our capital investments during the past three years have primarily consisted of initial spending on a building expansion and building improvements, a slitter for our specialty metals flat products segment, a stretcher leveling line as well as other processing equipment for our expanded value-added customer base in Winder, Georgia, added tube and pipe distribution capabilities from our Cleveland, Ohio, Locust, North Carolina and Monterey, Mexico facilities and additional processing equipment for all of our three segments.

 

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

 

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

 

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

 

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

 

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

 

Management. We believe one of our strengths is the depth, knowledge and experience of our management team. In addition to our executive officers, members of our senior management team have a diversity of backgrounds within the metals industry, including management positions at metals producers and other metals service centers. They average 29 years of experience in the metals industry and 17 years with our company. During 2017, we further enhanced our management team by the promotions of several employees to senior management positions within the organization.

 

 

Products, Processing Services and Quality Standards

 

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

 

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

 

6

 

 

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

 

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

 

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

 

The following table sets forth, as of December 31, 2017, the major pieces of processing equipment in operation by segment:

 

Processing Equipment

 

Consolidated Flat Products

   

Tubular and Pipe Products

   

Total

 

Tempering

    3       -       3  

Stretcher-leveling

    2       -       2  

Cutting-to-length

    12       13       25  

Slitting

    10       -       10  

Shearing

    7       -       7  

Blanking

    4       -       4  

Plate processing

    22       -       22  

Laser processing

    25       8       33  

Forming

    12       -       12  

Machining

    45       85       130  

Painting

    1       1       2  

Tube processing

    2       39       41  

Finishing

    28       3       31  

Total

    173       149       322  

 

 

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

 

In addition, 24 of our facilities have earned International Organization for Standardization (ISO) 9001:2008 or ISO 9001:2015 certifications. CTI has earned The American Society of Mechanical Engineers S Certification and The National Board of Boiler & Pressure Vessel Inspectors R Certification. Our office building in Winder, Georgia has received Leadership in Energy and Environmental Design (LEED) certification.

 

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Customers and Distribution

 

We have a diverse customer and geographic base, which helps to reduce the inherent risk and cyclicality of our business. Net sales to our top three customers, in the aggregate, approximated 8.0%, 8.9% and 11.6% of our consolidated net sales in 2017, 2016 and 2015, respectively. We serve customers in metals consuming industries, including manufacturers and fabricators of transportation and material handling lift equipment, construction, mining and farm equipment, storage tanks, environmental and energy generation equipment, automobiles, food service and electrical equipment, military vehicles and equipment, as well as general and plate fabricators and metals service centers. The table below shows the percentage of our consolidated net sales to the largest industries for the past three years.

 

Industry

 

2017

   

2016

   

2015

 

Industrial machinery and equipment manufacturers and their fabricators

    51.0%       51.3%       49.4%  

Metals service centers

    10.6%       9.7%       7.2%  

Automobile manufacturers and their suppliers

    9.0%       9.8%       9.6%  

Residential and commercial construction

    8.9%       8.3%       10.2%  

Transportation equipment manufacturers

    5.9%       6.4%       7.1%  

All others <5%

    14.6%       14.5%       16.5%  

 

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

 

We process our metals to specific customer orders as well as for stocking programs. Many of our larger customers commit to purchase on a regular basis at agreed upon or indexed prices for periods ranging from three to twelve months. To help mitigate price volatility risks, these price commitments are generally matched with corresponding supply arrangements, or to a lesser degree by commodities hedging. Customers notify us of specific release dates as processed products are required. Customers typically notify us of release dates anywhere from a just-in-time basis to one month before the release date. Therefore, we are required to carry sufficient inventory to meet the short lead time and just-in-time delivery requirements of our customers. CTI produces pressure parts and other fabricated components primarily for industrial boiler applications representing 1.9% of consolidated net sales in 2017. These products typically take several months to produce due to their size and complexity. Due to the time required for production, we may require progress payments throughout the construction period.

 

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

 

 

Raw Materials

 

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

 

Inventory management is a key profitability driver in the metals service center industry. Similar to many other metals service centers, we maintain substantial inventories of metals to accommodate the short lead times and just-in-time delivery requirements of our customers. Accordingly, we purchase metals in an effort to maintain our inventory at levels that we believe to be appropriate to satisfy the anticipated needs of our customers based upon historic buying practices, purchase commitments with customers and market conditions.

 

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Our commitments to purchase metals are generally at prevailing market prices in effect at the time we place our orders. During the past three years, we have entered into pass through nickel and carbon swaps at the request of our customers in order to mitigate our customers’ risk of volatility in the price of metals. The swaps are settled with the brokers at maturity and the economic benefit or loss arising from the changes in fair value of the swaps is contractually passed through to the customer. During 2014, we entered into cash flow metals hedges to mitigate our risk of volatility in the price of metals. The cash flow hedges were settled with the brokers at maturity and the economic benefit or loss arising from the changes in fair value of the hedges was recorded to “Cost of Materials Sold” in the Consolidated Statements of Comprehensive Income. All of the metals cash flow hedges settled during 2015, and we have no outstanding metals cash flow hedges as of December 31, 2017.

 

We have no long-term, fixed-price metals purchase contracts, except for commodity hedges. When metals prices decline, customer demands for lower prices and our competitors’ responses to those demands could result in lower sale prices and, consequently, lower gross profits and earnings as we use existing metals inventory. When metals prices increase, competitive conditions will influence how much of the price increase we can pass on to our customers.

 

 

Suppliers

 

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

 

The metals producing supply base has experienced significant consolidation, with a few suppliers accounting for a majority of the domestic carbon steel market. We purchased approximately 53% and 54% of our total metals requirements from our three largest suppliers in 2017 and 2016, respectively. Although we have no long-term supply commitments, we believe we have good relationships with our metals suppliers. If, in the future, we are unable to obtain sufficient amounts of metals on a timely basis, we may not be able to obtain metals from alternate sources at competitive prices. In addition, interruptions or reductions in our supply of metals could make it difficult to satisfy our customers’ just-in-time delivery requirements, which could have a material adverse effect on our business, financial condition, results of operations and cash flows.

 

 

Competition

 

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

 

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

 

 

Management Information Systems

 

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

 

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Our information systems focus on the following core application areas:

 

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

 

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

 

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

 

System and Process Enhancements. We have completed development of business system solutions to replace our legacy information systems and have successfully implemented new ERP systems at most of our locations and have decommissioned three legacy systems as of December 31, 2017. We continue to implement these systems to provide standardized business processes, enhanced inventory management, production cost, and sales administrative controls, and reduced technical support requirements. Our business analysts work with our quality team to identify opportunities for efficiency and improved customer service. We collaborate across the metal supply chain, working with metals producers, service providers, customers, and industry-sponsored organizations to develop industry processing standards to drive cost out of the supply chain.

 

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

 

 

Employees

 

At December 31, 2017, we employed approximately 1,670 people. Approximately 280 of the hourly plant personnel are represented by nine separate collective bargaining units. The table below shows the expiration dates of the collective bargaining agreements.

 

Facility

Expiration date

Duluth, Minnesota

December 21, 2017

St. Paul, Minnesota

May 25, 2018

Milan, Illinois

August 12, 2018

Locust, North Carolina

March 4, 2020

Romeoville, Illinois

May 31, 2020

Minneapolis, Minnesota (coil)

September 30, 2020

Indianapolis, Indiana

January 29, 2021

Minneapolis, Minnesota (plate)

March 31, 2022

Detroit, Michigan

August 31, 2022

 

 

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. Negotiations are currently on-going for our collective bargaining unit in Duluth, Minnesota.

 

10

 

 

Service Marks, Trade Names and Patents

 

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

 

We also hold a trademark for our stainless steel sheet and plate product “OLY-FLATBRITE,” which has a unique combination of surface finish and flatness.

 

 

Government Regulation

 

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

 

 

Environmental

 

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

 

 

Seasonality

 

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

 

 

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 has not had a material effect on our financial results during the past three years. We expect transportation expenses to increase in excess of general inflation in 2018 due to the Electronic Log Device mandate by the Federal Motor Carrier Safety Administration issued in 2017.

 

 

Backlog

 

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

 

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Available Information

 

We file annual, quarterly, and current reports, proxy statements, and other documents with the SEC under the Securities Exchange Act of 1934. The public may read and copy any materials filed with the SEC at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. Also, the SEC maintains an Internet website that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. The public can obtain any documents that are filed by the Company at http://www.sec.gov.

 

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

 

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

 

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Forward-Looking Information

 

This Annual Report on Form 10-K and other documents we file with the SEC contain various forward-looking statements that are based on current expectations, estimates, forecasts and projections about our future performance, business, our beliefs and our management’s assumptions. In addition, we, or others on our behalf, may make forward-looking statements in press releases or written statements, or in our communications and discussions with investors and analysts in the normal course of business through meetings, conferences, webcasts, phone calls and conference calls. Words such as “may,” “will,” “anticipate,” “should,” “intend,” “expect,” “believe,” “estimate,” “project,” “plan,” “potential,” and “continue,” as well as the negative of these terms or similar expressions are intended to identify forward-looking statements, which are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are subject to certain risks and uncertainties that could cause our actual results to differ materially from those implied by such statements including, but not limited to, those set forth in Item 1A (Risk Factors) below and the following:

 

 

general and global business, economic, financial and political conditions;

 

competitive factors such as the availability, global production levels and pricing of metals, industry shipping and inventory levels and rapid fluctuations in customer demand and metals pricing;

 

cyclicality and volatility within the metals industry;

 

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

 

the levels of imported steel in the United States and any associated and threatened tariffs and duties;

 

the availability and rising costs of transportation and logistical services;

 

the successes of our efforts and initiatives to increase sales and earnings, maintain or improve working capital turnover and free cash flows, improve our customer service, and achieve cost savings;

 

our ability to generate free cash flow through operations and repay debt within anticipated time frames;

 

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

 

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

 

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

 

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

 

the successes of our operational initiatives to improve our operating, cultural and management systems and reduce our costs;

 

the ability to comply with the terms of our asset-based credit facility;

 

the ability of our customers and third parties to honor their agreements related to derivative instruments;

 

customer, supplier and competitor consolidation, bankruptcy or insolvency;

 

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

 

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

 

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

 

the ability of our customers (especially those that may be highly leveraged, and those with inadequate liquidity) to maintain their credit availability;

 

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

 

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

 

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

 

access to capital and global credit markets;

 

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

 

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

 

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

 

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

 

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.

 

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ITEM 1A.  RISK FACTORS

 

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

 

Risks Related to our Business

 

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

 

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

 

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

 

Government actions during 2017, imposing tariffs on imports from certain countries and the pending Section 232 investigation by the Commerce Department, which may impose trade actions on imported steel and aluminum, has led to increased metals prices. Although the tariffs slowed imports from the countries impacted by the tariffs, imports from other countries increased in 2017 while awaiting the outcome of the Section 232 investigation. Any future tariffs or quotas imposed on steel and aluminum imports may increase the price of metal, which may impact our sales, gross margin and profitability if we are unable to pass the increased prices onto our customers.

 

 

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

 

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

 

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Approximately 51.0% of our 2017 consolidated net sales were to industrial machinery and equipment manufacturers and their fabrications. Due to the concentration of customers in the industrial machinery and equipment industry, a decline in production levels in that industry could result in lower sales, gross profits and profitability. Approximately 9.0% of our 2017 consolidated net sales were to automotive manufacturers or manufacturers of automotive components and parts, whom we refer to as automotive customers. Historically, due to the concentration of customers in the automotive industry, our gross profits on these sales have generally been less than our gross profits on sales to customers in other industries.

 

 

We depend, in part, on third parties for transportation services, and increases in costs or the availability of transportation could adversely affect our business and operations, as we may be unable to pass cost increases on to our customers.

 

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

 

If any of these providers were to fail to deliver raw materials to us in a timely manner, we may be unable to process and deliver our products in response to customer demand. In addition, if any of these third parties were to cease operations or cease doing business with us, we may be unable to replace them at a reasonable cost. In addition, such failure of a third-party transportation provider could harm our reputation, negatively affect our customer relationships and have a material adverse effect on our financial position and results of operations.

 

Changes to, or new, regulations within the transportation industry, such as the Electronic Log Device mandate by the Federal Motor Carrier Safety Administration issued in 2017, which would impact the availability of drivers, may increase our cost of transportation which may have a material adverse effect on our financial position and results of operations.

 

 

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

 

We have derived and expect to continue to derive a significant portion of our revenues from a relatively limited number of customers. Collectively, our top three customers accounted for approximately 8.0% and 8.9% of our consolidated net sales in 2017 and 2016, respectively. Many of our larger customers commit to purchase on a regular basis at agreed upon prices over periods from three to twelve months. We generally do not have long-term contracts with our customers. As a result, the relationship, as well as particular orders, can generally be terminated with relatively little advance notice. The loss of any one of our major customers or decrease in demand by those customers or credit constraints placed on them could have a material adverse effect on our business, our results of operations and our cash flows.

 

 

An interruption in the sources of our metals supply could have a material adverse effect on our results of operations.

 

In recent years, the metals producing supply base has experienced significant consolidation with a few domestic producers accounting for a majority of the domestic metals market. Collectively, we purchased approximately 53% and 54% of our total metals requirements from our three largest suppliers in 2017 and 2016, respectively. The number of available suppliers could be reduced in the future by factors such as further industry consolidation or bankruptcies affecting metals suppliers. Additionally, fewer available suppliers increases the risk of supply disruption through both scheduled and unscheduled supplier outages. We have no long-term supply commitments with our metals suppliers. If, in the future, we are unable to obtain sufficient amounts of metals on a timely basis, we may not be able to obtain metals from alternate sources at competitive prices. In addition, late deliveries, interruptions or reductions in our supply of metals could make it difficult to satisfy our customers’ just-in-time delivery requirements, which could have a material adverse effect on our business, financial condition, results of operations and cash flows.

 

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Conversely, the addition of new mill sources and decreased domestic demand could lead to domestic over capacity, which could lead to a decrease in steel prices.

 

 

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

 

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

 

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

 

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

 

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

 

 

We may not be able to retain or expand our customer base as the U.S. manufacturing industry continues to fluctuate.

 

Our customer base primarily includes manufacturing and industrial firms in the United States, some of which are, or have considered, relocating production operations outside the United States or outsourcing particular functions outside the United States. Our facilities are primarily located in the United States and, therefore, to the extent that our customers relocate or move operations where we do not have a presence, we could lose their business. 

 

 

Processing equipment investments at our existing locations may be unable to achieve expected results, and events or circumstances that could adversely impact the successful operation of new processing equipment and operations could have a material adverse effect on our results of operations.

 

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

 

 

a significant use of management and employee time;

 

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

 

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

 

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

 

 

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

 

Our success is dependent upon the management and leadership skills of our senior management team. We have employment agreements, which include non-competition provisions, with our Chief Executive Officer, our President, the President of CTI, our Executive Vice President and Chief Operating Officer and our Chief Financial Officer that expire on December 31, 2018, December 31, 2020, June 30, 2021, July 1, 2020 and January 1, 2021, respectively. During 2017, we further enhanced our management team by the promotions of several employees to senior management positions within the organization. The loss of any member of our senior management team or the failure to attract and retain additional qualified personnel could prevent us from implementing our business strategy.

 

 

Risks associated with our growth strategy may adversely impact our ability to sustain our growth.

 

Historically, we have grown internally by increasing sales and services to our existing customers, aggressively pursuing new customers and services, building or purchasing new facilities and acquiring and upgrading processing equipment in order to expand the range of customer services and products that we offer. In addition, we have grown through the acquisition of other service centers and related businesses. We intend to actively pursue our growth strategy in the future.

 

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

 

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

 

 

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

 

Increased global information technology security requirements, vulnerabilities, threats and a rise in sophisticated and targeted cyber crime pose a risk to the security of our systems, networks and the confidentiality, availability and integrity of our data. Despite our efforts to protect sensitive information and confidential and personal data, our facilities and systems and those of our third-party service providers may be vulnerable to security breaches. This could lead to disclosure, modification or destruction of proprietary and other key information, production downtimes and operational disruptions, which in turn could adversely affect our results of operations. We may face greater risks in this area than our competitors as we implement the ERP system because among other things, we must simultaneously protect both the ERP and legacy systems until the ERP project is complete.

 

 

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

 

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

 

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

 

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

 

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

 

 

We may not achieve the expected results of our operating expense and inventory management initiatives.

 

We actively manage our operating expenses and our inventory in an effort to enhance margins and profitability. The risks associated with these efforts include a significant use of management and employee time, the possibility that the efforts do not meet expectations and the possibility that our efforts do not provide the expected or sustained economic results. Difficulties associated with managing our operating expenses and inventory could adversely affect our business, our customer service, our results of operations and our cash flows.

 

 

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

 

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

 

 

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

 

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

 

The borrowings under our credit facility are primarily at variable interest rates. If interest rates in the future were to increase 100 basis points (1.0%) from December 31, 2017 rates and, assuming no change in total debt from December 31, 2017 levels, the additional annual interest expense to us would be approximately $2.0 million.

 

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

 

At December 31, 2017, we employed approximately 1,670 people. Approximately 280 of the hourly plant personnel are represented by nine separate collective bargaining units. Negotiations are currently on-going for our collective bargaining unit in Duluth, Minnesota, whose contract expired December 31, 2017. Any prolonged work stoppages by our personnel represented by collective bargaining units could have a material adverse impact on our business, financial condition, results of operations and cash flows.

 

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

 

 

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

 

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

 

 

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

 

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

 

 

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

 

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

 

 

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

 

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

 

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

 

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

 

 

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

 

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

 

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

 

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

 

 

Risks Related to Our Common Stock

 

 

The market price for our common stock may be volatile.

 

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

 

 

changes in commodity prices, especially metals;

 

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

 

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

 

developments affecting us, our customers or our suppliers;

 

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

 

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

 

sales of our common stock by large shareholders;

 

the amount of shares acquired for short-term investments;

 

general domestic or international economic, market and political conditions;

 

fluctuations in the value of the US dollar;

 

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

 

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

 

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

 

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

 

 

Our quarterly results may be volatile.

 

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

 

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

 

 

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

 

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

 

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

 

 

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

 

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

 

limit who can call a special meeting of shareholders; and

 

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

 

21

 

 

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

 

 

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

 

Michael D. Siegal, our Chief Executive Officer and Chairman of the Board and one of our largest shareholder, owned approximately 11.2% of our outstanding common stock as of December 31, 2018. Mr. Siegal may have the ability to significantly influence matters requiring shareholder approval. In deciding how to vote on such matters, Mr. Siegal may be influenced by interests that conflict with yours.

 

 

ITEM 1B.  UNRESOLVED STAFF COMMENTS

 

None.

 

22

 

 

ITEM 2.  PROPERTIES

 

We believe that our properties are strategically situated relative to our domestic suppliers, our customers and each other, allowing us to support customers from multiple locations. Product is shipped from the most advantageous facility, regardless of where the customer order is taken. The facilities are located in the hubs of major metals consumption markets, and within a 250-mile radius of most of our customers, a distance approximating the one-day driving and delivery limit for truck shipments. During 2017, we ceased operations at our Siler City, North Carolina facility and the building is currently held for sale. In addition, we terminated the lease on the Oklahoma City, Oklahoma warehouse facility in 2017.

