credit utilized amounted to, respectively, $105.171 and $87.677 million (including approximately $11.421 and $3.177 million of outstanding letters of credit).
Amounts borrowed by the Company bear interest of Eurodollar, money market, or base rates, at the Company’s option, plus an applicable margin. The applicable margin is determined by our leverage ratios. Borrowings under the credit agreement are collateralized by security interests in 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.
In connection with the revolving line of credit, we have entered into interest rate swaps with a total notional amount of $50 million terminating in 2010. The swap has been designated as a cash flow hedge of the variable interest on that portion of the credit agreement up to the notional amount. The Company will pay a fixed rate of 4.99% plus a spread to the bank and in return the bank will pay us a floating LIBOR rate plus a spread. This floating rate will reset monthly.
In December 2004, we entered into a mortgage and an interest rate swap in connection with the purchase of a warehouse. The mortgage, which had an outstanding balance of $2.3 million at June 30, 2006 and $2.4 million at December 31, 2005, respectively requires monthly payments of approximately $21,000 including interest at LIBOR + 1.75% and matures in December 2014. At the same time, we entered into an interest rate swap with a bank which has been designated as a cash flow hedge. Effective 2004 through December 29, 2014 the Company will pay a monthly fixed interest rate of 6.37% to the bank on a notional principal equal to the outstanding principal balance of the mortgage. In return, the bank will pay to the Company a floating rate, namely, LIBOR, to reset monthly plus 1.75% on the same notional principal amount.
Basic earnings per share are based upon weighted average number of common shares outstanding during each period. Diluted earnings per share are based upon the weighted average number of common shares outstanding during each period, plus dilutive potential common shares from assumed exercise of the outstanding stock options using the treasury stock method.
8. Dividends
On June 26, 2006, our Board of Directors declared a cash dividend of $0.05 per share to stockholders of record at the close of business on July 10, 2006. The dividend totaling $489,000 is reflected in dividends payable and was paid on July 24, 2006, bringing the total dividends declared year to date to $977,000.
9. Commitments and Contingencies
Empire has contingent liabilities in the form of letters of credit to certain of its suppliers, which at June 30, 2006 amounted to approximately $11.421 million.
10. Derivative Financial Instruments and Risk Management
Statement of Financial Accounting Standards (SFAS) No. 133, “Accounting For Derivative Instruments and Hedging Activities”, issued by the Financial Accounting Standards Board. requires the Company to recognize all derivatives in the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through earnings. If the derivative is a hedge, depending upon the nature of the hedge, changes in the fair value of the derivative are either offset against the change in fair value of the hedged assets, liabilities or firm commitments through earnings (fair value hedge), or recognized in other comprehensive income until the hedged item is recognized in earnings (cash flow hedge). The ineffective portion of a derivative’s change in fair value, if any, is immediately recognized in earnings. When a hedged item in a fair value hedge is sold, the adjustment in the carrying amount of the hedged item is recognized in earnings. At June 30, 2006, approximately $177,000 was deposited with various brokers for margin. Such deposits are classified as restricted cash on the accompanying balance sheet.
At June 30, 2006 and December 31, 2005, net unrealized gain on the Company’s open foreign exchange forward contracts amounted to approximately $195,000 and $192,000 respectively. Net unrealized gains (losses) on aluminum futures contracts at June 30, 2006 and December 31, 2005 amounted to approximately $250,000 and ($7,874,000), respectively. These amounts, which represent the fair value of the open derivative contracts, together with realized losses on closed futures contracts designated as fair value hedges of inventory held or open commitments, at the balance sheet date, were offset by like amounts for the changes in the fair value of the inventories and commitments which were hedged. Such amounts are reflected in the accompanying June 30, 2006 balance sheet in inventory ($9,716,000) and derivative asset $250,000. At December 31, 2005 such amounts are reflected in inventory ($11,744,000) and derivative liabilities ($7,874,000).
