The following MD&A is intended to help you understand our results of operations and financial condition. This MD&A is provided as a supplement to, and should be read in conjunction with, our financial statements and the accompanying notes to them.
We are engaged principally in the purchase, sale and distribution of semi-finished aluminum products to a diverse customer base located throughout the United States and Canada, Europe, Australia and New Zealand. We sell our products through our own marketing and sales personnel and our independent sales agents who are located in North America and Europe and who receive commissions on sales. We purchase our products from suppliers located throughout the world. One supplier, Hulett Aluminium Ltd., furnished approximately 51% of our products in the first three months of 2007. We do not typically purchase inventory for stock. In general, we place orders with our suppliers based upon orders that we have received from our customers.
The industry in which we operate is the sale and distribution of semi-finished aluminum products. These products are manufactured worldwide by rolling and extrusion facilities, many of which are owned by large integrated companies and others by independent producers. The products we purchase are in turn sold to varied metal working industries including automotive, housing, packaging, as well as distributors.
Our long-term growth will continue to depend upon understanding our customers’ particular requirements and delivering a high-level of service and quality products that meet those requirements consistently. Our growth will also depend upon our ability to continue building our market knowledge and in particular our understanding of the production capabilities of our suppliers. We will also need to maintain, strengthen and expand our supplier relationships. Finally, we will need to succeed in identifying and executing on opportunities to provide our customers additional value added offerings.
Our condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America. Certain accounting policies have a significant impact on amounts reported in the financial statements. A summary of those significant accounting policies can be found in Note B to our financial statements included in our 2006 Annual Report on Form 10-K. Except for the adoption of Financial Accounting Standards Board Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”), we have not adopted any significant new accounting policies during the three month period ended March 31, 2007.
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, aging of receivables, as well as review of specific accounts, and we make adjustments in the allowance as we believe to be necessary. We maintain a credit insurance policy on the majority of our customers. This policy has a co-insurance provision and specific limits on each customer’s receivables. The co-pay may be increased in selected instances, and we sometimes elect to exceed these specific credit limits. Changes in economic conditions could have an impact on our collection of existing receivable balances or future allowance considerations.
Results of Operations for the Three Months Ended March 31, 2007 (in thousands)
During the first quarter of 2007, net sales increased by $40,272 from $99,569 to $139,841, or a 40% increase from the first quarter of 2006. During this time period, prices for aluminum ingot grew by approximately 11%; the balance is due to increased shipments and product mix distribution to our customers. Gross profit increased by $491 to $8,418 during this period, or a 6% increase, from $7,927 in the first quarter of 2006. The gross profit margin has been impacted this quarter by a number of factors. Despite the sustained rise in aluminum pricing, the Company is experiencing continued price pressures from increased competition from both domestic and overseas mills. Second, we have not yet achieved full production at our manufacturing facility and this has had a negative impact on our extrusion conversion costs. Finally, we experienced a higher level of claims from one customer, including one particular claim for which we reached an agreement in principle, resulting in a non-recurring charge to earnings.
Interest expense during first quarter 2007 grew by $604 to $2,026 from $1,422 during first quarter of 2006. This 42% increase in interest expense resulted from a continued upward trend in interest rates as well as an increase in overall borrowings of $38,200 from March 2006 to March 2007.
Net income decreased from $2,420 to $2,411 due to the overall decline in our gross profit margin.
Liquidity and Capital Resources (in thousands, except per share data)
Our cash flow used in operations during the first three months of 2007 was $7,282 as compared to cash provided by operations of $2,051 in the first three months of 2006. Net cash used in operations was primarily the result of increases in trade accounts receivable of $24,098, and decreases in accrued expenses and derivative liabilities of $4,772 offset by decreases in inventory and increases in trade accounts payable of $4,650. During the first three months of 2007 restricted cash decreased by $277 from $1,046 in December 2006 to $769 in March 2007. This represents reductions in margin deposits at our LME brokers that are related to our unrealized losses on derivative contracts.
Cash flows from financing activities during the first three months of 2007 amounted to $7,366 made up primarily of increased borrowings under our line of credit, less dividends paid during the period.
