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HNH > SEC Filings for HNH > Form 10-K on 28-Feb-2014All Recent SEC Filings

Show all filings for HANDY & HARMAN LTD.

Form 10-K for HANDY & HARMAN LTD.


28-Feb-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes thereto that are available elsewhere in this Annual Report on Form 10-K. The following is a discussion and analysis of HNH's consolidated results of operations for the years ended December 31, 2013, 2012 and 2011. In addition to historical consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Annual Report on Form 10-K, particularly in "Item 1A - Risk Factors."

Business Segments

HNH's business units encompass the following segments: Joining Materials, Tubing, Building Materials, Arlon and Kasco. Management has determined that certain operating companies should be aggregated and presented within a single segment on the basis that such segments have similar economic characteristics and share other qualitative characteristics. Management reviews net sales, gross profit and operating income to evaluate segment performance. Operating income for the segments generally includes costs directly attributable to the segment and excludes other unallocated general corporate expenses. Interest expense, other income and expense, and income taxes are not presented by segment since they are excluded from the measure of segment profitability reviewed by the Company's management. For a more complete description of the Company's business segments, see "Item 1 - Business - Products and Product Mix."

Recent Developments

During 2013, we entered into a series of transactions to improve liquidity, enhance our product offerings and position us for growth in our niche markets.

We acquired substantially all of the assets of Wolverine Joining used for the development, manufacturing and sale of brazing, flux and soldering products and the alloys for electrical, catalyst and other industrial specialties, and also acquired PAM, a distributor of screw guns, collated screws and hot melt systems.

We divested substantially all of the assets and existing operations of our Continental and CMCC business units, and sold substantially all of the equipment owned or utilized by ITM.

We made investments in capital projects totaling $16.2 million.

We amended our senior secured credit facility to, among other things, increase the lenders' commitments under the revolving credit facility to $160.0 million and their commitments under the term loan to $125.0 million, provide H&H Group with additional flexibility regarding its ability to utilize net cash proceeds from permitted asset sales, and amended certain financial covenants and the amortization schedule of the term loan.

We completed the repurchase of all of our remaining 10% subordinated secured notes.

The results of the Continental and CMCC business units, as well as the operations of ITM, have been classified as discontinued operations in the Company's consolidated financial statements for 2013, as well as all historical periods, and are not reflected in the tables and discussion of the Company's continuing operations below.

Results of Operations

Comparison of the Years Ended December 31, 2013 and 2012

The Company's consolidated operating results for the years ended December 31,
2013 and 2012 are summarized in the following table:

                                                                       Page | 16
--------------------------------------------------------------------------------

                                                                     Year Ended
                                                                    December 31,
(in thousands)                                                   2013           2012
Net sales                                                    $  655,224     $  579,528
Gross profit                                                    184,875        169,486
Gross profit margin                                                28.2 %         29.2 %
Selling, general and administrative expenses                    128,583        116,383
Pension expense                                                   5,342          3,313
Operating income                                                 50,950         49,790
Other:
Interest expense                                                 13,705         16,719
Realized and unrealized gain on derivatives                      (1,195 )       (2,582 )
Other expense                                                       291            439
Income from continuing operations before tax and equity
investment                                                       38,149         35,214
Tax provision                                                    16,028         13,065
Gain from associated company, net of tax                         (6,006 )            -
Income from continuing operations, net of tax                $   28,127     $   22,149

Net Sales

Net sales for the year ended December 31, 2013 increased by $75.7 million, or 13.1%, to $655.2 million, as compared to $579.5 million in 2012. Value added sales, defined as net sales less revenue from the direct purchase and resale of precious metals, increased by $95.4 million on higher volume, primarily from the Joining Materials segment, including the acquisition of Wolverine Joining, the Tubing segment, and the Building Materials segment, and were partially offset by the impact of lower average precious metal prices of approximately $19.8 million, principally due to silver. The average silver market price was approximately $23.79 per troy ounce in the year ended December 31, 2013, as compared to $31.22 per troy ounce in 2012. The acquisition of Wolverine Joining provided incremental net sales of approximately $39.8 million in the year ended December 31, 2013, and the December 31, 2012 acquisition of Hickman provided incremental net sales of $17.1 million in 2013.