For the six months ended June 30, 2006 and 2005, hedge ineffectiveness associated with derivatives designated as fair value hedges was insignificant, and no fair value hedges were derecognized.
11. Recent Accounting Pronouncements
On July 13, 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”), which is effective for fiscal years beginning after December 15, 2006. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in the financial statements in accordance with FASB Statement No.109,
8
“Accounting for Income Taxes.” This Interpretation prescribes a comprehensive model for how a company should recognize, measure, present and disclose in its financial statements uncertain tax positions that the company has taken or expects to take on a tax return. We are studying how FIN 48 might impact our financial statements, however, at this point, we do not anticipate that the implementation of FIN 48 will have a material impact on our financial position, results of operations and cash flows.
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward Looking Statements
The discussions set forth below and elsewhere herein contain certain statements that may be considered “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements generally are identified by the words “believes,” “project,” “expects,” “anticipates,” “estimates,” “intends,” “strategy,” “plan,” “may,” “will,” “would,” “will be,” “will continue,” “will likely result,” and similar expressions. Forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties which may cause actual results to differ materially from the forward-looking statements. Our particular risks include those factors listed under “Risk Factors,” beginning on page 9 of our Annual Report on Form 10-K for the year ended December 31, 2005. 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 Hulett Aluminium Ltd.; failure to successfully integrate manufacturing 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.
Overview
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 in the purchase, sale and distribution of principally aluminum semi-finished 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 who receive commissions on sales. We purchase our products from suppliers located throughout the world. One supplier, Hulett Aluminium Ltd., furnished approximately 56% of our products in the first six months of 2006. We do not typically purchase inventory for stock. Instead, 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
9
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 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. We believe that an example of this latter strategy is the recent addition of our production capability for aluminum extrusions located in our warehouse/distribution facility in Baltimore, Maryland, which we expect to commence regular operation during the third quarter of this year.
Application of Critical Accounting Policies
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 2005 Annual Report on Form 10-K. We have not adopted any significant new accounting policies during the six month period ended June 30, 2006.
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 generally 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, 2006 (in thousands)
During the first six months of 2006, net sales increased by $40,447 to $209,907, or a 24% increase, from $169,460 in the first six months of 2005. Unit volume increased approximately 13%, with the balance of the increase due to upward trend in aluminum pricing. Gross profit increased by $3,028 to $16,490 for the period, or a 22% increase, from $13,462 in the first six months of 2005. The dollar increase in gross profit was due primarily to the increased sales volume. As a result of our hedging policy on aluminum sales and purchases, gross profit margins are fairly consistent.
We experienced an increase of approximately 21% in selling, general and administrative costs from that of the first six months of 2005. These costs were attributable primarily to increased payroll costs, and legal expenses. Certain items reported as cost of sales in the quarter ended March 31, 2005 have been reclassified to selling, general, and administrative expense for the six months ended June 30,
10
2005. The effect of this reclassification reduced cost of sales for the six months ended June 30, 2005 by approximately $800,000 and increased selling general and administrative expenses by a corresponding amount.
Interest expense grew during the first six months of the year by $1,516 to $2,952 from $1,436 during the first six months of 2005. This 106% increase in interest expense resulted from a continued upward trend in interest rates as well as an increase of $9,250 in borrowings from December 2005 as compared to June 2006. We have entered into interest rate swaps with a total notional amount of $50 million terminating in 2010 which has been designated as a cash flow hedge. The Company will pay a fixed rate of 4.99% plus a spread to the bank and in return the bank will pay us a floating LIBOR rate plus a spread. This floating rate will reset monthly.
Net income increased 7% from $4,746 to $5,093. Net income grew at a lower rate than our sales as a result of the more substantial rise in our interest expense.