 

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

 

 

Segment

Operation

Location

Square

Feet

 

Function

Owned or

Leased

Carbon

Specialty Metals

Pipe

and

Tube

Cleveland

Bedford Heights, Ohio (1)

       127,000

 

Corporate offices, coil processing and distribution center

Owned

 

 
 

Bedford Heights, Ohio (1)

       121,500

 

Coil and plate processing, distribution center and offices

Owned

 

Bedford Heights, Ohio (1)

         59,500

 

Plate processing, distribution center and offices

Leased (2)

   
 

Dover, Ohio

         62,000

 

Plate processing, fabrication and distribution center

Owned

   

Minneapolis

Plymouth, Minnesota

       196,800

 

Coil and plate processing, distribution center and offices

Owned

 
 

Plymouth, Minnesota

       112,200

 

Plate processing, fabrication, distribution center and offices

Owned

   

Chambersburg

Chambersburg, Pennsylvania

       157,000

 

Plate processing, distribution center and offices

Owned

   
 

Chambersburg, Pennsylvania

       150,000

 

Plate processing, fabrication, distribution center and offices

Owned

   

Iowa

Bettendorf, Iowa

       244,000

 

Coil and plate processing, fabrication, distribution center and offices

Owned

   

Winder

Winder, Georgia

       285,000

 

Coil and plate processing, fabrication, distribution center and offices

Owned

Detroit

Detroit, Michigan

       256,000

 

Coil processing, distribution center and offices

Owned

 

Kentucky

Mt. Sterling, Kentucky

       100,000

 

Plate processing, fabrication and distribution center

Owned

   
 

Mt. Sterling, Kentucky

       107,000

 

Distribution center and offices

Owned (3)

 

Gary

Gary, Indiana

       183,000

 

Coil processing, distribution center and offices

Owned

   

Connecticut

Milford, Connecticut

       134,000

 

Coil processing, distribution center and offices

Owned

 

Chicago

Schaumburg, Illinois

         80,500

 

Coil and sheet processing, distribution center and offices

Owned

 

Streetsboro

Streetsboro, Ohio

         66,200

 

Coil and sheet processing, distribution center and offices

Owned

   
 

Latrobe, Pennsylvania

         43,200

 

Coil and sheet processing, distribution center

Leased (4)

   

Washington

Moses Lake, Washington

         14,000

 

Distribution center

Leased (5)

   

Mexico

Monterrey, Mexico

         60,000

 

Distribution center

Leased (6)

Chicago

Romeoville, Illinois

363,000

 

Corporate offices, fabrication and distribution center

Owned

   

St. Paul

St. Paul, Minnesota

132,000

 

Distribution center and offices

Owned

 

Charlotte

Locust, North Carolina

127,600

 

Distribution center, fabrication and offices

Owned

 

 

23

 

 

           

Segment

Operation

Location

Square

Feet

 

Function

Owned or Leased

Carbon

Specialty Metals

Pipe

and

Tube

Fond du Lac

Fond du Lac, Wisconsin

117,000

 

Distribution center and offices

Owned

 

Indianapolis

Indianapolis, Indiana

79,000

 

Distribution center and offices

Owned

   

Quad Cities

Milan, Illinois

57,600

 

Distribution center and offices

Owned

   

Des Moines

Ankeny, Iowa

50,000

 

Distribution center and offices

Owned

   

Duluth

Proctor, Minnesota

45,202

 

Distribution center and offices

Leased (7)

   

Owatonna

Owatonna, Minnesota

23,000

 

Production cutting center

Owned

   

 

(1)

The Bedford Heights facilities are all adjacent properties.

(2)

This facility is leased from a related party. The lease expires on December 31, 2018, with renewal options.

(3)

50% of the facility is leased on a month-to-month basis to an unrelated party.

(4)

The lease on this facility expires on May 1, 2019.

(5)

The Moses Lake location is comprised of two different facilities located in Moses Lake and Quincy, Washington. The facilities are leased on a month-to-month basis.

(6)

The lease on this facility expires on August 31, 2021. 75% of the facility is leased to an unrelated party whose lease expires on May 31, 2018 with renewal options.

(7)

The lease on this facility expires on April 30, 2019.

 

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

 

 

ITEM 3.  LEGAL PROCEEDINGS

 

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

 

 

ITEM 4.  MINE SAFETY DISCLOSURES

 

Not applicable.

 

24

 

 

EXECUTIVE OFFICERS OF THE REGISTRANT

 

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

 

Michael D. Siegal, age 65, has served as our Chief Executive Officer since 1984 and as Chairman of our Board of Directors since 1994.  From 1984 until January 2001, he also served as our President.  He has been employed by us in a variety of capacities since 1974. Mr. Siegal serves on the Board of Directors of Cleveland-Cliffs, Inc. He is also the immediate past Board Chair of the Jewish Federations of North America and is currently on the Board of the Development Corporation for Israel and the Chair of the Board of Trustees of the Jewish Agency for Israel.

 

David A. Wolfort, age 65, has served as our President since January 2001 and as a director since 1987. He previously served as Chief Operating Officer from 1995 to 2016 and as Vice President Commercial from 1987 to 1995, after having joined us in 1984 as General Manager. Prior thereto, he spent eight years with a primary steel producer in a variety of sales assignments. Mr. Wolfort serves as a member of the United States Industry Trade Advisory Committee on Steel. He previously served on the board of directors of the MSCI and was a past Chairman of both the MSCI Political Action Committee and the MSCI Governmental Affairs Committee. He was previously a Trustee and Chair of Ohio University Board of Trustees and is a current Trustee of the Musical Arts Association (Cleveland Orchestra), where he serves as Vice Chairman of the Human Resources Committee, and is a member of the Finance Committee.

 

Andrew S. Greiff, age 56, has served as our Executive Vice President and Chief Operating Officer since August 2016. He previously served as President, Specialty Metals from 2011 to 2016 after having joined us in 2009 as Vice President of Specialty Metals. Prior thereto, Mr. Greiff spent 24 years in various positions within the steel industry and served as the President and CEO of his own steel trading company. Mr. Greiff is a past director of Hawken School and the MSCI Specialty Metals Product Council.

 

Richard T. Marabito, age 54, serves as our Chief Financial Officer. He joined us in 1994 as Corporate Controller and served in this capacity until being named Chief Financial Officer in March 2000. He also served as Treasurer from 1994 through 2002 and again from 2010 through 2012. Prior to joining us, Mr. Marabito served as Corporate Controller for a publicly traded wholesale distribution company and was employed by a national accounting firm in its audit department. Mr. Marabito is a Governance board member of the Make-A-Wish Foundation of Ohio, Kentucky and Indiana and also was the immediate past Chair of its Northeast Ohio regional board. Mr. Marabito serves on the Board of Trustees and was the Treasurer for Hawken School in Cleveland, Ohio. He is also a Vice Chair and Executive Committee member of the Metals Service Center Institute and is a past Chair of its Foundation for Education and Research.

 

Richard A. Manson, age 49, has served as our Vice President and Treasurer since January 2013 and has been employed by us since 1996.  From March 2010 through December 2012, he served as our Vice President of Human Resources and Administration.  From January 2003 through March 2010, he served as our Treasurer and Corporate Controller.  From 1996 through 2002, he served as our Director of Taxes and Risk Management.  Prior to joining us, Mr. Manson was employed for seven years by a national accounting firm in its tax department.  Mr. Manson is a Board Member of the West Side Catholic Center and the Cleveland Catholic Cemeteries Association.  Mr. Manson is a certified public accountant and member of the Ohio Society of Certified Public Accountants and the American Institute of Certified Public Accountants.

 

Donald McNeeley, age 63, has served as the President of CTI, a wholly owned subsidiary of Olympic Steel, Inc., since the acquisition on July 1, 2011.   He joined CTI in 1972 and has held several operational and executive positions within the company. After serving as CTI’s Vice President of Operations and subsequently Executive Vice President, in 1990, Dr. McNeeley was appointed President and Chief Operating Officer. He is a former Chairman of the Metals Service Center Institute.  Dr. McNeeley is an adjunct professor at Northwestern University where he teaches in the graduate engineering program.  He serves on the board of directors of Saulsbury Industries in Odessa, Texas, where he chairs the Audit Committee. Dr. McNeeley also serves on the board of directors of Vail Rubber Industries in St. Joseph, Michigan, and is a former director of The Committee for Monetary Research in Greenwich, Connecticut.  

 

25

 

 

PART II

 

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

 

Price Range of Common Stock

 

Our common stock trades on the Nasdaq Global Select Market under the symbol “ZEUS.” The following table sets forth, for each quarter in the two-year period ended December 31, 2017, the high and low sales prices of our common stock as reported by the Nasdaq Global Select Market:

 

   

2017

   

2016

 
   

High

   

Low

   

High

   

Low

 

First quarter

  $ 27.93     $ 18.05     $ 17.50     $ 7.98  

Second quarter

    24.00       15.83       27.48       15.41  

Third quarter

    22.44       16.58       31.19       17.42  

Fourth quarter

    22.86       18.10       28.67       17.14  

 

 

Holders of Record

 

As of February 1, 2018, we estimate there were approximately 41 holders of record and 4,973 beneficial holders of our common stock.

 

 

Dividends

 

During 2017, our Board of Directors approved regular quarterly dividends of $0.02 per share that were paid on March 15, 2017, June 15, 2017, September 15, 2017 and December 15, 2017.

 

During 2016, our Board of Directors approved regular quarterly dividends of $0.02 per share that were paid on March 15, 2016, June 15, 2016, September 15, 2016 and December 15, 2016.

 

We expect to make regular quarterly dividend distributions in the future, subject to the continuing determination by our Board of Directors that the dividend remains in the best interest of our shareholders. Our asset-based credit facility (the Loan Agreement) restricts the aggregate amount of dividends and common stock repurchases that we can pay to $5.0 million annually without limitations. Dividend distributions in excess of $5.0 million require us to (i) maintain availability in excess of 20.0% of the aggregate revolver commitments or (ii) to maintain availability equal to or greater than 15.0% of the aggregate revolver commitments, and we must maintain a pro-forma ratio of EBITDA minus certain capital expenditures and cash taxes paid to fixed charges of at least 1.00 to 1.00. Any determinations by the Board of Directors to pay cash dividends in the future will take into account various factors, including our financial condition, results of operations, current and anticipated cash needs, plans for expansion and restrictions under our credit agreement and any agreements governing our future debt. We cannot assure you that dividends will be paid in the future or that, if paid, the dividends will be at the same amount or frequency.

 

 

Issuer Purchases of Equity Securities

 

We did not purchase any of our equity securities during the quarter ended December 31, 2017.

 

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

 

 

Recent Sales of Unregistered Securities

 

We did not have any unregistered sales of equity securities during the quarter ended December 31, 2017.

 

26

 

 

ITEM 6.  SELECTED FINANCIAL DATA

 

The following table sets forth selected financial and other data for each of the five years in the period ended December 31, 2017. The data presented should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the consolidated financial statements and notes thereto included elsewhere in this Annual Report on Form 10-K.

 

 

    For the Years Ended December 31,  
       
   

2017

   

2016

   

2015

   

2014

   

2013

 
   

(in thousands, except per share data)

 
                                         

Income Statement Data:

                                       

Net sales

  $ 1,330,696     $ 1,055,116     $ 1,175,543     $ 1,436,270     $ 1,263,331  

Cost of materials sold

    1,055,212       820,040       942,214       1,160,310       999,207  

Gross profit (a)

    275,484       235,076       233,329       275,960       264,124  

Operating expenses (b)

    251,498       229,328       236,157       261,332       244,469  

Goodwill and intangible asset impairment

    -       -       24,951       23,836       -  

Operating income (loss)

    23,986       5,748       (27,779 )     (9,208 )     19,655  

Interest and other expense on debt

    7,518       5,273       5,690       6,780       6,703  

Income (loss) before income taxes

    16,350       420       (33,594 )     (16,114 )     12,924  

Net income (loss) (c)

  $ 18,963     $ (1,078 )   $ (26,777 )   $ (19,064 )   $ 7,647  
                                         

Per Share Data:

                                       

Net income (loss) - basic (d)

  $ 1.67     $ (0.10 )   $ (2.39 )   $ (1.71 )   $ 0.69  

Net income (loss) - diluted (e)

  $ 1.67       (0.10 )     (2.39 )     (1.71 )     0.69  

Dividends paid

  $ 0.08     $ 0.08     $ 0.08     $ 0.08     $ 0.08  
                                         

Shares Outstanding:

                                       

Weighted average shares - basic

    11,381       11,210       11,192       11,120       11,065  

Weighted average shares - diluted

    11,381       11,210       11,192       11,120       11,074  
                                         
                                         

Balance Sheet Data (as of December 31):

                                       

Current assets (f)

  $ 420,136     $ 364,940     $ 308,946     $ 458,709     $ 417,631  

Current liabilities (f)

    111,147       104,898       77,060       131,977       165,633  

Working capital (g)

    308,989       260,042       231,886       326,732       251,998  

Total assets (f)

    604,158       556,068       511,880       699,154       695,375  

Total debt

    197,165       166,424       148,490       247,620       199,269  

Shareholders' equity

  $ 272,583     $ 253,390     $ 254,695     $ 280,781     $ 298,616  

 

 

(a)

Gross profit is calculated as net sales less the cost of materials sold (includes LIFO expense of $2,707 in 2017, LIFO income of $1,489 and $3,347 in 2016 and 2015, respectively, LIFO expense of $365 in 2014 and LIFO income of $3,572 in 2013).

(b)

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

(c)

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

(d)

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

(e)

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

(f)

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

(g)

Calculated as current assets less current liabilities.

 

27

 

 

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

 

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from the results discussed in the forward-looking statements. Factors that might cause a difference include, but are not limited to, those discussed under Item 1A, Risk Factors in this Annual Report on Form 10-K. The following section is qualified in its entirety by the more detailed information, including our financial statements and the notes thereto, which appears elsewhere in this Annual Report.

 

Overview

 

We are a leading metals service center that operates in three reportable segments; carbon flat products, specialty metals flat products, and tubular and pipe products. We provide metals processing and distribution services for a wide range of customers. Our carbon flat products segment’s focus is on the direct sale and distribution of large volumes of processed carbon and coated flat-rolled sheet, coil and plate products and fabricated parts. 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. In addition, we distribute metal tubing, pipe, bar, valves and fittings and fabricate pressure parts supplied to various industrial markets. 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, Mexico and Central and South America. International sales are immaterial to our consolidated financial results and to the individual segments’ results.

 

Our results of operations are affected by numerous external factors including, but not limited to: general and global business, economic, financial, banking and political conditions; fluctuations in the value of the U.S. dollar to foreign currencies, competition; metals pricing, demand and availability; transportation and energy costs; pricing and availability of raw materials used in the production of metals; global supply, the level of metals imported into the United States, and inventory held in the supply chain; 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.  We have entered into nickel and carbon 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.

 

Reportable Segments

 

The Company operates in three reportable segments; carbon flat products, specialty metals flat products and tubular and pipe products. The carbon flat products segment and the specialty metals flat products 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.

 

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. 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 20 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 nine 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.

 

29

 

 

Results of Operations

 

2017 Compared to 2016

 

Our results of operations are impacted by the market price of metals. Over the past 24 months, metals prices 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. Metals market prices in December 2017 were approximately 7% and 77% higher than metals market prices in December of 2016 and 2015, respectively. Average quarterly metals market prices during 2017 have remained relatively flat after increasing in the first quarter of 2017 and were higher than the average quarterly metals market prices in the comparable quarters of 2016.

 

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. Our year-over-year net sales and earnings comparisons were positively impacted by the price increases, improved customer demand, and increased sales volume of products that we sell in 2017.

 

During the second quarter of 2017, we announced the permanent closure of our carbon flat products segment’s Siler City, North Carolina operation. The facility ceased operations in the third quarter of 2017. The land and building associated with the operation is classified as Assets held for sale on the accompanying December 31, 2017 Consolidated Balance Sheet. The operating loss related to the Siler City, North Carolina operation was $1.4 million in 2017.

 

The following table sets forth certain consolidated income statement data for the years ended December 31, 2017 and 2016 (dollars shown in thousands):

 

   

2017

   

2016

 
    $    

% of net sales

    $    

% of net sales

 

Net sales

  $ 1,330,696       100.0     $ 1,055,116       100.0  

Cost of materials sold (a)

    1,055,212       79.3       820,040       77.7  

Gross profit (b)

    275,484       20.7       235,076       22.3  

Operating expenses (c)

    251,498       18.9       229,328       21.7  

Operating income

    23,986       1.8       5,748       0.5  

Other loss, net

    (118 )     (0.0 )     (55 )     (0.0 )

Interest and other expense on debt

    7,518       0.6       5,273       0.5  

Income before income taxes

    16,350       1.2       420       0.0  

Income taxes (d)

    (2,613 )     (0.2 )     1,498       0.1  

Net income (loss)

  $ 18,963       1.4     $ (1,078 )     (0.1 )

 

(a)

Includes $2,707 of LIFO expense and $1,489 of LIFO income for 2017 and 2016, 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.  

(d)

2017 includes a $6.2 million tax benefit related to the U.S. Tax Cuts and Jobs Act

 

Net sales increased $275.6 million, or 26.1%, to $1.33 billion in 2017 from $1.06 billion in 2016. Carbon flat products net sales increased $198.6 million, or 29.6%, and were 65.4% of total net sales in 2017 compared to 63.6% in 2016. Specialty metals flat products net sales increased $37.3 million, or 19.6%, and were 17.1% of total net sales in 2017 compared to 18.0% in 2016. Tubular and pipe products net sales increased $39.7 million, or 20.4%, and were 17.6% of total net sales in 2017 compared to 18.4% of total net sales in 2016. The increase in sales for the year ended December 31, 2017 was due to an 11.3% increase in sales volume and a 13.3% increase in average selling prices. Average selling prices increased in all segments during 2017 compared to 2016 as market pricing for metals was higher year-over-year. During the year, we increased our market share for a majority of the product categories that we sell.

 

Cost of materials sold increased $235.2 million, or 28.7%, to $1.06 billion in 2017 from $820.0 million in 2016. During 2017, we recorded LIFO expense of $2.7 million compared to LIFO income of $1.5 million in 2016. The increase in cost of materials sold in 2017 is due to the increased sales volume and increased metals costs of 15.6% during 2017.

 

30

 

 

As a percentage of net sales, gross profit (as defined in footnote (b) in the table above) decreased to 20.7% in 2017 from 22.3% in 2016. Gross profit as a percentage of net sales decreased in the carbon flat products segment to 20.2% from 21.2% in 2016, in the specialty metals flat products segment to 14.5% in 2017 from 15.7% in 2016 and in the tubular and pipe products segment to 28.5% from 32.6% in 2016. LIFO expense decreased gross profit by 0.2% of net sales in 2017 and the LIFO income increased gross profit by 0.1% of net sales in 2016. The decrease in gross profit as a percentage of net sales during 2017 was due to the cost of materials sold increasing more than selling prices in all segments and the increase of carbon flat products sales as a percentage of total net sales.

 

Operating expenses (as defined in footnote (c) in the table above) increased $22.2 million, or 9.7%, to $251.5 million in 2017 from $229.3 million in 2016. As a percentage of net sales, operating expenses decreased to 18.9% in 2017 from 21.7% in 2016. Variable operating expenses, such as distribution and warehouse and processing, increased primarily related to the 11.3% volume increase. Distribution expense, in addition to the volume increase, increased as a result of the continued inflationary pressures for freight. Warehouse and processing costs increased $7.9 million, or 9.9%, and distribution expense increased by $5.3 million, or 14.5%. Selling and administrative and general costs increased $9.8 million, or 11.4%, primarily related to increased variable based incentive compensation based on increased sales volumes and profitability. Depreciation expense decreased $1.0 million, or 5.7%, as a result of certain assets being fully depreciated in 2017. Operating expenses in the carbon flat products segment increased $11.7 million, operating expenses in the specialty metals products segment increased $1.9 million, operating expenses in the tubular and pipe products segment increased $6.3 million, and Corporate expenses increased $2.3 million.

 

Interest and other expense on debt totaled $7.5 million in 2017 compared to $5.3 million in 2016. Our effective borrowing rate, exclusive of deferred financing fees and commitment fees, was 3.0% in 2017 compared to 2.4% in 2016 due to the increases in LIBOR rates since 2016. Total average borrowings increased $48 million, or 31.5%, from $152.5 million in 2016 to $200.6 million in 2017, primarily related to increased working capital needs in 2017.

 

Income before income taxes totaled $16.4 million in 2017 compared to $0.4 million in 2016.

