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ERS > SEC Filings for ERS > Form 10-Q on 14-Nov-2013All Recent SEC Filings

Show all filings for EMPIRE RESOURCES INC /NEW/

Form 10-Q for EMPIRE RESOURCES INC /NEW/


14-Nov-2013

Quarterly Report


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

You should read the following discussion of our financial condition and results of operations in conjunction with the consolidated financial statements and the notes thereto included elsewhere in this Quarterly Report on Form 10-Q and our 10-K filed with the Securities and Exchange Commission on March 25, 2013. All numbers used in this discussion are in thousands, except for per share information.

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains "forward-looking statements," which include information relating to future events, future financial performance, strategies, expectations, competitive environment and regulation. Words such as "may," "should," "could," "would," "predict," "potential," "continue," "expect," "anticipate," "future," "intend," "plan," "believe," "estimate," and similar expressions, as well as statements in future tense, identify forward-looking statements. Forward-looking statements should not be read as a guarantee of future performance or results and may not be accurate indications of when such performance or results will be achieved. Forward-looking statements are based on information we have when those statements are made or our management's good faith belief as of that time with respect to future events, and are subject to risks and uncertainties that could cause actual performance or results to differ materially from those expressed in or suggested by the forward-looking statements. Important factors that could cause such differences include, but are not limited to:

· loss or default of one or more suppliers;

· loss or default of one or more significant customers;

· default by the counterparties to our derivative financial instruments;

· changes in general, national or regional economic conditions;

· an act of war or terrorism that disrupts international shipping;

· changes in laws, regulations and tariffs;

· the imposition of anti-dumping duties on the products we import;

· changes in the size and nature of our competition;

· changes in interest rates, foreign currencies or spot prices of aluminum;

· loss of one or more key executives;

· increased credit risk from customers;

· our failure to grow internally or by acquisition; and

· failure to improve operating margins and efficiencies.

For a discussion of these and other risks that relate to our business and investing in shares of our common stock, you should carefully review the risk factors and other cautionary statements in our Annual Report on Form 10-K for the year ended December 31, 2012 that was filed with the Securities and Exchange Commission on March 25, 2013, and those described from time to time in our other reports filed with the Securities and Exchange Commission. The forward-looking statements contained in this Quarterly Report on Form 10-Q are expressly qualified in their entirety by this cautionary statement. We do not undertake any obligation to publicly update any forward-looking statement to reflect events or circumstances after the date on which any such statement is made or to reflect the occurrence of unanticipated events.

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Our Business

We are engaged in the purchase, sale and distribution of semi-finished aluminum and steel products to a diverse customer base located in the Americas, Europe, Australia and New Zealand. We sell our products through our own marketing and sales personnel as well as through commission based independent sales agents located in North America and Europe. We purchase products from suppliers located throughout the world. Our two largest suppliers furnished approximately 50% of our products during the first nine months of 2013 as compared to 59% of our products during the same period in 2012. While we generally place orders with our suppliers based upon orders that we receive from our customers, we also purchase material for our own stock, which we typically use for shorter term deliveries to our customers.

Critical Accounting Policies and Estimates

The following discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the U.S. The preparation of financial statements in accordance with generally accepted accounting principles in the U.S. requires us to make estimates and assumptions that affect the amounts reported in our financial statements. The financial statements include estimates based on currently available information and our judgment as to the outcome of future conditions and circumstances. Significant estimates in these financial statements include allowance for doubtful accounts and the derivative liability for the embedded conversion option in our 10% Convertible Senior Subordinated Notes Due June 1, 2016 in the principal amount of $12,000. Changes in the status of certain facts or circumstances could result in material changes to the estimates used in the preparation of the financial statements and actual results could differ from the estimates and assumptions.

Among the significant judgments made by management in the preparation of our financial statements are the following:

Allowance for Doubtful Accounts

As of September 30, 2013, we had $63,579 in trade receivables, after an allowance for doubtful accounts of $525. We report accounts receivable, net of an allowance for doubtful accounts, to represent our estimate of the amount that ultimately will be realized in cash. We review the adequacy of our allowance for doubtful accounts on an ongoing basis, using historical collection trends, age of receivables, as well as review of specific accounts, and make adjustments in the allowance that we believe are necessary. We maintain a credit insurance policy on the majority of our customers. In general, this policy has a 10% deductible; however there are some instances where the co-insurance may vary and instances where we may exceed the insured values. Changes in economic conditions could have an impact on the collection of existing receivable balances or future allowance considerations. In addition, changes in the credit insurance environment could affect the availability of credit insurance and our ability to secure it.