Results of Operations for the Three months ended June 30, 2006 (in thousands)
Net sales increased $20,892 or 23% during the second quarter of 2006 from $89,446 in 2005 to $110,338 in 2006. Shipment volumes to our customers increased approximately 4% over the same period in 2005; increased pricing in aluminum accounted for the remainder of the sales growth. Gross profit increased in the current three month period by $1,775 to $8,563 from $6,788 as compared to the same period in 2005. The dollar increase in gross profit is primarily due to the increased sales.
Selling, general and administrative costs for the second quarter of 2006 as compared to the same period in 2005 increased by $871. These costs are primarily attributable to increased sales commissions, payroll costs, legal expenses.
Interest expense increased during the three month period by $658 from $872 to $1,530. This 75% increase in interest expense is due to both the growth in loans outstanding during the period to support revenue growth and the continuing upward trend in interest rates.
Net income increased by $151 from $2,522 to $2,673 for the three months ended June 30, 2006, an increase of 6%.
Liquidity and Capital Resources (in thousands, except per share data)
Our cash flow used in operations during the first six months of 2006 was $5,224 as compared to cash used in operations of $32,490 in the first six months of 2005. Net cash used in operations was primarily the result of an increase in accounts receivable of $8,750, and a decrease in trade accounts payable, and accrued expenses of $10,692 offset by the decrease in restricted cash and reduction in inventory. During the first six months of 2005, net cash used in operations consisted primarily of increased accounts receivable and increased inventory. During the first six months of 2006 restricted cash decreased by $4,873 from $5,050 in December 2005 to $177 in June 2006. 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 2006 amounted to $6,329 made up primarily of increased borrowings under our line of credit less dividends paid during the period.
11
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, 2006 and December 31, 2005, the credit utilized amounted to respectively $105.171 and $87.677 million (including approximately $11.421 and $3.177 million of outstanding letters of credit).
On June 26, 2006, we announced that our Board of Directors had declared a cash dividend of $.05 per share. This dividend was $489 in the aggregate and was paid on July 24, 2006 to stockholders of record at the close of business on July 10, 2006. 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 the anticipated cash requirements relating to our existing operations through the expiration of our current credit facility.We may require additional debt financing in connection with the future expansion of our operations.
Commitments and Contingencies
We had contingent liabilities in the form of letters of credit totaling $11.421 million to certain of our suppliers and as of June 30, 2006, the credit utilized under our credit facility amounted to $105.171 million. 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, 2005.
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.
12
Please refer to our Annual Report on Form 10-K for the year ended December 31, 2005 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, 2005.
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), 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 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.
(a) We held our annual meeting of stockholders on June 26, 2006.
(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 re-elected as directors at the annual meeting.
13
(c) At the annual meeting, three 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 2007 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 | 8,760,974 | | 355,208 | |
NATHAN KAHN | 8,756,171 | | 360,011 | |
SANDRA KAHN | 8,755,168 | | 361,014 | |
HARVEY WRUBEL | 8,757,191 | | 358,991 | |
JACK BENDHEIM | 9,098,950 | | 17,232 | |
PETER G. HOWARD | 8,757,845 | | 358,337 | |
NATHAN MAZUREK | 9,098,973 | | 17,209 | |
MORRIS J. SMITH | 9,093,900 | | 22,282 | |
L. RICK MILNER | 9,097,430 | | 18,752 | |
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 the our independent public accounting firm for the current fiscal year.
| |
For: | 9,061,692 |
Against: | 42,256 |
Abstain: | 12,234 |
Proposal 3 – Approval of the Empire Resources, Inc. 2006 Stock Option Plan
| |
For: | 6,047,162 |
Against: | 443,393 |
Abstain | 20,208 |
Broker Non Vote | 2,605,419 |
Item 5. Other Information.
None.
Item 6. Exhibits.
The following are included as exhibits to this report:
| | |
Exhibit No. | | Description |
| | |
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* |
14
| | |
32.1 | | Certifications 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
15
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, 2006 | 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) |
16