 

An income tax benefit of (16.0%) was recorded for 2017, compared to an income tax provision of 356.6% in 2016. On December 22, 2017, the President of the United States signed the Tax Cuts and Jobs Act, or the Tax Act. The Tax Act, among other things, lowered the U.S. corporate income tax rate from 35% to 21% effective January 1, 2018. As a result, our 2017 effective tax rate included a one-time $6.2 million benefit from a revaluation of our deferred tax liability to the new corporate income tax rate. The net benefit recorded was based on currently available information and interpretations of applying the provisions of the 2017 Tax Act as of the time of filing this Annual Report on Form 10-K. In accordance with Staff Accounting Bulletin, or SAB, No. 118 issued by the Securities and Exchange Commission, or SEC, the income tax effect for certain aspects of the Tax Act represent provisional amounts for which our accounting is incomplete but a reasonable estimate could be determined and recorded during the fourth quarter of 2017. The 2017 effective tax rate also included an out-of-period adjustment to correct and record previously unrecognized deferred tax assets, and the associated tax benefit, related to our supplemental executive retirement plan recorded in the first quarter of 2017. The adjustment, which has accumulated since the inception of the plan in 2005, resulted in an increase to after-tax income of $1.9 million. The effective tax rate was disproportionately high in 2016 due to low income before taxes relative to items that impact the effective tax rate. The 2016 effective income tax rate was also impacted by increased valuation allowances and non-deductible expenses.

 

Net income for 2017 totaled $19.0 million, or $1.67 per basic and diluted share, compared to net loss of $1.1 million, or $0.10 per basic and diluted share, for 2016.

  

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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 ended December 31, 2017 and 2016 (dollars shown in thousands, except per ton data):

 

   

2017

   

2016

 
         

% of net

sales

         

% of net

sales

 

Direct tons sold

    1,060,002               952,888          

Toll tons sold

    87,748               73,880          

Total tons sold

    1,147,750               1,026,768          
                                 

Net sales

  $ 869,628       100.0     $ 670,983       100.0  

Average selling price per ton

    758               653          

Cost of materials sold

    693,742       79.8       529,021       78.8  

Gross profit (a)

    175,886       20.2       141,962       21.2  

Operating expenses (b)

    158,000       18.2       146,333       21.8  

Operating income (loss)

  $ 17,886       2.0     $ (4,371 )     (0.6 )

 

(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 121 thousand tons, or 11.8%, to 1.15 million tons in 2017 from 1.03 million tons in 2016. Toll tons sold increased 14 thousand tons, or 18.8% to 88 thousand tons in 2017 from 74 thousand tons in 2016. The increase in tons sold is due to improved customer demand in the markets we serve and improved industry-wide shipments by U.S. service centers in 2017 compared to 2016. The improved customer demand enabled us to grow our market share in most of the carbon flat products categories we sell.

 

Net sales increased $198.6 million, or 29.6%, to $869.6 million in 2017 from $671.0 million in 2016. Average selling prices in 2017 increased 15.9% to $758 per ton, compared to $653 per ton in 2016. The increase in sales was due to the 15.9% increase in average selling prices and the 11.8% increase in sales volume. The increase in the average selling price is a result of higher prices in the metals industry during 2017 as discussed in the overview of Results of Operations above. We expect carbon flat metals market prices in the first quarter of 2018 to increase over the prices in the fourth quarter of 2017.

 

Cost of materials sold increased $164.7 million, or 31.1%, to $693.7 million in 2017 from $529.0 million in 2016. The increase in cost of materials sold was due to a 17.3% increase in the average cost of materials sold per ton during 2017 compared to 2016 and the 11.8% increase in sales volume.

 

As a percentage of net sales, gross profit (as defined in footnote (a) in the table above) decreased to 20.2% in 2017 from 21.2% in 2016. The average gross profit per ton sold increased $15 per ton to $153 in 2017 from $138 in 2016.

 

Operating expenses in 2017 increased $11.7 million, or 8.0%, to $158.0 million from $146.3 million in 2016. As a percentage of net sales, operating expenses decreased to 18.2% for 2017 from 21.8% in 2016. The percentage increase in operating expenses in 2017 were less than the volume increases during the year. Variable operating expenses, such as distribution and warehouse and processing, increased as a result of increased sales volume and distribution cost inflation. Selling and administrative and general expenses increased primarily as a result of increased variable performance based incentive compensation.

 

Operating income for 2017 totaled $17.9 million compared to operating loss of $4.4 million in 2016.

  

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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 December 31, 2017 and 2016 (dollars shown in thousands, except per ton data):

 

   

2017

   

2016

 
         

% of net

sales

         

% of net

sales

 

Direct tons sold

    90,106               82,156          

Toll tons sold

    54               129          

Total tons sold

    90,160               82,285          
                                 

Net sales

  $ 227,200       100.0     $ 189,930       100.0  

Average selling price per ton

    2,520               2,308          

Cost of materials sold

    194,199       85.5       160,185       84.3  

Gross profit (a)

    33,001       14.5       29,745       15.7  

Operating expenses (b)

    21,761       9.6       19,904       10.5  

Operating income

  $ 11,240       4.9     $ 9,841       5.2  

 

(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 increased 8 thousand tons, or 9.6%, to 90 thousand tons in 2017 from 82 thousand tons in 2016. The increase in tons sold is due to improved customer demand in the markets we serve. Industry-wide shipments increased in 2017 compared to 2016. The specialty metals flat products segment increased its market share in stainless products in 2017.

 

Net sales increased $37.3 million, or 19.6%, to $227.2 million in 2017 from $189.9 million in 2016. Average selling prices in 2017 increased to $2,520 per ton, compared to $2,308 per ton in 2016. The increase in the average selling price is a result of higher prices in the metals industry during 2017 as discussed in the overview of Results of Operations above. We expect stainless steel and aluminum market prices in the first quarter of 2018 to increase over the fourth quarter 2017 prices.

 

Cost of materials sold increased $34.0 million, or 21.2%, to $194.2 million in 2017 from $160.2 million in 2016. The increase in cost of materials sold was due to a 10.6% increase in the average cost of materials sold per ton during 2017 compared to 2016 and the 9.6% volume increase.

 

As a percentage of net sales, gross profit (as defined in footnote (a) in the table above) decreased to 14.5% in 2017 from 15.7% in 2016. The average gross profit per ton sold totaled $366 in 2017 compared to $361 per ton in 2016. The decrease in the gross profit percentage is a result of relatively flat gross margins per ton realized on higher average selling prices in 2017.

 

Operating expenses (as defined in footnote (b) in the table above) increased $1.9 million, or 9.3%, to $21.8 million in 2017 from $19.9 million in 2016. As a percentage of net sales, operating expenses decreased to 9.6% of net sales in 2017 from 10.5% in 2016. Variable operating expenses, such as distribution and warehouse and processing, increased as a result of increased sales volume and distribution cost inflation. Selling and administrative and general expenses increased primarily as a result of increased variable based incentive compensation related to the increased sales volume and gross profit.

 

Operating income for 2017 totaled $11.2 million compared to $9.8 million in 2016.

 

33

 

 

Tubular and pipe products

 

The following table sets forth certain income statement data for the tubular and pipe products segment for 2017 and 2016 (dollars shown in thousands).

 

   

2017

   

2016

 
   

$

   

% of net sales

   

$

   

% of net sales

 

Net sales

  $ 233,868       100.0     $ 194,203       100.0  

Cost of materials sold (a)

    167,271       71.5       130,834       67.4  

Gross profit (b)

    66,597       28.5       63,369       32.6  

Operating expenses (c)

    62,029       26.5       55,656       28.7  

Operating income

  $ 4,568       2.0     $ 7,713       3.9  

 

(a)

Includes $2,707 of LIFO expense and $1,489 of LIFO income in 2017 and 2016, 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 increased $39.7 million, or 20.4%, to $233.9 million in 2017 from $194.2 million in 2015. The increase in net sales was due to a 12.6% increase in average selling prices and a 6.9% increase in sales volume during 2017. The increase in volume was due to increased customer demand despite lower industry-wide shipments of pipe and tube products. The increase in the average selling price is a result of higher prices in the metals industry during 2017 as discussed in the overview of Results of Operations above. We expect tubular and pipe products market prices in the first quarter of 2018 to increase over the fourth quarter 2017 prices 

 

Cost of materials sold increased $36.5 million, or 27.8%, to $167.3 million in 2017 from $130.8 million in 2016. The increase in cost of materials sold was due to a 12.6% increase in sales volume and a 19.6% increase in the average cost of materials sold which was impacted by the LIFO expense of $2.7 million in 2017 compared to LIFO income of $1.5 million in 2016.

 

As a percentage of net sales, gross profit (as defined in footnote (b) in the table above) decreased to 28.5% in 2017 compared to 32.6%, in 2016. The LIFO expense decreased gross profit by 1.2% of net sales in 2017 compared to the LIFO income which increased gross profit by 0.8% of net sales in 2016. In addition, tubular and pipe products segment gross profit decreased as a result of a change in sales mix to more pipe and fitting products, which traditionally has a lower gross profit, from higher gross profit fabrication product sales.

 

Operating expenses (as defined in footnote (c) in the table above) increased $6.3 million, or 11.6%, to $62.0 million from $55.7 million in 2016. As a percentage of net sales, operating expenses decreased to 26.5% in 2017 compared to 28.7% in 2016. Operating expenses increased in 2017 primarily as a result of increased distribution expense related to increased shipments and distribution cost inflation, less labor and overhead capitalized into inventory, and increased variable incentive compensation related to increased gross profit and costs associated with a settlement of a commercial dispute.

 

Operating income for 2017 totaled $4.6 million, compared to an operating income of $7.7 million in 2016.

 

 

Corporate expenses

 

Corporate expenses increased $2.3 million, or 30.6%, to $9.7 million in 2017 compared to $7.4 million in 2016. The increase in corporate expenses is primarily attributable to increased variable performance based incentive compensation and, effective August 2016, when our President of Specialty Metals was appointed to the position of Executive Vice President and Chief Operating Officer, his associated costs were classified as Corporate expenses.

 

 

2016 Compared to 2015

 

During 2015, the hot-rolled carbon coil index pricing declined by approximately 36% as a result of the strengthened U.S. dollar, a historically high level of imported material arriving in the United States, low raw material costs to produce metals and a global oversupply of metals. The pricing environment in 2015 drove our average selling prices down and caused margins to be pressured as the average cost of inventory did not decrease as quickly as the average selling price, as we traditionally keep approximately two and a half to three months of inventory on hand.

 

34

 

 

During the first six months of 2016, the market price of metals increased and fully recovered the decrease experienced during 2015. Metals market pricing peaked in June 2016, and then decreased until November 2016. Metals prices in December 2016 were not as high as the June 2016 prices, but were more than 65% per ton higher than the December 2015 prices. Although prices increased during 2016, the average selling price during 2016 was still lower than the average selling price during 2015. 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. As sales volumes were relatively flat between the years, lower average selling prices were the driver for our decreased net sales in 2016. When the average selling price decreases, and net sales decreases, the gross profit and operating expenses as a percentage of net sales will generally increase.

 

The following table sets forth certain consolidated income statement data for the years ended December 31, 2016 and 2015 (dollars shown in thousands):

 

   

2016

   

2015

 
   

$

   

% of net sales

   

$

   

% of net sales

 

Net sales

  $ 1,055,116       100.0     $ 1,175,543       100.0  

Cost of materials sold (a)

    820,040       77.7       942,214       80.2  

Gross profit (b)

    235,076       22.3       233,329       19.8  

Operating expenses (c)

    229,328       21.7       236,157       20.1  

Goodwill and intangible asset impairment (d)

    -       (0.0 )     24,951       2.1  

Operating income (loss)

    5,748       0.5       (27,779 )     (2.4 )

Other loss, net

    (55 )     (0.0 )     (125 )     (0.0 )

Interest and other expense on debt

    5,273       0.5       5,690       0.5  

Income (loss) before income taxes

    420       0.0       (33,594 )     (2.9 )

Income taxes

    1,498       0.1       (6,817 )     (0.6 )

Net loss

  $ (1,078 )     (0.1 )   $ (26,777 )     (2.3 )

 

(a)

Includes $1,489 and $3,347 of LIFO income for 2016 and 2015, 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. Excludes goodwill and intangible asset impairment shown seperately below for comparability purposes.

(d)

The 2015 non-cash goodwill and intangible asset impairment charge is seperately displayed for operating expense comparability purposes. $24,451 of the impairment charge is related to the tubular and pipe products segment and $500 is related to the specialty metals flat products segment.

 

Net sales decreased $120.4 million, or 10.2%, to $1.06 billion in 2016 from $1.18 billion in 2015. Carbon flat products net sales decreased $94.4 million, or 12.3%, and were 63.6% of total net sales in 2016 compared to 65.1% in 2015. Specialty metals flat products net sales decreased $2.6 million, or 1.3%, and were 18.0% of total net sales in 2016 compared to 16.4% in 2015. Tubular and pipe products net sales decreased $23.4 million, or 10.8%, and were 18.4% of total net sales in 2016 compared to 18.5% of total net sales in 2015. The decrease in sales for the year ended December 31, 2016 was due to a 10.2% decrease in average selling prices as sales volumes were flat between years. Average selling prices decreased in all segments during 2016 compared to 2015 as market pricing for metals was still lower year-over-year. During 2016, we increased our market share for all of the product categories that we sell.

 

Cost of materials sold decreased $122.2 million, or 13.0%, to $820.0 million in 2016 from $942.2 million in 2015. During 2016, we recorded LIFO income of $1.5 million compared to LIFO income of $3.3 million recorded in 2015. The decrease in cost of materials sold in 2016 is due to the decreased metals costs of 12.9% during 2016 as sales volumes were flat between years.

 

As a percentage of net sales, gross profit (as defined in footnote (b) in the table above) increased to 22.3% in 2016 from 19.8% in 2015. Gross profit as a percentage of net sales increased in the carbon flat products segment to 21.2% in 2016 from 19.2% in 2015 and in the tubular and pipe products segment to 32.6% in 2016 from 32.5% in 2015. Gross profit as a percentage of net sales increased in the specialty metals flat products segment to 15.7% in 2016 from 8.2% in 2015. LIFO income increased gross profit by 0.1% and 0.3% of net sales in 2016 and 2015, respectively. The increase in gross profit as a percentage of net sales during 2016 was primarily due to the cost of materials sold decreasing more than selling prices in all segments.

 

35

 

 

Operating expenses (as defined in footnote (c) in the table above) decreased $6.8 million, or 2.9%, to $229.3 million in 2016 from $236.2 million in 2015. As a percentage of net sales, operating expenses increased to 21.7% in 2016 from 20.1% in 2015. Warehouse and processing costs decreased $5.9 million, or 6.9%, primarily due to reductions in labor hours worked. Administrative costs decreased by $1.9 million, or 3.0%, primarily related to reductions in labor and personnel expenses and lower variable based incentive compensation. Distribution expense increased by $0.4 million, or 1.2%, on flat sales volumes. Selling expenses increased $1.9 million, or 9.0%, as a result of hiring additional sales professionals. Occupancy expenses decreased $0.8 million as a result of elimination of certain leased warehouse space. Depreciation expense decreased $0.6 million, or 3.0%, as a result of certain assets being fully depreciated in 2016. Operating expenses in the carbon flat products segment decreased $7.6 million, operating expenses in the specialty metals products segment increased $3.0 million, operating expenses in the tubular and pipe products segment decreased $2.5 million, and Corporate expenses increased $0.3 million.

 

The goodwill and intangible asset impairment charge in 2015 included a $16.5 million non-cash goodwill impairment and a $8.0 million intangible asset impairment for the tubular and pipe products segment as well as a $0.5 million goodwill impairment for the specialty metals flat products segment. The 2015 goodwill impairment charges fully impaired the goodwill for both the tubular and pipe products segment and the specialty metals flat products segment.

 

Interest and other expense on debt totaled $5.3 million in 2016 compared to $5.7 million in 2015. Our effective borrowing rate, exclusive of deferred financing fees and commitment fees, was 2.4% in 2016 compared to 2.1% in 2015. The decrease in interest and other expense on debt in 2016 was attributable to lower average borrowings during 2016 compared to 2015.

 

Income before income taxes totaled $0.4 million in 2016 compared to a loss before income taxes of $33.6 million in 2015. 2015 loss before income taxes includes goodwill impairment charges of $17.0 million and a $8.0 million intangible asset impairment charge.

 

An income tax provision of 356.6% was recorded for 2016, compared to an income tax benefit of (20.3%) in 2015. The effective tax rate was disproportionately high in 2016 from comparative periods due to low income before taxes relative to items that impact the effective tax rate. The 2016 effective income tax rate was impacted by increased valuation allowances and non-deductible expenses. The 2015 effective income tax rate was impacted by the non-deductibility of the goodwill impairment charges. The income tax benefit for 2015 prior to the goodwill impairment charge was 39.8%.

 

Net loss for 2016 totaled $1.1 million, or $0.10 per basic and diluted share, compared to net loss of $26.8 million, or $2.39 per basic and diluted share, for 2015. The goodwill and intangible asset impairments in 2015 impacted earnings per share by $1.93 per basic and diluted shares.

  

36

 

 

Segment Results of Operations

 

Carbon flat products

 

The following table sets forth certain income statement data for the carbon flat products segment for the years ended December 31, 2016 and 2015 (dollars shown in thousands, except per ton data):

 

   

2016

   

2015

 
         

% of net

sales

         

% of net

sales

 

Direct tons sold

    952,888               935,165          

Toll tons sold

    73,880               102,360          

Total tons sold

    1,026,768               1,037,525          
                                 

Net sales

  $ 670,983       100.0     $ 765,400       100.0  

Average selling price per ton

    653               738          

Cost of materials sold

    529,021       78.8       618,674       80.8  

Gross profit (a)

    141,962       21.2       146,726       19.2  

Operating expenses (b)

    146,333       21.8       153,943       20.1  

Operating loss

  $ (4,371 )     (0.6 )   $ (7,217 )     (0.9 )

 

(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 1.0% to 1.03 million tons in 2016 from 1.04 million tons in 2015. Toll tons sold decreased 27.8% to 74 thousand tons in 2016 from 102 thousand tons in 2015. The decrease in tons sold is due to decreased customer demand and lower industry-wide shipments by U.S. service centers in 2016 compared to 2015. Despite the further softening of industry-wide shipments in 2016, we grew our market share in all of the carbon flat product categories we sell.

 

Net sales decreased $94.4 million, or 12.3%, to $671.0 million in 2016 from $765.4 million in 2015. Average selling prices in 2016 decreased 11.4% to $653 per ton, compared to $738 per ton in 2015. The decrease in sales was primarily due to a 11.4% decrease in average selling prices during 2016 as volumes were down only 1%. The decrease in the average selling price is a result of lower prices in the metals industry during 2016, discussed in the overview of Results of Operations above.

 

Cost of materials sold decreased $89.7 million, or 14.5%, to $529.0 million in 2016 from $618.7 million in 2015. The decrease in cost of materials sold was due to a 13.6% decrease in the average cost of materials sold per ton during 2016 compared to 2015, as volumes were down only 1% between years.

 

As a percentage of net sales, gross profit (as defined in footnote (a) in the table above) increased to 21.2% in 2016 from 19.2% in 2015. The increase in gross profit percentage in 2016 was primarily due to the cost of materials sold decreasing more than selling prices. The average gross profit per ton sold declined to $138 in 2016 from $141 in 2015, due to the significant decline in market prices for metals in 2016.

 

Operating expenses in 2016 decreased $7.6 million, or 4.9%, to $146.3 million from $153.9 million in 2015, exceeding the sales volume decrease of 1.0%. As a percentage of net sales, operating expenses increased to 21.8% for 2016 from 20.1% in 2015. Operating expenses decreased through reductions in labor and personnel expenses, lower variable based incentive compensation, lower depreciation expense and lower occupancy expense as a result of elimination of certain leased warehouse space offset by an increase in distribution expense and increased selling expenses as a result of hiring additional sales professionals.

 

Operating loss for 2016 totaled $4.4 million compared to operating loss of $7.2 million in 2015.

 

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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 December 31, 2016 and 2015 (dollars shown in thousands, except per ton data):

 

   

2016

   

2015

 
           

% of net

sales

           

% of net

sales

 

Direct tons sold

    82,156               72,041          

Toll tons sold

    129               36          

Total tons sold

    82,285               72,077          
                                 

Net sales

  $ 189,930       100.0     $ 192,516       100.0  

Average selling price per ton

    2,308               2,671          

Cost of materials sold

    160,185       84.3       176,686       91.8  

Gross profit (a)

    29,745       15.7       15,830       8.2  

Operating expenses (b)

    19,904       10.5       16,904       8.8  

Goodwill impairment charge (c)

    -       -       500       0.2  

Operating income (loss)

  $ 9,841       5.2     $ (1,574 )     (0.8 )

 

(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. Excludes goodwill impairment charge shown separately below for comparability purposes.