Gross Profit

Gross profit for the year ended December 31, 2013 increased to $184.9 million, as compared to $169.5 million in 2012. Gross profit as a percentage of net sales decreased to 28.2%, as compared to 29.2% in 2012. The decrease of 1.0% was due to unfavorable product mix and reduced profit generated on the material portion of our products in the Joining Materials segment, due principally to lower precious metal prices, and unfavorable production variances in the Arlon segment, which were partially offset by favorable product mix in the Tubing segment and increased sales of higher-margin branded fasteners in the Building Materials segment. The acquisition of Wolverine Joining provided incremental gross profit of approximately $3.6 million during the year ended December 31, 2013, and the acquisition of Hickman provided incremental gross profit of $7.5 million in 2013.

Selling, General and Administrative Expenses

Selling, general and administrative expenses ("SG&A") for the year ended December 31, 2013 were $128.6 million, or 19.6% of net sales, as compared to $116.4 million, or 20.1% of net sales, in 2012. Lower SG&A as a percentage of net sales during 2013 was driven by effective cost control on higher sales volume and an insurance reimbursement of $1.1 million received for previously incurred environmental remediation costs, which were partially offset by higher business development costs, including acquisition fees and integration costs related to our acquisition of Wolverine Joining, as compared to 2012. Also, the lower average precious metal prices had a negative impact on SG&A as a percentage of net sales, as compared to the prior year.

Pension Expense

Non-cash pension expense was $5.3 million for the year ended December 31, 2013, which was $2.0 million higher than in 2012. The increase in non-cash pension expense was primarily due to the fact that historical investment returns on the assets of the WHX Pension Plan have been lower than actuarial assumptions. Such actuarial losses are amortized and result in an increase

Page | 17

in pension expense over the amortization period. We currently expect non-cash pension expense to be approximately $4.5 million in 2014.

Interest Expense

Interest expense for the year ended December 31, 2013 was $13.7 million, as compared to $16.7 million in 2012. On March 26, 2013, H&H Group instructed Wells Fargo Bank, National Association ("Wells Fargo"), as trustee and collateral agent, to deliver an irrevocable notice of H&H Group's election to redeem all of its outstanding 10% subordinated secured notes due 2017 ("Subordinated Notes") and irrevocably deposited with Wells Fargo funds totaling $36.9 million for such redemption and interest payment in order to satisfy and discharge its obligations under the indenture. Interest expense for the three months ended March 31, 2013 included a $5.7 million loss associated with the redemption of the Subordinated Notes, including the redemption premium and the write-off of remaining deferred finance costs and unamortized debt discounts. This loss was offset by a lower average interest rate in the year ended December 31, 2013, principally due to the Company's debt refinancing in the fourth quarter of 2012, which resulted in the write-off of $1.1 million in prior debt issuance costs in that period, and the redemption of the Subordinated Notes.

Realized and Unrealized Gain (Loss) on Derivatives

Realized and unrealized gain (loss) on derivatives for the years ended
December 31, 2013 and 2012 were as follows:
(in thousands)                                           Year Ended
                                                        December 31,
                   Derivative                         2013        2012
Commodity contracts (economic hedges)               $ 1,988     $   522
Derivative features of Subordinated Notes              (793 )     2,060
Total realized and unrealized gain on derivatives   $ 1,195     $ 2,582

H&H utilizes commodity forward and futures contracts to mitigate the impact of price fluctuations on its precious metal and certain non-precious metal inventories. The factors that affect the gain or loss on these derivative instruments are changes in the price of the associated metals and the amount of ounces hedged. The $2.0 million gain in the year ended December 31, 2013 was primarily driven by a 23.8% average silver price decrease during the year.

In addition, the Company's Subordinated Notes had embedded call premiums and warrants associated with them. Prior to redemption of the Subordinated Notes as described above, the Company treated the fair value of these features together as both a discount on the debt and a derivative liability at the inception of the loan agreement. The discount was being amortized over the 7-year life of the notes as an adjustment to interest expense, and the derivative was marked to market at each balance sheet date. Interest rates and the market price of HNH's stock were significant factors that influenced the valuation of the derivative. Upon redemption, the value of the derivative was removed from the balance sheet and such write-off is included in the $0.8 million loss noted above.