Accruals for Inventory Claims

Generally, our exposure on claims for defective material is relatively small, as we usually refer all claims on defects back to our suppliers. If we do not believe that a supplier will honor a material claim for a defective product, we will record an allowance for inventory adjustments.

Results of Operations

General

We are engaged in the purchase, sale and distribution of semi-finished aluminum and steel products which we purchase from producing mills around the world. The market prices of materials we purchase, as well as the market price of materials we sell, fluctuate constantly in world markets. Our cost of sales is composed of metal content, which in part is determined on world metal exchanges, plus a unique fabrication premium charged by each producer to convert the raw metal to a semi-finished product. In turn, we typically sell to our customers either on a fixed price basis or based on metal content plus a premium which includes supplier fabrication margin, and costs of importation, warehousing, and delivery of material to customers. Since metal content costs are the largest component of cost of sales and selling price, our sales pricing trends and cost of sales trends generally track consistently.

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Comparison of Three Months Ended September 30, 2013 and 2012

During the three months ended September 30, 2013, net sales decreased by $11,315, from $137,705 to $126,390 or 8% from the same period in 2012. This decrease was due to lower metal pricing as well as lower unit volume shipments in North and South America during the period ending September 30, 2013 as compared to the same period in 2012.

Gross profit decreased by $800, to $5,308 during the three months ended September 30, 2013 from $6,108 in the same period of 2012, representing a 13% decrease. The dollar decline is attributable to lower sales volume and reduced gross profit margin in our Australian and Brazilian segments as a result of increased competition from global competitors entering these markets.

Selling, general and administrative expenses increased 5.0% or $170, from $3,432 during the three months ended September 30, 2012, to $3,602 in the same period in 2013. Increased payroll, legal and banking costs were partially offset by decreases in professional fees during the quarter.

As a result of reduced sales revenue and lower gross profit margin, operating income decreased by $970 during the three months ended September 30, 2013 from $2,676 to $1,706, or a decrease of 36%.

During the three months ended September 30, 2013, interest expense decreased 16.1% or $222, to $1,156 from $1,378 for the same period in 2012. As we rationalized our inventories bank debt declined, resulting in reduced interest expense. During the three months ended September 30, 2013 and 2012, interest on our 10% Convertible Senior Subordinated Notes Due June 1, 2016 and amortization of the debt discount in connection with these notes totaled $441 in both periods.

Our 10% Convertible Senior Subordinated Notes Due June 1, 2016 have an embedded conversion option which has been bifurcated and recorded as a separate derivative liability at a fair value at issuance of the notes. The derivative liability is carried at fair value with changes in mark to market recorded in income. The changes in the fair value of the derivative liability resulted in a non-cash non-operating gain of $1,715 during the three month period ended September 30, 2013, as compared to a $410 non-cash non-operating gain during the same period in 2012.

Net income increased by $419, from $1,052 during the three months ended September 30, 2012 to $1,471 during the three months ended September 30, 2013, primarily as a result of the non-cash non-operating gain in mark to market of the derivative liability.

Comparison of Nine Months Ended September 30, 2013 and 2012

During the nine months ended September 30, 2013, net sales decreased by $58,718, from $429,006 to $370,288 or 14% from the same period in 2012. This decrease was due to lower metal pricing as well as lower unit volume shipments in North America, Australia and New Zealand during the period ending September 30 2013 as compared to the same period in 2012.

Gross profit decreased by $1,678, to $17,205 during the nine months ended September 30, 2013 from $18,883 in the same period of 2012, representing an 8.9% decrease. The dollar decline during the nine months ended September 30, 2013 was attributable to lower sales volume, even as our gross profit percentage improved to 4.65% as compared to 4.4% during the nine months ended September 30, 2012. The improvement in the percentage gross profit is attributed in part to lower storage costs as a result of lower inventory levels as well as reduced processing costs achieved by rebalancing the products held in inventory.

Selling, general and administrative expenses increased 1.7% or $170, from $10,191 during the nine months ended September 30, 2012, to $10,361 in the same period 2013.

As a result of reduced sales revenue, operating income decreased by $1,848 during the nine months ended September 30, 2013 from $8,692 to $6,844 during the nine months ended September 30, 2012, or a decrease of 21.3%.

During the nine months ended September 30, 2013, interest expense decreased by $716, to $3,403 from $4,119 for the same period in 2012. As we rationalized our inventories bank debt declined, resulting in reduced interest expense. During the nine months ended September 30, 2013 and 2012, interest on our 10% Convertible Senior Subordinated Notes Due June 1, 2016 and amortization of the debt discount in connection with these notes totaled $1,324 in both periods.