(c)

The 2015 non-cash goodwill impairment charge is separately displayed for operating expense comparability purposes.

 

Tons sold increased 14.2% to 82 thousand tons in 2016 from 72 thousand tons in 2015. The specialty metals flat products segment increased its market share in both the stainless steel and aluminum products it sells.

 

Net sales decreased $2.6 million, or 1.3%, to $189.9 million in 2016 from $192.5 million in 2015. Average selling prices in 2016 decreased to $2,308 per ton, compared to $2,671 per ton in 2015. The decrease in sales was due to a 13.6% decrease in the average selling price during 2016, offset by a 14.2% increase in sales volume. The decrease in the year-over-year average selling price per ton is a result of lower market prices of stainless steel and aluminum in 2016. Average market prices for nickel (a component of stainless steel) were also lower in 2016 compared to 2015.

 

Cost of materials sold decreased $16.5 million, or 9.3%, to $160.2 million in 2016 from $176.7 million in 2015. The decrease in cost of materials sold was due to a 20.6% decrease in the average cost of materials sold per ton during 2016 compared to 2015, offset by a 14.2% sales volume increase.

 

As a percentage of net sales, gross profit (as defined in footnote (a) in the table above) increased to 15.7% in 2016 from 8.2% in 2015. The average gross profit per ton sold totaled $361 in 2016 compared to $220 per ton in 2015. The increase in the gross profit percentage is a result of our cost of materials sold decreasing more than the average selling price in 2016, compared to 2015 as inventory turnover improved in 2016.

 

Operating expenses (as defined in footnote (b) in the table above) increased $3.0 million, or 17.7%, to $19.9 million in 2016 from $16.9 million in 2015. The increase in operating expenses is related to the increased sales volume of 14.2%. As a percentage of net sales, operating expenses increased to 10.5% of net sales in 2016 from 8.8% in 2015. Variable operating expenses, such as distribution, wages and variable based incentive compensation increased as a result of higher sales volumes and improved profitability. In 2015, we recorded a $0.5 million non-cash goodwill impairment charge as a result of the continued market pressures which fully eliminated the goodwill for the specialty metals flat products segment.

 

Operating income for 2016 totaled $9.8 million compared to operating loss of $1.6 million in 2015.

 

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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 2016 and 2015 (dollars shown in thousands).

 

   

2016

   

2015

 
   

$

   

% of net sales

   

$

   

% of net sales

 

Net sales

  $ 194,203       100.0     $ 217,627       100.0  

Cost of materials sold (a)

    130,834       67.4       146,854       67.5  

Gross profit (b)

    63,369       32.6       70,773       32.5  

Operating expenses (c)

    55,656       28.7       58,190       26.8  

Goodwill and intangible asset impairment (d)

    -       -       24,451       11.2  

Operating income (loss)

  $ 7,713       3.9     $ (11,868 )     (5.5 )

 

(a)

Includes $1,489 and $3,347 of LIFO income in 2016 and 2015, 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.  

(d)

The 2015 non-cash goodwill and intangible asset impairment charges are separately displayed for operating expense comparability purposes.

 

Net sales decreased $23.4 million, or 10.8%, to $194.2 million in 2016 from $217.6 million in 2015. The decrease in net sales was due to a 0.8% decrease in sales volume and a 10.0% decrease in average selling prices during 2016. The decrease in volume was due to decreased customer demand and lower industry-wide shipments of tube and pipe products. The decrease in average selling prices were due to lower industry market prices for metals in 2016 compared to 2015.

 

Cost of materials sold decreased $16.0 million, or 10.9%, to $130.8 million in 2016 from $146.9 million in 2015. The decrease in cost of materials sold was due to a 0.8% decrease in sales volume and a 10.2% decrease in the average cost of materials sold which was impacted by the LIFO income of $1.5 million in 2016, compared to LIFO income of $3.3 million in 2015.

 

As a percentage of net sales, gross profit (as defined in footnote (b) in the table above) remained relatively flat at 32.6% in 2016 compared to 32.5%, in 2015. The LIFO income increased gross profit by 0.8% of net sales in 2016, compared to 1.5% of net sales in 2015.

 

Operating expenses (as defined in footnote (c) in the table above) decreased $2.5 million, or 4.4%, to $55.7 million from $58.2 million in 2015. As a percentage of net sales, operating expenses increased to 28.7% in 2016 compared to 26.8% in 2015. Variable operating expenses, such as variable performance-based incentive compensation, decreased in 2016 as a result of lower sales and income before impairment charges.

 

In 2015, we recorded a $16.5 million non-cash goodwill impairment charge and an $8.0 million non-cash intangible asset impairment charge. There were no intangible asset impairment charges recorded in 2016.

 

Operating income for 2016 totaled $7.7 million, compared to an operating loss of $11.9 million in 2015. The operating loss for 2015 was the result of the goodwill impairment of $16.5 million and the asset impairment charge of $8.0 million.

 

Corporate expenses

 

Corporate expenses increased $0.3 million, or 4.4%, to $7.4 million in 2016 compared to $7.1 million in 2015. The increase in corporate expenses is primarily attributable to our President of Specialty Metals being appointed to the position of Executive Vice President and Chief Operating Officer and the associated transfer of expenses from the Specialty Metals flat products segment to the Corporate expenses in 2016.

 

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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, leasing transactions and borrowings under our credit facility to fund these requirements.

 

We believe that funds available under our credit facility, lease arrangement proceeds and the sale of equity or debt securities, 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 share repurchases and any 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.

 

 

2017 Compared to 2016

 

Operating Activities

 

During 2017, we used $19.0 million of cash for operations, of which $26.7 million was generated from operating activities and $45.7 million was used for working capital. During 2016, we used $9.8 million of cash for operations, of which $16.8 million was generated from operating activities and $26.6 million was used for working capital.

 

Net cash generated from operations totaled $26.7 million during 2017 and was primarily comprised of net income of $18.9 million, depreciation and amortization of $18.6 million offset by the net change in long-term assets and liabilities of $11.9 million, which includes the $6.2 million tax benefit related to the Tax Act. Net cash generated from operations totaled $16.8 million during 2016 and was primarily comprised of depreciation and amortization of $19.4 million offset by the net change in long-term assets and liabilities of $1.7 million and the net loss of $1.1 million.

 

Working capital at December 31, 2017 totaled $310.0 million, a $50.0 million increase from December 31, 2016. The increase was primarily attributable to a $31.0 million increase in accounts receivable (resulting primarily from higher sales in 2017) and a $20.8 million increase in inventory (resulting from increased inventory levels throughout 2017), offset by a $4.6 million increase in accounts payable and outstanding checks (resulting from the increased inventory purchases at the end of 2017) and a $1.6 million increase in accrued payroll and other accrued liabilities.

 

Investing Activities

 

Net cash used for investing activities was $9.2 million during 2017, compared to $6.4 million during 2016. In 2017, capital expenditures totaled $10.2 million and were primarily attributable to processing equipment, facilities expansions and facilities maintenance. During 2018, we expect our capital spending to approximate $25 million primarily related to a building expansion and new processing equipment at our existing facilities.

 

Financing Activities

 

In 2017, $28.9 million of cash was generated from financing activities which primarily consisted of $31.6 million of net borrowings under our Third Amended and Restated Loan and Security Agreement, or Loan Agreement, offset by $0.9 million of credit facility fees and expenses paid in connection with the Loan Agreement. In 2016, $17.0 million of cash was generated from financing activities which primarily consisted of $18.8 million of net borrowings under our asset- based credit facility, or ABL Credit Facility.

 

In February 2018, our Board of Directors approved a regular quarterly dividend of $0.02 per share, which is payable on March 15, 2018 to shareholders of record as of March 1, 2018. Our Board previously approved 2017 regular quarterly dividends of $0.02 per share, which were paid on each of March 15, 2017, June 15, 2017, September 15, 2017 and December 15, 2017. Dividend distributions in the future are subject to the availability of cash, limitations on cash dividends under our Loan Agreement (as defined below) and continuing determination by our Board of Directors that the payment of dividends remains in the best interest of our shareholders.

 

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Stock Repurchase Program

 

In 2015, our Board of Directors authorized a stock repurchase program of up to 550,000 shares of the Company’s issued and outstanding common stock, which could include open market repurchases, negotiated block transactions, accelerated stock repurchases or open market solicitations for shares, all or some of which may be effected through Rule 10b5-1 plans. Repurchased shares are 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 Loan Agreement. Under the Loan Agreement, 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 20.0% of the aggregate revolver commitments ($80.0 million at December 31, 2017) or (ii) to maintain availability equal to or greater than 15.0% of the aggregate revolver commitments ($60.0 million at December 31, 2017) and we must maintain a pro-forma ratio of Earnings before Interest, Taxes, Depreciation and Amortization, or EBITDA, minus certain capital expenditures and cash taxes paid to fixed charges of at least 1.00 to 1.00. The timing and amount of any repurchases under the stock repurchase program will depend upon several factors, including market and business conditions, and limitations under Loan Agreement, and repurchases may be discontinued at any time. During 2018, we expect to be limited to the $5.0 million available without restrictions to repurchase common stock and pay dividends.

 

There were no shares repurchased during 2017 or 2016. During the fourth quarter of 2015, we repurchased 65,283 shares for a total cost of $0.7 million.

 

Debt Arrangements

 

On December 8, 2017, we entered into a Third Amended and Restated Loan and Security Agreement, or Loan Agreement. The Loan Agreement provides for, among other things: (i) a revolving credit facility of up to $370 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 Loan Agreement, we may, subject to the satisfaction of certain conditions, request additional commitments under the revolving credit facility in the aggregate principal amount of up to $200 million to the extent that existing or new lenders agree to provide such additional commitments. The Loan Agreement matures on December 8, 2022.

 

The Loan Agreement is secured by substantially all of our existing and future personal property. The Loan Agreement 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 the Company; (vi) incur or suffer to exist liens securing indebtedness; (vii) consolidate, merge or transfer all or substantially all of their assets; and (viii) engage in transactions with affiliates. In addition, the Loan Agreement contains a financial covenant which includes: (i) if any commitments or obligations are outstanding and our availability is less than the greater of $30 million or 10.0% of the aggregate amount of revolver commitments ($40.0 million at December 31, 2017) or 10.0% of the aggregate borrowing base ($32.9 million at December 31, 2017) then we must maintain a ratio of 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, or LIBOR plus a premium ranging from 1.25% to 2.75%.

 

As of December 31, 2017, we were in compliance with our covenants and had approximately $128.9 million of availability under the Loan Agreement.

 

As of December 31, 2017, $1.9 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 Loan Agreement and are included in “Interest and other expense on debt” on the accompanying Consolidated Statements of Comprehensive Income.

 

As part of the CTI acquisition in July 2011, we assumed approximately $5.9 million of Industrial Revenue Bond, or IRB, indebtedness ($0.9 million at December 31, 2017). The bond matures in April 2018, with the option to provide principal payments annually in April. On April 3, 2017, we made an optional principal payment of $0.9 million. The remaining balance of the IRB is included in “Current portion of long-term debt” on the accompanying Consolidated Balance Sheets as the payment is due in April 2018. Interest is payable monthly, with a variable rate that resets weekly. As a security for payment of the bonds, we obtained a direct pay letter of credit issued by JPMorgan Chase Bank, N.A. The letter of credit reduces annually by the principal reduction amount. The interest rate at December 31, 2017 was 1.71% for the IRB debt.

 

41

 

 

CTI entered into an interest rate swap agreement to reduce the impact of changes in interest rates on the above IRB. At December 31, 2017, the effect of the swap agreement on the bond was to fix the rate at 3.46%. The swap agreement matures in April 2018, and is reduced annually by the amount of the optional principal payments on the bond. The Company is exposed to credit loss in the event of nonperformance by the other parties to the interest rate swap agreement. However, the Company does not anticipate nonperformance by the counterparties.

 

We entered into a forward starting fixed rate interest rate hedge that commenced June 2013, in order to eliminate the variability of cash interest payments on $53.2 million of the then outstanding LIBOR-based borrowings under the ABL Credit Facility. The hedge, which matured on June 1, 2016, fixed the rate at 1.21% plus a premium ranging from 1.25% to 1.75%.

 

 

2016 Compared to 2015

 

Operating Activities

 

During 2016, we used $9.8 million of cash for operations, of which $16.8 million was generated from operating activities and $26.6 million was used for working capital. During 2015, we generated $107.5 million of cash from operations, of which $12.4 million was generated from operating activities and $95.1 million was generated from working capital.

 

Net cash used for operations totaled $16.8 million during 2016 and was primarily comprised of depreciation and amortization of $19.4 million offset by the net change in long-term assets and liabilities of $1.7 million and the net loss of $1.1 million. Net cash from operations totaled $12.4 million during 2015 and was primarily comprised of depreciation and amortization of $19.9 million and the non-cash goodwill and intangible asset impairment of $25.0 million, offset by the net loss of $26.8 million.

 

Working capital at December 31, 2016 totaled $260.0 million, a $28.2 million increase from December 31, 2015. The increase was primarily attributable to a $47.9 million increase in inventory (resulting from increased inventory purchases at the end of 2016), a $9.0 million increase in accounts receivable (resulting primarily from higher sales volume at the end of 2016) offset by a $23.8 million increase in accounts payable and outstanding checks (resulting from the increased inventory purchases at the end of 2016) and a $4.9 million increase in accrued payroll and other accrued liabilities.

 

Investing Activities

 

Net cash used for investing activities was $6.4 million during 2016, compared to $7.3 million during 2015. In 2016, capital expenditures were primarily attributable to additional processing equipment and facilities maintenance.

 

Financing Activities

 

In 2016, $17.0 million of cash was generated from financing activities, which primarily consisted of $18.8 million of net borrowings under our ABL Credit Facility. In 2015, $100.8 million of cash was used for financing activities, which primarily consisted of $98.3 million of net repayments under our ABL Credit Facility.

 

Our Board previously approved 2016 and 2015 regular quarterly dividends of $0.02 per share, which were paid in March, June, September and December of 2016 and 2015.

  

42

 

 

Contractual Obligations

 

The following table reflects our contractual obligations as of December 31, 2017:

 

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) $ 197,165     $ 930     $ -     $ 196,235     $ -  

Interest obligations

(b)   31,522       6,513       13,005       12,004       -  

Unrecognized tax positions

(c)   40       14       26       -       -  

Other long-term liabilities

(d)   11,972       373       6,905       2,859       1,835  

Operating leases

(e)   26,740       6,385       10,256       6,646       3,453  

Total contractual obligations

  $ 267,439     $ 14,215     $ 30,192     $ 217,744     $ 5,288  

 

(a)  See Note 6 to the Consolidated Financial Statements.  

(b)  Future interest obligations are calculated using the debt balances and interest rates in effect on December 31, 2017.

(c)  See Note 12 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.

(e)  See Note 11 to the Consolidated Financial Statements

 

 

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 operating leases, which are disclosed above, and derivative instruments discussed in Note 7 to the Consolidated Financial Statements, as of December 31, 2017, we had no material off-balance sheet arrangements.

 

 

Effects of Inflation

 

Inflation generally affects us by increasing the cost of employee wages and benefits, transportation services, processing equipment, purchased metals, energy and borrowings under our credit facility. General inflation, excluding increases in the price of metals and increased distribution expense, has not had a material effect on our financial results during the past three years. We expect transportation expenses to increase in excess of general inflation in 2018 due to the Electronic Log Device mandate by the Federal Motor Carrier Safety Administration issued in 2017.

 

 

Critical Accounting Policies

 

This discussion and analysis of financial condition and results of operations is based on our consolidated financial statements, which have been prepared in conformity with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and assumptions that affect the amounts reported in the financial statements. Actual results could differ from these estimates under different assumptions or conditions. On an on-going basis, we monitor and evaluate our estimates and assumptions.

 

43

 

 

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.

 

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.

 

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

 

Inventories are stated at the lower of its cost or net realizable value with the adoption of Accounting Standards Update, or ASU, 2015-11 on January 1, 2017. Inventory costs include the costs of the purchased metals, inbound freight, external and internal processing and applicable labor and overhead costs. Net realizable value is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation.

 

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

 

Certain of our tubular and pipe products inventory is stated under the LIFO method. At December 31, 2017, approximately $48.1 million, or 17.5% of consolidated inventory, was reported under the LIFO method of accounting. The cost of the remainder of tubular and pipe product segment’s inventory is determined using a weighted average rolling first-in, first-out method.

 

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

 

44

 

 

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 for the tubular and pipe products segment 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.

 

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.

 

During 2017, a net tax benefit was recorded based on currently available information and interpretations of applying the provisions of the Tax Act as of the time of filing this Annual Report on Form 10-K. In accordance with SAB No. 118 issued by the SEC, the income tax effect for certain aspects of the Tax Act represent provisional amounts for which our accounting is incomplete but a reasonable estimate could be determined and recorded during the fourth quarter of 2017. The guidance provides for a measurement period, up to one year from the enactment date, in which provisional amounts may be adjusted when additional information is obtained, prepared or analyzed about facts and circumstances that existed as of the enactment date, which, if known, would have affected the amounts that were initially recorded as provisional amounts. Adjustments to provisional amounts identified during the measurement period should be recorded as an income tax expense or benefit in the period the adjustment is determined.

 

Revenue Recognition

 

For both direct and toll shipments, revenue is recognized when title and risk of loss is transferred, which generally occurs upon delivery to our customers. Given the proximity of our customers to our facilities, substantially all of our sales are shipped and received within one day. 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.

 

45

 

 

Certain engineered products produced by CTI can take several months to manufacture due to their size and complexity. Substantially all projects are completed within six months. We may request advance payments from customers during the production of these products. These payments are included in “Other accrued liabilities” on the Company’s Consolidated Balance Sheets. Revenue for the contracts is recognized when the product is shipped and title of the product transfers to the customers. Revenues for these engineered products accounted for approximately 1.9%, 1.7% and 1.8% of our net sales during 2017, 2016 and 2015, respectively.

 

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 10, Equity Plans in the accompanying Notes to Consolidated Financial Statements.

 

 

Impact of Recently Issued Accounting Pronouncements 

 

In August 2017, the Financial Accounting Standards Board, or FASB issued ASU No 2017-12, “Derivatives and Hedging”. This ASU aligns an entity’s risk management activities and financial reporting for hedging relationships through changes to both the designation and measurement guidance for qualifying hedging relationships and the presentation of hedge results. To meet that objective, the ASU expand and refine 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 make 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 Accounting Standards Update 2016-310, “Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities”, which has been deleted. For public business entities, this ASU is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020. Early application is permitted in any interim period after issuance of the ASU. All transition requirements and elections should be 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 should be reflected as of the beginning of the fiscal year of adoption. The adoption of this ASU is not expected to materially impact our consolidated financial statements.

 

In May 2017, the FASB issued ASU No 2017-09, “Compensation – Stock Compensation (Topic 718)”. This ASU provides clarity and reduces both (1) diversity in practice and (2) cost and complexity when applying the guidance in Topic 718, Compensation – Stock Compensation, to a change to the terms or conditions of a share-based payment award. The ASU provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in Topic 718. This Update is the final version of proposed Accounting Standards Update 2016-360, “Compensation—Stock Compensation (Topic 718)—Scope of Modification Accounting,” which has been deleted. The amendments in this Update are effective for all entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. Early adoption is permitted, including adoption in any interim period, for (1) public business entities for reporting periods for which financial statements have not yet been issued and (2) all other entities for reporting periods for which financial statements have not yet been made available for issuance. The amendments in this Update should be applied prospectively to an award modified on or after the adoption date. The adoption of this ASU is not expected to materially impact our consolidated financial statements.

 

In August 2016, the FASB issued ASU No 2016-15, “Classification of certain cash receipts and cash payments”. This ASU addresses the following eight specific cash flow issues: Debt prepayment or debt extinguishment costs; settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; contingent consideration payments made after a business combination; proceeds from the settlement of insurance claims; proceeds from the settlement of corporate-owned life insurance policies (COLIs) (including bank-owned life insurance policies (BOLIs)); distributions received from equity method investees; beneficial interests in securitization transactions; and separately identifiable cash flows and application of the predominance principle. The guidance will be effective for annual reporting periods beginning after December 15, 2017, and interim periods within those fiscal years with early adoption permitted. The adoption of this ASU is not expected to materially impact our consolidated financial statements.