Income Taxes

For the years ended December 31, 2013 and 2012, tax provisions of $16.0 million and $13.1 million from continuing operations were recorded, respectively. The effective tax rates in the years ended December 31, 2013 and 2012 were 42.0% and 37.1%, respectively. Changes in the effective tax rate arise principally from differences in the mix of income between taxable jurisdictions, including the impact of foreign sourced income.

Gain from Associated Company

As further described in Note 10 - "Investments" to our consolidated financial statements included in "Item 8 - Financial Statements and Supplementary Data," the Company concluded that it gained significant influence over the operating and financial policies of ModusLink during the first quarter of 2013. The $6.0 million gain from associated company is due primarily to increases in the share price of ModusLink's common stock, which were partially offset by the impact of the reclassification of the Company's historical unrealized loss associated with this investment from accumulated other comprehensive loss to earnings.

Segment Analysis


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The following table summarizes information about HNH's segment operating results
for the years ended December 31, 2013 and 2012:
                                       Year ended
                                      December 31,
(in thousands)                      2013         2012       Inc./(Decr.)    % Change
Net sales:
Joining Materials                $ 195,187    $ 174,621    $     20,566       11.8  %
Tubing                              91,002       80,849          10,153       12.6  %
Building Materials                 226,806      189,106          37,700       19.9  %
Arlon                               84,060       80,815           3,245        4.0  %
Kasco                               58,169       54,137           4,032        7.4  %
Total net sales                  $ 655,224    $ 579,528    $     75,696       13.1  %
Segment operating income:
Joining Materials (a)            $  16,624    $  23,942    $     (7,318 )    (30.6 )%
Tubing                              17,434       14,258           3,176       22.3  %
Building Materials                  27,789       22,172           5,617       25.3  %
Arlon                               10,769       11,594            (825 )     (7.1 )%
Kasco                                4,496        4,431              65        1.5  %
Total segment operating income   $  77,112    $  76,397    $        715        0.9  %

a) The results for the Joining Materials segment for 2012 include a gain of $0.6 million, resulting from the liquidation of precious metal inventory valued at LIFO cost. No similar gain was recorded in 2013 due to an increase in ending inventory quantities.

Joining Materials

For the year ended December 31, 2013, the Joining Materials segment net sales increased by $20.6 million, or 11.8%, to$195.2 million, as compared to net sales of $174.6 million in 2012. The increase in net sales was driven by higher sales volume, including the acquisition of Wolverine Joining, partially offset by a decrease of approximately $7.43 per troy ounce in the average market price of silver in the year ended December 31, 2013, as compared to 2012, as well as lower demand from the mining and exploration sectors. The effect of lower average precious metal prices reduced net sales by approximately $19.8 million, as compared to 2012. The acquisition of Wolverine Joining provided incremental net sales of approximately $39.8 million during the year ended December 31, 2013.

Segment operating income for the year ended December 31, 2013 decreased by $7.3 million, or 30.6%, to $16.6 million, as compared to $23.9 million in 2012. During the year ended December 31, 2013, lower gross profit margin resulted from unfavorable product mix and reduced profit generated on the material portion of our products in the Joining Materials segment, due principally to lower precious metal prices, as compared to 2012. The Joining Materials segment operating income was also unfavorably impacted by higher SG&A associated with business development activities, including acquisition fees and integration costs related to our acquisition of Wolverine Joining.

Tubing

For the year ended December 31, 2013, the Tubing segment net sales increased by $10.2 million, or 12.6%, to $91.0 million, as compared to $80.8 million in 2012. The increase was primarily driven by higher sales volume of our stainless steel tubing products for the oil and gas and chemical processing sectors served by the Tubing segment.

Segment operating income for the year ended December 31, 2013 increased by $3.2 million, or 22.3%, to $17.4 million, as compared to $14.3 million in 2012. The increase in segment operating income was driven primarily by gross profit margin improvement resulting from favorable product mix and higher sales volume.

Building Materials

For the year ended December 31, 2013, the Building Materials segment net sales increased by $37.7 million, or 19.9%, to $226.8 million, as compared to $189.1 million in 2012. The increase in net sales was primarily the result of higher sales of

Page | 19

roofing products and FastenMaster products for the home center segment, as well as $17.1 million of incremental sales associated with the Hickman acquisition.