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Our 10% Convertible Senior Subordinated Notes Due June 1, 2016 have an embedded conversion option which has been bifurcated and recorded as a separate derivative liability at a fair value at issuance of the notes. The derivative liability is carried at fair value with changes in mark to market recorded in income. The changes in the fair value of the derivative liability resulted in a non-cash non-operating loss of $452, during the period ended September 30, 2013, as compared to a $361 non-cash non-operating gain during the same period in 2012.

Net income decreased from $3,051 during the nine months ended September 30, 2012 to $1,923 during the nine months ended September 30, 2013, which was attributable to the decline in sales as well as the $452 non-operating non-cash charge for the change in derivative liability on our convertible senior subordinated debt.

Liquidity and Capital Resources

Overview

At September 30, 2013, we had cash of $2,246, accounts receivable of $63,579, total senior secured debt of $113,000 and subordinated debt of $12,000. Management believes that cash from operations, together with funds available under our credit facility will be sufficient to fund the cash requirements relating to our existing operations for the next twelve months. However, we will require additional debt or equity financing in connection with the future expansion of our operations.

Comparison of Periods Ended September 30, 2013 and 2012

Net cash provided by operating activities was $3,842 during the nine months ended September 30, 2013, as compared to $30,637 during the same period in 2012, resulting from reductions in inventories of $21,708 and $54,451, respectively. During 2013, we continued our focus on decreasing inventory and improving inventory turns, however the opportunity for further reduction was limited as inventory levels had already been reduced to prudent levels relative to sales.

We focus on our days' sales outstanding and our inventory turnover rate to manage working capital, because accounts receivable and inventory are the two most significant elements of our working capital.

During the first nine months of 2013, our inventory turn rate was about 4.0 times (or 90 days on hand), compared to our September 2012 rate of about 4.4 times (or 82 days on hand). Our inventory in warehouses, available for delivery to customers, as of September 30, 2013 was less than two months of sales; our inventory in transit was approximately 56% higher than on the same date in 2012, and this accounts for the decrease in the inventory turns.

The days payable increased to 23 days as of September 30, 2013 as compared to 18 days as of the same date last year. As of September 30, 2013, our days' sales outstanding rate was approximately 46 days, as compared to 41 days as of September 30, 2012. This increase is attributable to expansion of sales in new markets which traditionally have longer payment cycles.

Cash flows provided by investing activities during the nine months ended September 30, 2013 amounted to $2,500, as compared to cash flows used in investing activities of $5,038 during the same period in 2012. Cash flows provided by investing activities during the nine months ended September 30, 2013 reflects the monthly repayment by PT. Alumindo Light Metal Industry of the advance related to our supply agreement.

Cash flows used in financing activities during the nine months ended September 30, 2013 amounted to $7,233, as compared to cash flows used of $27,251 during the same period in 2012. We repaid $6,594 of our bank debt as our reduction of inventory continued to generate positive cash flow. In addition, we acquired 7 additional common shares at a cost of $23 during the period ended September 30, 2013.

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Credit Agreements and Other Debt

On April 28, 2011, we entered into a working capital credit agreement with Rabobank International, for itself and as lead arranger and agent, JPMorgan Chase, for itself and as syndication agent, and ABN AMRO, BNP Paribas, RBS Citizens, Société Générale, and Brown Brothers Harriman. The $200,000 secured, asset-based credit facility matures on June 30, 2014 and refinanced our prior $175,000 credit agreement which would have matured on June 30, 2011. The agreement also allows additional increases in the line of credit of up to $50,000, subject to certain restrictions. Amounts borrowed bear interest of Eurodollar, money market or base rates, at our option, plus an applicable margin. Our borrowings under this line of credit are secured by substantially all of our assets. The credit agreement contains financial and other covenants including but not limited to, covenants requiring maintenance of minimum tangible net worth of $25,000 plus an aggregate amount equal to 25% of our positive net earnings and compliance with a leverage ratio of not more than 6.00 to 1, as well as an ownership minimum and limitations on other indebtedness, liens, and investments and dispositions of assets. The credit agreement provides that amounts under the facility may be borrowed and repaid, and re-borrowed, subject to a borrowing base test, until the maturity date of June 30, 2014. As of September 30, 2013, we had direct borrowings of $113,000 outstanding under the credit agreement, bearing interest at 2.69%, and letters of credit of $48,676 to some suppliers, leaving an availability of approximately $38,324 on our credit agreement, or approximately 19%. All of the letters of credit will expire on or before February 29, 2014. As of September 30, 2013 we were in compliance with all financial covenants under this credit agreement.