 

46

 

 

In March 2016, the FASB issued ASU No 2016-09, “Improvements to Employee Share-Based Payment Accounting”. This ASU is part of the FASB’s Simplification Initiative and has been issued to reduce complexity in the presentation of employee share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The adoption of this ASU did not materially impact our consolidated financial statements.

 

In February 2016, the FASB issued ASU No. 2016-02, “Leases,” which specifies the accounting for leases. The objective is to establish the principles that lessees and lessors shall apply to report useful information to users of financial statements about the amount, timing and uncertainty of cash flows arising from a lease. This ASU introduces the recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases under previous guidance. The guidance will be effective for annual reporting periods beginning after December 15, 2018 and interim periods within those fiscal years with early adoption permitted. We are in the process of evaluating the impact of the future adoption of this standard on our consolidated financial statements.

 

In July 2015, the FASB issued ASU No 2015-11, Simplifying the Measurement of Inventory, “Inventory (Topic 330)”, which requires that inventory within the scope of this ASU be measured at the lower of cost and net realizable value. Net realizable value is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation. Subsequent measurement is unchanged for inventory measured using last-in, first-out (LIFO) or the retail inventory method. We adopted this standard effective January 1, 2017. The adoption of this ASU did not have a material impact to our consolidated financial statements.

 

In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, which deferred the effective date of ASU 2014-09 for all entities by one year. This update is effective for public business entities for annual reporting periods beginning after December 15, 2017, including interim periods within those reporting periods. Earlier application was permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. ASU 2014-09 was to become effective for us beginning January 2017; however, ASU 2015-14 deferred our effective date until January 2018, which is when we adopted this standard. The ASU permits two methods of adoption: retrospectively to each prior reporting period presented (full retrospective method), or retrospectively with the cumulative effect of initially applying the guidance recognized at the date of initial application (the modified retrospective method). The ASU also requires expanded disclosures relating to the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. Additionally, qualitative and quantitative disclosures are required for customer contracts, significant judgments and changes in judgments, and assets recognized from the costs to obtain or fulfill a contract. We have completed the process of evaluating the effect of the adoption and determined there were no material changes required to our reported revenues as a result of the adoption. The majority of our revenue arrangements generally consist of a single performance obligation to transfer goods or services. Based on our evaluation process and review of our contracts with customers, the timing and amount of revenue recognized based on ASU 2015-14 is consistent with our revenue recognition policy under previous guidance.

.

47

 

 

ITEM 7A.  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.

 

Similar to other metals service centers, we maintain substantial inventories of metals to accommodate the short lead times and just-in-time delivery requirements of our customers. Accordingly, we purchase metals in an effort to maintain our inventory at levels that we believe to be appropriate to satisfy the anticipated needs of our customers based upon historic buying practices, supply agreements with customers and market conditions. Our commitments to purchase metals are generally at prevailing market prices in effect at the time we place our orders. We have no long-term, fixed-price metals purchase contracts. When metals prices increase, competitive conditions will influence how much of the price increase we can pass on to our customers. To the extent we are unable to pass on future price increases in our raw materials to our customers, the net sales and profitability of our business could be adversely affected. 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 51%, 51% and 49% of our consolidated net sales in 2017, 2016 and 2015, 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 has not had a material effect on our financial results during the past three years. We expect transportation expenses to increase in excess of general inflation in 2018 due to the Electronic Log Device mandate by the Federal Motor Carrier Safety Administration issued in 2017.

 

We are exposed to the impact of fluctuating metals prices and interest rate changes. During 2017, 2016 and 2015, we entered into metals swaps at the request of customers. While these derivatives are intended to be effective in helping us manage risk, they have not been designated as hedging instruments. We had no outstanding metals cash flow hedges at December 31, 2017. In 2014, we entered into carbon swaps in order to mitigate the volatility in the price of metals. The carbon swaps were accounted for as cash flow hedges and all of them settled in 2015.

 

Our primary interest rate risk exposure results from variable rate debt. If interest rates in the future were to increase 100 basis points (1.0%) from December 31, 2017 rates and, assuming no change in total debt from December 31, 2017 levels, the additional annual interest expense to us would be approximately $2.0 million. We have the option to enter into 30- to 180-day fixed base rate LIBOR loans under the Loan Agreement. We assumed an interest rate swap agreement on the $5.9 million of CTI IRB. The swap agreement matures in April 2018, but the notional amount may be reduced annually by the amount of the optional principal payments on the IRB. We are exposed to credit loss in the event of nonperformance by the other parties to the interest rate swap agreements. However, we do not anticipate nonperformance by the counterparties.

 

48

 

 

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

 

Olympic Steel, Inc.

 

Index to Consolidated Financial Statements

 

   

  Page
   

Report of Independent Registered Public Accounting Firm

 50

Management’s Report on Internal Control Over Financial Reporting

 51

Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2017, 2016 and 2015

 52

Consolidated Balance Sheets as of December 31, 2017 and 2016

 53

Consolidated Statements of Cash Flows for the Years Ended December 31, 2017, 2016 and 2015

 54

Supplemental Disclosures of Cash Flow Information for the Years Ended December 31, 2017, 2016 and 2015

 55

Consolidated Statements of Shareholders’ Equity for the Years Ended December 31, 2017, 2016 and 2015

 56

Notes to Consolidated Financial Statements for the Years Ended December 31, 2017, 2016 and 2015

 57

Schedule II – Valuation and Qualifying Accounts for the Years Ended December 31, 2017, 2016 and 2015

 76

 

49

 

 

Report of Independent Registered Public Accounting Firm

 

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

 

Opinions on the Financial Statements and Internal Control over Financial Reporting

 

We have audited the accompanying consolidated balance sheets of Olympic Steel, Inc. and its subsidiaries as of December 31, 2017 and 2016, and the related consolidated statements of comprehensive income, cash flows, and shareholders’ equity for each of the three years in the period ended December 31, 2017, including the related notes and financial statement schedule listed in the accompanying index (collectively referred to as the “consolidated financial statements”). We also have audited the Company's internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2017 and 2016, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2017 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO.

 

Basis for Opinions

 

The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control over Financial Reporting. Our responsibility is to express opinions on the Company’s consolidated financial statements and on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.

 

Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions..

 

 

Definition and Limitations of Internal Control over Financial Reporting

 

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

 

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

 

 

/s/PricewaterhouseCoopers LLP

Cleveland, Ohio 

March 2, 2018

 

We have served as the Company’s auditor since 2002.

 

50

 

 

MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

 

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

 

Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2017. In making this assessment, our management used the criteria established in Internal Control - Integrated Framework (2013), issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on our assessment, we concluded that, as of December 31, 2017, our internal control over financial reporting was effective based on those criteria.

 

The effectiveness of our internal control over financial reporting as of December 31, 2017 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears herein.

 

51

 

 

 

Olympic Steel, Inc.

Consolidated Statements of Comprehensive Income

For The Years Ended December 31,

(in thousands, except per share data)

 

   

2017

   

2016

   

2015

 
                         

Net sales

  $ 1,330,696     $ 1,055,116     $ 1,175,543  
                         

Costs and expenses

                       

Cost of materials sold (excludes items shown separately below)

    1,055,212       820,040       942,214  

Warehouse and processing

    87,425       79,521       85,411  

Administrative and general

    69,659       63,054       64,987  

Distribution

    41,789       36,490       36,073  

Selling

    26,285       23,060       21,158  

Occupancy

    8,862       8,718       9,492  

Depreciation

    16,589       17,596       18,147  

Amortization

    889       889       889  

Goodwill and intangible asset impairment

    -       -       24,951  

Total costs and expenses

    1,306,710       1,049,368       1,203,322  

Operating income (loss)

    23,986       5,748       (27,779 )

Other loss, net

    (118 )     (55 )     (125 )

Income (loss) before interest and income taxes

    23,868       5,693       (27,904 )

Interest and other expense on debt

    7,518       5,273       5,690  

Income (loss) before income taxes

    16,350       420       (33,594 )

Income tax provision (benefit)

    (2,613 )     1,498       (6,817 )

Net income (loss)

  $ 18,963     $ (1,078 )   $ (26,777 )
                         

Gain (loss) on cash flow hedges

    -       114       (1,816 )

Tax effect of hedges

    -       (44 )     699  

Reclassification of loss included in net income, net of tax of $804 for 2015

    -       -       1,596  

Total comprehensive income (loss)

  $ 18,963     $ (1,008 )   $ (26,298 )
                         

Net income (loss) per share - basic

  $ 1.67     $ (0.10 )   $ (2.39 )

Weighted average shares outstanding - basic

    11,381       11,210       11,192  
                         

Net income (loss) per share - diluted

  $ 1.67     $ (0.10 )   $ (2.39 )

Weighted average shares outstanding - diluted

    11,381       11,210       11,192  
                         

Dividends declared per share of common stock

  $ 0.08     $ 0.08     $ 0.08  

 

 

 

 

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

 

52

 

 

 

 Olympic Steel, Inc.

Consolidated Balance Sheets

As of December 31,

(in thousands)

 

   

2017

   

2016

 

Assets

               

Cash and cash equivalents

  $ 3,009     $ 2,315  

Accounts receivable, net

    132,737       101,902  

Inventories, net (includes LIFO debit of $5,337 and $8,045 as of December 31, 2017 and 2016, respectively)

    275,307       254,526  

Prepaid expenses and other

    8,333       6,197  

Assets held for sale

    750       -  

Total current assets

    420,136       364,940  

Property and equipment, at cost

    376,710       374,242  

Accumulated depreciation

    (229,062 )     (218,476 )

Net property and equipment

    147,648       155,766  

Intangible assets, net

    22,980       23,869  

Other long-term assets

    13,394       11,493  

Total assets

  $ 604,158     $ 556,068  
                 

Liabilities

               

Current portion of long-term debt

  $ 930     $ 1,825  

Accounts payable

    84,034       79,458  

Accrued payroll

    11,999       8,445  

Other accrued liabilities

    14,184       15,170  

Total current liabilities

    111,147       104,898  

Credit facility revolver

    196,235       164,599  

Other long-term liabilities

    12,048       10,062  

Deferred income taxes

    12,145       23,119  

Total liabilities

    331,575       302,678  
                 

Commitments and contingencies (Note 11)

               
                 

Shareholders' Equity

               

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

    -       -  

Common stock, without par value, 20,000 shares authorized, 10,989 and 10,963 shares issued and outstanding

    129,453       128,619  

Treasury stock, at cost, 31 and 57 shares held

    (337 )     (609 )

Retained earnings

    143,467       125,380  

Total shareholders' equity

    272,583       253,390  

Total liabilities and shareholders' equity

  $ 604,158     $ 556,068  

 

 

 

 

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

 

53

 

 

 

Olympic Steel, Inc.

Consolidated Statements of Cash Flows

For The Years Ended December 31,

(in thousands)

 

   

2017

   

2016

   

2015

 

Cash flows from (used for) operating activities:

                       

Net income (loss)

  $ 18,963     $ (1,078 )   $ (26,777 )

Adjustments to reconcile net income (loss) to net cash from operating activities -

                       

Depreciation and amortization

    18,587       19,402       19,873  

Goodwill and intangible asset impairment

    -       -       24,951  

(Gain) loss on disposition of property and equipment

    (52 )     (376 )     15  

Stock-based compensation

    1,096       534       1,759  

Other long-term assets

    (2,874 )     (638 )     44  

Deferred income taxes and other long-term liabilities

    (8,988 )     (1,074 )     (7,500 )
      26,732       16,770       12,365  

Changes in working capital:

                       

Accounts receivable

    (30,835 )     (9,025 )     30,927  

Inventories

    (20,781 )     (47,881 )     104,463  

Prepaid expenses and other

    (1,303 )     1,620       13,808  

Accounts payable

    3,918       28,619       (21,923 )

Change in outstanding checks

    658       (4,846 )     (13,644 )

Accrued payroll and other accrued liabilities

    2,570       4,930       (18,511 )
      (45,773 )     (26,583 )     95,120  

Net cash from (used for) operating activities

    (19,041 )     (9,813 )     107,485  
                         

Cash flows from (used for) investing activities:

                       

Capital expenditures

    (10,160 )     (6,824 )     (7,317 )

Proceeds from disposition of property and equipment

    991       376       3  

Net cash used for investing activities

    (9,169 )     (6,448 )     (7,314 )
                         

Cash flows from (used for) financing activities:

                       

Credit facility revolver borrowings

    387,220       307,298       311,372  

Credit facility revolver repayments

    (355,584 )     (288,499 )     (409,662 )

Industrial revenue bond repayments

    (895 )     (865 )     (840 )

Credit facility fees and expenses

    (969 )     (131 )     (127 )

Proceeds from employee stock purchases

    10       46       30  

Repurchase of common stock

    -       -       (699 )

Dividends paid

    (878 )     (877 )     (879 )

Net cash from (used for) financing activities

    28,904       16,972       (100,805 )
                         

Cash and cash equivalents:

                       

Net change

    694       711       (634 )

Beginning balance

    2,315       1,604       2,238  

Ending balance

  $ 3,009     $ 2,315     $ 1,604  

 

 

 

 

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

 

54

 

 

Olympic Steel, Inc.

Supplemental Disclosures of Cash Flow Information

For The Years Ended December 31,

(in thousands)

 

   

2017

   

2016

   

2015

 

Cash paid during the period

                       
                         

Interest paid

  $ 6,433     $ 4,300     $ 5,083  

Income taxes paid

  $ 9,357     $ 982     $ 565  

 

 

 

 

The accompanying notes are an integral part of these consolidated statements

 

55

 

 

 

Olympic Steel, Inc.

Consolidated Statements of Shareholders’ Equity

For The Years Ended December 31,

(in thousands) 

 

                   

Accumulated

                 
                   

Other

                 
   

Common

   

Treasury

   

Comprehensive

   

Retained

   

Total

 
   

Stock

   

Stock

   

Loss

   

Earnings

   

Equity

 
                                         

Balance at December 31, 2014

  $ 126,339     $ -     $ (549 )   $ 154,991     $ 280,781  
                                         

Net loss

  $ -     $ -     $ -     $ (26,777 )   $ (26,777 )

Repurchase of common stock

            (699 )                     (699 )

Payment of dividends

    -       -       -       (879 )     (879 )

Employee stock purchases (2 shares)

    30       -       -       -       30  

Stock-based compensation

    1,759       -       -       -       1,759  

Changes in fair value of hedges

    -       -       479       -       479  

Other

    1       -       -       -       1  

Balance at December 31, 2015

  $ 128,129     $ (699 )   $ (70 )   $ 127,335     $ 254,695  
                                         

Net loss

  $ -     $ -     $ -     $ (1,078 )   $ (1,078 )

Payment of dividends

    -       -       -       (877 )     (877 )

Employee stock purchase (3 shares)

    46                               46  

Stock-based compensation

    444       90       -       -       534  

Changes in fair value of hedges

    -       -       70       -       70  

Balance at December 31, 2016

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

Net income

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

Payment of dividends

    -       -       -       (878 )     (878 )

Employee stock purchases (1 share)

    10       -       -       -       10  

Stock-based compensation

    824       272       -       -       1,096  

Other

    -       -       -       2       2  

Balance at December 31, 2017

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

 

 

 

 

 

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

 

56

 

 

Olympic Steel, Inc.

Notes to Consolidated Financial Statements

For The Years Ended December 31, 2017, 2016 and 2015

 

 

 

1.    Summary of Significant Accounting Policies:

 

Nature of Business

 

The Company is a leading U.S. metals service center specializing in the processing and distribution of large volumes of carbon, coated, aluminum and stainless steel, flat-rolled coil, sheet and plate products and tubular and pipe products from facilities throughout the United States. The Company operates in three reportable segments; carbon flat products, specialty metals flat products, and tubular and pipe products. The carbon flat products segment and the specialty metals flat products segments are at times consolidated and referred to as the flat products segments. The flat products segments’ assets and resources are shared by the carbon and specialty metals segments and both segments’ products are stored in the shared facilities and, in some locations, processed on shared equipment. Due to the shared assets and resources, certain of the flat products segment expenses are allocated between the carbon flat products segment and the specialty metals flat products segment based upon an established allocation methodology. Through its carbon flat products segment, the Company sells and distributes large volumes of processed carbon and coated flat-rolled sheet, coil and plate products, and fabricated parts. Through its specialty metals flat products segment, the Company sells and distributes processed aluminum and stainless flat-rolled sheet and coil products, flat bar products and fabricated parts. Through our tubular and pipe products segment, which consists of our Chicago Tube & Iron (CTI) subsidiary the Company distributes metal tubing, pipe, bar, valves and fittings and fabricate pressure parts supplied to various industrial markets.

 

Principles of Consolidation and Basis of presentation

 

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

 

Accounting Estimates

 

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

 

Concentration Risks

 

The Company is a major customer of flat-rolled coil and plate and tubular and pipe steel for many of its principal suppliers, but is not dependent on any one supplier. The Company purchased approximately 53%, 54% and 51% of its total steel requirements from its three largest suppliers in 2017, 2016 and 2015, respectively.

 

The Company has a diversified customer and geographic base, which reduces the inherent risk and cyclicality of its business. The concentration of net sales to the Company’s top 20 customers approximated 27%, 29% and 31% of consolidated net sales in 2017, 2016 and 2015, respectively. In addition, the Company’s largest customer accounted for approximately 4%, 4% and 6% of consolidated net sales in 2017, 2016 and 2015, respectively. Sales to industrial machinery and equipment manufacturers and their fabricators accounted for 51%, 51% and 49% of consolidated net sales in 2017, 2016 and 2015, respectively.

 

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.

 

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Fair Market Value

 

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

 

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

 

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

 

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

 

Financial instruments, such as cash and cash equivalents, accounts receivable, accounts payable and the credit facility 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.

 

Accounts Receivable

 

The Company’s allowance for doubtful accounts is maintained at a level considered appropriate based on historical experience and specific customer collection issues that the Company has identified. Estimations are based upon the application of a historical collection rate to the outstanding accounts receivable balance, which remains fairly level from year to year, and judgments about the probable effects of economic conditions on certain customers, which can fluctuate significantly from year to year. The Company cannot guarantee that the rate of future credit losses will be similar to past experience. The Company considers all available information when assessing the adequacy of the allowance for doubtful accounts each quarter.

 

Inventories

 

Inventories are stated at the lower of its cost or net realizable value with the adoption of Accounting Standards Update (ASU) 2015-11 on January 1, 2017. Inventory costs include the costs of the purchased metals, inbound freight, external and internal processing and applicable labor and overhead costs. Net realizable value is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation.

 

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

 

Certain of the Company’s tubular and pipe products inventory is stated under the last-in, first-out (LIFO) method. At December 31, 2017 and December 31, 2016, approximately $48.1 million, or 17.5% of consolidated inventory, and $43.4 million, or 17.1% of consolidated inventory, respectively, was reported under the LIFO method of accounting. The cost of the remainder of tubular and pipe product segment’s inventory is determined using a weighted average rolling first-in, first-out (FIFO) method.

 

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

 

Property and Equipment, and Depreciation

 

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

 

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Intangible Assets and Recoverability of Long-lived Assets

 

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

 

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

 

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

 

Income Taxes

 

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

 

During 2017, a net tax benefit was recorded based on currently available information and interpretations of applying the provisions of the 2017 U.S. Tax Cuts and Jobs Act (Tax Act) as of the time of filing this Annual Report on Form 10-K. In accordance with Staff Accounting Bulletin (SAB) No. 118 issued by the Securities and Exchange Commission (SEC), the income tax effect for certain aspects of the Tax Act represent provisional amounts for which the Company’s accounting is incomplete but a reasonable estimate could be determined and recorded during the fourth quarter of 2017. The guidance provides for a measurement period, up to one year from the enactment date, in which provisional amounts may be adjusted when additional information is obtained, prepared or analyzed about facts and circumstances that existed as of the enactment date, which, if known, would have affected the amounts that were initially recorded as provisional amounts. Adjustments to provisional amounts identified during the measurement period should be recorded as an income tax expense or benefit in the period the adjustment is determined.