We currently operate under a $150 million revolving line of credit, including a commitment to issue letters of credit, with five commercial banks. Amounts borrowed bear interest of Eurodollar, money market or base rates, at our option, plus an applicable margin. The applicable margin is determined by our leverage ratios. 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 and compliance with leverage ratios, as well as an ownership minimum and limitations on other indebtedness, liens, and investments and dispositions of assets. This facility will expire on June 30, 2011.
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, 2011. As of March 31, 2007 and December 31, 2006, the credit utilized amounted to, respectively, $131,865,000 and $135,486,000 (including approximately $8,165,000 and $21,236,000 of outstanding letters of credit).
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On March 14, 2007, our Board of Directors declared a cash dividend of $0.05 per share to stockholders of record at the close of business on March 29, 2007. The dividend totaling $489,500 is reflected in dividends payable and was paid on April 25, 2007. The Board of Directors will review its dividend policy on a quarterly basis, and a determination by the Board of Directors will be made subject to the profitability and free cash flow and the other requirements of our business.
Management believes that cash from operations, together with funds available under our credit facility, will be sufficient to fund theanticipated cash requirements relating to our existing operations through the expiration of our current credit facility.We may require additional debt financing in connection with any future expansion of our operations.
Commitments and Contingencies
We had outstanding letters of credit totaling $8,165,000 to certain of our suppliers and as of March 31, 2007, the credit utilized under our credit facility amounted to $131,865,000. Except as noted, there have been no material changes to our commitments and contingencies from that disclosed in our Annual Report on Form 10-K for the year ended December 31, 2006.
We hedge metal pricing and foreign currency as we deem appropriate for a portion of our purchase and sales contracts. There is a risk of a counterparty default in fulfilling the hedge contract. Should there be a counterparty default, we could be exposed to losses on the original hedged contract.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
We use financial instruments designated as fair value hedges to manage our exposure to commodity price risk and foreign currency exchange risk inherent in our operations. It is our policy to hedge such risks, to the extent practicable. We enter into high-grade aluminum futures contracts to limit our gross margin exposure by hedging the metals content element of firmly committed purchase and sales commitments. We also enter into foreign exchange forward contracts to hedge our exposure related to commitments to purchase or sell aluminum denominated in international currencies. We record “mark-to-market” adjustments on these futures and forward positions, and on the underlying firm purchase and sales commitments which they hedge, and reflect the net gains and losses currently in earnings.
Please refer to our Annual Report on Form 10-K for the year ended December 31, 2006 for more detailed disclosure about quantitative and qualitative disclosure of market risk. Quantitative and qualitative disclosure about market risk has not materially changed since December 31, 2006.
ITEM 4. Controls and Procedures
As required by the Securities Exchange Act of 1934, as amended (the “Exchange Act”), our management conducted an evaluation with the participation of our Chief Executive Officer and Chief Financial Officer, regarding the effectiveness of our “disclosure controls and procedures” (as defined in Rule 13a-15(e) of the Exchange Act), as of the end of the fiscal quarter covered by this report. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange
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Commission’s rules and forms. We intend to continue to review and document our disclosure controls and procedures, including our internal controls and procedures for financial reporting, and we may from time to time make changes to the disclosure controls and procedures to enhance their effectiveness and to ensure that our systems evolve with our business.
There was no change in our internal control over financial reporting that occurred during the period covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II OTHER INFORMATION
Item 1. Legal Proceedings.
We are a party from time to time to certain legal proceedings and claims that arise in the ordinary course of our business. We do not believe that the disposition of any claims that are pending or have been asserted would have a material adverse effect on our results of operation or financial position.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
None.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
Item 5. Other Information.
None.
Item 6. Exhibits.
The following are included as exhibits to this report:
31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934*
31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934*
32.1 Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002**
- --------------------| * | Filed herewith |
| ** | Furnished herewith |
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SIGNATURES
In accordance with the requirements of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned hereunto duly authorized.
| | | EMPIRE RESOURCES, INC. |
| |
| |
| Dated: May 15, 2007 | | By: /s/ Sandra Kahn |
| | | Sandra Kahn |
| | | Chief Financial Officer |
| |
| | | (signing both on behalf of the registrant and in her |
| | | capacity as Principal Financial and Principal |
| | | Accounting Officer) |
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