year ended December 31, 2006 as supplemented by Item 1A. of Part II of this report. We are also subject to many other uncertainties, such as 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 imported, including those produced by Hulamin Ltd.; failure to successfully integrate manufacturing and the sales of extrusions in the business of the Company; changes in the size and nature of the Company’s competition; changes in interest rates, foreign currencies or spot prices of aluminum; loss of one or more foreign suppliers or key executives; loss of one or more significant customers; increased credit risk from customers; failure of the Company to grow internally or by acquisition and to integrate acquired businesses; and failure to improve operating margins and efficiencies. We undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise.
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 also manufacture prime aluminum extruded products in our facility located in Baltimore, MD. 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, Hulamin Ltd., furnished approximately 54% of our products in the first six 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 and profitability 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 in light of continued pricing pressures. Finally, we will need to succeed in identifying and executing opportunities to provide our customers additional value added offerings, in both our existing markets and product offerings as well as in broader or new product groups and geographic areas.
On August 13, 2007, we amended and restated our supply agreement with Hulamin, our largest supplier. Under the amended agreement, we will remain Hulamin's exclusive supplier in the U.S. and Canada. In contrast to the original agreement, which had no term but was terminable by either party on 12 months' written notice, the amended agreement provides for a fixed term that expires on August 9, 2008 and may be extended by mutual agreement. In requesting this amendment, Hulamin expressed a desire to improve their profitability and have stated their intention to review their route to market during the coming year which may result in our agreement being renewed or modified, or it may lapse. We do not know whether we and Hulamin will agree to renew or to further modify the contract upon or prior to its expiration, and it is unlikely that we will know until that time draws near. Accordingly, we plan in the meantime to continue working closely with Hulamin as well as seeking to expand and diversify our sources of supply, including with some of our long-term existing suppliers, and with others that we have developed more recently, as well as with others with whom we may not have dealt previously. We will also continue to work to diversify our business through the growth of our extrusion production and distribution as well as by seeking opportunities to consider acquisitions both in our traditional and in other lines of business. We believe that doing so remains strategically critical to the maintenance and growth of our business, whether or not the Hulamin agreement is renewed next August.
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 six month period ended June 30, 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 Six Months Ended June 30, 2007 (in thousands)
During the first six months of 2007, net sales increased by $46,714 to $256,621 from $209,907, or a 22% increase from the first six months of 2006. This increase is due to increased volumes shipped as well as continued strong underlying aluminum ingot pricing. Gross profit declined by $1,551 to $14,939 from $16,490 for the period, or a 9% decrease, in the first six months of 2007 as compared to the first six months of 2006. Our gross profit margin has been impacted by continued price pressures from increased competition in North America from both domestic and overseas mills. This strong competition has depressed the fabrication premiums in the marketplace, which affects the pricing spreads we can charge to our customers. Additionally, we have not yet achieved full production at our extrusion manufacturing facility, and this has had a negative impact on our extrusion conversion costs.
Interest expense during first six months of 2007 grew by $1,155 to $4,107 from $2,952 over the same period in 2006. This 39% increase in interest expense resulted primarily from the increase in overall borrowings from June 2006 to June 2007 and secondarily from small increases in interest rates during the same period.
Net income decreased from $5,093 in the first six months of 2006 to $3,536 in the first six months of 2007 due to the overall decline in our gross profit and increased interest expense.
Results of Operations for the Three Months Ended June 30, 2007 (in thousands)
Net sales increased $6,442 or 6% during the second quarter of 2007 from $110,338 in 2006 to $116,780 in 2007. This increase is primarily due to continued strong pricing in the underlying aluminum ingot. Gross profit decreased in the current three month period by $2,042 to $6,521 from $8,563 as compared to the same period in 2006, as a result of factors described above with respect to the six month periods.
Interest expense increased during the three month period by $551 from $1,530 to $2,081. This 36% increase in interest expense is due to the growth in loans outstanding during the period and to a lesser extent to the continued upward trend in interest rates.
Net income decreased by $1,548 from $2,673 to $1,125 for the three months ended June 30, 2007, a decrease of 58% due to the decline in our gross profit as well as the increase in interest costs.
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Liquidity and Capital Resources (in thousands, except per share data)
Our cash flow used in operations during the first six months of 2007 was $9,197 as compared to $5,224 in the first six months of 2006. Net cash used in operations was primarily the result of increases in trade accounts receivable of $12,640 and decreases in inventories of $22,639, accrued expenses and derivative liabilities of $11,674 and trade accounts payable of $5,936. During the first six months of 2007 restricted cash decreased by $719 from $1,046 in December 2006 to $327 in June 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 six months of 2007 amounted to $9,610 composed of a net increase in borrowings of $12,154 under our lines of credit and mortgage, less dividends paid during the period of $2,544.
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 June 30, 2007 and December 31, 2006, the credit utilized amounted to, respectively, $138,178 and $135,486 (including approximately $17,678 and $21,236 of outstanding letters of credit).
In addition, our European subsidiary, Imbali Metals has entered into a separate credit facility for EUR 10 million, which includes a commitment to issues letters of credit with a commercial bank. Amounts borrowed bear interest at EUROBOR plus an applicable margin. The borrowings under this line of credit are secured by all of the assets of Imbali Metals and is unconditionally guaranteed by Empire Resources, Inc. This agreement contains financial and other covenants. The agreement has a one year term and may be renewed by mutual agreement of both Imbali Metals and the bank. As of June 30, 2007, the credit utilized under this agreement amounted to EUR 4.4 million (US $6.0).
