Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Statements
This Quarterly Report on Form 10-Q contains or incorporates forward-looking statements within the meaning of the Private Securities Reform Act of 1995, which involves risks and uncertainties. The following information should be read in conjunction with the unaudited consolidated financial information and the notes thereto included in this Quarterly Report on Form 10-Q. You should not place undue reliance on these forward-looking statements. Actual events or results may differ materially due to competitive factors and other factors referred to in Part 1A. Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2022, our other filings with the Securities and Exchange Commission and elsewhere in this Quarterly Report. These factors may cause our actual results to differ materially from any forward-looking statement. These forward-looking statements are based on current expectations, estimates, forecasts, and projections about the industry and markets in which we operate, and management’s beliefs and assumptions. In addition, other written or oral statements that constitute forward-looking statements may be made by us or on our behalf. Words such as “expect,” “anticipate,” “intend,” “plan,” “believe,” “could,” “estimate,” “may,” “target,” “project,” or variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve risks, uncertainties, and assumptions that are difficult to predict.
Overview
We manufacture and market semi-finished and finished specialty steel products, including stainless steel, nickel alloys, tool steel and certain other alloyed steels. Our manufacturing process involves melting, remelting, heat treating, hot and cold rolling, forging, machining and cold drawing of semi-finished and finished specialty steels. Our products are sold to service centers, forgers, rerollers, and original equipment manufacturers. Our customers further process our products for use in a variety of industries, including the aerospace, power generation, oil and gas, heavy equipment and general industrial markets. We also perform conversion services on material supplied by our customers.
Sales in the first quarter of 2023 were $65.9 million, which is the highest level since the second quarter of 2019 and represents a 17.2% increase from the fourth quarter of 2022. During this period, sales to our largest end market, aerospace, increased $8.9 million, or 22.2%. Sales also increased in the power generation and heavy equipment end markets, while sales decreased sequentially in the oil and gas and general industrial end markets.
Total company backlog at the end of the first quarter, before surcharges applied at the time of shipment, was $366 million, an increase of $78.1 million, or 27.1% compared to the end of 2022. Despite our increase in sales, our backlog increased to another new record in the current quarter due to strong order entry resulting from sustained high demand for our products.
Sales of premium alloy products, which we define as all vacuum induction melt products, rose to $17.7 million in the first quarter and comprised 26.8% of total sales. Our premium alloy products are primarily sold to the aerospace end market.
Our gross margin for the first quarter was $7.7 million, or 11.7% of net sales, and increase from 4.3% of sales in the fourth quarter of 2022. This reflects higher base prices and higher surcharges during the quarter, while inflationary impacts in our costs have started to decelerate. Additionally, lingering negative impacts of the previously reported liquid metal spill that occurred in April 2022 have eased as we have now had several quarters of strong operating activity after returning to full operation in our Bridgeville melt facility.
The higher gross margin resulted in operating income of $1.4 million for the quarter, but higher market interest rates resulted in interest expense of $2.0 million and a net loss of $0.5 million for the period.
COVID-19 Pandemic
COVID-19 related challenges negatively impacted the efficiency of our operations from 2020 through the first quarter of 2023. These challenges have impacted the Company’s backlog, end markets, overall operations, cash flows and financial results, and may continue into the future. The ultimate extent of the effects of COVID-19 on the Company, and the end markets we serve, remains uncertain and will continue to depend on future developments.