 

Revenue Recognition

 

For both direct and toll shipments, revenue is recognized when title and risk of loss is transferred, which generally occurs upon delivery to the Company’s customers. Given the proximity of the Company’s customers to its facilities, substantially all of the Company’s sales are shipped and received within one day. 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.

 

Certain engineered products produced by the tubular and pipe products segment typically take several months to produce due to their size and complexity. Substantially all projects are completed within nine months. The Company may request advance payments from customers during the production of these products. These payments are included in current short-term liabilities on the Company’s Consolidated Balance Sheet. Due to their short-term nature, the Company uses the units of delivery method to account for these contracts. Revenue for the contracts is recognized when the product is shipped and title of the product transfers to the customers. Revenues for these engineered products accounted for approximately 1.9%, 1.7% and 1.8% of the Company’s consolidated net sales during 2017, 2016 and 2015, respectively.

 

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Shipping and Handling Fees and Costs

 

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

 

Stock-Based Compensation

 

The Company records compensation expense for stock awards issued to employees and directors. For additional information, see Note 10, Equity Plans.

 

Impact of Recently Issued Accounting Pronouncements 

 

In August 2017, the Financial Accounting Standards Board (FASB) issued ASU No 2017-12, “Derivatives and Hedging”. This ASU aligns an entity’s risk management activities and financial reporting for hedging relationships through changes to both the designation and measurement guidance for qualifying hedging relationships and the presentation of hedge results. To meet that objective, the ASU expand and refine 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 make 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 Accounting Standards Update 2016-310, “Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities, which has been deleted. For public business entities, this ASU is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020. Early application is permitted in any interim period after issuance of the ASU. All transition requirements and elections should be 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 should be reflected as of the beginning of the fiscal year of adoption. The adoption of this ASU is not expected to materially impact the Company’sconsolidated financial statements.

 

In May 2017, the FASB issued ASU No 2017-09, “Compensation – Stock Compensation (Topic 718)”. This ASU provides clarity and reduces both (1) diversity in practice and (2) cost and complexity when applying the guidance in Topic 718, Compensation – Stock Compensation, to a change to the terms or conditions of a share-based payment award. The ASU provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in Topic 718. This ASU is the final version of proposed Accounting Standards Update 2016-360,Compensation—Stock Compensation (Topic 718)—Scope of Modification Accounting,” which has been deleted. The amendments in this ASU are effective for all entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. Early adoption is permitted, including adoption in any interim period, for (1) public business entities for reporting periods for which financial statements have not yet been issued and (2) all other entities for reporting periods for which financial statements have not yet been made available for issuance. The amendments in this ASU should be applied prospectively to an award modified on or after the adoption date. The adoption of this ASU is not expected to materially impact the Company’s consolidated financial statements.

 

In August 2016, the FASB issued ASU No 2016-15, “Classification of certain cash receipts and cash payments”. This ASU addresses the following eight specific cash flow issues: Debt prepayment or debt extinguishment costs; settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; contingent consideration payments made after a business combination; proceeds from the settlement of insurance claims; proceeds from the settlement of corporate-owned life insurance policies (COLIs) (including bank-owned life insurance policies (BOLIs)); distributions received from equity method investees; beneficial interests in securitization transactions; and separately identifiable cash flows and application of the predominance principle. The guidance will be effective for annual reporting periods beginning after December 15, 2017, and interim periods within those fiscal years with early adoption permitted. The adoption of this ASU is not expected to materially impact the Company’s consolidated financial statements.

 

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In March 2016, the FASB issued ASU No 2016-09, “Improvements to Employee Share-Based Payment Accounting”. This ASU is part of the FASB’s Simplification Initiative and has been issued to reduce complexity in the presentation of employee share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The adoption of this ASU did not materially impact the Company’s consolidated financial statements.

 

In February 2016, the FASB issued ASU No. 2016-02, “Leases,” which specifies the accounting for leases. The objective is to establish the principles that lessees and lessors shall apply to report useful information to users of financial statements about the amount, timing and uncertainty of cash flows arising from a lease. This ASU introduces the recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases under previous guidance. The guidance will be effective for annual reporting periods beginning after December 15, 2018 and interim periods within those fiscal years with early adoption permitted. The Company is in the process of evaluating the impact of the future adoption of this standard on the Company’s consolidated financial statements.

 

In July 2015, the FASB issued ASU No 2015-11, Simplifying the Measurement of Inventory, “Inventory (Topic 330)”, which requires that inventory within the scope of this ASU be measured at the lower of cost and net realizable value. Net realizable value is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation. Subsequent measurement is unchanged for inventory measured using last-in, first-out (LIFO) or the retail inventory method. The Company adopted this standard effective January 1, 2017. The adoption of this ASU did not have a material impact to the Company’s consolidated financial statements.”

 

In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, which deferred the effective date of ASU 2014-09 for all entities by one year. This update is effective for public business entities for annual reporting periods beginning after December 15, 2017, including interim periods within those reporting periods. Earlier application was permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. ASU 2014-09 was to become effective for us beginning January 2017; however, ASU 2015-14 deferred our effective date until January 2018, which is when we adopted this standard. The ASU permits two methods of adoption: retrospectively to each prior reporting period presented (full retrospective method), or retrospectively with the cumulative effect of initially applying the guidance recognized at the date of initial application (the modified retrospective method). The ASU also requires expanded disclosures relating to the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. Additionally, qualitative and quantitative disclosures are required for customer contracts, significant judgments and changes in judgments, and assets recognized from the costs to obtain or fulfill a contract. The Company completed the process of evaluating the effect of the adoption and determined there were no material changes required to the reported revenues as a result of the adoption. The majority of the revenue arrangements generally consist of a single performance obligation to transfer goods or services. Based on the evaluation process and review of the contracts with customers, the timing and amount of revenue recognized based on ASU 2015-14 is consistent with the revenue recognition policy under previous guidance. The adoption of this ASU on January 1, 2018 using the modified retrospective approach will not have a material impact to the Company’s consolidated financial statements.

 

 

 

2.     Accounts Receivable:

 

Accounts receivable are presented net of allowances for doubtful accounts and unissued credits of $2.8 million and $2.4 million as of December 31, 2017 and 2016, respectively. Bad debt expense totaled $0.6 million, $0.4 million and $0.5 million in 2017, 2016 and 2015, respectively.

 

The Company’s allowance for doubtful accounts is maintained at a level considered appropriate based on historical experience and specific customer collection issues that the Company has identified. Estimations are based upon a calculated percentage of accounts receivable, which remains fairly level from year to year, and judgments about the probable effects of economic conditions on certain customers, which can fluctuate significantly from year to year. The Company cannot guarantee that the rate of future credit losses will be similar to past experience. The Company considers all available information when assessing the adequacy of its allowance for doubtful accounts.

 

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3.     Inventories:

 

Inventories consisted of the following:

 

As of December 31,     

(in thousands)

 

2017

   

2016

 

Unprocessed

  $ 225,187     $ 203,256  

Processed and finished

    50,120       51,270  

Totals

  $ 275,307     $ 254,526  

 

During 2017, the Company recorded $2.7 million of LIFO expense as a result of increased metals pricing during 2017. The LIFO expense decreased the Company’s inventory balance and increased its cost of materials sold. During 2016, the Company recorded $1.5 million of LIFO income as a result of decreased metals pricing during 2016. The LIFO income increased the Company’s inventory balance and decreased its cost of materials sold.

 

If the FIFO method had been in use, inventories would have been $5.3 million and $8.0 million lower than reported at December 31, 2017 and 2016, respectively.

 

 

 

4.     Property and Equipment:

 

Property and equipment consists of the following:

 

(in thousands)

 

Depreciable

Lives

   

December 31,

2017

   

December 31,

2016

 

Land

      -       $ 15,881     $ 16,001  

Land improvements

    5 - 10       3,270       3,133  

Buildings and improvements

    7 - 30       131,655       133,010  

Machinery and equipment

    2 - 15       184,683       185,676  

Furniture and fixtures

    3 - 7       6,298       6,311  

Computer software and equipment

    2 - 5       28,677       27,848  

Vehicles

    2 - 5       1,746       1,456  

Construction in progress

      -         4,500       807  
                  376,710       374,242  

Less accumulated depreciation

                (229,062 )     (218,476 )

Net property and equipment

              $ 147,648     $ 155,766  

 

 

Leasehold improvements are included with buildings and improvements and are depreciated over the life of the lease or seven years, whichever is less.

 

Construction in progress as of December 31, 2017, primarily consisted of payments for a building expansion and additional processing equipment at our existing facilities that were not yet placed into service.

 

During the second quarter of 2017, the Company began actively marketing for sale certain property at the flat product segment’s Siler City, North Carolina facility. As a result of that decision, the Company reclassified $0.8 million of net book value related to that property along with certain machinery and equipment as assets held for sale in the Consolidated Balance Sheets. The sale of those assets is expected to be completed within the next twelve months and are presented as current assets. Based on the present real estate market and discussions with the Company’s real estate adviser, no material impairment of the recorded amounts has occurred as of December 31, 2017.

 

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5.     Intangible Assets:

 

In accordance with the Accounting Standards Codification (ASC), an impairment test of indefinitely lived intangible assets is performed at least annually 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.

 

All of the Company’s intangible assets were recorded in connection with its July 1, 2011 acquisition of CTI. The intangible assets were evaluated on the premise of highest and best use to a market participant, primarily utilizing the income approach valuation methodology. The useful life of the CTI trade name was determined to be indefinite primarily due to its history and reputation in the marketplace, the Company’s expectation that the CTI trade name will continue to be used throughout the life of CTI, and the conclusion that there are currently no other factors identified that would limit its useful life. The useful life of the CTI customer relationships was determined to be fifteen years, based primarily on the consistent and predictable revenue source associated with the existing CTI customer base, the present value of which extends through the fifteen year amortization period. The Company will continue to evaluate the useful life assigned to our amortizable customer relationships in future periods.

 

During 2017 and 2016, a step zero test was performed for the indefinitely lived intangible assets and no indication of impairment was present.

 

Intangible assets, net, consisted of the following as of December 31, 2017 and 2016:

 

   

As of December 31, 2017

 

(in thousands)

 

Gross Carrying Amount

   

Accumulated Amortization

   

Impairments

   

Intangible Assets, Net

 
                                 

Customer relationships - subject to amortization

  $ 13,332     $ (5,777 )   $ -     $ 7,555  

Trade name - not subject to amortization

    15,425       -       -       15,425  
    $ 28,757     $ (5,777 )   $ -     $ 22,980  

 

 

   

As of December 31, 2016

 

(in thousands)

 

Gross Carrying Amount

   

Accumulated Amortization

   

Impairments

   

Intangible Assets, Net

 
                                 

Customer relationships - subject to amortization

  $ 13,332     $ (4,888 )   $ -     $ 8,444  

Trade name - not subject to amortization

    15,425       -       -       15,425  
    $ 28,757     $ (4,888 )   $ -     $ 23,869  

 

The Company estimates that amortization expense for its intangible assets subject to amortization will be $0.9 million per year in each of the next five years.

 

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6.     Debt:

 

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

 

   

As of December 31,

 

(in thousands)

 

2017

   

2016

 

Asset-based revolving credit facility due December 8, 2022

  $ 196,235     $ -  

Asset-based revolving credit facility due June 30, 2019

    -       164,599  

Industrial revenue bond due April 1, 2018

    930       1,825  

Total debt

    197,165       166,424  

Less current amount

    (930 )     (1,825 )

Total long-term debt

  $ 196,235     $ 164,599  

 

On December 8, 2017, the Company entered into a Third Amended and Restated Loan and Security Agreement (the “Loan Agreement”). The Loan Agreement provides for, among other things: (i) a revolving credit facility of up to $370 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 Loan Agreement, the Company may, subject to the satisfaction of certain conditions, request additional commitments under the revolving credit facility in the aggregate principal amount of up to $200 million to the extent that existing or new lenders agree to provide such additional commitments. The Loan Agreement matures on December 8, 2022.

 

The Loan Agreement is secured by substantially all of the existing and future personal property of the Company. The Loan Agreement contains customary representations and warranties and certain covenants that limit the ability of the Company to, among other things: (i) incur or guarantee additional indebtedness; (ii) pay distributions on, redeem or repurchase capital stock or redeem or repurchase subordinated debt; (iii) make investments; (iv) sell assets; (v) enter into agreements that restrict distributions or other payments from restricted subsidiaries to the Company; (vi) incur or suffer to exist liens securing indebtedness; (vii) consolidate, merge or transfer all or substantially all of their assets; and (viii) engage in transactions with affiliates. In addition, the Loan Agreement contains a financial covenant which includes: (i) if any commitments or obligations are outstanding and the Company’s availability is less than the greater of $30 million or 10.0% of the aggregate amount of revolver commitments ($40.0 million at December 31, 2017) or 10.0% of the aggregate borrowing base ($32.9 million at December 31, 2017) then the Company must maintain a ratio of Earnings before Interest, Taxes, Depreciation and Amortization (EBITDA) minus certain capital expenditures and cash taxes paid to fixed charges of at least 1.00 to 1.00 for the most recent twelve fiscal month period.

 

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

 

As of December 31, 2017, the Company was in compliance with its covenants and had approximately $128.9 million of availability under the Loan Agreement.

 

As of December 31, 2017, $1.9 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 Loan Agreement and are included in “Interest and other expense on debt” on the accompanying Consolidated Statements of Comprehensive Income.

 

As part of the CTI acquisition in July 2011, the Company assumed approximately $5.9 million of Industrial Revenue Bond (IRB) indebtedness. The bond matures in April 2018, with the option to provide principal payments annually in April. On April 3, 2017, the Company paid an optional principal payment of $0.9 million. The remaining balance of the IRB is included in “Current portion of long-term debt” on the accompanying Consolidated Balance Sheets as the payment is due in April 2018. Interest is payable monthly, with a variable rate that resets weekly. As a security for payment of the bonds, the Company obtained a direct pay letter of credit issued by JPMorgan Chase Bank, N.A. The letter of credit reduces annually by the principal reduction amount. The interest rate at December 31, 2017 was 1.71% for the IRB debt.

 

CTI entered into an interest rate swap agreement to reduce the impact of changes in interest rates on the above IRB. At December 31, 2017, the effect of the swap agreement on the bond was to fix the rate at 3.46%. The swap agreement matures in April 2018, and is reduced annually by the amount of the optional principal payments on the bond. The Company is exposed to credit loss in the event of nonperformance by the other parties to the interest rate swap agreement. However, the Company does not anticipate nonperformance by the counterparties.

 

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Scheduled Debt Maturities, Interest, Debt Carrying Values

 

The Company’s principal payments over the next five years are detailed in the table below:

 

(in thousands)

 

2018

   

2019

   

2020

   

2021

   

2022

   

Total

 

ABL Credit Facility

  $ -     $ -     $ -     $ -     $ 196,235     $ 196,235  

Industrial revenue bond

    930       -       -       -       -       930  

Total principal payments

  $ 930     $ -     $ -     $ -     $ 196,235     $ 197,165  

 

The overall effective interest rate for all debt, exclusive of deferred financing fees and deferred commitment fees, amounted to 3.0%, 2.4% and 2.1% in 2017, 2016 and 2015, respectively. Interest paid totaled $6.4 million, $4.3 million and $5.1 million for the years ended December 31, 2017, 2016 and 2015, respectively. Average total debt outstanding was $200.6 million, $152.5 million and $211.2 million in 2017, 2016 and 2015, respectively.

 

 

 

7.     Derivative Instruments:

 

Metals swaps

 

During 2017, 2016 and 2015, the Company entered into nickel swaps indexed to the London Metal Exchange (LME) price of nickel with third-party brokers. The nickel swaps are treated as derivatives for accounting purposes and are included in “Other accrued liabilities” and “Prepaid expenses and other” on the Consolidated Balance Sheet at December 31, 2017 and 2016. The Company entered into the swaps to mitigate its customers’ risk of volatility in the price of metals. The outstanding nickel swaps have one to twelve months remaining as of December 31, 2017. The swaps are settled with the brokers at maturity. The economic benefit or loss arising from the changes in fair value of the swaps is contractually passed through to the customer. The primary risk associated with the metals swaps is the ability of customers or third-party brokers to honor their agreements with the Company related to derivative instruments. If the customer or third-party brokers are unable to honor their agreements, the Company’s risk of loss is the fair value of the metals swaps.

 

While these derivatives are intended to help the Company manage risk, they have not been designated as hedging instruments. The periodic changes in fair value of the metals and embedded customer derivative instruments are included in “Cost of materials sold” in the Consolidated Statements of Comprehensive Income. The Company recognizes derivative positions with both the customer and the third party for the derivatives and classifies cash settlement amounts associated with them as part of “Cost of materials sold” in the Consolidated Statements of Comprehensive Income. The cumulative change in fair value of the metals swaps that have not yet settled as of December 31, 2017 are included in “Accounts receivable, net”, and the embedded customer derivatives are included in “Other accrued liabilities” on the Consolidated Balance Sheets at December 31, 2017. The cumulative change in fair value of the metals swaps that had not yet settled as of December 31, 2016 were included in “Other accrued liabilities”, and the embedded customer derivatives were included in “Accounts receivable, net” on the Consolidated Balance Sheets at December 31, 2016.

 

In 2014, the Company entered into cash flow metals hedges to mitigate its risk of volatility in the price of metals. The cash flow metals hedges were indexed to the NYMEX price of U.S. Midwest Domestic Hot-Rolled Coil Steel with third-party brokers. The metals hedges were accounted for as cash flow hedges. The impact of the mark-to-market adjustment on settled hedges is recorded in “Cost of materials sold” in the accompanying Consolidated Statements of Comprehensive Income. The impact for the twelve months ended December 31, 2015 was $2.4 million of expense. There were no cash flow metals hedges outstanding as of December 31, 2017 or 2016.

 

Interest rate swap

 

CTI entered into an interest rate swap to reduce the impact of changes in interest rates on its IRB. The swap agreement matures in April 2018, the same time as the IRB, and is reduced annually by the amount of the optional principal payments on the IRB. The Company is exposed to credit loss in the event of nonperformance by the other parties to the interest rate swap agreement. However, the Company does not anticipate nonperformance by the counterparties. The interest rate swap is not treated as a hedge for accounting purposes.

 

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The periodic changes in fair value of the interest rate swap and cash settlement amounts associated with the interest rate swap are included in “Interest and other expense on debt” in the Consolidated Statements of Comprehensive Income.

 

Fixed rate interest rate hedge

 

In June 2012, the Company entered into a forward starting fixed rate interest rate hedge commencing June 2013 in order to eliminate the variability of cash interest payments on $53.2 million of the then outstanding LIBOR-based borrowings under the ABL Credit Facility. The hedge, which matured on June 1, 2016, fixed the rate at 1.21% plus a premium ranging from 1.25% to 1.75%. The fixed rate interest rate hedge was accounted for as a cash flow hedging instrument for accounting purposes.

 

There was no net impact from the nickel swaps or embedded customer derivative agreements to the Company’s Consolidated Statements of Comprehensive Income for the years ended December 31, 2017, 2016 and 2015. The table below shows the total impact to the Company’s Consolidated Statements of Comprehensive Income through “Net income (loss)” of the derivatives for the years ended December 31, 2017, 2016 and 2015.

 

   

Net Gain (Loss) Recognized

 

(in thousands)

 

2017

   

2016

   

2015

 

Interest rate swap (CTI)

  $ (31 )   $ (66 )   $ (77 )

Fixed interest rate swap (ABL)

    -       (98 )     (365 )

Cash flow metals hedges

    -       -       (2,400 )

Metals swaps

    475       68       (2,304 )

Embedded customer derivatives

    (475 )     (68 )     2,304  

Total loss

  $ (31 )   $ (164 )   $ (2,842 )

 

 

 

8.     Fair Value of Assets and Liabilities:

 

The Company’s financial instruments include cash and cash equivalents, short-term trade receivables, derivative instruments, accounts payable and debt instruments. For short-term instruments, other than those required to be reported at fair value on a recurring basis and for which additional disclosures are included below, management concluded the historical carrying value is a reasonable estimate of fair value because of the short period of time between the origination of such instruments and their expected realization.