Our wholly owned Belgian subsidiary, Imbali Metals BVBA ("Imbali"), operates under a line of credit with ING Belgium S.A./N.V., with a EUR 8,000 ($10,821) commitment for loans and documentary letters of credit. Loan advances are limited to a percentage of Imbali's pledged accounts receivables and inventory. This secured credit arrangement is unconditionally guaranteed by us. As of September 30, 2013, Imbali had borrowings of EUR 3,410 ($4,612) under this line of credit, bearing interest at EURIBOR plus 1.75%, leaving an availability of approximately EUR4,590 ($6,209) or approximately 57%. As of September 30, 2013 we were in compliance with all financial covenants under this line of credit.

In addition, we are a party to a mortgage and an interest rate swap that we entered into in 2004 in connection with the purchase of our Baltimore warehouse. The mortgage loan, which had an outstanding balance of $1,333 at September 30, 2013, requires monthly payments of approximately $21.6, including interest at LIBOR plus 1.75%, and matures in December 2014. Under the related interest rate swap, which has been designated as a cash flow hedge and remains effective through the maturity of the mortgage loan, we will pay a monthly fixed interest rate of 6.37% to the counterparty bank on a notional principal equal to the outstanding principal balance of the mortgage. In return, the bank will pay us a floating rate, namely, LIBOR, to reset monthly, plus 1.75% on the same notional principal amount.

On June 3, 2011, we issued $12,000 principal amount of 10% Convertible Senior Subordinated Notes Due June 1, 2016 in a private placement to selected accredited investors. The notes are currently convertible at the option of the holders into shares of common stock at a conversion rate of 248.80 shares of common stock per $1 principal amount of notes, subject to adjustment for cash and stock dividends, stock splits and similar transactions, at any time before maturity. The current conversion price reflects ten adjustments for dividends. In addition, if the last reported sale price of the common stock for 30 consecutive trading days is equal to or greater than $7.00, and a registration statement is effective covering the resale of the shares of common stock issuable upon conversion of the notes, we have the right, in our sole discretion, to require the holders to convert all or part of their notes at the then applicable conversion rate. Interest on the notes is payable in arrears on the first day of June and December every year the notes are outstanding.

Derivative Financial Instruments

Inherent in our business is the risk of matching the timing of our purchase and sales contracts. The prices of the aluminum products we buy and sell are based on a constantly moving terminal market price determined by the London Metal Exchange. Were we not to hedge such exposures, we could be exposed to significant losses due to the continually changing aluminum prices.

We use aluminum futures contracts to manage our exposure to this commodity price risk. It is generally our policy to hedge such risks to the extent practicable. We enter into hedges to limit our exposure to volatile price fluctuations that we believe would impact our gross margins on firm purchase and sales commitments. As an example, if we enter into fixed price contracts with our suppliers and variable priced sales contracts with our customers, we will generally enter into a futures contract to sell the aluminum for future delivery in the month when the aluminum is to be priced and delivered to the customer and repurchase this position once the pricing has been fixed with our customer. If the underlying metal price increases, we suffer a hedging loss and have a derivative liability, but the sales price to the customer is based on a higher market price and offsets the loss. Conversely, if the metal price decreases, we have a hedging gain and recognize a derivative asset, but the sales price to the customer is based on the lower market price and offsets the gain.

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We also enter into foreign exchange forward contracts to hedge our exposure related to commitments to purchase or sell metals denominated in some international currencies. In such cases, we will purchase or sell the foreign currency through a bank for an approximate date when we anticipate making a payment to a supplier or receiving payment from the foreign customer.

In accordance with generally accepted accounting principles in the U.S., we designate these derivative contracts as fair value hedges and recognize them on our balance sheet at fair value. We also recognize offsetting changes in the fair value of the related firm purchase and sales commitment to which the hedge is attributable in earnings upon revenue recognition, which occurs at the time of delivery to our customers.

The potential for losses related to our hedging activities, given our hedging methodology, arises from counterparty defaults with banks for our foreign exchange hedging, the London Metal Exchange for our aluminum hedges, or customer defaults. In the event of a customer default, we might be forced to sell the material in the open market and absorb losses for metal or foreign exchange hedges that were applied to the defaulting customers' transactions. Our results of operations could be materially impacted by any counterparty or customer default, as we might not be able to collect money owed to us and/or our hedge might effectively be cancelled.

We use futures and forward contracts as hedges, for no purpose other than to avoid exposure to changes in aluminum prices and foreign currency rates between when we buy a shipment of aluminum from a supplier and when we deliver it to a customer. Our derivatives are not for purposes of trading in the futures market. We earn our gross profit margin through our business operations and not from the movement of aluminum prices.

As part of our business we also engage in the purchase, sale and distribution of steel products. If we do not have a matching sales contract related to such products, (for example, any steel products that are unsold in our inventory), we have price risk that we currently do not or are unable to hedge. As such, any decline in pricing for such products may adversely impact our profitability.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements.

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