Segment operating income increased by $5.6 million, or 25.3%, to $27.8 million for the year ended December 31, 2013, as compared to $22.2 million in 2012. Gross profit margin for the year ended December 31, 2013 was higher, as compared to the year ended December 31, 2012, primarily due to increased sales of higher-margin branded fasteners. The remaining increase in operating income was primarily due to the higher roofing products sales level during the year ended December 31, 2013, as compared to the prior year.

Arlon

For the year ended December 31, 2013, the Arlon segment net sales increased by $3.2 million, or 4.0%, to $84.1 million, as compared to $80.8 million in 2012. The increase in net sales resulted from higher demand for printed circuit board materials for use in telecommunications infrastructure in Asia and increased sales of extruded silicone products.

Segment operating income decreased by $0.8 million, or 7.1%, to $10.8 million for the year ended December 31, 2013, as compared to $11.6 million in 2012. Gross profit margin was lower during the year ended December 31, 2013, as compared to 2012, primarily due to unfavorable production variances.

Kasco

For the year ended December 31, 2013, the Kasco segment net sales increased by $4.0 million, or 7.4%, to $58.2 million, as compared to $54.1 million in 2012. The net sales improvements were principally from its repair business sales in North America.

Segment operating income was $4.5 million for the year ended December 31, 2013, which was relatively flat compared to 2012. Higher gross profit as a result of increased sales levels during 2013 was offset by higher sales commissions, travel costs and automobile expenses, as compared with the prior year.

Comparison of the Years Ended December 31, 2012 and 2011

The Company's consolidated operating results for the years ended December 31,
2012 and 2011 are summarized in the following table:
                                                       Year Ended
                                                      December 31,
(in thousands)                                     2012          2011
Net sales                                       $ 579,528     $ 579,764
Gross profit                                      169,486       157,878
Gross profit margin                                  29.2 %        27.2 %
Selling, general and administrative expenses      116,383       105,283
Pension expense                                     3,313         6,357
Asset impairment charge                                 -           700
Operating income                                   49,790        45,538
Other:
Interest expense                                   16,719        16,268
Realized and unrealized gain on derivatives        (2,582 )        (418 )
Other expense                                         439         1,360
Income from continuing operations before tax       35,214        28,328
Tax provision (benefit)                            13,065      (106,088 )
Income from continuing operations, net of tax   $  22,149     $ 134,416

Net Sales

Net sales for the year ended December 31, 2012 were $579.5 million, which was relatively flat compared to the year ended December 31, 2011. Value added sales, defined as net sales less revenue from the direct purchase and resale of precious

Page | 20

metals, for the year ended December 31, 2012 increased $11.1 million driven by higher demand for our products, primarily in the Building Materials segment. Lower average precious metal prices, principally silver, had a negative effect of approximately $11.4 million on net sales for the year ended December 31, 2012. The average silver price was approximately $31.22 per troy ounce in 2012, as compared to $35.40 per troy ounce for the year ended December 31, 2011.

Gross Profit

For the year ended December 31, 2012, gross profit increased to $169.5 million, as compared to $157.9 million in 2011, and, as a percentage of net sales, increased to 29.2%, as compared to 27.2% in 2011. The gross margin improvement of 2.0% in the year ended December 31, 2012 was principally due to favorable product mix, effective cost control and improved operating efficiency at our manufacturing plants, across all segments.

Selling, General and Administrative Expenses

For the year ended December 31, 2012, SG&A was $116.4 million, or 20.1% of net sales, as compared to $105.3 million, or 18.2% of net sales, for the year ended December 31, 2011. The increase in SG&A as a percentage of net sales in 2012 was primarily due to higher selling and promotion costs related to product sales of the Building Materials segment, increased employee benefit costs, as compared to 2011, as well as costs associated with the Company's business development activities in 2012, which resulted in the Inmet and Hickman business combinations. Also, the lower average precious metal prices had a negative impact on SG&A as a percentage of net sales, as compared to the prior year.