 

During 2017 and 2016, there were no transfers of financial assets between Levels 1, 2 or 3 fair value measurements. There have been no changes in the methodologies used at December 31, 2017 and December 31, 2016. Following is a description of the valuation methodologies used for assets and liabilities measured at fair value as of December 31, 2017 and December 31, 2016:

 

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

 

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

 

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

 

   

Value of Items Recorded at Fair Value

 
   

As of December 31, 2017

 

(in thousands)

 

Level 1

   

Level 2

   

Level 3

   

Total

 

Assets:

                               

Metal Swaps

  $ -     $ 382     $ -     $ 382  

Total assets at fair value

  $ -     $ 382     $ -     $ 382  
                                 

Liabilities:

                               

Embedded customer derivatives

  $ -     $ 382     $ -     $ 382  

Interest rate swap (CTI)

    -       5       -       5  

Total liabilities recorded at fair value

  $ -     $ 387     $ -     $ 387  

 

   

Value of Items Not Recorded at Fair Value

 
   

As of December 31, 2017

 

(in thousands)

 

Level 1

   

Level 2

   

Level 3

   

Total

 

Liabilities:

                               

IRB

  $ 930     $ -     $ -     $ 930  

ABL Credit Facility

    -       196,235       -       196,235  

Total liabilities not recorded at fair value

  $ 930     $ 196,235     $ -     $ 197,165  

 

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

 

   

Value of Items Recorded at Fair Value

 
   

As of December 31, 2016

 

(in thousands)

 

Level 1

   

Level 2

   

Level 3

   

Total

 

Assets:

                               

Embedded customer derivatives

  $ -     $ 113     $ -     $ 113  

Total assets at fair value

  $ -     $ 113     $ -     $ 113  
                                 

Liabilities:

                               

Metals swaps

  $ -     $ 113     $ -     $ 113  

Interest rate swap (CTI)

    -       36       -       36  

Total liabilities recorded at fair value

  $ -     $ 149     $ -     $ 149  

 

   

Value of Items Not Recorded at Fair Value

 
   

As of December 31, 2016

 

(in thousands)

 

Level 1

   

Level 2

   

Level 3

   

Total

 

Liabilities:

                               

IRB

  $ 1,825     $ -     $ -     $ 1,825  

ABL Credit Facility

    -       164,599       -       164,599  

Total liabilities not recorded at fair value

  $ 1,825     $ 164,599     $ -     $ 166,424  

 

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

 

The fair value of the IRB is determined using Level 1 inputs. The carrying value and the fair value of the IRB that qualify as financial instruments were $0.9 million and $1.8 million at December 31, 2017 and 2016, respectively.

 

The fair value of the ABL Credit Facility is determined using Level 2 inputs. The carrying value of the ABL Credit Facility was $196.2 million and $164.6 million at December 31, 2017 and 2016, respectively. Because the ABL Credit Facility was amended on December 8, 2017, management believes that it is carried at fair value.

 

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9.     Accumulated Other Comprehensive Loss:

 

In June 2012, the Company entered into a forward starting fixed rate interest rate hedge commencing July 2013 in order to eliminate the variability of cash interest payments on $53.2 million of the outstanding LIBOR-based borrowings under the ABL Credit Facility. The hedge matured on June 1, 2016 and the notional amount was reduced monthly by $0.7 million. The balance as of December 31, 2015 was $31.4 million. The fixed rate interest rate hedge was accounted for as a cash flow hedging instrument for accounting purposes. The fair value of the interest rate hedge was included in “Accumulated other comprehensive loss” on the Consolidated Balance Sheets at December 31, 2015.

 

 

 

10.     Equity Plans:

 

Restricted Stock Units and Performance Share Units

 

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

 

On March 13, 2017, May 1, 2016 and March 1, 2015, the Compensation Committee of the Company’s Board of Directors approved the grant of 3,501, 3,094 and 4,639 restricted stock units (RSUs), respectively, to each non-employee Director. Subject to the terms of the Plan and the RSU agreement, the RSUs vest after one year of service (from the date of grant). The RSUs are not converted into shares of common stock until the director either resigns or is terminated from the Board of Directors. The fair value of each RSU was estimated to be the closing price of the Company’s common stock on the date of the grant, which was $19.99, $22.62 and $15.09 on March 13, 2017, May 1, 2016 and March 1, 2015, respectively.

 

On July 1, 2016, the Company created a new Senior Management Stock Incentive Program (the New Plan) for certain participants. Under the New Plan, each participant, subject to the terms and conditions of the plan and the attainment of minimum performance requirements, can be awarded RSUs with a dollar value equal to 10% of the participant’s base salary, up to an annual maximum of $17,500. The RSUs have a five-year vesting period and the RSUs will convert into the right to receive shares of common stock upon a participant’s retirement, or earlier upon the participant’s death or disability or upon a change in control of the Company. The carbon and specialty metals flat products segments adopted the New Plan on July 1, 2016 and the tubular and pipe products segment adopted the New Plan on January 1, 2017.

 

Prior to July 1, 2016, the Company’s Senior Management Compensation Program included an equity component in order to encourage more ownership of common stock by the senior management (the Old Plan). The Old Plan imposed stock ownership requirements upon the participants. Each participant was required to own at least 750 shares of common stock for each year that the participant participated in the Old Plan. Any participant that failed to meet the stock ownership requirements would be ineligible to receive any equity awards under the Company’s equity compensation plans, including the Plan, until the participant satisfied the ownership requirements. To assist participants in meeting the stock ownership requirements, on an annual basis, if a participant purchased 500 shares of common stock on the open market, the Company awarded that participant 250 shares of common stock. During 2016 and 2015, the Company matched 2,500 and 9,000 shares, respectively. Additionally, any participant who continued to comply with the stock ownership requirements as of the five-year, 10-year, 15-year, 20-year and 25-year anniversaries of the participant’s participation in the Senior Management Compensation Program would receive a restricted stock unit award with a dollar value of $25 thousand, $50 thousand, $75 thousand, $100 thousand and $100 thousand, respectively. Restricted stock unit awards would convert into the right to receive shares of common stock upon a participant’s retirement, or earlier upon the participant’s death or disability or upon a change in control of the Company. The carbon and specialty metals flat products segments terminated this plan on July 1, 2016 and the tubular and pipe products segment terminated the plan on January 1, 2017.

 

As part of the termination of the Old Plan and the transition to the New Plan, participants were paid the RSU grants that were earned to date, or a pro-rata amount of the RSUs earned, depending on the participants’ length of time they participated in the plan. After the payment of the RSUs noted above, the remaining liability of approximately $1.0 million was reversed during 2016 in accordance with ASC No. 718.

 

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In 2016, the Company adopted a formal RSU award program for employees who are promoted to an executive level position. During the third quarter of 2016, Andrew Greiff received 10,573 RSUs upon his promotion to Executive Vice President and Chief Operating Officer. These RSUs vest on the fifth anniversary of his promotion.

Stock-based compensation income or expense recognized on RSUs is summarized in the following table:

 

   

For the years ended December 31,

 

(in thousands)

 

2017

   

2016

   

2015

 

RSU expense before taxes of New Plan

  $ 560     $ 42     $ -  

RSU (income) expense before taxes of Old Plan

    -       (73 )     1,047  

RSU (income) expense after taxes

    636       81       631  

 

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

 

The following table summarizes the activity related to RSUs for the twelve months ended December 31, 2017:

 

 

 

 

Number of

Shares

   

Weighted Average Estimated Fair Value

 

Outstanding at December 31, 2016

    421,486     $ 19.93  

Granted

    73,021       20.01  

Converted into shares

    (25,439 )     16.71  

Forfeited

    -       -  

Outstanding at December 31, 2017

    469,068     $ 20.11  

Vested at December 31, 2017

    403,428     $ 19.89  

 

Of the RSUs granted in 2017, 2016 and 2015, 26,837, 51,075 and 47,639, respectively, were used to fund supplemental executive retirement plan contributions (SERP). There was no intrinsic value for the RSUs that were converted into shares in 2017, 2016 and 2015.

 

 

 

11.   Commitments and Contingencies:

 

Operating Leases

 

The Company leases certain warehouses, sales offices, machinery and equipment and vehicles under long-term operating lease agreements. The leases expire at various dates through 2025. In some cases, the leases include options to extend. Rent and lease expense was $9.7 million, $9.1 million and $8.7 million for the years ended December 31, 2017, 2016 and 2015, respectively.

 

The future annual minimum lease payments as of December 31, 2017 are as follows:

 

(in thousands)

 

2018

   

2019

   

2020

   

2021

   

2022

   

Thereafter

   

Total

 

Lease payments

  $ 6,385     $ 5,482     $ 4,774     $ 3,775     $ 2,871     $ 3,453     $ 26,740  

 

 

Commitments and Contingencies

 

The Company is party to various legal actions that it believes are ordinary in nature and incidental to the operation of its business. In the opinion of management, the outcome of the proceedings to which the Company is currently a party will not have a material adverse effect upon its results of operations, financial condition or cash flows. During 2017, the Company recorded $1.0 million related to a settlement of a commercial dispute. The amount was included in “Administrative and general” expenses in the Consolidated Statements of Comprehensive Income. During 2016, the Company paid $1.7 million related to an arbitration decision for a 2015 foreign steel purchase. The amount was included in “Cost of materials sold” in the Consolidated Statements of Comprehensive Income.

 

In the normal course of business, the Company periodically enters into agreements that incorporate indemnification provisions. While the maximum amount to which the Company may be exposed under such agreements cannot be estimated, it is the opinion of management that these indemnifications are not expected to have a material adverse effect on the Company’s results of operations or financial condition.

 

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At December 31, 2017, approximately 280 of the hourly plant personnel are represented by nine separate collective bargaining units. The table below shows the expiration dates of the collective bargaining agreements. Negotiations are currently on-going for our collective bargaining unit in Duluth, Minnesota.

 

 

Facility

Expiration date

Duluth, Minnesota

December 21, 2017

St. Paul, Minnesota

May 25, 2018

Milan, Illinois

August 12, 2018

Locust, North Carolina

March 4, 2020

Romeoville, Illinois

May 31, 2020

Minneapolis, Minnesota (coil)

September 30, 2020

Indianapolis, Indiana

January 29, 2021

Minneapolis, Minnesota (plate)

March 31, 2022

Detroit, Michigan

August 31, 2022

 

 

 

12.  Income Taxes:

 

The components of the Company’s provision (benefit) for income taxes from continuing operations were as follows:

 

   

As of December 31,

 

(in thousands)

 

2017

   

2016

   

2015

 

Current:

                       

Federal

  $ 7,695     $ 2,563     $ (149 )

State and local

    666       929       (752 )
      8,361       3,492       (901 )

Deferred

    (10,974 )     (1,994 )     (5,916 )

Income tax provision (benefit)

  $ (2,613 )   $ 1,498     $ (6,817 )

 

 

The components of the Company’s deferred income taxes at December 31 are as follows:

 

(in thousands)

 

2017

   

2016

 

Deferred tax assets:

               

Inventory (excluding LIFO reserve)

  $ 1,690     $ 2,531  

Net operating loss and tax credit carryforwards

    3,520       3,224  

Allowance for doubtful accounts

    419       533  

Accrued expenses

    5,684       7,228  

Other

    143       169  

Deferred tax assets before valuation allowance

    11,456       13,685  

Valuation allowance

    (2,379 )     (2,017 )

Total deferred tax assets

    9,077       11,668  
                 

Deferred tax liabilities:

               

LIFO reserve

    (3,958 )     (5,874 )

Property and equipment

    (11,363 )     (19,846 )

Intangibles

    (5,901 )     (9,067 )

Total deferred tax liabilities

    (21,222 )     (34,787 )

Deferred tax liabilities, net

  $ (12,145 )   $ (23,119 )

 

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The following table summarizes the activity related to the Company’s gross unrecognized tax benefits:

 

(in thousands)

 

2017

   

2016

   

2015

 

Balance as of January 1

  $ 38     $ 38     $ 58  

Decreases related to prior year tax positions

    -       -       (20 )

Increases related to current year tax positions

    15       13       13  

Decreases related to lapsing of statute of limitations

    (13 )     (13 )     (13 )

Balance as of December 31

  $ 40     $ 38     $ 38  

 

It is expected that the amount of unrecognized tax benefits will not materially change in the next twelve months. The tax years 2014 through 2016 remain open to examination by major taxing jurisdictions to which the Company is subject.

 

The Company recognized interest related to uncertain tax positions in income tax expense.

 

The following table reconciles the U.S. federal statutory rate to the Company’s effective tax rate:

 

   

2017

   

2016

   

2015

 

U.S. federal statutory rate in effect

    35.0%       35.0%       35.0%  

State and local taxes, net of federal benefit

    3.6%       11.8%       1.4%  

Sec. 199 manufacturing deduction

    (3.8% )     (33.6% )     0.0%  

Meals and entertainment

    1.8%       64.3%       (0.6% )

Tax credits

    (1.3% )     (48.7% )     0.4%  

Change in valuation allowance

    0.6%       205.4%       0.0%  

Change in U.S. federal statutory rate

    (37.7% )     0.0%       0.0%  

Change in tax affect of SERP

    (11.4% )     0.0%       0.0%  

Goodwill impairment

    0.0%       0.0%       (17.1% )

All other, net

    (2.8% )     122.4%       1.2%  

Effective income tax rate

    (16.0% )     356.6%       20.3%  

 

In 2017, the Company made an out-of-period adjustment to correct and record previously unrecognized deferred tax assets, and the associated tax benefit, related to a portion of the SERP that had previously been considered non-deductible under Section 162(m) limitations in prior years. Due to the mandatory waiting period of six months prior to any SERP payment distribution, in 2017 the Company determined that the Section 162(m) non-deductibility limitations did not apply. The adjustment, which had accumulated since the inception of the SERP in 2005, resulted in an increase to after-tax income of $1.9 million in 2017.  The Company determined that this adjustment was not material to its current or prior period consolidated financial statements.

 

On December 22, 2017, the President of the United States signed into law the Tax Act. The Tax Act, among other things, lowered the U.S. corporate income tax rate from 35% to 21% effective January 1, 2018. Consequently, the Company decreased its net deferred tax liability as of December 31, 2017 by $6.2 million resulting in an income tax benefit to reflect the estimated impact of the Tax Act. Based on the Company’s predominantly U.S. based operational footprint, additional international and minimum tax provisions under the Tax Act, including the one-time transition tax for the transition from the worldwide system to the territorial system, are not applicable, or would not be material to the Company.

 

The Company believes the calculation of the impact as a result of the reduced U.S. corporate income tax rate is complete except for changes in estimates that can result from finalizing the filing of its 2017 U.S. income tax return, which are not anticipated to be material, and changes that may be a direct impact of other provisional amounts recorded due to the enactment of the Tax Act.

 

While the Company has substantially completed its analysis of the income tax effects of the Tax Act and recorded a reasonable estimate of such effects, certain items related to the Tax Act may differ, possibly materially, due to further refinement of the calculations, changes in interpretations and assumptions made, additional guidance that may be issued by the U.S. government, and actions related to accounting policy decisions the Company may make as a result of the Tax Act. The Company will complete its analysis of these items over a one-year measurement period ending December 22, 2018, and any adjustment provided by the SEC under SAB 118 during this measurement period will be included in net earnings from continuing operations as an adjustment to income tax expense (benefit) in the reporting period when such adjustments are determined.

 

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The Company's effective tax rate was disproportionately high in 2016 from comparative periods due to low income before taxes relative to items that impact the effective tax rate.  During 2016, the Company recorded a valuation allowance of $0.9 million to reduce certain state deferred tax assets to the amount that is more likely than not to be realized.

 

Income taxes paid in 2017, 2016 and 2015 totaled $9.4 million, $1.0 million and $0.6 million, respectively. Some subsidiaries of the Company’s consolidated group file state tax returns on a separate company basis and have state net operating loss carryforwards expiring over the next seven to 20 years. A valuation allowance is recorded to reduce certain deferred tax assets to the amount that is more likely than not to be realized.

 

 

 

13.  Shares Outstanding and Earnings Per Share:

 

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

 

   

For the years ended December 31,

 

(in thousands, except per share data)

 

2017

   

2016

   

2015

 
                         

Weighted average basic shares outstanding

    11,381       11,210       11,192  

Assumed exercise of stock options and issuance of stock awards

    -       -       -  

Weighted average diluted shares outstanding

    11,381       11,210       11,192  

Net income (loss)

  $ 18,963     $ (1,078 )   $ (26,777 )

Basic earnings (loss) per share

  $ 1.67     $ (0.10 )   $ (2.39 )

Diluted earnings (loss) per share

  $ 1.67     $ (0.10 )   $ (2.39 )

Anti-dilutive securities outstanding

    65       167       125  

 

 

 

14.  Stock Repurchase Program:

 

On October 2, 2015, the Company announced that its Board of Directors authorized a stock repurchase program of up to 550,000 shares of the Company’s issued and outstanding common stock, which could include open market repurchases, negotiated block transactions, accelerated stock repurchases or open market solicitations for shares, all or some of which may be effected through Rule 10b5-1 plans. Any of the repurchased shares are held in the Company’s treasury, or canceled and retired as the Board may determine from time to time. Any repurchases of common stock are subject to the covenants contained in the Loan Agreement. Under the Loan Agreement, the Company may repurchase common stock and pay dividends up to $5.0 million in the aggregate during any trailing twelve months without restrictions. Purchases of common stock or dividend payments in excess of $5.0 million in the aggregate require the Company to (i) maintain availability in excess of 20.0% of the aggregate revolver commitments ($80.0 million at December 31, 2017) or (ii) to maintain availability equal to or greater than 15.0% of the aggregate revolver commitments ($60.0 million at December 31, 2017) and the Company must maintain a pro-forma ratio of EBITDA minus certain capital expenditures and cash taxes paid to fixed charges of at least 1.00 to 1.00.

 

There were no shares repurchased during 2017 or 2016. During the fourth quarter of 2015, the Company repurchased 65,283 shares of outstanding common stock at an average cost of $10.71 per share.

 

 

 

15.  Segment Information:

 

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

 

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The Company operates in three reportable segments; carbon flat products, specialty metals flat products, and tubular and pipe products. Certain of the flat products segments’ assets and resources are shared by the carbon and specialty metals segments and both segments’ products are stored in the shared facilities and, in some locations, processed on shared equipment. 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. Through its carbon flat products segment, the Company sells and distributes large volumes of processed carbon and coated flat-rolled sheet, coil and plate products. Through its specialty metals flat products segment, the Company sells and distributes processed aluminum and stainless flat-rolled sheet and coil products, flat bar products and fabricated parts. Through its tubular and pipe products segment, the Company distributes metal tubing, pipe, bar, valve and fittings and fabricates pressure parts supplied to various industrial markets.

 

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

 

The following table provides financial information by segment and reconciles the Company’s operating income by segment to the consolidated income before income taxes for the years ended December 31, 2017, 2016 and 2015.

 

   

For the Year Ended December 31,

 

(in thousands)

 

2017

   

2016

   

2015

 

Net sales

                       

Carbon flat products

  $ 869,628     $ 670,983     $ 765,400  

Specialty metals flat products

    227,200       189,930       192,516  

Tubular and pipe products

    233,868       194,203       217,627  

Total net sales

  $ 1,330,696     $ 1,055,116     $ 1,175,543  
                         

Depreciation and amortization

                       

Carbon flat products

  $ 10,906     $ 11,690     $ 12,200  

Specialty metals flat products

    811       797       698  

Tubular and pipe products

    5,659       5,896       6,036  

Corporate

    102       102       102  

Total depreciation and amortization

  $ 17,478     $ 18,485     $ 19,036  
                         

Operating income

                       

Carbon flat products

  $ 17,886     $ (4,371 )   $ (7,217 )

Specialty metals flat products

    11,240       9,841       (1,074 )

Tubular and pipe products

    4,568       7,713       12,583  

Corporate

    (9,708 )     (7,435 )     (7,120 )

Goodwill and intangible asset impairment (a)

    -       -       (24,951 )

Total operating income (loss)

  $ 23,986     $ 5,748     $ (27,779 )

Other loss, net

    (118 )     (55 )     (125 )

Income (loss) before interest and income taxes

    23,868       5,693       (27,904 )

Interest and other expense on debt

    7,518       5,273       5,690  

Income (loss) before income taxes

  $ 16,350     $ 420     $ (33,594 )

 

(a)

$24,451 of the goodwill and intangible asset impairment in 2015 related to the tubular and pipe products segment, $500 related to the specialty metals flat products segment.