12
Results of Operations
Three months ended March 31, 2023 as compared to the three months ended March 31, 2022:
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Three months ended March 31, |
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(in thousands, except shipped ton information) |
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2023 |
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2022 |
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Amount |
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Percentage of net sales |
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Amount |
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Percentage of net sales |
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Dollar variance |
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Percentage variance |
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Net sales |
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$ |
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65,865 |
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100.0 |
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% |
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$ |
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47,562 |
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100.0 |
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% |
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$ |
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18,303 |
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38.5 |
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% |
Cost of products sold |
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58,141 |
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88.3 |
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43,509 |
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91.5 |
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14,632 |
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33.6 |
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Gross margin |
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7,724 |
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11.7 |
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4,053 |
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8.5 |
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3,671 |
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90.6 |
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Selling, general and administrative expenses |
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6,275 |
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9.5 |
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5,049 |
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10.6 |
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1,226 |
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24.3 |
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Operating income (loss) |
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1,449 |
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2.2 |
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(996 |
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(2.1 |
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2,445 |
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(245.5 |
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Interest expense |
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1,968 |
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3.0 |
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653 |
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1.4 |
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1,315 |
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201.4 |
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Deferred financing amortization |
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64 |
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0.1 |
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56 |
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0.1 |
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8 |
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14.3 |
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Other (income) expense, net |
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(42 |
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(0.1 |
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13 |
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- |
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(55 |
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NM |
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Loss before income taxes |
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(541 |
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(0.8 |
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(1,718 |
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(3.6 |
) |
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1,177 |
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(68.5 |
) |
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Income tax benefit |
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(29 |
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- |
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(103 |
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(0.2 |
) |
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74 |
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(71.8 |
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Net loss |
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$ |
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(512 |
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(0.8 |
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% |
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$ |
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(1,615 |
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(3.4 |
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% |
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$ |
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1,103 |
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(68.3 |
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Market Segment Information |
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Three months ended March 31, |
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(in thousands) |
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2023 |
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2022 |
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Amount |
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Percentage of net sales |
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Amount |
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Percentage of net sales |
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Dollar variance |
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Percentage variance |
Net sales: |
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Service centers |
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$ |
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49,323 |
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74.9 |
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% |
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$ |
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33,253 |
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69.9 |
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% |
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$ |
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16,070 |
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48.3 |
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% |
Original equipment manufacturers |
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4,208 |
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6.4 |
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4,704 |
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9.9 |
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(496 |
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(10.5 |
) |
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Rerollers |
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6,645 |
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10.1 |
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4,508 |
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9.5 |
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2,137 |
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47.4 |
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Forgers |
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5,029 |
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7.6 |
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4,688 |
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9.9 |
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341 |
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7.3 |
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Conversion services and other |
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660 |
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1.0 |
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409 |
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0.8 |
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251 |
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61.4 |
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Total net sales |
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$ |
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65,865 |
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100.0 |
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% |
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$ |
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47,562 |
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100.0 |
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% |
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$ |
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18,303 |
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38.5 |
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% |
13
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Melt Type Information |
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Three months ended March 31, |
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(in thousands) |
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2023 |
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2022 |
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Amount |
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Percentage of net sales |
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Amount |
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Percentage of net sales |
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Dollar variance |
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Percentage variance |
Net sales: |
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Specialty alloys |
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$ |
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47,549 |
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72.2 |
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% |
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$ |
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38,220 |
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80.4 |
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% |
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$ |
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9,329 |
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24.4 |
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% |
Premium alloys (A) |
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17,656 |
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26.8 |
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8,933 |
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18.8 |
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8,723 |
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97.6 |
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Conversion services and other |
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660 |
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1.0 |
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409 |
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0.8 |
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|
251 |
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61.4 |
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Total net sales |
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$ |
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65,865 |
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100.0 |
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% |
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$ |
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47,562 |
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100.0 |
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% |
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$ |
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18,303 |
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38.5 |
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% |
(A)Premium alloys represent all vacuum induction melted (VIM) products.
The majority of our products are sold to service centers rather than the ultimate end market customers. The end market information in this Quarterly Report is our estimate based upon our knowledge of our customers and the grade of material sold to them, which they will in-turn sell to the ultimate end market customer.
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End Market Information |
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Three months ended March 31, |
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(in thousands) |
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2023 |
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2022 |
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Amount |
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Percentage of net sales |
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Amount |
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Percentage of net sales |
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Dollar variance |
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Percentage variance |
Net sales: |
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Aerospace |
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$ |
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48,958 |
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74.3 |
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% |
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$ |
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30,102 |
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|
63.3 |
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% |
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$ |
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18,856 |
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62.6 |
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% |
Power generation |
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1,086 |
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1.7 |
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1,297 |
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2.7 |
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(211 |
) |
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(16.3 |
) |
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Oil & gas |
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4,752 |
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7.2 |
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4,352 |
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9.2 |
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400 |
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9.2 |
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Heavy equipment |
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6,931 |
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10.5 |
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|
8,074 |
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17.0 |
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(1,143 |
) |
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(14.2 |
) |
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General industrial, conversion services and other |
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4,138 |
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|
6.3 |
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|
3,737 |
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|
7.8 |
|
|
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|
401 |
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|
10.7 |
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|
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|
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|
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|
Total net sales |
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$ |
|
65,865 |
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|
100.0 |
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% |
|
$ |
|
47,562 |
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|
100.0 |
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% |
|
$ |
|
18,303 |
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|
38.5 |
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% |
Net sales:
Net sales for the three months ended March 31, 2023 increased $18.3 million, or 38.5%, compared to the same period in the prior year. This reflects both higher shipment volume and a strong pricing environment. The increase in demand and selling price is driven by our aerospace end market.