Pension Expense

For the year ended December 31, 2012, pension expense was $3.3 million, which was $3.0 million lower than for the year ended December 31, 2011. The reduction in non-cash pension expense was primarily due to a change in the amortization period for actuarial losses to reflect the average future lifetime of the participants, which is expected to be approximately 21 years, a longer period than the average future service years of active participants, which was previously used. The Company believes that use of the future lifetime of the participants is more appropriate because the WHX Pension Plan is now completely inactive.

Asset Impairment Charge

A non-cash asset impairment charge of $0.7 million was recorded for the year ended December 31, 2011 related to vacant land owned by the Company's Arlon segment located in Rancho Cucamonga, California. The Company reduced this property's carrying value by $0.7 million to reflect its lower fair market value.

Interest Expense

Interest expense for the year ended December 31, 2012 was $16.7 million, as compared to $16.3 million in 2011. As a result of certain Subordinated Note repurchases during both 2012 and 2011, interest expense included a $1.4 million loss for the year ended December 31, 2012 and a $0.2 million gain in the year ended December 31, 2011 related to such repurchases. In addition, the Company wrote-off $1.1 million in prior debt issuance costs based on the Company's fourth quarter of 2012 debt refinancing. These unfavorable impacts on interest expense were partially offset by a lower average amount of borrowings outstanding and lower average interest rates on outstanding debt in 2012.

Realized and Unrealized Gain (Loss) on Derivatives

Realized and unrealized gain (loss) on derivatives for the years ended
December 31, 2012 and 2011 were as follows:

(in thousands)                                           Year Ended
                                                        December 31,
                   Derivative                         2012        2011
Commodity contracts (economic hedges)               $   522    $ (1,236 )
Derivative features of Subordinated Notes             2,060       1,654
Total realized and unrealized gain on derivatives   $ 2,582    $    418

Page | 21

H&H utilizes commodity forward and futures contracts to mitigate the impact of price fluctuations on its precious metal inventory. The factors that affect the gain or loss on these derivative instruments are changes in the price of the associated metals and the amount of ounces hedged. The $0.5 million gain in the year ended December 31, 2012 was primarily driven by an 11.8% average silver price decrease during the year.

In addition, the Company's Subordinated Notes had embedded call premiums and warrants associated with them. Prior to redemption of the Subordinated Notes, the Company treated the fair value of these features together as both a discount on the debt and a derivative liability at the inception of the loan agreement. The discount was being amortized over the 7-year life of the notes as an adjustment to interest expense, and the derivative was marked to market at each balance sheet date. Interest rates and the market price of HNH's stock were significant factors that influenced the valuation of the derivative.

Income Taxes

For the years ended December 31, 2012 and 2011, a tax provision of $13.1 million and a tax benefit of $106.1 million from continuing operations were recorded, respectively. The increase in the tax provision for the year ended December 31, 2012, as compared to 2011, was due to a higher federal tax provision resulting principally from the non-recurring benefit of the Company's reversal of its deferred income tax valuation allowance for federal NOLs in the fourth quarter of 2011.

Segment Analysis

The following table summarizes information about HNH's segment operating results
for the years ended December 31, 2012 and 2011:
                                       Year Ended
                                      December 31,
(in thousands)                      2012         2011       Inc./(Decr.)     % Change
Net sales:
Joining Materials                $ 174,621    $ 190,607    $     (15,986 )     (8.4 )%
Tubing                              80,849       76,676            4,173        5.4  %
Building Materials                 189,106      178,948           10,158        5.7  %
Arlon                               80,815       81,282             (467 )     (0.6 )%
Kasco                               54,137       52,251            1,886        3.6  %
Total net sales                  $ 579,528    $ 579,764    $        (236 )        -  %
Segment operating income:
Joining Materials (a)            $  23,942    $  24,747    $        (805 )     (3.3 )%
Tubing                              14,258       13,958              300        2.1  %
Building Materials                  22,172       19,883            2,289       11.5  %
Arlon (b)                           11,594        8,348            3,246       38.9  %
Kasco                                4,431        4,227              204        4.8  %
Total segment operating income   $  76,397    $  71,163    $       5,234        7.4  %

a) The results for the Joining Materials segment for 2012 and 2011 include gains of $0.6 million and $1.9 million, respectively, resulting from the liquidation of precious metal inventory valued at LIFO cost.

. . .

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