 

73

 

 

   

For the Year Ended December 31,

 

(in thousands)

 

2017

   

2016

   

2015

 

Capital expenditures

                       

Flat products

  $ 7,325     $ 5,105     $ 4,295  

Tubular and pipe products

    2,833       1,719       3,022  

Corporate

    2       -       -  

Total capital expenditures

  $ 10,160     $ 6,824     $ 7,317  
                         

Assets

                       

Flat products

  $ 409,116     $ 363,626          

Tubular and pipe products

    194,787       192,088          

Corporate

    255       354          

Total assets

  $ 604,158     $ 556,068          

 

There were no material revenue transactions between the carbon flat products, specialty metals flat products and tubular and pipe products segments for the years ended December 31, 2017, 2016 and 2015.

 

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

 

 

 

16.  Retirement Plans:

 

The Company’s retirement plans consist of two 401(k) plans covering certain non-union employees, two separate 401(k) plans covering all union employees, a multi-employer pension plan covering certain CTI employees and a supplemental executive retirement plan (SERP) covering certain executive officers of the Company.

 

The 401(k) retirement plans allow eligible employees to contribute up to the statutory maximum. The Company’s non-union 401(k) matching contribution is determined annually by the Board of Directors and is based on a percentage of eligible employees’ earnings and contributions. For the 401(k) retirement plans, the Company matched one-half of each eligible employee’s contribution, limited to the first 6% of eligible compensation.

 

In 2005, the Board of Directors adopted a SERP, which has been amended from time to time. Contributions to the SERP are based on: (i) a portion of the participants’ compensation multiplied by a factor of 6.5% or 13% depending on participant; and (ii) for certain participants a portion of the participants’ compensation multiplied by a factor which is contingent upon the Company’s return on invested capital. Benefits are subject to a vesting schedule of up to five years.

 

The Company, through its CTI subsidiary, contributes to one multiemployer pension plan – the Plumbing and Heating Wholesalers Retirement Income Plan for the Benefit of the Shopmen’s Division of Pipe Fitters’ Association Local Union 597, EIN 36-6511016, Plan Number 001 (the Multiemployer Plan). The risks of participating in the Multiemployer Plan are different from a single-employer plan in that 1) assets contributed to the multiemployer plan by one employer may be used to provide benefits to employees of other participating employers, 2) if a participating employer stops contributing to the plan, the unfunded obligations of the plan may be borne by the remaining participating employers, and 3) if CTI chooses to stop participating in the Multiemployer Plan, CTI may be required to pay the plan an amount based on the unfunded status of the plan, referred to as a withdrawal liability.

 

The most recent Pension Protection Act zone status available is for the plan year beginning January 1, 2017, and the Multiemployer Plan’s actuary has certified that the Multiemployer Plan is neither in critical status nor endangered status and that it is in the green zone. The green zone status is based on information that CTI received from the Multiemployer Plan and is certified by the Multiemployer Plan’s actuary. Among other factors, plans in the green zone are at least 80 percent funded.

 

CTI contributes to the Multiemployer Plan under the terms of a collective bargaining agreement that covers certain of its union employees, and which expires May 31, 2020. CTI contributions to the Multiemployer Plan were immaterial for the years ended December 31, 2017 and 2016.

 

Retirement plan expense, which includes all Company 401(k), SERP defined contributions and the Multiemployer Plan, amounted to $2.6 million, $2.2 million and $2.0 million for the years ended December 31, 2017, 2016 and 2015, respectively.

 

74

 

 

The fair values of the Company's SERP assets as of December 31, 2017 were $6.5 million and are measured at Net Asset Value (NAV) as a practical expedient to estimate fair value and therefore are not classified in the fair value hierarchy. Under the practical expedient approach, the NAV is based on the fair value of the underlying investments held by each fund less its liabilities. This practical expedient would not be used when it is determined to be probable that the fund will sell the investment for an amount different than the reported NAV. The fair value of the SERP assets are included in Other Long Term Assets on the consolidated Balance Sheets.

 

 

 

17.  Related-Party Transactions:

 

The Company’s Chief Executive Officer owns 50% of an entity that owns one of the Cleveland warehouses and leases it to the Company at a fair market value annual rental of $0.2 million. The lease expires on December 31, 2018 with four five-year renewal options.

 

75

 

 

 

Schedule II – Valuation and Qualifying Accounts

(in thousands)

 

           

Additions

                 

Description

 

Balance at

Beginning

of Period

   

Charged to

Costs and

Expenses

   

Charged to

Other

Accounts

   

Deductions

   

Balance at

End of

Period

 

Year Ended December 31, 2015

                                       

Allowance for doubtful accounts

  $ 1,348     $ 506     $ -     $ (555 )   $ 1,299  

Tax valuation reserve

  $ 1,381     $ -     $ -     $ (351 )   $ 1,030  
                                         

Year Ended December 31, 2016

                                       

Allowance for doubtful accounts

  $ 1,299     $ 369     $ -     $ (283 )   $ 1,385  

Tax valuation reserve

  $ 1,030     $ 987     $ -     $ -     $ 2,017  
                                         

Year Ended December 31, 2017

                                       

Allowance for doubtful accounts

  $ 1,385     $ 641     $ -     $ (416 )   $ 1,610  

Tax valuation reserve

  $ 2,017     $ 362     $ -     $ -     $ 2,379  

 

76

 

 

 

SUPPLEMENTAL FINANCIAL INFORMATION

(in thousands, except per share data)

(unaudited)

 

 

2017

 

1st quarter

   

2nd quarter

   

3rd quarter

   

4th quarter

   

Year

 

Net sales

  $ 334,893     $ 356,195     $ 331,442     $ 308,166     $ 1,330,696  

Operating income (loss) (a)

    11,051       9,633       5,286       (1,984 )     23,986  

Income (loss) before income taxes

    9,399       7,817       3,298       (4,164 )     16,350  

Net income (b)

  $ 7,699     $ 4,797     $ 2,280     $ 4,187     $ 18,963  

Basic net income (loss) per share

  $ 0.68     $ 0.42     $ 0.20     $ 0.37     $ 1.67  

Weighted average shares outstanding - basic

    11,369       11,383       11,386       11,389       11,381  

Diluted net income (loss) per share

  $ 0.68     $ 0.42     $ 0.20     $ 0.37     $ 1.67  

Weighted average shares outstanding - diluted

    11,369       11,390       11,386       11,391       11,381  

Market price of common stock: (c)

                                       

High

  $ 27.93     $ 24.00     $ 22.44     $ 22.86     $ 27.93  

Low

    18.05       15.83       16.58       18.10       15.83  

 

 

2016

 

1st quarter

   

2nd quarter

   

3rd quarter

   

4th quarter

   

Year

 

Net sales

  $ 258,349     $ 273,608     $ 268,255     $ 254,904     $ 1,055,116  

Operating income (loss) (d)

    35       8,339       27       (2,653 )     5,748  

Income (loss) before income taxes

    (1,255 )     7,007       (1,288 )     (4,044 )     420  

Net income (loss)

  $ (767 )   $ 3,550     $ (1,757 )   $ (2,104 )   $ (1,078 )

Basic net income (loss) per share

  $ (0.07 )   $ 0.32     $ (0.16 )   $ (0.19 )   $ (0.10 )

Weighted average shares outstanding - basic

    11,182       11,216       11,219       11,221       11,210  

Diluted net income (loss) per share

  $ (0.07 )   $ 0.32     $ (0.16 )   $ (0.19 )   $ (0.10 )

Weighted average shares outstanding - diluted

    11,182       11,216       11,219       11,221       11,210  

Market price of common stock: (c)

                                       

High

  $ 17.50     $ 27.48     $ 31.19     $ 28.67     $ 31.19  

Low

    7.98       15.41       17.42       17.14       7.98  

 

(a)

Operating income (loss) in 2017 includes $2,707 of LIFO expense related to the Company's tubular and pipe products segment.

(b)

Includes a $6.2 million tax benefit related to the U.S. Tax Cuts and Jobs Act.

(c)

Represents the high and low sales prices of our common stock as reported by the Nasdaq Global Select Market.

(d)

Operating income (loss) in 2016 includes $1,489 of LIFO income related to the Company's tubular and pipe products segment.

 

77

 

 

ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

 

None.

 

 

ITEM 9A.  CONTROLS AND PROCEDURES

 

Disclosure Controls and Procedures

 

Evaluations required by Rule 13a-15 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 Annual Report have been carried out under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer. Based upon such evaluations, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of December 31, 2017 in providing reasonable assurance that information required to be disclosed by us in reports filed under the Exchange Act is recorded, processed, summarized and reported within time periods specified in the rules and forms of the SEC.

 

 

Management’s Report on Internal Control Over Financial Reporting

 

Management’s Report on Internal Control Over Financial Reporting is set forth in Part II, Item 8 of this Annual Report on Form 10-K and is incorporated herein. PricewaterhouseCoopers LLP, the Company’s independent registered public accounting firm, has issued an attestation report on our internal control over financial reporting that is set forth in Part II, Item 8 of this Annual Report and is incorporated herein by reference.

 

 

Changes in Internal Control Over Financial Reporting

 

There have been no changes in our internal control over financial reporting during the quarter ended December 31, 2017 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

 

ITEM 9B.  OTHER INFORMATION

 

None.

 

78

 

 

PART III

 

ITEM 10.  DIRECTORS, EXECUTIVE OFFICERS OF THE REGISTRANT AND CORPORATE GOVERNANCE

 

Information required by Item 10 as to the executive officers is provided in Part I of this Annual Report on Form 10-K and is incorporated by reference into this section. Other information required by Item 10 will be incorporated herein by reference to the information set forth in our definitive proxy statement for our 2018 Annual Meeting of Shareholders.

 

 

ITEM 11.  EXECUTIVE COMPENSATION

 

Information required by Item 11 will be incorporated herein by reference to the information set forth in our definitive proxy statement for our 2018 Annual Meeting of Shareholders.

 

 

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

 

Information required by Item 12 will be incorporated herein by reference to the information set forth in our definitive proxy statement for our 2018 Annual Meeting of Shareholders.

 

 

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

 

Information required by Item 13 will be incorporated herein by reference to the information set forth in our definitive proxy statement for our 2018 Annual Meeting of Shareholders.

 

 

ITEM 14.  PRINCIPAL ACCOUNTANT FEES AND SERVICES

 

Information required by Item 14 will be incorporated herein by reference to the information set forth in our definitive proxy statement for our 2018 Annual Meeting of Shareholders.

 

79

 

 

PART IV

 

ITEM 15.  EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

 

 

(a)(1) The following financial statements are included in Part II, Item 8:

 

Report of Independent Registered Public Accounting Firm

Management’s Report on Internal Control Over Financial Reporting

Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2017, 2016 and 2015

Consolidated Balance Sheets as of December 31, 2017 and 2016

Consolidated Statements of Cash Flows for the Years Ended December 31, 2017, 2016 and 2015

Supplemental Disclosures of Cash Flow Information for the Years Ended December 31, 2017, 2016 and 2015

Consolidated Statements of Shareholders' Equity for the Years Ended December 31, 2017, 2016 and 2015

Notes to Consolidated Financial Statements for the Years Ended December 31, 2017, 2016 and 2015

 

(a)(2) Financial Statement Schedules.

Schedule II – Valuation and Qualifying Accounts

 

(a)(3) Exhibits. The Exhibits filed herewith are set forth on the Index to Exhibits filed as part of this Annual Report and incorporated herein by reference.

 

 

INDEX TO EXHIBITS

 

 

Exhibit

 

Description

   

Reference

 
 

3.1(i)

 

Amended and Restated Articles of Incorporation

   

Incorporated by reference to Exhibit 3.1(i) to the Registration Statement on Form S-1 (Registration No. 33-73992) filed with the Commission on January 12, 1994.

 
 

3.1(ii)

 

Amended and Restated Code of Regulations

   

Incorporated by reference to Exhibit 3.1 to Company’s Form 10-Q filed with the Commission on August 6, 2015 (Commission File No. 0-23320).

 
 

4.25

 

Third Amended and Restated Loan and Security Agreement, dated as of December 8, 2017, by and among the Registrant, the financial institutions from time to time party thereto, Bank of America, N.A., as administrative agent, and the other agents from time to time party thereto.

   

Incorporated by reference to Exhibit 4.25 to Registrant's Form 8-K filed with the Commission on December 14, 2017 (Commission File No. 0-23320).

 
 

10.8 *

 

Form of Management Retention Agreement for Senior Executive Officers of the Company

   

Incorporated by reference to Exhibit 10.8 to Registrant's Form 10-Q filed with the Commission on August 7, 2000 (Commission File No. 0-23320).

 
 

10.9 *

 

Form of Management Retention Agreement for Other Officers of the Company

   

Incorporated by reference to Exhibit 10.9 to Registrant's Form 10-Q filed with the Commission on August 7, 2000 (Commission File No. 0-23320).

 
 

10.14 *

 

Olympic Steel, Inc. Executive Deferred Compensation Plan dated December 15, 2004

   

Incorporated by reference to Exhibit 10.14 to Registrant’s Form 10-K filed with the Commission on March 14, 2005 (Commission File No. 0-23320).

 

 

80

 

 

  Exhibit   Description     Reference  
 

10.15 *

 

Form of Non-Solicitation Agreements

   

Incorporated by reference to Exhibit 10.15 to Registrant’s Form 8-K filed with the Commission on March 4, 2005 (Commission File No. 0-23320).

 
 

10.16 *

 

Form of Management Retention Agreement

   

Incorporated by reference to Exhibit 10.16 to Registrant’s Form 10-Q filed with the Commission on August 8, 2005 (Commission File No. 0-23320).

 
 

10.17 *

 

Supplemental Executive Retirement Plan Term Sheet

   

Incorporated by reference to Exhibit 99.1 to Registrant’s Form 8-K filed with the Commission on January 5, 2006 (Commission File No. 0-23320).

 
 

10.20 *

 

Olympic Steel, Inc. Supplemental Executive Retirement Plan

   

Incorporated by reference to Exhibit 10.20 to Registrant’s Form 8-K filed with the Commission on April 28, 2006 (Commission File No. 0-23320).

 
 

10.21 *

 

Amended and Restated Olympic Steel, Inc. 2007 Omnibus Incentive Plan

   

Incorporated by reference to Exhibit 4.3 to Registrant’s Registration Statement on Form S-8 (Registration No. 333-211023) filed with the Commission on April 29, 2016.

 
 

10.30 *

 

Olympic Steel, Inc. Senior Manager Compensation Plan

   

Incorporated by reference to Exhibit 10.30 to Registrant’s Form 10-Q filed with the Commission on May 6, 2011 (Commission File No. 0-23320).

 
 

10.31 *

 

David A. Wolfort Employment Agreement effective as of January 1, 2016

   

Incorporated by reference to Exhibit 10.31 to Registrant’s Form 8-K filed with the Commission on December 31, 2015 (Commission File No. 0-23320).

 
 

10.32 *

 

Donald McNeeley Employment Agreement effective as of March 31, 2016

   

Incorporated by reference to Exhibit 10.32 to Registrant’s Form 8-K filed with the Commission on March 31, 2016 (Commission File No. 0-23320).

 
 

10.33 *

 

Richard T. Marabito Employment Agreement effective as of November 23, 2016

   

Incorporated by reference to Exhibit 10.13 to Registrant’s Form 8-K filed with the Commission on November 23, 2016 (Commission File No. 0-23320).

 
 

10.34 *

 

Form of RSU Agreements for Messrs. Siegal, Wolfort and Marabito.

   

Incorporated by reference to Exhibit 10.34 to Registrant’s Form 10-K filed with the Commission on February 23, 2012 (Commission File No. 0-23320).

 
 

10.35 *

 

Michael D. Siegal Employment Agreement effective as of December 20, 2017

   

Incorporated by reference to Exhibit 10.35 to Registrant’s Form 8-K filed with the Commission on December 22, 2017 (Commission File No. 0-23320).

 

 

81

 

 

  Exhibit   Description     Reference  
 

10.37*

 

Amendment to Form of Management Retention Agreement for Senior Executive Officers of the Company 

   

Incorporated by reference to Exhibit 10.1 to Registrant’s Form 10-Q filed with the Commission on May 1, 2015 (Commission File No. 0-23320).

 
 

10.38 *

 

Andrew S. Greiff Employment Agreement effective as of August 19, 2016

   

Incorporated by reference to Exhibit 10.38 to Registrant’s Form 8-K filed with the Commission on August 23, 2016 (Commission File No. 0-23320).

 
 

21

 

List of Subsidiaries

   

Filed herewith

 
 

23

 

Consent of Independent Registered Public Accounting Firm

   

Filed herewith

 
 

24

 

Directors and Officers Powers of Attorney

   

Filed herewith

 
 

31.1

 

Certification of the Principal Executive Officer of the Company, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

   

Filed herewith

 
 

31.2

 

Certification of the Principal Financial Officer of the Company, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

   

Filed herewith

 
 

32.1

 

Written Statement of Michael D. Siegal, Chairman and Chief Executive Officer of the Company pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

   

Furnished herewith

 
 

32.2

 

Written Statement of Richard T. Marabito, Chief Financial Officer of the Company pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

   

Furnished herewith

 
 

101.INS

 

XBRL Instance Document

       
 

101.SCH

 

XBRL Taxonomy Extension Schema Document

       
 

101.CAL

 

XBRL Taxonomy Extension Calculation Linkbase Document

       
 

101.DEF

 

XBRL Taxonomy Extension Definition

       
 

101.LAB

 

XBRL Taxonomy Extension Label Linkbase Document

       
 

101.PRE

 

XBRL Taxonomy Extension Presentation Linkbase Document

       

 

*      This exhibit is a management contract or compensatory plan or arrangement.

 

82

 

 

ITEM 16. FORM 10-K SUMMARY

 

None.

 

83

 

 

SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) 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.

 

 

OLYMPIC STEEL, INC.

 

 

 

 

 

March 2, 2018

By:

/s/ Richard T. Marabito

 

 

 

Richard T. Marabito,

 

 

 

Chief Financial Officer

 

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons in the capacities indicated and on the dates indicated.

 

March 2, 2018

/s/

Michael D. Siegal *

 

 

 

Michael D. Siegal

 
    Chairman of the Board and Chief Executive Officer   

 

 

(Principal Executive Officer)

 

 

 

 

 

March 2, 2018

/s/

David A. Wolfort *

 

 

 

David A. Wolfort

 

 

 

President and Director

 

 

 

 

 

March 2, 2018

/s/

Richard T. Marabito *

 

 

  Richard T. Marabito  
    Chief Financial Officer (Principal Financial Officer  

 

 

and Principal Accounting Officer)

 

 

 

 

 

March 2, 2018

/s/

Donald R. McNeeley *

 

 

 

Donald R. McNeeley

 

 

 

President of Chicago Tube and Iron and Director

 

 

 

 

 

March 2, 2018

/s/

Ralph M. Della Ratta, Jr. *

 

 

 

Ralph M. Della Ratta, Jr., Lead Director

 

 

 

 

 

March 2, 2018

/s/

Arthur F. Anton *

 

 

 

Arthur F. Anton, Director

 

 

 

 

 

March 2, 2018

/s/

Dirk A. Kempthorne *

 

 

 

Dirk A. Kempthorne, Director

 

 

 

 

 

March 2, 2018

/s/

Michael G. Rippey *

 

 

 

Michael G. Rippey, Director

 

 

 

 

 

March 2, 2018

/s/

Howard L. Goldstein *

 

 

 

Howard L. Goldstein, Director

 

 

 

* The undersigned, by signing his name hereto, does sign and execute this Annual Report on Form 10-K pursuant to the Powers of Attorney executed by the above-named officers and directors of the Company and filed with the Securities and Exchange Commission on behalf of such officers and directors.

 

By:

/s/ Richard T. Marabito

 

March 2, 2018

 

Richard T. Marabito, Attorney-in-Fact

 

 

 

 

 

 

 

84