Gross margin:
As a percent of sales, our gross margin for the three months ended March 31, 2023 was 11.7% compared to 8.5% for the three months ended March 31, 2022. The increase includes higher average selling prices and the benefit of higher shipment volumes, partly offset by inflationary pressures on substantially all of our production inputs throughout 2022 and the first quarter of 2023.
Selling, general and administrative expenses:
Our selling, general and administrative (“SG&A”) expenses consist primarily of employee costs, which include salaries, payroll taxes and benefit related costs, insurance costs and professional services. SG&A expenses increased by $1.2 million for the three months ended March 31, 2023 compared to the same period in the prior year.
Interest expense and other financing costs:
Interest expense totaled approximately $2.0 million in the first quarter of 2023 compared to $0.7 million in the first quarter of 2022. The increase reflects higher average debt levels and the impact of higher variable interest rates paid on our revolving credit facility debt.
Income tax benefit:
Management estimates the annual effective income tax rate quarterly based on forecasted full year results. Items unrelated to current year ordinary income are recognized entirely in the period identified as a discrete item of tax. The quarterly income tax provision includes tax on ordinary income provided at the most recent estimated annual effective tax rate (“ETR”), increased or decreased for the tax effect of discrete items.
For the three months ended March 31, 2023 and 2022, our estimated annual effective tax rates applied to ordinary income were 12.9% and 10.6%, respectively. In both periods, the projected annual ETR is less than the federal statutory rate of 21.0% due to the impact of research and development credits. Discrete items during the three months ended March 31, 2023 and 2022 were approximately $0.1 million of expense related to share-based compensation items, and the ETR for each period was 5.3% and 6.0%, respectively.
14
Net loss:
For the three months ended March 31, 2023, the Company recorded a net loss of $0.5 million, or $0.06 per diluted share, compared to net loss of $1.6 million, or $0.18 per diluted share, for the three months ended March 31, 2022.
Liquidity and Capital Resources
Historically, we have financed our operations through cash provided by operating activities and borrowings on our credit facilities. At March 31, 2023, we maintained approximately $24 million of remaining availability under our revolving credit facility.
We believe that our cash flows from continuing operations, as well as available borrowings under our credit facility are adequate to satisfy our working capital, capital expenditure requirements, and other contractual obligations for the foreseeable future, including at least the next 12 months.
Net cash provided by (used in) operating activities:
During the three months ended March 31, 2023, our operating activities generated $3.5 million of cash. Our net loss, after adjustments for non-cash expenses, generated $4.8 million. We used $2.1 million of cash on our managed working capital, which we define as net accounts receivable, plus inventory, minus accounts payable, minus other current liabilities. Accounts receivable increased $3.2 million and inventory decreased $4.3 million on higher sales. Accounts payable decreased $3.1 million due to the timing of vendor payments. We also generated $0.7 million of cash from our other assets and liabilities.
During the three months ended March 31, 2022, net cash of $4.0 million was used in operating activities. Our net loss, after adjustments for non-cash expenses, generated $3.5 million. We used $5.9 million of cash from managed working capital, which we define as net accounts receivable, plus inventory, minus accounts payable, minus other current liabilities. Accounts receivable increased $7.2 million due to higher sales. Inventory also grew in support of our record backlog and used $7.4 million in cash. An increase in accounts payable provided $7.9 million in cash, partially offsetting the increased inventory and accounts receivable. We also used $0.9 million of cash from other assets and liabilities.
In February 2022, the Company entered into an agreement with the Department of Transportation (“DOT”) under the Aviation Manufacturing Jobs Protection (“AMJP”) Program for a grant of up to $3.6 million, and received the first installment of $1.8 million. The Company expects to receive additional funds from the DOT after upon final confirmation from the DOT of the Company's compliance with the terms of the agreement. The additional amount we will receive was conditioned upon the Company committing to not furlough or lay off a defined group of employees during the six-month period of performance between February 2022 and August 2022. The total estimated grant benefit was recognized over the six-month performance period as a reduction to cost of sales. The $1.8 million portion of the grant that is earned but not yet received is recorded within Other current assets on the Consolidated Balance Sheet as of March 31, 2023.
Net cash used in investing activities:
During the three months ended March 31, 2023, we used $4.5 million of cash for capital expenditures, compared to $2.5 million for the same period in the prior year. Full year 2023 capital spending is expected to approximate $16 million to $18 million.