On June 20, 2007, our Board of Directors declared a cash dividend of $0.05 per share to stockholders of record at the close of business on July 6, 2007. The dividend totaling $490 is reflected in dividends payable and was paid on July 20, 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.
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Commitments and Contingencies
We had outstanding letters of credit totaling $17,678 to certain of our suppliers and as of June 30, 2007, the credit utilized under our credit facility amounted to $138,178.
On June 29, 2007, we amended our credit agreement to permit Imbali Metals to enter into a credit facility with Fortis Bank S.A./N.V., New York Branch, in which Imbali Metals was provided with a EUR 10 million commitment available for loans and documentary letters of credit. After completion of this amendment Imbali Metals entered into a secured credit arrangement which is unconditionally guaranteed by Empire Resources, Inc. The one year line of credit provides that amounts under the facility may be borrowed, repaid and re-borrowed, subject to a borrowing base test. The loans under the facility bear interest at a rate equal to 1.75% per annum in excess of EUROBOR. The loan may be renewed subject to the agreement of the parties.
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 1A. Risk Factors
As discussed in our MD&A overview under Part I and in Item 5 of this Part II, we have recently amended and restated our supply agreement with Hulamin, our largest supplier. Hulamin supplied approximately 52%, 54% and 54% of our product in 2006, 2005 and 2004, respectively, and approximately 54% during the six-month period ended June 30, 2007. Under the amended agreement, we will remain Hulamin's exclusive supplier in the U.S. and Canada. In contrast to the original agreement, which had no term but was terminable by either party on 12 months' written notice, the amended agreement provides for a fixed term that expires on August 9, 2008 and may be extended by mutual agreement. We do not know whether we and Hulamin will agree to renew or to further modify the contract upon or prior to its expiration, and it is unlikely that we will know until that time draws near. The non-renewal or substantial modification of the Hulamin agreement may have a material adverse effect on our business, financial position and results of operation.
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.
(a) We held our annual meeting of stockholders on June 20, 2007.
(b) Our current directors, being William Spier, Nathan Kahn, Sandra Kahn, Harvey Wrubel, Jack Bendheim, Peter J. Howard, Nathan Mazurek, L. Rick Milner and Morris J. Smith, were reelected as directors at the annual meeting.
(c) At the annual meeting, two matters were voted upon by shareholders. The results were as follows:
Proposal 1 -- Election of Directors. By the vote reflected below, the stockholders elected the following individuals to serve as directors until the 2008 Annual Meeting of Stockholders and until their respective successors are duly elected and qualified. There were no broker non-votes in the election of directors.
| | | | |
| | | FOR | | WITHHELD |
| WILLIAM SPIER | | 9,215,211 | | 179,569 |
| NATHAN KAHN | | 9,217,529 | | 177,251 |
| SANDRA KAHN | | 9,217,449 | | 177,331 |
| HARVEY WRUBEL | | 9,218,894 | | 175,886 |
| JACK BENDHEIM | | 9,240,772 | | 154,008 |
| PETER G. HOWARD | | 9,217,551 | | 177,229 |
| NATHAN MAZUREK | | 9,241,742 | | 153,038 |
| MORRIS J. SMITH | | 9,240,195 | | 154,585 |
| L. RICK MILNER | | 9,240,065 | | 154,715 |
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Proposal 2 – Ratification of Eisner, LLP as independent accountants for the current fiscal year. The shareholders voted to ratify the selection of Eisner, LLP as our independent public accounting firm for the current fiscal year.
| | | |
| For: | | 9,299,172 | |
| Against: | | 37,411 | |
| Abstain: | | 58,195 | |
Item 5. Other Information.
(a) On August 13, 2007, we amended and restated our supply agreement with Hulamin, our largest supplier. Hulamin supplied approximately 52%, 54% and 54% of our product in 2006, 2005 and 2004, respectively, and approximately 54% during the six-month period ended June 30, 2007.
Under the amended agreement, we will remain Hulamin's exclusive supplier in the U.S. and Canada. In contrast to the original agreement, which had no term but was terminable by either party on 12 months' written notice, the amended agreement provides for a fixed term that expires on August 9, 2008 and may be extended by mutual agreement. The agreement otherwise remains substantially unchanged and continues to provide, among other things, that our transactions with Hulamin will be negotiated on a transaction by transaction basis and that we will continue to provide customer support services, including market research and planning.
In requesting this amendment, Hulamin expressed a desire to improve their profitability, and have stated their intention to review their route to market during the coming year which may result in our agreement being renewed or modified, or it may lapse. We do not know whether we and Hulamin will agree to renew or to further modify the contract upon or prior to its expiration, and it is unlikely that we will know until that time draws near. Accordingly, we plan in the meantime to continue working closely with Hulamin as well as seeking to expand and diversify our sources of supply, including with some of our long-term existing suppliers, and with others that we have developed more recently, as well as with others with whom we may not have dealt previously. We will also continue to work to diversify our business through the growth of our extrusion production and distribution as well as by seeking opportunities to consider acquisitions both in our traditional and in other lines of business. We believe that doing so remains strategically critical to the maintenance and growth of our business, whether or not the Hulamin agreement is renewed next August. The non-renewal or substantial modification of the Hulamin agreement may have a material adverse effect on our business, financial position and results of operation.
(b) None.
Item 6. Exhibits.
The following are included as exhibits to this report:
| Exhibit No. | Description |
| 10.24 | Agreement, dated August 13, 2007, between Empire Resources, Inc. and Hulamin Rolled Products.* |
| | |
| 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: August 14, 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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