Net cash provided by financing activities:
Net cash provided by financing activities was $0.5 million for the three months ended March 31, 2023, compared to $6.7 million for the same period in the prior year. The decrease in financing cash inflows was primarily due to stronger operating cash flow, driven by our higher gross margin and lower investments in working capital.
Raw materials
The cost of raw materials represents approximately 40% to 50% of the cost of products sold in the first three months of 2023 and 2022. The major raw materials used in our operations include nickel, molybdenum, vanadium, chrome, iron and carbon scrap. The average price of substantially all our major raw materials, including iron, nickel, molybdenum, vanadium, and chrome, increased in 2022 compared with 2021 and remain at elevated levels compared to historical prices through the first three months of 2023.
We maintain sales price surcharge to mitigate the risk of substantial raw material cost fluctuations. The market values for these raw materials and others continue to fluctuate based on supply and demand, market disruptions and other factors. Over time, our surcharge will effectively offset changes in raw material costs; however, during a period of rising or falling prices the timing will cause variation between reporting periods.
Credit Facility
On March 17, 2021, we entered into the Second Amended and Restated Revolving Credit, Term Loan and Security Agreement (the “Credit Agreement”), with PNC Bank, National Association, as administrative agent and co-collateral agent (the “Agent”), Bank of America, N.A., as co-collateral agent (“Bank of America”), the Lenders (as defined in the Credit Agreement) party thereto from time to time and PNC Capital Markets LLC, as sole lead arranger and sole bookrunner. The Credit Agreement provides for a senior secured revolving credit facility in an aggregate principal amount not to exceed $105.0 million (“Revolving Credit Facility”) and a senior secured term loan facility (“Term Loan”) in the amount of $15.0 million (together with the Revolving Credit Facility, the “Facilities”).
At March 31, 2023, we had total Credit Agreement related net deferred financing costs of approximately $1.3 million. For the three months ended March 31, 2023, we amortized $0.1 million of those deferred financing costs.
The Company was in compliance with all the applicable financial covenants throughout the term of the Credit Agreement and at March 31, 2023.
The Facilities, which expire on March 17, 2026 (the ‘Expiration Date”), are collateralized by a first lien on substantially all of the assets of the company and its subsidiaries, except that no real property is collateral under the Facilities other than Company’s real property in North Jackson, Ohio.
15
Availability under the Credit Agreement is based on eligible accounts receivable and inventory. The Company must maintain undrawn availability under the Credit Agreement of at least $11.0 million. That requirement can be overcome if the Company maintains a fixed charge coverage ratio of not less than 1.10 to 1.0 measured on a rolling two-quarter basis and calculated in accordance with the terms of the Credit Agreement.
The Company is required to pay a commitment fee of 0.25% based on the daily unused portion of the Revolving Credit Facility.
With respect to the Term Loan, the Company pays quarterly installments of the principal of approximately $0.5 million, plus accrued and unpaid interest, on the first day of each fiscal quarter beginning after June 30, 2021. To the extent not previously paid, the Term Loan will become due and payable in full on the Expiration Date.
Amounts outstanding under the Facilities, at the Company’s option, bear interest at either a base rate or the current LIBOR (prior to September 30, 2022) or SOFR (after September 30, 2022) rate plus a spread, in either case calculated in accordance with the terms of the Credit Agreement. Interest under the Credit Agreement is payable monthly. We elected to use the SOFR based rate for the majority of the debt outstanding under the Facilities for the three months ended March 31, 2023, which approximated 7.0% to 7.5% for commitments under our Revolving Credit Facility and was 7.85% for the Term Loan.
Leases
The Company periodically enters into leases in its normal course of business. At March 31, 2023, the leases in effect were primarily related to mobile equipment and other production equipment. The term of our leases is generally 72 months or less, and the leases do not have significant restrictions, covenants, or other nonstandard terms.
Right-of-use assets and lease liabilities are recorded at the present value of minimum lease payments. For our operating leases, the assets are included in Other long-term assets on the consolidated balance sheets and are amortized within operating income over the respective lease terms. The long-term component of the lease liability is included in Other long-term liabilities, net, and the current component is included in Other current liabilities. For our finance leases, the assets are included in Property, plant and equipment, net on the consolidated balance sheets and are depreciated over the respective lease terms which range from three to six years. The long-term component of the lease liability is included in Long-term debt and the current component is included in Current portion of long-term debt.
The Company entered one new financing lease during the first quarter of 2023.